MSN Watch

Next week, Microsoft's seven business divisions will outline their strategy for the upcoming year. Microsoft's 2004 fiscal year started on July 1.

The division to watch, and the one potentially with the most at stake: MSN.

MSN faces crises on two major fronts, both of which put the division's revenue and eventual profitability at risk--at least for the foreseeable future. MSN's more immediate problem comes from subscribers. The company is in a position to lose a large number of subscribers over the next 12 months--that means a loss of revenue from these customers--or conversion of a good chunk of dial-up customers to broadband services, which means less profit from these subscribers.

The problem: Three years ago, PC sales soared to record heights as Internet Service Providers offered instant rebates of up to $400 on new computers. Most rebates required a three-year commitment to the dial-up ISP. Oh, the deals were sweat. Some consumers walked out of Best Buy stores with eMachines PCs for as little as $99; in some cases for a single greenback. But, of course, to get those deals, consumers had to sign up for three years of the ISP service. Most major ISPs offered the rebates, but MSN was particularly aggressive. So aggressive in fact that rebates hurt MSN during Microsoft’s fiscal 2002 second quarter, which ended Dec. 31, 2001. By then, most other ISPs had gotten out of the rebate business. MSN continued through the 2001 holiday quarter, picking up about a half million new subscribers in the process. Best Buy, which offered the MSN rebates on anything in the store, not just PCs, racked up 200,000 subscribers for the ISP. Do the math: That means MSN paid out at least $80 million in rebates for the quarter; MSN revenue was $506 million.

This summer, the leading edge of those rebate subscribers is coming of age, so to speak. They have the option of canceling their existing accounts, and, of course, some may choose to continue with MSN, either as dial-up or broadband customers. To be fair, MSN isn’t alone here. Most major ISPs, including AOL, are facing the same dilemma, which is lose-lose from either perspective. Bolting subscribers obviously mean a decline in revenue coming in. Those that stay but convert to broadband access, a wise move for any home connecting to the Internet, bring in less profit. ISPs generally garner higher margins from dial-up accounts than they do from broadband.

Unfortunately, this subscriber crisis isn't MSN's only big problem. As I have blogged before, Yahoo!’s acquisition of Overture puts MSN in a sticky situation. Doubly so, in fact. Months earlier, Yahoo! acquired Inktomi. The one acquisition provides algorithmic services necessary to indexing sites and, thus, ensuring accurate search results. The Overture buy makes MSN dependent on a major competitor for a large chunk of revenue. That’s because Overture's paid search services account for the majority of MSN revenue growth, as seen in yesterday's fiscal 2003 fourth-quarter results. If either Yahoo! or Microsoft pulls the plug on the Overture spigot, MSN would face a potential revenue crisis.

During yesterday's conference call with financial analysts, John Connors, Microsoft's chief financial officer, warned that subscriber problems would dramatically reduce MSN revenue growth during the first quarter. Take away Overture and matters are much worse.

MSN offers a great range of services, but the division has yet to find its niche to profitability. Microsoft always seems to work best under pressure. Well, it’s building pretty fast, folks.

Posted by Joe Wilcox at July 18, 2003 09:56 AM