Zenon Molima

Week 8 Topic Paper

BUSN 6120
Thomas Makemson
Webster University
Abstract
 Now our days the internet market can be called an oligopoly which is being dominated by

three gigantic companies to be precise Yahoo, Microsoft and Google. On February 1, 2008,

Microsoft publicly disclosed its takeover bid for Yahoo. The corporation was hoping that

Yahoo's major stockholders would pressure its board to accept the offer. The main reason for the

merger was, according to Microsoft, to be able to compete more effectively with Google in

online advertising on the long-term. The cost of the transaction was to be of at a 62% premium to

Yahoo’s stock closing price on January 31, 2008. Unfortunately, on May 3 of the same year,

Microsoft dropped its $44.6 billion takeover bid, that in turn, Yahoo had rejected on the grounds

that it would have undervalued the company (www.findingdulcinea.com/news).

Microsoft said it dropped the bid, because it would have taken too much time and it was not

worth the cost of the merger. Before the corporation dropped the whole transaction it gave

Yahoo a clear ultimatum to either negotiate an acquisition or prepare for a fight. In a letter to the

Yahoo board, Microsoft CEO Steve Ballmer said his company was tired of waiting for Yahoo to

work out a deal. He also said that if an agreement wasn't made in three weeks, Microsoft would

take its case straight to Yahoo shareholders and launch a proxy battle to elect alternative

directors to Yahoo's board.

Had the talks not faltered, I believe that the U.S. Government should not have allowed a

merger between Microsoft and Yahoo. Through this paper I will support my reasoning by first

presenting the number of events that brought Yahoo and Microsoft to almost merge. In addition I

will explain the several laws that would influence such a merger and how they would apply to it.

I will also discuss the market structure in which the internet search engine sector operates.

Furthermore, I will discuss how the firms’ size, the industry concentration, and the potential for

entry would influence the decision of the Federal Trade Commission and the Antitrust Division
of the U.S. Department of Justice. I will also discuss the benefits or the lack thereof, if such a

merger would have taken place for both companies and the leader in the industry, Google.

The first to explore the search engine sector was Yahoo and became the early market leader.

In April 1994, David Filo and Jerry Yang created the Yahoo Directory. This directory was a

collection of their favorite web pages. With time their number of links grew and they had to

reorganize them in such a way that it would become a searchable directory. What made this

searchable directory different from other previous technologies was the fact that it provided a

human compiled description with each URL. As the Yahoo Directory grew they began to charge

commercial sites for inclusion which started a booming ad business for Yahoo. In 1998

Microsoft launched MSN Search, but the company did not get serious about the search engine

business until after Google tried the business model. Before this, Microsoft primarily relied on

partners like Overture, Looksmart, and Inktomi to power their search service

(www.searchenginehistory.com).

Since then the market in which this two companies have operated has changed with the

arrival of Google. As mentioned before, Yahoo, Microsoft and Google are the biggest players in

the market. Although Yahoo was the first search engine to compete in the big league and gained

a big market share, it has lost a lot of ground against Microsoft and primarily Google. As shown

on Table 1, as of January 2008, Yahoo's market share for Web search in the U.S. was 16.7

percent. At the same time MSN/Windows Live Search was 8.7 percent of the total market. Other

companies in the market and a smaller market share, such as Ask which had a 3.7 percent and

AOL that had a 1.7 percent. Meanwhile the leader of the industry, Google had an overwhelming

68.6 percent market share (blog.compete.com).

 Table 1

As we can see, the percentages speak for themselves. Google ranks number one, Yahoo at

number two and Microsoft comes at number three. This positioning has made Microsoft pretty

worried because its current third place gives them little control over the online searches. This in

turn made Microsoft launch its bid for Yahoo. But in order to be able to do so there were many

obstacles to overcome if the deal would off gone all the way.

One of these obstacles would be a combination of government policies. Antitrust policy is

the name given to government policies designed to keep firms from monopolizing their markets

(Baye 2010). Such policies are the Sherman Antitrust Act of 1890, the Clayton Act of 1914, the

Robinson-Patman Act of 1936, the Cellar-Kefauver Act of 1950 and the Hart-Scott-Rodino

Antitrust Improvement Act of 1976. Now our days, these laws cannot influence a merger by

themselves. However, been in succeeding combination they regulate what corporations can and

cannot do in regards to merger activities.

The first policy of this kind to be conceived was the Sherman Antitrust Act of 1890. Sections

1 and 2 of this act make up the core of the U.S. antitrust policy. Primarily, the Sherman Act

makes it illegal for manager of U.S. firms to join together with other firms either domestic or

foreign. The law is interpreted by the courts and is considered ambiguous (Baye 2010).

The Clayton Act of 1914 is an amendment that provides clarification and substance to the

Sherman Antitrust Act of 1890. This Act provides barriers to a large range of anti-
competitiveness issues. Topics such as price discrimination, price fixing and unfair business

practices are addressed in this Act. They are enforced by the Federal Trade Commission and the

Antitrust Division of the U.S. Department of Justice (www.answers.com)

The Robinson-Patman Act amended Section 2 of the Clayton Act. This Act prohibits a seller

of commodities from selling comparable goods to different buyers at different prices, except in

certain circumstances (legal-dictionary.thefreedictionary.com).

The Cellar-Kefauver Act of 1950, often called the Antimerger Act, is an antitrust law that

closed a major loophole within the Clayton Act. The loophole was that even as the Clayton Act

prohibited mergers, it allowed companies to buy individual assets from their competitors. Some

of these companies began doing this more and more to the point that it reduced competition

among companies. This allowed these companies to effectively sideline the Clayton Act. The

Celler-Kefauver Act closed this loophole and gave the government the power to stop vertical

mergers and asset acquisitions that were considered a threat that in turn would reduce

competition. The Hart-Scott-Rodino Antitrust Improvement Act of 1976 established the federal

premerger notification program. This program provides the FTC and the Department of Justice

with the information regarding large mergers and acquisitions before they occur. (www.ftc.gov).

Based on these laws the FTC and the Antitrust Division of the U.S. Department of Justice

determined that they needed more information in order to give a decision on the merger request

made by Microsoft. These laws prohibit the occurrence of mergers that may hinder the

competition in an industry. This particular merger was not the exemption to the rule. Knowing

this, Yahoo CEO Carol Bartz and Microsoft CEO Steve Ballmer, were very careful when

announcing that they were initiating talks of a merger. They claimed that this merger would not

hinder the search engine market, but that instead it would enhance it. Furthermore, they claimed
that by joining forces, the two companies would be able to become a stronger competitor to

Google and thus create more competition which ultimately would benefit the consumers

(www.heartland.org).

That was a smart move by the CEOs. Unfortunately for them the FTC and the Antitrust

Division of the U.S. Department of Justice do not make their decisions exclusively based on

these policies. They also take into consideration the market structure of the industry in question,

the size of the firms that would be involved in the merger, the industry concentration, the

potential for entry and how all these together would affect competition.

As mentioned before the search engine market operates in an oligopoly in which there are

many firms but only about five have the biggest market shares. Before making a decision the

FTC and the Antitrust Division of the USDOJ, will look into the size of the firms that would be

involved in the merger. Microsoft represents about 16.7 percent of the market while Yahoo

represented about 8.7 percent. If allowed to merged, they would come to represent about 25.4

percent of the total market. While this market share is dwarfed by Google’s market share of 68.6

percent, still it would mean that in the internet search engine industry, the two biggest firms

would be controlling about 94 percent of the whole market. I do not see how this would help

increase competition in an industry controlled by two huge firms literally by creating a duopoly.

The United States government classifies markets based on degrees of competitiveness. The

classification ranges from competitive, moderately concentrated to concentrated. These agencies

use some key indexes to determine a proper classification for the market a company operates in.

One such index would be the Herfindal – Hirschman Index (HHI). The data given by the HHI is

used to determine if a proposed merger might be anti-competitive (tynerblain.com).

 The US government uses a range of values based in the HHI to classify markets as mentioned

before. Markets in which the HHI is between 1000 and 1800 points are considered to be

moderately concentrated. Those markets in which the HHI is surpasses 1800 points are

considered to be concentrated (www.justice.gov). If combining the market share of two or more

companies results in an increase in the HHI calculation for a market of more than 100 points,

then the move will raise anti-trust concerns.

After calculating the HHI for the search engine market, based on the market shares presented

on Table 1, I was able to come up with a HHI of 5077 points. This means that the search engine

market is concentrated. After adding the two market shares of Microsoft and Yahoo I

recalculated the HHI. I was able to determine that the new HHI would be 5368 points, which

would mean an increase of 291 points. Is no wonder that when the deal was announced anti-trust

concerns were aroused.

Aside from these anti-trust concerns, if this merger was to be executed there would be

benefits for some and detriments for others. The greater benefits would be for Microsoft. The

biggest benefit would be that Microsoft would be that it automatically becomes the number two

search provider. Another benefit would be that Microsoft would be able extend its data center

infrastructure. A third benefit would be that Microsoft would gain very valuable search and

advertising assets, as well as new customers and credibility.

The disadvantages would be that Microsoft would have to deal with different negative factors

brought by the merger. One such factor would be the product overlap. Since Microsoft and

Yahoo offer the same services like mail and messaging, they would have to come up with some

type of arrangement to see what to keep. Another negative factor would be branding conflict.

Microsoft would probably keep some of the most popular brands like Flickr and Yahoo Music,
but many other brands that would cause customer overlap, are a different story. Data center

integration would mean that Microsoft would need to come up with a strategy in order to be able

to combine the infrastructure which is made more difficult by the fact that both companies use

different software (Wilcox 2008).

As in the case for Microsoft, there would be benefits for Yahoo. One such benefit would be

that it would strengthen the company by the combination of market shares making it more

competitive. Another benefit would be that of the stakeholders due to a rise in price of Yahoo

shares. Yahoo would also benefit of Microsoft's main strength which is its product development

capability.

As in the case of Microsoft some disadvantages would be the product overlap, branding

conflict, and data center integration problems. But in addition to these problems Yahoo would be

facing another more inclusive problem. This problem would be the cultural conflict caused by a

merger. Microsoft and Yahoo have different corporate cultures. Yahoo's corporate culture is very

Silicon Valley, and at the same time is very independent. As any other company that faces a

hostile takeover, Yahoo's board and many employees probably won't be very happy with the

transaction. This merger would probably add more animosity in regards to cultural and

operational differences between the companies (Wilcox 2008). All of these negative factors

make a merger less beneficial f or Yahoo.

On the side of the biggest competitor, Google, such a merger would mean a headache. The

reason for this is that after the transaction was completed it would find its two closest and bigger

competitors working together not only with a bigger economic power but also with lot more

operational efficiency (Kumar 2008). Other smaller firms also would be affected negatively due

to the fact that now instead of three firms competing against each other and pulling costumers
away from each other, now there would be only two cats in the prowl and will get the entire

market share they can by using the huge capabilities.

Even if the talks gave fruit to a Microsoft/Yahoo merger I think that the U.S. government

should not allow such a merger. Regardless of what the companies say the merger would not

create more competition among the search engine providers. The detriments outweigh the

benefits. Because of the way the policies are written it would be very hard for the companies to

go past the Federal Trade Commission and the Antitrust Division of the U.S. Department of

Justice. The merger would clearly affect competition due to the fact that the HHI increase from

before to the aftermath of the merger would be greater than 100 points.

Furthermore, the merger would further monopolize the market by creating a duopoly in

which two companies, Google and Microsoft/Yahoo, would control about 94 percent of the

market. Although this merger could create a new field for innovation, it does not sound to me

like it would create a good environment for any other company. In addition, these two companies

would become the main suppliers of search engine services, what would happen if one of them

happens to fail? Although we do not pay for these services we depend on them for many things,

and they have become a part of life. Could these companies become too big to fail? I think yes

they could.
 References

Kumar, V. (2008). Microsoft/Yahoo! Merger Would Benefit Both Companies

Retrieved from: http://seekingalpha.com/article/63565-microsoft-yahoo-merger-would-benefit-
both-companies

Mills, E. (2008). Google U.S. search market share up, Yahoo down
Retrieved from: http://news.cnet.com/8301-10784_3-9903672-7.html#ixzz1EdGIVlqL

Szustek, A. (2008). Microsoft-Yahoo Merger Crashes

Retrieved from: http://www.findingdulcinea.com/news/business/May-June-08/Microsoft-Yahoo-
Merger-Crashes.html

Wall, A. Search Engine History

Retrieved from: (http://www.searchenginehistory.com/)

Wilcox, J. (2008). News Commentary. How a Yahoo Merger Could Screw Up Microsoft
Retrieved from: http://www.microsoft-
watch.com/content/corporate/how_a_yahoo_merger_could_screw_up_microsoft.html

Clayton Antitrust Act definition (2011).

Retrieved from: http://www.answers.com/topic/clayton-antitrust-act#ixzz1EdT70ajf

Robinson-Patman Act definition (2011).

Retrieved from: http://legal-dictionary.thefreedictionary.com/Robinson-Patman+Act

Celler-Kefauver Antimerger Act definition (2011).

Retrieved from: http://financial-dictionary.thefreedictionary.com/Celler-
Kefauver+Antimerger+Act

Hart-Scott-Rodino Act definition (2011).

Retrieved from: http://www.ftc.gov/bc/hsr/

Sehlhorst, S. (2009). Measuring Market Concentration (Competition)

Retrieved from: http://tynerblain.com/blog/2009/04/13/measure-market-concentration/

Crane, J. (2008). January 2008 Search Market Share: Google Who?

Retrieved from: http://blog.compete.com/2008/02/08/search-market-share-january-yahoo-
microsoft-google-ask-aol-msn-live/

Domenech, B. (2009). Microsoft-Yahoo Search Deal Drawing Antitrust Scrutiny.

The Heartland Institute. Retrieved from: http://www.heartland.org/full/25947/MicrosoftYahoo_
Search_Deal_Drawing_Antitrust_Scrutiny.html

The Herfindahl-Hirschman Index (2011)

Retrieved from: http://www.justice.gov/atr/public/testimony/hhi.htm