At its core, this agreement means that Yahoo has given up on its search engine business. Microsoft will be able to increase its market share in the search engine and search advertising market. Yahoo will receive revenue from Bing searches generated on Yahoo's sites and become "the exclusive worldwide relationship sales force for both companies' premium search advertisers." What remains to be seen, though, is what will happen to Yahoo's investments in interesting search technologies like BOSS and Search Monkey. Integrating these technologies, which are tied to Yahoo's search engine, could prove rather difficult for Microsoft. We will also have to wait and see what's going to happen to Yahoo's search APIs.

If anything, the Yahoo Search team will probably not be too happy to hear Yahoo suggest on its blog that Yahoo used to offer a "great" search experience but that Bing will offer an "awesome" one. In a call earlier this morning, Yahoo CEO Carol Bartz announced that some employees from the Yahoo search team will move to Microsoft, while others will move to the display business.

Creating Competition for Google

As we pointed out before, we think Bing is a worthy competitor to Google's search engine, which both Microsoft and Yahoo try not to mention in all their press materials but whose shadow obviously looms large over this deal. Advertisers aren't likely to spend a lot of money on a search engine that only commands less than 10% of the market, but once combined with Yahoo Search, Bing could easily reach 20% or more. At this point, advertising on Bing becomes far more interesting.

In a taped video statement Microsoft's CEO Steve Ballmer argues that the agreement will bring choice back to consumers (a Silverlight version is embedded below, a WMV version is available for download here). We can't help but note that consumers always had lots of choices with regards to search engines - in the past, most just didn't make the choice Ballmer would have preferred.

It's important to note, though, that neither Microsoft nor Yahoo seem to have worked out all the details of this deal, and that users won't see any changes before early 2010. The companies expect the agreement to be reviewed by industry and government regulators before this.

The Details

Here are the details of the search/ad pact between the two companies, according to this morning's press release:

• The term of the agreement is 10 years;
• Microsoft will acquire an exclusive 10 year license to Yahoo!'s core search technologies, and Microsoft will have the ability to integrate Yahoo! search technologies into its existing web search platforms;
• Microsoft's Bing will be the exclusive algorithmic search and paid search platform for Yahoo! sites. Yahoo! will continue to use its technology and data in other areas of its business such as enhancing display advertising technology.
• Yahoo! will become the exclusive worldwide relationship sales force for both companies' premium search advertisers. Self-serve advertising for both companies will be fulfilled by Microsoft's AdCenter platform, and prices for all search ads will continue to be set by AdCenter's automated auction process.
• Each company will maintain its own separate display advertising business and sales force.
• Yahoo! will innovate and "own" the user experience on Yahoo! properties, including the user experience for search, even though it will be powered by Microsoft technology.
• Microsoft will compensate Yahoo! through a revenue sharing agreement on traffic generated on Yahoo!'s network of both owned and operated (O&O) and affiliate sites.
• Microsoft will pay traffic acquisition costs (TAC) to Yahoo! at an initial rate of 88% of search revenue generated on Yahoo!'s O&O sites during the first 5 years of the agreement.
• Yahoo! will continue to syndicate its existing search affiliate partnerships.
• Microsoft will guarantee Yahoo!'s O&O revenue per search (RPS) in each country for the first 18 months following initial implementation in that country.
• At full implementation (expected to occur within 24 months following regulatory approval), Yahoo! estimates, based on current levels of revenue and current operating expenses, that this agreement will provide a benefit to annual GAAP operating income of approximately $500 million and capital expenditure savings of approximately $200 million. Yahoo! also estimates that this agreement will provide a benefit to annual operating cash flow of approximately $275 million.
• The agreement protects consumer privacy by limiting the data shared between the companies to the minimum necessary to operate and improve the combined search platform, and restricts the use of search data shared between the companies. The agreement maintains the industry-leading privacy practices that each company follows today.

$3 Billion?

Kara Swisher reports that on the financial side of things, it looks like the latest deal would include Microsoft paying several billion dollars to Yahoo upfront to take over its search advertising business. If this deal goes through, Swisher reports, Yahoo would also take over Microsoft's display ads business. Concrete numbers are still hard to come by, but 27/7 Wall Street reports that Yahoo would get $3 billion upfront and "will get 11% of the revenue that its searches provide after traffic acquisition costs in each of the first two years. In the third year, that figure would go to 90%."

As always, we will keep a close eye on this story as it unfolds. For now, there are still rumors, but they seem to be quite substantial, and a deal between Microsoft and Yahoo (though not a merger of the two companies) would definitely make sense at this point.