Microsoft-Yahoo: Desperation Sets In

The latest talks clearly suggest Microsoft lacks a Plan B to compete with Google in search, while Yahoo is feeling the heat from Carl Icahn

Microsoft Chief Executive Officer Steve Ballmer. David Hecker/AFP/Getty Images

by Jay Greene

When Microsoft announced May 3 that it was dropping its $47.5 billion bid for Yahoo (BusinessWeek.com, 5/3/08), executives said the company had "moved on." Clearly, the company has barely budged.

Microsoft's May 18 announcement that it's discussing a different transaction—not an outright acquisition—with Yahoo shows how desperate Microsoft (MSFT) is in efforts to contend with Web search juggernaut Google (BusinessWeek.com, 5/8/08). "Microsoft really does not have a Plan B, especially to win in search marketing," says Collins Stewart analyst Sandeep Aggarwal. Adding to pressure on Microsoft is the prospect that Yahoo (YHOO) may soon strike its own Web search-related deal with Google (GOOG).

Discussions between Microsoft and Yahoo likely involve some combination of the companies' search operations. In April, when Microsoft executives traveled to California to negotiate an acquisition, their Yahoo counterparts proposed a more limited partnership, focused on putting together search businesses, according to one source. Microsoft was more interested in buying the company outright, so those discussions didn't progress—though they appear to have taken on new life amid pressure from billionaire investor Carl Icahn, who has nominated a slate of directors he hopes will replace Yahoo's board and be more amenable to a Microsoft buyout (BusinessWeek.com, 5/15/08).

How to Gain on Google?

It remains unclear how Microsoft and Yahoo would put together their businesses. Joining forces would give both companies much needed scale, offering up a larger slice of the search market to would-be advertisers. Even then, the combined search businesses would pale next to Google's business. In April, queries on Google's search engine accounted for 62% of all searches conducted in the U.S., compared with just 17.5% for Yahoo and 9.7% for Microsoft's search engines, according to industry research firm Neilsen Online. What's more, Google grew faster than Microsoft, while Yahoo lost ground.

One possible scenario involves the acquisition of Yahoo's search-ad business, according to news reports. But removing search-ad operations would leave behind an unattractive business, says Todd Dagres, general partner with Boston-based venture capital firm Spark Capital, which invests in media, entertainment, and technology firms. "What's left after you take out the search piece is a portal. And portals are kind of the walking dead," soon to be replaced by fragmented, distributed content.