BILL KOEFOED: Now, for our next section, I would like to welcome up Dr. Qi Lu, president of our Microsoft Online Services Division. Dr. Lu.

QI LU: Good morning. What I'm going to talk about this morning is our online search business, Online Services Division as a whole—but my speech today will be focused on the search business.

What I will start with is to share with you our world view on how we think about this business. This is important because these views inform our strategic thinking.

First, the opportunity. If we take a historic and holistic view about search product and search business, at its core, it's about computationally understanding intent and to fulfill that user intent with information and services.

In search as a consumer product, what you get is a query. A user query is an explicit, specific, and immediate expression of needs and interest. At the early days of the Web, we built search products primarily by matching the user query against hypertext documents. As the Web grew, it became increasingly richer. The materials you can use to work with to fulfill that user intent becomes much, much better. Lots and lots of queries can be better answered by showing images and videos.

Third-party studies will show that the amount of queries on YouTube has already surpassed the total amount of queries that happens on Yahoo. But the important point is: there is a sustained trend because the Internet is about ever lowering the barrier of capturing, producing, interacting with, consuming digital content, digital information.

So there will always be new ways of encoding digital artifacts that we produced. Just to give you a couple of examples—Facebook. There is a lot of human interaction. People are motivated to interact on that property. And imagine if we can harvest the information that is produced on sites like Facebook. It can solve a lot of search problems that so far the industry hasn't been able to solve. For example, finding people—it's always a difficult problem.

And then another good example is Twitter. There are lots and lots of short text segments that have been produced that are describing all that's happening in the world. Imagine trying to find out what's going on in every corner, part of the world. The future of evolution of services like Twitter will enable that to happen. But the point is, the opportunities to innovate, the opportunity to enter and to compete will always be there.

And another important part is, as long as we keep building technology, understanding—truly, truly understanding—the user intent and serving those user intents, a natural portion of those intents are commercial in nature. And then you can build a better marketplace like you see today in the search advertising marketplace.

You allow service providers, merchants, and offers to be part of what we provide to serve user intent. And when the intent is commercial in nature, the ads are exactly what they're looking for. You have genuine value for consumer, genuine ROI for advertisers. Huge economic value can be created—the so-called search economics. So, from that perspective, we believe the opportunity to enter, the opportunity to compete, the opportunity to innovate, will always be there.

Second is the challenges that we're seeing. In the search space, we have Google, a category leader. They have a very strong market share position—in the U.S., in Europe, less so in Asia. They have a very, very strong brand that has become a verb that stands for "search." We have seen plenty of studies whereby you put the Google brand on top of a search result provided by another search engine—versus the other way around, where you put the Google search results underneath, put the different brand on top of search results. People will prefer the Google brand because of the strength it has.

Second, the important challenge we're facing is scale because this is a scale-driven business. Even if you have one user, you have to crawl the whole Web building an index, through R&D. So, when you operate at subscale, you will incur a certain amount of financial loss. It needs to get to certain scales. When you are at scale, this can be a hugely profitable business. But at subscale, there is a financial cost to be incurred.

The second—search as a consumer product. Scale actually is visible as part of the experience because the businesses supply constant business, when you have more scale, more volumes, you have more advertisers. You have more ads to draw from, and therefore, the overall experience—the ad—will become more relevant. So, a smaller-share player relative to the larger-share player—the actual consumer experience in those areas will be less versus the larger ones.

So those are two very important challenges that we are facing. Then we look at the strengths, what we have. I have been in this business for a number of years. To me, it takes two things to be in there and to be good at it: First, you need to have the capability of building vast computing infrastructures. Second, you need to have the capability to have the talent base for top-notch R&D teams because the combination of these two will give you the ability to scale. Scale is key because the Web grows every second. This product requires you to scale constantly.

The second was the combination of these two—vast computing infrastructure and talent give you the ability to have the rate of innovation that's needed in all the key areas. And we have that. Our company's heritage and culture and spirit, its long-term commitment, tenacity. We have the talent base, we have the R&D strengths. Plus we get the others to work with. We start with a strong online presence in our portal products, in advertising products. We also have the overall Microsoft ecosystem to work with plus our commitment to invest for the long-term.

So, at one time, on one hand we want to be very objective. As I keep telling my teams, we want to be brutally honest about where we are, understand the hurdles we have to overcome. At the same time, we have deep, deep faith that we have here at Microsoft what it takes to compete. We have what it takes to win in the long-term. It is going to take time.

That's our world view, how we think about this business. So, let me talk about a framework, a strategic framework on how we compete. That strategic framework for search has three layers of activities: The first layer is what we call the foundations. These are large-scale R&D operations that you have to do just to be in the game. That includes crawling the whole Web, build a huge index, billions—tens of billions—of Web pages to keep the index fresh, a certain part of the Web corpus. You need to keep it super fresh because it's constantly updating. And do all the R&D, the scientific discoveries, to understand user intent, which generates a distribution of possible meanings, possible needs or interests, and then match that against what we work with out on the Web today.

And the focus of building platform capability so that we can produce a top-notch relevance ranking and presentation, overall package of experience as a baseline—that's foundational work.

The second tier is differentiation. As we all know, at this stage, even if we are ahead at the foundational level, it is not going to be enough to gain market share because of what we talked about. Market dynamics—we have an incumbent who has a strong brand and has share lead. So, we have to produce a search experience that is materially different and is competing at the same time.

So, our focus is on a few things—focusing on user intent and understanding computationally what the users are trying to accomplish and helping users to complete the tasks better and make more informed decisions faster.

The other focus is to extract distilled knowledge. As you will see in our Bing experience now and going forward, it will increasingly showcase the entities, not just the Web documents. Entities are people, organizations, locations, products. And the relationship among those entities—that's working knowledge. That enables our users not only to find out what, but figure out the how and the why. So, that's our focus in differentiation in R&D and product development.

The third segment of our activities is big bets for big breakthroughs. I will give you one example: to innovate the search business model. And we have a product currently in the U.S. market called Bing cashback. And it is in the early stage of work. We see positive traction, but products and services like that—if it truly works out—have the capability to change the business landscape in a profound way, to cause more innovation to happen that benefits consumers, advertisers, all around.

On top of these three segment activities—foundation, differentiation, game-changing activities—we also are focusing on building a brand. And to keep our compete strategies, Bing on a global basis is our new brand, and we are also doing a number of distribution deals so that our product is used by increasingly more users and will generate more liquidity into our marketplace.

Collectively, we add all those together. You can think of this as a balanced portfolio that maximizes our chances of growing market shares, building strengths so that we can compete and truly win in the long-term. At this point, our primary focus is on Bing: differentiate a search experience and go-to market.

So with that, I will invite Yusuf Mehdi, our senior vice president of online audiences, to come on stage to give us a quick demo about Bing and some of the features.

YUSUF MEHDI: Thank you, Qi. All right. I won't need that, thanks. All right, so I'm going to give you about a five-minute tour of Bing. Show you a little bit about how it works and the process, talk to you about the feedback and what's working, what's not working, and how that's coming along.

And before I jump in, I just want to make sure we set the context for Bing so you guys understand what it is we are trying to do and what's guided the product development and how we're bringing that to life in the marketplace.

Unlike other search engines, we tried to focus on where the market is moving forward, because we had the benefit of coming later. And so we talk about it more as, in a way, a decision engine than a search engine. What does that mean? It means today that search engines are about getting you great Web results. They will let you connect from your PC to any Web site out there. It's kind of a navigation tool.

But what you find when you really understand what consumers are doing, they are doing a lot more with search engines today than they were five years ago, 10 years ago. They are actually now looking for information. They are looking for understanding, and in many cases, they're actually trying to accomplish tasks.

And today's search engine with the ten-blue-link user experience isn't designed to that. We are trying to pioneer that and go in a new area to accomplish that.

So, let me go ahead and let's take look at the product, and I'll show you a little bit about it.

Now, one of the things before I start is, the product has done pretty well in terms of technology and algorithms relative to competition. But we've also done really well in an emotive sense with consumers in a way that's even surprised us, one of which is just even the home page. So, for those of you who haven't actually used it, on the home page, we have a very sort of visual picture we have every day. There are hover spots that tell you places that you can go and discover the Web.

And what we've found is the home page has become incredibly hot with kids in schools. In fact, many kids, many children in elementary schools now who are using computers are flipping over to this page because if you compare it with the competition, you get sort of more of a white, utilitarian page. This new mode for discovering the Web has really connected.

It surprised us, and we are pretty happy about it. In fact, you all should try it too if you haven't. If you wanted to change your search page, you just come up here to the right and go ahead and set the page. Go ahead, I'll wait for you. Take your time. If you need any help, I will be around at lunch to help you set the page.

All right. So, let's go ahead and talk about the product. As I said, there are really three areas where we chose to shine: Best search results, a more organized page to get knowledge from the Web, and to help you accomplish key tasks in four specific areas: Travel, health, shopping, local. And those, not surprisingly, are where there is a lot of commercial activity and where a lot of the money is made.

So let's go ahead and start with the first one, best results. We will go ahead and do a simple tour and we'll take a look at—we'll use the competition. It's okay, I think, to be competitive and show some competition. Here I'm looking for Tour de France. I type in "Tour de France" in the search engine today, and you get a decent set of results. You get the official site.

One of the things we try and do is we try and make that simpler for you and bring the answers right to the front. In many cases, now the tour is over, I missed some of it because we were busy over the past couple weeks. But just by typing it in, I get a link to all of the results, who won, their time, et cetera. And so very nice results.

In addition, we are doing some things—a feature we just released. This came after Bing, so it's already 30 days after and the development team is really innovating fast.

We have the ability to search Twitter. So, one of the ways you want to get information, one of the things that's hot right now is how do you get real-time information in the search engine. And so one of the things that you can do here is you can do a tweet. You can say Lance Armstrong tweet, for example.

And he was tweeting a lot during the tour. We will pull up the results from him. But during the tour, it was pretty nice because you could see sort of the controversy that was going on between himself and Alberto Contador. And now you can see—let's see, what did he tweet? I haven't checked these here. "You know you've made it when Wendy's signs on campus in Austin." "I'm going to make a video of my ride." So, you get sort of some information.

Another one, we'll try someone else. I think Karen Swisher said she was going to be here. I'm sure if she is, she's tweeting about the conference. Hopefully something positive on there. Microsoft's Ballmer says, "Stop kicking sand at Yahoo!" So you can see real time, we have basically a partnership with Twitter where we get access to real-time tweets, and we can surface that in the search engine. You can't do that in any other search engine except for Bing. It is just one of many areas in which we are trying to advance the case and move forward more speedily.

Let me switch now to the second topic, which is how you want to go get knowledge and information and understanding. So, let's say you are looking for a new musical artist or you have heard of one. You have heard of Taylor Swift. And we want to come in and learn something about Taylor Swift. She is kind of a young, new artist.

What you see here in the competition is they have the official site, the Wikipedia site, a few pictures, a few images. And what you see is they understand—what's happened is it's no longer about ten blue links. You have to put more information on the page. The problem is that becomes a bit of a clunky experience. With Bing, we took a fresh approach and we designed a new user experience to more speedily get you that information.

So down the left side, what you see here is we have what we call an explorer bar that basically lets you very quickly click between pictures and images, and we automatically surface for you things that you might care about. So, for example, is she on a tour? What's the tour information? With one click, I can find out—oh, here's where I can go and find her. She's in the Midwest right now.

Images—we also go ahead, versus other competition because you are able to sort of scroll infinitely. Again, studying what consumers do, people don't like to click, click, click. 60 percent of the clicks on image pages are the "next" button. So, we said let's save people some time. And there are some nice, powerful features where I can come in and I can look at just black-and-white photos and the like.

And you see it really is evolving now, it's not like most regular search engines. We've really sort of taken the next step forward.

Xrank is a nice feature if you want to find out where she ranks relative to other musicians in terms of popularity. You can learn news about her and then even watch videos. Here we've really sort of done a nice job. We have a couple features where you can just hover. You can automatically quickly find a video. And we do smart technology here to get you the important clip. And now if I click on that particular video, we get you a much better video experience than you might even find in some of the other videos. So, we have the main video at the top. You can scroll down and still find all the other ones.

So, you see, it's a very powerful way to quickly learn. And it's just click, click, click, all in one page. You go to the competition; there is a bunch of information. If you click on the video, what happens is you are taken out of context. Now you are in another user experience and most consumers say, well, where did all that other information go? And so that's one nice thing we have done to really improve it.

And then the last set of things I want to show you is how we have gone deep in some of the verticals we talked about, the commerce verticals. Let's start with restaurants here. Let's say you're staying over, you are looking for a good restaurant to eat near the Microsoft campus.

So you just type in "restaurants." We automatically do a reverse IP lookup so we know that you are near Redmond. We put eight to the top here. But if you want to go and do more of an enhanced search, something you just can't do with other search engines, if I click on lists, we do now a very nice local search that let's you look at all these restaurants.

I can sort of customize. So, let's say, for example, I want to look for Indian food. We do a whole decision-support system. Here's Shamiana, a pretty good one. I can click on that restaurant and see the map automatically. You get one-click directions, which is also unique, and I can come in and read the reviews on that.

And so as you see, it's a full-fledged experience to help you find out where to go eat. I didn't have to go off, I didn't have to go blue link, blue link—I get the answer I want right away.

Same applies for shopping. So, I'm looking for a Canon camera. Of course, again, uniquely we have things like I can see the videos on the cameras in one click. I can go look at used dealers. Or we have a robust, refined search. So, I can come in and look at all the cameras. We put them all in a nice list. I can, again, customize my search by vendor, by price, by reviews. And if I pick one particular one, I can come in and first put together all the reviews across the Web. These are from any site. I can get all the details, check out how much detailed information we have here on that product. We do that for every camera. And I can read expert reviews, user reviews, and finally I can compare prices. And here are all the prices from all the vendors across the Web.

So within a few seconds, you can actually see what the going rate is for that camera and you don't have to pay more money. And then we have, in addition, a feature called Bing cashback, which is unique to Bing, unlike any other search engine, where we actually take money that's made on search and give that back to the consumer in the form of rebates.

And so here you're getting 5 percent back on a $350 camera. It's a pretty good rebate. This is a thing that as consumers try it, it's really—it's also landing pretty well and building a lot of loyalty.

Final thing to show you is travel. Again, we go deep in the travel area. Rather than just giving you a link off to Orbitz or Expedia, we actually have a refined ability to do enhanced travel search. And so when I bump in here, you get a whole travel experience. I can find flights. In this case, let's say Seattle to San Francisco. We'll go out automatically, fetch those prices. You can then sort your prices. I can say I want to leave later in the day. I can sort by airline. I can sort by price. And I can, ultimately, then find out if airfares are going to go up or down. So based on Farecast, a company we bought about a year ago, we have unique technology that tells you whether prices are going to go up or down.

In this case, the algorithm is predicting that flight prices are going to go up and here you see the historical. So, very, very powerful technology to help you accomplish key tasks. You try and do that in your search engine today, and you'll see that we've gone beyond improving a couple areas.

So the last thing to finish up is let's say, for example, you want to take that flight. You want to find out if the flight is going to be on time. You just type in "Alaska 220" and that will tell you that this is the flight that comes from Puerto Vallarta through San Francisco to Seattle. And you can see it was at 5:54, it's delayed to 6:23, comes into gate 22, terminal one. So, we just gave you a bunch of information there. I encourage you all before you head out, after the conference, go ahead and type your flight into search. We need a search query share and then we're good. Thanks very much. (Applause.)

QI LU: Thank you, Yusuf.

As you have seen, this is a quick tour of a demo of the features we have in Bing. Actually, I was earlier sitting in the audience, and I saw some of you using Bing. Very, very encouraging. And I saw one of you was actually comparing Google and the Bing results.

So, let me just share some of the early results that we're seeing in the first months of release of Bing. First, we see healthy growth of 15 percent of unique users from 71 million users to over 82 million users in the U.S. market.

And we also see a small increase, 4 percent increase, but this is only after the initial four weeks of launch from 8.0 percent of U.S. query market share to 8.4 percent. And we also are seeing good results in our go-to-market campaigns.

Our own awareness numbers are reaching 33 percent, and our perception numbers, which when we survey users who have seen our campaigns about our key brand messages, are also growing very healthy at 13 percent. We are also gaining strength and good momentum in online communities. On Facebook, we have over 63,000 fans. And on Twitter, over 23,000 followers. Certainly, our Bing community sites also attracted a good amount of usage.

So overall, the early feedback from the market has been encouraging. But the larger perspective is that this is only the beginning. It's a good step that's a first step in a long, long, long journey, and we're absolutely committed to do the best we can to keep improving our product, keep differentiating our experience, and we want to work hard to earn each of you as a user, and as a loyal user in the future.

So, let me briefly talk a little bit about what we announced: the strategic partnership with Yahoo! Steve Ballmer earlier talked about the key aspects of this deal. Let me just walk through three dimensions. One is platform scale. As we all know, the search business is primarily driven by scale.

With this strategic partnership, we will be able to put substantial skills into the Bing search platforms at the Microsoft adCenter paid search advertising platforms. With larger scale, there are several important advantages. First is almost immediate lift on the quality of user experience. For those of you familiar with search engines, there is quite a number of features actually that are very sensitive by the scale of the usage of search engine.

For example, if you go to a search engine and type in the query, there is a drop-down query suggestion. That's a very simple algorithm behind that. But how good the suggestion is depends on how many people are using the search engine. So by aggregating scale, we will be able to get immediate benefit on consumer experience on a number of fronts. And it is important to call that out.

The strategic partnership is that Microsoft committed to provide full parity of the entire user experience. So, the benefit of R&D, the benefit of lift, the improvement, will be available on all Yahoo! sites—their own sites, and their affiliate sites.

Second is on the advertising side where we have larger volumes of advertisers combined. To begin with, you have more queries to draw from, so you can present more relevant ads.

But with larger volumes, more data, more clicks, the algorithms will be able to match that better against the user intent. Any time you improve the matching quality, you increase user experience for sure, but you also increase the convergence, because if the ad is exactly what you are looking for, the probability of your purchasing downstream also goes higher.

So advertisers will get better ROIs per click just by combining the scales. We will deliver true benefits to all the parties that are involved because of larger scale. And, second, the partnership will enable Microsoft and Yahoo! to be more competitive, to innovate better, to benefit all our users and our customers.

We will be able to draw synergies, technologically, by combining—selecting the best of breed and offer that to our users, to our advertisers, to our publishers. And certainly, there are opportunities to pool some talent together. So, combined we can have better technology to work with, more strength in R&D forces going forward.

And the last is the attractive economics that Steve talked about. We will be able to improve the yield, monetization per query, and there is also synergy, value creation on the cost side. In aggregate, we truly believe this is a win-win—genuine win-win—for the two companies. And this is genuinely a positive event for the industry as a whole.

To summarize for our Online Services Division, here are a few key points I would like for you to take away: First, search is our number-one priority. And for the entire division, we are very, very focused on growing search market shares, building long-term strength in that business.

Second, a big priority for us is to implement the Yahoo! partnership. It is a 10-year partnership. We're absolutely committed in spirit, in everything we do, to deliver the true economic values, consumer benefits, customer benefits for advertisers, publishers all around.

And, third is to invest responsibly and achieve our financial targets. We need to do a whole lot of work to improve our ability to manage costs. We have made large strides in FY '09. There is more room for improvement, and we're very, very committed to do that.

We want to be more disciplined in almost everything we do so that we can keep enhancing our execution capabilities so that, given unit allocation of capital investment, we can get larger returns to achieve our search, long-term strategic goals and also our FY '10 financial targets.

With that, I'm going to turn to the next section, which is Q&A.

(Break for lunch.)

Due to the varying sound quality and subject matter of tapes, the information in this transcript may contain inaccuracies.