Why Microsoft Needs Yahoo!

The escalating rivalry between Google(GOOG) and Microsoft(MSFT) may have an unexpected beneficiary: Yahoo!(YHOO).

As Google continues to encroach on Microsoft's turf -- the search giant introduced an upgraded version of its application suite last week -- Yahoo!'s potential value as an acquisition candidate is growing for Microsoft.

And while speculation about a Microsoft acquisition of Yahoo! has been swirling since The Wall Street Journal reported last year that a faction within Microsoft's MSN search division was pushing for such a deal, recent developments make the case even more compelling.

For one thing, Google has continued to dominate the search space and pick up market share since May 2006 -- when reports of a possible Microsoft and Yahoo! deal first surfaced -- while Microsoft has ceded ground despite its best efforts.

Nine months ago, Google commanded 44.1% of the search market, as compared with Microsoft's 12.9%, according to research firm ComScore. As of January 2007, Google had moved up to 47.5% while Microsoft slipped to 10.6%.

A combined Yahoo! and Microsoft would garner about 38.7% of the market -- enough to present formidable competition to Google. That traffic number could also stand to benefit from Microsoft's launch of Vista, letting the software giant bundle a stronger search offering into the desktop experience that it dominates. And traffic is exactly what Microsoft needs.

Microsoft boasts conversion rates that are higher than either Yahoo!'s or Google's. (Conversion rates are the amount of advertisements that are clicked through when presented next to search queries, which is the way search engines make money.)