In a new mission statement sent to Microsoft (NASDAQ:MSFT) employees, CEO Satya Nadella stated that Microsoft must "innovate in new areas" and "make some tough choices in areas where things are not working". That's probably why the company recently handed over its display ad business to AOL and sold its mapping technologies to Uber.
AOL is a minor player in display advertising today, but its new parent company Verizon (NYSE:VZ) plans to grow that business. As part of the deal, AOL will sell display ads in Skype, Outlook, MSN, Xbox, and other apps, and switch its default search engine from Google (NASDAQ:GOOG) (NASDAQ:GOOGL) to Bing. However, Microsoft will retain the search ad business.
Meanwhile, Uber's back-end is currently powered by Google Maps, so acquiring its own mapping technology could help it reduce its dependence on the search giant.
Why Microsoft doesn't need display ads or maps
Microsoft's display ads and maps have always been overshadowed by Google's comparable services. But unlike Google, Microsoft doesn't depend on advertising or tracking user movements to generate most of its revenue.
Microsoft's online ad revenue is expected to rise 18.5% annually this year to $3.45 billion, according to research firm eMarketer. However, that's a big slowdown from 48.7% annual growth in 2013 and 33.3% growth in 2013.
Even if Microsoft's total ad revenue hits eMarketer's forecast this year, it would represent less than 4% of its projected companywide revenue for fiscal 2015. Moreover, eMarketer expects Microsoft's share of the U.S. display ad market to drop from 3.9% to 1.7% between 2013 and 2015.
As for Bing Maps, Microsoft will stop gathering first-party mapping data like Google and continue using licensed data from Nokia and other partners. Microsoft will sell most of its in-house mapping technology to Uber, which will offer jobs to 100 Microsoft employees and buy its data center in Colorado. This means that Microsoft will spend less money on mapping streets while still generating revenue from API licensing to companies like Facebook.
Downsizing those two businesses is a smart move, because neither one plays a crucial role in the growth of Microsoft's cloud business, which consists of Office 365, Dynamics CRM, and Azure. Between the fourth quarter of FY14 and the third quarter of FY15, Microsoft's cloud business' annual revenue run rate rose 43% from $4.4 billion to $6.3 billion.
If that run rate hits $7 billion by the end of fiscal 2015 and keeps growing over 40% annually, Microsoft might achieve Nadella's ambitious goal of hitting a $20 billion cloud revenue run rate by 2018.
What does this mean for everyone else?
When Verizon bought AOL for $4.4 billion last month, it declared its intentions to diversify into display ads. However, eMarketer estimates that AOL controls just 3.5% of the U.S. digital display ad market. With Microsoft's ads included, AOL's U.S. display ad share rises to 5.2%, compared to Facebook and Google's respective shares of 25% and 13%. By combining Microsoft and AOL resources, Verizon can also offer marketers better ad bundles that straddle both companies' networks.
Meanwhile, Uber's investment in Microsoft mapping tech puts Google in an awkward position. Google is one of Uber's top investors, but both companies realize that they're headed into a war regarding driverless vehicles. Google, which directly integrated Uber into Maps last year, reportedly wants to turn its driverless vehicles into autonomous taxis that can be hailed with an app. Uber has the same vision for the future.
Therefore, if Uber doesn't want to become completely dependent on Google's Maps and driverless technology, it needs its own mapping technology. However, matching Google's mapping muscle will be an expensive endeavor.
Well played, Microsoft
Microsoft knows that it can't go toe-to-toe against Google or Facebook in display ads, so it's wisely handing those businesses off to companies that can dedicate more time and money to their growth.
In my opinion, that's a win-win-win situation for all three companies involved. Microsoft can focus more on its operating systems, productivity software, and cloud services. Verizon can expand AOL's display ad inventory and generate more revenue, while Uber will take a few baby steps toward declaring independence from Google.