Microsoft finally persuaded Yahoo to surrender control of the Internet's second most popular search engine and join it in a daunting battle — taking on the overwhelming dominance of Google in the online advertising market.
A 10-year deal announced Wednesday gives Microsoft its best shot yet to show its new search technology, Bing, is as good as or better than Google's. Microsoft also hopes to use Yahoo to divert sales from Google, which generates more than $20 billion a year from ads.
Gaining access to Yahoo's audience would instantly more than triple Bing's U.S. market share to 28 percent. That's still a far cry from the remarkable 65 percent of U.S. searches handled by Google, according to the research firm comScore Inc.
By joining forces, Microsoft and Yahoo are betting they will be able to focus on their respective strengths. By turning over responsibility for search technology to Microsoft, Yahoo can concentrate on sales of billboard-style advertising on the Web — and figuring out how to keep luring traffic to its Web sites, which already attract more than 570 million people worldwide every month.
While the agreement shapes up as a potential boon for Microsoft, it was greeted in the stock market as a letdown for Yahoo. Just 14 months ago, Microsoft dangled $9 billion in front of Yahoo in an attempt to forge a search advertising partnership, only to be rebuffed. Yahoo had also turned down Microsoft's $47.5 billion bid to buy the entire company.
Yahoo has been struggling so badly since then that Microsoft isn't paying any money in advance. Instead, it will give Yahoo 88 percent of the search ad sales made on its Web site, above the usual commission of 70 to 80 percent.
By spending less on its own search technology, Yahoo expects to boost its annual operating profit by about $500 million — but not until 2012, when the two companies expect to have all the pieces of a complex technological puzzle in place.
"I think a lot of people are kind of looking at the numbers and seeing a lot of question marks where they expected to see exclamation points," said Scott Kessler, a Standard&Poor's equity analyst.
Yahoo Inc. shares plunged $2.08, or 12 percent, to $15.14 as investors expressed disappointment over the absence of an immediate windfall. Microsoft Corp. shares gained 33 cents to $23.80 while Google Inc. shares shed $3.61 to $436.24.
It took Carol Bartz, Yahoo's chief executive, 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.
"This move makes up for a lot of the stupid mistakes made by the preceding administration," said technology analyst Rob Enderle, who thinks Yahoo will be able to devote more energy to developing services to compete with online hangouts like Facebook.
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 get adequate information about its users' interests. Bartz predicted the deal will enrich the company over the long run.
"This agreement comes with boatloads of value for Yahoo, our users, and the industry," Bartz said.
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.
Microsoft CEO Steve Ballmer could barely contain his excitement as he gushed about finally getting Yahoo on his side — something he has been trying to do for at least three years.
"I am very enthusiastic," Ballmer said in an interview. "This is what I have basically been saying for the past 18 months: The world will be better served for consumers, advertisers and publishers, and there will be more competition for Google, if we can somehow figure out how to get Microsoft and Yahoo together in search."
Antitrust regulators plan to review the agreement to make sure it doesn't lessen competition or compromise the privacy of people who use the search engines.
Google tried to stop Yahoo from falling into Microsoft's camp. Last year it formed its own proposed search advertising deal with Yahoo, only to be forced to retreat after U.S. antitrust officials threatened to sue.
Microsoft helped spearhead the campaign against a Google-Yahoo partnership. Now many people, including Ballmer, expect Google to try to turn the tables on Microsoft by opposing its Yahoo deal.
"There has traditionally been a lot of competition online, and our experience is that competition brings about great things for users," Google spokesman Adam Kovacevich said. "We're interested to learn more about the deal."
Advertisers will probably support Microsoft because a stronger player in the search market should protect them from potential abuses by Google, said Kevin Lee, CEO of online marketing specialist Didit Inc.
"If there's only one choice in search, that's just an uncomfortable position to be in," Lee said.
Like Yahoo, Microsoft has invested billions in search technology during the past decade. Yet it remained a distant third in market share while its online losses piled up. Microsoft is counting on Bing, unveiled last month, 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 the successful debut pushed Microsoft to reopen negotiations so it could expose its search engine improvements to a wider audience.
While Microsoft and Yahoo await government approval of their partnership, there is no doubt Google will try to increase its lead by upgrading its own search engine, said Danny Sullivan, editor of the online newsletter SearchEngineLand.
Already, Google is going after Microsoft's bread-and-butter business of software for personal computers. It's working on a free operating system for inexpensive PCs, a move that could threaten Microsoft's Windows.
"Google is very paranoid about Microsoft," Sullivan said. "They are always trying to figure out what kind of 'evil' thing Microsoft is going to do next."
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