July 30, 2009 / 12:06 AM / 8 years ago

Yahoo-Microsoft alliance faces many obstacles

SAN FRANCISCO (Reuters) - It took Microsoft Corp (MSFT.O) and Yahoo Inc YHOO.O several years to find common ground on the best way to team up in the Internet search market. Now comes the hard part.

The partnership announced on Wednesday seeks to challenge the dominance of Google Inc (GOOG.O), but executives at Yahoo and Microsoft acknowledge that building a search powerhouse will be a multi-year effort -- in a business where staying ahead of the competition, not playing catch-up, is critical.

And unlike previous discussions which involved an outright acquisition of Yahoo by Microsoft, this deal will create a number of uncertainties for both companies as they fuse disparate technologies, cultures and business priorities.

Yankee analyst Carl Howe said integrating two separate search engines is an inherently thorny process that requires merging vast and often incompatible indices of Web data.

"One of the ways they could have made this simple was to say 'We're throwing away Yahoo's search engine and going with (Microsoft's) Bing,'" he said.

"Ask any two banks that have ever been through a merger," Howe said. "The announcement of a merger is easy, it's combining the back end that takes years."

Under the terms of the 10-year deal, search on Yahoo's websites will be generated by Microsoft's new Bing search engine. Microsoft will license Yahoo's search technology, allowing it to integrate certain aspects of it into Bing.

Microsoft's advertising search product, AdCenter, will also replace Yahoo's equivalent product, Panama.

The two companies together would hold roughly 30 percent of the U.S. search market, which makes their combined audience a more attractive place for marketers to spend their dollars.

"The pieces are all there. Microsoft has a great product already developed. Yahoo has a massive audience," said Bob Davis, a partner at Highland Capital Partners and the former CEO of search engine Lycos.

But integration will be a lengthy and potentially distracting process.

Yahoo and Microsoft projected the complete, worldwide transition will take up to 24 months after the deal's closing and clearance by government regulators expected in early 2010.

ENGINEERS RELOCATE?

Many Yahoo search engineers will be asked to take jobs at Microsoft, whose Redmond, Washington headquarters is far removed from Yahoo's California homebase.

A Microsoft representative would not say where the company's search efforts were based, but noted that the search team is located in various offices including Silicon Valley.

"It ties them together but in a complicated way with no long-term certainty and limited control," said Ryan Jacob, chief investment officer of Jacob Asset Management, which owns Yahoo shares.

"I was in the camp that thought Microsoft should have just bought them. As a Yahoo shareholder, that would have been the best outcome. From Microsoft's standpoint, what happens if Yahoo decides to go somewhere else?" he added.

Any hiccups or technical glitches that affect search results or ad placements while the new technology is being rolled out might not sit well among advertisers.

Yahoo said the deal will allow it to save $200 million in capital expenditure and boost annual operating income by $500 million. Those cost savings could be crucial to a company that has seen revenue growth stall and profit margins shrink.

The benefits to innovation are less clear though, said Boston University Professor N. Venkat Venktatraman.

"What they should watch out for is Google coming into it with new innovations that these two companies independently do not know how to respond to, and collectively may not have gotten their processes for innovation in tune," said Venkat Venktatraman.

Yahoo CEO Carol Bartz said handing off search technology to Microsoft will free Yahoo to invest in its websites, display advertising products and mobile products.

But an increasingly vital ingredient in developing such products is the data that's gleaned from search queries, which can be used to create more targeted experiences for users.

Bartz and Microsoft CEO Steve Ballmer said determining how search data is shared between them was the most complex part of the negotiations. But the specific details are vague.

"Are they giving up the rights to use the search data that powers display advertising? That's still not clear," said Brigantine Advisors analyst Colin Gillis.

Reporting by Alexei Oreskovic, editing by Tiffany Wu

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