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How Yahoo went from Web star to Microsoft prey

John Letzing
MarketWatch (MCT)

SANTA CLARA, Calif. - Two years ago, Yahoo Inc. acquired a vast patchwork of commercial lots in the heart of Silicon Valley, a prime location that local officials hoped would become home to thousands of new employees.

But now the lots - part of a $112 million property acquisition in 2006, according to regulatory filings - sit partially abandoned and in varying states of disrepair, a 10-minute drive from Yahoo's Sunnyvale, Calif., headquarters.

Rather than bulking up with staff, Yahoo is shrinking. The Web portal recently laid off roughly 1,000 employees in a cost-cutting move and is scrambling for alternatives to fend off an unsolicited takeover bid by rival Microsoft Corp.

"They stated at the time they were looking for some long-term flexibility," Santa Clara deputy city manager Carol McCarthy said of Yahoo's purchase of the lots. "It's not unusual for companies to buy large parcels of land thinking they'll grow into it."

Until roughly mid-2006, Yahoo had every reason to believe its future was bright as a premier destination on the Web. But its more recent past has been rife with destructive technology misfires, mismanagement and ego clashes, according to interviews with former executives and employees.

While Yahoo garners a large online audience, it has still not managed to turn one aspect of its business, search advertising, into the sort of wild growth phenomenon showcased by archrival Google Inc. In response, Yahoo has doubled down on what many saw as a losing proposition: beating Google at its own game.

To do this, Yahoo has since 2005 developed a technology dubbed "Project Panama," meant to increase the relevance of search results, and in turn boost revenue from users clicking on sponsored links. Panama, however, has been largely ineffective to date. In 2007, Google managed to receive 71.2 percent of U.S. search advertising revenue in the U.S., while Yahoo saw a mere 8.9 percent, according to eMarketer Inc.

Meanwhile, Yahoo's management has become obsessed with pouring more money and resources into Panama and search, while neglecting Yahoo's other businesses, such as graphical display advertising, said a former senior executive who asked not to be identified.

Yahoo President Sue Decker, a former Wall Street analyst, has been particularly committed to investing in search at all costs, because she's enamored of the easily measurable financial results it produces, she said.

But Wall Street has been largely unimpressed with both the timing and effectiveness of Panama. Cowen & Co. analyst Jim Friedland said that "Panama and their investment in search came way too late. Google had already won the war."

A Yahoo spokeswoman declined to comment.

During a conference call accompanying Yahoo's fourth-quarter earnings report in late January, Decker told analysts that Panama was showing results - thanks to the technology, she said, U.S. search revenue on Yahoo sites grew more than 30 percent.

But Decker's update quickly got obscured by the subsequent melee. Two days after the earnings report and conference call, Microsoft disclosed its $44.6 billion acquisition offer.

Peter Sealey said he was surprised when fellow former Hollywood film executive Terry Semel took the CEO job at Yahoo in 2001.

Sealey, who was president of marketing and distribution at Columbia Pictures in the late 1980s, said that while at Warner Bros., Semel was part of "the best management team in the film industry." But Semel never seemed to have the same touch at Yahoo, Sealey said. "Terry brought Warner Bros. 360 miles north, and it didn't work."

Now Sealey, an adjunct professor of marketing at Claremont Graduate University in Claremont, Calif., said he uses his old rival's missteps at Yahoo as a cautionary tale for students.

For example, Sealey said Semel's increasing drive to turn Yahoo into a premier player in search was undercut by his reluctance to give up on its future as a broader media company. "You can't have a more egregious error than the CEO having an incorrect vision of the business model of his company," he said.

Former Yahoo software engineer Michael Temkin said that this lack of focus was apparent to most employees.

"Google is highly aware of how they make money internally, they have the ability to go and try a lot of different things, but at the end of the day they know their money is coming from search," Temkin said. "Yahoo's management has not done a good job of communicating how they make money. Yahoo is not a search company, it's a content company, and it should be focusing on that audience and how it can monetize it."

Temkin said that another issue Semel could have better addressed was the never-ending turf war among different management teams.

While working in a mobile phone software group that utilized content from many other parts of Yahoo, Temkin said he saw first-hand the difficulties different divisions had working together.

"The lack of focus made it impossible to just get something done," Temkin said. "People had ideas, and people internally were trying to innovate, but pretty much that got squashed across the board. It was not the place I'd hoped it would be."

Temkin and six colleagues left Yahoo to join a small San Francisco-based mobile phone game company in 2006. Yahoo then sued them for allegedly attempting to steal the company's intellectual property, though that case has since been settled.

Semel left the company more recently, resigning as chairman shortly before Microsoft's acquisition bid was disclosed earlier this month. Semel had stepped down from the CEO job in June, when he was replaced by company co-founder Jerry Yang.

Cowen & Co.'s Friedland said Semel may have simply started too late to reverse Yahoo's course. It had already dedicated too much energy to gathering content for users of its finance, sports and other sites, he said, in order to properly address the search market.

"Yahoo needed to recognize in 2000 or 2001 that the world was going to go toward search, and there was more money to be made by creating a search engine than actually doing content deals," Friedland said. "The bottom line is the Internet has changed and consumers have changed."

For investors, Yahoo's recent history has been trying.

Eric Jackson, a Yahoo shareholder who has been a vocal critic of the company's management, said it's beyond salvaging as an independent entity. Jackson is leading a group of about 130 other shareholders with roughly 2.2 million shares in advocating for a sale of Yahoo.

"We want to sell whether it's to Microsoft or to another party that makes a better offer," Jackson said. "What we don't want to do its go along with an independent Yahoo strategy."

Jackson said he was particularly disheartened by Yahoo's response to the circulation in 2006 of the so-called "peanut butter manifesto," an exhortation by senior vice president Brad Garlinghouse for the company to "get back up" from its malaise and refocus.

Garlinghouse's memo was later leaked to the media.

"That was a warning sign that senior people within the company thought there were problems," Jackson said, "and yet the response by management was an early December 2006 reorganization that changed peoples' positions at the top, but really didn't address some of the underlying problems."

Jackson said he has also been disappointed with "mismanaged expectations" for Panama.

"They gave this expectation that once Panama was fully online it would dramatically increase revenue per search," he said. But "by spring of 2007 it really wasn't delivering as promised, and everyone stopped talking about it."

Friedland noted that Panama has in fact been showing results - but too little, and too late. The irony now may be that it is Microsoft that stands to be the prime beneficiary of all of the resources poured by Yahoo into the technology.

Temkin, the former Yahoo mobile software engineer, said he thinks Yahoo "still could be a great company," thanks to its deep pool of talent. But with Microsoft bearing down, that talent is increasingly headed for the exits.

Former Yahoo vice president Bradley Horowitz announced his departure in a blog post Thursday. "I wish I were leaving with Yahoo on top of the world," he wrote. "I thought that since so many people were leaving on Tuesday, it'd be a good day for me to slip out unnoticed too." Horowitz wrote that he's taken a job at Google.

Temkin, who is now chief technology officer at the San Francisco company he joined in 2006, Hands-On Mobile Inc., said he would welcome any Yahoo engineers now looking for new jobs.

"There are a lot of talented people there, I'd love to find my former colleagues and give them a chance to do something innovative here," Temkin said.

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