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Why the Microsoft-Yahoo Search Deal Won't Help Bing

Regulators have approved a deal that would allow Microsoft's (MSFT) Bing search engine to power Yahoo (YHOO) search queries -- but the assumption that this will actually help the companies combat Google (GOOG) might be all wrong.

Microsoft initially sought the Yahoo deal in July 2009 to funnel more queries into Bing, saying that increased search volume would allow Bing to deliver better results.

"Success in search requires both innovation and scale," Ballmer said at the time. The Department of Justice's antitrust division apparently buys that logic; in their decision to approve the deal on February 18th, regulators said that a bigger Bing query pool "should accelerate the automated learning of Microsoft's search and paid search algorithms and enhance Microsoft's ability to serve more relevant search results." And that, the statement continues, means "a more viable alternative to Google." (Google commands about 65% marketshare in the United States and nearly 90% in Europe. Bing's is just over 11%.)

But is this assumption actually true?

Google Chief Economist and U.C. Berkeley professor Hal Varian, doesn't believe so -- and while he obviously has his biases, his argument is hard to dismiss. In an August 2009 interview with our sister site CNET, Varian explained that the size of the data pool is much less relevant than Microsoft would like to think:

  • We're very skeptical about the scale argument, as you might expect. There's a lot of aspects to this subject that are not very well understood. On this data issue, people keep talking about how more data gives you a bigger advantage. But when you look at data, there's a small statistical point that the accuracy with which you can measure things as they go up is the square root of the sample size. So there's a kind of natural diminishing returns to scale just because of statistics: you have to have four times as big a sample to get twice as good an estimate.
  • Another point that I think is very important to remember ... query traffic is growing at over 40 percent a year. If you have something that is growing at 40 percent a year, that means it doubles in two years.
So the amount of traffic that Yahoo, say, has now is about what Google had two years ago. So where's this scale business? I mean, this is kind of crazy.
  • The other thing is, when we do improvements at Google, everything we do essentially is tested on a 1 percent or 0.5 percent experiment to see whether it's really offering an improvement. So, if you're half the size, well, you run a 2 percent experiment. So in all of this stuff, the scale arguments are pretty bogus in our view--
The genesis of this causative "scale-accuracy" correlation can be traced back to tech thinker Tim O'Reilly and his original definition of "Web 2.0." In 2008, O'Reilly said that the big Web 2.0 success stories -- Google, Amazon (AMZN), eBay (EBAY), Craigslist, and Wikipedia -- all had one thing in common: the advantage of scale. "Understanding the dynamics of increasing returns on the web is the essence of what I called Web 2.0," he said. "Ultimately, on the network, applications win if they get better the more people use them."

But Varian and others say that's a reductive way of explaining success, and that technology, not scale, is the real driver of a site's popularity. Technology writer and author of Nicholas Carr took issue with O'Reilly's argument in a 2008 blog post. He explains:

The intelligence embedded in a link is equally valuable to Google whether the person who wrote the link is a Google user or not... O'Reilly is confusing "harnessing collective intelligence" with "getting better the more people use them." They are not the same thing. The fact that my neighbor uses Google's search engine, rather than Yahoo's or Microsoft's, does not increase the value of Google's search engine to me, at least not in the way that my neighbor's use of the telephone network or of Facebook would increase the value of those services to me. The network effect underpins and explains the value of the telephone network and Facebook; it does not underpin or explain the value of Google. (Indeed, if everyone other than myself stopped using Google's search engine tomorrow, that would not decrease Google's value to me as a user.)
Carr argues that Google's salient advantage might not be its scale, but instead -- surprise! -- the quality of its engineering. Better algorithms, smarter Web crawlers, and faster searches, Carr says, might keep Google ahead even if Bing gains exponentially more traffic. Google also benefits from of a kind of perpetual-motion branding engine run almost entirely on user word-of-mouth, which author Seth Godin has argued may be the company's most powerful asset. lastly, Google has developed a suite of powerful tools (Gmail, YouTube, etc.) that drives users back to Google search.

Microsoft has promised to pay Yahoo $150 million in cash to help lubricate the transition to Bing technology, and has also ceded 88% of the alliance's ad revenue to Yahoo for the first five years. Yahoo, for its part, is predicted to make an additional $500 million per annum from the deal. Microsoft may end up getting hardly anything at all.

Photo, top: Microsoft CEO Steve Ballmer and Yahoo CEO Carol Bartz ink their search deal.