Implementing search deal a tough task for Microsoft and Yahoo

The companies will have to execute the terms of their deal carefully as missteps are likely to end up helping Google

Now is when the hard work begins for Microsoft and Yahoo, after finally getting the regulatory green light from the U.S. and the European Union to implement their ballyhooed search engine partnership.

To accomplish the lofty goal of offering credible search competition to Google, the companies will have to execute the terms of their deal carefully and precisely.

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Otherwise, Yahoo and Microsoft could end up confusing advertisers, displeasing end users, demoralizing employees, alienating application developers, and disappointing Web publishers, thus strengthening Google even more.

In an industry where culture clashes and corporate infighting often derail the best planned mergers and partnerships, Microsoft and Yahoo are embarking on a very complicated and extensive business and technology integration.

A lot is riding on how this 10-year deal gets implemented, and all eyes in the search industry will be on them.

"This is like a baseball trade where you don't know from the outset who is the winner and who is the loser," said Gartner analyst Allen Weiner.

The deal, announced in July of last year, calls for Yahoo to outsource to Microsoft the back-end functions of its search engine, like crawling and indexing Web sites, as well as the ability to match queries to results. In addition, Microsoft gets a license to Yahoo's core search technologies, giving it the right to integrate them into Bing.

Yahoo has insisted time and again that it will continue innovating on the front end, offering enough unique search features and services to differentiate its engine from Microsoft's Bing.

Still, it's one thing to talk the talk and another one to walk the walk, said industry analyst Greg Sterling from Sterling Market Intelligence. Yahoo struck the deal in part to cut its costs in search. "It won't have the same amount of search money and bodies it has had," he said. "Yahoo doesn't have the same capacity as in the past to execute on a search vision."

While Yahoo search officials claim their efforts enjoy backing from the company's top executives, it's not clear whether CEO Carol Bartz fully understands the level of financial commitment required to stay ahead of the curve in search technology.

"Bartz is a skillful manager, but she's not a product person, and she may not fully appreciate some of the nuances of the search product in the same way as [former CEO] Jerry Yang," Sterling said.

"She's managing costs, speaking to Wall Street, as CEOs do, but one doesn't get sense there is the same type of passionate commitment [for search] as before," Sterling added.

And by the look of things, Yahoo needs to jazz up its search engine quickly. Since April last year, its search usage market share in the U.S. has dropped from 20.4 percent to 17 percent in January this year, according to comScore. Meanwhile, Bing has jumped from 8.2 percent to 11.3 percent in the same timeframe.

"The danger is that Yahoo doesn't keep pace, doesn't invest enough and continues to see usage share losses," Sterling said. "What happens if Yahoo keeps losing share? Is this still a good deal for Microsoft?"

IDC analyst Susan Feldman is optimistic that Yahoo, through its extensive experience and knowledge of user behavior, will succeed at differentiating its search experience and remaining a viable search player. In particular, Yahoo can leverage what users have voluntarily shared with it through their opt-in Yahoo accounts to personalize their search experience, she said.

In addition, Yahoo can complement the Bing-powered search results with content of its own, and offer specialized query refinement suggestions and filters for people to slice and dice those results through different parameters, thus making it easier to zero in on the information they're looking for, she said.

Feldman is also bullish on the potential benefits Microsoft and Yahoo may reap from joining forces on the advertising front by offering marketers a stronger alternative to Google than exists today.

"This search deal is a smart move by Yahoo," Feldman said.

The companies said on Thursday they hope to have transitioned Yahoo's back-end search functions over to Bing by the end of this year, at least in the U.S.

Yahoo will also rely exclusively on Microsoft for self-service search advertising sales, the highly profitable market that Google dominates with its AdWords program. Thus, another transition that must be managed very carefully is the switch of Yahoo search advertisers and Web publisher partners over to Microsoft's search ad platform.

The companies said on Thursday they will work on "a customized plan" to make the transition "as efficient and seamless as possible." Microsoft and Yahoo are pledging to be in regular communication with advertisers, publishers and developers "via phone, e-mail, webinars" and a new Web site called Search Alliance.

For the deal's first five years, Microsoft will get a 12 percent cut of paid clicks on the search sites of Yahoo and of Yahoo Web publisher partners, so it's key for Yahoo to maintain its search usage, or ideally grow it. Success in search advertising is closely tied to usage volume.

Yahoo and Microsoft hope to complete the transition of U.S. advertisers and publishers over to Microsoft's platform prior to this year's holiday season, but may postpone it to early 2011 depending on how the process goes, the companies said Thursday. Internationally, the transition should be completed by early 2012, they said.

Yahoo will be in charge of selling premium guaranteed search ads on behalf of both companies, and will handle the one-on-one relationships with the biggest advertisers, search marketing firms, resellers and their clients, the companies said.

Back in July, Yahoo estimated that, when fully implemented, the search deal would boost its annual operating income by about US$500 million, provide capital expenditure savings of about $200 million and increase annual operating cash flow by about $275 million.

Assuming the deal is implemented successfully, Yahoo is still left with a big question, according to Weiner: "If Yahoo isn't going to be known in the market as a leader in search technology, what do they want to be known as?," he said.

Being a general purpose Web portal and provider of online communications services won't be enough to make Yahoo an exciting Internet brand again and improve its competitive position, both technologically and financially, he said.

"For Yahoo to have kept up with competition in search, it would have had to spend an extraordinary amount of money, so it made the pragmatic decision to spend those resources somewhere else," Weiner said.

There are opportunities in emerging fields like connected TV, mobile and video, he said.

"The biggest question is: What now for Yahoo?," Weiner said.

Copyright © 2010 IDG Communications, Inc.

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