2008: Yahoo's Year to Forget

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For Jerry Yang, 2008 was going to be the year when Yahoo's long-awaited technology and business turnaround began in earnest.

After years of decline at the expense of Google and nimble startups like Facebook, MySpace and YouTube, Yahoo would come roaring back and eventually reclaim its position as the ruler of the Internet roost. Leading the comeback, Yang would reprise the role Steve Jobs played after retaking Apple's helm.

Yang, a Yahoo co-founder, had taken over as CEO in mid-2007 to save his company. Optimism ran high. Some pundits said no one knew Yahoo better than Yang, and that he had the mix of technical and business knowledge to right the ship.

After several corporate reorganizations in 2006 and 2007, Yahoo finally had the right structure in place, the company's upper management argued.

Yang's goals were ambitious: Make Yahoo the preferred starting point for users, the preferred marketing vehicle for online advertisers and the preferred Web application platform for external developers.

In short, Yang would ensure that when the 2008 holiday season rolled around, Yahoo investors, partners and employees would have plenty to be jolly about.

Things haven't quite worked out that way.

Instead, the year brought two big rounds of layoffs, an embarrassing exodus of high-profile managers, disappointing financials, a tanking stock price, free-falling employee morale and little or no advances in key areas, like search usage and search advertising. Oh yeah, and yet another corporate reorganization that many cynically viewed as more spinning of the wheels.

At the center of it all was Microsoft's historic acquisition attempt. It's clear that it radically disrupted Yang's plans and that he failed to handle the situation properly. It was a curve ball that, hard as he tried, he struck out on.

Although he never admitted it, the unsolicited bid clearly rankled Yang, whose turnaround vision for Yahoo didn't include a merger with Microsoft. "The Microsoft offer was a devastating distraction for Yahoo's upper management," said industry analyst Greg Sterling from Sterling Market Intelligence.

It's unclear whether Yang may have been able to execute his turnaround plan better if the Microsoft bid hadn't been made, Sterling said. "The other way to look at it is that the Microsoft situation simply accelerated the inevitable," he said.

The Microsoft offer had to be dealt with. Whether Yang liked it or not, the $31 per share, $44.6 billion cash and stock bid represented a 62 percent premium for Yahoo shareholders when it was announced on Feb. 1.

Microsoft also made a compelling and brutally honest argument for fusing its Internet unit with Yahoo: It was the way to mount at least a credible challenge to Google, absolute ruler of search, the largest, most profitable and most important online ad market segment.

Thus began the tragicomic cat-and-mouse game between Microsoft and Yahoo that, surreally, lasts to this day.

We saw Yahoo's repeated rejections of Microsoft's attempts to acquire the company and, later, of buying only its search business.

Meanwhile, Yang made overtures towards seemingly anyone -- Google, News Corp., Disney, AOL -- who might be interested in a deal that would allow him to save face before his shareholders.

Investors became incensed at what they perceived as Yang's attempts to derail the Microsoft negotiations out of pride or self-interest but, in their view, never to protect their money. Leading the charge was Carl Icahn, who railed at Yang and his fellow board members and mounted a proxy battle before being appeased with a board seat for himself and two of his backers.

Finally, a deal was struck with Google, calling for Yahoo to run search ads from its competitor, which would give Yahoo a much-needed cash influx. But the deal was never implemented. It imploded when the U.S. government made clear it would challenge it on antitrust grounds and Google opted to walk away.

Talks about a merger with AOL have been popping up regularly since February, but evidently the companies haven't been able to agree to one.

In early November, a week before announcing his intention to give up the CEO role and shortly after the Google deal collapsed, Yang took the stage at the Web 2.0 Summit in San Francisco and declared: "To this day I would say that the best thing for Microsoft to do is to buy Yahoo."

Recently, to settle a shareholder lawsuit, Yahoo agreed to dilute a severance plan it adopted days after Microsoft made its initial bid and which critics called a poison pill designed to discourage Steve Ballmer and company. "Yahoo has been retrenching, to make it easier for the company to be sold," said industry analyst Charlene Li, founder of Altimeter Group. But Microsoft CEO Steve Ballmer has been saying for months that his company is no longer interested in buying all of Yahoo.

Ironically, the resistance offered to the acquisition by Yahoo's board and upper management may have worked in Microsoft's favor, giving Ballmer a chance to realize that it's not in Microsoft's best interest to swallow Yahoo whole.

"Buying all of Yahoo made sense on paper, but the reality of making the two companies work together would have been a nightmare," Li said.

There are so many overlaps between the Microsoft Internet unit and Yahoo, that the integration would have been highly complex, requiring a lot of time and effort, when in fact Microsoft only needs the search portion, Li said.

Sensing that Microsoft's acquisition of Yahoo's search business is inevitable, Ballmer recently urged Yahoo to cooperate in getting it done "sooner rather than later."

Yahoo, with its stock in the $12 to $13 range, has much less leverage or negotiating power than it had at the start of 2008. Still, Yahoo would be in an even weaker position without a search business, so it should attempt to cut a more limited deal, similar to the one with Google, Sterling said.

"Yahoo's next main challenge in 2009 is generating search advertising revenue, especially if advertisers continue to pull back on display ad spending," said IDC analyst Caroline Dangson via e-mail. Not only is search the biggest online ad market segment, but it will remain so over the next five years. "Yahoo has to innovate in search to compete with Google," she said.

Yang did oversee ambitious technical projects to improve services for end users, developers, publishers and advertisers. Some have been delivered, others are in progress, like Yahoo Open Strategy (Y OS), a project to rearchitect the company's sites and services to tap into the popularity of social networking.

With Y OS, Yahoo pledges to open all its sites, online services and Web applications to outside developers, and give users a "social profile" dashboard to unify and manage their Yahoo services. Yet, Li faults Yahoo's leaders for taking too long to articulate that strategy: Y OS was announced in late April.

Meanwhile, Google continues dominating search, and its position continues to strengthen, at the expense of Yahoo and Microsoft.

In the third quarter of 2008, Google nabbed 28.4 percent of all online ad spending in the U.S., up from 25.4 percent in the same period in 2007, according to IDC.

By comparison, Yahoo had 12.5 percent in 2008's third quarter, down from 13.3 percent, while Microsoft's share increased slightly to 6.7 percent from 6.1 percent in 2007's third quarter, according to IDC.

In the search segment specifically, Google's share of spending has increased from 50 percent to 54 percent in this year's third quarter, while Yahoo's has dropped from 14 percent to 13 percent. Microsoft also saw a decline of 1 percentage point to 6 percent.

In display advertising, Yahoo's forte, the company has been unable to build on its leadership position, with its share falling 1 percentage point to 16 percent year-on-year in 2008's third quarter. Microsoft held on to second place and improved its share to 12 percent, up from 9 percent. Google, a nonentity traditionally in this segment, grew its share from 1 percent to 3 percent.

Looking ahead at 2009, Li sees in Yahoo a company with many valuable assets but with a management culture that needs a shakeup.

"Can Yahoo become much more flexible and fluid? It has a chance, though it's going to be very hard," Li said.

"My goodness, any company would love to have their user base and their technology," Li added. "Yahoo needs to get out of its own way."

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