Yahoo's Joyful, Difficult Journey

The beloved Internet icon's buoyant beginning gave way to missed acquisitions, an inferior understanding of the Web's evolution, and Google's shadow
From left, Yahoo! co-founder David Filo, former CEO Terry Semel, and Jerry Yang. Spencer Platt/Getty Images

For a company whose very name is a joyous exclamation, it's almost unbelievable that Yahoo! may end up going out with a whimper. Yahoo's possible purchase by Microsoft, which launched an unsolicited $44.6 billion bid on Feb. 1, would end one of the technology world's iconic fairy tales. If the deal happens, the company that put a friendly face on the wild and woolly Internet would be reduced to nothing more than a brand within the bowels of an old-guard technology titan.

That would be a huge comedown—and an object lesson in how easily a tech company can lose its way in the industry's treacherous rapids. What shocks many people about Yahoo's decline is that this is no shell of a company. Yahoo (YHOO) has seemingly unmatched assets: a global base of 500 million monthly visitors, leadership in key online content categories such as finance, sports, and e-mail, and even a new search ad system that's managed to win some kudos from advertisers in a market dominated by Google.

But after years of watching promising projects get mangled in a convoluted corporate bureaucracy, both shareholders and many employees have been giving up on the once-loved company. Matters came to a head on Jan. 29, when Yahoo issued another disappointing quarterly report and an even more troubling outlook, announcing 1,000 job cuts (, 1/29/08). When Yahoo executives essentially said a turnaround was another year away, investors reached a boiling point, knocking the stock to its lowest level in four years. "Management has no credibility," fumed Oppenheimer & Co. analyst Sandeep Aggarwal.

At the same time, even some longtime Yahoo executives and employees—those not among the hundreds who departed for greener pastures in the past two years—were getting close to throwing in the towel. "I just don't see things changing," says one angry executive who has worked at Yahoo almost six years and is looking elsewhere now. "I don't see people making really tough decisions. There's been a lot of talking but not a lot of walking."

Comeback Options

When a company spirals this low, it's often impossible to stage a comeback. And in Yahoo's case, the company has few options left. Microsoft's (MSFT) offer, a whopping 62% higher than Yahoo's market value before the announcement, seems crafted to ward off potential rival bids. Yahoo could swallow a poison pill of sorts, seeking an alliance with Google (GOOG) in which its rival would run its search and ad businesses, a strategy some analysts had suggested even before the Microsoft bid. Alternatively, Yahoo could look for a private equity firm to take it private, though the credit crunch has made raising such a huge sum more difficult.

With shareholders unlikely to show much patience for stalling, Yahoo's best bet may be to force Microsoft to pay more by courting a cable TV company like Comcast (CMCSA) or a media company like News Corp. (NWS). Either way, most analysts think Yahoo's fate is sealed and that the deal will go through. And at this early stage, it's entirely unclear which parts of Yahoo would survive inside a company often dubbed the Borg, after the race of human-robot hybrids from Star Trek.

Mergers, of course, are part and parcel of every industry, most of all the fast-moving technology business. But this tale is particularly poignant because it's about Yahoo, the little company started by two Stanford guys who shelved their pursuit of engineering degrees in 1994 to create the first widely used Internet directory in a campus trailer.

After Netscape Communications' pioneering Web browser helped usher in the commercial Internet, Yahoo emerged as the original Internet icon—the one with the famous yodel in its television ads, the trademark yellow-and-purple hues that extended even to the sprinkler heads at company headquarters, the warm-and-fuzzy image that made the Internet almost cozy.

Not Tech-Savvy Enough

Yahoo's decline is all the more surprising because the business opportunities on the Web are now bigger than ever. But those opportunities still require cutting-edge technology much more than the traditional-media skills Yahoo had veered toward in the last five years. The company that pioneered online media failed to keep up with waves of change still crashing onto the Internet's shores, from new technologies to the ways people use the Web.

Yahoo dominated when new Internet users needed the comfort and guidance of a familiar starting point from which to find resources on the rest of the Net—literally, a home page. Through the 1990s, Yahoo thrived as it signed deals with content providers and became the one go-to place for advertisers seeking to reach lucrative online consumers. But after a series of stumbles, Yahoo brought in former Warner Bros. (TWX) studio boss Terry Semel as CEO in May, 2001, and the company's direction began to change. To his credit, Semel cleared out bloated organizations and brought Yahoo back to prosperity for several years. By mid-2003, Semel's magic had returned Yahoo's market value close to its all-time high of $127 billion, reached in early 2000 at the peak of the dot-com boom.

But Semel's big-media background ultimately backfired. It pushed Yahoo and its culture in a new direction that ultimately proved fruitless, if not ruinous. In 2004, Semel began building a large operation with posh offices in Santa Monica, Calif., near Hollywood, for Yahoo's media activities, such as video-heavy Web sites. "Santa Monica was a huge and costly distraction…at a time when they needed to focus on other things," most of all search technology, says one former Yahoo executive.

Perhaps just as important, Semel never meshed with the engineering culture of Silicon Valley that drives innovation more than anyone at the top. Famously spending weekday evenings in a San Francisco hotel suite, then flying home to Southern California on many weekends, Semel was seen by some as too aloof, uninterested in the technology that Yahoo needed to keep pace with a fast-rising Google and a raft of startups. "He doesn't have a core understanding of technology, and he never did," says a former senior executive.

All the Right Moves?

It's not that Yahoo had no clue. Indeed, it seemed to be making the right moves on the technology front after Semel arrived. It bought search engine Inktomi in late 2002 to bolster its effort to catch Google. The next year, it snapped up Overture, which had come up with the novel idea of placing paid ads on other Web sites. But a year earlier, Google had also seized on that idea as its business model—but with a critical twist: The ads people clicked on more often, not just those for which advertisers paid more, would get higher placement on the page. With that key change and a search engine that produced much more relevant results for users, advertisers got much better returns on ads placed with Google.

Then, on Aug. 19, 2004, Google went public. According to some former Yahoos, that was a turning point for the company's culture as well. Yahoo became a company obsessed with Google rather than one looking to make the next leap on the Net. "Yahoo became super-paranoid," says one former search manager. "We switched from charting our own course to looking over our shoulder."

By the end of 2005, Yahoo realized the search ad operation it created out of Overture was foundering and started a crash program called Panama. But throughout 2006, it kept running into delays.

When Panama finally launched last February, it got some good reviews but struck many as too little, too late (, 2/26/07). Google not only kept growing at many times the rate of Yahoo, it even launched a deal last April to buy DoubleClick, which if approved would give Google a huge foothold in Yahoo's mainstay, online display ads.

Missed Opportunities

Meantime, Yahoo missed one huge opportunity after another. In 2005, it was said to be interested in buying the popular social network MySpace, but lost out to News Corp. In 2006, Google snatched up the hot video-sharing site YouTube, which had quickly grown in popularity even as people within Yahoo were pushing for the company to create much the same kind of service from its large stable of video resources and properties. The same year, Yahoo offered around $1 billion for another hot social network, Facebook, but was spurned. Last year, Microsoft swooped in with a $240 million purchase of a small stake that valued Facebook at a stunning $15 billion.

Yahoo has made some mildly successful Web service acquisitions, such as buying the popular photo-sharing site Flickr; and some promising ones on the advertising side, purchasing ad exchange Right Media and targeted-ad network BlueLithium last year. But none of them halted Yahoo's decline. As profits plummeted last year and executive after executive fled, it was becoming clear that Semel's days were numbered. He stepped down last June (, 6/19/07), replaced by co-founder Jerry Yang and new President Susan Decker.

Ultimately, what Yahoo missed, says Silicon Valley strategy consultant Sramana Mitra, is "a visceral understanding of how the Web is going to evolve." In particular, the quintessential Web 1.0 company failed to make the transition to Web 2.0, which involves creating services that tap the talents and efforts of users themselves: the volunteer-written encyclopedia Wikipedia, video-sharing sites like YouTube, and even Google, whose very search results are based on algorithms that track the links people make from their Web sites to others.

But despite all the missteps, few people would have imagined that Yahoo would become nothing more than a pawn in the titanic struggle between Google and Microsoft to define and dominate the future of the Internet. Indeed, one former senior executive who knows Yang said at the time he took over as CEO: "This is not a flip for him. He really does want the company back on the right track." But after failing to do that in his first six months at the top, his chance to save the company he co-founded may have passed.

Before it's here, it's on the Bloomberg Terminal.