If consummated, the deal would re-draw the competitive landscape in Internet consumer services, where both Microsoft and Yahoo have struggled to compete with Google. The offer of $31 a share represents a 62 per cent premium over Yahoo’s closing stock price of $19.18 on Thursday. It would be Microsoft’s largest acquisition ever.

Microsoft said the combination of the two companies would create efficiencies that would save approximately $1 billion annually. The software giant also said that it has an integration plan to include employees of both companies and intends to offer incentives to retain Yahoo employees.

Steven A Ballmer, the Microsoft chief executive, said that he called his Yahoo counterpart, Jerry Yang, on Thursday night to tell him that Microsoft intended to bid on the company, and that they had a substantive discussion. “I wouldn’t call it a courtesy call,” he said in an interview.

Ballmer said he had decided to pursue a takeover because friendly deal negotiations would most likely be protracted and would probably become public. “These things are hard to keep quiet in the best of times,” he said. He said his conversation with Yang was constructive, but suggested that a deal may not come easily.

Yahoo said in a news release on Friday that its board would evaluate Microsoft’s bid “carefully and promptly in the context of Yahoo’s strategic plans.”

In a letter to Yahoo’s board, Ballmer wrote that the two companies discussed a possible merger, as well as other ways to work together, in late 2006 and 2007. Ballmer said that in February 2007, Yahoo decided to end the merger discussions because its board was confident in the company’s “potential upside.”

“A year has gone by, and the competitive situation has not improved,” Ballmer wrote. As a result, he said, “while a commercial partnership may have made sense at one time, Microsoft believes that the only alternative now is the combination of Microsoft and Yahoo that we are proposing.”

Ballmer met several times in late 2006 and 2007 with Terry S Semel, then Yahoo’s chief executive, people involved in the talks said. While the talks — originally focused on the prospect of a merger or a joint venture — were initially constructive and appeared to move forward, they quickly broke down, these people said.

After a series of secret meetings between both sides in hotels around California and elsewhere, Semel and Yahoo’s board decided against progressing with the talks, betting that its stock would turn around as it introduced a new advertising system called Panama, these people said. Yang, in particular, was adamantly against selling the company to Microsoft and championed the view of remaining independent, they added.

Ballmer constantly consulted with Bill Gates, the Microsoft chairman, about the progress of the negotiations, people close to the company said, and when the talks collapsed, he decided to wait to see the fate of Yahoo’s stock price. As the stock continued to fall, they said, Microsoft’s management became emboldened and began internal meeting in late 2007 about the prospect of making a hostile bid.

Despite their heavy investments in online services, both Yahoo and Microsoft have watched Google extend its dominance over Internet search and the lucrative online advertising business that goes along with it. In recent months, Yahoo has struggled to develop a plan to turn around the company under Yang, its co-founder, who was appointed chief executive amid growing shareholder dissatisfaction last June.

Yahoo investors, however, remain skeptical. The company’s shares have slumped, and the closing price on Thursday was 44 per cent below its 52-week high. In pre-market trading Friday, Yahoo’s shares were up 50 per cent, to almost $29. Microsoft’s shares were down about 4 per cent, and Google’s shares were down 6 per cent.

Microsoft, like Yahoo, has faced an uphill battle against Google. The company invested heavily to build its own search engine and advertising technology. Last year, it spent $6 billion to acquire the online advertising specialist aQuantive. Microsoft’s online services unit has been growing, but remains unprofitable.

Meanwhile, Google’s share of the search market and of the overall online advertising business has continued to grow.

Announcing its quarterly earnings earlier this week, Yahoo said it would cut 1,000 jobs in an effort to re-focus the company and reduce spending, and issued an outlook for 2008 that disappointed investors.

The timing of Microsoft’s bid could allow the company to mount a proxy contest for control of Yahoo’s board should it try to dismiss the offer. Microsoft has discussed the prospect of mounting such a campaign, people close to the company said, and has until March 13 to propose a slate.

In his letter to Yahoo’s board, Ballmer wrote, “Depending on the nature of your response, Microsoft reserves the right to pursue all necessary steps to ensure that Yahoo’s shareholders are provided with the opportunity to realise the value inherent in our proposal.”

• Why would Microsoft make an unsolicited offer of $44.6 bn for Yahoo?

Because Microsoft’s logic has always been Innovate or Buy. It makes sense to team up against a competitor —Google is the Goliath that looms over online search and advertising markets.

A merger has been discussed several times in the past though Yahoo was then confident of turning its results around — however, it has continued to slump vis-a-vis Google. Microsoft’s online “Live” ventures remain unprofitable.

• So is Google worried?

Well, going by the fact that the announcement raised Yahoo’s share price by 60 per cent and Google fell 8 per cent, the combination might finally be some real competition in a Google-dominated online world. Online advertising, which offers most bang for the buck with the advantages of contextualising and targeting viewers, is a space that Google effortlessly dominates. The combination of Yahoo’s online expertise and loyal users, and Microsoft’s offline muscle could affect that.

• If the deal goes through, how will it impact the internet service landscape?

Paradoxically, the real impact will be a constriction of choices for the internet user rather than expansion. It will hit other search engines like Ask.com, and make it harder for new entrants. Microsoft realises that more and more software is now delivered via the Web, and it is trying to aggressively ramp up its online presence. — Amulya Gopalakrishnan