• by Laurie Sullivan  @lauriesullivan, July 29, 2009

Yahoo and Microsoft announced a partnership in Internet search and advertising Wednesday to create a stronger rival to Google.

The exclusive 10-year license deal to Yahoo's core technology gives Microsoft access to the Internet's second-largest search engine audience. Yahoo estimates the deal will increase annual operating profit by $500 million and save the company about $200 million on capital expenditures per year because it will not invest in its own search technology. The deal should close in early 2010.

Bing and adCenter will serve the Yahoo network of properties. Microsoft's adCenter platform will fulfill search advertising, as well as pricing set by the auction process.

Yahoo will continue to integrate search throughout its properties. The backend technologies will be powered by Bing. The agreement does not include display ads, allowing both companies to compete. Yahoo will serve as the exclusive worldwide sales force for search ads.

"For users, the agreement will deliver a better search experience and more relevant ads," said Yahoo CEO Carol Bartz during a conference call with analysts. "Advertisers want an alternative that has scale. They will get the combined marketplace in a single platform."

Microsoft will pay Yahoo 88% of search revenue generated on Yahoo-owned-and-operated sites for the first five years of the agreement. Yahoo will continue to syndicate existing search affiliate partnerships. Microsoft will also guarantee revenue for search for each country during the first 18 months. Bartz expects revenue to decline slightly as a result of sharing revenue.

The transition will begin in the United States, and will take about three to six months. All advertisers should transition from Yahoo Panama to Microsoft adCenter in about 12 months.

Search industry executives are still digesting the news. "The partnership builds more scale and efficiencies in search advertising, enabling marketers to take better advantage of Bing's traffic," says John Ragals, COO of digital communications agency 360i. "This should also allow Yahoo to focus more on sales support, especially for its larger advertisers and agencies."

Trip Chowdhry, managing director at equity research firm Global Equities Research, calls the deal a "non event" because the main structure of the processes and landscape remain the same. "It still remains Google and others," Chowdhry says. "The deal doesn't make sense because Bing has no brand equity or traction. Investors can just yawn on it."

New York-based Didit CEO Kevin Lee says the deal, which will need regulatory approval, is both good and potentially bad for advertisers, but the good outweighs the bad based on first analysis.

"The Microsoft ad-targeting system is getting a higher level of attention and investment than the Yahoo platform," Lee says. "Plus, the adCenter platform is more similar to Google's system from a standards perspective, which simplifies campaign management."

On the down side, it could push up pricing for paid search keywords. Ad auctions for search engine placement could become more competitive. Bid prices could rise as advertisers bid for the combined inventory from Bing/Microsoft and Yahoo, Lee says.