Drawing Scrutiny, Microsoft and Yahoo Strike a Partnership

By Cecilia Kang
Washington Post Staff Writer
Thursday, July 30, 2009

Microsoft and Yahoo's blockbuster deal to form a 10-year partnership in Internet search and advertising lands at a time when the Obama administration is taking an especially hard look at consolidation in the high-tech industry.

But the companies say it is the only way to form a credible competitor to the industry's Goliath, Google, which holds 65 percent of the market for Internet search advertising.

"We actually think this is one of those cases where us coming together will provide more competition to the market leader, not less," Microsoft chief executive Steve Ballmer said in a conference call.

The deal marks the latest move in a long dance between Microsoft and Yahoo, which have both struggled to remain relevant on the Web as Google steadily marched toward dominance in search and advertising.

Compared with Microsoft's botched attempt at a $47.5 billion hostile takeover of Yahoo last year, which led to the replacement of Yahoo chief executive Jerry Yang, this new partnership is significantly scaled back. Yahoo will use Microsoft's new search engine, Bing, as the underlying technology on its popular content sites. That gives Microsoft instant access to Yahoo's millions of daily visitors. Yahoo, meanwhile, will abandon its expensive search business and focus on building content for its sites. It will also handle sales of premium advertisements for both companies.

The deal also ramps up the rivalry between Google and Microsoft, which compete in multiple high-tech businesses, including mobile operating systems, online documents and Web browsers. Much of their battles have taken place in Washington, where Google opposed Microsoft's proposed takeover of Yahoo last year, arguing that the deal would reduce competition in e-mail, instant messaging and search businesses where the two firms compete. Microsoft protested Google's ad partnership with Yahoo last year, which eventually was withdrawn after months of regulatory review.

The Obama administration has promised to increase scrutiny of anti-competitive practices in the high-tech industry. The Justice Department is reviewing Google's settlement with book authors and publishers, which would give Google the rights to millions of digital books. The Federal Trade Commission is investigating the broad ties between potential competitors Google and Apple. Google chief executive Eric Schmidt sits on the boards of both companies.

Analysts said regulators will face complex questions in the Yahoo-Microsoft case about how the partnership will affect consumers and competition. Critics argue that the deal reduces the number of major Internet search companies from three to two, and privacy advocates have raised concerns that the partnership would concentrate data about users.

"Microsoft will need to make a good case that it cannot compete effectively against Google without partnering with Yahoo in a way that justifies the atrophy of Yahoo's search and that does not concede significant barriers," said Rebecca Arbogast, head of tech policy research for Stifel Nicolaus.

Together, the companies would draw 28 percent of all online searches, compared with Google's 65 percent, according to Internet survey and research firm ComScore. Analysts said the deal will be reviewed by the Justice Department's antitrust division or by the Federal Trade Commission and could also face scrutiny by antitrust regulators in the European Union. Microsoft is being investigated by the E.U. for bundling its Internet browser, Explorer, with its dominant Windows operating system.

Already, Congress has shown interest in the deal. Sen. Herb Kohl (D-Wis.), chairman of the Senate Judiciary Committee's antitrust subcommittee, said the partnership "warrants our careful scrutiny." In a statement, Kohl said members of the subcommittee are "concerned about competition issues in these markets because of the potentially far-reaching consequences for consumers and advertisers."

Microsoft and Yahoo said that they will submit their proposal for review by antitrust regulators and that they hope to gain approval by early 2010, arguing that competition concerns should be diminished from those about the merger attempted last year. "The difference here is that this transaction is about paid search and algorithmic search," said Brad Smith, Microsoft's general counsel. "The companies will continue to compete aggressively in other things such as portals, e-mail, instant messaging and display advertising."

Yahoo may have found itself with the short end of the bargain, analysts and legal experts said. Compared to the $47.5 billion in cash offered last year, this partnership does not give Yahoo much-needed funds upfront. And while it was being actively courted last year for its greatest asset -- the millions of visitors to its popular home page, news, finance and other sites -- its new leadership under chief executive Carol Bartz recognized that market conditions have changed and that it needed to strike a deal with Microsoft to regain its footing.

"Yahoo is one of the most attractive destinations on the Internet, but they ended up as kind of a pawn in this battle between Google and Microsoft, both with very big cash reserves," said Carl Howe, director of consumer research at research firm Yankee Group. "They used to be hot kid on the block and now they are like, 'Oh gee, how do we keep from looking old?' "

Shares of Yahoo fell 12 percent Wednesday, to $15.14. Microsoft's stock edged up 1.4 percent, to $23.80.

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