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Microsoft looks beyond AOL

Redmond's desktop leadership, new ad business will help it compete with Google after losing out on the AOL deal, analysts say.

Time Warner has chosen Google as the most suitable partner for its America Online Internet unit--but the game isn't over for jilted suitor Microsoft.

The Redmond, Wash., software giant plans to leverage its desktop market dominance to compete with Google on search and advertising, analysts said Wednesday.

After spending much of this year wooing AOL in an attempt to get its search business, Microsoft lost out to Google. Google and AOL announced Tuesday that Google will invest $1 billion for a 5 percent stake in AOL under a broad partnership that expands their existing search engine deal to include collaboration on advertising, instant messaging and video.

Google also is offering a $300 million credit that AOL can use to buy keyword-based ads from Google, and AOL will be able to sell all types of ads on Google sites and its publisher sites that display ads powered by the search giant. In addition, Google will help AOL better expose its content to Google's Web crawler.

But given that AOL and Google have had a search engine agreement for three years, "at the end of the day, nothing much has really changed" for Microsoft, said Michael Gartenberg, an analyst at JupiterResearch. "From Microsoft's perspective, the ability to do a deal with AOL would have been a good thing, but it was not a critical thing."

Microsoft plans to integrate desktop search into the upcoming version of Windows, code-named Vista, and eventually extend that to the Internet, Gartenberg said. "When search becomes an integrated part of the Windows experience, that will put Google on the defensive," he said.

Microsoft also is expected to gain traction with its brand-new AdCenter pay-per-click advertising service that's being tested and its year-old search engine, said Rob Helm, director of research at independent research firm Directions on Microsoft.

"It is definitely a lost opportunity for Microsoft, but also Microsoft is looking at this as a long-term process and still has assets to deploy" such as integrated search in Vista, Helm said. "So Microsoft, in a sense, hasn't really started the competition yet."

Adam Sohn, an MSN director, said the fact that the search business is still in its infancy and online ad spending is booming means it is anybody's game going forward.

"Yeah, it would have been nice to bootstrap that (AOL) ad network, sure. But, do we need it? No," he said. "This is a long-term strategic bet for us, and we're going to continue on with the plan we have today."

Sohn did not dismiss the possibility of striking a deal in the future, though.

"That being said, we would never preclude ourselves from a partnership that makes sense," he said.

Microsoft could bundle different Internet advertising types and pricing together to try to compete with Google's ad business, said Charles Di Bona, an analyst at Bernstein Research. It also could offer minimum revenue guarantees or more favorable revenue-sharing terms, he said.

Microsoft "remains in a better position to sell a bundled Internet advertising offering, including display and search, which could be appealing to advertisers as they expand their nontraditional spending and, frankly, feel their way through the issues of mix and methodology in approaching the Internet medium," Di Bona wrote in a research note.

"We continue to view (Microsoft's competition with Google) to be a prolonged, multi-move game, and while (Microsoft) has slipped in the first few rounds, we expect the company to move into the next round relatively swiftly and most certainly aggressively," he wrote.

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