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Microsoft and Yahoo Agree on Search Deal

Microsoft and Yahoo finally consummated an Internet search advertising-text deal after almost two years of contentious wooing.

The deal, announced on Wednesday, calls for Yahoo to use Microsoft's latest search advertising technology, called Bing. Yahoo, for its part, will take over the advertising sales roles for both companies worldwide. Yahoo will use Microsoft's adCenter platform to conduct ad-space auctions, which is the process by which advertisers compete for search ad placements.

The deal doesn't affect Web display advertising, in which the two companies plan to continue their competition. Display ads typically use animated graphics in a broad area on a Web page, rather than being confined to text.

Microsoft introduced Bing in late May after it had hired away several of Yahoo's search technology personnel. One of those hires was Dr. Qi Lu, who now runs Microsoft's Online Services Group after having served as the head of Yahoo's Engineering and Advertising Technology Group.

Microsoft had initially submitted an unsolicited proposal to acquire all of Yahoo on Jan. 31, 2008. However, that offer never got off the ground in negotiations with Yahoo's then-CEO Jerry Yang, who has since stepped down. This latest deal was established with Yahoo's new CEO, Carol Bartz.

While Bartz had earlier declared that such a deal would require a "boatload of money," she described it slightly differently in a joint Microsoft-Yahoo press conference on Wednesday, saying that this deal was a "boatload of value" for Yahoo. The deal requires no upfront payment of cash from Microsoft to Yahoo.

Yahoo's personnel loss to Microsoft may have contributed to this current deal. In February, Microsoft's CEO Steve Ballmer bragged about hiring 10 of Yahoo's chief search technologists. Today, in a recorded press conference, Ballmer suggested that having Qi Lu on the operations side will smooth the transition as Yahoo begins to use Bing, which may occur in three to six months' time. Yahoo will continue to use its own user interface on its owned-and-operated (O&O) properties, but Bing will run in the background, powering Yahoo's search.

Cash considerations may also have been a compelling reason for the deal. Yahoo reported a 10 percent decrease in cash holdings in its second quarter, down from $427 million in 2Q 2008 to $385 million in 2Q 2009.

One of the perks of the current Microsoft-Yahoo search advertising deal is that Yahoo will get about $275 million in annual operating cash flow.

The deal is established for 10 years, and Yahoo is expected to gain $650 million in "savings from reductions in spending on Yahoo's search technology," according to the fine print of a press release. That seems to imply that Yahoo is exiting the search-engine development business, and that there may be personnel changes or cuts on the Yahoo side.

In the joint Microsoft-Yahoo press conference, Ballmer suggested that some of Yahoo's personnel might go to Microsoft.

"From an op-ex perspective, we have a plan in which, over time, some Yahoo engineers may move to Microsoft," Ballmer said.

Under the deal, Microsoft will license Yahoo's core search technologies for 10 years.

Both Yahoo and Microsoft contend that this search advertising deal will be good for advertisers, publishers and consumers -- and that it won't run afoul of regulators in Washington or Brussels.

"We suspect we will face some opposition from the competitor [Google], who may not like more competition because we actually think this is one of those cases where us coming together will produce more competition to the market leader, not less," Ballmer said in the press conference.

Google's search engine handles about 70 percent of search traffic on the Web (StatCounter suggests it's more like 88.6 percent), making it the leader in search text advertising. A similar search ad-text deal proposed between Google and Yahoo was vehemently opposed by Microsoft last year. That deal was finally dropped after some members of Congress suggested that antitrust scrutiny would be initiated.

In a July hearing conducted last year, Brad Smith, Microsoft's senior vice president and general counsel, had suggested that the Google-Yahoo deal would amount to illegal price fixing for ad costs, as well as opening up privacy concerns for users of the search service. It's not clear how advertisers will benefit if the Microsoft-Yahoo deal goes through, as there will be one less search ad market to compare prices.

Under the proposed Microsoft-Yahoo deal, the two companies expect to maintain their current privacy policies. The deal will provide greater scale to both Microsoft and Yahoo, which will lead to improved search technology, Ballmer said.

The deal is subject to regulatory and U.S. judicial approvals, but Yahoo and Microsoft are expecting it to go through "by early 2010," according to the press conference.

Other details in the deal include a proposal in which Microsoft will share revenue on Yahoo O&O and Yahoo-affiliate Web sites.

"Microsoft will pay traffic acquisition costs (TAC) to Yahoo! at an initial rate of 88% of search revenue generated on Yahoo!'s O&O sites during the first 5 years of the agreement," according to the press release. Since the deal is a 10-year agreement, it's not clear what happens in the subsequent five years. Microsoft will guarantee the revenue for the first 18 months.

Further details about the agreement are described at a Microsoft-Yahoo Web site, which can be accessed here.

About the Author

Kurt Mackie is senior news producer for the 1105 Enterprise Computing Group.

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