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Another Try for a Microsoft and Yahoo Deal

Yahoo's Carol Bartz and Microsoft's Steve Ballmer are in early talks for an Internet search and advertising agreement

In a development that can't be too surprising but may revamp the Internet landscape, Yahoo (YHOO) Chief Executive Carol Bartz and Microsoft (MSFT) CEO Steve Ballmer have started talking about forging Internet search and advertising deals.

First reported by Kara Swisher in a post on the AllThingsD blog Boomtown on the morning of Apr. 10, the talks are at an early stage. They include "many scenarios, such as one in which the companies swap online advertising assets and deliver services to each other," Swisher wrote. Yahoo "might take over all of Microsoft's display and premium advertising business to sell along with its own, while Microsoft would run the search advertising business for the pair."

One source close to the situation said the talks are preliminary. They don't involve Microsoft buying Yahoo outright. Neither is a simple outsourcing of Yahoo's search to Microsoft likely, because Yahoo under Bartz has made it clear the company considers its search business, which trails far behind Google's (GOOG) but is far ahead of Microsoft's, a valuable asset it wouldn't easily part with.

Yahoo's Search Data

Microsoft has repeatedly indicated in recent months that it's still interested in a search deal with Yahoo. But the appointment of Bartz as the new Yahoo CEO in January, replacing co-founder Jerry Yang, effectively put further discussions on hold while Bartz found her footing.

It's believed that any deal Bartz would agree to would have to allow Yahoo continued access to data on Yahoo searches. That data is exceedingly valuable for mining buying intentions. Yahoo aims to use search data to help it more precisely target pictorial display ads, its mainstay business, to the most likely prospective customers. Such targeting is a key way Yahoo and others hope to boost display-ad rates, which have seen precipitous drops in recent quarters. As Bartz said in an early March interview at a Morgan Stanley (MS) conference: "Search data is extremely important."

Several people have suggested the attractiveness of a larger partnership between the two companies, in which Microsoft would handle all search ads for the two companies and Yahoo would take over display ads for the pair. But it's not clear whether that big an arrangement, which could be complex, is under serious discussion.

Not least, for Yahoo any deal would also have to include a whopping big check from Microsoft and likely ongoing payments. Yahoo probably wouldn't want such a deal to continue indefinitely, since if the arrangement allowed Yahoo to invest in and strengthen other parts of its business, it would want to retain the ability to take back control of search in the future—or at least play Microsoft off Google. A deal for Google to place ads on Yahoo search results imploded last summer, abandoned by Google when it was faced with the threat of an antitrust lawsuit by the Justice Dept.

Shareholder Pressure

For all those reasons, a Yahoo-Microsoft deal could take some time to work out. What may make it happen this time is that the two companies more than ever need each other to compete with Google, whose share of Internet searches remains as high as 72%—and whose share of search advertising revenues likely tops 80%. With search slowing and Yahoo and Microsoft continuing to lose ground to Google, shareholder pressure on the two companies to find common ground seems sure to rise.

Meanwhile, Yahoo faces the potential loss of search market share in the coming year and a half as its agreement with Hewlett-Packard (HPQ) and Acer to promote its browser toolbar expire. Because Yahoo is the default search engine on those toolbars, the end of those deals could eliminate some search traffic to Yahoo.

Microsoft, on the other hand, has hired a number of Yahoo search executives and engineers, including Qi Lu, now head of all of the Redmond (Wash.) company's online businesses. And it's preparing for a summer launch of a major new version of its search engine.

Stocks didn't trade Apr. 10, Good Friday, so it's not yet known what shareholders think of the new development. Whatever the particulars of any deal, they're less likely than last year's acquisition talks to get leaked until they're pretty much wrapped up. "I said this to Mr. Ballmer: I'm not going to negotiate with my 50,000 favorite friends," said Bartz recently: "We are going to negotiate as companies negotiate, and that is privately." But apparently not as privately as she would like.

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