Evolution of the Internet opens doors for Microsoft

A coming shift in the dynamics of the internet advertising business, as the momentum starts to shift away from the keyword-based systems used by search engines, is one of the biggest factors behind Microsoft's takeover approach to Yahoo, according to industry executives and analysts.

Microsoft has shown few signs yet that it is even starting to win back any ground lost to Google in search, despite heavy investments over the past three years to build its own search engine and keyword advertising system.

Other changes in online advertising, however, could create new opportunities to stand shoulder- to -shoulder with its biggest rival.

A purchase of Yahoo is only one idea among a broader range of options for co-operation between the two companies that have been discussed. If pursued, it could finally give Microsoft's famously impatient and hard-driving chief executive Steve Ballmer a way to jump back into contention at a time when the online ad world is in a state of flux.

"It would give Microsoft most of the pieces they've been missing" in online advertising, says Gary Savoy, a former Google advertising executive who now works at Leading Edge, an IT consulting firm.

Besides Yahoo's revamped search advertising system, known as Panama, it would bring a well-regarded advertising salesforce and some important parts of the technology needed to distribute advertising well beyond Yahoo's company-owned sites, he adds.

For now, search advertising is still king. The $1bn in advertising revenues that Google added in its latest quarter was more than the total generated by Yahoo. However, the focus of advertisers - particularly thebig-name brands that dominate other media, such as TV - has been turning increasingly to other forms of "branded", or display, advertising.

Google's planned purchase of DoubleClick and Yahoo's deal for Right Media both reflect that pressure. Both deals involve advertising systems with wider reachon the internet, making them foundations for advertising platforms that could serve a wide range of online publishers.

Google and Yahoo both hope to use these new networks to develop a wider set of tools and techniques to help advertisers reach relevant audiences across the entire web, and publishers to maximise the value of their ad inventory.

The science of "behavioural targeting", or serving up adverts to users who are most likely to respond to them, remains in its infancy. Applying more refined techniques will be key in this race to build the nextgeneration of online ad systems. Behind the flurry of deals lies a change in how the internet is used, and changing demands from advertisers.

The average internet user spends a growing amount of time on social networking sites, with video in particular showing rapid growth.

"What we're seeing now is a shift in the online advertising space away from a very search-centric viewpoint," says Chris Moore, a partner at Redpoint Ventures, the venture capital backer of Right Media. "Search inventory only accounts for 3-5 per cent of aggregate page views on the web."

The trouble is, it is proving hard to turn this new audience behaviour into advertising dollars - as Yahoo itself demonstrated with the rapid deceleration in its display advertising growth in the latest quarter.

A further reason for this new interest in the display business has been a reassessment by advertisers of how internet users behave.

Often, product searches made on search engines are prompted by banner ads that suggest an idea, says Tim Vanderhook, chief executive officer of Specific Media, which operates an online ad network.

Yahoo's own research also points to this tighter link between search and display. If it can take advantage of that connection by creating more effective tools for advertisers before Google enters the display market in force, it may have a shot at stealing a lead in the next round of the internet advertising race.

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