Outsourcing search would have been a good move in the past, experts say
By John Letzing, MarketWatch
Last update: 1:41 p.m. EDT April 17, 2008
SAN FRANCISCO (MarketWatch) -- Yahoo Inc. has battled Google Inc. over the lucrative online search advertising business for years, spending hundreds of millions of dollars in the process on related technology even as it's faced an increasingly daunting task.
So when Yahoo (YHOO) announced last week it would test having Google handle a portion of its search advertising business in exchange for a share in the proceeds, it was seen by many as an insincere move aimed only at squeezing a better acquisition offer out of Microsoft Corp. See related story. Yahoo argues that it merits a better offer than Microsoft's (MSFT) $44.6 billion bid made more than two months ago, as its prospects are still bright as a stand-alone company. A search outsourcing arrangement with Google (GOOG), for example, could net hundreds of millions of dollars in additional annual revenue for the Sunnyvale, Calif.-based company.
Many analysts and investors have long urged Yahoo to outsource its search service in order to narrow its focus. But those same analysts and investors now say that the option has most likely expired, as Microsoft is bearing down with an increasingly hostile bid.
Yahoo was widely thought of as an online media company when it began to pursue the expensive development of its own search technology, called Project Panama, a stew of complex code meant to provide better results for users. Jefferies & Co. analyst Youssef Squali has estimated that Yahoo has spent $150 million on Panama -- while outsourcing search to Google could add between $800 million and $900 million to its 2009 revenue.
Outsourcing search would also allow the return of a media focus for Yahoo -- on the better targeting of graphical display ads around sports and finance content, for example, while developing new features such as its AMP technology for distributing of such ads. That in turn could hew to the vision former Yahoo Chief Executive Terry Semel had for the company, albeit roughly a year after he was compelled to step down.
"I don't think it quite rises to irony," said Endpoint Technologies Associates analyst Roger Kay, though he added that, "Doubling down on display was what Semel was all about."
"If he'd said we're going to be king of search, maybe they could have kept up with Google," Kay said, "but they went off in the media and content direction and they lost time." Semel resigned in June following criticism that his push for Yahoo to be a media company and search leader was muddled, and ultimately destructive. Semel's successor, Jerry Yang, has sought to present a clearer vision for the company, albeit with mixed results.
Outsourcing search to Google could therefore help investors understand Yahoo's direction. And Yahoo is familiar with the concept -- until early 2004, the company depended on search technology provided by the then-closely held Google. "They should never have dropped using Google in the first place, and they should have bought Google when they had the chance five years ago," said Eric Jackson, a Yahoo shareholder who has been a vocal critic of both Semel and Yang.
Still, Jackson said that while first delving into the search market was a poor choice, he doesn't believe Yahoo's move to outsource to Google means that it sincerely wants out. "It's less about them becoming a pure media company than deal gamesmanship" with Microsoft, Jackson said.
One less ball in the air, as the air runs out
"My concern is Yahoo has a lot of balls in the air," said Forrester Research analyst Shar VanBoskirk. Abandoning a losing search effort could therefore be a boon for a company in need of focus, VanBoskirk said. "They should just cede the search space to Google and focus on online ads, they are a much better media firm than Google."
Ceding the search market seems to already be underway, even without Yahoo's consent. According to data from comScore Inc., Google broadened its already substantial lead over Yahoo in March, capturing 59.8% of the U.S. search market, compared with Yahoo's 21.3%. And in terms of the sales wrung out of those respective market shares, Google dominates in the U.S. -- it pulled in 71.2% of U.S. paid search revenue in 2007, according to data from research firm eMarketer Inc., while Yahoo pulled in a mere 8.9%.
Yahoo has said publicly that it's seeing progressively better results in its search business thanks to Panama. But analysts such as VanBoskirk nonetheless bemoan the resources that Panama's diverted. "The Panama platform has some promise, Yahoo is just focused so much on the technology it's neglected its social media platforms, and its ad targeting capabilities," VanBoskirk said.
But VanBoskirk is afraid that at this point, Yahoo's move to outsource search is just an ill-fated ploy to fend off Microsoft. That's because Microsoft could likely scuttle any search partnership formed with Google upon assuming control of Yahoo. And despite Yahoo's wrangling, its sale to Microsoft is widely seen as a likely outcome.
Yahoo indicated early Thursday that results of its search outsourcing test with Google have been encouraging, which may lead it to expand the partnership. (See related story).
Those early results may not be surprising, as Google has traditionally managed to reap more revenue out of its search market share than Yahoo. In addition, similar search outsourcing deals that Google has reached with companies such as IAC/InterActive Corp.'s (IACI) Ask.com generally involve handing a generous portion of the resulting revenue to its partner.
Unlike Ask.com, however, Yahoo holds a large share of the market. An expanded deal with Google would therefore amount to the number two search provider selling share to the market leader, likely drawing close scrutiny from antitrust regulators.
Yahoo has said its outsourcing test with Google will cover only 3% of the searches done on its U.S. site, which may alleviate some antitrust concerns. And while the companies could pack that 3% with only the most lucrative of search terms, thus increasing its practical impact of the deal, Endpoint Technologies' Kay said that's unlikely. Instead, the move should be seen as a symbolic challenge to Microsoft, more than anything else.
"In theory, it could be the juiciest 3% of words packed in there and that could make the deal different, but I don't think that's the point," Kay said. "The purpose is to create inconvenient links harder to make the deal with Microsoft."
John Letzing is a MarketWatch reporter based in San Francisco.