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Microsoft's war against Google

Threatened by Google's growing power, Microsoft goes after Google's new ad pact with Yahoo.

By Yi-Wyn Yen, reporter
Last Updated: June 26, 2008: 7:23 AM EDT

SAN FRANCISCO(Fortune) -- Microsoft is pushing hard to stop Google from teaming up with Yahoo now that the software giant has given up on acquiring the tarnished Internet portal. But antitrust lawyers and technology analysts outside the case don't think Ballmer & Co. has much of a prayer at stopping the deal from going through.

Microsoft (MSFT, Fortune 500) intends to put up a strong fight nonetheless. The company is on a mission to derail or delay Google's deal to outsource a portion of its ads on Yahoo. The company says it's still interested in buying just Yahoo's search business. Microsoft has deployed its lawyers and Washington staff to meet with lawmakers to discuss how Google will monopolize search advertising and drive up prices through its new Yahoo partnership.

Antitrust experts disagree with Microsoft's argument that Google's search ad pact with Yahoo (YHOO, Fortune 500) will make Google (GOOG, Fortune 500) too big and too powerful. "I see them exercising political jargon here. It's surprising. Every antitrust lawyer would agree big isn't bad. Bad is bad," says Glenn Manishin, an antitrust and technology policy litigator at Duane Morris who isn't representing any of the three companies.

Microsoft offered to acquire Yahoo in February for $44.6 billion. When Yahoo held out for more than the software giant was willing to pay, Microsoft withdrew an increased bid of $47.5 billion in early May and proposed buying Yahoo's search business for $9 billion a month later.

Instead, Yahoo cut a deal with Google in mid-June to run some of Google's search ads on its Web properties, and says it expects to generate an additional $250 million to $450 million in cash flow. Yahoo says it plans to use the extra money to invest in its own search engine. Google, meanwhile, hopes to keep Yahoo out of the arms of Microsoft, its main adversary. Microsoft CEO Steve Ballmer has stated that the company does not want to inherit the regulatory problems and potential lawsuits that would come with buying a Google-supported Yahoo.

With or without Yahoo, Microsoft is continuing efforts to chip away at Google's dominance. The company last month introduced a "cashback" program to pay users money whenever they buy products like the Wii or digital cameras on Microsoft's Live Search engine.

What's next?

Google and Yahoo could conceivably start the business agreement today since only mergers above $50 million need federal approval beforehand. Manishin, who represented a coalition of software companies in the Microsoft antitrust case, says it's not uncommon, however, for deals of this size to receive federal scrutiny.

The Department of Justice opened an investigation one day after Google and Yahoo announced plans to form an ad pact. Both Google and Yahoo are working with the DOJ to address any anticompetitive issues and have said they will not start the partnership while under scrutiny.

The DOJ commands political clout that Google will be reluctant to ignore. "Google is getting more and more powerful, and can't afford to publicly hurt how their brand is perceived," says Jeffrey Chester, the executive director of the Center for Digital Democracy.

If the DOJ decides to fight the deal, it can request a court order to prevent Google and Yahoo from moving forward. Experts say that's highly unlikely, however, given that the Bush Administration appointees that make decisions on antitrust cases tend to favor big deals.

Google remains confident that the deal will get clearance. "We obviously believe that the transaction is a straightforward non-exclusive commercial deal that is both pro-competitive and doesn't raise the issues that a merger would," wrote Google's chief counsel Kent Walker in an e-mail to Fortune.

Microsoft is banking on a DOJ snub to kill the deal. The software giant says Google will have a hard time convincing the agency that the deal won't lead to a monopoly by Google. "When you have a situation of the No. 1 and No. 2 competitors in a market, the burden falls on them to convince regulators the partnership's not going to be a problem," says a source familiar with Microsoft's argument.

Some antitrust lawyers say that argument is unlikely to fly with the DOJ for a non-merger case. "What the Justice Department is really worried about is if Google raises prices on online advertising. If this were a merger where Google was buying Yahoo and Google did raise prices on its customers, you'd have to worry about this because Yahoo would cease to exist and you can't go back and undo the damage. But that's not what is happening here," says Gary Reback, an antitrust lawyer who defended PeopleSoft against an Oracle takeover. "It's tempting to the Justice Dept. to monitor this and see what happens."

Google says that the agency has never denied a nonexclusive business arrangement. Google's legal team, which includes Dana Walker, a former DOJ attorney, argues that if Toyota is allowed to sell its hybrid technology to General Motors, then Google should be allowed to sell its superior search technology to Yahoo, which will decide how often to run the outsourced ads.

Microsoft says the deal is really a friendly takeover of Yahoo and a danger to advertisers, who fear that Google will have too much control of the online advertising market. "This deal will essentially strengthen Google and make Yahoo more dependent on Google. No matter how they cut it, Yahoo is transferring search traffic to Google," says the Microsoft source.

Several antitrust lawyers say that the DOJ will likely favor the deal going through as a way to help Yahoo stay independent. "Let's suppose this case doesn't get clearance. It's likely that Yahoo will get even weaker and go away as a separate company. We'd like Yahoo to exist to provide competition for Google. Yahoo is closer to restraining Google's power than Microsoft is," says Reback, a litigator who is not representing any of the interested companies.

"The Justice Dept. will want to see Yahoo take the money and do something productive with it. If, say, six months later Yahoo doesn't do anything, becomes too addicted to Google, and prices for advertisers go up, then the Justice Dept. can shut it down," Reback adds.

Still, the high-profile deal has many politicians in Washington worried. In addition to worries about how the pact will affect competition, many fear what Google can do with access to so much online data. Together, Google, with a 61.8% share and Yahoo, with 20.6%, own 82.4% of the U.S. search market, according to comScore's latest monthly report. CEO Jerry Yang has already made the rounds on Capitol Hill last week to assure members of both the House and Senate that the deal, which applies only to ads shown in the U.S. and Canada, won't prevent competition and that Yahoo will protect its own data.

A decision by the DOJ is expected by Oct.1. Congressional lawmakers have promised to hold hearings on the broad implications of the deal, but tech regulatory analysts say that this will not affect the DOJ's decision. "In my experience, the DOJ isn't particularly susceptible to congressional hearings," says Rebecca Arbogast, a D.C.-based regulatory analyst with Stifel Nicolaus.

Microsoft admits Capitol Hill has little influence over the DOJ. But as long as the DOJ investigates the deal, Microsoft's camp will continue to fuel the antitrust debate. Says the Microsoft source, "If Google endures a little bit of scrutiny, people will see how they're trying to weaken Yahoo in order to cement their dominant position. Google can do without Yahoo. Google has nothing to lose." That's a position Microsoft wishes it had.  To top of page

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