The discussions revive exploratory talks held last year between the two companies. Yahoo reportedly ended those negotiations.
Microsoft recently lost DoubleClick to Google, which also beat out Microsoft for AOL's search businesses in late 2005. Microsoft has seen its search advertising efforts make only slow progress and it has seen some key search executives depart.
In March, Google sites surpassed Microsoft sites in terms of worldwide unique visitors for the first time, according to comScore.
Microsoft has seen key industry partners like Dell and Intel open up to Linux, something CEO Steve Ballmer once likened to "a cancer that attaches itself in an intellectual property sense to everything it touches."
And Microsoft's Zune music player remains an also-ran.
Microsoft is hardly dead, as some bloggers have suggested. It continues to deliver strong financial results and has made savvy acquisitions like Tellme and Massive Inc. It got Vista out the door, though how to qualify that success remains a matter of debate. It remains one of the most successful and formidable companies in the computer industry.
Yet among industry watchers there's a palpable sense that Google already has the makings of a monopoly in Internet advertising and the emerging software-as-a-service business model. The stage is set for Microsoft to do something dramatic.
In a blog post, former Wall Street Internet analyst Henry Blodget, president of consulting firm Cherry Hill Research, argues that Microsoft would need to spin out Yahoo-MSN for the deal to work because Microsoft's Internet businesses will always be subordinate to the "Windows/Office cash machine."
"With all due respect to the amazing talent and resources at Microsoft, no company can do everything," Blodget said. "Microsoft is now so massive and broad that it is competing with IBM and Oracle on one end, and Sony, Apple, Google, and Yahoo on the other. All of these businesses are complex and tough, and focus is a major advantage." Not everyone agrees. Venture capitalist and blogger Paul Kedrosky dismisses the notion that the Internet portion of Microsoft's business can be separated from its other lines of business. "Pretending there are Internet and non-Internet aspects to a tech company like Microsoft is like pretending you can have peeing and non-peeing sections in a swimming pool," he said on his blog. "It doesn't work."
But there does appear to be consensus that a Microsoft-Yahoo deal would face difficulties. "It's hard to see how a Microsoft-Yahoo behemoth could be nimble enough to stay competitive in the fast-moving online ad business," observed Cynthia Brumfield, president of media research consultancy Emerging Media Dynamics, on her Friday blog.
"Given the messiness of a full out merger -- and also the limited benefit it would bring to Yahoo! -- I believe that a merger won't be in the works anytime soon," Forrester analyst Charlene Li said on her blog. "More logical would be partnership agreements where the strengths of each company are shared."
In a comment sent by e-mail, Datamonitor analyst Ri Pierce-Grove said, "Whilst acquiring Yahoo would significantly boost Microsoft's capabilities, integration of operations could potentially present thorny cultural and technological challenges."
The branding alone would be a nightmare and given that Microsoft still struggles with differentiating MSN and Windows Live, there's no reason to assume the conglomerated companies would be anything other than a corporate chimera.
Microhoo or Yahoosoft (or whatever umbrella brand might eventually shelter the combined businesses) would have real power, but it would still trail Google in search market share and in the number of ads served.
Google handled 54% of U.S. searches in March, according to Nielsen//NetRatings. Yahoo handled 22% and Microsoft handled 10%.
In terms of the number of sponsored link ad impressions in the United States in March, Google had more than 88 billion, Yahoo had more than 18 billion, and Microsoft had almost 2 billion, according to Nielsen//NetRatings.
Yet, Yahoosoft would represent a massive audience and there's no doubt advertisers would want access to that audience. But Yahoo's value goes beyond mere numbers. Its online audience might be enough to spur the rapid adoption of Microsoft's new Silverlight development technology, if Yahoosoft can create sufficiently compelling rich Internet applications to access Yahoosoft online services.
Such an application would strike not only at Adobe but at Google by moving users away from the Web browser. EBay already has a beta version of an eBay desktop application. Imagine all of Yahoo's services, under Microsoft's banner, with attractive, standalone client applications and no Google search box to be found.
That sounds like a plan.