Just after he was named CEO of Microsoft, Satya Nadella got a visit from Yahoo CEO Marissa Mayer.
At the meeting, which took place in the Seattle area where the software giant is headquartered, the former Google exec apparently gave him an earful of advice about turning around the culture at Microsoft, based on her own experience so far at the Silicon Valley Internet company.
Putting aside the fact that Microsoft has no Chinese treasure chest, like the big hunk of lucrative Alibaba stock that has masked a lot of bumps on Mayer’s pot-hole-filled road to recovery at Yahoo, the encounter was described to me by several people familiar with the meeting as cordial and friendly.
Except when the topic got to the long-fraught search advertising and technology partnership between the companies, which Mayer has been agitating to change for some time now. Mayer’s basic message to Nadella has remained the same as it has been for a while now — Yahoo wants out of the deal, and sooner than later.
Much sooner the better, actually, as recent stats show. According to comScore, in February, U.S. explicit core search for Yahoo fell dramatically, 14 percent year over year, while Microsoft search was up seven percent (Google, the massive leader here, was down, but only three percent). Going forward in the first quarter, while Google and Microsoft are expected to have gains, analysts estimate that Yahoo will continue to decline six percent. As to share, as you can see from the chart here: Yahoo declined to 10.3 percent from 10.4 percent — and that’s after several such declines in previous months.
That has impacted results. For 2013, according to Yahoo, its GAAP search revenue declined eight percent from 2012 to $1.74 billion from $1.89 billion. Removing traffic acquisition costs, it was flat, at $1.69 billion versus $1.61 billion.
With the downward trends, that performance could hit the bottom line again in the first quarter, unless Yahoo’s CFO Ken Goldman pulls some fancy accounting related to costs or the company sees gains in its investments in China and Japan.
Or, of course, if Microsoft and Yahoo can increase revenue per search, which they have not done very effectively since the deal was struck in 2009.
Under the 10-year agreement, Microsoft’s Bing search engine provides the search technology on Yahoo, as well as the search-advertising technology. In essence, with that deal, Yahoo signed away any ambitions to be a real player in search.
While there have been improvements, as well as guarantees and other payments put in place to bridge the gap, the fact of the matter is Yahoo is tethered to a partner that is not helping it grow its revenue at all in a key arena, a much-needed thing if Mayer is to revive its core business.
Thus, as I have previously reported, she is deep into an effort to build up its own search business again, focused on contextual search and more fast-forward and potentially lucrative avenues in the mobile sector. She has several search initiatives going full steam ahead, called Projects Fast Break and Curveball, in algorithmic and search advertising respectively.
Fast Break and Curveball involve a number of top Yahoo execs, including Laurie Mann, SVP of search products; Adam Cahan, SVP of mobile and emerging products; and Jay Rossiter, SVP of platforms.
Mayer has focused Yahoo’s new efforts on stream, shopping and mobile and contextual search. Currently, Yahoo only has control over the search experience, but Mayer clearly wants more purview over the business.
Perhaps most importantly, she now has the money to do it, as Yahoo has never had, with the pending IPO of Alibaba. That will put billions of dollars in the corporate kitty for things like, well, putting a serious effort into building the next generation of search.
The next moment to watch comes in only two weeks, which is when a long-extended agreement for Microsoft to provide make-good payments to Yahoo expires. That income from search has become important to Yahoo, which said in a recent regulatory filing that 31 percent of its revenue came from its search deal, much higher than had previously been thought by investors.
In a regulatory filing, Yahoo outlined the current status clearly:
Under the Search Agreement, for each market, Microsoft generally guarantees Yahoo!’s revenue per search (“RPS Guarantee”) on Yahoo! Properties only for 18 months after the transition of paid search services to Microsoft’s platform in that market based on the difference in revenue per search between the pre-transition and post-transition periods and certain other factors. The Company records the RPS Guarantee as search revenue in the quarter the amount becomes fixed, which is typically the quarter in which the associated shortfall in revenue per search occurred. In the fourth quarter of 2011, Microsoft agreed to extend the RPS Guarantee in the U.S. and Canada through March 2013 and in the second quarter of 2013, Microsoft extended the RPS Guarantee in the U.S. through March 2014. In June 2013, Microsoft and Yahoo! agreed upon the RPS Guarantee payment amounts to be paid to the Company for the quarters ended December 31, 2012, March 31, 2013 and June 30, 2013. The Company also agreed to fixed quarterly payments in lieu of the RPS Guarantee in the U.S. for the quarters ending September 30, 2013, December 31, 2013 and March 31, 2014. In addition, the Company agreed to waive its right to receive any future RPS Guarantee payments in all other markets except Taiwan and Hong Kong.
If the pair cannot come to an agreement, it’s not clear what comes next. Currently, sources at both companies are working together to improve performance. But those sources add that the results are nowhere near the kind of growth Mayer is looking for.
This lack of traction has been an issue with Mayer for a while, who has tried various legal means to exit some of Yahoo’s search commitments with Microsoft. For example, Yahoo tried and failed to delay the transition of paid search in Taiwan and Hong Kong, via complex legal fighting.
In these legal efforts, by the way, Yahoo used the excuse of the Microsoft CEO transition as one of its arguments for the delay. Now that Nadella is in place, presumably, the situation could escalate. And he’s not coming to the arena without experience, due to a critical stint at Microsoft’s Online Services division at the time of the initial Yahoo deal.
Whether Mayer will try to use more legal means — citing lack of performance — is unclear. She will have a much clearer juncture next year at the five-year mark of the agreement, when the pair could more easily part ways.
For now, inside Yahoo, the focus is on finding another way to do search outside the parameters of the deal, such as contextual search.
“When I look at things like contextual search, I get really excited,” she said at a recent investors conference in San Francisco. “The amount of information available to build a service on is just incredible.”
Unlike keyword search, which relies on input by users, contextual search uses all kinds of signals that users share, most times without an effort, as they move through the world, both digitally and physically. This is the red-hot opportunity of mobile, because consumers are constantly beaming information from devices that can be taken advantage of by Yahoo and extended to marketers.
Mobile could also be a way out, since it has always been served by Yahoo, even as the arena has grown in size and importance. At a recent Allen & Co. conference, Mayer said onstage that its mobile audience was now bigger than its Web one.
One other option that has been bandied about by some is the possibility of Mayer buying Bing from Microsoft and becoming its search technology provider. While an interesting notion, those inside Microsoft discount the idea, noting Bing is highly integrated into other company services and is a key asset in a mobile-first, cloud-first world.
“Mayer certainly has the money to buy Bing,” said one person inside Microsoft familiar with the relationship. “But it’s not really for sale, and it’s not clear she can’t do it on her own anyway and in a whole new way with all the money Yahoo will have from Alibaba.”
Such an effort is vintage Mayer, who was a key search exec at Google. “She thinks she can do it,” said one person inside Yahoo. “And she is very determined.”
Microsoft and Yahoo representatives declined to comment.