The AOL Winnah: Google, by a Knockout

It’s finally official: America Online and Google confirmed late yesterday that they have agreed to a deal under which Google will pay $1 billion for a 5% stake in AOL and AOL will retain Google as its search provider.

The board of directors of Time Warner, parent to AOL, met in New York yesterday and agreed to accept the Google offer despite strong opposition from shareholder Carl Icahn.

The deal will give Google another five years as AOL’s search provider and will establish some new advertising relationships between the pair. Perhaps as importantly for Google, it represents a setback for Microsoft, which has courted AOL since September in hopes of scoring a large customer win—and a major ad market– for its fledgling MSN Search product.

The agreement will “meaningfully strengthen AOL’s position in the fast-growing online advertising business and help drive more advertisers to its Web properties,” Time Warner chairman and CEO Dick Parsons said in a release. “This agreement is key to fulfilling our commitment to realize the potential of AOL’s very large online audience.” Estimates put AOL’s base of registered users at about 125 million worldwide.

Details of the proposed agreement are still incomplete at press time, but the general terms of the agreement are that AOL will “whitelist” Google’s ad-serving technology and then sell search advertising that will appear only on AOL Web sites, through a platform to be called “AOL Marketplace”. Google will also permit AOL to sell some display ads directly into Google’s AdSense network.

The announced deal will also give AOL some credits—pre-announcement reports put the figure at more than $400 million—with which to purchase sponsored listings for its Web properties within Google’s search ad program. The same reports said these ads would appear in a special featured section of the relevant Google search results pages, possibly marked with an AOL logo or some other graphic branding device.

AOL will also get help from Google in “making AOL content more accessible to Google Web crawlers,” the statement said. Observers say this will probably involve optimizing AOL pages to improve their natural rankings within the Google search engine. The assistance won’t involve changing the Google search algorithm, according to reports, but will be “technical” assistance to bring the pages into closer compliance with Google’s relevance measurements. Google has in the past offered that same kind of help to other online marketers, including eBay and DVD rental service Netflix.

Google also agreed to collaborate with AOL to showcase its premium video service within Google Video, the engine’s increasingly popular video search platform. Where its media content is relevant, AOL will also see some of that content featured in a dedicated spot on Google search results pages. It’s not clear what this will look like, but reports have suggested that it might be a special location on the page marked with an AOL logo or some other graphic branding.

Google in turn gets at least two important benefits from the agreement as it’s currently understood. There’s the immediate benefit of retaining its single most important client for search services, and therefore an important source of ad revenue. AOL reportedly accounts for 10% of Google’s total income from pay-per-click ads.

In a statement announcing the deal, Google CEO Eric Schmidt said, “Our investment underscores our recognition of AOL as a valuable strategic asset and our desire both to contribute to and to participate in its future success.”

“AOL and Google have a very successful history working together, and this is an opportunity to take it to a new level that will benefit both companies and the customers we serve,” said AOL chairman and CEO Jonathan Miller.

The deal is also being seen as a major competitive block to MSN Search, which was reportedly trying to woo AOL away from Google.

In recent years, AOL has been trying to refashion itself as a Web portal and content provider, now that its dial-up business model is drying up. For its part, Google has been exploring new ad alternatives to grow revenue beyond its pay-per-click origins. Last March, the company began a test selling various display ads on a cost-per-thousand basis, reportedly in hopes of drawing online the big brand advertisers who are largely uninterested in selling directly online.

Advertisers will be watching the impact of the AOL deal on Google’s ad model will be particularly noteworthy, say industry observers. In particular, search advertisers and search marketing firms will want to see if offering AOL content guaranteed featured placement either in ads or in natural search results will have an effect on their own results.

“Given that [Google has] built their brand largely on the integrity of their search results, I think it’s important that they provide transparency into the nature of these arrangements and any advertiser or partner that may be getting preferred placement across the network,” said Peter Hershberg, a managing partner with Reprise Media. “That’s something that the public and advertisers should have some visibility into, because it’s a departure from the way they’ve done things in the past. Given Google’s history, I can’t say for certain that’s going to happen.”

Search optimization expert Jim Hedger of StepForth Placement says it’s an open question whether Google is risking the “purity” of its search results with the compromises it has made to keep AOL. “We’re hearing rumors out of the Time Warner Building of graphical ads on Google’s front page with the AOL brand on them. Will that devalue the Google brand [among users]? I don’t know if that’s possible.” Hedger doubts Google will wander too far from the clean, uncluttered look of their current search and results pages.

What the company will have to watch out for, he says, will be bridging the gap between what registered Google users expect from their Google services and what AOL users will tolerate. Like Yahoo! and MSN, Google is encouraging its users to register and to stay on the service by rolling many different features up with its search services into a total branded experience. For example, Google combines the mapping qualities of Google Earth with the local data of Google Local and serves up geo-targeted ads to users of its Gmail service—ads that may even contain mash-ups of Google Earth maps.

“As a user, I’m in the Google universe, and I give those ads a bit more credibility because this is the universe I’ve chosen,” Hedger says. But that credibility is fragile, and it’s partly founded on an expectation of restraint. And while Google and AOL will not be sharing subscribers, they will be sharing access to subscriber lists. Hedger believes Google must be wary of combining too far with a company like AOL, “which has traditionally been paid a lot of money to be not so subtle.”

“Am I, as a registered Google who uses them for several life-services now, going to start seeing ads that really have nothing to do with my interests?” he asks.

Bryan Weiner, CEO of interactive marketing firm 360i, finds the ad-sales portion of the agreement to be the most interesting thing for advertisers. “For the first time, Google is showing some flexibility to another party, in that AOL is going to be allowed to sell some of the ads itself on its network,” he says. “There will be some combination of pooled Google ads and ads sold by AOL specifically. To the ad community, it will look like AOL is going to be selling search. It will be on a Google-run network, but you’ll be able to buy AOL specifically.” That should give advertisers more visibility into how AOL performs in comparison to the total Google network, he says—something that has not been possible before now.

“I think it’s a smart deal from AOL’s standpoint in that they get to keep this massive revenue stream from Google, while at the same time carving out an ability to isolate their property,” Weiner says.

What went wrong for Microsoft, which only a month ago seemed to have an inside track with AOL? The systems giant may have been disadvantaged by the fact that its own search ad platform, MSN adCenter, is still in beta test here in the United States and is only fully operational in France and Singapore. MSN is currently using both adCenter and Yahoo! for its search ads. “I think that made them too much of an unknown from AOL’s standpoint,” Hershberg says. “Google is very much a known quantity at this stage, whereas with MSN, nobody really knows how well their system is going to work and what the economics of it are really going to look like.”

There was also the inherent complexity of a partnership between two companies which both fancy themselves as content providers. Compared to an integration with MSN, AOL may have decided a straightforward distribution deal with a techie ad network like Google was simply more feasible.

Both Hershberg and Weiner agree that MSN’s next step—once adCenter is in general release– should be to go out and find more Web distribution. “Marketers want both return on investment and sheer volume of distribution,” Weiner says. “If the volume is not being brought to the table, then the media property becomes less interesting. Microsoft has to prove not only that they’re effective in delivering ROI but that they can deliver enough volume to make them matter to advertisers.”

The loss of AOL to Google is “not catastrophic” for MSN, but it does shut them off from the largest ad syndication opportunity out there now, Hershberg points out. “They’re going to have to find other ways to get distribution outside the MSN network.

That might involve offering Web publishers certain guarantees of cost-per-thousand (CPM) revenue from MSN ads in return for their real estate—something that is fairly common in offline advertising. “Microsoft needs to prove that they have a viable ad product, and then they need to use some of those billions of dollars that they have in the bank to go out and guarantee CPM revenue to potential partners,” says Hershberg.

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