WASHINGTON — Yahoo Inc. and Microsoft Corp. hope that by joining forces, they can tilt the balance of power in Internet search away from Google Inc. First, however, Yahoo and Microsoft have to convince regulators that their plan won't hurt online advertisers and consumers.
As the U.S. Justice Department reviews the proposed partnership, approval figures to hinge on this question: Will the online ad market be healthier if Google's dominance is challenged by a single, more muscular rival instead of two scrawnier foes?
The first step toward getting an answer came earlier this month when Microsoft and Yahoo filed paperwork with federal regulators to comply with the Hart-Scott-Rodino Act, an antitrust law governing mergers and alliances between competitors. The Justice Department has until early September to approve the agreement or - as is likely in this case - request additional information.
European regulators are also expected to review the deal. Microsoft and Yahoo are bracing for the examinations to extend into early next year, and the outcome is far from certain.
Just nine months ago, Google abandoned its own proposed partnership with Yahoo to avoid a showdown with the government, which had concluded that Google was already too powerful in the lucrative market for selling ads alongside search results.
Google had hoped to extend its reach even further by selling ads next to some of Yahoo's search results, and in the process, keep Yahoo out of Microsoft's clutches. Microsoft aggressively lobbied against the partnership.
With the Google-Yahoo inquiry behind them, U.S. antitrust regulators are likely to enter this examination with a clearer definition of the Internet search landscape and a better understanding of how it affects the steadily growing online-advertising market.
Justice Department spokesman Gina Talamona would not comment on the antitrust review, the existence of which was confirmed by Microsoft and Yahoo.
Microsoft is counting on the Yahoo partnership to close the wide gap separating the software maker from Google in search. Under the 10-year agreement announced last month, Microsoft's Bing search engine would process all search requests and steer search-related ads on Yahoo.
Analysts believe the move will free Yahoo to phase out of the search business so it can focus on other products. Yahoo would keep 88 percent of advertising revenue generated by searches on its site for the first five years of the deal, and as much as 93 percent in the final five years.
The Microsoft-Yahoo alliance may stand a better chance of winning antitrust approval than the Google-Yahoo pact because it would combine the second and third players in the search market instead of the top two, said Melissa Maxman, head of the antitrust practice group at Baker & Hostetler LLP. In fact, a combination of Microsoft and Yahoo would still lag far behind Google.
Google handled 64.7 percent of all U.S. Web searches in July, while Yahoo processed 19.3 percent and Microsoft 8.9 percent, according to comScore Inc., a firm that tracks search numbers.
The lopsided competition means neither Yahoo nor Microsoft has a large enough audience on its own to lure a significant amount of search advertising dollars away from Google, Microsoft General Counsel Brad Smith said.
"Advertisers want scale," Smith said, "so we need to increase our scale to offer something compelling to advertisers."
Already, one large group of advertisers that opposed the Google deal is supporting the Microsoft marriage.
Last year, the Association of National Advertisers feared Google would gain too much pricing leverage over advertisers through a Yahoo alliance. But Microsoft still won't be in the driver's seat if it teams with Yahoo, said Bob Liodice, president of the trade group. Its members include such big marketers as Procter & Gamble Co., Johnson & Johnson and General Motors Corp.
"This is a whole different ball game," Liodice said. "We are not concerned about monopolization of the market as a result of two weaker competitors coming together. We would still have a very competitive marketplace."
Maxman said regulators will have to consider another factor as well: Yahoo may need Microsoft to survive. Although it remains profitable, Yahoo might not be able to afford to keep spending so much money on search - where it has been losing ground to Google for years - while its hold on its audience is threatened by rapidly growing Internet hubs such as Facebook and Twitter.
Nevertheless, Maxman said, antitrust regulators could still conclude that Microsoft and Yahoo don't absolutely need each other to compete effectively with Google. Microsoft has deep pockets and plenty of brainpower. And while Yahoo's profits have been slipping for the past three years, the company is now run by a chief executive, Carol Bartz, who has been trying to instill more discipline and focus during the first seven months of her tenure.
"There is no reason that, with the right management and right strategy, that it can't remain a viable third alternative in the search market," said Matthew Cantor, a New York lawyer specializing in antitrust law.
Antitrust regulators generally frown on deals that create duopolies, unless one of the players can show it needs to bow out of a cutthroat competition to stay alive, Cantor said.
Maxman said the real challenge for antitrust regulators is that it can be difficult to predict how a rapidly changing technology market will evolve.
"The Justice Department's goal is to prevent the market from becoming too concentrated," Maxman said.
Jeff Chester, executive director of the Center for Digital Democracy, a privacy advocacy group, said the Microsoft-Yahoo agreement merits an examination of how the two companies intend to share the data they gather about Web surfers.
"This will be a litmus test for the Obama administration on whether they incorporate privacy into antitrust review," Chester said.
Business, Pages 19, 22 on 08/24/2009