Microsoft-Yahoo search deal: 3 reasons why it makes sense

A mega-push to take on rival Google

The Microsoft Corp. and Yahoo Inc. courtship that has been taking place on and off for the past four years had grown as tiresome as the annual Brett Favre retirement watch.

But unlike the All-Pro quarterback, who finally decided Tuesday to remain retired from football for good, Microsoft and Yahoo decided that day to do the opposite and finally came to a belated embrace in order to take on their common foe, Google Inc.

While the deal will no doubt face extra scrutiny -- and criticism -- from jaded observers, it also appears to be a winning move. Why?

1. It's no Heaven's Gate (or Waterworld)

Heaven's Gate was the late-1970s Hollywood epic that clocked in at five and a half hours and cost a then-unheard-of $30 million to make. It was the standard for bloated box office bombs, until Kevin Costner's Waterworld drowned in 1995.

Similarly, the Microsoft-Yahoo merger that almost took place in spring 2008 for $44.6 billion would have set the modern standard for overpriced acquisitions, becoming the symbol of the end of the Web 2.0 era, just as the $165 billion AOL-Time Warner merger came to symbolize the end of the dot-com era and its excesses.

A search partnership with Microsoft's up-and-coming Bing search engine becoming the default engine for Yahoo will, far from leading to overspending, likely help Yahoo save hundreds of millions of dollars in R&D investment, and potentially help both vendors reap more advertising dollars by combining forces to create the scale that Madison Avenue apparently craves.

According to terms of the 10-year agreement announced this morning, Microsoft will compensate Yahoo through a revenue-sharing agreement on traffic generated on Yahoo's network, paying Yahoo traffic acquisition costs equivalent to 88% of search revenue for the first five years, and an undislcosed guaranteed revenue-per-search figure for the first 18 months.

Within 24 months, the deal should help add $500 million annually to Yahoo's operating income while saving it $200 million a year, the companies announced in a press release.

That would generate billions of dollars for Yahoo, according to AllThingsD, citing anonymous sources, and it would enable Microsoft to become the clear No. 2 in search behind Google.

2. There's no cannibalization

As much as Microsoft and Yahoo differ in the general public's eye, a merger between the two companies would have resulted in a massive overlap of workers and products, and billions of dollars in cannibalized revenue. A smaller deal results in less risk of potential downsides.

Since Bing's launch on June 1 as a replacement for Live Search, Microsoft's share of the search market has risen from 5.5% to a high of 15.6% at one point, and has since continued to rise and fall. But the changes in Microsoft's market share have pretty much paralleled rises and falls in Google's usage, according to figures published by StatCounter.

In other words, Bing appears to be stealing users away from Google, not Yahoo, whose market share has remained fairly steady at about 11%.

Combining forces will give the two search portals a total share of almost 20%, based on Monday's figures from StatCounter, with minimal cannibalization.

3. Yahoo knows how to outsource search

Having started as a human-created directory of Web sites rather than a search engine, Yahoo arguably has neglected search almost as much as Microsoft historically did.

For many years, Yahoo used search technology from Inktomi Corp., culminating in its purchase of the company in 2002. Just a year later, it bought Overture Services Inc., which owned the AlltheWeb and AltaVista search engines.

Despite owning all of those search engines, Yahoo continued to license search technology from Google for several years, before deciding to go back to the drawing board and roll its own, developing the current Yahoo Search system.

While Yahoo Search has rebounded and held more market share than Bing as of Monday, according to StatCounter, it appears to benefit mostly from integration with Yahoo's many portal properties -- and from Yahoo's expertise at selling to advertisers.

Meanwhile, financially struggling Yahoo lacks Microsoft's deep pockets to invest in either improving Yahoo Search's technology or marketing it.

Microsoft CEO Steve Ballmer has said that his company is willing to commit up to $11 billion a year on Bing in order to catch up to Google.

While dropping Yahoo Search could leave Yahoo vulnerable if Microsoft ever decides to abandon the deal, in the near term it will save Yahoo lots of money and help it reap billions, too.

Copyright © 2009 IDG Communications, Inc.

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