Microsoft Ready To Challenge Google? Yahoo? Both?

If the entertainment and device division performance by Microsoft in its second quarter was a surprise, the company's online business growth is a stunner, especially as the company tries to chip away at Google's near total dominance.

Stunning because while independent market research has suggested Microsoft continues to enjoy incremental gains in search market share, the company is doing nothing to dampen expectations that this momentum is merely just beginning. And while that's not such good news for Google, it's particularly distressing for Yahoo .

Why? Microsoft gained a full point in search market share, according to Nielsen Online, with 14 percent, narrowing the gap to Yahoo's 18 percent, but still way behind Google's 56 percent. But in our exclusive interview with Microsoft's chief financial officer Chris Liddell earlier this morning, he told me Microsoft was more than pleased with the dramatic gains the company is seeing in its online business. (Read my post on the first part of the interview here.)

The company posted $863 million in revenue, a 38 percent jump; analysts had anticipated $839 million instead. And even though the loss in that division almost doubled, year over year, from $118 million to $245 million, if the Xbox model is any indication, Microsoft's "you gotta spend to earn" may work yet.

"Really that's a multi-year journey that we're going on, and we're still a long way from getting to critical mass," Liddell tells me.

Message: growth is going well, Microsoft's on track, and has a long-term time horizon for staking its claim online. Anyone looking for an overnight drubbing of Google might be disappointed. Microsoft clearly has the deep pockets to fund a longer-term strategy. We all scoffed at Xbox, its slow start, and Microsoft's attempts at taking the fight right to Sony's doorstep. Who's to say the exact same scenario won't play out online as well as Microsoft tries to take on Yahoo and Google?

Does this make a Microsoft play for Yahoo more possible? Lots of chatter along those lines this week, though I still believe that's a long-shot. Intriguing, but a long shot.

All of this makes Yahoo's earnings news Tuesday and Google's the following Thursday very interesting indeed. Stay tuned!

Questions? Comments?