How Yahoo! Aims To Reboot

By Jeremy Caplan

It can't be easy for Yahoo!, the Internet's most durable portal, to play Pepsi to Google's Coke. But if Yahoo! continues to fall further behind Google in ad sales, the company may find itself stuck a perennial second--or worse. With its stock down 36% last year and ad sales failing to keep up with Google's, Yahoo!'s reputation has suffered as Google's stock has soared.

So Yahoo! is in the midst of a massive reorganization to focus on what matters: wringing more money from its ads and more time from its community. That hasn't been easy for a company that has divided its attention among dozens of products and services. "Yahoo! is many things to so many people, whereas the beauty of Google is that at the end of the day, it's search done well," says Drew Neisser, CEO of Renegade Marketing Group, an ad agency.

In January, Yahoo! announced that Panama, a new advertising platform central to its shift in strategy, would debut Feb. 5, refining how the company sells ad space. The system gives advertisers more control over their ad campaigns, letting them freely change keywords or ad strategies to adapt to what's working. It also enables Yahoo! to highlight ads relevant to a user's search rather than ordering them simply according to who paid more. Because search advertising accounts for nearly 50% of Yahoo!'s revenue, Panama is critical to its growth.

CEO Terry Semel had downplayed the system's repeated postponements, calling Panama an undertaking as big as any product launch ever. But there was a price to pay for the delay. "A lot of people [at Yahoo!] feel abused by the outside world and its perception of the company," says Ellen Siminoff, one of Yahoo!'s founding executives, who heads search-advertising agency Efficient Frontier. "They have missed a few quarters this year, they have lowered expectations, they were late in delivering Panama, and so they're in the penalty box with Wall Street."

Panama is just one piece of the reboot for the 11-year-old company. Yahoo!, based in Sunnyvale, Calif., also reorganized its 11,000 employees in December from many overlapping subgroups into three distinct business units: Web communities, advertisers and infrastructure. Susan Decker, the company's chief financial officer since 2000, was promoted to oversee the advertising group, a signal to analysts that she might be in line to succeed Semel.

The taming of Yahoo!'s many-headed beast echoes the task Semel took on after arriving in 2001. He trimmed the 44 business units to four, and the company rededicated itself to search by developing a new engine and buying Overture, which pioneered search ads. Yahoo!'s stock price nearly tripled in Semel's first three years, but its search tools still trailed Google's.

By 2005 the company's focus was adrift. It had dabbled in creating content, a strategy it later cut back on, and had fallen further behind Google in generating revenue from its huge audience. Last November an agent provocateur emerged in Brad Garlinghouse, a senior vice president, whose leaked memo became known as the Peanut Butter Manifesto. He argued passionately that Yahoo! was wasting its talent by distributing its resources like peanut butter on a widening slice of bread. "The result: a thin layer of investment spread across everything we do and thus we focus on nothing in particular," Garlinghouse wrote. "I hate peanut butter. We all should." He criticized the company's services for competing with one another and recommended an overhaul of the ungainly corporate structure. "We lack decisiveness," he added, and "we are held hostage by our analysis paralysis." Garlinghouse got part of his wish. Yahoo! reorganized management. And it is reducing redundancies. For instance, interfaces for presenting video have been winnowed from 16 to eight.

Significantly, Semel (who declined TIME's request for an interview) is getting Yahoo! to decide what it wants to be when it grows up. "There's always been some ambiguity about whether it's a tech company or a media company," says Stewart Butterfield, Yahoo!'s director of product management and co-founder of the photo site Flickr, which Yahoo! acquired in March 2005. "But there's been a shift in the internal messaging. I never hear execs refer to Yahoo! as a media company. A year and a half ago, there wasn't a satisfying articulation of what the mission of the company was. That has changed."

The Flickr deal turned out to be a critical one. Butterfield says he chose to sell to Yahoo! rather than Google because the former was a more disciplined company. "At that time, Google was especially chaotic," says Butterfield. Google bought YouTube, which has generated a mountain of buzz, but Yahoo! has quietly leveraged Flickr, Answers and Del.icio.us, among other recent acquisitions and launches, to get its audience--which includes nearly half of the world's Web users--to spend more time on its network of sites. Yahoo!'s new ad system will capitalize on their presence--and on data it collects from their interactions--more efficiently, with more carefully targeted ads.

Yahoo! is a more popular website than Google but not as lucrative. Yahoo!'s 500 million monthly visitors easily exceeds Google's 380 million. But Google searches each generate about 30% to 40% more revenue. "Yahoo! is three to four years behind Google in the development of its algorithm," says Jordan Rohan, an analyst with RBC Capital Markets.

Advertisers are increasingly eager to focus campaigns around search ads. Panama gives them a new, cleanly designed online spot where they can plan, track and change ad campaigns in progress. It may help improve Yahoo!'s return on investment in that arena because it gives advertisers more leeway in targeting specific geographic areas. A pizza-shop owner can pinpoint his pitch to local diners who search for pepperoni, for instance. "Geo-targeting is huge," says Neisser. The company is also adding a mobile search tool that will eventually extend Panama's reach to cell phones. The new services should help Yahoo! close the revenue-per-search gap, although the improvement probably won't show up on its balance sheet until midway through 2007.

Despite its recent stock stumbles, the portal remains a diversified giant. Its sites draw more users than AOL's or Microsoft's. Among 18-to-34-year-olds, Myspace and YouTube had a combined 32 million unique visitors in December; Yahoo! had 39 million. And Yahoo!'s e-mail remains tops with 250 million users worldwide. The company is either first or second in 17 Web categories, from e-mail to photos. It also landed a deal with eBay to sell ads on the company's domestic site and engineered a partnership to sell ad space for 215 newspapers.

Panama may not be Semel's last bullet. Analysts have suggested Yahoo! could benefit from merging with AOL, a division of Time Warner (TIME's parent), or a linkup with Microsoft, which lags in search. Either deal would help Yahoo! take on Google more aggressively. One thing that won't change: the quirky Yahoo! culture. Early on, founders Jerry Yang and David Filo set up a free cappuccino bar for employees and have followed up with annual company-wide gifts, ranging from MP3 players to sleeping bags. Google has topped the coffee bar with free meals and a host of perks. But in Yahoo!'s case, staying caffeinated and hungry might not be a bad idea.

With reporting by Jeffrey Ressner