Putting most of your eggs in one basket can get you scrambled, especially if that basket happens to be Microsoft (NASDAQ:MSFT). Last night the software giant announced that it has decided not to renew its sponsored search contract with LookSmart (NASDAQ:LOOK) when it comes up in January.

While LookSmart will still provide paid text ads to popular online destinations like About.com and Terra's (NASDAQ:TRLY) Lycos search engine, losing Mr. Softy is a real heartbreaker. Microsoft made up roughly two-thirds of LookSmart's listing revenue.

At least LookSmart was honest about its situation. Over the summer, in its 10Q filing, the company revealed that Microsoft was testing out alternatives to LookSmart's services.

Contextual advertising, in which targeted text ads are sold and then displayed on relevant search result pages and content sites, is big business. It's so meaty that Yahoo! (NASDAQ:YHOO) decided to acquire its contract provider, Overture (NASDAQ:OVER).

Because of Microsoft's monopolistic tendencies (and whether that is deliberate or simply because quality wins in the free market is a debate for another day), it will be interesting to see if Microsoft goes with a rival provider or simply develops an in-house solution.

As far as business models go, you've got to love sponsored searches. The advertiser wins because it reaches the appropriate audience. The site displaying the ad comes out ahead as it reaps the fruit of significant yet unobtrusive marketing that will ultimately kill the dreaded pop-ups once and for all.

That's why even a small fry like LookSmart was able to land ad money from the likes of Wal-Mart (NYSE:WMT), FedEx (NYSE:FDX) and Bank of America (NYSE:BAC) -- along with tens of thousands of small companies just looking to get noticed online.

Sponsored searches work. Ironically enough, LookSmart's success is why its days are numbered with Microsoft. Yes, you can be too good for your own good. You can even look too smart -- if you're LookSmart.

Is Microsoft right to pull the plug on its relationship with LookSmart? What do you think of sponsored text ads? Too much? A better alternative than pop-up and banner ads? All this and more -- in the Microsoft discussion board. Only on Fool.com.