Whither Now Yahoo!?

This must have been an interesting weekend for Yahoo! employees. First, you get the direct fallout from the Wall Street Journal's story covering "the Peanut Butter Manifesto." Then you get the secondary analysis of just what ailes the world's most popular network of web properties. Finally, Yahoo! announces a deal with a clutch of newspaper chains. What's it all mean, and what's the relationship between these stories?

Let's try to connect some dots.

This year, Yahoo has suffered from slumping shares, slowing revenue growth, staff defections and a delay in a crucial project aimed at boosting online ad sales. As the memo shows, even some current executives have been fretting that the Internet company's top management isn't prepared to take the strong medicine they feel is needed to right the ship.

Some worry that Yahoo — whose activities range from online dating to fantasy sports — has stretched itself thin and lost track of priorities. Recently, the company has been outmatched in key areas such as search advertising and social networking. (See related article.)

Last month Brad Garlinghouse, a Yahoo senior vice president, wrote the memo, titled "The Peanut Butter Manifesto," for top executives. His contention: "Change is needed and it is needed soon."

Mr. Garlinghouse, who once shaved a "Y" in the back of his head, argued in his manifesto that Yahoo is spreading its resources like peanut butter on bread, thinly and evenly across all its activities. "Thus we focus on nothing in particular," he wrote, saying the Sunnyvale, Calif., company needs to pick specific areas to focus on and make bigger bets on them while dropping nonessential activities.

So, is Yahoo! broken? So heavily matrixed, sclerotic, and unfocused that it needs radical surgery? Or is Yahoo! simply a successful upgrade or a deal away from returning to their former glory atop the internet advertising pile, thanks to their industry-leading reach? It would seem that Wall Street can't figure it out either. Accoding to the New York Times this morning:

So is Yahoo stock, which now trades at $26.91, down 31.3 percent this year, a bargain suitable for value investors? Or is the once highflying company — which in its heyday was regarded not unlike today’s Google — destined to bring further disappointment?

Yahoo management, led by its chief executive, Terry S. Semel, is counting heavily on a technological upgrade of its search engine to enhance profits. The delayed upgrade, called Project Panama, is now scheduled for introduction in 2007, and analysts expect it to narrow Yahoo’s search gap with Google. Merrill Lynch figures that the project will raise revenue per search to around 5 cents in 2008, or as much as 7 cents if Panama proves a rousing success.

“Monetization is a hard thing; not too many people do it very well,” said Mr. Befumo at Legg Mason. But, he contended, Yahoo has some appealing alternatives.

“If you have a traffic problem, then you have a fundamental business problem because you have nothing to convert into revenue dollars,” he said. “But if you have a monetization problem, which is what Yahoo effectively has, you always have options.”

So the (investment) world is splitting into two perspectives on Yahoo!: those who believe the company is caught between aggressive competition from Microsoft and AOL as well as niche players like MySpace and YouTube, and those who see strength in their massive reach—a huge audience simply awaiting the right tools to properly address their needs.

What's the state of Yahoo!'s traffic? Fred "A VC" Wilson has a very useful post on the matter. It's clear from his numbers (which come from comScore) that Yahoo!'s still the biggest property manager on the 'net. Unfortunately, Yahoo! isn't growing their audience at the average rate of the internet as a whole. Google itself is barely keeping pace (if you don't factor in YouTube's audience growth). Here, I drew a quick graph (using Fred's comScore numbers) to show you what I'm talking about:

As Fred points out, the internet may not be mature (there's still triple-digit growth available for new services), but the warhorses of internet eyeballs—the portals—are looking pretty mature themselves, relatively speaking. Yahoo! has to keep pace with the net as a whole, otherwise every point of growth in the size of the internet audience comes at its expense. The chart above, however, makes me think that a portal-based strategy, essentially creating an all-encompassing destination for an audience, isn't where the internet's growth is coming from. Audiences are being attracted to sites that showcase within some kind of niche, either by virtue of the medium (YouTube for video), or the subject (Facebook for college kids), or the purpose (Wikipedia as a reference source). The portal's dilemma is that it's simply untenable to be as good as a specialist might be when that specialist is simply a click away.

So, should Yahoo! acquire audience growth? One of the things Yahoo! has taken some heat for has been their seeming inability to close deals for Web 2.0 properties like MySpace and YouTube. When you see the audience growth rates for Fox Interactive (ie, MySpace) and YouTube, you can see why: if Yahoo!'s core portal offerings aren't even keeping pace with the growth of the medium, then they can only increase their share by quickly incorporating the up and coming destinations.

On the other hand, if you're a Peanut Butterite, you'd have to believe that Yahoo! couldn't have digested those properties, leaving them as-is alongside existing (and competing) internally-developed services like Yahoo! 360 or Yahoo! Video. Even if you think Yahoo!'s traffic is fine but the monetization needs a tweak, then you'd have to imagine that the incremental traffic delivered by either acquisition would have come in handy later rather than sooner. In either case, it would have been a short-term waste of shareholders' money.

Back to Garlinghouse's assertion, then, that Yahoo! needs to focus on high-impact businesses where it can dominate. That sounds partly right, but it's a half-measure unless Yahoo! also addresses how they earn money with those visitors. Yahoo! has to get their ad network (search, contextual, rich media, and otherwise) right.

Google, of course, has neatly sidestepped these issues by not being a destination and concentrating on brokering individual audence members' needs with the information in their index. By focusing on building an ad network rather than a content destination, they allow the specialists to chip away at Yahoo!'s share of the audience (in fact, they finance the specialists through ad revenue).

And while it's critical for Yahoo to bring their ad network up to parity with Google's, they'll have to cut deals and spend money to ensure Google doesn't erode Yahoo!'s third party reach any further. That's the motivation behind today's announcement that Yahoo! will work with 176 local papers from seven different newspaper chains on a long-term project to share ad revenue and local content. Whatever the details of the deal, the main point is that it takes some powerful local ad distribution out of Google's reach. Yahoo! will be able to offer advertisers regionally targeted ads distributed by well-known local brands (such as the Atlanta Journal-Constitution).

Yahoo! has grown up to be the biggest media property on the web but their slice of the web's audience is declining all the time. Google, with their focus on search and advertising technology, has positioned itself to not only put ads in front of more people than Yahoo! can, but to earn more money when they do it. Yahoo! has rightly started to take a hard look at itself: what good is all the traffic it generates if it can't convert it into profits the way Google can? With competition on all sides, should the company consider reducing the scope of its services to focus on ways it can compete with Google, or is its breadth of offerings a strength, hidden behind second-rate ad technology?

Yahoo! CEO Terry Semel will come under inreasing pressure to find decisive answers to these questions, and soon.

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