Google: The Change Agent

What is it that's transforming the trademark exclamation point in the Yahoo! logo into a question mark? In a word, Google.

Sure, Yahoo survived the dot-com bust and evaporation of easy money in Internet advertising. But that's history. Now the company is forced to compete with the powerhouse that invented a search engine advertising money machine right under its nose and is dwarfing it financially. Yahoo's profits dropped almost six percent to $454 million during the first nine months of 2007, while Google's profits rose 46 percent to $3 billion.

Worse, Yahoo has lost its longtime position as the Internet's most trafficked Web site. Although Yahoo's family of Web sites still attracts slightly more unique visitors than Google's in the U.S., according to ComScore Media Metrix, it trails internationally with 478.7 million unique visitors compared with 561 million for Google as of August. Microsoft also ranks high on the list, though it's not yet a major threat in Internet advertising. And younger Internet users are increasingly choosing social networking sites like Facebook or MySpace as alternative portals.

Not All Gloom and Doom

There are bright spots, assuming Yahoo can cash in on them sooner rather than later.

In search:
Yahoo retains the No. 2 position in the search market, albeit largely as a byproduct of its audience for news, mail and other Web site features. An upgrade to its search marketing system that started rolling out late last year is paying off: Yahoo says search revenue for its Web sites rose 30 percent from Q3 levels a year ago, contributing to an overall 12 percent increase in revenue. Also, an October search engine upgrade is getting good early reviews from analysts for its inclusion of Yahoo Search Assist, which suggests keywords to users hesitating over what to enter in the search box. Yahoo has also integrated image and media search results. Yahoo Answers, a social search site where users can submit and answer each other's questions, is also proving to be one of Yahoo's fastest-growing properties.

Beyond search:
Most Google properties going head to head with Yahoo properties (think Google Finance vs. Yahoo Finance and the like) haven't made much of a dent.

Even Gmail had less than a third the audience of Yahoo Mail as of August, with 82 million unique visitors worldwide vs. 255 million, according to ComScore. However, Gmail's audience grew 64 percent year over year while Yahoo Mail's audience dropped one percent.

Off-site ads:
Yahoo's summer purchases of online ad exchange Right Media for almost $700 million and behavioral marketing network Blue Lithium for $300 million expand the company's ability to place ads on other publishers' Web sites. This is another strong market for Google, but a more fragmented one in which Yahoo has a better chance of making inroads.

On-site ads:
With its new SmartAds product, Yahoo aims to create a new category of display advertising based on behavioral targeting techniques that mimic the specificity of search advertising. For example, SmartAds can match a Los Angeles user researching a trip to Las Vegas with an airline offering cheap flights between the two cities. Better yet, the relevant ads may appear throughout the site, not just on the search results page, letting Yahoo and its customers capitalize on the breadth of its content.

Additions and Upgrades:
Yahoo continues to invest in new specialty sites, such as its new Yahoo Mash social networking site, and revitalization of existing sites (Yahoo Mail, with its more interactive Web 2.0-style user interface, and Yahoo Real Estate, which is gaining market share by mashing up data and applications from other Yahoo and partner sites). The company is also embracing open source technology, and inviting developers to work on its platform. (For more, see "Accentuate the Positive," page 31.)

"They've lost the battle of the search box," says Whit Andrews, a search technology analyst at Gartner. "Their effort now is to find a new battle."

Yahoo's greatest potential, Andrews says, is in tying together its wide assortment of Web properties, particularly those with a social component.

Yahoo 360, a site aimed at connecting people a la Facebook and MySpace, never gained a large following, and now the company is trying again with Mash. But Yahoo Groups, Yahoo Instant Messenger, bookmark-sharing site Del.icio.us, photo-sharing site Flickr and other properties are solid building blocks, he says. And he sees Yahoo combining those assets more intelligently—by letting Yahoo Instant Messenger users see what songs their friends are listening to on Yahoo Music, for example.

"They still have assets any other company in the world would die to have," says Jeremy Ring, a former Yahoo sales executive who's now a Florida state senator and venture investor. "Yahoo may be a broken brand on Wall Street but it's not a broken brand in the rest of the world."

Even on Wall Street, where its stock has hovered in the mid-$20s much of the year (Google's recently topped $600), Yahoo has friends. Bear Stearns analyst Robert S. Peck named Yahoo a "top pick" in September, saying the pendulum in investor sentiment between greed and fear has swung too far toward fear.

Yahoo is taking steps to get beyond its "sunk costs" in past mistakes and invest in new initiatives with greater potential, he said.

Peck also rejected the argument advanced by several other Wall Street analysts that Yahoo could make more money by outsourcing search advertising to Google rather than continuing to compete in that market. While that might pay off short term, he said, Yahoo will be better positioned to offer advertisers a complete package if search remains part of the mix.