Yahoo's US$1.63 billion buyout of Overture Services signals a dramatic shake-up of the Web search market that could wake a sleeping giant: Microsoft.

Yahoo announced it would dive into paid-search business head first by acquiring the industry's pioneer and largest operator, Overture. The deal thrusts Yahoo into the spotlight as the one to beat in the fastest growing segment of the online advertising market, sharpening tensions with three-year search partner Google as well as its primary Web portal competitor, Microsoft's MSN.

Yahoo for now will face off most directly with Google, but analysts said the wild card will likely be Microsoft. MSN is Overture's biggest partner, delivering as much as one-third of Overture's revenue this year, or an estimated US$350 million. As a result, many industry watchers say that it is only a matter of time before MSN takes stock of its alternatives, including replacing Overture with Google on its Web sites and hastening efforts build its own Web search technology.

"Overture always says it's such good friends and partners with Microsoft, even helping them with their (search) crawler, but now I wouldn't think it would be all that friendly," said Danny Sullivan, industry specialist and editor of the newsletter SearchEngineWatch.com. "Yahoo has made a decision that it needs to own all this technology, and that forces Microsoft's hand. If you were MSN and needed to trump Yahoo's move, what better way to do it then to partner with or buy Google?"

Search-related advertising is the golden goose of online marketing, with sales growing faster than any other area of the Web-based ad market. Commercial search revenue comprised nearly 15.4 percent of the nearly US$6 billion online ad industry, according to the IAB. Revenues from paid search placements at nearly US$1 billion were up more than 200 percent in 2002, compared with 2001. Financial analysts Salomon Smith Barney expects the estimated US$1.4 billion market in 2003 to grow 30 percent to 35 percent per year, reaching US$5 billion by 2008. Paid search is also making inroads into the US$200 billion traditional direct marketing industry.

Monday's deal culminates a buying spree that will bring the assets of four separate search companies under Yahoo's control. In December, Yahoo bought Inktomi for US$235 million, while Overture in the past eight months picked up rival algorithmic Web search technology from AltaVista and Fast Search & Transfer for a combined investment of nearly half-a-billion-dollars.

As a result, the Web search market is quickly concentrating among three main players: Yahoo, Google and Microsoft.

Yahoo's acquisition of Overture could hasten industry consolidation if Microsoft jumps into the fray. Rumors that Microsoft might seek to acquire Google have also surfaced in recent months, although it is uncertain how attractive Google would find such an offer. The privately held company is widely expected to be preparing for an initial public offering that could dwarf any price Microsoft might reasonably put on the table at this stage.

Microsoft might also respond by bidding for a second-tier commercial search company such as FindWhat.com, Looksmart or AskJeeves. LookSmart's stock price jumped nearly 25 percent to US$4.21 on Monday, while FindWhat.com's shares closed up 12 cents to US$23.11, after reaching a high of more than US$25 during afternoon trading.

Next move is Microsoft's

Whether Microsoft makes such a play, the software giant will have to be cautious in any efforts to replace Overture. MSN's search traffic arguably rivals that of Yahoo or Google and would not be easily handled by an inferior commercial system. Constructing a pay-for-placement ad network and technology in-house, on the other hand, would likely take the company a few years.

Despite the blossoming commercial promise of Web search and ownership changes, MSN has so far been slow to tinker with its outsourcing lineup, which includes Overture, Inktomi and LookSmart. Earlier this year, when Yahoo bought Inktomi, Microsoft did not sever its relationship with the company immediately, as many analysts had expected. It has yet to say whether it will replace Inktomi, but many assume that it will now do so, either before or after it cuts ties with Overture.

Indeed, one of the chief risks of Overture's sale to Yahoo is the likelihood that Microsoft will take advantage of a green light to back out of its contract early, analysts said. Microsoft has agreements with the pay-for-placement company through 2004. But according to financial analysts, Microsoft has an out clause built into its contract that gives it the right to forfeit its agreement in the event that Yahoo buys Overture. The clause includes an obligation by Overture to pay Microsoft US$50 million in the case of a buyout.

One financial analyst expects, conservatively, that Sunnyvale, Calif.-based Yahoo will record US$1.725 billion in revenue in 2003 after the Overture deal closes--a number that factors in losing MSN as a customer, which would eliminate some US$350 million in projected revenues.

Added another analyst, Jupiter Research's Matthew Berk: "We expect Microsoft to be in a tizzy about this. The heat has been dramatically turned up for Google. We also expect the heat has been turned up for Microsoft, too."

Microsoft is still evaluating terms of the deal and how they will affect its business, said Lisa Gurry, group product manager for MSN. It is meeting with Yahoo and Overture in the coming days to help understand the deal's likely ramifications, she said. In the short term, MSN's business won't change, she said, adding that she could not comment on any "out clause."

"We'll be evaluating our options over the next several days. Right now, it's a three-horse race between Yahoo, Google and MSN, with lots of room for improvement across the industry. We look forward to be being at the forefront of delivering those improvements to consumers," Gurry said.

Microsoft has shown increasing signs of interest in Web-based search, recently hiring engineers to begin work on search-related projects.

Last month, the software company quietly launched a new search program called MSNBot, which scours the Web to build an index of HTML links and documents. The homegrown system, which performs robot functions previously left to Inktomi and other partners, may pose a significant threat to Google if Microsoft fulfills its promise to make the program a cornerstone of its overall PC and services strategies.

Such development efforts could be years away from fruition, however, likely forcing Microsoft to continue outsourcing its MSN search services for the time being.

Google may benefit

As a result, Monday's deal could play out well for Google, a still privately held company that had estimated earnings from paid search of nearly US$275 million last year. Google may benefit from the acquisition on several fronts, including becoming a more attractive partner to MSN.

Monday's buyout could also lead to better distribution deals for Google, which may face less pressure to offer up huge revenue sharing percentages to its partners, one analyst said.

In a sign of cut-throat competition between Google and Overture, Google recently beat out Overture to win a deal with natural language search provider Ask Jeeves by offering nearly 80 percent of the search advertising revenues raised on its site, according to one source familiar with the deal.

Pasadena, California-based Overture has also been under enormous pressure this year as competition from Google mounted, forcing it to forfeit a larger portion of revenue to partners to maintain their favor. In the first quarter, Overture reported earnings of US$11.1 million, down two-thirds compared with the same period last year, as traffic acquisition costs increased from 54 percent to 64 percent of revenue. At the time, the company reduced its full-year financial forecast by between 40 percent and 50 percent.

Going forward, Yahoo will likely rein in bids to distribution partners, financial analysts said, a move that would help both companies.

"Two intelligent companies competing head to head are not going to offer terms that are going to harm their own business," said a financial analyst who asked to remain anonymous. "The industry has taken out one important player and the fewer you have in the middle, the economics for the others improves."

Yahoo sees opportunities from its Overture acquisition outside of search, as well.

For Yahoo, the acquisition cements its position as a new-fangled online advertising network. The company already operates a vast system of advertising research and analysis, designed to improve ad placement and sales within its site network and report on the success of those marketing campaigns. Now, with Overture, Yahoo will be able to coordinate efforts and sell text-based ads across a wide swath of the Internet, as well as its own properties.

"Because Yahoo needs to expand its base from Web page advertising such as banners--a declining market--its purchase of Overture is a natural and logical fit," said David Hallerman, senior analyst at eMarketer. "That's especially true because next to Google, Yahoo is the second most popular search destination."

Through the acquisition, Yahoo not only owns Web search technology and properties from Overture-owned AltaVista and Fast Search & Transfer, but it also owns emerging software that helps evaluate the content of any Web page in order to place relevant text ads on the page. Armed with that technology combination, Yahoo becomes instantly Google-like, with the ability to sell and place ads across a network of Web sites, as well as hawk the search technology to power it.

"Yahoo's now in a position to say, 'We can give you search powered by Yahoo and you can make money off of it, too," SearchEngineWatch's Sullivan said.

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