This $115M acquisition has journalists and travel insiders scratching their heads especially given how much smaller Farecast is than Sidestep, the $180M Kayak paid for Sidestep and because MSN hasn’t shown prior interest in travel. But the confusion about the rationale is because the strategic driver for the purchase likely isn’t about travel per se, it’s about something bigger, much bigger – search. Why search? Because travel is a huge category within web search and travel is an even bigger category for paid search. And the last time we checked, Microsoft is really, really serious about closing the very large gap between the MSN web and paid search offerings and those from Google and Yahoo. How should we quantify “huge”? Internal analysis at web/paid search companies indicate between 3-5% of web searches are travel related. Not surprisingly, perhaps, given 79% of travelers search before booking.

Travel paid search spend on just Google and Yahoo is over a billion dollars a year, again, not surprisingly given there is $8.7B spent annually on online marketing and over $90B booked online (U.S.).

So, let’s get back to Farecast/Microsoft. Farecast gives Microsoft an opportunity to slow, and then reverse market share losses in this critical category of search. How? Because Farecast’s “smart search” technology should enable Microsoft to deliver on the holy grail of paid and web search – ‘contextual targeting.’ By understanding more about what consumers are searching for (e.g. their dates of travel) and about the relevant pages (e.g. real time prices – or even better, price predictions), Microsoft should be able to offer a significantly more relevant set of results then Google can.

Google’s current SRP (search results page) for “flights to Boston” points to a bunch of pages all over the web where a consumer would type in their trip context on each.

Microsoft’s SRP (like Yahoo’s today) could offer consumers the ability to give more context like dates, number of folks traveling etc. With this context, Microsoft could return a much more relevant set of integrated results.

That’s a better consumer experience, but Microsoft has an even bigger opportunity around targeting paid search advertisements – especially given Farecast’s ability to predict prices. As Rick at Motley Fool points out, “there is no easier lay-up in the online advertising industry than serving sponsored leads to folks ready to spend money.” With Farecast, Microsoft can hyper target those ads to make it more compelling for consumers to click and make more money per click given Farecast’s existing relationships with travel advertisers.

Well done Steve Ballmer, well done Hugh Crean! Good luck executing on your vision – and good luck acquiring companies to enable your next vertical categories.

Note: This post is based on internal UpTake analysis, and does NOT include data or context from discussions with Hugh or anyone on the Farecast management team, nor Brad, Erick or anyone on the Farecast board.

UPDATE on 4/22: More coverage at WebWare on 4/17 by Ina Fried, the FareCast blog on 4/17 by Hugh Crean, the 4/17 SeattlePI post on Todd Bishop’s Microsoft Blog, John Cook‘s original news break, Profy 4/17 post by Cyndy Aleo-Carreira, TechCrunch post on 4/17, Seattle Times on 4/17, CenterNetworks on Farcast acquired Microsoft, WebGuild on 4/18, PaidContent.org on 4/17, Venture Beat on 4/17, SearchEngineLand on 4/17, Rev2.0rg on 4/18.

It seems like just yesterday that the travel sector crowned Kayak the undisputed heavyweight champion of price comparison search following their acquisition of SideStep. But wait! It looks like Yahoo has (finally!) unveiled FareChase, the price search engine they acquired back in 2004. On the Yahoo Travel homepage, the Travelocity booking engine is no longer the default search option, it has been re-labeled ‘classic search’ and FareChase is the default search.

Yahoo is a formidable, albeit very delayed, entrant to the price search. It searches more supplier sites then Kayak directly, which presumably leads to better prices for consumers. And Yahoo is the fourth largest travel aggregator, behind only the ‘big three’ of Expedia, Travelocity and Orbitz. Greg at Compete.com estimates that the combined entity (Kayak-SideStep) will attract over 5 million monthly U.S. website (unique) visitors – about 60% of Yahoo’s footprint.

Presumably this brings a new competitive element that Kayak might not have expected (let’s be serious, four years after the acquisition, did ANYONE expect Yahoo to finally launch FareChase?). With their market share, Kayak is in a strong position as the suppliers perceive Kayak to be an important channel in the continued battle with aggregators for market share. But they aren’t the only player anymore, which as Tim at BOOT suggests, would have made it easier to move from a position of strength to an IPO. Perhaps, as Sramana at Seeking Alpha suggests, they might do additional roll-ups on their way to the IPO. On the other hand, Yahoo plunging into this price search is good validation to Wall Street that price search is still important.

Another implication is that a potential operating benefit from the acquisition might not fully accrue for Kayak. Both Kayak and SideStep depended heavily on acquiring consumers through online marketing. Buying SideStep should have allowed Kayak to acquire those consumers more cost efficiently, but having Yahoo-FareChase also competing might make the acquisition costs higher then anticipated.

Stay tuned, it should be an interesting year.