CEOs: Details slowed deal on Yahoo, Microsoft search tie-up

The agreement, which calls for no cash up front, is expected to close in 2010

Microsoft and Yahoo took so long to reach an Internet search and advertising agreement because they considered factors beyond key financial considerations to ensure a deal would allow both companies to drive their separate online businesses forward, their CEOs said Wednesday.

Microsoft CEO Steve Ballmer and Yahoo CEO Carol Bartz explained on a conference call Wednesday why the companies struck a deal now when a similar one was on the table a year ago. Under terms of the 10-year deal, Microsoft's Bing search engine and adCenter platform will power Yahoo's search-based advertising business, while Yahoo's sales team handles both companies' premium search customers.

Last year's proposed deal involved a cash payment up front and less annuity revenue for Yahoo, whereas the deal announced Wednesday involves no up-front cash and more revenue for Yahoo over the long term. That revenue will come in the form of Microsoft paying Yahoo traffic acquisition costs (TAC) at an initial rate of 88% of search revenue generated by owned and operated sites, the companies said. TACs are payments made to a company to acquire traffic on its Web site.

That revenue over time will benefit Yahoo and its shareholders better than a big up-front cash payment, which is why Wednesday's deal was more attractive to Yahoo than the one presented by Microsoft last year, Bartz said.

"Having cash payment up front doesn't help us from an operating standpoint," she said. "What was important was a significant TAC rate -- revenue that's supported -- so we could invest in the business."

However, it was not just the financial terms of the previously proposed deal that proved problematic last summer, when Yahoo co-founder Jerry Yang was still at the helm. Bartz became CEO in January after Yang stepped down last November amid pressure over his failure to reach a deal with Microsoft.

"Frankly, the big thing was to work through not just high-level financial but the details and working process" of how the companies would execute both from a corporate standpoint and in the marketplace, Microsoft's Ballmer said.

This was the topic of meetings between Ballmer and Bartz this year in the months leading up to the deal. They worked out back-end details to ensure the deal was in line with both companies' long-term goals and strategies for their Internet businesses, he said.

The companies also worked hard to ensure they could protect the privacy of their customers and users when sharing information between them, he said.

Another factor the companies weighed in the deal is the opportunity it gives them to reach a larger network of advertisers to compete more effectively with Google, Bartz said. Google has about 78% of the search advertising market in the U.S. and about 92% in Europe, Ballmer said on Wednesday.

"What's really important about this deal is scale," Bartz said. "It's great news for all of our customers and will really allow us to create more innovation in search and real consumer choice."

Indeed, scale is one big benefit the two companies will get from the deal, agreed industry analyst Greg Sterling from Sterling Market Intelligence, who echoed Bartz's sentiment. That scale, he added, "makes them more viable competitors to Google."

When asked how Yahoo will continue to innovate in search when it essentially will shut down its own search-engineering efforts in favor of using Microsoft's, Bartz said that Yahoo's display-ad business and engineering efforts can benefit from the combined search business. Both companies are retaining their display-advertising businesses, which are not a part of the deal.

"There is a lot of innovation that happens above search results -- how it's integrated with search that goes on the Yahoo side," Bartz said. "We're kind of learning we can use search data for display targeting. There is a lot that can happen."

Yahoo's mission is to be the primary destination for media and content for Web users, she said, and a search deal with Microsoft will help the company gain even more users to achieve this goal.

"Yahoo is the place where millions go every day to see what's happening," Bartz said. To accommodate them, Yahoo launched a revamped home page earlier this week that focused on the ability of users to customize it according to personal preferences.

Indeed, Yahoo made a pragmatic decision to reallocate money and resources from search engineering to other areas that it considers more important for its business, while Microsoft clearly decided it was in the search market for the long haul when it last month launched Bing, a major overhaul of its only marginally used Windows Live Search engine, said Gartner analyst Allan Weiner.

However, it's not entirely clear what Yahoo will do with the resources it is freeing up from search, said Weiner, who wasn't very impressed with Yahoo's recently redesigned home page. "The new home page isn't a sign of major innovation," he said.

Yahoo needs to provide concrete examples of how it plans to innovate in non-search areas. "We need more clarity from Yahoo about that," Weiner said.

Bartz said on the conference call that the companies expect the deal to close by early 2010, after which the companies will move hastily to integrate search and advertising platforms.

Yahoo's search will transition to Bing in all global markets starting with the U.S. three to six months after the deal closes. Yahoo will migrate its advertising network from its Panama platform to Microsoft adCenter fully about a year after close of the deal, she said.

Yahoo's search will be powered by Bing and will say so at the bottom of search pages, but it will continue to be branded by Yahoo, Bartz said.

The companies are prepared to argue their case for a swift close to the deal to regulators in the U.S. and Europe, since they expect Google to protest it, Ballmer said.

"We suspect we'll face some opposition from the competitor who may not like more competition," he said. "This is one of those cases where us coming together will provide more competition to the market leader, not less. We'll expect the competitor to be aggressive."

However, Ballmer said the companies have a good case as to why the deal improves competition and will overall provide benefits to consumers, advertisers and publishers by creating a more viable alternative to Google than the companies were independently.

David Mitchell, senior vice president of IT research at analyst Ovum, said it's unlikely that regulators in either Europe or the U.S. would intervene given that neither Microsoft nor Yahoo hold large shares of the online advertising market.

However, regulatory opposition can't be ruled out. The deal could be viewed as allowing Microsoft to become too dominant overall given its strength in areas such as operating systems, Mitchell said. But "my personal view is that it would be very difficult for regulators to sustain that as a defensible position," he said.

As two smaller players in search-based advertising, Microsoft and Yahoo should both derive great benefits from the deal, said Rebecca Jennings, principal analyst at Forrester Research. This will turn them into a powerful second player behind Google and could spark a price competition between the two, she said.

Once the deal closes, Microsoft's share of the online advertising market will jump from 8% or 9% to 30% or so in the U.S., she said. The U.S. market is estimated to be worth around $15 billion this year, growing 15% a year to as much as $30 billion by 2014, she said.

Yahoo benefits by no longer needing to invest in a search engine, which was not gaining traction against Google anyway, Jennings said. Since the deal gives Yahoo 88% of the revenue from the sites it operates, it means Yahoo can concentrate on its strengths, such as display advertising, she said.

"Yahoo gets out of a market that a lot of analysts have told them to get out for a while," Jennings said. "I think hopefully it will mean the emergence of a leaner company but better focused on the stuff they're good at."

Jeremy Kirk in London and Juan Carlos Perez in Miami contributed to this report.

Copyright © 2009 IDG Communications, Inc.

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