By inking a 10-year search deal with Microsoft yesterday Yahoo has opted out of the search battle, and given Microsoft the opportunity to take on Google in the domain where Google is most dominant. Yahoo will host Microsoft?s recently launched search engine Bing on its owned & operated (O&O) sites, give its search technology to Microsoft and replace its Panama search advertising platform with Microsoft?s AdCenter. This means that any small advertiser interested in advertising on Yahoo search results will now have to use AdCenter, and users who search on Yahoo will receive search results and paid advertisements delivered by Bing.

This deal is being driven primarily by the dominance of Google in the market: it is estimated that Google has a marketshare of over 70 percent in the US, and in other markets like western Europe, it could be as high as 90 percent. Usage depends on the quality of results and revenues on the relevancy of the advertising, and both of these depend on one aspect: scale. The more people use a particular search or click on an advertisement, the better the search algorithm understands which results and advertisements are more relevant: it?s a virtuous cycle. With Microsoft keen on investing in search and battling Google, and Yahoo keen to focus on its display advertising business, it isn?t too surprising that Yahoo has signed off its marketshare. Though their combined marketshare will still be less than that of Google, Yahoo?s user base will provide Bing with the opportunity to learn from more usage, and provide a competitive alternative to the might of Google. Microsoft also expects that the scale that the two companies have on offer will attract some of the estimated 800,000 advertisers?many of them advertisers with very small budgets?to Bing.

This situation of deploying external search on Yahoo isn?t entirely new to the company: with a belief that search isn?t very profitable, Yahoo had once allowed an upcoming search engine called Google to power its search. By the time the two parted ways in 2004, Google was already a search giant. It?s deja vu with Yahoo CEO Carol Bartz saying that Yahoo wants to focus on being a media company, invest its properties in mobile, and the display advertising business. But this time, the reasons are different: this time, though search is far more profitable than a portal or a media business, it appears that Yahoo doesn?t believe it can compete with Google, or simply cant afford to. Ever since Bartz has taken over as CEO, she?s focused on Yahoo as a property, and highlighted the advertising virtues that such a premium property offers.

The writing on the wall was clear: Bing is more likely to give Google a run for its money than Yahoo Search, and it?s likely that without a large enough competitor?with both Bing and Yahoo search comparatively small?Google?s global dominance would probably increase over the next 10 years. Instead of spending money on search, Yahoo has decided to dispense with search related costs and focusing on premium advertisers. Microsoft will get Yahoo?s search technology to incorporate into Bing, possibly some of Yahoo?s employees and its users. For this, Microsoft will give a bulk of the revenues (88%) generated from Yahoo?s O&O sites during the first 5 years of the agreement with Yahoo, along with a guarantee of Yahoo?s revenue per search (RPS) for 18 months following implementation in each country. For Microsoft, this will also turn a foe into a friend, since the two companies will work together: Yahoo will sell search advertisements to premium advertisers, while Microsoft will sell to smaller advertisers.

But ten years is a long term for a deal, and it is unlikely that Yahoo will get back into the search game after this. Yahoo is dismantling its Search division?once the deal goes through regulatory hurdles, expected sometime in early 2010, some of Yahoo?s search employees will be asked to join Microsoft, others moved to display advertising, and some will be asked to leave. Look ahead ten years from now: if Bing is a success, the onus will be on Yahoo to establish its value as a affiliate to either Google or Bing. Microsoft would have been able to build its own search marketing team, and Yahoo would probably have no guarantees any more.

Possibly the most interesting element of this deal is the regulatory aspect: firstly, how much information about users searching on Bing, or visiting Yahoo, will the two companies be able to share with each other. Secondly, given Google?s dominance, would this deal increase competition or reduce it? Microsoft and Yahoo are arguing that Google is too large in the search space, and it?s not possible for two the smaller search companies to compete against it. It is only by allowing Bing more usage (a combined marketshare of around 30 percent in the US) would Bing really be able to compete, and hence benefit users. The regulators would have to consider whether having fewer competitors for Google in the search market would actually benefit users.

The author is the editor of MediaNama.com