Microsoft Searches for Answers

Why buy the cow when you can get the milk for fee?

Microsoft (Nasdaq: MSFT  ) has abandoned plans to buy Yahoo! (Nasdaq: YHOO  ) , for now, but it may be making a play for Yahoo!'s search business. At least, that's been the predominant media speculation since Microsoft announced that it was exploring alternative combinations.

Microsoft isn't alone in vying for Yahoo!'s search engine space. Yahoo! tested outsourcing its ad spots to Google (Nasdaq: GOOG  ) last month. The deal apparently went well, even if a more permanent arrangement would raise antitrust concerns.

If Microsoft wants to fill that ad space, it'll have to pay up. Microsoft lacks the depth of Google's ad inventory, so it will probably have to offer Yahoo! either a substantial fixed sum or at least 100% of the revenue-sharing action.

Paying up for Yahoo!
For Microsoft's sake, let's hope it doesn't go the route of offering minimum guarantees. Google has lamented offering News Corp.'s (NYSE: NWS  ) MySpace at least $300 million a year, even with MySpace's explosive growth.

Yahoo! isn't even keeping up with the market. Industry watcher Interactive Advertising Bureau claims that online advertising grew by 26% last year to $21.1 billion. For those scoring at home, Yahoo!'s revenue inched just 8% higher.

Microsoft knows that Yahoo! is an industry laggard. And since Microsoft sells even less online advertising than Yahoo!, it needs to assume that it will fare even worse, at least initially.

As for revenue-sharing, don't laugh at the possibility of Microsoft offering 100% of the pie, if not more. Microsoft needs to treat any ad deal with Yahoo! as a loss leader, in order to both pad its Rolodex of sponsors and keep that real estate out of Google's hands.

Google repaid third-party publishers $1.34 billion of the $1.69 billion it generated by placing its ads on their sites this past quarter. That's a generous 79% cut of the revenue, and it's widely believed that bigger sites like Time Warner's (NYSE: TWX  ) AOL and get even more than that.

Yahoo! would obviously be worth a market premium, given its sheer volume of traffic.

This doesn't mean that Yahoo! has to choose between Microsoft and Google for advertising providers. It can continue to serve its own ads. However, impatient shareholders are already rattling the cages. Outsourcing ads would diminish the company's place in search engine marketing, but create huge cost savings and heaps of high-margin revenue-sharing royalties.

Paying up for everyone else
How desperate is Microsoft to become a search-engine powerhouse? Let's just say that it may be willing to pay you for your patronage., launched two years ago, is a comparison-shopping site that rewards members with cash-back rebates on purchases from commissioned merchants. Microsoft acquired the site last year, getting into the loyalty-shopping business dominated by sites like United Online's (Nasdaq: UNTD  )

Microsoft hasn't done much with the Jellyfish model thus far, but this morning's Wall Street Journal claims that the software giant is preparing to roll out "Live Search Cashback," according to "people familiar with the company's plan." The move aims to motivate potential shoppers to go through Mr. Softy as a way to get more bang for their bucks.

Microsoft paying for traffic isn't a new concept. Bill Gates suggested making its search engine a rewards-based portal three years ago. The idea brought back dot-com bubble images of, the search portal -- now part of IAC (Nasdaq: IACI  ) -- that tried to make waves with lottery giveaways to its users.

Will Live Search Cashback help the company's fledgling search business? Probably. For Internet users unfamiliar with sites like MyPoints and Fat Wallet, getting a few pennies back on the dollar is better than nothing. That kind of traffic certainly won't help Microsoft overtake Google, but by appealing to folks set on spending money online, Microsoft will be nibbling at a lucrative chunk of Google's traffic.

Either way, it's good to see Microsoft exploring several options to establish itself as a place to go for both advertisers and Web users.

Good luck with that cow, Microsoft. Anything you can do short of calling Google for milking lessons is worth applauding.

Microsoft is an Inside Value recommendation. Time Warner is a Stock Advisor selection. You don't need to go searching hard to unearth either of the newsletter services. A 30-day trial subscription to see which one fits you like a glove is available.

Longtime Fool contributor Rick Munarriz is a fan of Yahoo! and Microsoft, but not of bad weddings. He does not own shares in any of the stocks in this story. Rick is  part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.

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  • Report this Comment On May 21, 2008, at 10:48 PM, hitmeyouFool wrote:

    I think Microsoft needs to swallow its bid to own the world, buckle down and figure out what it needs to do to build excellent software for a change. The world *will* run out of oil and, eventually, people *will* give up on mediocre software.


    Long AAPL

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