Panama Puts Yahoo Back in the Race

A lengthy revamp of the company's methods for ranking online ads was time well spent—and may help narrow Google's lead

by Andy Beal

If you've watched any professional motor sport, you've likely witnessed the following scenario. The early leader loses ground to other racers as his car's tires begin wearing out or the engine starts smoking. A pit stop will initially cause the driver to fall even further behind. But ultimately the time taken under the care of mechanics helps the driver pull back into the lead. If the Web's search engine industry is the race track, Yahoo has just taken a timely pit stop to try and win back ground lost against the new leader, Google.

On Feb. 5, Yahoo! (YHOO) started moving all of its paid search advertisers over to a new ranking model, informally known as "Panama." The aim: Gain some much-needed momentum on Google's more widely used AdWords platform.

It took Yahoo many months to create the new model, effectively rebuilding the system it acquired with the $1.6 billion purchase of Overture Services. Although Panama is just getting off the ground, there's reason to believe this time in the pit has done Yahoo good.

Platform Competition

It might be a distant memory now, but when Yahoo acquired Overture in 2003, it picked up the leader in paid search advertising—those sponsored links often seen alongside Web search results.

Overture had built a successful advertising platform that was as simple as it was popular. Advertisers could select certain search phrases and "bid" to have their text advertisement shown alongside the regular search results. It was a huge success, and Yahoo was smart to acquire the company and the technology.

Unfortunately for Yahoo, Google (GOOG) decided to enter the race and built a better model along the way. Instead of a simple, whoever-pays-the-most-wins approach, Google's AdWords platform takes into account the effectiveness of the ads themselves, as well as the advertiser's bid.

A combination of the highest bid and most clicks earns advertisers the No. 1 spot. This model proved an even bigger success than Overture's, now named Yahoo Search Marketing, and it gave Google a solid lead in search advertising. The business garnered Google $10.61 billion in sales last year, compared with Yahoo's $5.53 billion.

Pay Per Click

Yahoo faced a difficult decision: Continue with its current advertising model and watch as it lost ground to Google, or rebuild the platform from the ground up. Yahoo hesitated, stuck with the original game plan, and watched Google AdWords become a huge success.

Not only did advertisers prefer a model that rewarded them for creating better quality ads by effectively reducing the amount per click needed to achieve the top spot, but Google's bottom line benefited greatly because its platform always selected the ads that generated the highest return, thereby increasing the search engine's earnings per search.

By 2006 analysts estimated that Google earned 4.5¢ to 5¢ on every search, while Yahoo earned just 2.5¢ to 3¢. That pretty much forced Yahoo's pit stop—the hard work of rebuilding its search ad technology and the underlying infrastructure.

The result? In October, 2006, Yahoo announced the launch of a new marketing console, with better targeting options, increased reporting ,and faster approval of new search ads (Yahoo previously took days to approve ads, while Google approved within minutes). This launch was the first step in a two-part plan to mount a stronger challenge to Google.

With the Feb. 5 launch of the underlying algorithm and ranking model, Yahoo addressed the final issue that had caused it to lose so much ground. On that day, dozens of Yahoo engineers watched an array of charts, graphs, and statistics as the company flicked the switch on an advertising model that would rank ads based on the amount the advertiser bid (from pennies to more than $100 per click, in some cases) and the click volume (how often the ad was clicked on).