Shortly after the news broke that Yahoo! (YHOO) had ousted Chief Executive Carol Bartz on Sept. 6, Tim Armstrong’s phone began ringing. According to people with knowledge of the calls who were not authorized to speak on the record, the AOL (AOL) CEO spoke several times that day with bankers who wanted to reopen talks begun in 2010 about merging the two companies under Armstrong’s leadership. The logic: By combining the companies’ content and audience, the former Google (GOOG) executive could extract better ad rates and build a more profitable business.
It’s a terrific idea—if you’re Armstrong or a fee-seeking investment banker. But the idea of merging these struggling Internet icons has become a tech-industry punchline. (“Two dogs don’t make a right,” cracked TechCrunch’s Erick Schonfeld.) It’s unlikely that any kind of McKinsey-style synergies will help reanimate AOL or Yahoo. They’ve joined the ranks of the Web’s walking dead—not yet in the ground, but hearts barely beating—alongside other former stars such as Myspace, Digg, and RealNetworks (RNWKD). “It’s very hard to see either of those companies becoming sustainable growth companies again,” says Mark Mahaney, a leading Internet stock analyst with Citigroup (C). AOL and Yahoo declined to comment.
Reinvigorating a Web giant is harder than, say, reviving a drug-store chain because of the peculiar economics of the technology world, where the path to greatness is built on network effects. Apple (AAPL) became the most valuable company in the world by understanding that when people buy iPods, they’re more likely to buy music from iTunes—and then iPhones, iPads, and anything else the Cupertino, Calif., company dreams up. Google mints money because googling has become an everyday occurrence for billions of people, and they’re less likely to switch search vendors once they sign up for Gmail and start sharing YouTube videos. Facebook, too, has become an unavoidable online common where 750 million people go to hang out with their friends. All made massive investments in uncertain but innovative technologies, winning hordes of new customers while raising the entry cost for rivals to match them.
By comparison, Yahoo and AOL have tried to live by Old Media rules while masquerading as New Media powerhouses. They have been and continue to be successful at building audiences: Yahoo alone receives nearly 700 million monthly visitors. They have young users attractive to advertisers, with 43 percent of their traffic coming from people younger than 34, according to ComScore (SCOR). But unlike Google or Facebook, Yahoo and AOL earn revenues the old-fashioned way—by employing rafts of reporters and maintaining costly ad sales teams to make sure the articles and deals keep flowing. It’s a model with lots of competition. “Switching costs are pretty low for [visitors to] both of these companies,” says Citigroup’s Mahaney. “There’s no real way for them to lock in customers.”
As a result, Yahoo and AOL have to spend a lot just to keep pace, and they lack the profits to pay the table stakes of playing with the Internet’s premier companies. AOL has lost $800 million since its spinoff from Time Warner (TWX). Yahoo cranked out $1.2 billion in cash from operations last year, but that’s in part due to Bartz’s aggressive cost-cutting. Meanwhile, Google was able to spend $4 billion on capital investments in 2010. Same goes for Microsoft (MSFT) ($2.4 billion), Apple ($2 billion), and Amazon.com (AMZN) ($979 million).
With less of a cash cushion, it’s hard to focus on new markets. Yahoo had no notable product launches during Bartz’s 32-month reign, a period when new social-networking services and mobile apps were revolutionizing how the Internet is used. In 2009 she outsourced Yahoo’s search engine to Microsoft’s Bing. Yahoo’s biggest whiff may be in the mobile market. Its iPhone app for Fantasy Football—a key franchise for the company—gets a dismal one-star rating despite years of development. A giant in display ads, Yahoo has done next to nothing in the mobile advertising market that’s expected to grow from $416 million in 2009 to $2.5 billion in 2014, according to eMarketer. “We couldn’t get Yahoo to call us back!” says Greg Woock, the CEO of Pinger, which makes mobile apps that offer free texting and phone calls. Woock had hoped Yahoo would want to serve ads through Pinger’s apps, but “they’re nowhere in mobile,” he says.
By remaining far from the cutting edge, Yahoo and AOL struggle to attract the most talented techies. Already, Yahoo is better known for departures (such as Flickr founder Caterina Fake and LinkedIn CEO Jeff Weiner) than arrivals. According to Glassdoor.com, a crowd-sourcing site that collects anonymous employee reviews of companies, AOL and Yahoo both had a 3.2 rating on a five-point scale, lagging Facebook at 4.2, Google at 3.9, Apple at 3.6, and Microsoft at 3.3.
So what’s to be done with the walking dead? Many on Wall Street say management should treat them like the mature businesses they are and focus on cutting costs and maximizing cash flow. In a recent letter, hedge fund manager Daniel Loeb called for new board management at Yahoo. Ryan Jacob, whose Jacob Asset Management has been aggressively buying Yahoo shares, suggests that Yahoo consider splitting itself up, detaching the stagnant U.S. display ad business from lucrative holdings in Yahoo Japan, an independent company, and Alibaba, China’s largest e-commerce company. “If shareholders don’t want to own the core business, they wouldn’t have to,” he says.
Yet people who remember the company’s glory days insist it’s never too late. Priceline (PCLN) and EBay (EBAY) both came close to zombification but are looking much more vigorous these days. And Apple, of course, was just weeks from bankruptcy when Steve Jobs returned in 1997. “Apple was in worse shape in 1997 than Yahoo is today, and now look,” says Geoff Ralston, who worked at Yahoo for years after selling it the company that begat Yahoo Mail. His suggestion is to follow the Steve Jobs playbook: cut more costs and me-too offerings and spend or acquire whatever it takes to create “consumer experiences that are unbelievably great.” Nice advice. Tough to pull off.