Yahoo CEO Jerry Yang has told Microsoft executives that the company's search advertising deal with Google would reduce the Internet search market from two poles to one, Microsoft general counsel Brad Smith told U.S. lawmakers Tuesday.

The deal, which would allow Yahoo to display Google search advertising on its search pages, will make for reduced competition, and Yahoo has recognized that, Smith told the U.S. Senate Judiciary Committee's antitrust subcommittee. He told senators that Yang's comments came during a June 8 meeting between Yahoo and Microsoft executives.

Yang described the Internet search market as "bipolar," with Google on one side and Yahoo and Microsoft on the other, said Smith, who attended the meeting in San Jose, Calif. Yang told Microsoft executives that if the company signed the advertising deal with Google, it would become "part of Google's pole," and Microsoft would not be strong enough to compete, Smith recalled.

"The principle question is this: Can a single company establish effective control of 90 percent of the market for search advertising by entering into an agreement with its single largest competitor?" Smith told senators.

Michael Callahan, general counsel at Yahoo, said he didn't recall hearing Yang make the comments Smith attributed to him, but he disputed Smith's description of the tone of the June 8 meeting. Microsoft in recent months has made multiple offers to buy Yahoo or its search functionality, and the meeting was part of those talks, but Yahoo has so far rejected the Microsoft offers.

[ For the complete saga of Microsoft's attempted takeover of Yahoo, check out InfoWorld's special report ]

While the deal with Google, announced in June, would allow Yahoo to display Google search ads, the company plans to continue to offer its own search advertising system and compete with Google in basic search functionality and other areas, Callahan said.

"We are confident that the more one learns about this agreement, the more clear it becomes that it is good for competition -- good for consumers, good for advertisers, and yes, good for Yahoo," Callahan said. "The intent of Yahoo moving forward is to help make our company an even stronger competitor to Google, to Microsoft and to others in the dynamic and rapidly growing online advertising world."

Microsoft, the main opponent to the Yahoo/Google deal, owns about 90 percent of the operating system market and 80 percent of the Web browser market, said David Drummond, Google's chief legal officer. Microsoft has been trying to "destabilize" or buy Yahoo, he said.

Microsoft, still under a court order to comply with a 2001 antitrust settlement for anticompetitive behavior in the operating system and browser markets, suggested that the Yahoo/Google deal will result in higher search advertising prices because Google generally charges higher rates than Yahoo.

Yahoo has projected that it could eventually earn up to $800 million a year through the deal, Smith said. "This additional money will flow from the pockets of advertisers -- in many cases in the form of higher prices for the same ads they purchase directly from Yahoo today," he said.

Rep. John Conyers, at a later hearing before the House Judiciary Committee's antitrust task force, also questioned how Microsoft could complain about anticompetitive behavior by its competitors. "I've never felt so sorry for poor, little old Microsoft," said Conyers, a Michigan Democrat. "I'm stunned by the fact that these predators, these competitors, are about to swallow you guys up."

Google and Yahoo officials disputed that the deal would lead to higher ad rates. Yahoo will maintain its separate search advertising system, and Yahoo ads will likely make up most of the ads on a search page there, Callahan said.

"We're not looking to sell ads at higher rates," added Google's Drummond. "We're looking to sell more ads."

Senators said they were concerned that the deal would reduce online competition and lead to privacy complaints. "We are forced to ask today whether this agreement will reduce Yahoo to nothing more than the newest satellite in the Google orbit," said Senator Herb Kohl, a Wisconsin Democrat and subcommittee chairman. "The stakes are very high in maintaining a vibrant and competitive Internet advertising sector."

Sen. Patrick Leahy, a Vermont Democrat, said he was just as concerned with the potential impact on Internet users' privacy as with the competition issues. Leahy has called for Congress to pass a new privacy law outlining what companies can do with personal information.

"If this agreement goes forward, Congress may not have to enact a national privacy policy," said Microsoft's Smith. "We'll have a national policy. It'll be Google's."

Senators also heard from two customers of search advertising. AT&T's Yellowpages.com said the deal will hurt small advertisers. But Tim Carter, owner of home-improvement Web site AsktheBuilder.com, said the deal can help Yahoo stay competitive.

"If they can lease space on their Web site to some other company and derive revenue for doing virtually nothing, why would you or anyone stop them?" he said. "Who is getting harmed? Perhaps some other company or companies that decided to follow a different pathway in the business jungle. My father-in-law taught me long ago that there is no substitute for brains."

This story was updated July 15, 2008.