By Yi-Wyn Yen

Microsoft is trying its luck at social networking – again.

After a failed attempt four years ago, Microsoft (MSFT) is ripping a page from Facebook’s playbook, introducing on Thursday new profile and photo-sharing features to its web-based Windows Live services. The software giant allows users with Windows Live Hotmail or Messenger accounts to create online profiles that highlight what a person is doing through a Facebook-like newsfeed.

Microsoft hopes that giving Windows Live a new facelift will encourage more people to spend more time on its web properties. Checking e-mail or instant messaging accounts for up a third of the time people spend on the Internet, according to research firm comScore. Microsoft has 375 million Hotmail users and 325 million Messenger users worldwide. “If we can gain a whole 60 minutes per user, we would grow a whole Facebook in [time spent],” says Brian Hall, general manager for Windows Live.

Though Hall admits that Microsoft’s new strategy could shift some attention from Facebook – in which Microsoft holds a minor stake – to Windows Live, the real concern is longtime rival, Google (GOOG). The search giant already has a commanding lead in the search advertising business, and Microsoft worries about Gmail’s growing share in the e-mail market. “According to comScore, Google has a 6% share of email [in the U.S.] But they’re growing fast,” Hall said.

Like Google, Microsoft has struggled to make inroads in social networking. Four years ago, Microsoft launched Spaces, a blogging tool to build a social networking site within Windows Live. Though Microsoft added 100 million people in it first year, less than 1% of social networking users use Spaces today. “The blogging approach [to social networking] is not the right approach. People are too busy to make that investment,” Hall said.

Windows Live lets its new newsfeed feature do the heavy lifting to give people’s friends updates on what they’re up to. Microsoft has partnered with more than 50 web companies, including Amazon.com (AMZN), Twitter, Flickr,and iLike, a music discovery site. Anytime you blog on WordPress, write a restaurant review on Yelp, or watch videos on Veoh, your status is updated through your Windows Live profile.

Analysts say the new Windows Live makeover is a preview of Microsoft’s newest operating system, Windows 7. The latest version of Windows is expected to integrate tools like photo-sharing, videos, and messaging more seamless between PCs and mobile devices. “All these built-in applications with a blend of Google, Apple, and Facebook is Microsoft’s view of an integrated world,” said Rob Enderle, president of the Enderle Group. “Windows Live comes out first. This is designed for Windows 7.”

Microsoft’s had success with operating systems, but the company still struggles to make a profit from its Internet businesses. Microsoft is banking that more time spent on Windows Live will translate into more web searches on Live and more ads viewed on its portal, MSN. For its fiscal first quarter, which ended in September, Microsoft lost $480 million from its online unit. “We have to get great at the advertising business,”  Hall said.

By Scott Moritz

Yahoo (YHOO) moves back to the deal market as its controversial advertising partnership with Google (GOOG) is now dead.

As Fortune’s Legal Pad blogger Roger Parloff outlined last month, the legal footing was never very solid as the No.1 and No.2 Internet advertisers explored plans to work together on search advertising efforts.

The plan was first introduced in June as Yahoo was trying to fend off an unsolicited takeover bid from Microsoft (MSFT). Yahoo stubbornly resisted Microsoft’s early offers, including a $33-a-share bid in May. Microsoft then walked away and in July, activist investors like Carl Icahn started pushing for a shakeup of the Yahoo board and a more deal-friendly line up.

Yahoo shares, which had fallen to a five-year low of $11.25 last month, surge up 9% on Wednesday after news that the Google partnership was killed.

Investors apparently like Yahoo’s options a lot better without the antitrust battle that seemed to be looming with its Google ad plan. Microsoft and Time Warner’s (TWX) AOL unit – Time Warner is the parent of Fortune and CNNMoney – are among the potential deal partners.

On a conference call with analysts, Time Warner executives said that the news was positive for AOL. “The opportunity remains open for this business to rebuild itself,” the executives said.

News Corp. President Peter Chernin says online video is a premium money-making opportunity. Image: News Corp.

By Jon Fortt

HALF MOON BAY, Calif. – Looking at big money-making opportunities online, News Corp. (NWS) President Peter Chernin pointed to video, mobile and overseas markets as good long-term bets.

In an interview with Fortune editor at large Richard Siklos at Brainstorm Tech on Tuesday, Chernin said advertisers still haven’t completely embraced the online opportunity, and that they continue to have a television mindset. He said an advertiser recently told a MySpace sales rep to come back when the social network has a “SuperBowl-level” event. What the advertiser failed to recognize, Chernin said, is that the MySpace homepage has as many viewers every day as the SuperBowl has once a year. (Of course, there’s a good argument that MySpace visitors aren’t quite as engaged with the content as SuperBowl viewers are.)

He also addressed the challenges News Corp. faces in getting a decent price for ads on MySpace. (The company partners with Google (GOOG) to monetize the site.) The answer, Chernin said, may be to look beyond banners and text ads. “What drives ad prices is scarcity,” he said. “The place that is most promising is probably in video. By definition there’s more scarcity in video, and there’s even more scarcity in premium video.”

Mobile is attractive because of its scale. It “is by far the most penetrated device on earth,” he said. “So it’s this enormous distribution platform, but by definition you’re not going to be watching two-hour movies. It’s going to be interesting to see people develop uniquely mobile content.” It will take the medium a long time to develop, he said and predicted that in two years, the industry will still be trying to figure mobile out.

Geographically, Chernin said he expects emerging overseas markets to show faster revenue growth for News Corp. than the U.S. and more developed markets. “We’ve invested in cable channels in all sort of Podunk places.”

By Scott Moritz, writer

There may be more than money to consider in the Microsoft-Yahoo standoff.

Microsoft (MSFT) has given Yahoo a deadline of Saturday to accept its buyout offer (or, presumably, at least at start serious talks) or risk triggering a hostile takeover battle. Yahoo wants a higher offer — a demand that Microsoft has so far rebuffed.

But the focus on price may be missing a key subtlety behind the impasse.

One possible stumbling block might be Yahoo CEO and co-founder Jerry Yang’s role in a combined company. As displeased as Yang may be by the prospect of joining forces with Yahoo’s culturally-mismatched rival, some observers say he could be open to a leadership role in the merged Internet division.

“I’ve always believed Jerry Yang wants do something bigger with Yahoo,” as opposed to watching it dissolve into the works of a bigger company, says an analyst who has known Yang since Yahoo went public in 1996. ”He’s Jerry Yahoo, that’s really who he is.”

Yahoo has been exploring other options, including a possible tie up with the AOL division of Time Warner (TWX) and an advertising partnership with rival Google (GOOG) to help outsource some of its ads and trim costs. But almost any type of hookup between the No.1 and No.2 online ad giants seemed fraught with antitrust concerns.

Without a better offer in sight, Yang and the board will likely have to sit down with Microsoft over the weekend and negotiate. If Microsoft told Yang that he would play a top role in the combined company, it might sway the Yahoo founder, says the analyst, who did not want to be identified.

“He’s already a billionaire,” adds the analyst, referring to Yang. “What he wants is his brand to be massive. When the history of the Internet is written it will feature names like [Amazon (AMZN) chief Jeff] Bezos, [Google CEO] Schmidt, Page, [AOL founder Steve] Case. Yang wants to be there.”

Stay tuned.

By Scott Moritz, writer

The yelling phase of the proposed Microsoft/Yahoo merger got a bit louder as Yahoo (YHOO) turned in good numbers ahead of the deal negotiation deadline.

In the wake of a solid first quarter performance from Yahoo Tuesday, Microsoft (MSFT) chief Steve Ballmer said his company was standing pat on its original $31 a share unsolicited takeover offer. Microsoft has given Yahoo until Saturday to come to the table with a counter proposal, or face a proxy battle.

“We know what Yahoo is worth to us. We offered a lot of money: $44 billion,” Ballmer said in Milan Wednesday, according to a Reuters report. “If their board thinks that’s fair, great. If not, we’ll move forward,” Ballmer said.

Ballmer is likely waiting to see what Yahoo does come Saturday — the end of the three-week period Microsoft gave Yahoo to consider its options. Microsoft has threatened to start a proxy fight if the two companies fail to come to terms. This would open up an ugly process where Microsoft takes its appeal to shareholders calling for the ouster of Yahoo’s top management and key board members.

Last week, Yahoo rejected the Microsoft bid for a second time saying the proposal undervalued the company. Yahoo also held discussions with Time Warner (TWX) about a deal involving a 20% stake to be held by Time Warner in exchange for AOL and a pile of cash for share buybacks.

But many analysts and investors favor a more amicable conclusion that seems to call for a slightly sweeter offer from Microsoft, either a price higher than $31 a share or an all-cash offer.

Yahoo’s earnings Tuesday, while far from dazzling, did show that the company is not deteriorating as quickly as Microsoft may have suggested. Both companies, however, continue to lose business to Google (GOOG) a point that industry observers say makes the Microsoft Yahoo merger a growing necessity.

The trouble for Yahoo is that it must convince Microsoft to outbid itself, says Darren Chervitz analyst with the Jacob Internet Fund, a big Yahoo investor.

It’s well known that Yahoo has long been losing Net search traffic to Google. And by passing on the acquisition of Facebook last year, they’ve done little to improve their competitive position, says Chervitz.

And for its part, Microsoft has gained very little traction on the Internet. Efforts like MSN mail and .Net haven’t exactly hit any jackpots. Meanwhile, Google has expanded into Microsoft’s software domain with word processing and other office applications available to users online for free.

An even bigger threat to Microsoft is Google’s push into wireless applications. The Google-sponsored Android project hopes to create an operating system for a new generation of mobile devices, a direct threat to Microsoft’s Windows Mobile system. Microsoft can’t easily afford to miss the mobile Internet opportunity, says Chervitz.

“Yahoo,” says Chervitz, “is the only acquisition that gets Microsoft into the game.”

By Michael Copeland

On the eve of the latest and largest Internet gathering this year, O’Reilly’s Web 2.0 Conference and Expo, Forrester Research dropped a report that concludes that companies will spend $4.6 billion on Web2-related technologies by 2013. What that means for you, fellow office dweller, is that Forrester believes the world of wikis, widgets, blogs, mashups and social networks will increasingly find a way into your work life.

The emphasis won’t be entirely on internal collaboration, Forrester analyst G. Oliver Young writes, but will also offer “a fundamentally new way to connect with customers and prospects…By 2013 investment in customer-facing Web 2.0 technology will dwarf spending on internal collaboration software by nearly a billion dollars.”

In other words, you will interact with your customers and prospects the same way you do with friends on Facebook or maybe more likely with colleagues on LinkedIn, and with the same Web-based communication and tracking tools.

It makes sense that companies embrace the same easy-to use Web-based tools that we use increasingly in our social lives. Mark Benioff at Salesforce.com has been preaching that for some time now, both through AppExchange and his latest brainchild Force.com, his so-called platform-as-a-service offering. There are numerous other Web-based services including Jigsaw, BaseCamp, Yahoo’s Zimbra, Zoho, and many others that are already bring a Web2 flavor to the work world. What Forrester is arguing, however, is that for everyone who still thinks AJAX is a cleaner, and Twitter is what birds do, a lot of Web2.0 will come.

Does that mean you will be getting Twitter updates from your customers or your boss? If not actual Twitter updates, than perhaps a more corporate version that can offer the same immediacy and easy access to a list of key people. Much of the consumer Web2.0 stuff that makes it fun won’t make the leap, no doubt, but the ease of use and connectivity will.

Will it be a less exciting and dynamic Web-based world that Forrester anticipates? Clearly. What it might also be, however, is a more profitable one. And that is something that many of the Web2 startups that are piling into San Francisco at the moment will be very happy to hear.

By Michael V. Copeland

I was having lunch with Flixster CEO Joe Greenstein the other day when we came to the topic of how to monetize all these widgets that are cropping up like poppies in a Silicon Valley spring.

Flixster, for those of you who are not Web geeks or film-buffs, is an online community of more than 1 million people focused on movie recommendations and reviews. While it has its own Flixster.com site, where it has really grown over the last six months is as a Facebook application — so much so, that Barry Diller’s InterActive Corp. (IAC) was rumored to be interested in buying Flixster in a deal estimated to be worth $150 million.

Greenstein spends his waking hours thinking about ways not just to grow that user base, but also how to make money from it, and he’s got a novel idea.

One way his service — and vast numbers of other widgets out there — could monetize more easily, Greenstein says, is if there were a button embedded on a site to make small purchases. “If you want to charge for a virtual teddy bear, there’s the button, you charge 99 cents for it, and that’s it,” Greenstein says. “PayPal is too cumbersome for something like this, it needs to be really simple.”

If that 99-cent button did exist, all those Facebook and MySpace applications that now depend on online advertising would suddenly have another way of making money: by charging small amounts for small items.

Those items might be virtual goods — a digital photo of a favorite band, a simple game. The point is that it could enable an economy that has been mostly missing from the widget world. If you think charging 99 cents doesn’t add up to much, remember that the ringtone business grew to a multibillion dollar industry worldwide by charging similar amounts.

So who is best suited to introduce a simple, secure 99-cent button?

In many ways Facebook is the logical choice, and one of the worst-kept secrets in the Valley is that Mark Zuckerberg and crew are working on a Facebook “wallet.” It makes perfect sense that a next step for the Facebook platform would be to introduce a simple, universal payment scheme. Facebook has already collected credit card information on some portion of its users, so it wouldn’t take much to turn something like the 99-cent button on.

I’ll bet almost a buck on Facebook doing it, and soon. The larger question is whether Facebook’s wallet becomes the standard for the rest of the Web, or if some other, more enterprising gang swoops in with a better version of PayPal for the widget world.

What are you waiting for? Get on it.

By Josh Quittner

The idea that Microsoft would take Yahoo as its hapless partner has been discussed for years down in the Valley. But most of the folks I’ve talked to pretty much dismissed it as too wrong to contemplate. Even Microsoft, dissed by Valley Guys as not getting the Web (see previous column here), wouldn’t actually go through with it, Yahoo’s decent dowry notwithstanding.

Granted, this part of the world is unabashedly Google Country. Virtually any startup that’s hot right now (Facebook being the exception that proves the rule) is making its money in Google’s slipstream.

Microsoft (MSFT) does nothing for these people. So it’s an admittedly biased sampling. That explains, in part, why, when news of the Microsoft offer broke at dawn on the Pacific this morning, most of us awakened to hoots of derision, rather than the crowing of roosters.

The Valley view, then: Yahoo (YHOO) will be Microsoft’s AOL. Microsoft is paying too dearly for too little. When AOL and TimeWarner (TWX) merged, the Street went crazy with the wonderful possibilities that the synergy would bring: Combine AOL’s online reach with TimeWarner’s content? What a no-brainer! A no-brainer is right.

In the same way, this is a deal that smells right to the same crowd — Microsoft comes away with 30 percent of the search market and $1 billion in “cost synergies.” And, while the recession is already hitting advertising, we can assume that the online world will only benefit over time as the flow of ad dollars increases. But sniff deeper and longer, and this thing begins to be redolent of the AOL-TimeWarner “synergies” that at first appeared so sweet.

What exactly is Microsoft buying here? Technology? Yahoo has been managing a declining asset since Google invented a better way to do search, then figured out how to sell (And sell! And sell!) relevant ads against its superior results. Technologists? Talent has been fleeing Yahoo Central since Terry Semel got there — and the fact that co-founder Jerry Yang returned to get the company back on track hasn’t yet lured any of those Smart Dudes back. Nor will it: Smart techies only want to work for startups these days. And let’s not even talk about the clash of cultures that such a merger will surely create.

Nope—Microsoft is buying an empty bag. At the risk of climbing even further out on a limb here, let me make an alternative suggestion. Microsoft should move in the opposite direction: Unbundle what it already has. Get rid of everything that isn’t core! Microsoft is the monopoly provider of desktop operating systems. Guess what? It’s a great business! (Or would be if it did a better job of improving it rev to rev. Vista was a disgrace.)

Want to juice the stock price? Get rid of everything that’s unrelated to the business of improving the OS — search, xBox, Zune, etc. That OS, by the way, is quickly starting to move up into the cloud. It’ll be enough of a challenge to maintain Windows’s dominance as that happens.
It will take incredible focus and innovative thinking to maintain Windows. Don’t get distracted by Google (which, by the way, ought to get back to it’s knitting, too. Targeted search is a great business. Google (GOOG) ought to get out of everything else and it’s stock price would double.)

If we’ve learned one lesson during the past decade it’s this: Technology is changing so fast that the “synergy” that’s supposed to occur when massive companies merge simply doesn’t work. The Internet belongs to the small. Unbundle now — before it’s too late.

By Josh Quittner

Ah, Microsoft. Nothing gets the knickers of Silicon Valley startup guys more twisted than signs that the world’s largest software company is over-reaching again. The latest outrage? Some of my friends at the Valley’s best-known social networks and Web 2.0 companies are privately grousing that emissaries from Redmond are trying to “strong-arm” (their term) startups into giving special treatment to Messenger, Microsoft’s (MSFT) answer to AIM and other instant messaging programs.

The problem typically arises when a social network, say, offers its users the ability to import the list of contacts they’ve accumulated on Microsoft Hotmail.

Since the summer, my friends tell me, Mister Softie has been sending cease-and-desist letters to startups that try to do this. These nastygrams are typically followed up by a meeting with Microsoft reps, who then try a couple different approaches to get the startup to integrate Messenger into their service.

If the company wants to offer other IM services (from Yahoo, Google or AOL, say), Messenger must get top billing. And if the startup wants to offer any other IM service, it must pay Microsoft 25 cents a user per year for a site license.

If, however, the startup decides to use Messenger exclusively, the licensing “fee will be discounted 100 percent.”

Such a deal!

Or not. The standard Microsoft term sheet being shown around the Valley also instructs  startups that if they want to offer search at any point in the future, they must agree “to negotiate in good faith for a period of sixty days exclusively with Microsoft on the terms under which Microsoft may provide such search service functionality…”

Naturally–and no one is complaining this is unfair—Microsoft also demands reciprocity of contacts. They say, in effect, we’ll show you our Hotmail contacts, but you have to let your users share theirs when they sign up for Microsoft’s Windows Live services.

None of the folks I spoke to agreed to talk on the record for fear of reprisals. So I will refrain from blind quoting some of their more incendiary remarks. Well, all but one: “This is a great example of why Google is the leader in the Net ecosystem and Microsoft is not,” an angry entrepreneur (who does not work for Google) told me. “Microsoft is the anti-data-portability company.”

Google (GOOG) and Yahoo (YHOO) routinely allow users to take their contacts with them when they join new social networks. So why doesn’t Microsoft? Just who owns that data anyway?

We put the question to Brian Hall, general manager for Windows Live. “We want the user to be in control of their stuff,” he told me. “We believe strongly that it’s the user’s data, it’s the user’s choice.”

Hall said he was unaware of any Messenger tie-in being a part of a signed contract, but didn’t rule out the possibility. “I don’t know of any contract we’ve signed that has those terms,” he said, pointing out that the term sheets that are being passed around merely represent what Microsoft wants—not what it will ultimately get in each instance.

Aside, that is, from the social network Bebo, which in August announced an alliance with Microsoft that would bring Messenger in house for its users. In exchange, Bebo and Windows Live users are now able to exchange contact information to invite their friends to their respective services. (Hmmm, will Facebook—in which Microsoft is a minority investor—be next to make Messenger it’s official IM client?)

Hall did say that in situations where Microsoft was dealing with a tiny company with few users, Redmond might be looking for a more favorable deal simply because the exchange of contact lists was so lopsided.

“Let’s say you are a startup and we offer to do a reciprocity deal where you can access contacts for our 410 million [Hotmail] users and I have access to your zero users,” he said, noting that it took Microsoft 12 years to amass its enormous user database. Why should it simply allow that data to flow in one direction, without getting a little something back?

But wait a second. If I’m a Hotmail user, aren’t all the contacts I amass mine? Can’t I take my friends with me?

Hall said that Microsoft’s main concern, and the reason it sent out Big Foot letters in the first place, was security. “If you look at what a number of sites are doing, they’re asking for your Hotmail login info, They’re storing your identity, which is not a best practices [approach] for anyone’s data from a security standpoint. We want to make sure our data is kept between our users and our servers.”

The thrust of the term sheets, he said, was to create a process whereby Hotmail and other Windows Live data could be shared securely with third parties. Added Hall: “There are models for federation where you can trust other services—and that’s what we’re trying to do with our partners.”

Thats what doesn’t make sense to me. If this is such a security problem, why do Google and Yahoo let their users take their contacts with them?

Disclosure: Time Warner (TWX) is the parent company of Fortune and AOL, which competes with Microsoft via its AIM messenger service and other services.

By Josh Quittner

I can’t tell if Hasbro (HAS), the maker of Scrabble, is the smartest company in the world or the dumbest. Over 100 million sets of the game have been sold in 121 countries, in 29 different languages, according to everyone’s favorite source. What a cash cow.

So, why in the world didn’t it create a free online version? Could it have something to do with the digital rights being in flux, thanks to a recent licensing deal that assigned online Scrabble rights to EA (ERTS). If so, why oh why would it let someone else do it, and reap the rewards? But that’s just what happened when two guys from Calcutta, Jayant Agarwalla, 21, and his brother, Rajat, 26, created a knockoff called Scrabulous.

Their site launched in 2006 and quickly signed up 600,000 registered users. Not too shabby for a year’s worth of work. So the brothers launched a Facebook application in June, 2007 and the results were stunning: 2.3 million active users as of today. For those of you keeping score, the application generated 270 70 million pageviews in the past month. Not a bad deal for a two-man operation.

But all good things must come to an end, which is bad news for Scrabulous fans, and even worse for the Agarwalla Bros.: Hasbro’s trying to shut the site down. “They sent a notice to Facebook about two weeks ago,” Jayant confirmed to me. “The lawyers are working on it.”

As a recovering Scrabulous addict (actually, I have since moved on to Facebook’s harder stuff, Texas Hold ‘em), I’m devastated. But as a tech writer and life-long student of what passes for Internet economics, I’m baffled. Is Hasbro just a stupid Potato Head? Or is this a brilliant game of Stratego?

My calls to the company have so far gone unanswered. A spokesman for Facebook, who said she was unaware of what was in the works with Hasbro or Scrabulous, said, “we don’t typically comment on legal matters.”

If I were an evil genius running a board games company whose product line spanned everything from Monopoly to Clue, I might do this: Wait until someone comes up with an excellent implementation of my games and does the hard work of coding and debugging the thing and signing up the masses. Then, once it got to scale, I’d sweep in and take it over. Let the best pirate site win! If I were compassionate, I’d even cut in the guys who did all the work for a percentage point or two to keep the site running.

Perhaps that’s what will happen since both the Scrabulous site and Facebook app are still up and running. Indeed, Jayant told me that he was hopeful they’d find an 11th Hour solution. “We’re trying to work out some kind of deal,” he said. I hope so, too.

Jayant said that he didn’t exactly understand what all the fuss was about. Its ability to generate insane numbers of pageviews notwithstanding—he said some players play as many as 170 games at a time on Facebook—the application isn’t throwing off that much money. He declined to say exactly how much, pegging revenues at “over $25,000 a month.” Hmmmmm.

The brothers got the idea for Scrabulous after becoming Scrabble freaks a few years ago and playing at another free site, Quadplex. After it started charging users, however, they decided to build their own “without thinking through the legal aspect at the time.”

Jayant pointed out that there are a number of other Scrabble knockoffs online. “I’m not sure why Hasbro actually picked on this,” he added. Because, dude, you’re the best.