The 10-year deal announced Wednesday gives Microsoft access to the Internet's second-largest search engine audience, beefing up the software maker's arsenal as it tries to better confront Google, which is by far the leader in online search and advertising.
Microsoft didn't have to give Yahoo an upfront payment to make it happen, as many Yahoo investors had been counting on since Microsoft dangled $1 billion last summer in an attempt to forge a search partnership.
Google tried to stop Yahoo from falling into Microsoft's camp. Last year it formed its own proposed search advertising deal with Yahoo, only to be forced to retreat from that alliance after U.S. antitrust officials threatened to sue.
Now the extended reach Microsoft is gaining will let it introduce its recently upgraded search engine, called Bing, to more people. The Redmond, Wash.-based software maker believes Bing is just as good, if not better, than Google's search engine. Taking over search responsibilities on Yahoo's popular site gives Microsoft a better chance to convert Web surfers who had been using Google by force of habit.
"Microsoft and Yahoo know there's so much more that search could be," said Microsoft Chief Executive Steve Ballmer. "This agreement gives us the scale and resources to create the future of search."
Even with Yahoo's help, Microsoft has its work cut out. Combined, Microsoft and Yahoo handle 28 percent of the Internet searches in the United States, well behind Google's 65 percent, according to online measurement firm comScore Inc. Google is even more dominant in the rest of the world, with a global share of 67 percent compared to a combined 11 percent for Microsoft and Yahoo.
In return for turning the keys to its search engine over to Bing, Yahoo will keep 88 percent of the revenue from all ads that run alongside search requests on its site for the first five years of the deal. Yahoo also will have the right to sell search ads on some Microsoft sites.
Yahoo estimated the deal will boost its annual operating profit by $500 million and save the Sunnyvale, Calif.-based company about $200 million on annual capital expenditures because it won't have to invest as much in its own search technology. An unspecified number of Yahoo engineers will lose their jobs as the company scales back, Yahoo Chief Executive Carol Bartz told analysts in a Wednesday conference call.
The deal isn't expected to close until early next year, and then it could take another two years before all the pieces of the partnership are in place. The companies first will give antitrust regulators time to review the possible effects on the Internet ad market. Then they will need time to stitch together their technologies.
Microsoft is doubling down on Internet search at the same time Google is attacking Microsoft's bread-and-butter business of software for personal computers.
Google is working on a free operating system for inexpensive PCs in a move that could threaten Microsoft's Windows franchise. If it gains traction, Google's alternative, called Chrome OS, could divert revenue from Microsoft while the software maker is trying to grab more money pouring into search advertising.
Chrome OS isn't supposed to hit the market until the second half of next year.