Microsoft's Bid for Yahoo!: The Long View

Microsoft’s bid for Yahoo! is something that has been rumored for a long time, but it’s really the first of many more consolidation steps for the computer industry. Every new industry starts with a few crazy innovators, who are followed by thousands of entrepreneurs engaged in a fierce Darwinian competition. Some of those entrepreneurs build large companies, but as the new industry that has been created matured, few of them make it to the finish line.

Almost everything I posited about Web 2.0 I learned by thinking about the lessons of the PC industry that preceded it: the migration of value from one business model to another (see The Open Source Paradigm Shift), the rise of new levers of competitive advantage, and, of course, the inevitable consolidation as the business ecology matures.

Virtually every first generation Web company will eventually be in play, and most of the second generation too. One or two may become the acquiror rather than the acquiree — but even those apparent winners may be swallowed by an even more established company. (Think of Compaq’s acquisition of Digital, followed by HP’s acquisition of Compaq.)

The web companies that have a chance of surviving as independent entities are those that truly understand and exploit the rules of the new platform: harnessing collective intelligence to build rich troves of data that literally get better the more people use the application, running ahead of any possible competitor simply because of the network effects that pile on to keep them improving faster than any newcomer. Some of Yahoo!s properties (e.g. Flickr) have that characteristic, but Yahoo!’s business as a whole did not. It was ultimately a halfway house on the way to Web 2.0. Its original business was based on a literal aggregation of user generated content, but it quickly became a more traditional content and services portal. Later companies like Google leapfrogged it by building services that tapped more directly into the native network effects of the Web.

The other important characteristic of the winners, of course, is that they tap into a data stream that really matters. Owning network effects around consumer photos, for instance, is much less powerful than owning network effects around paid search. So one of the key questions we have to ask ourselves going forward is this: what are the major data subsystems of the future Internet Operating System. Location, identity (and social graph), search (and not just web search but also product search, in which Amazon has a very strong position) come to mind. In a lot of ways, finding the data associated with the old vectors who, what, when, where, and how is a good place to start.

In terms of the historical analogy, it’s really worthwhile to think about any industry as a series of evolutionary layers. In the computer industry, the first layer was hardware. The second layer was software. The third layer is information services and APIs (where we are now.) I can’t really imagine the next layer, but when it comes, it will strike us like an avalanche, starting small but then filling our entire world, just like the previous layers did…

More thoughts as this story develops.