updated 7/24/2008 8:32:47 PM ET 2008-07-25T00:32:47

Microsoft’s CEO defended the software maker’s decision to invest heavily in its unprofitable online business, but shed minimal light Thursday on specific steps it will take to challenge Google in the wake of the failed bid to buy Yahoo.

Analysts arrived for a yearly meeting at Microsoft Corp. headquarters hoping for new details about the software maker’s online strategy, on the heels of Wednesday’s news that Kevin Johnson, a key executive in Microsoft’s pursuit of Yahoo Inc., is stepping down.

But aside from an announcement that online hangout Facebook will build Microsoft’s Live Search engine into its site, executive presentations offered more cheerleading than fresh insights.

On stage, Chief Executive Officer Steve Ballmer filled in for Johnson, president of Microsoft’s Windows and online operations since 2005, to sketch out how the software maker is thinking about investing in its online business. Last week, the company announced $500 million of additional spending for fiscal 2009, but didn’t say how the money would be spent.

(Msnbc.com is a joint venture of Microsoft and NBC Universal.)

Ballmer didn’t disclose dollar amounts Thursday, but indicated Microsoft would focus the bulk of that investment on search technology, data center infrastructure, Web indexing and marketing, and called search the mission-critical part of the online business.

Search is “a two-horse race” between Microsoft and Google Inc., Ballmer said, making only passing reference to Yahoo Inc.’s current position as the second-largest search and advertising provider. The executive said Google and Microsoft are the only two with the resources to play in what he sees as a $1 trillion market.

However, Microsoft must “ante up” to get in the game, Ballmer said repeatedly, laying out investments of as much as $1.2 billion to $1.5 billion a year, including the $500 million announced a week ago.

“Everything you read, everything you watch, everything you want to communicate, all of those experiences are going to happen over the Internet,” Ballmer said, calling search “the killer app, if you will, for this new world. How do I find the merchants? How do I find the people? How do I find the information?”

Ballmer said Microsoft has found itself in a chicken-and-egg bind that’s hampering its ability to compete with Google. To get more search advertisers, Microsoft needs more search traffic. To get that traffic, it needs more advertisers.

Microsoft’s $47.5 billion bid for Yahoo, which collapsed in May, and its later attempt to make a smaller deal for Yahoo’s search operations, was one way to solve that pickle, Ballmer said.

“There’s nothing under discussion between the two of us,” Ballmer said of Yahoo. Instead, he said, “There are alternate approaches around this Catch-22, which I’m not going to talk about today.”

Microsoft did announce one solid development aimed at increasing search traffic. Facebook, the second-largest social networking site in the U.S. behind News Corp.’s MySpace, plans to incorporate Microsoft’s Web search engine into its U.S. site by the end of the year. Microsoft, which already powers Facebook’s display advertising, will provide search ads alongside results.

Financial terms of the deal were not disclosed, nor were details about how the search function will look on Facebook’s site.

It’s not clear that such a deal will have much impact on Microsoft’s search share or revenue, however. Even Google, the best so far at search advertising, has acknowledged difficulties making money on social networking sites where users are goofing off, not shopping for shoes or plane tickets.

Financial analysts left the eight-hour meeting with mixed views.

“There is more clarity on where the money is really going, even within online,” said McAdams Wright Ragen analyst Sid Parakh. He said he walked away from side conversations with executives with the impression that marketing to increase Live Search’s profile among consumers was one of the top spending priorities.

But, Parakh said, Wall Street is still deeply skeptical that investing billions will yield a return any time soon, if at all.

Charles DiBona, a Bernstein Research analyst, said Microsoft offered a level of detail that exceeded his low expectations. But after hours of PowerPoint slides and number crunching, “I still don’t know exactly what they’re spending on” within the online services business, he said.

Ballmer mentioned a few other areas Microsoft has targeted for investment in the current fiscal year, among them the marketing push to improve consumers’ perceptions of Windows Vista and Live Search, and search distribution deals such as the one announced earlier this year with Hewlett-Packard Co.

Under the terms of that deal, HP will preset Live Search as the default search engine on PCs shipped in the U.S. and Canada starting in January. The PC maker will also install a special Web browser toolbar, demonstrated Thursday, that can tell when Web shoppers are searching on Google for certain products, then lure them to Live Search for a rebate.

Speaking more broadly, Ballmer reiterated the company’s position that the industrywide shift to software delivered over the Internet won’t replace the need for the Windows operating system.

Shares of Microsoft dipped 99 cents, or 3.8 percent, to close at $25.44.

Copyright 2008 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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