Why are Microsoft and Google fighting over AOL?

Microsoft and Google are currently in negotiations with Time Warner over a possible acquisition or partnership with AOL. Why are Microsoft and Google interested in AOL?

It is all about online advertising, and in the short term, about the small text ads that appear above and at the right hand side of content on web pages and on the search results pages of major search engines. Text ads are served by ad networks such as Google Adwords and Yahoo and the advertiser pay those ad networks a pre-determined amount every time an Internet user clicks on an ad. Last year Google generated around 95 percent of its revenue from text ads and Yahoo reported that it generated about 50 percent of its revenue from pay-per-click text ads.

Online advertising will account for 10 percent of the total US ad dollars spend by 2010, according to according to a recent report from Parks Associates, and grow with a compound annual growth rate of 14 percent per year.

It is, therefore, no surprise that Microsoft wants a piece of the online advertising action. Evidence of this are recent statements by Bill Gates and CEO Steve Ballmer and the launch of a new ad-supported portal offering called Windows Live, the announcement of Freemont, a new online classified system that is suppose to take on eBay and Craigslist and possibly Google's Googlebase, and the phased roll-out of its own paid search advertising program AdCenter. To make money from those small text ads they need to be visible to many Web users that click on them. But Microsoft's own Web portal, MSN Search, only attracts 15 percent of the number of people that search each day. That's where AOL in with its large subscriber base of 25 million can help. AOL currently serves text ads from Google, Microsoft's main competitor in this space. In the first half of this year Google has generated about 11 percent of its revenue from text ads served on AOL, according to a recent article from Reuters. A web advertising distribution deal with AOL would accomplish two things for Microsoft: reduces Google's current and future dominance in the online media space and significantly boosts its own ad revenue from text ads when its paid advertising system AdCenter has been fully launched in the US in the first half of 2006.