Searching for a Winner

Welcome back to American Idol Preview, where we try to predict who will be the next Idol by looking at the businesses the competitors seem to embody. This week, we're taking a peek at their complementary Internet search engines.

Let's look over Katharine McPhee's shoulder first. She's looking for material to use in the free-choice section of this week's competition, and she's doing it with Yahoo! (Nasdaq: YHOO  ) . Her service of choice features both a modern search engine and the trademark Yahoo! Directory system, giving her a couple of options for conducting her quest for the perfect song.

Yahoo! didn't exactly start out as a search engine -- it was really more of a directory -- but the company added search ability to its portfolio early on. After it acquired paid-search provider Overture, its effort to promote revenue-generating, ad-supported search kicked in with a vengeance. Today, revenue from advertising services dwarfs the direct fees that Yahoo! pulls in from subscription services and small-business-consulting operations, and the company currently controls 28% of the search market, according to the latest comScore Media Metrix numbers.

Net margin was 15% in 2003, 23% the year after, and 36% in fiscal 2005, on top of 77% average annual revenue growth over that period. That growth has allowed Yahoo! to spend more and more on strategic acquisitions, such as the stake in Chinese search specialist Alibaba, and still put away $1.3 billion of free cash flow. Nice.

Yahoo!'s heritage from its directory-based past lingers on. Many of the company's services even today rely on some human effort to pull together or directly create the content that drives traffic through Yahoo.com and its many subsites. Yahoo! searches now even tap into the user-driven Yahoo! Answers service to help deliver relevant results. That ties the most autonomous service in the Yahoo! stable back into human efforts once again. And that places Katharine's search engine in stark contrast to what Taylor Hicks is using.

Our gray-haired entertainer likes Google (Nasdaq: GOOG  ) , because it's simple, powerful, and always ready to deliver a surprise or two. Like Taylor, Google also has mass appeal -- the search giant controls 43% of the worldwide search market. There's no moderated directory structure to fall back on, and no wide-ranging portal project with original and hand-picked content. Instead, Google excels at automating its services and handing the wheel to users and third-party developers.

Having started out as a simple but potent search engine, Google has branched out into many other fields lately, including a financial information site in direct competition with Yahoo! Finance, and email and calendar applications to match Hotmail and Yahoo! Mail. It's even got a public database application, with a native payment system scheduled for debut later this year and the potential to threaten the core business of eBay (Nasdaq: EBAY  ) and Craigslist.

That broad range of services stems partly from the company policy of letting engineers spend one day a week of their working time on their own projects, affectionately known as "20% time" projects. The calendar application is one example of such projects graduating to beta status, where many Google applications spend a long time before becoming official releases. Gmail is still in beta, more than three years after becoming accessible to the public on an invitation basis.

Many of these business practices sound unusual, and they are. Google prides itself on not doing business like everybody else, and even its IPO was conducted as a thoroughly unconventional Dutch auction. The stock enjoyed a spectacular ride straight up from the $80 IPO pricing to more than $470 a share nearly 18 months later. The "don't be evil" credo seemed to be working, and everything Google touched turned to virtual gold.

A couple of PR setbacks and its first missed earnings estimate, coupled with sky-high valuation ratios, brought some sanity back to the stock price earlier this year. It's still anyone's guess whether the current share price represents a fair value or not, but it's worth pointing out how Google is working to diversify its income stream and bring in revenue from new sources very soon.

The purchase of dMarc Broadcasting in February gave Google an entry into traditional media advertising, and there are ongoing trials of print ads as well. With a presence in the Intel (Nasdaq: INTC  ) Viiv platform as well as search and advertising agreements with companies such as TiVo (Nasdaq: TIVO  ) and Motorola (NYSE: MOT  ) , it seems as though Google is ready to break out of your computer screen and leap onto your cell phone, into your living room, out of your car stereo, and everywhere else it can bring its expertise in targeted advertising to bear.

Net margins are accelerating, much like Yahoo!'s, from 7.2% in 2003 to 24% last year. It's getting to the point where there are rumors about other online giants hammering out alliances to keep the Google threat to their own businesses at bay. One such alleged deal involved Yahoo! selling a stake in its advertising services to Microsoft (Nasdaq: MSFT  ) , though Yahoo! management has since said that doing so would be "like selling your right arm while keeping your left; it does not make any sense."

That leaves Elliott Yamin's search provider, Microsoft, struggling to keep up with the two leaders. Elliott is the most businesslike Idol contestant in recent memory, and his decision to sing "Trouble" in the Elvis round, with memorable lines like "I'm evil, evil, evil as can be," makes Google's arch-rival a natural choice for reasons of business reputation as well. At least in tech circles, Microsoft has a certain degree of notoriety for the ruthless methods it uses to gain and protect its market shares. Its efforts have even made it the target of legal action.

Now, Microsoft doesn't depend on its online services the way Yahoo! and Google do. The operating-systems and office-software businesses alone make the two search rivals look like small potatoes. But online is where the growth is, so the MSN network is getting some serious backing from upper management. CEO Steve Ballmer recently said he has a goal of having MSN AdCenter catch up to the revenues of Google's AdWords and Yahoo! Search Marketing within five years. That's a tall order, even for a company with Microsoft's deep pockets and worldwide mindshare.

MSN doesn't have a storied past or even a recent history of groundbreaking innovation. The latest upgrade to MSN's search technology is Windows Live Search, a good-looking but somewhat counterintuitive new service that also leverages the Windows brand name. That's important, because arguably the main reason for MSN Search's 13% market share is that Internet Explorer holds more than 80% of the browser market (which, in turn, rests on a 90%-plus market share for Microsoft Windows) and MSN Search is its default search engine. The service certainly garners no respect from Yahoo! CEO Terry Semel, who says, "My impartial advice to Microsoft is that you have no chance. The search business has been formed."

Google isn't putting up fighting words like that. Instead, CEO Eric Schmidt thinks that you're missing the point if you're looking for a winner and a loser in the search-engine battle -- there's room for several winners, and Google simply intends to be one of them.

That may be true in the business world, but here at American Idol, we have to send somebody home again this week. Who will it be? I wouldn't bet against any of our three fine competitors, either on stage or in business. That's all we have time for today, but come back next week for the final showdown. Seacrest -- out!

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Microsoft is a Motley Fool Inside Value selection. TiVo and eBay are Motley Fool Stock Advisor recommendations.Is your portfolio looking for help? Whatever your investing style, we have anewsletter servicethat willhelp keep you informed and attuned. A 30-day trial is yours for free.

Fool contributorAnders Bylundmakes a passable Ryan Seacrest impersonation, but not in public. He doesn't own any stocks mentioned in this story. The Idol spoofing is all in good fun, but Foolishdisclosureis a serious matter.


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