Is Firefox Search Worth $375M/Year to a Yahoo Buyer?

Marissa Mayer and Firefox: worth it?

Marissa Mayer and Firefox: can the marriage last? Photo of Marissa Mayer by Fortune Global Forum on Flickr.

Who stands to lose if Yahoo is sold — besides of course Marissa Mayer, who will probably lose her job along with a fair number of Yahoo staff? The surprising, and unobvious, answer is Mozilla and the Firefox browser.

That’s because Mozilla is highly dependent on a five-year contract with Yahoo, signed in December 2014, where it receives about $375m per year to make Yahoo the default search provider in the Firefox browser on the desktop. From 2004 to 2014, that contract was exclusively with Google; now it’s Yahoo in the US, Google in Europe, Yandex in Russia and Baidu in China.

How much is $375m per year compared to Mozilla’s spending? Most of it. Mozilla’s audited financials offer some useful details. They’re not as timely as a public company’s numbers; the most recent date to the end of 2014.

Mozilla’s numbers

In 2013, the Mozilla foundation recorded “royalties” (mainly, search income) of $306.1m out of total revenues of $314.1m; in 2014, 323.3m of $329.6m. Search income is about 97% of Mozilla’s total income.

It’s also clear Yahoo is paying Mozilla more than it got from Google. Marissa Mayer was reportedly so keen to secure the business, she made a preemptive bid that turned out to be far too high for the reality of a world where Firefox’s share on the desktop was falling and its position on mobile is minimal.

The question is, with Yahoo on the block, would a buyer of Yahoo want to continue with the Mozilla contract? It is a big drag on Yahoo’s spending. According to Yahoo’s financials, its Traffic Acquisition Costs (TAC) – the money it pays other companies to bring traffic to it – have rocketed.

Yahoo spending on traffic acquisition

Clearly, it’s spending a lot more both for display ads and for search. TAC can be a good thing: you pay a third-party site to bring people to you and then you make a profit by selling those people products or showing them ads.

Yahoo’s search TAC, in particular, has rocketed from a low of 0.7m in the first quarter of 2014 to $141m in the fourth quarter of 2015, just over a year after signing the deal with Mozilla.

That’s not all going to Mozilla. But digging into Yahoo’s financial statements, we can find out precisely how much it is paying.

In its annual report for 2015, Yahoo says: “Of the $350m increase in revenue and $660m increase in TAC for the year ended December 31, 2015, $394m and $375m were attributable to the agreement we entered into in November 2014 to compensate Mozilla for making us the default search provider on certain of Mozilla’s products in the United States (the “Mozilla Agreement”).”

(You might wonder: why is the increase in overall revenue smaller than the increase from Mozilla? It’s because Yahoo’s overall revenues fell.)

So Yahoo is paying $375m annually to Mozilla just to be the default search engine in Firefox on the desktop in the US. And it’s going to keep on paying. In the 3Q 15 report, it said: “The Company is obligated to make payments, which represent TAC, to its Affiliates. As of September 30, 2015, these commitments totaled $1,682 million, of which $100m will be payable in the [fourth quarter] of 2015, $401m will be payable in 2016, $400m will be payable in 2017, $375m will be payable in 2018, $375m will be payable in 2019, and $31 million will be payable thereafter.”

Given that $375m went to Mozilla in 2015, it seems likely the large part of those future sums are also bound for Mozilla.

But a future buyer might not want to stick with Mozilla because Yahoo’s TAC is beginning to get out of whack.

For comparison, Google’s TAC used to be between 23% and 25% of its ad and total revenues; more recently – since the end of the Mozilla contract – that has fallen below 20%.

As a proportion of search revenue, Yahoo’s search TAC has gone from a low of almost 1% of search revenue, to 27% in the fourth quarter of 2015. That’s bigger than Google’s TAC proportion. Yahoo’s problem is it doesn’t have the monopoly Google does and doesn’t monetise its advertising as well as Google. Google’s AdWords are a high-margin ad business. Yahoo offers display ads, which are a commodity.

The end of the search affair

So a Yahoo buyer would be very likely to look for a way to get out of the five-year Mozilla contract. How would that affect Mozilla?

Quite hard.

Mozilla’s expenses in 2013 were, mainly, $197.5m on “software development” (out of total costs of $295.4m); in 2014, that was $212.8m (of a total of $317.8m). “Software development” swallowed up about 65% of the royalty income in 2013; the same in 2014.

As Mozilla acknowledges, those “royalties” are payments from “various search engine and information providers”. What happens if one of those sources dries up?

Mozilla knows it’s at risk here. Under the “Concentrations of Risk” subheading, there’s this:

Mozilla entered into a contract with a search engine provider for royalties which expired in November 2014. In December 2014, Mozilla entered into a contract with another search engine provider for royalties which expires December 2019.

Approximately 90% of Mozilla’s royalty revenues were derived from these contracts for 2014 and 2013 with receivables from these contracts representing approximately 77% and 66% of the December 31, 2014 and 2013 outstanding receivables, respectively.

Yahoo, as we can see, is paying about $400m per year just for US search. How much did Google pay? In 2011, when it re-signed for three years, the estimate was that Google was paying just over $100m per year – for a worldwide deal. It seems likely the real figure was higher. But Mozilla relied on it. And the Yahoo money is even more needed as Mozilla tries to recover from the dead-end of Firefox OS on mobile.

Pulling the plug

Basically, if a new Yahoo owner pulls the plug on the search deal, Mozilla will have to seek a new contract in the US. But who’s going to be willing to step up? Microsoft, probably; but the price that Mozilla will be able to demand will be much lower than it got from Yahoo. Unless, of course, Google decides to step back in and push the bidding up. But its actions around the last auction suggest it wouldn’t be interested; Chrome is too dominant, and Firefox is dwindling.

So the next few weeks aren’t going to be tense just for Yahoo. There’s a whole team of software engineers working on Firefox and other products who will have to wonder about their future if Yahoo has a new owner.

How AlphaGo Illustrates the “Warm Bath And Ice Bucket” View of Technology Progress

Positions from AlphaGo's first win against Fan Hui

Remember the last time you took a bath or shower and it started lukewarm but you gradually warmed it by adding more hot water, until it reached a temperature so hot you could never have got into it at the start? Isn’t it strange how we can be immune to subtle, slow changes all around us?

Then there’s the other extreme – the ice bucket experience, where you’re abruptly plunged into something so dramatically different you can’t think of anything else.

The warm bath and the ice bucket: that’s how technology progresses, too.

As an example of the warm bath, you could point to the improvements in computing power in PCs and smartphones. Every year, they’re faster. You don’t notice how much better until you have to use an old device. (Or, of course, upgrade from a years-old device to a brand new one. These days, the effect is less visible on PCs than smartphones.)

Warm enough yet?

Another, less familiar, example is the burgeoning field of artificial intelligence (also known as machine learning, deep learning, neural networks, expert systems and so on). AI has been the “next big thing” for decades; the burden of expectation was so great it couldn’t meet them. Where, in the year 2001, was HAL, the talking sentient computer from 1968’s film 2001?

And yet, bit by bit, AI has been improving. I realised something was going on two years ago when I wrote a story about an app called Jetpac which could examine Instagram photos and determine whether the people in it were happy, grumpy, and so on.

To do that, Jetpac analysed 100 million photos and was able to determine whether those in it were wearing lipstick (so must be “glammed up”), had moustaches, etc.

A fun story, but it was the underlying technology, which Pete Warden, then CTO at Jetpac, explained to me that made me realise AI was back on the agenda again. He had used a neural network (which mimics, in machine form, the way neurons in the brain work: certain stimuli are reinforced, others are de-emphasised, in a learning process) to do the analysis.

It wasn’t surprising when eight months later Google bought Jetpac. The fit with Google’s broader AI drive was so obvious.

Where’s that tech now? Almost certainly powering the recognition system in Google Photos. Isn’t the Photos recognition system clever? But equally, isn’t it so obviously a progression from the face recognition we’ve seen in apps for years? The temperature is rising.

In fact, the AI temperature is now so high that this week we may witness a key event: a machine winning against a human at one of the subtlest board games ever. AlphaGo, an AI program developed at Google’s Deepmind in London, learned how to play the Chinese game Go at a professional level – and then beat Europe’s best player 5-0. On Wednesday – Tuesday night in the US – AlphaGo takes on Lee Sedol, the game’s top player. (If you haven’t played Go (most people in the West haven’t) let me put it like this: it makes chess look crowded and trivial: the board has four times more points than a chessboard, and the number of possible moves is far, far larger.)

AlphaGo isn’t like Deep Blue; it isn’t programmed just to play Go. Instead, it has a “learning” system which was tuned to play Go by working through millions of games and learning what outcomes were best. It could probably learn to win at chess. The core program learned to play video games.

This is the warming bath: how did we get to the point where computers could learn to beat the best player in the world at a game where intuition and “feel” are seen as essential?

The ice bucket

By contrast, some technologies are ice baths – so dramatically different from what has gone before they upend our expectations. Virtual reality (VR) fits this well. Immersive VR is an utterly different experience from what has gone before and the potential for creating new ways of interacting are what have so many people excited about it.

To people who haven’t tried it, VR tends to be “that thing where you wear the stupid helmet”. But that’s because they haven’t experienced the ice bucket. In the past, trains were a similarly disjunctive experience, able to travel at absurd speeds. There were even fears that the velocity would make passengers’ bodies fly apart.

Are there other “ice bucket” technology examples? The original iPhone was a shock to pretty much everyone, even though the technologies it contained (notably the multi-touch screen) were already known. From January 2007, Google’s Android team sidelined their work on a BlackBerry-like device and focussed instead on a multi-touch product.

Your preference doesn’t matter

Ice buckets change the game abruptly; warm baths surround us and raise the temperature so we can’t imagine life before them. There’s no way to pick which is “better” – and we don’t get to pick anyway, because they happen quite independently of our wishes or expectations. But in truth, there are more warm baths than ice buckets. The gradual improvement of smartphone screens, battery life, chip speeds, mobile reception, mobile speeds, design improvements – they’re all slow improvements which you don’t notice until you don’t have them. For dramatic change, though, the ice bucket beats the lot.

Moment of truth

There’s an instant as you first experience a splash of water when you don’t know whether it’s hot or cold. The match between Lee Sedol and AlphaGo could be like that: an odd mixture of hot and cold, a “where were you when…?” moment. Garry Kasparov’s loss to Deep Blue in 1997 was an iconic moment, remembered by many. It has taken nearly 20 years for a computer program to be able to challenge the top human in Go, which tells you about the gap in complexity between the two games. Fewer people understand Go than chess; but everyone understands winning and losing. Computing’s advance is bringing us a moment when the ice bucket comes from a warm bath.

The first match between AlphaGo and Lee Sedol starts at 1pm Seoul time on Wednesday (4am GMT Wednesday, 11pm EST Tuesday, 8pm PST Tuesday). The match will last up to four hours. It can be viewed on Youtube; there will be commentary (which might not mean much to non-Go players) at Gogame.