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Google, Dell Confirm Rumored Software Pact

Dell Inc. (DELL) and Google Inc. (GOOG) confirmed on Tuesday they are testing a pre-installed package of Google software on Dell computers, in a potential blow to Microsoft Corp.'s (MSFT) dominance of desktop software.

Bob Kaufman, a spokesman for Dell, the world's leading personal computer maker, said his company is evaluating Google Inc. software that PC customers could use to search both the public Web and for local information stored on their PCs.

"We can confirm that we are running a test with Google that could include a Google-powered Dell home page, Google desktop search and a Google Toolbar," Kaufman told Reuters.

"We are conducting a test of distribution of some of our software via Dell," Google spokesman Jon Murchinson said.

Dell and Google spokesmen were responding to a report in the Wall Street Journal that described the inroads Google appears to be making with personal computer makers, including Dell and No. 2 vendor Hewlett-Packard Co. (HPQ).

The report, citing unnamed sources, said Dell and Google are in exclusive talks to install Google software on as many as 100 million new Dell PCs following a bidding process in which Google edged out Microsoft and after Yahoo Inc. (YHOO) withdrew.

Google shares were down 5 percent, or $19.23, to $365.87 in afternoon trading on Nasdaq. Analysts cited concerns that the Web search company was prepared to dramatically increase the cost of acquiring new customers by agreeing to pay huge upfront fees to win deals with PC makers.

Google already has partnerships with PC makers such as Hewlett-Packard, Gateway Inc. (GTW), Sony Corp. (SNE), Apple Computer Inc. (AAPL) and Toshiba Corp. to distribute the Google Toolbar, Murchinson said.

A decade ago Microsoft used its leverage over PC makers to gain control over which software programs would be prepackaged with the new machines sold to consumers. Once installed, customers rarely bother to replace many of these programs.

This was one of the key tactics Microsoft used to dislodge Web browser pioneer Netscape Communications Inc. in the second half of the 1990s and was a major issue in the landmark U.S. antitrust case against Microsoft.

Diversifying, but at what cost to margins?

Google analyst Safa Rashtchy of brokerage Piper Jaffray said that the latest stock decline reflects ongoing concern by investors since the company's disappointing year-end financial report last week led the stock to plunge as low as $350.

By some estimates, for Google to win broad product placement for its search software on major PC makers could require it to jack up customer acquisition costs by hundreds of millions of dollars from nearly zero now. Google's global popularity means that it acquires most customers for free.

"I would rule out that Google would spend some major amount of money just for customer acquisitions," Rashtchy said. "It is hard to see why they would do it given their major and growing market share."

To be sure, whatever upfront costs Google might pay PC makers would be a bet by the company that it would make the money back in years to come by locking in a vast audience of Web searchers who would make Google money every time they clicked on ads accompanying Google Web search results.

Neither Dell nor Google spokesmen would comment on details of the relationship beyond the pilot test of Google software, in particular on whether they were in talks on a broad deal.

"We are always evaluating different technologies and various relationships on behalf of our customers," Kaufman said.

"We won't go into any specifics," Murchinson said. "We don't have anything to announce at this point in time."

Hoefer & Arnett analyst Martin Pyykkonen said winning placement on the PC screens of major makers would help answer questions about how Google is going to diversify its revenue. But potentially lower profit margins also frighten investors.

"Where do you find almost 90 percent gross margins?" Pyykkonen asked, referring to Google's current highly profitable business. "If it costs you more to acquire traffic, it could hurt margins," he said.

Google is the world's most popular supplier of Web search services. The Google Toolbar is a handy way to conduct Google Web searches from a box which is installed in the menu of a Web browser page, without first going to the Google home page.

It also offers Google Desktop, which, once installed on an individual PC can automatically catalog the user's e-mail, computer files, music photos, chats and Web pages, making searching for information as easy as searching the Web.