The first sign that the game had changed for Yahoo! Inc. (YHOO ) came just days after its stock hit an all-time high--of $237.50. On Friday, Jan. 7, 2000, when Yahoo's staff was winding down for the weekend, a phone call came in to the third-floor executive cubicles. On the other line: an investment banker with a juicy tip that chief rival America Online Inc. (AOL ) was about to buy old-media giant Time Warner Inc., a deal that ultimately went through for $85 billion in stock. The move would rearrange the planets in the media universe--and rock Yahoo's world.
The next morning, CEO Timothy A. Koogle, President Jeffrey Mallett, and co-founder Jerry Yang held a council of war in a purple-and-yellow conference room at the company's Santa Clara (Calif.) headquarters. Should Yahoo stick to its guns and remain an independent assembler of news and entertainment supplied by others? Or should it take advantage of its $110 billion market cap to make an old-media purchase of its own? Koogle favored staying the course, saying Yahoo had a better chance of lining up quality content if it teamed with all comers instead of buying one big media company. Mallett said later that he was "torn." After four hours, a pot of Koogle's bitter coffee, and umpteen squiggles on the white board, the trio reached consensus: They would not follow AOL's lead. All of Yahoo's chips would remain on the Net.
It was Yahoo's first big mistake--and a presage of what was to come. Over the next 13 months, Yahoo's management troika, the "Three Amigos," would commit a series of blunders that would downgrade the No. 1 Internet portal from powerhouse to Milquetoast. Corner-office intrigue, consensus management in gridlock, a souring economy, and plain old bad judgment would conspire to send Yahoo's revenues plummeting 42% in the most recent quarter, to $180 million. Yahoo's market cap is $11 billion, down 92% from its high. The company has ordered its first-ever layoff--some 400 people. And 3,100 remaining workers are saying good-bye to Koogle, their longtime leader, who was pushed out two months ago.
Worse yet, Yahoo's problems can't be fixed by a little cost-snipping and an upsurge in the economy. Its reliance on advertising revenues has turned into a liability as dot-com advertisers die off like mayflies and corporate advertisers pony up 50% less for online ads than they did a year ago. Meanwhile, AOL Time Warner boasts a $221 billion market cap and controls a vast empire of online properties, magazines, movie studios, and book publishers. Its advertising and commerce revenues rose 10% last quarter.
Today, Yahoo's fate rests with Terry S. Semel, the former co-CEO of Warner Bros. who took over on May 1. He has set aside 60 days to figure out what to do. Then, analysts say, he'll shake things up. Semel is considering bringing in a couple of lieutenants from his Tinseltown days, including James Moloshok, an ex-Warner Bros. man, says an executive close to the discussions. The new team's job is twofold: to convince advertisers Yahoo can deliver a solid return for their money and to reduce Yahoo's dependence on those ad dollars. Semel is likely to speed up forays into newer sources of revenue--including its premium subscription services for consumers. Analysts are looking for nonadvertising revenues to increase from 10% of the total last year to about 25% in 2002.
Semel is betting heavily that he can turn the company around. In an unusual move, he plunked down more than $17 million of his own money to buy 1 million shares of the company's stock. Moreover, he signed an equity-heavy package that gives him just $300,000 in salary. Many of his stock options are priced at or above the price when he joined. So he must make dramatic improvements to collect on his bet. "I have a strong conviction about Yahoo's ability to leverage its core assets into a successful global company," he said after being appointed to the job.
Can Semel do it? It's a long shot. As a 21-year Warner Bros. veteran who left Time Warner in 1999, he earns kudos for running the movie business, where he was responsible for megahits such as the Lethal Weapon series. But Semel failed to deliver when his duties were expanded to include Time Warner's music and amusement-park businesses. He didn't turn the company's Web sites into moneymakers. And he has little experience with advertising. "Semel's not a turnaround expert. And he doesn't know how to sell to large advertisers," says analyst Scott Reamer of SG Cowen Securities Corp. Semel responds that he has extensive experience running a media company, and that's what matters.
Semel's most daunting challenge will be rebuilding Yahoo's dysfunctional management team. In a surprise move, Koogle was pushed out of his CEO job on Feb. 27 by the board of directors, who also passed over Mallett to seek a CEO from outside. Insiders say Koogle had taken a 30,000-foot view: He acted as chief visionary, distancing himself from operational chores and losing touch with the market. He misjudged how badly the dot-com implosion would hurt the company.
At the same time, Mallett, who was running daily operations, was angling for the CEO job. An operations whiz, he was growing more frustrated with Koogle's consensus-style management and his lack of involvement. "He felt like he was dog-paddling with one arm tied behind his back," says a former Yahoo executive. Mallett, 36, began telling people he would "move up" shortly, says a job candidate who talked to him. And seasoned execs, who could challenge Mallett's influence, were blocked from critical roles. Tension mounted between Mallett and Koogle. What seemed on paper a good match--of a big-picture CEO and a nuts-and-bolts president--turned into a toxic brew.
Emerging from the melee stronger than ever is co-founder and board member Jerry Yang. While Yahoo's "professional" managers, Koogle and Mallett, were blamed for Yahoo's slip-ups, Yang's image as Yahoo's goodwill ambassador has shielded him from criticism. He also has the ear of Masayoshi Son, CEO of Softbank Corp., which owns 21% of Yahoo's stock and has a representative on the board. Yang, along with board member Michael J. Moritz, a grizzled venture capitalist at Sequoia Capital who was Yahoo's first backer, spearheaded the decision to replace Koogle and pass over Mallett, say insiders and several outside sources close to the board. They then orchestrated the hiring of Yang's buddy, Semel.
Yang, Koogle, and Mallett were precisely the ones who led Yahoo to its early success. In less than six years, they transformed the company from a simple directory of Web sites into the best-known brand on the Web, with $1 billion in annual revenues and more than 190 million monthly visitors worldwide. At its peak, on Jan. 3, 2000, the company's market cap was $128 billion, more than twice that of media giant Walt Disney Co. (DIS )
Now, Semel must find a way to restore Yahoo to its former stature. To grasp just how difficult that will be, it's important to understand how the upstart ran aground. Koogle and Moritz would not comment for this story, and Yang, Mallett, and Semel would talk only about the company's business prospects. But through interviews with 20 current and former executives and well-placed sources outside the company, BusinessWeek has reconstructed Yahoo's slide. Here, for the first time, is the inside story behind Yahoo's meltdown:
MISTAKE NO. 2
Less than three months after Yahoo balked at an old-media acquisition, it got a second chance to alter its fate. Again, it blew it. Seeking to beef up its e-commerce revenues, Yahoo began negotiating to buy Web auction leader eBay Inc. in late March, 2000. But as acquisition talks heated up, so did Yahoo's internal politics. Koogle wanted the deal. But Mallett was concerned about having eBay CEO Margaret C. Whitman in Yahoo's executive lineup, say eBay (EBAY ) insiders. Whitman wanted to report directly to Koogle, say the insiders, while Mallett insisted that eBay's CEO report through him. Koogle and Mallett also differed on the strategic importance of the deal. "Tim could see the wisdom of challenging the Yahoo culture through a deal with eBay. Others were more threatened," says Robert C. Kagle, a venture capitalist on eBay's board.
With the deal looming, Mallett went on the offensive, according to sources close to the negotiations. He appealed to co-founders Yang and David Filo, trying to convince them that the eBay culture would be a poor fit for Yahoo. Soon, both founders were in his camp. Filo sent an e-mail to Koogle, urging him to back away from the deal. "The whole thing got very dysfunctional. They were clashing," says a source close to the negotiations. With Koogle outnumbered, the potential deal unraveled. "This was Yahoo's most fundamental problem. It was always management by persuasion, not management by dictation," says former Yahoo manager Rich Rygg.
And Yahoo paid for it. While Yahoo's fortunes have flagged, eBay has emerged as a rare dot-com success story. In the first quarter, eBay's revenues jumped 79%, to $184 million, and its net income hit $21 million. If the merger had gone through, Yahoo would no longer have to rely on advertising for 90% of its revenues, and rather than losing $11 million last quarter, it would be profitable.
TURNING A BLIND EYE
How could things like this happen? Call it the arrogance of success. The Three Amigos felt invincible and had little incentive to seek talent or advice from outside their brain trust. Seemingly with good reason. While other ad-supported sites began to struggle with the slowdown in dot-com budgets, Yahoo blew past revenue estimates quarter after quarter. A leading Web property such as Yahoo, it appeared, could withstand just about any shellacking to the Web advertising market.
The company made no special effort to make traditional advertisers see the value of creating a presence online. It was accustomed to getting the rates it asked for, cutting a deal, and then moving on. "We ran Yahoo to optimize market share. I make no apologies for that," Mallett said in a January interview. "If there was a company that didn't get it [Internet advertising], we moved on very quickly."
Even big potential clients got the brush-off. Consider OgilvyInteractive, which handles online media buying for mammoth customers such as IBM. They held a meeting with Yahoo in early 2000 to explore an advertising relationship. The Ogilvy executives, however, were more interested in buying some advertising six months out, instead of right away. So the relationship disintegrated. "They were more interested in the here and now," says Jeannette McClennan, president of OgilvyInteractive North America. She notes, however, that Yahoo has become more accommodating in recent months.
Yahoo's take-the-money-and-run style, along with its dearth of media veterans, prevented it from spotting fundamental changes in the Net advertising market. As the summer of 2000 wore on, the biggest traditional advertisers began looking for online marketing ideas beyond Yahoo's banner ads, which elicited less and less interest from consumers--even as Yahoo's audience continued to grow. These corporations wanted ad campaigns integrating the Internet, TV, and radio. The soon-to-be-merged AOL Time Warner could offer that. Not Yahoo.
EARTH TO YAHOO
It was Monday morning, Oct. 23, when Yahoo took its first serious look in the mirror. At a retreat in California's Yosemite National Park for Yahoo's top brass and managers, Mallett took the stage and prodded the several hundred attendees to change the way they did business. Yahoo needed to treat its advertisers and business partners better. "It was just what everyone needed to hear," says one former exec who attended the powwow. Problem was, many of the managers didn't take the message seriously. "The business-development people all had smirks on their faces," recalls the executive. "Then the ideas never got reinforced."
That complacency didn't last long. Yahoo salespeople started noticing that advertisers weren't willing to pay the same rates for banner ads. The real wake-up call came on Nov. 21. Longtime Yahoo cheerleader and Morgan Stanley Dean Witter analyst Mary Meeker issued a report that punctured the company's prospects. She downgraded Yahoo's stock from "buy" to "outperform" and advised it to beef up its executive ranks. Yahoo's stock plunged 15% in a day.
Yahoo execs were furious. The hyperkinetic Mallett fumed for about 10 minutes, he said later. Then he read the report again. Slowly it started to sink in. On most fronts, Meeker was dead-on. In fact, Yahoo was already working to address several of the criticisms. Within days, Mallett had pinned a copy of Meeker's report to his cubicle wall next to his children's artwork. On top of the report, Mallett stuck a note: "The market's tough, but we're tougher."
The company's board began to stir as well. Long chided by analysts for its insular nature, the seven-member board included Koogle, Mallett, and Yang, as well as backers Moritz and Eric Hippeau of Softbank. The only true outsiders: Arthur Kern, chairman of holding company American Media, and the recently appointed Edward Kozel, former executive at Cisco Systems Inc. Starting in November, the directors floated a number of ideas for strengthening Yahoo management. One possibility discussed: bringing in a new CEO. But with Yahoo closing in on $1.1 billion in sales for 2000, nearly twice as much as in 1999, the idea gained little traction. Instead, Yahoo stepped up its efforts to hire a new sales chief and brought in other traditional-media execs.
WINTER OF THEIR DISCONTENT
With the pressure on Yahoo's top execs rising fast, the stress started to show. For starters, tension was growing between Mallett and Koogle. A key friction point was Koogle's consensus-style management, which slowed decision-making to a snail's pace, say former Yahoo execs. "Every time we went into a meeting, we'd ask, `Is this going to be a T.K. [Tim Koogle] meeting? Or is this not going to be a T.K. meeting?"' recalls a former exec. "We wanted to know if we were actually going to get anything done." According to this former Yahoo exec, it began to wear on Mallett. "He insisted he knew how to fix Yahoo but was frustrated by [Koogle's] lack of involvement and the consensus-driven management," the source says. On the flip side, the former executive says: "Koogle felt that if Mallett knew how to fix things at Yahoo, he would have already done it."
Mallett was coveting the CEO job, say insiders. One of the candidates for Yahoo's top sales job recalls that during a January interview, Mallett made it clear that he was planning to "move up" shortly. He also continued to protect his turf fiercely. Shortly after Yahoo polished off its acquisition of community site eGroups Inc. in August, Koogle and eGroups CEO Michael Klein were seen chumming around the office and appeared to hit it off, say current and former Yahoo execs. "From that point on, it was like [Klein] had a bull's-eye painted on his forehead," says a former Yahoo executive. Later, Klein was put into a nonoperating role. A Yahoo spokesman says Mallett did not try to promote his own interests at the expense of others: "If someone is the right fit for Yahoo and its business, the management team is absolutely supportive of their role and success in the company."
By January, the board was focused on leadership. Ad sales were weakening. On Jan. 10, the company was forced to slash its forecast for the upcoming first quarter by 25%, to $230 million. Publicly, Yahoo blamed general market conditions and said it was moving away from dot-com advertisers. In reality, the board was looking closely at Yahoo's missteps and its struggling management team. In January and February, Yahoo's directors batted around ideas. Koogle floated the idea of his stepping down, say insiders. And directors discussed bringing in someone above Mallett or bolstering the vice-president ranks, say insiders.
Then things got worse. Ad sales dropped so quickly that Yahoo eventually had to slash its first-quarter forecast by an additional 25%, to $175 million. Equally bad, Yahoo began losing international executives at a frightening pace. On Feb. 15, European chief Fabiola Arredondo announced her resignation. A day later, the director of Yahoo Asia, Savio Chow, stepped down. Within weeks, six international executives left the company. Heavy-handed control from Yahoo headquarters left some overseas execs irked, say two former international managers. All of the former international execs declined to comment.
By the time of the Feb. 27 board meeting, the directors had seen enough. With Moritz and Yang leading the discussion, the board came to a verdict: Koogle would step down as CEO but could remain on as chairman. And Mallett would not be considered to replace Koogle. "Mallett was generally viewed as not being ready for the job," says a source close to the board.
Koogle took the decision calmly. "He was well aware of his shortcomings," says a source close to the company. "He blamed himself for not keeping a closer eye on Mallett. Koogle also felt that his lack of media experience had hurt the company." At 10 o'clock that night, Koogle put in a telephone call to a CEO recruiter to begin the search for his replacement. The most critical leg of Yahoo's management overhaul was about to begin.
DOC HOLLYWOOD TO THE RESCUE
One candidate quickly rose to the top of the CEO-search list. In the two days following the fateful board meeting, several directors secretly gathered at Yahoo's headquarters with Spencer Stuart recruiter Jim Citrin. The agenda: brainstorming on what they wanted in a new leader and floating the names of possible candidates. Yang was pushing for Semel. They had met at a 1999 media conference in Idaho. Since then, the two had forged a friendship, meeting for lunch every two months or so. Adding to the allure, Semel is a friend of Gordy Crawford, a partner in Capital Research & Management, which owns a 6% stake in Yahoo.
Yahoo was interested, but was Semel? After all, the 58-year-old had retired from Warner Bros. a multimillionaire in late 1999. Since then, he had been investing in online entertainment companies with his own company, Windsor Media Inc. Yang and Semel met for lunch on Mar. 9 in one of Yahoo's conference rooms. Yang quickly brought Semel up to speed on the leadership change and asked if he was interested in the CEO job. Semel said he was intrigued.
It was time for serious talks. Semel met with members of Yahoo's board. He squeezed in an hourlong meeting with Mallett. That started out uncomfortably, according to a source close to the board, but then Semel suggested that they talk about their lives outside of work. Even though Mallett was bitterly disappointed about being passed over, he was charmed by Semel, say two sources close to Yahoo's board. Semel's candidacy was picking up steam.
By the time of a board teleconference on Apr. 6, the Yahoo directors were sold. Director Moritz, who headed the board's search committee, went around to all participants in the phone call, asking for their thoughts about Semel. Although Semel wasn't steeped in advertising experience, he knew how to manage a fast-growing company. He had helped build Warner Bros. from $1 billion to more than $11 billion. The vote was unanimous: Semel was to be offered the CEO job.
But the drama wasn't over. On Apr. 8, Moritz and Yang flew to Los Angeles, rented a car, and sped out to Semel's house in Bel Air. After pitching their offer to Semel, Moritz and Yang walked through the details of the contract--including the fact that they wanted to pay only $300,000 in salary, offering a large option package instead. Semel was interested, but a few stumbling blocks emerged. One biggie: Koogle's role as chairman. "Semel was worried about following a legendary CEO who still had the affection of his employees," says a source close to the board. "It wasn't an ego thing. It was about making it perfectly clear who was in charge."
Just a month earlier, the popular Koogle had promised Yahoo's employees that he would remain as chairman. Relinquishing the title would all but sever his daily contact with the company he had run since 1995. But there was little ambiguity: Koogle would have to part with the chairman role, or Semel would probably walk. Several days after the Apr. 8 job offer, Koogle threw in the chairman title, say insiders. "I'm glad it didn't come to a head. It could have been a deal killer," says an insider. Koogle stayed on the board of directors with the title of vice-chairman.
On May 1, Koogle's era came to a close. Some of the 49-year-old exec's allies say he has long been ready to ratchet back his lifestyle and pursue his myriad interests, from racing his Mercedes convertible to hobnobbing with artists in Italy. Indeed, it seems as if his moment has passed. The youthful enthusiasm and experimentation of the early days of the Net has been replaced by a brass-tacks management style to which he's ill-suited. "He was extremely gentlemanly and, in a way, very unbusinesslike," says Adriano Berengo, an Italian glassblower and Koogle friend.
It's not clear if Mallett has a future at Yahoo, either. Although Semel and Mallett insist he'll remain, there's a question whether he'll stay on for very long after the transition is complete. If Semel brings in his former Warner Bros. lieutenants, that could speed Mallett's departure. "Mallett will be gone," says analyst Andrea Rice of Deutsche Bank Alex. Brown. "It was assumed that at some point the mantle would be passed to him. Now there's no reason to stay." Sure, Mallett knows the inner workings of Yahoo's business better than anyone else and boasts a loyal following among employees. But he's also partly responsible for the hubris that damaged Yahoo with so many partners and advertisers--the very past from which Semel will want a clean break.
Together, Koogle and Mallett will be remembered as the management duo that built Yahoo into one of the mightiest Internet companies. But the bad mix of Koogle's disengagement and Mallett's headstrong ways kept them from anticipating vital adjustments, and this left the company vulnerable when Yahoo's world began to spin out of control. Is the company that Koogle and Mallett helped build a long-term business or will Yahoo be the ultimate example of blown opportunities during the Web's glory days? The answer to that question is now in Semel's hands.
By Ben Elgin
With Linda Himelstein in San Mateo, Calif., Ronald Grover in Los Angeles, and Heather Green in New York