The Microsoft-Yahoo megamerger now looks far less likely than it did late last week.

But the reason the companies would want to join forces - Google's continued dominance in online advertising revenue and in web-based services in general - remains as strong as ever. And it raises questions about what Microsoft's next move will be to generate a healthy online advertising business and avoid losing even more ground to the flourishing search company.

There are many reasons why a Microsoft-Yahoo deal would have been a bad idea, and some in the industry are breathing a sigh of relief that they won't have to deal with the complexity it would have wrought.

Critics questioned how the two companies would navigate separate ad platforms and network infrastructures, as well as how they would integrate their disparate corporate cultures. They also said the full union of the companies would take at least two years to complete, giving Google even more time to solidify its leading market position.

Wall Street analysts also noted it would be a bad idea for Microsoft to undertake such an enormous merger when the company has traditionally made smaller, more strategic acquisitions. A research note by analyst Heather Bellini at UBS advised the company to tackle its online technology challenges on its own while acquiring more customers by buying startups and other small companies.

However, she also noted that there aren't a lot of valuable internet assets on the market now that Google has snapped up Doubleclick, a deal that is expected to close by the end of the year.

Microsoft's online action plan

So what's a software company that waited too long to capitalise on the new business model of the internet to do now? Microsoft is in dire straits in the online advertising market, and the company has to change tactics before it becomes too late to even be a serious contender, let alone the revenue leader, as Microsoft CEO Steve Ballmer has promised.

Leveraging its skyrocketing revenue and profits, Google has diversified its line of products and services, moving into areas outside of consumer online services, such as offline advertising, hosted software for businesses and enterprise search. Within consumer online services, it has also expanded beyond internet search, developing a broad menu of products in areas such as photo management, webmail, video, instant messaging and voice messaging.

Microsoft, on the other hand, has failed to promote its Windows Live-branded services since it launched a major revamp and branding plan in November 2005. Moreover, the company has seen revenues in its Online Services Group rise only slightly since that time, and has made new and improved services languish in beta testing only for select users before making them publicly available. This runs counter to the strategy of Google, which pushes out services to users in rapid-fire fashion even if they remain in beta for years. Microsoft also has had a hard time marketing its Office Live hosted service, which provides a web presence, CRM (customer relationship management), email and other hosted services to small businesses.

Some industry watchers said there still are ways other than merger for Microsoft and Yahoo - or Microsoft and another competitor - to team up against Google.

One financial analyst who asked not to be named suggested that Microsoft and Yahoo broaden an ad-revenue sharing deal they already have. It lets Microsoft use the Yahoo Search Marketing platform, formerly called Overture, in overseas markets to provide paid search listings to Microsoft's MSN and affiliates. Microsoft would not disclose the terms of the revenue-sharing deal, but essentially Microsoft pays Yahoo to push out ads to some of its sites, and in turn earns advertising revenue. Eventually, markets currently served by Yahoo's search platform will be powered by Microsoft's adCenter platform, which is already handling Microsoft's paid search advertising in the UK, US, France, Singapore and China.

Possible partnerships

Andrew Brust, chief of new technology for consulting firm Twentysix New York, offered another plan for Microsoft, of which his company is a partner. He thinks it would be a good idea for Microsoft to cosy up to multimedia content providers such as AOL and News Corp, which owns both the Fox media empire and the popular social-networking site MySpace, to earn more advertising revenue. A deal with Myspace would be an especially smart move because it would give Microsoft a presence they are far short of right now," he said.

One stumbling block to any online acquisition or partnership is Microsoft itself, Brust said. "I’m still not convinced they really want this," he said. "Rather, I think that they think they have to have it, and so their approach is too reactive."

Michael Gartenberg, vice president and research director at Jupiter Research, suggested that rather than acquire or partner another company to gain ground on Google, Microsoft should turn inward and focus on execution of its own online strategy. The company has developed innovative online services behind the scenes but has been slow getting those out to users, he said.

"One of the challenges at Microsoft is how to get the technology out the door," Gartenberg said. "Look at how long the Hotmail upgrade was in beta. Part of what Microsoft has to do is execute... [and] deliver on things that it may already have in the back room."

Microsoft in January 2006 launched Windows Live Labs as a way to develop new online technologies and services quickly so they can push out offerings the way Google does. However, the group has delivered only a few services since its creation.

Juan Carlos Perez in contributed to this story.