Like most people, when I saw the headline “Google founder spooked by Microsoft bid” (because Microhoo dominance would stifle innovation on the Internet) my thoughts ran to pots and kettles, PR battle for proxy votes, confuse the enemy with antitrust and so forth.

Don’t the Google guys realise how big and dominant they have become? Sure they do, but “only the paranoid survive” and Microhoo does give some room for paranoia in the Googleplex.

These guys run the numbers and the numbers that scare them will say something like 49% and 56%. They will have access to way better data than I do; I have restricted myself to what is available free online. But even allowing for some margin of error these are “unnerving” to use Brin’s actual word.

• Email is 49% of Impressions. Portals and Search Engines is 10% by contrast. This is some free data from Nielsen-Netratings. click on Top Site Genres.
• 56% is Microsoft and Yahoo combined market share of webmail. Gmail is down at 7%. This data is via Fred Wilson’s back of envelope calculations.

Yes both data sets can have a pretty wide margin of error, but even discounting that, this would be cause for worry.

Sure, in the early adopter world we live in, Gmail rocks and who would be seen dead with AOL or Hotmail? But that 50% market share for Microhoo is what you will see in the real world.

Hotmail has lagged terribly. Most people who used it would not return, I cannot imagine who would switch (an AOL user maybe) and most people already have email. So it is a lost cause. One major reason it lagged IMHO was Microsoft fear of cannibalizing Outlook. So they won’t offer the features that users want that both Google and Yahoo have been rushing to fill. Yahoo is reputed to have the most “Outlook-like” interface and that matters massively to people making the switch.

Microsoft will probably do the smart thing and let the Yahoo team run with email. Hotmail will die as a separate brand, eventually.

Feature for feature, Google and Microhoo will slug it out for a long time. Today Gmail looks to be ahead but that position is not written in the stars. With the “don’t cannibalize Outlook” shackles off, its just needs some well-directed R&D dollars and they have plenty of that.

The real battle of course remains around search within email and thus monetization. Google is better at relevant ads in Gmail because they have a better search engine. But if Microhoo gets its act together in search, they have the bigger content/audience to monetize. Technically improving search is not that hard. Microsoft have all the R&D money they need and, more importantly, every search start-up looking to exit to them. If you really can improve search you have one fat valuation offer coming down the pike!

Here is the really interesting bit. Improving ad relevance within email does not require any searching behavior change. That is worth repeating. Say after me, “if we have 56% of 49% we have something like 25% of ad impressions and all we need to do is serve relevant ads”. Come on developers, you can fix that, right? Page rank is not relevant. Getting people to switch from Google to another search engine is not required.

So, in the final analysis, it is not really as much about search quality as it is about Ad Networks; both Microsoft and Yahoo have good Networks and advertisers always want a choice. So nobody can dominate this for too long. The Adwords auction model is brilliant but is self-limiting in the end; when the price gets too high, advertisers seek out alternatives.

However email is not just fodder for search it is the key to ad relevance, via the social graph. As Fred Wilson puts it, email is “the biggest social graph“. What is social networking except in-site messaging? Add in messaging within Facebook, where Microsoft has the ad deal, and I can see some 3am wake-ups among the Google team.

The social graph is key to ad relevance because it enables “SEO resistant search”. This is what Scoble calls it in this great series of Podcasts. Skip to # 3 if you know the basics. His closing remark (made in August 2007 for historical record) is kinda fun in the circumstances “watch Yahoo, they are the wild card”.

He is right, look at all Yahoo’s social assets. Massively underexploited but great. If the social graph is the key to SEO resistant search and thus search relevance and webmail is the key to the social graph….

When two gorillas duke it out, watch out! You can get crushed by accident - oops sorry, Chimp, did not see you there - but it is also full of opportunity for entrepreneurs.