Microsoft, Yahoo link up in Internet search deal

Microsoft and Yahoo have finally struck a deal to take on giant rival Google.

The 10-year partnership, announced Tuesday, will combine technologies, revenue sharing and ad search sales staff for the two tech and ad giants.

The two competitors paired up to better challenge Google, which has 88% of the search market business. Ad search is the biggest chunk of the $23.4 billion Internet ad business and accounted for 45%, or $10.5 billion, last year, according to the Internet Advertising Bureau. That's a 20% increase at a time when ad when advertising was down 2.6%

At the core of the deal is Bing, Microsoft's new search engine, unveiled in May. The positive response to Bing helped pave the way for the deal, says Microsoft CEO Steve Ballmer.

"If Bing was not good, I bet we would not have a partnership," he says.

Yahoo CEO Carol Bartz says the combined market reach of Yahoo and Microsoft will eventually serve consumers well with improved search results and more relevant ads. "It all sounds like a win for consumers and advertisers to me," Ballmer said.

Bartz said she isn't concerned about a 11% drop in Yahoo shares this morning. "I'm not a CEO who believes in short-term things," she says. "I believe this will play out well in the long run. It's hard to give a report card on (this year) based on half a day of trading."

Search advertising, those pesky little text ads that pop up when you search for a term, business or topic are considered the holy grail of advertising. If a consumer clicks on them they present timely, relevant ads. Google dominates that market.

"The hope (for Microsoft and Yahoo) is that better technology will mean more relevant results and more relevant results will attract more users," says David Hallerman, senior analyst with eMarketer. "More users mean more potential to click on ads and that means more money."

Terms of the deal include:

• Microsoft has a 10-year exclusive license to Yahoo's search technologies and will be able to integrate Microsoft's search technology into Microsoft's existing Web search platforms.

• Microsoft's new Bing search technology will the exclusive paid and algorithmic search platform for Yahoo sites.

•Yahoo will operate the exclusive worldwide sales force for both companies search ad services. Each will maintain their own display sales teams.

Hallerman says that in order to continue to generate audiences Microsoft will have to invest heavily in its advertising for Bing.

Microsoft believes Bing is just as good, if not better, than Google's search engine. Taking over the search responsibilities on Yahoo's highly trafficked site gives Microsoft a better chance to convert Web surfers who had been using Google by force of habit.

In return for turning over the keys to its search engine, Yahoo will get to keep 88% of the revenue from all search ad sales on its site for the first five years of the deal, and will have the right to sell ads on some Microsoft sites.

Yahoo estimated the deal — which the companies hope to close next year — will boost its annual operating profit by $500 million and save the Sunnyvale, Calif.-based company about $275 million on capital expenditures a year because it won't have to invest in its own search technology.

Assuming it can pass antitrust scrutiny, the alliance could give Yahoo a chance to recoup some of the money squandered in May 2008, when it turned down a chance to sell the entire company to Microsoft for $47.5 billion.

Yahoo's market value currently stands at about $24 billion. Yahoo just came off a tough quarter in search advertising, with its revenue in that niche falling 15% in the April-June period.

The two rivals began talking about a possible alliance as far back as 2005 before Microsoft intensified the courtship with last year's attempt to buy Yahoo.

It took Yahoo's current chief executive, Carol Bartz, just six months to strike a deal with Microsoft — something that neither of her predecessors, Terry Semel and Yahoo co-founder Jerry Yang, seemed interested in doing.

Shortly after her arrival, Bartz made it clear she was willing to farm out Yahoo's search engine for "boatloads of money" as long as she as thought the company would still receive adequate information about its users' interests.

"This agreement comes with boatloads of value for Yahoo, our users, and the industry, and I believe it establishes the foundation for a new era of Internet innovation and development," Bartz said.

Under the agreement, Yahoo will have limited access to the data on users' searches — which yield insights that can be used to pick out ads more likely to pique a person's interest. The value of that information is why Microsoft wants to process more search requests.

Like Yahoo, Microsoft has invested billions in its search technology during the past decade, yet remained a distant third in market share while its online losses piled up. The company's Internet services division lost $2.3 billion in the fiscal year ending in June, nearly doubling from the previous year.

Microsoft is counting on Bing, unveiled in early June, to turn things around.

Bing has been getting mostly positive reviews and picking up slightly more traffic with the help of a $100 million marketing campaign. Analysts believe Bing's successful debut pushed Microsoft to reopen negotiations so it could expose its search engine improvements to a wider audience more quickly.

"The reason the deal happened now is the recent success of Bing. I think it put pressure on Yahoo, as well as Yahoo not being able to turn it around on its own," said Gartner Inc. analyst Neil MacDonald.

Even with Yahoo's help, Microsoft still has its work cut out. Combined, Microsoft and Yahoo have a 28% share of the Internet search market in the United States, well behind Google's 65%, according to online measurement firm comScore Inc. Google is even more dominant on in the rest of the world, with a global share of 67% compared to a combined 11% for Microsoft and Yahoo.

It could be a while before Microsoft and Yahoo can begin working together because the partnership is likely to draw federal antitrust scrutiny to ensure the combination won't have an adverse effect on competition in the online ad market.

The U.S. Justice Department spent five months dissecting a proposed search advertising partnership between Google and Yahoo before concluding that it would give Google too much control over the market.

Microsoft used its lobbying muscle to spearhead the campaign against Google teaming up with Yahoo, so it wouldn't be a surprise if Google turned the tables.

Under the Obama administration, the Justice Department is promising to pore over technology deals far more rigorously than it did when the proposed Google-Yahoo partnership came up.

Just getting Yahoo to succumb to its latest advance represents a coup for Microsoft and the boisterous Ballmer, who were rebuffed for so long.

Microsoft is doubling down on Internet search at the same time Google is attacking Microsoft's bread-and-butter business of making software for personal computers.

Google is working on a free operating system for inexpensive personal computers in a move that could threaten Microsoft's ubiquitous Windows franchise. If it gains traction, Google's alternative, called Chrome OS, could divert some revenue from Microsoft while the software maker is trying to grab more of the money pouring into search advertising.

Chrome OS, though, isn't supposed to hit the market until the second half of next year. That means Microsoft could get a head start on Google in the duel to steal each other's financial thunder.

The Associated Press contributed to this story.