Beyond Binary

Microsoft's top lawyer said that a tentative agreement with Brussels announced earlier Wednesday could potentially allow the software maker to move out of the regulatory crosshairs, perhaps paving the way for regulators to shift their attention elsewhere.

"It's important for us to get closure in Europe on issues that have obviously been controversial for over a decade," General Counsel Brad Smith said in an interview. "Today's decision takes us an important step closer to doing that."

Smith

(Credit: Microsoft)

Microsoft initially took a much different approach to the European Commission's assertion that the inclusion of a browser in Windows violated antitrust law. The company had initially proposed just stripping out the browser from Windows 7 entirely, leaving users the prospect of trying to get a browser on their own. The software maker eventually backed down after indications that that approach was unlikely to fly.

While not final, Microsoft's moves would appear to resolve all of its outstanding regulatory issues with the Commission and were greeted warmly by regulators on Wednesday.

Although most of the early attention focused on the agreement around a browser "ballot screen," Microsoft also announced on Wednesday an agreement around product interoperability. Under that deal, a 10-year commitment by Microsoft, the software maker agrees to publish communication protocols and adopt certain standards as part of Windows, Windows Server, Office and other high market share products. Companies could also purchase for 5,000 euros a warranty that would subject Microsoft to court oversight and monetary penalties if it doesn't live up to its commitments.

Smith said that the approach Microsoft took with regard to interoperability was designed to adopt methods that Nellie Kroes, commissioner for competition, had outlined in a speech last year for how companies with high market share products should behave.

"I actually think this in effect implements the model that the Commission has been advocating," Smith said. Moreover, he said it is a model that other software companies should pay attention to, he said, noting that there are lots of companies that have high market share. He noted that Google has 78 percent of the paid search market and IBM has 100 percent of the mainframe market, while Adobe also has dominant positions in certain areas, such as Photoshop.

"It is important we believe to create a level legal and regulatory playing field," Smith said. "Everyone that has a high market share needs to respect the same set of rules. I think a number of these rules are likely to be applicable to other companies and other products."

Settling now with Brussels also could help Microsoft in its effort to win approval for its search deal with Yahoo, Smith said.

"This certainly isn't going to hurt when it comes to the Yahoo-Microsoft agreement," he said. "It's not necessarily going to make a huge difference. We didn't feel a particular step was needed to help it along."

Microsoft is in the process of trying to ascertain whether the deal needs approval from Brussels or from individual European antitrust authorities. It also needs approval from U.S. regulators, who have asked for more information on the deal.

REDMOND, Wash.--In the wake of Microsoft's search deal with Yahoo, online chief Qi Lu outlined why the business is so important to Microsoft and how the company hopes to make headway.

For one thing, he promised the crowd of financial analysts, it can be a huge money maker.

Lu

"When you are at scale it can be a hugely profitable business," Lu said.

The problem is that many of the costs are the same even if you are not operating at scale, which is the place Microsoft has found itself. "Even if you have one user you have to crawl the whole Web."

But the challenge goes further, he said, noting that smaller players, by their nature, have fewer ads to show, meaning those ads are less relevant and the search experience is not only less profitable, but less desirable for users.

The Yahoo deal will help Microsoft in the scale arena. Combined, the two companies would have more than triple the search share that Microsoft has on its own. That said, the combined entity still has less than half of Google's share.

"With larger scales there are several important advantages," Lu said. "There is an almost immediate lift in the quality of user experience."

For example, suggested searches are based on a fairly simple algorithm, but one that gets much better the more queries a search provider sees.

But, even beyond the scale issues, Lu acknowledged that Microsoft also faces a brand challenge. He said that studies show that given a choice between Google's brand with another provider's results and Google's results with another provider's brand--users will choose the Google name, which has become synonymous with search.

"People will prefer the Google brand because of the strength it has," said Lu, who joined Microsoft from Yahoo at the end of last year.

Answering those challenges won't happen overnight, he said.

"We want to be brutally honest about where we are," he said. "It's going to take time."

Microsoft relaunched its search engine as Bing in June and has seen a slight bump in market share, though it remains to be seen whether it can hold onto and build on that initial interest.

"Overall the early feedback from the market has been encouraging," Lu said. "It's a good step, but it's the first step in a long, long journey."

(Credit: Microsoft)

Microsoft's search deal with Yahoo is the culmination of months of well documented negotiations, but in many ways, it is just the beginning of the long road ahead.

In the coming months, Microsoft and Yahoo will not only have to win regulatory approval for the deal, but also figure out how to bring together disparate approaches to the search market.

Microsoft has spent much of its energy in the last couple years refining its core technology, improving in vertical categories, and rebranding its Web search under the Bing moniker. Yahoo, meanwhile has put a lot of energy into tools that allow others to build on its technology, including the BOSS (Build your Own Search Service) and SearchMonkey efforts.

Mehdi

As part of the deal announced on Wednesday, Microsoft will now be responsible for trying to merge those efforts. In an interview, Microsoft Senior Vice president Yusuf Mehdi said Microsoft hasn't looked at the specific lines of code in that area, but is open to trying to take Yahoo's best ideas and integrate them into Bing.

"We like the approach that Yahoo has done," he said, referring to SearchMonkey and BOSS.

Both Mehdi and Yahoo Executive VP Schneider acknowledged that there are integration challenges, but Schneider said there is a clear delineation of who is responsible for what.

"At the same time we are integrating, we are really divide-and-conquering," Schneider said in the joint interview with Mehdi. "The reality is in the way we structured (the deal), it allows each of us to innovate in the areas that will jointly bring advantage."

The fact that the companies have already spent time thinking about these issues reflects the different nature of the discussions this time around.

Whereas last year's negotiations were done with Yahoo's board and a keen eye on Wall Street, the deal announced on Wednesday is much more focused on how to build a search business for the long term.

CEO Steve Ballmer noted on the conference call earlier Wednesday that the two sides have a 100-page playbook as opposed to a two-page term sheet and also noted that the negotiations were handled by management as opposed to representatives of the company's boards.

Schneider

In addition to being run by the top management from Microsoft's online group, including Mehdi, Senior Vice President Satya Nadella, and online unit President Qi Lu (a former Yahoo executive), Mehdi and Schneider said the negotiating teams routinely called on the companies' engineering and sales ranks to make sure the deal they were structuring made operational sense.

It wasn't just the typical few business development executives in a room hashing out financial details, the pair said. "We really have got a great vibe with Yahoo's operating team," Mehdi said.

The two companies will be able to do some work on their joint plans while the deal is pending, but there are limits as to how much collaboration can take place.

"We will do all of the pre-work that we are allowed to do in terms of preparing," Mehdi said. "We feel like we can make a lot of progress."

Ultimately, though, the two companies said they expect just integrating Bing's results into Yahoo in the U.S. will take several months, while moving from Yahoo's Panama ad-serving technology to Microsoft's AdCenter could take a year. It could be two years from the deal close before the two companies can fully implement the deal across the globe.

Microsoft's Mehdi didn't close the door on an eventual expansion of the deal into some of the areas the two companies had at one point considered, such as joint work on display advertising.

"Today is a start on a fantastic partnership which we are very excited about," Mehdi said. "By starting this partnership it allows us to over time build greater and deeper relationships. Right now the focus is on getting to a credible No. 2 player in search and paid search."

One of the open questions is what will happen to each company's business and workforce during the time that the deal is pending. Schneider said the companies have a communications plan for employees as well as the sorts of retention bonuses planned to keep key employees in place.

"We believe this is a winning plan," she said. "People want to be part of a winning vision."

Ultimately, Yahoo CEO Carol Bartz said some of Yahoo search employees will move to other parts of the company, some will be offered jobs at Microsoft, while others will eventually lose their jobs.

For his part, Mehdi said the company will continue to beef up its search staff while the deal is pending. "We are continuing to hire and invest in search."

Roughly 18 months after the word Microhoo entered the technology lexicon, the two companies finally have a partnership to speak of.

As part of a 10-year pact announced early Wednesday, Microsoft's technology will power the two companies' search sites, while Yahoo will handle ad-selling duties.

Executives from both companies will discuss the deal in a conference call from Yahoo's headquarters in Sunnyvale, Calif., at 5:30 a.m. PDT. Follow the live coverage here.

5:32 a.m.: Still listening to meditative hold music. They really could use something more upbeat.
5:33 a.m.: Getting the details on how conference calls work. Apparently we'll be in some sort of "listen-only mode."
5:34 a.m.: There will be some forward-looking statements. (Stuff they predict may or may not happen.)
5:35 a.m.: Yahoo CEO Carol Bartz says deal is a game changer "and I'm glad to finally be able to talk about it." She added: "We face a formidable competitor in one area and that area is search."
5:37 a.m.: Yahoo's sales force will handle sales of both sites' search. Self-serve ads will be fulfilled via Microsoft's AdCenter.

"What this deal is really about for everyone is scale," Bartz said. By combining, they can deliver a viable alternative.

Funny how it's all about Google, but she's not naming Google.

"Everyone wants a real alternative and advertisers are no different," Bartz said.

"Powered by Bing" will appear at the bottom of the Yahoo search results.
5:40 a.m.: "This agreement has been a longtime coming," CEO Steve Ballmer said. Um, yeah.

Ballmer continues: the bottom line is the agreement will enable us to create more innovation in search, better value, and world peace. (Maybe not the latter. Remember, these are forward-looking statements.)

It's apparently a win-win.

"Both companies benefit from scale and better economics. Consumers really will get better products," Ballmer said.
5:42 a.m.: Bartz talking nitty-gritty details. Both companies will have separate display-ad sales forces. Microsoft will pay Yahoo 88 percent of revenue for search ads on Yahoo sites.

"Our revenue will come down a bit due to revenue sharing," Bartz said, but added that operating income should rise, expenses drop, etc.

"This deal won't happen overnight," Bartz said. First, the companies will have to convince regulators it's a good thing.

Assuming they get the OK, the companies will start with major markets, including the U.S., which will transition to using Bing results in 3 to 6 months. Shifting from Yahoo's Panama paid search tool to Microsoft's AdCenter will take 12 months. Full global roll-out should take 24 months.
5:46 a.m.: On to the Q&A.

So why not display advertising? "We wanted to keep this as simple and straightforward as possible," Bartz said.

"We're taking a big bite here," Ballmer said. "Search is a more well-known thing" when it comes to automating the ad-selling.

How big is the revenue-per-search gap? (Microsoft is guaranteeing a certain amount of revenue for each search query to Yahoo.

"We and Yahoo are sort of close and we both lag Google," Ballmer said. Some of that is scale, he said which will be helped by deal.
5:49 a.m.: Why no "boatloads of cash" from Microsoft. Why wasn't there an up-front payment?

"Having a big cash payment up front doesn't really help us from an operating standpoint," Bartz said. As far as we're concerned, she said, the "boatloads of cash" is preserving our revenue line.
5:51 a.m.: The two companies have talked about the financial impact to Yahoo, but what about Microsoft?

Ballmer acknowledges that most of the revenue from Yahoo's search results will go back to Yahoo. "We paid a high TAC rate," he said, referring to traffic acquisition costs and the 88 percent of revenue that Yahoo will get.

Microsoft will spend "a couple of hundreds of millions" of dollars for implementation and transition costs "We're sort of betting into the future," Ballmer said. The upside, he said, is better relevance. "Ads are part of being relevant and we have a better chance of being relevant." Ballmer said it should improve relevance on both sites. The upside comes as execution really builds.

"There's a lot of work involved in this transition to our platform," Ballmer said.
5:56 a.m.: Any opposition in Washington?

"We expect we will face some opposition from...the competitor," Ballmer said. (Assuming he is talking about Google and not Ask.com)

Ballmer said that the deal benefits advertisers, publishers, and consumers.

"Obviously, we will be called to present that case in D.C. and Brussels and other places," Ballmer said.
5:58 a.m.: What about impact on jobs?

"There are certainly many Yahoo search employees that will be asked to take jobs at Microsoft as they integrate the technology," Bartz said. "There will also be search employees that we look to help us on the display side... And then unfortunately, there will be some redundancies in Yahoo."

Nothing will change until we get regulatory approval, which we hope is in early 2010, Bartz said. "There will be redundancies, but it will be in the future." Bartz didn't give an estimate of how many jobs will be lost.
6:01 a.m.: The most complex part of the deal, Ballmer said, is around protecting privacy and allowing both companies to build their products around search.

"You really have to say what data gets shared and how does it get shared," he said.

6:03 a.m.: How can Yahoo innovate if Microsoft is in charge of the technology?

"There is a lot of innovation that happens above the search results," Bartz said.
6:04 a.m.: What does this mean in terms of mobile and platforms beyond the Web?

"We spent time talking about mobile," Bartz said. "We have the option of using the Microsoft technology for the mobile Web experience. It's not exclusive as it is on the PC. The only difference is it is not exclusive. If somewhere down the road we wanted to switch, we could."
6:06 a.m.: What is the rate when Yahoo sells on Bing.com? What is the risk and impact on Yahoo's affiliates? What about all of the 800,000 advertisers that are running their campaigns only on Google.

Yahoo actually doesn't get split of Bing revenue.

"When the Yahoo sales people sell (they) don't know whether will sell on Yahoo or Bing," Ballmer said. "You are buying the keyword in both environments."

As for Google-only advertisers, Bartz said that combining Panama and AdCenter will help. "Smaller advertisers want to make sure there's a meaningful market, and they don't want to learn three platforms."

Ballmer said that the bulk of Google-only advertisers are outside the U.S. where the companies have even less share. Google has 78 percent of the paid search market here, but in Western Europe, Ballmer said, it is more like 92 percent.
6:12 a.m.: How much code will come from Yahoo vs. Microsoft's Bing. Our engineers know Bing, Ballmer said, but he added that Microsoft will be getting access to any technology from Yahoo. "We have a license to code."

Ultimately, though, Ballmer said, Microsoft will have to make those choices and build a product that is financially more successful than its current search effort. "The burden is on us to deliver the goods."
6:17 a.m.: Why is this deal better than one on the table last year.

"I've done some exploring of that," Bartz said. "There's actually more fiction in the market than there is fact."

The search partnership discussed last year would have had a big up-front payment, but would have generated less revenue over the long term for Yahoo.

"We really are trying to run a long-term business here," Bartz said.

Ballmer noted that last year's deal was negotiated more by the boards than by the operating management.

"The deal is different...For Microsoft, this deal is not better, but this deal is different," Ballmer said.
6:21 a.m.: Who will be in charge of execution?

There will be a team from both sides, Bartz said.

"This is not a minor project," Ballmer agreed. "This is a major execution (challenge)," he said, noting that for Microsoft, the team will include the top leadership of the online business, including former Yahoo executive Qi Lu.

"It's not like we come here with a two-page term sheet," Ballmer said. "I think we have well over 100 pages written to describe what we are doing."

Bartz acknowledged that a partnership is harder in some ways than going it alone. That's why the companies wanted to make sure they were really committed to one another.

"Dating is one thing," she said. "Having a partnership is another."
6:28 a.m.: Call ends, with a pitch for the companies' joint Web site www.choicevalueinnovation.com. (I guess ButItsNotGoogle.com was taken.)

Yahoo CEO Carol Bartz and Microsoft CEO Steve Ballmer were all smiles on Wednesday morning.

(Credit: Yahoo/Microsoft )

Microsoft CEO Steve Ballmer uses a giant pen to sign the 10-year deal, alongside Yahoo CEO Carol Bartz, on Wednesday at Yahoo's headquarters in Sunnyvale, Calif.

(Credit: Yahoo/Microsoft )

After months of fits and starts, Microsoft and Yahoo on Wednesday announced a 10-year search deal that will see the two companies join forces to take on Google.

"In simple terms, Microsoft will now power Yahoo search while Yahoo will become the exclusive worldwide relationship sales force for both companies' premium search advertisers," the companies said in a joint statement. The deal is expected to go into effect in 2010 and improve Yahoo's profitability, though not its revenue, the companies said.

Less expansive than the all-out, $44 billion acquisition Microsoft proposed last year--and even than some of the search partnerships once discussed--the deal does allow the companies to share resources and combine their engineering efforts. Even together, however, the two companies have only about 30 percent of the search market compared to Google, which has more than twice that amount.

"This agreement gives us the scale and resources to create the future of search," Microsoft CEO Steve Ballmer said in a statement. "Success in search requires both innovation and scale. With our new Bing search platform, we've created breakthrough innovation and features. This agreement with Yahoo will provide the scale we need to deliver even more rapid advances in relevancy and usefulness."

Yahoo CEO Carol Bartz, meanwhile, said that the move will help Yahoo focus on other areas, also adding that the deal has the full support of the company's board (lest anyone wonder what Carl Icahn thinks about the more limited deal).

"This is a significant opportunity for us," Bartz said. "Microsoft is an industry innovator in search and it is a great opportunity for us to focus our investments in other areas critical to our future."

Editors' note: The two companies had a conference call Wednesday morning to discuss the deal. Click here for our live-blog coverage of that event.

The dollar value
As for the financial terms, there is not the large upfront payment once discussed. However, Microsoft will offer both revenue guarantees to Yahoo as well as the lion's share of the search-advertising revenue generated on Yahoo's site.

That apparently wasn't enough to satisfy investors. In trading before the market opened, Yahoo's stock dropped more than 7 percent, or $1.28, to $15.94. Microsoft rose 1 percent, or 24 cents, to $23.71.

Yahoo will get 88 percent of search revenue created by its sites during the first five years, while Microsoft will guarantee a certain level of search revenue for 18 months in each country. The companies expect it will take about two years after the deal is approved to fully get the partnership up and running.

Once fully in place, Yahoo said it expects the deal will boost its annual operating income by about $500 million, while reducing capital expenditure by $200 million and increasing operating cash flow by about $275 million per year.

Microsoft will be able to incorporate Yahoo's search technology, including its Panama ad-selling tool, but the companies will use Microsoft's AdCenter sales tool and Bing search engine to power both sites.

Aiming to head off privacy concerns, the two companies noted that "the agreement protects consumer privacy by limiting the data shared between the companies to the minimum necessary to operate and improve the combined search platform, and restricts the use of search data shared between the companies."

The deal must still pass regulatory muster and the two companies anticipate it will take several months to finalize. "Microsoft and Yahoo expect the agreement to be closely reviewed by the industry and government regulators, and welcome questions," the companies said. "The companies are hopeful that closing can occur in early 2010."

Microsoft and Yahoo are joining forces in search, but in a line clearly aimed at regulators, the companies take pains to note that their collaboration is limited to that arena.

"The agreement does not cover each company's Web properties and products, e-mail, instant messaging, display advertising, or any other aspect of the companies' businesses," they said. "In those areas, the companies will continue to compete vigorously."

When things are going to take awhile, executives like to tell us that it's a marathon and not a sprint. Well, the Microhoo affair has moved beyond marathon. It's at least up to the status of multi-day cricket match.

That is to say, it has become this painful thing that we all wish would end so that we can report the final score. Ad Age says that we may well be able to hit publish on our long-ago-written deal stories sometime this week. I'm also hearing that a deal could still come this week. But I learned a long time ago not to hold my breath.

According to the Ad Age report, Microsoft reached for a glass of water after Yahoo demanded a large upfront payment (hundreds of millions of dollars) in addition to the long-term guarantees in exchange for handing search duties over to Redmond. But Ad Age reports that things got back on track late last week.

Things heated back up a couple weeks ago now and have been close but no cigar since then, according to sources all too familiar with the situation. That said, a deal could come any time now.

In essence, this boils down to the same thing every time. The two companies have to decide how to compete with Google on search. They can either go it alone or tie their fates together. Each is the other's only real move to gain scale in a business that is all about scale.

Microsoft has made it abundantly clear all along that it would prefer to add Yahoo's market share to its effort, which makes sense, since Yahoo holds on the order of twice Microsoft's market share, which tends to be around 10 percent of the search market.

It may sound like trivializing to suggest this is like a giant teenage romance, but really these things are as much about the people involved as the finances.

Yahoo has played hard to get, while at the same time trying to figure out how to be more popular. But Yahoo now seems to be happy enough with its outfit and willing to be seen in public with Microsoft, provided it is willing to spend enough to make the date worthwhile.

Now we just have to wait to see whether they pick an early breakfast or a matinee for the date and which day they pick--assuming Yahoo doesn't get cold feet again.

Microsoft and Yahoo may well reach some sort of search partnership, but any deal is unlikely to come this week, a source told CNET News.

The on-again, off-again talks reportedly heated up last week, with Microsoft executives said to have traveled to Yahoo. The All Things Digital Web site reported that things were "down to the short strokes."

Among those said to have made the Silicon Valley trip were three of Microsoft's top online executives: Yusuf Mehdi, Satya Nadella, and Qi Lu.

However, a deal has yet to materialize, and a source said on Thursday that none is likely this week.

The Wall Street Journal reported on Thursday that Yahoo's board plans to meet on Thursday for an "update" on the talks.

Yahoo CEO Carol Bartz said in May that she was open to a search deal if she believed in the partner's technology and they provided "boatloads" of money.

Microsoft CEO Steve Ballmer has indicated for more than a year now that he would like to strike some sort of search deal, although he no longer wants to acquire all of Yahoo as his company offered to do in February 2008.

Yahoo declined to comment on board meetings or matters. A Microsoft representative declined to comment

It's unclear whether they brought the requested "boatloads of money," but several top Microsoft executives are in Silicon Valley to try to finalize a search deal with Yahoo, according to an All Things Digital report late on Thursday.

According to the report, the two sides are "down to the short strokes" after years of excruciatingly well publicized on-again, off-again talks. A deal could come within a week, All Things Digital said.

Included in the Microsoft entourage, according to the report, are three of its top online executives: Yusuf Mehdi, Satya Nadella, and Qi Lu.

Yahoo CEO Carol Bartz said in May that she was open to a search deal if she believed in the partner's technology and they provided said boatloads of money. Microsoft CEO Steve Ballmer has indicated for more than a year now that he would like to strike some sort of search deal, although he no longer wants to acquire all of Yahoo as the company offered to do in February 2008.

With Microsoft's Bing getting some good reviews and Microsoft having billions in cash on hand, the ingredients would seem to be in place, if both sides have the will to make it happen.

Microsoft has grabbed another Yahoo executive.

Operations Vice President Kevin Timmons becomes the latest to swap Yahoo purple for Microsoft blue. In his new role, Timmons will lead a data center services team, Microsoft infrastructure services general manager Arne Josefsberg said in a blog posting.

In February, Microsoft announced it was hiring Larry Heck, another VP from Yahoo. Other defectors include Microsoft online unit chief Qi Lu, along with Sean Suchter and Scott Moore (who was actually a former Microsoft worker who went to Yahoo and is now back at Microsoft).

Microsoft has said it no longer wants to acquire all of Yahoo, though clearly the company is happy to continue hiring talent from the online company. CEO Steve Ballmer has also continued to press for some sort of search partnership between the two companies.

At last month's D: All Things Digital conference, Yahoo CEO Carol Bartz confirmed the two companies continue to talk, but analysts say a deal is looking less likely.