Inside the Microsoft-Yahoo Deal, and the Future of the Search Competition with Google

7/29/09

Microsoft and Yahoo officially announced this morning that they had reached a search engine and advertising agreement. Amid intense speculation, and after more than a year of disagreements over minor and not-so-minor details, the two companies have signed a ten-year agreement that puts Redmond, WA-based Microsoft (NASDAQ: MSFT) in control of both companies’ search engine technology, and Yahoo (NASDAQ: YHOO) in charge of the sale and distribution of advertising for both its own search engine and Microsoft’s Bing search engine.

As part of the announcement, Microsoft and Yahoo launched a website dedicated to explaining and promoting the agreement. “It establishes the foundation for a new era of Internet innovation and development,” Yahoo CEO Carol Bartz said in the press release attached to the website. Microsoft now owns an exclusive license to the Sunnyvale, CA-based company’s search technology, including the right to integrate it into its own search platforms, a process that will cost hundreds of millions of dollars, according to Microsoft CEO Steve Ballmer in a conference call with reporters and financial analysts this morning.

Even before that integration, the Bing search algorithm developed by Microsoft will be used on the search engine sites of both companies. According to Ballmer, expanding Bing onto Yahoo will give the fledgling search engine, just a few months old, the room to compete more effectively, both in terms of users and advertising dollars. The press release does not mention Google, the colossus of Internet search, by name, instead referring to it as “one company that dominates more than 70 percent of all search.” But it’s hard to imagine Microsoft and Yahoo would have reached an accord without Google overwhelmingly outcompeting them. At the moment though, Google employees are not allowed to comment on the deal.

On the other end of the deal, advertisers wanting to use either company’s search engine will have to go through Yahoo, although this only applies to so-called premium advertisers. Yahoo will use Microsoft’s AdCenter program to run this business, and AdCenter will still be the program for self-serve advertising. Although Yahoo is in control, both companies will still have their own sales and advertising groups, and outside of the search engines, will still compete with each other.

The employment situation for both companies is still uncertain. Ballmer said he expects some computer engineers from Yahoo will migrate to Microsoft (as has often happened before), since Yahoo will no longer need them. Bartz added that some Yahoo employees may be let go, but slowly, over the next few years.

It may seem like Yahoo gets the short end of the stick in this deal, until the revenue sharing aspect of the agreement is examined. Under the deal, 88 percent of the money made through the deal, referred to as “traffic acquisition costs,” goes to Yahoo, for at least the first five years. In the short term at least, Yahoo stands to make a lot more money from the deal than Microsoft, but Ballmer said this deal is about much more than the short term.

Online search is so heavily dominated by Google that it can be easy to forget that Yahoo still has about one-fifth of the market share. Therefore, Bing, with 8 percent of the search market, will take a huge leap ahead in the search market and, ideally for Microsoft, become a real competitor to Google. With Yahoo’s search engine to augment its own, and access to a vastly larger group of users to tailor search and advertising to, it is not inconceivable that by the end of this ten-year agreement, we will see a real competition between Microsoft and Google—although what will happen to Yahoo is anybody’s guess. Perhaps Microsoft will even make another attempt to acquire the company as it did last year, when Yahoo rejected a $45 billion offer.

The next step is getting the agreement approved by regulatory commissions, both governmental and industrial. If all goes well, Yahoo and Microsoft hope to have the deal close sometime early next year. “This agreement gives us the scale and resources to create the future of search,” Ballmer said in the release.

Eric Hal Schwartz was an intern in Xconomy's Seattle office. Follow @

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