Microsoft and Yahoo: Search partners

After a year and a half of dealing, the tech giants reach a 10-year deal to take on Google, which holds a 65% market share in online search.

Microsoft and Yahoo reached a long-awaited partnership Wednesday in a bid to challenge Google’s dominance in online search.

Under the 10-year deal, and will maintain their own branding but search results on will say “powered by Bing.” Yahoo, in turn, will be responsible for attracting premium advertisers.

Microsoft will pay Yahoo 88% of the revenue it gains from searches on Yahoo’s sites. Microsoft will also have the rights to integrate Yahoo’s search technology into its own existing Web search platforms.

Yahoo said the agreement will modestly decrease its overall revenue but increase its operating income by about $500 million annually.

Shares of Yahoo (YHOO, Fortune 500) tanked 12% on the news, as investors expected Microsoft to pay the company up to $1 billion in cash up front for the deal, albeit with a more modest revenue-sharing figure. Microsoft’s (MSFT, Fortune 500) shares rose about 1%, and search leader Google’s (GOOG, Fortune 500) stock price fell 1%.

The deal is expected to close in early 2010. U.S. users will start to see the change three months later and users around the world will see the full effect within two years.

“This deal is really about scale,” said Yahoo Chief Executive Carol Bartz on a conference call. “By combining the … technology of both companies, we can create a real, viable alternative for advertisers.”

Microsoft said the transition will cost the company “several hundreds of millions of dollars,” but it will benefit in the long run from the ability to charge advertisers more for its service, because the deal will improve the relevance of search results. Microsoft said it also expects to benefit from Yahoo’s expertise, acknowledging that its new partner has more ad sales experience.

“This really is a win-win agreement both for Microsoft and for Yahoo,” said Microsoft chief Steve Ballmer. “Consumers will get better products, and it will help the industry as a whole to prosper through our shared vision and shared values.”

Bartz said that some Yahoo employees will eventually move over to Microsoft and that some search personnel would be laid off. But she added that the transition will occur over time, so virtually nothing will change at least until the deal is inked next year.