When you acquire, what do you acquire

We have all heard of the time when Bill Gates invited Sabeer Bhatia (at that time President and CEO of Hotmail.com, one of the first web-based free email service) and asked him to sell Hotmail.

Hotmail was not always big or famous nor was its founder CEO. When Hotmail users touched 8 million, was the time industry began to take serious notice. And among those who took notice was Microsoft co-founder and CEO at that time, Bill Gates.

Finally, Microsoft bought Hotmail for $ 500 million which was a little more than seven times the initial offer of about $ 70 million and the deal was settled. That happened in 1998 just about two years after it was initially set up.

So, one of the frequently asked questions is “what exactly did Microsoft get in return for $ 500 million…..or in other words what did they really acquire”?

That was then. Today, many years later, that question still gets asked very frequently and with good reason.

This isn't just a rhetorical question. Hotmail costs its present owners lots of money to maintain. The volume of mail has been going up each year — according to an industry insider, Microsoft has had to add six times the amount of storage (from 20 petabytes to 120) between 2007 to 2011. And even more since then……

Yes, as one may guess, Hotmail is insignificant to Microsoft's business — it's part of Windows Live, which has had operating losses year after year - Microsoft doesn't normally break out Windows Live finances separately, but it moved the Windows Live group from the Online financial segment to the Windows financial segment starting FY'10, so it gave some rare one-time insight into Windows Live performance as part of that move.

There's also a Windows Live Mail client that ships as part of Windows. That makes sense — the Mac has an email client, so Windows must have one as well. Microsoft Windows, as we all know or can guess is a highly profitable business ($13 billion a year on $19 billion in sales) and a lot of that money comes from consumers. Consumers love email. They need to be able to log on and send and receive email as soon as they set up their new computer. Sounds good.

But the Windows Live client can connect to almost any e-mail system — Yahoo Mail, Gmail, Exchange Server. So can Microsoft's Windows Phone mail client.

So why does Microsoft keep investing in the Hotmail service?

Over time, Hotmail spokespersons have admitted that Hotmail supports other businesses like Office — for instance, Hotmail ties to Skydrive, which is part of Microsoft's answer to Google Apps. Hotmail and other Windows Live services also drive a lot of users to Bing, where Microsoft ... also loses lots of money.

But it seems that Hotmail has too much momentum to kill — nobody wants to throw away 350 million users — so the company seems to have decided it might as well do as much as possible to make it competitive. Meanwhile, users benefit from competition from other free & perhaps better email services.

To answer some questions, they say the best place to start is right at the beginning. So, let’s go back to 1998 – when Microsoft acquired Hotmail.

At that time, the global digital economy was nowhere near the size and width it has today. And Hotmail was one of the strongest global internet brands. Those who understood strategy and competitiveness knew well that the source of competitive advantage was ever increasingly linked to intangible assets. And brands across industries and geographies have proved to be an enduring and intangible source of competitive advantage.

Being one of the most well known global internet brands, Hotmail was expected to remain a market leader and generate revenues in future as the internet economy grew and evolved and newer business models were created and deployed.

It was also a way to create high entry barriers in an industry which did not have as many players as it has now – Microsoft, Apple, Google….that’s all.

By acquiring Hotmail, Gates was acquiring the future cash flows of one of the best known internet brands of the time and at the same time creating an additional entry barrier.

In many cases of acquisition, that’s the reason the brand name and its identity are retained – like P&G acquiring Gillette. While P&G is itself a strong corporate brand with a robust portfolio of brands in its portfolio including Ariel, Tide, Whisper, Pantene, Head & Shoulders, Oral-B etc. it decided to retain the Gillette brand because of the inherent strength of the brand in the men’s grooming space. Gillette was seen as complimenting its existing brand portfolio and further strengthening it.

Gaining ownership of a brand & leveraging it - which was not once yours or maybe was even your competitor is as much a strategic issue as it is an issue of leadership behaviour.

Of course we have also seen some cases of acquisition where a strong brand has been abandoned or cannibalized by the acquirer and has ended up paying the price for it.

Any acquisition therefore is an acquisition of future cash flows – with more than a reasonable dose of probability inevitably tied to it.