Yahoo’s Microsoft partnership dismantles search expansion, returns company to early philosophy

Yahoo comes full circle with retreat from search

SAN FRANCISCO — Yahoo Inc. invested billions of dollars in its Internet search engine during the past six years before realizing it made more sense to entrust the job to an outsider — hearkening back to a conclusion the company’s co-founders reached shortly after they started their Web directory in the mid-1990s.

The latest shift in direction will put rival Microsoft Corp. in control of the search results and the ads that appear alongside search results on Yahoo’s highly trafficked Web site, assuming the proposed partnership is approved by antitrust regulators in the United States and Europe.

The 10-year deal announced Wednesday blows up a search expansion undertaken under Yahoo’s former chief executive, Terry Semel, who resigned under shareholder pressure two years ago. The repudiation of Semel’s strategy returns Yahoo to a philosophy embraced by co-founders Jerry Yang and David Filo in the company’s early days.

Within two years of starting what was originally known as “Jerry and David’s Guide to the World Wide Web,” Yang and Filo concluded Yahoo wouldn’t be able to index all the new sites proliferating on the Internet without more automation and sophistication.

Rather than spend its own money on expensive upgrades, Yahoo hired AltaVista to supplement its search engine and then later turned to Inktomi. Those decisions freed up more cash for Yahoo to spend on compelling content and developing other services that established its Web site as the biggest draw on the Internet.

As indexing the Web grew even more complicated in 2000, Yahoo sought the expertise of an ambitious young startup called Google.

In a move that the company later regretted, Yahoo promoted the Google brand next to its search box to show where it got its results. The exposure on one of the Web’s most popular pages drove millions of people to Google’s search engine, which quickly supplanted Yahoo as the go-to place to find stuff on the Web.

After Google came up with a way to make big money from text ads placed alongside search results, Semel wanted a bigger piece of the action.

Beginning in 2002, Yahoo spent more than $2 billion buying other search engines, including the remnants of AltaVista and Inktomi. Later, Yahoo invested heavily in search improvements that included a much-delayed advertising system called Panama.

Although it helped boost Yahoo’s profits early on, the search expansion never panned out the way Semel envisioned. Google widened its lead in search as Yahoo’s U.S. share shriveled from about one-third of the market in 2004 to about one-fifth of the market today. To make matters worse, socializing hubs like Facebook and MySpace supplanted Yahoo as the hot spots to hang out on the Web.

“They just lost their way,” said technology analyst Rob Enderle. “This (Microsoft deal) will let them rediscover what they once were — a place where a lot of people liked to spend a lot of their time online.”

While he was Yahoo’s CEO last year, Yang tried to lessen Yahoo’s financial commitment to search by forming an advertising partnership with Google. Under that plan — which is narrower than what Yahoo now wants to do with Microsoft — Google would have served up some of the ads that ran alongside search results on Yahoo. U.S. antitrust regulators threatened to sue to block the arrangement, scaring Google off.

Yang didn’t seem to want any part of Microsoft. In May 2008, he and the rest of Yahoo’s board rebuffed a Microsoft offer to pay Yahoo $1 billion in cash and buy $8 billion worth of stock in return for a search partnership.

Now, Yahoo will get no cash upfront, and instead will get a big share of the ad revenue generated by Microsoft’s search engine when it handles queries on Yahoo’s site. (Microsoft will also keep running its search engine at its usual locations, such as msn.com, bing.com and on the “toolbars” it lets people download to their Web browsers.)

Carol Bartz, Yahoo’s chief executive for the past six months, quickly realized that the Sunnyvale, Calif.-based company needed to get back to its roots. Since her arrival, Bartz has been de-emphasizing Yahoo’s need to run its own search engine.

“It really hard to tell whether (Bartz) just thinks Yahoo isn’t that strong in search or whether she thinks she needs to jettison search to save the company,” said Danny Sullivan, editor of the online newsletter SearchEngineLand.

This much is certain: Microsoft has been stalking Yahoo for years because it wants to boost its meager U.S. market share of 8 percent to narrow the gap separating it from Google, which commands a 65 percent share. Because Yahoo handles about 20 percent of search requests, the Microsoft-Yahoo combination would have about 28 percent share, assuming no big shifts in usage between now and when the project is fully running — which could take two years.

“We found a partner willing and excited to put a lot of technology behind search,” Bartz said in an interview Wednesday. “So our customers are still going to get the same search experience or better search experience because of the investment that Microsoft is willing to make.”

Microsoft is no stranger to the concept of farming out search, having done that itself earlier this decade, when it relied on Yahoo’s technology.

Another prominent Web site, AOL, has used Google for search results and advertising for years. Having the extra money to spend on other products and services hasn’t proven that effective for AOL, which has been faring so badly for so long that its corporate parent, Time Warner Inc., is cutting the subsidiary loose this year.

Since breaking away from its first partnership with Yahoo, Microsoft has been continually honing its search expertise and even hired away one of Yahoo’s top engineers, Qi Lu, to further the cause.

This time, Yahoo won’t feature its partner’s brand in the prime space located next to its search box. Bing’s name instead will only appear at the bottom of the search results page.