Microsoft's Yahoo bid is over, but the aftermath might prove just as interesting. And it looks like Google could play a significant role.

During its tussle with Microsoft, Yahoo tested a search-related advertising alliance with Google in an attempt to boost its profits and fend off Microsoft's unsolicited offer. Under the arrangement, ads from Google's lucrative system were delivered alongside Yahoo search results.

Microsoft, itself no stranger to antitrust problems, objected to even the hint of a more permanent deal -- saying that such an agreement would "consolidate over 90% of the search advertising market in Google's hands," and adding that it would assess its options closely.

The test has since ended, but a longer-term Google-Yahoo partnership remains a possibility, even after Microsoft dropped its bid. Speaking with reporters today prior to Google's annual meeting, the company's executives defended the possible partnership. According to this CNet News.com post, Google co-founder Sergey Brin suggested that those with antitrust objections weren't defining the market broadly enough: "You are narrowly focused on search advertising," he said. "Advertising as a whole is much broader, and Internet advertising is much broader."

Is that how antitrust regulators would see it? Microsoft might take solace in this passage from the Federal Trade Commission's approval of Google's DoubleClick deal (PDF, 13 pages, emphasis added below):

It has been suggested that the transaction would eliminate competition between Google and DoubleClick in an "all online advertising" market that would include search advertising, ads sold through intermediaries, and directly sold ad inventory. The evidence, however, indicates that all online advertising does not constitute a relevant antitrust market. Advertisers purchase different types of ad inventory for different purposes, and one type does not significantly constrain the pricing of another. For instance, advertisers primarily purchase search advertising space to implement direct response ad campaigns, while directly sold ad inventory is generally purchased for brand advertising campaigns.

The FTC pointed out that Google is "the dominant provider of sponsored search advertising," and it concluded its DoubleClick ruling with a cautionary note: "We want to be clear ... that we will closely watch these markets and, should Google engage in unlawful tying or other anticompetitive conduct, the Commission intends to act quickly."

However, Google and Yahoo have reportedly been thinking about addressing antitrust concerns by creating a non-exclusive, auction-style setup that would let other advertising platforms, including Microsoft's system, compete to put ads next to Yahoo search results, too.

From the coverage out of Mountain View today, it appears that Google's executives didn't talk explicitly about that possibility. However, the Associated Press quotes Google CEO Eric Schmidt saying, "If there were a deal (with Yahoo), we would anticipate structuring the deal to address the antitrust concerns that have been widely discussed."

Microsoft declined to comment today beyond the company's previous statements on the subject. But this probably won't be the last we hear about this issue. CNet's report quotes an anonymous source saying that an announcement is expected next week.

Executives at MySpace parent company News Corp. apparently have a more nuanced understanding of differences in the terms "conversations," "discussions," and "talks" than the average person does. Or maybe they don't. At any rate, the bottom line is that a Microsoft-MySpace deal doesn't look likely right now, at least not based on comments made during News Corp.'s conference call yesterday afternoon. Here's an excerpt:

Q: There's been reports that talks with Yahoo have cooled ... Can we read that there are no more discussions with Yahoo?

Peter Chernin, News Corp. president and chief operating officer: I think saying talks have cooled probably overstates them. We have regular conversations with everyone in the space. I'm not sure I would ever characterize them as talks. The important thing is to reiterate what I said, which is that we will always look at strategic options, but we feel very comfortable with our current positioning.

Q: Have there been any discussions with Microsoft at this point, since they've disengaged from the Yahoo talks.

Chernin: We're not in discussions with Microsoft. We talk with everybody in the space, but there are no discussions with Microsoft. ...

Q: What's your level of interest in deals with Microsoft or Yahoo or with AOL, for that matter?

Chernin: I don't think we have any level of interest. I think that we would respond accordingly to any propositions that we thought did or didn't make sense to us. But we're not sort of sitting around saying, you know, this is of interest to us or not of interest to us. We're prepared to have any strategic conversation that we think does or doesn't make sense.

Q: Does that mean that, as with Microsoft, there's no discussions ongoing with Yahoo or AOL?

Chernin: I have not had a conversation with Yahoo or AOL in a couple weeks.

Rupert Murdoch, chairman and chief executive: Nor have I.

Chernin: So I would say no, there are no ongoing discussions.

As the dust settles from Microsoft's thwarted Yahoo acquisition bid, there's lots of speculation about which company or companies Microsoft should try to buy next. Facebook? Digg? Time Warner's AOL, perhaps? Or maybe Microsoft should go it alone and focus on organic growth. Bill Gates is being criticized for delivering mixed messages on the issue -- saying yesterday that the company wasn't ruling out partnerships, and today that it would stay focused on its independent strategy.

So here's a chance to weigh in on the question: After the withdrawal of its Yahoo bid, what should Microsoft pursue next? Our options: AOL; Digg; Facebook; LinkedIn; MySpace; Twitter; Yahoo (again); other; or none of the above, focus solely on internal development. If you choose "other," feel free to post the name of your pick in the comments below.

Click here to vote and see the results.

P.S.: Maybe the results of this poll shouldn't be taken too lightly: Our poll last week asked what Microsoft should do in its Yahoo bid, and the largest number of respondents favored walking away from the deal.

This unsolicited piece is by Michael G. McDonald of Atlanta, a retired advertising executive and a Microsoft shareholder since 2000, the year Steve Ballmer became CEO. His opinion is his own. It caught my attention because it reflects, in clear terms, a general sentiment that other shareholders sometimes express in e-mails and phone calls. For Microsoft's perspective, I'm also including excerpts from Bill Gates' comments on Fox Business this week, and Ballmer's remarks during Microsoft's 2007 annual meeting. -- TB

By Michael G. McDonald

The attempted takeover of Yahoo by Microsoft is the crowning blow of the Ballmer era. His willingness to spend the entire treasury of over $40 billion of Microsoft for an unworthy and unwilling acquisition, clearly demonstrates his lack of judgment and leadership. The litany of the wrong-headed strategies and tactics employed by the team of Gates and Ballmer and recently, (Ray) Ozzie, is fodder for a case history entitled: "Microsoft - A Decade of Gross Corporate Negligence and Destroyed Shareholder Value."

If there were a wrong path to take, this group was sure to take it. And they did. From WebTV to MSN to MSNBC to .Net to EU to Xbox to Zune to aQuantive to the fortuitously botched Yahoo attempt, and the love-child, Windows Vista. These are but a few of the paths poorly chosen and poorly trodden. Tens of billions of dollars squandered while tens of billions of incremental revenues and profits were unrealized.

At its software core, Microsoft is the world's biggest profit-making enterprise. Instead of focusing on the infinite opportunities of its core domain, under Ballmer et al, Microsoft has frittered away its golden birth right in a greedy grab for fool's gold beyond its innate core competence. Instead of competing from a position of strength and competence, Ballmer has chosen to attempt to compete from a position of weakness and incompetence. In the process of this misguided trip Microsoft has even compromised its basic DNA with the Vista debacle. These are but a few reasons why the MSFT stock that I purchased at $36 (adjusted for split) is now worth less than $30 per share, seven and a half years later. Under prudent, shrewd management, a bright, golden goose such as MSFT could be selling well north of $100 per share by now.

It is time for the long-term institutional and individual MSFT investors to take a proactive and confrontational stand vis a vis the management and board of Microsoft.

The board is weak. The management is flawed. A revolution is needed and it starts with toppling the top. Microsoft needs a modern day (Lou) Gerstner (IBM's former chief executive) … perhaps the old model would be available?

The mandate is to restore the brand's luster and to unlock shareholder value.

After seven lean years, the Bible indicates that seven fat years follow. With Ballmer out and a true business leader in, this hope can come true. Let the revolution begin.

Fox Business Network had an extensive on-air interview yesterday with Berkshire Hathaway's Warren Buffett and Microsoft's Bill Gates, Buffett's friend and a Berkshire board member. They covered a range of topics, and given the timing, Microsoft's decision to walk away from the Yahoo acquisition bid naturally came up. Here are extended excerpts from the relevant parts of the discussion, reprinted with permission of Fox Business.

LIZ CLAMAN: Speaking of deals, this guy here is sitting on a day when Microsoft walked away from the Yahoo! deal. Is that it? Or is that a negotiating tactic?

GATES: Well, we -- Steve Ballmer, the CEO, announced on Saturday in his letter that we had walked away and we were pursuing an independent strategy. And so that's where the focus is. And, you know, obviously we have a strong competitor in that category, and so we need to do breakthrough software.

CLAMAN: If you were advising him, would you say do that deal?

BUFFETT: I would not presume to advise Bill in that game. That's his game.

CLAMAN: But you have often said that sometimes two behemoths envision that combining themselves would be a great thing, but that often one plus one doesn't equal two, it kind of ends up being one and a half.

BUFFETT: Yes, but with Steve and with Bill, they're going to analyze it properly. And there's a point in which you walk in deals. I've walked in deals, and sometimes they come back later on, sometimes they don't. But, you know, you can't want something at any price. You will do a lot of silly things if you come in with that approach.

CLAMAN: And a lot of people think that you actually gave a very fair price. So if the opportunity arose again, would you welcome Yahoo!?

GATES: Well, that's not the focus. We spent time with them, and we're going to start to make some investments that are based on the great work our people are doing in gaining share organically.

CLAMAN: Well, today your stock is up. And you kind of -- a lot of people are saying you need to get it up higher because he knocked you out of the Forbes 400 richest men on the planet list.

BUFFETT: They may not even be counting accurately. I wouldn't bet on that.

(LAUGHTER)

CLAMAN: Do you think he's wealthier than you?

BUFFETT: Oh, he probably is, yes.

CLAMAN: Just because of all the added things that don't get picked up in the Forbes list.

BUFFETT: That's right. I mean, just look at the house.

(LAUGHTER)

GATES: Warren has saved a lot in the house category.

BUFFETT: I left a -- when he visited one time, on his bed I found a book on a garage sale -- how to build your dream house for, what, $3,500 was it, or something like that? But it was a little too late.

CLAMAN: Just a little too late.

You know, you're in an interesting position, Mr. Gates, that you sit on this board with Sue Decker, the president of Yahoo! Was there any tension over the weekend? You guys talked together, or were you both very busy on the phone dealing with the situation?

GATES: I like Sue. You know, she's -- we have a great board. All the board members are super. Sue and I didn't talk about the deal because Steve Ballmer and Jerry Yang were handling that, and so I was able to focus on my Berkshire activities.

BUFFETT: I watched them at dinner last night. Believe me, when Bill said, "Pass the salt," Sue just got it over there right away.

Earlier in the discussion, Claman was talking with Buffett when the subject of hostile takeovers came up. Yahoo wasn't mentioned directly, but Buffett's remarks were particularly interesting in light of Microsoft's decision.

CLAMAN: This was the third year out of 10 where you made a big deal the week of the shareholder meeting. This year it was Wrigley. I believe a year or two ago it was Iscar.

BUFFETT: Right.

CLAMAN: ... Is this now your modus operandi, where you land the big fish to feed to the masses who come to see you?

BUFFETT: I love to do it, but it's been accident obviously, because deals happen at Berkshire when the other person initiates something. I had no idea about Mars and Wrigley a few weeks ago, so I hope I can come up with something, but I will take them any time.

CLAMAN: You never launch a hostile takeover, anything like that?

BUFFETT: No. No.

CLAMAN: Why not?

BUFFETT: Well, it's just not my way of -- I want people that want to join us, and I want managers that are enthused once they get here. We're going to keep the management in place that comes with the deal, and we're not equipped to take over something and raid a castle and then bring in our own troops afterwards or anything like that. So...

CLAMAN: You don't do that.

BUFFETT: We'll never have an unfriendly deal.

Microsoft said late Monday that it has struck a deal with Hyundai-Kia Automotive Group to develop new automotive "infotainment" systems.

The company said the first product to result from the partnership will be introduced in North America in 2010, focusing on voice control of mobile devices inside the car. The companies say they also plan to expand into Asian and European markets, adding support for multimedia and navigation devices.

Microsoft already has an arrangement with Ford Motor Co. to offer its Microsoft Auto system in North America under the Sync brand name. Fiat Auto Group also uses Microsoft's technology in Europe and South America.

Bill Gates, Microsoft's chairman, was expected to announce the latest partnership Tuesday in Seoul, South Korea, along with Mongku Chung, Hyundai-Kia Automotive Group's chairman.

Confirming the rumors, Microsoft says it will start selling downloadable television shows for its Zune device -- including selected programs from NBC, the network that split from market leader Apple.

The move comes more than two years after Apple introduced television shows and movies for its dominant iTunes store and iPod -- reflecting Zune's latecomer status. Microsoft launched the device in late 2006, after devices from its hardware partners struggled to gain any significant traction against Apple's iPod.

Microsoft says its Zune online store will add television shows starting Tuesday, offering about 800 episodes initially. The episodes will cost the equivalent of $1.99 in Microsoft "points." The company requires consumers to first buy points that they can apply to online purchases.

NBC had been a significant provider of content to Apple's iTunes store, which works in conjunction with the iPod, but the companies split last year after a disagreement over pricing. Microsoft said it will offer shows including NBC programs "The Office," "Heroes," and "30 Rock."

Other TV shows to be available for the Zune will include Comedy Central's "South Park," the SciFi Channel's "Battlestar Galatica,"and VH1's "Rock of Love with Bret Michaels."
Zune devices had already been capable of playing video, including video podcasts and music videos, but the Zune online store has until now concentrated largely on music.

"This is a first step into the (television) market for us," said Jason Reindorp, Zune product marketing director, explaining Microsoft's decision to launch with a selected library of shows. Microsoft "will be adding to that significantly over time," he said.

Separately, Microsoft already sells TV shows and movies for download and viewing on its Xbox 360 video-game consoles. Reindorp said shows to be available through the Zune store won't be able to be played directly on any other device but a Zune or a PC, although a Zune can connect to a TV or an Xbox 360 to stream content for viewing.

In interviews with Bloomberg News and Reuters today, Yahoo Chief Executive Jerry Yang said he wasn't necessarily closing the door on further talks with Microsoft. The comments came as Yahoo's shares closed down more than 14 percent today following Microsoft's announcement Saturday that it was withdrawing its acquisition bid.

"We were negotiating a way to find common ground and then on Saturday they chose to walk away," Yang told Reuters. "They started it and they walked away." He added: "If they have anything new to say, we would be open ... I am more than willing to listen."

In his Saturday letter withdrawing the bid, Microsoft CEO Steve Ballmer cited the premium represented by Microsoft's original $31-per-share offer, the company's willingness to raise the bid to $33 per share, and wrote that he was "disappointed that Yahoo! has not moved towards accepting" the offer. Yahoo ultimately sought $37 per share.

In a post on the Yahoo blog Sunday, Yang sought to dispel the notion that Yahoo didn't take the Microsoft offer seriously enough.

Frankly, there's a lot of nonsense and misinformation in what's being reported. Just so we are all clear, here's what happened. The board took its mission very seriously. We clearly indicated to Microsoft that we were open to a transaction but only if it were on terms that fully recognized the value of Yahoo! and was in the best interests of our stockholders.

No one is celebrating about the outcome of these past three months… and no one should. We live and work in a competitive world and the Web is only going to get more competitive. Executing on our strategic plan is what matters most.

Microsoft shares closed down 16 cents today, at $29.08.

Someone at Microsoft is either a taskmaster or a comedian. Via an anonymous tipster, and confirmed with someone else inside the company, this is what employees see when they type facebook -- without the www or the .com -- into the IE address bar from inside the Microsoft firewall.

And so the aftermath begins: Yahoo's shares are down 16 percent in early trading today, to about $24, following Microsoft's decision to withdraw its bid to acquire the company. (Microsoft ultimately offered $33 a share; Yahoo's board wanted $37.) Microsoft shares are up 2 percent, to about $29.85.

So what did the saga of the past three months do for Microsoft and Yahoo in the eyes of the stock market? While broader market trends also come into play, it's worth looking back to where each company stood just prior to Microsoft's Feb. 1 announcement of its unsolicited offer. Microsoft was trading up around $32.60 on Jan. 31. Yahoo was down around $19.18.

The big question now is what each company will do next, and how each business will fare on its own. See this story from today's paper for an assessment of Microsoft's potential moves. And here's the San Francisco Chronicle's take on Yahoo's post-Microsoft prospects.

Analysts are dissecting the news in notes to clients this morning. Highlights:

Sid Parakh, McAdams Wright Ragen:

While "questions on how Microsoft will grow its Online business will now return, Microsoft may be able to justify added investments in the Online business without much opposition from shareholders after having stopped short of investing ~$50 billion for Yahoo!. Investments will be across multiple fronts – product development, marketing, etc. Microsoft has continually indicated its willingness to make significant investments in this business."

Brent Thill, Citigroup:

The Good -- MSFT investors will breathe a sigh of relief in the near-term for three reasons; 1) integration would have been a considerable distraction, 2) MSFT showed price discipline by holding firm at $33 which sets a strong precedent for future M&A, and 3) the deal would have likely been dilutive near term and MSFT can now use part of the $48bn for other acqs./buybacks.

The Bad -- Full Circle Back to #3 Player - MSFT's Internet strategy is hampered by its #3 status in search (which reflects its lack of brand equity) and limited ad inventory. While some have questioned whether MSFT should even be in the Internet business given it is out of its core competency, we believe it is essential that MSFT fixes its Online strategy as the future is shifting towards cloud computing.

Jeffrey Lindsay and Charles Di Bona, Sanford C. Bernstein & Co.:

While we expect some recovery in MSFT's stock, a full recovery seems unlikely until MSFT articulates a substantive, credible and new online strategy. We believe simply returning to the original, pre-YHOO strategy is likely insufficiently credible.

After an initial drop, the direction of YHOO's share price depends on how quickly the company indicates deals with GOOG and/or AOL. If there is a deal, YHOO's stock could recover; without one, investor confidence will likely continue to suffer.

After one of the shortest meetings in its history, our research staff has come to the unanimous conclusion that the events of the past weekend necessitate an adjustment in the Steve Ballmer Mood Index -- our finely tuned, highly scientific method of monitoring developments in the Microsoft-Yahoo saga. Here's the new setting, along with the standing key.

Understanding the Steve Ballmer Mood Index (SBMI)

Frustrated: May or may not include chair-throwing, depending on whom you believe.

Intense: Characterized by repetition of words for emphasis. ("... very, very, very, very well.")

All Business: Not taking "no" -- or "not enough" -- for an answer.

Victorious: Characterized by much fist-pumping and whooping.

Monkey Boy: State of extreme enthusiasm, with even more repetition of words. Sometimes accompanied by dancing.

Microsoft has reduced its legendary cash balance by tens of billions of dollars in recent years through a series of buybacks, dividends and acquisitions. The importance of cash was evident in the Microsoft-Yahoo saga: Had the Redmond company succeeded in the proposed $44.6 billion acquisition, it would have needed to borrow money for the first time in its history to fund the deal.

Apple, meanwhile, has seen its cash balance soar over the same time period, closing the gap with its longtime rival.

I explored the two trends in this story in Monday's newspaper. For purposes of comparison, I also spent time last week digging through the financial statements of other selected technology companies. Here's the chart we put together to reflect all that data. Google is No. 3 No. 4 on the list, with $12.1 billion in cash and marketable securities. That's up from $2.1 billion in 2004.

Correction, 10 a.m.: Cisco's total on the graphic below should be $22.7 billion. I mistakenly didn't include securities investments that should have been counted for purposes of this comparison. We're in the process of correcting the graphic now. Apologies for the error, and thanks to the reader who brought it to my attention.

Update, 10:25 a.m.: The corrected graphic is below.

Now that Microsoft has withdrawn its bid for Yahoo, new details are emerging about the behind-the-scenes discussions between the companies. Here's a timeline of what happened, based on information from a person with knowledge of how things unfolded. For context, I've also included the milestones that were already publicly known.

Jan. 31: Microsoft CEO Steve Ballmer calls Yahoo CEO Jerry Yang to inform him that Microsoft will make an unsolicited offer for the Internet company.

Feb. 1: Microsoft goes public with acquisition bid of $31 per share, or $44.6 billion.

Feb. 11: Yahoo turns down the offer, saying it "substantially undervalues" the company.

April 5: Ballmer gives Yahoo a three-week deadline for coming to terms. Following that letter, Microsoft starts exploring other alternatives, as well, including its own discussions with AOL and News Corp.

April 15: Senior Microsoft and Yahoo executives meet in Portland, Ore., during a session also attended by Yahoo's bankers. They discuss issues including potential cultural challenges that would come up in the integration of the two companies. Yahoo gives a presentation about its financial prospects. Microsoft asks Yahoo to name a price for the company. Yahoo declines. The two sides agree that, until at least April 26, neither will publicly disclose the fact that they have met, although either can terminate the agreement after that point.

April 18: In a phone call involving Microsoft and Yahoo bankers, Yahoo tells Microsoft that it will take at least $40 per share to strike an amicable deal.

April 26: The three-week deadline passes.

April 29 (last Tuesday): In phone conversations, Yang and Yahoo Chairman Roy Bostock indicate to Ballmer that a deal below $40 per share could be possible. Alternatively, they suggest that the companies might work out some sort of search-related alliance.

April 30 (last Wednesday): The companies meet in the Bay Area. Those in attendance include Ballmer, Microsoft Platforms and Services President Kevin Johnson, and their Yahoo counterparts. Yang names a price of $38 per share.

Saturday: Yang and Yahoo co-founder David Filo fly to Seattle and meet with Ballmer and Johnson at the airport. By this point, Microsoft has indicated that it's willing to raise its offer to $33 per share. (The value of the original cash-and-stock offer had slipped below $30, based on a decline in Microsoft's share price following the announcement.)

Yang and Filo say the Yahoo board would be amenable to a price of $37 a share. They fly back to California. After they arrive home, Ballmer calls Yang to say that Microsoft is walking away from its offer. Saturday evening, Microsoft announces its decision.

One outside expert in a unique position to assess Microsoft's prospects, following the withdrawal of its Yahoo bid, is Michael Cusumano, a professor at MIT's Sloan School of Management who has studied the company for years and written books on Microsoft and the software industry. Here are excerpts from a phone interview I had with him today.

Q: What are Microsoft's options at this point, if it wants to build the scale -- the volume of users -- that it needs to compete with Google in the advertising market?

Cusumano: Well, most Web entry is through search, and they've got to come up with a better search algorithm. If they can't do that, I think they just need to maybe leverage their applications. If they had a site offering Office over the Web, people would certainly go to that. In other words, other services, as compared to traditional search. Office Live, other applications, host files -- some of the things they've been doing, but that's about all I can think of. [Microsoft offers file-sharing and collaboration online but doesn't yet offer full-fledged, Web-based Office document creation and editing.]

Q: Are there other prospective acquisitions out there? MySpace, Facebook ...

Cusumano: Well, there's always new ones coming up. I guess that's another alternative. There's lots of startups in the social networking space. ... Ninety percent of those, maybe even 95 percent of those will collapse, never get anywhere. It's possible they could try to roll up some of those startups and try to make something of them. ... A lot of this is just a waste of money. They're trying to figure out, how could they waste more money. That's why, I had suggested a while back (they should) buy other software companies. The software industry is generally depressed. There's lots of product companies out there, even video-game companies. There's still a lot of money in the software business, if you can buy these assets cheaply.

I think they can still get some advertising from some sites where they deliver their software as a Web service. Lots of people still use Hotmail, and they can gradually try to build that up. It's possible they could have an aggressive campaign to get advertisers, but the problem with that is it's the network effects of these sites -- advertisers want to advertise where the most eyeballs are going, so there's an increasing return to being the biggest site, and it's really hard to dislodge that. I guess that's the logic of buying Yahoo, but I personally thought it was a dumb idea to spend that much money for Yahoo. It's an old-style Internet asset in decline, and they'd have to buy it at a premium. The action is in the social networking sites, it's not in these traditional channels that you have on Yahoo. If they could buy it at the market price, I'd say, sure, fine. You're just, again, buying eyeballs. ... Which is why I'm actually glad they withdrew their offer. I think Yahoo's got no future now. The stock is going to absolutely collapse, and maybe Microsoft will come back in and buy it for a more reasonable price. I think that's another option for them.

But I don't think Microsoft's future is really in advertising revenues on the Web, competing head-to-head with a Google-style firm. I think its strength is really as a software-product company, as a platform company, and it's moved into applications. It could have gone after a company like SAP. Could have bought a whole bunch of companies that Oracle bought in the last year. There still are some companies out there.

Q: Which of Oracle's acquisitions do you think might have fit most appropriately with Microsoft?

Cusumano: Could have bought BEA Systems. Just thinking of itself as a platform company, rather than a Windows company. SAP also bought Business Objects. Could have gone after Business Objects. (Microsoft) has its own analytics, but not as good as Business Objects, for business intelligence. These were pretty strong product companies.

Q: Do you think Microsoft has taken its eye off the software ball, as it were, in going after the advertising market?

Cusumano: I think so. I think they believe the future of software revenues is going to be mostly advertising. I don't actually see that in my own research. We see some companies doing that. But we see lots of variety in pricing models these days. So the traditional upfront license fee is under tremendous pressure, that is true, but different types of software-as-a-service programs, and subscription-type payments, those are becoming very common. Advertising is just a very tiny part of the funding for software companies. Now, of course, the Internet service companies like Google are a little bit different. Google and Yahoo. I don't see why Microsoft needs to try to play in that game. There's not going to be many successful companies there. I think Google's got it.

There are lots of little companies working on new types of search -- there are new ways of using search in different applications. Again, if Microsoft rolled up some of those companies, it might come up with something. They could buy a huge number of those little software companies, working on search technology, social-networking technology, video-game technology. For the amount of money they would spend on Yahoo, $40 billion, they could be the most powerful R&D funder in the world. There's a lot that they could do with that money, and wasting it on Yahoo -- which is barely worth what its pre-Microsoft-offer value was -- is not the way to go.

Q: What's your assessment of this moment in Microsoft's history? Where is the company right now?

Cusumano: I think the company is doing pretty well. The Windows desktop, Windows Server and the Office businesses are relatively strong, and they're very profitable. They just escaped wasting $40 billion on an old asset that's not worth very much. I think this is a new opportunity for Microsoft to think more carefully about how they're going to spend their money in the future, and not just act out of desperation. And I see the Yahoo acquisition as a desperate move. They just couldn't think of anything better to do. They've tried and tried, and that was what they finally came up with, but I think they need to think differently.

Q: If the company is to think differently, is Steve Ballmer the right person to lead that?

Cusumano: I'm happy with Ballmer where he is, because I think it's too disruptive to bring in an outside person to lead a company. I think they can continue to seed the company with people that think differently. Ray Ozzie is one of them, and I think they can keep going after some different people, as well, and younger people. But I think Steve is smart enough and strategic enough to take different advice. ... I think he's OK, but they need more people advising them and telling them different things. I don't know that they have that kind of advice in the company, or people in the company right now. It's not just Ballmer's fault -- it's the whole top cadre of executives there.

What's next for Microsoft following its decision to walk away from its Yahoo bid? Below is the text of the internal e-mail message that Microsoft Chief Executive Steve Ballmer sent to employees today. (Also see Ballmer's letter to Yahoo CEO Jerry Yang, and Yahoo's response.)

This afternoon I sent the attached letter to Jerry Yang announcing that Microsoft has withdrawn its proposal to acquire Yahoo. We proposed the deal in the belief that a Microsoft-Yahoo merger would create a combined company with the resources and assets to win in the fast-growing market for advertising and online services.

Although the acquisition of Yahoo would have accelerated our ability to deliver on our strategy in advertising and online services, I remain confident that we can achieve our goals without Yahoo. We have a strategy in place to do so and we will continue to expand on this strategy and accelerate our progress.

Our strategy has three components:

Deliver on the basics. We will continue to improve search relevance and build out our ad platform.

Change the game through innovation. We will expand investments in engineering and deliver transformative tools and Web experiences.

Expand our global scale and focus. We will pursue partnerships and investments to realize the competitive advantages that come with scale.

At the heart of our strategy is a commitment to bring the benefits of competition, choice, and innovation to everyone who uses the Internet--from consumers to content creators to advertisers.

We are 100 percent focused on executing on this strategy and we have made good progress in a very short time. We've improved search relevance dramatically, introduced compelling new search verticals, successfully integrated aQuantive, and added nearly 100 new publishers to our ad platform. In the last couple of months we've rolled out new versions of key products including Internet Explorer and Silverlight, and introduced new technologies like Live Mesh. We now have over 430 million active users of our Windows Live services worldwide. And we continue to add new technologies with acquisitions such as YaData, which brings leading-edge behavioral targeting technology, and Caligari, which gives us advanced 3D modeling capabilities that will help us continue to improve Virtual Earth.

Ultimately, our goal is to build the industry-leading business in search, online advertising, media, and social networking.

We are absolutely committed to being the leader in each of these areas. Now is the time to do what we have always done best--be tenacious, focus on the long term, innovate, and keep working hard.

I want to thank all of you for your patience during this process and for your dedication and hard work across all of our businesses. We asked that you remain focused on our goals through these cycles, and you have done this extremely well. We are committed to making the investments that will enable us to compete and, ultimately, lead in the online services and advertising businesses. Together, I know we will succeed.

Steve