So, after years and years and years, Microsoft is finally buying Yahoo!. OK, they’ve made an offer, but really, how often does Company A make a big public notice about an offer only for Company B to say, “Um, no thanks…” The writing was pretty much on the wall when Semel was booted and Jerry Yang became the CEO (Oh, and in an aside, he just left the Yahoo! Board of Directors…. yeah, the deal is pretty much done.). So right now every talking and writing head is busy sizing up the deal and making broad predictions. There’s lots to be said for the pro and the con side. So, rather than actually give some predictions, I’ll see if I can’t analyze the two sides and see where things might end up. To start, I’ll talk about the cons.

Microsoft and Yahoo: It can’t possibly work
There’s lots of reasons why Yahoo and Microsoft won’t work. Here are a couple:

1. Neither Microsoft nor Yahoo has shown it can take share away from Google. Microsoft is in fact losing share. So putting Microsoft in charge of a bigger operation will simply cause share to evaporate from Yahoo as well as Microsoft.
2. Yahoo is a Linux shop, and the core technical expertise really won’t transfer well. Anyone remember the Hotmail.com acquisition? But hey, Google is just up the street!
3. Independent of Microsoft vs Linux technologies, Yahoo is a much different culture than Microsoft, even Microsoft’s SVC campus. The people just won’t mesh.
4. Microsoft execs really won’t be able to manage Yahoo. Parting out Yahoo to the appropriate teams (Search and MSN, mostly) will randomize those teams. Having one local exec in charge in California will also be unlikely to work, as Yahoo will turn into a random fiefdom competing with Search and MSN.
5. The ~5 years it’ll take for Microsoft to absorb Yahoo on the portal side alone (Hotmail + Yahoo Mail, MSN Money + Yahoo Finance, MSN Messenger + Yahoo Messenger, etc.) will distract from doing something new that’ll convince customers to leave Google.

That’s good enough for now. But let’s pause for a moment and ponder… what if Ballmer isn’t a complete idiot, and this will work?

Microsoft and Yahoo: The Giant Awakens
Let’s pause for a moment and think about what Microsoft and Yahoo look like together…

1. Yahoo Search now with MSN Technology. I’ve said this before, and I’ll say it again… meta-search beats regular search for relevance when the engines being used are roughly the same quality. Go ahead, try MetaCrawler with just Google, Yahoo, and MSN. Better yet, compare Google with Yahoo + MSN (click on the lovely buttons to see the results side by side). This will make search better, and all Microsoft entry points will have it (Yahoo, MSN, Live, etc.).
2. MSN / Live is now Yahoo. Microsoft completely botched their “Windows Live” and “Live” offering. Now, rather than go back to MSN (which they didn’t like, thus the new brand), or pick a new brand from scratch (putting them in the same boat as Live), they have a new brand. A good brand. One people like. Yahoo! MSN Messenger and Hotmail will probably survive, but the rest will likely transform into their Yahoo branded counterparts, slowly but surely. Granted, the technology will almost certainly be Microsoft under the hood.
3. Complete portal dominance. AOL is going to scream at this, assuming their new Time Warner lords and masters care. MSN and Yahoo Messenger will be combined. Yahoo Mail and Hotmail will be combined. MSN Money and Yahoo Finance will be combined. MSN and Yahoo home pages will be one and the same. For all intents and purposes, the new entity will be “The Portal.”
4. Combined infrastructure services. It isn’t just the consumer-facing services that will benefit. Hotmail and Yahoo will combine their anti-spam and anti-phishing technology (hell, you can just cascade them and likely get a huge improvement). Yahoo Search and MSN Search will combine their anti-spam in search for fantastic index quality. And things go from there.
5. MSR + Yahoo Research. Yeah, a number of people from Yahoo Research left MSR (Usama Fayyad), but there are some serious heavy hitters at Yahoo Research: Prabhakar Raghavan, Andrei Broder, Ricardo Baeza-Yates, and Ron Brachman to name a few.

Yeah, lots of reasons… so people will go back and forth. But here’s my own thoughts on why this will work, to some degree, no matter what:

The ad market wants a strong #2 to keep #1 honest.

It doesn’t take much to find lots of grumbling about Google’s policies towards advertisers, especially in the syndication market. Lots of people feel Google is charging more than it should. With Microsoft now as the #2 player, the market will do what it can to ensure Microsoft is strong enough to keep Google honest. Certainly, the market won’t care if Microsoft remains #2 forever, but two choices is good. Incidentally, the same doesn’t hold for whomever is in the #3 position. The market will encourage #2 to survive, but #3 and down… best of luck, gentlemen.

Finally, here’s another thought. The ad business is cyclical, and we haven’t really seen a downturn in ad spending… yet. But all signs point to a downturn coming. Microsoft is actually making some serious bank on Vista (surprise!) and Office, and will certainly offer very aggressive pricing to gain market share in an ad downturn from Google. I’m not saying short Google, but boy would I be hard-pressed to buy now….

Update 2/11/08: OK, I know nothing, and this deal wasn’t previously in the works like I thought. So don’t come to me for stock advice!