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Several presentations at the All Things Digital conference this week made it clear that Microsoft (MSFT) has probably lost its appetite for buying Yahoo! (YHOO). According to Reuters, "Yahoo Inc Chief Executive Jerry Yang said on Wednesday a potential deal with Microsoft has tremendous power, but the software giant appears no longer interested in a full merger."

The news may serve to drive down Yahoo!’s share price and vex the company’s board and takeover king Carl Icahn who wants to have control of the portal firm. But, the news says much more about Microsoft than it does about Yahoo!.

Somewhere deep in its heart of hearts, Microsoft believes that it can challenge Google on the search company’s own ground and have some success. As implausible and audacious as that sounds, it is within the Redmond culture to think such things can be done.

Seabiscuit was not supposed to beat the larger and stronger War Admiral in 1938, but he did.

It would appear that casting Microsoft as an underdog at anything makes little if any sense. It may be the most successful technology company of the last fifty years, but the firm was far too late at seeing the search business would be the key to internet domination.

Microsoft does have a history of coming from behind. Netscape had the lion’s share of the browser market in the mid-1990s. Microsoft took that away with its Internet Explorer. No one thought Redmond could challenge Sony in the game console business, but the Xbox now does better than the Playstation.

The Sony case is not terribly different from the Google one. It would be fair to argue the the complexity of search cannot be compared to consumer electronics. But, Microsoft does have the capital to mount an attempt to improve its search product by a considerable margin.

Sony was the premier consumer electronics company in the world when Microsoft began to chase it. Sony has lost its preeminent position to Apple. But, seven years ago, almost every analyst with a opinion believed that the Playstation franchise was beyond competition. That did not turn out to be true.

Times change.

Douglas A. McIntyre