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What Yahoo! Should Do With Search

This article is more than 10 years old.

Microsoft CEO SteveBallmer (Image credit: AFP/Getty Images via @daylife)

A few weeks ago, I said that Ross Levinsohn needed to make 3 phone calls in his first day on the job as interim CEO at Yahoo (YHOO).

I said the first call should be made to Jack Ma. We now have the outline of a deal with Alibaba Group and Yahoo. The market still seems unwilling to give Yahoo shares any credit for this deal until they are sure that Alibaba has the money to pay for the deal. But this appears to be a sure thing.

I said the second call should be made to Mark Zuckerberg. There have been reports made in the last couple of weeks that Facebook (FB) and Yahoo are deep in discussions on how to resolve their patent dispute. If all goes well, it seems likely that we’ll hear a settlement announcement in the next few weeks.

I said the third call should be made to Steve Ballmer at Microsoft (MSFT). The search agreement between the two companies was first signed by Carol Bartz in 2009. We’re now 3 years into the deal and it’s fair to say it hasn’t really worked for either party.

Yahoo outsourced its back-end search technology to Microsoft, although it kept a hold of the front-end that helps to control click-through rates.

Microsoft was supposed to get more search queries that would improve its revenue per search (RPS) to help it more effectively compete with Google. Yahoo was supposed to be able to lay off a bunch of people and save those costs, while still getting strong revenues.

Microsoft has had difficulty getting the RPS numbers up. Even in the most recent quarter, when Yahoo’s search revenues were higher than expected, it was due to Yahoo’s tweaks on the front end of its search pages, rather than improvements made by Microsoft on the back-end.

Yahoo has about 13,000 employees today and probably several thousand more in contractors. That’s about as high a headcount as it was a few years ago when Bartz signed the deal. So where are the cost savings? There must still be a lot working on search.

What’s interesting is that, through today, only Yahoo North America has switched over its back-end search to Microsoft’s Bing. Europe is scheduled to switch over this soon and Asia will do so in a few months. Until the switch over happens, Yahoo’s search revenues are based on just what they used to be. Only as they switch over, do the new economics of the revenue share kick in.

Very recently, Yahoo introduced Axis. It’s a plug-in to existing desktop browsers and a mobile stand-alone browser. It’s good, as it focuses on visual search. The reviews have been positive. I’ve been using it for 2 weeks now and I find it’s just as good as Google, something I couldn’t say about the old Yahoo search.

So what are the options for Yahoo in search?

1. Organize a better search deal with Microsoft. They could decide to stick with the partnership agreement they have already. However, there would have to be better terms for Yahoo as part of this.

2. Turning all its search business over to Microsoft.  Kara Swisher reported this morning that Yahoo was considering this option.  Just pass it all over to Ballmer and presumably considerably reduce Yahoo's headcount in a more meaningful way than before.

3. Cancel the deal with Microsoft and go with Google (GOOG). The DOJ previously objected to too much power for search being in the hands of Google when Yahoo tried to work with Google in search before. Since then though, the back-end search technology has all been outsourced to Microsoft from Yahoo (in all geographies by the end of the year). Therefore, Yahoo could partner with Google in search now and argue that Microsoft had all the back-end search technology now, if they were asked by the government. The Microsoft deal can be cancelled halfway through the term which is around now. There would have to be a tail period that Yahoo would have to endure but they’d then be able to select a new partner.

4. Cancel the deal with Microsoft and go with Facebook. Facebook needs revenues now as a public company. It’s a no brainer that they’ll go into paid search – it’s just too profitable to be ignored. Facebook has already hired a lot of ex-Google search people. Yahoo still has a lot of good search people and is innovating in search and mobile (as evidenced by Axis). Yahoo could provide Facebook with a jumpstart in getting into paid search more quickly than they could otherwise. In some ways, Facebook would be a better alternative as a search partner to Microsoft compared to Google because there’d be no regulatory uncertainty about the partnership closing.

4. Try to strike a deal with Apple over Axis.  Axis has a lot of promise.  It would be great to get Apple to consider dumping Google as its default search engine in favor of referring its users to something like Axis which is much more intuitive and better suited for mobile searches, however this hope is premature. Apple signaled its interest in dumping Google properties on iOS when it announced it would switch out Google Maps for its own mapping service last week.  However, Apple wants to ensure its users have the best experience possible (whether that uses competitors or not). Despite Axis being very promising, it's too soon to make such a change.  Therefore, Apple is not a likely partner

The bottom line is that, although there are potential options aside from Microsoft, it's likely that the best outcome here for Yahoo shareholders is either a reworked deal or (more likely) completely outsourced with Microsoft.  It's the one that probably has the fewest hairballs on it that can deliver the most value in the shortest amount of time.

[Long YHOO and AAPL]