The Devil Went Down to Yahoo!

If Yahoo! (Nasdaq: YHOO  ) wants to make Microsoft (Nasdaq: MSFT  ) jealous, it knows just whose open arms to turn to.

Yahoo! revealed that it will be testing the outsourcing of Google (Nasdaq: GOOG  ) text ads on its own search engine's query result pages. The trial period will run just two weeks and cover a small fraction of Yahoo! pages, but it sets several events in motion:

  • Yahoo! will realize how Google's inventory ad depth and targeting technology are more lucrative than its own.
  • If successful, Yahoo! may gut its Yahoo! Search Marketing department, shifting worthwhile hires into its display-advertising stronghold instead.
  • Microsoft will try to object to the deal, fail, and ultimately arm itself elsewhere to take on a mightier Google, the only remaining paid-search competitor.

Yahoo!'s income statement will get a near-term boost from making Google its designated contextual-marketing driver. The combination of higher clickthrough rates on Google's superior platform, more competitive keyword bids, and steep savings on its own overhead may create the explosive bottom-line results that Yahoo! has lacked for years.

The beast of burden
There's a trade-off, of course. You don't sell your soul to Google without paying a price. Yahoo! would join other soulless dot-com giants like Time Warner's (NYSE: TWX  ) AOL and (Nasdaq: ANSW  ) in simply cranking out as many pages as possible for the Google AdSense assembly line. Even part-time outsourcers like CNET Networks (Nasdaq: CNET  ) and IAC (Nasdaq: IACI  ) have to feel a bit hollow inside sometimes.

Going with Google would be a great business decision for nearly every company. Who wouldn't want more money by simply flicking the autopilot switch? After achieving such a critical mass over the years, doesn't Yahoo! deserve to coast? The problem is that Yahoo! may feel a creepy sense of deja vu through all this.

If Yahoo! can jog its memory hard enough, it may remember when it outsourced its searches to a then-fledgling, yet proficiently search-superior, Google. We all know how that turned out. Google wound up with the good traffic -- the folks who were online to go somewhere else. That left Yahoo! trying to squeeze clickthroughs out of its free email and entertainment pages. Yahoo! wound up serving up more pages, but at a fraction of Google's revenue and earnings production.

The deal with Google is simple; money today, irrelevance later. Even if Yahoo! decides to keep both its own paid-search product and run it alongside Google AdSense, the advertisers will know the score before Yahoo! realizes that they're moving on.

And the winners are ...
As bleak as this scenario may seem, it's actually a win-win-win. Really. Google benefits because it generates more ad revenue. Yahoo! hits the jackpot by generating higher-margin profits. And Microsoft, strangely enough, will spare its shareholders the massive dilution of a costly acquisition, while eliminating the second-largest player in search marketing.

Microsoft may find itself a distant second, but at least it will clearly become the logical alternative to Google.

Microsoft adCenter isn't exactly a household word. The company doesn't even have a product similar to Google's AdSense or Yahoo!'s YPN to reach small and medium website publishers. That will change, since the same Yahoo! void Microsoft was looking to fill via acquisition will now exist via Google absorption. Mr. Softy will get all the benefits it wanted, without paying a dime.

What about Yahoo!'s soul? Well, with all of the incremental revenue that it stands to rake in, maybe it can buy that soul back somewhere down the line.

The saga continues:

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