Microsoft buy Yahoo …but Why?

Now lets face it Yahoo isn’t that big of a deal really…we all know shares plummeted and the company didn’t make much money. Right now lets look a little deeper into this… Yahoo made plenty of money through its Paid-Ads … but not enough. They never truly made PPC pay for them, nor any of their other ventures, geocities closed last year and yahoo games seems to be unable to hold its ground with the likes of Facebook Applications on the seen. The money they have generated over the past few years haven’t paid the bills and salaries of the company… so why on earth would Microsoft want to buy them?
Well here is the answer:

In 2002 Yahoo acquired Overture… a leading paid-internet-advert company… thier 2002 annual report reads:

Overture Services, Inc. is the global leader in Pay-For-Performance search (also known as paid search) on the Internet. Overture’s search service is comprised of advertiser’s listings, which are screened for relevance and accessed by consumers and businesses through Overture’s affiliates, a network of Web properties that have integrated Overture’s search service into their sites or that direct user traffic to Overture’s own site. In some cases, consumers and businesses access our search listings directly at our site. The search listings are ranked by the advertisers’ bid; the higher the bid, the higher the ranking. Advertisers pay Overture the bid price for clicks on the advertisers’ search listing (also known as a paid introduction, click-through or a paid click).

Sounds alot like Google Adwords doesn’t it… and it is. Google is generally credited with the creation of these services and pioneering the technology behind it…quite correctly too. However Overture was the first company to realise the niche and further to this they even managed to patent certain principles behind Paid Advert Placements (PPC), this was granted in 2001 by the US Patent office. The ‘361 patent effectively granted Overture the right to monopolize the lucrative US paid-search market and subsequently dictated the evolution of the global paid-search market.

After getting the ‘361 patent, Overture wasted no time going after its paid-search competitors and quickly mobilised its lawyers to corner the paid-search market. Initially, Microsoft, Yahoo, and most of the other paid search players chose to license the ‘361 patent. However, Google and Miva (a small paid search operator formerly known as FindWhat) chose to challenge the patent in court. In doing subsequently Overture sued them for Patent Infringement.

The challenge of the ‘361 patent made a lot of sense as Overture was demanding hefty fees for the patent’s use. Overture’s financial statements from 2002 indicate that the company on average retained 38 percent of ad revenue generated by its paid search ads at customer websites. Microsoft and Yahoo were two of Overture’s biggest customers in 2002 and were responsible for 60 percent of Overture’s revenue that year.

Overture reported a huge growth in 2002, so they began to look for a suitable buyer. With Googles growth enormous in the PPC industry and the anticipation of Yahoo & Microsoft surpassing overture in rolling out their own PPC solutions like Google. Overture did own ‘361 patent and could use it to block Yahoo and Microsoft but the patent was being challenged in court. Any setback in court would have destroyed Overture, and on account of the questions surrounding the ‘361 patent filing, the company had good reasons to expect a less than favorable outcome in court.

Overture initally began with marketing itself to Microsoft, however Bill Gates hugely miscalculated the worth of overture and the need for the Patent they held. Bill Gates rejected the deal out of hand on the basis it was patent play and they couldn’t enforce the ‘361 patent on grounds of anti trust … they couldnt afford the court battles it may cause. With Microsoft no longer in the picture Overture was in essence driven to Yahoo and they ahd no worries about snapping up Overture. It wasn’t long before they enforced the patent after the purchase in 2003 for around $1.3billion. The purchase price amounted to more than 8.5 percent of Yahoo’s valuation at that time, though yahoo considered this a snip at half the price for controlling the PPC industry.

Yahoo’s Overture acquisition completely cornered Microsoft in the paid-search market. Microsoft had been licensing the ‘361 patent and in doing so it had admitted to the patent being valid. Microsoft could still challenge the patent in court but it did not have a good case. Yahoo now effectively dictated what Microsoft could and could not do in the paid-search market. Microsoft’s only hope was the challenge to the ‘361 patent by Google and Miva.

Unsuprissingly the outcome of the court proceedings wasn’t in the favour of Microsoft. In a rather mysterious and shady deal Google chose to settle with Yahoo. Google claimed to have won royalty free use of Yahoo’s paid search patents for around $300 million in stock… though Googles official figures seem to show only $30 million was spent on the settlement. The remainder was considered (probably for accounting reasons) as compensation to yahoo for its trouble.

Miva, the other ‘361 patent litigant, persisted with the litigation, and the case eventually went to trial in April 2005. In May 2005, the case resulted in a mistrial after a jury failed to reach a verdict. It was found 6 claims made my Miva were invalid during the trail, the jury was indecissive. Judge Cormac was in a position to dismiss the major claims of ‘361 patent, and there were reports in the media that he was inclined to do just that. Additionally, Judge Cormac was reported as favoring Miva in the inequitable conduct dispute about the ‘361 patent. Yahoo could have appealed an unfavorable ruling but such a ruling would have been a massive setback nevertheless.

With the prospect of more court proceedings Miva and Yahoo also settled out of court. Miva ended up paying Yahoo $8 million in cash and undisclosed royalties. Again, inexplicably, Yahoo insisted on getting royalties from a marginal player when it allowed Google to use the ‘361 patent royalty free.

The Miva settlement is all the more interesting because it directly contradicts Google’s claims of having settled with Yahoo for $300 million in stock with no ongoing royalties. (The settlement amounted to roughly $30 million according to Google’s own financial statements.) Both companies’ business models depended on having access to ‘361 patent, but Miva’s was less dependent on account of its having acquired paid-search assets overseas where the ‘361 patent could not be enforced. More importantly, Miva settled from a position of strength as Yahoo could not afford to have major claims of the ‘361 patent dismissed, but Google settled from a position of weakness as its IPO was at stake when it settled. Even ignoring the massive competitive threat Google posed to Yahoo, Google’s settlement should have been at least two orders of magnitude bigger than Miva’s on account of Google’s size, growth potential, and weak bargaining position.

Microsoft’s subsequent experience with its adCenter paid-search product outlines just how extreme and damaging Yahoo’s control over paid-search became. Microsoft began with roll outs in france and singapore followed by the UK in June 2006 … it was not available at this point in the US. Microsoft attempted to pay $1 billion in cash for access to the yahoo owned patent. However Microsoft wanted some very specific terms, it came as no suprise when this was rejected by Yahoo. The money Microsoft offered may have been good in the short-term but it was questionable if Yahoo could have stayed independent after losing its search assets. However Yahoo arranged a better deal with Google who now co-owned yahoo’s search assets and also helped improve the ROI of yahoo paid search.

Surprisingly, Microsoft instead of proposing a more competitive deal has been busy trying to subvert the Yahoo Google deal by raising antitrust concerns, and even seems to have succeeded at getting the US courts to investigate this deal… the deal was delayed until the investigation was complete however.

Microsoft was completely aware of the ludicrousness of its attempts to buy Yahoo’s paid-search assets and Microsoft’s earlier acquisition bid seems to have been an attempt to soften up Yahoo’s opposition to a paid-search asset acquisition. Microsoft’s publicized $31 a share bid was preceded by an unpublicized $40 a share bid in January of 2007. The initial $40 bid seems to have conveyed the message that if Yahoo refuses to let Microsoft co-own paid search, it can expect a public bid from Microsoft at some inopportune time. Yahoo responded to the threat by handing over the CEO job to Jerry Yang, a founder and a major shareholder, and attempting to shore up its share price by cost-cutting. Of course, this did not help and eventually Yahoo’s share price fell to a point where Microsoft felt that it could make a safe play for Yahoo’s paid search assets. This opened the door to much trouble and more changes within Yahoo management – as microsoft had wanted. In doing so Microsoft hoped this would force Yahoo into their hands.

There was a further bid to Yahoo by Microsoft Rejected (of a reported near $50billion in january 2008) as Google continued talks with Google… this explains why the deal fell through. Google does have a perpetual royalty-free license, but $30 million was not all Google paid for the license. Evidently, Google is hiding some material terms of its patent settlement with Yahoo from the general public and its investors. Google had a legal obligation to disclose anything material that was likely to influence its future business operations, but Google’s management subverted that obligation. It seems that the terms Google did not disclose were covered by a “grace period” of several years during which Google got free use of the patent, and escape clauses; so back in 2004, Google’s management under pressure of an imminent IPO convinced itself that the terms covered by the grace period were unlikely if ever to come into play even after the grace period ended, and so were immaterial and did not need to be disclosed. The thinking at Google must have been that either the ‘361 patent is not going to hold-up in court, or Miva is going to extract a good settlement out of Yahoo triggering escape clauses in the agreement, or somebody else is going to get a good deal out of Yahoo.

The problem for both Yahoo and Google is that Microsoft wants to force itself into the deal. Microsoft knows that it can block any compensation deal between Yahoo and Google by beating up the antitrust drum. Microsoft is using this as leverage to goad Yahoo into selling its paid-search assets. Essentially, Microsoft has conveyed to Yahoo that there can be no payday for Yahoo if Microsoft does not get Yahoo’s paid-search assets, but if Yahoo acts sensibly Microsoft can conveniently look the other way when Google comes knocking with the ransom.

The google “deal” was abandoned by Yahoo and Google over this antiturst threat.

So thats the history and the why… and so to today.

Microsoft’s Bing search engine will power the Yahoo website and Yahoo will in turn become the advertising sales team for Microsoft’s online offering. Microsoft boss Steve Ballmer said the 10-year deal would provide Microsoft’s Bing search engine with the necessary scale to compete. “Through this agreement with Yahoo, we will create more innovation in search, better value for advertisers, and real consumer choice in a market currently dominated by a single company”.

In return for ceding control of its search engine, Yahoo will get to keep 88% of the revenue from all search ad sales on its site for the first five years of the deal, and have the right to sell adverts on some Microsoft sites.

“This agreement comes with boatloads of value for Yahoo, our users, and the industry. And I believe it establishes the foundation for a new era of internet innovation and development,” said Ms Bartz (YAHOO CEO)

Read more about todays deal.

Where does this leave SEO and what about this Google access to the patent? … well lets just see over the next few months… If anything happens I will report it here for you.

We’d love to here what you have to say on this deal

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