In the now-suspended takeover fight between software titan Microsoft Corp. and Internet poster child Yahoo Inc., the winner was a heckler in the audience.
The combined companies could have created a formidable challenger to Google Inc., but the Web search king helped scuttle the deal by complaining about the potential effect on competition and by tossing Yahoo a lifeline in the form of an advertising partnership.
Now Google not only gets to watch its two biggest competitors continue to struggle, it also is preparing to bulk up by nearing a deal to place ads on Yahoo’s search engine, the Internet’s second-biggest.
“Microsoft used to set the agenda for technology, period, and Google is setting the agenda now,” Jupiter Research analyst David Card said.
People familiar with the talks said Google and Yahoo were negotiating their arrangement, which has already drawn scrutiny from antitrust regulators, in hopes of unveiling it within a week. But landing an ad partnership with Yahoo, which four years ago dumped Google to try its own hand at Web search, would give Mountain View, Calif.-based Google even more dominance: It already reaps three out of every four dollars spent on search ads in the U.S.
A distant-third-place Microsoft would be left scrabbling for mergers or partnerships with AOL and other second-tier players in the $26-billion online-advertising industry.
Small wonder then that Google lifted its voice from the pews to object to the MicroHoo marriage, and why its executives were happy when Microsoft withdrew its bid Saturday after failing to agree on a sale price.
Yahoo shares tumbled $4.30, or 15%, to $24.37, and Microsoft shares slipped 16 cents to $29.08. But Google rose $13.61, or 2.3%, to $594.90.
Jay Wong, a portfolio manager with Los Angeles-based Payden & Rygel, which owns Google shares, said the failure of the Microsoft-Yahoo deal solidified Google’s spot as the top search engine and would allow the company to continue to grab market share from both Microsoft and Yahoo.
“Google can now go back to eating Yahoo’s lunch uninterrupted,” Wong said, adding that an advertising deal with Yahoo could lead to “bigger and better things for Google going forward.”
When Redmond, Wash.-based Microsoft announced its unsolicited $44.6-billion bid to acquire Yahoo on Feb. 1, some analysts predicted that Google might actually benefit from the resulting distraction. Instead of focusing on customers and advertisers, they said, the Google competitors would have to spend too much time melding their disparate products, cultures and technologies.
Still, Google mobilized quickly to fight the proposed deal. The company’s general counsel, David Drummond, publicly raised antitrust questions, citing Microsoft’s past problems with federal charges of anti-competitive behavior.
“Could Microsoft now attempt to exert the same sort of inappropriate and illegal influence over the Internet that it did with the PC?” he wrote on Google’s official blog.
Google also started putting its bulked-up Washington lobbying operation to work.
“They approached me and said, ‘We want your help stopping any deal,’ ” said Jeff Chester, executive director of the Center for Digital Democracy, a public interest group. “They dismissed my concern about their growth. They said, ‘It’s Microsoft.’ There is no recognition on Google’s part that they are an emerging digital monopoly.”
More than the threat of a big lobbying push, Google’s recent two-week test with Sunnyvale, Calif.-based Yahoo on search ads changed the dynamics of Microsoft’s pursuit, said Scott Cleland, president of Precursor, a technology research and consulting firm. The test allowed Yahoo to say it had an alternative plan to increase profit, even if it came at the expense of a core business strategy.
In his letter to Yahoo Chief Executive Jerry Yang announcing Microsoft’s withdrawal, CEO Steve Ballmer said a completed search-ad arrangement between Yahoo and Google would make an acquisition “undesirable to us.”
Yahoo’s failure to strike a deal with Microsoft infuriated some of its investors, who sent Yahoo’s shares down 15% on Monday. Some are pressuring Yahoo to reopen talks with Microsoft, which had been willing to pay a big premium.
Google’s triumph, at least for now, continued a string of victories. One was outbidding Microsoft for DoubleClick Inc., a leader in ad technology. Another was getting the Federal Communications Commission to require the winner of an auction for a major chunk of wireless spectrum to open its network to all services and devices. That move will boost Google’s efforts to get into the mobile phone business.
“They are doing things that are giving them small victories, and small battles make up the war,” Standard & Poor’s analyst Scott Kessler said.
Google declined to comment. Its executives have said that dominance in an Internet business is never as solid as in retail or manufacturing, because competitors are only a click away.
Google and Yahoo are crafting their ad partnership to include defenses to an antitrust challenge, according to people close to both companies who spoke on condition of anonymity. Yahoo’s own ads might continue to appear alongside Google’s, and the arrangement might be limited in geography or in the number of search terms affected.
The deal probably also would have some type of open bidding so that any advertising company could place ads with Yahoo search results.
Even in the absence of such a deal, research firm EMarketer Inc. expects Google’s ad revenue to grow by 32% this year, easily outpacing Microsoft’s 22% increase and Yahoo’s 8%. “Rarely does one company dominate a market so much,” analyst David Hallerman said.
Although Microsoft and others complain in Washington that Google is getting too powerful, its control of the search advertising business won’t guarantee success in other forms of Internet advertising.
EMarketer expects paid search to remain at about 40% of the overall market, with ads on Web video and mobile services increasing in importance.
“Google’s a one-trick pony, though it’s a really good trick,” Jupiter’s Card said.
Additionally, online advertising won’t necessarily end up as the linchpin of the technology ecosystem.
Some analysts foresee a collision in computing over the Internet, with Microsoft wielding its lock on personal computers and Google bearing Web services. But others say that software isn’t going to go away and that Google’s forays into Net-based word processing and the like haven’t drawn blood.
“Microsoft is first and foremost a software company, as opposed to an online advertising company,” said analyst Jeff Donlon of Manning & Napier Advisors Inc., which has stakes in both Google and Microsoft. “Although much has been made of a growing link between the two, I believe the link is very untested.”
Microsoft’s managers “don’t need to win in online advertising,” he said.
Google’s efforts to scuttle the Yahoo takeover might also have hurt the company’s standing in Washington, where regulators already are concerned by its growing might.
“This has further solidified Google’s commanding lead in the market,” said the Center for Digital Democracy’s Chester, who planned to ask regulators to block any Google-Yahoo deal. “There’s no competitors now.”
Menn reported from Los Angeles, Puzzanghera from Washington and Guynn from San Francisco.