The Search War Is About to Get Bloody
Three years ago, Yahoo! Inc. and the other leading Internet portals largely wrote off the search business. Spiffing up the way Web surfers plug words into a search engine to navigate around the Net seemed like a waste of time and money. So they put the brakes on developing their own search expertise and licensed technology from small fry like Google Inc. Big mistake: The search business boomed, and Google reaped the benefits. Consumers flocked to its site -- and thousands of advertisers quickly followed.
Now, Yahoo is out to take back some of the thunder it so unwittingly ceded. On July 14, the Net kingpin agreed to dole out $1.6 billion for Overture Services, Google's main competitor. The deal gives Yahoo better search technology and, even more important, a stronger position in "paid search," a fast-growing segment of the online ad market in which advertisers pay to be listed in Web search results. Overture is the top player in that market, raking in an estimated $1 billion this year by auctioning placement in search results to advertisers and then distributing those rankings on the sites of partners such as Microsoft Corp.'s MSN and Yahoo. "This assures a great rivalry between Yahoo and Google," says Anthony Valencia, an analyst at TCW Group Inc., which owns shares in both Yahoo and Overture.
They're rivals with very different strategies for dominating the Net. Nine-year-old Yahoo built what is still the most popular spot on the Web, with 121 million visitors in May, according to Nielsen//NetRatings Inc. It did this by creating a self-contained digital world packed with a smorgasbord of services that users can linger over, from e-mail to online shopping malls. Its revenues, which are expected to rise 35% this year, to $1.3 billion, are well diversified, coming from banner ads, paid search, subscriptions for services such as personals, and a fast-growing broadband partnership with SBC Communications. Google, with an elegantly simple site that offers nothing but search, has upended the traditional notion of what it takes to lure a large, loyal following online. In just a few years, this band of techies led by CEO Eric Schmidt have created the fourth-most-popular site on the Web, with 83 million visitors in May. It will pull in an estimated $700 million in revenues this year -- all from paid search and licensing of its search technology.
But the Overture deal may give Yahoo the means to keep its lead over the fast-rising newcomer. Yahoo now has search services that match Google's offerings, and can focus on using its unique advantages to best Google in ways the search-only service can't match. For example, Yahoo can offer businesses bundled packages of banner ads, paid search, online yellow-pages listings, and even the hosting of Net retailing sites. "The fact that Yahoo has all the components under one roof gives it a leg up. Yahoo can be all things to all advertisers, a one-stop shop," says Pacific Growth Equities Inc. analyst Derek L. Brown. That should help Yahoo maintain the top spot in what's shaping up to be a three-horse race, with Google and MSN, for the attention of advertisers and consumers online.
The Overture deal comes not a minute too soon. Since Yahoo started using Google's search technology on its site in 2000, Google's share of searches jumped from 1% to 38% this year. Over the same period, Yahoo has seen its share slip from 49% to 32%, according to analytics firm WebSide Story. Overseas, Google looks even stronger. In the past year, Google's traffic has soared past Yahoo's overall traffic in numerous key markets, including France and Britain, according to Nielsen//NetRatings.
It will be tough to beat Google at search, but now Yahoo has a better chance at holding its ground. Four months ago, it bought search engine Inktomi Corp. to bolster its position in traditional search, where results are based on mathematical algorithms, not on how much advertisers pay. Overture gives Yahoo more traditional search engine technology and a top-notch paid-search business. Overture has a network of 88,000 advertisers, just shy of Google's 100,000. That's critical because the paid-search market is projected to more than double over the next three years, to $5.4 billion, making up 60% of the U.S. online advertising market, according to Pacific Growth Equities. "Yahoo now owns all the crucial elements of an end-to-end search offering," says Yahoo CEO Terry S. Semel.
Semel & Co. will quickly try to wring even more benefits out of Overture. Yahoo could woo some of the 88,000 Overture advertisers into signing up for Yahoo's other forms of advertising, such as banner ads. And it should be able to convert some of its own 300,000 small-business customers into paid-search advertisers. "This may give us more leverage across the entire Yahoo portal," says Eric Opel, manager for online advertising at Gateway.com, which buys search ads from Google and Overture.
Beyond that, Yahoo hopes to distribute paid-search ads into places Google can't. Unlike Google, Yahoo develops much of its own content, from a careers site to a travel property. Instead of simply displaying paid-search ads when users type in a search, Yahoo plans to showcase these ads as users peruse the broader Yahoo site. For instance, a visitor reading Yahoo's Caribbean travel guide might see a paid-search ad from Club Med.
Yahoo also may have an edge over Google in placing paid-search ads into content from other companies, such as newspaper articles. Google's approach is almost entirely technology-based, scanning content and automatically placing ads with virtually no human intervention. That can lead to trouble. On July 1, a gruesome New York Post article about hacked-off body parts found in a deserted suitcase included three Google links to online luggage shops. Overture has a staff of 100 editors who screen out articles that may be inappropriate for advertisers. Google declined to comment for this article.
Still, all of this promise is based on one challenging assumption: Yahoo must skillfully integrate its newly acquired companies. While analysts have long speculated that Yahoo would purchase Overture, the timing could be problematic. Many analysts expected Yahoo to wait until it had fully digested its March acquisition of Inktomi, and Overture had integrated the search units it acquired from AltaVista and Fast Search & Transfer earlier this year.
Overture represents Yahoo's largest acquisition since Semel took over in 2001 and the third-biggest in the company's history. Overture, meanwhile, already is struggling to work out the kinks in its two acquisitions, analysts say. It cited unexpectedly high infrastructure costs in a recent warning that 2003 earnings would fall far short of expectations. Now, Yahoo must somehow solve these problems and weave a razor-sharp search organization out of business units scattered from southern California to Norway. "Strategically, there are a ton of positives here, but I'm surprised about the timing," says Pacific Growth's Brown.
Furthermore, making the acquisition pay off is no sure thing. As the behind-the-scenes provider of paid-search services to many Web sites, Overture occupied a neutral position. Now that that neutrality is gone, Yahoo rivals could jump ship. Most at risk is MSN, which accounts for about one-third of Overture's revenues. If that happens, Yahoo would end up paying about 60 times Overture's estimated 2004 earnings for the company. Even if MSN stays onboard, the price tag is still about 40 times next year's earnings. "That's fairly expensive," says Troy Mastin, an analyst at William Blair & Co. "I'm not sure it was a wise move."
Yahoo defends the price and timing of the deal. Semel argues that his merger-and-acquisition track record at Yahoo is solid and that the three previously acquired companies under his watch are right on schedule. In addition, Yahoo Chief Financial Officer Susan L. Decker insists the Overture acquisition will be at least at breakeven in its first year. Moreover, MSN's future as an Overture customer is not sealed. Although MSN can get out of its current Overture relationship if it wants to, Semel anticipates retaining the MSN business. MSN says the company has not made any decisions regarding its Overture deal.
Yahoo's bid to strengthen its search business won't be easy. But if the portal can pull it off, the price for additional firepower in this arms race could end up looking very affordable.
By Ben Elgin in San Mateo, Calif., and Arlene Weintraub in Los Angeles