Yahoo's Joyful, Difficult Journey

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After Netscape Communications' pioneering Web browser helped usher in the commercial Internet, Yahoo emerged as the original Internet icon—the one with the famous yodel in its television ads, the trademark yellow-and-purple hues that extended even to the sprinkler heads at company headquarters, the warm-and-fuzzy image that made the Internet almost cozy.

Not Tech-Savvy Enough

Yahoo's decline is all the more surprising because the business opportunities on the Web are now bigger than ever. But those opportunities still require cutting-edge technology much more than the traditional-media skills Yahoo had veered toward in the last five years. The company that pioneered online media failed to keep up with waves of change still crashing onto the Internet's shores, from new technologies to the ways people use the Web.

Yahoo dominated when new Internet users needed the comfort and guidance of a familiar starting point from which to find resources on the rest of the Net—literally, a home page. Through the 1990s, Yahoo thrived as it signed deals with content providers and became the one go-to place for advertisers seeking to reach lucrative online consumers. But after a series of stumbles, Yahoo brought in former Warner Bros. (TWX) studio boss Terry Semel as CEO in May, 2001, and the company's direction began to change. To his credit, Semel cleared out bloated organizations and brought Yahoo back to prosperity for several years. By mid-2003, Semel's magic had returned Yahoo's market value close to its all-time high of $127 billion, reached in early 2000 at the peak of the dot-com boom.

But Semel's big-media background ultimately backfired. It pushed Yahoo and its culture in a new direction that ultimately proved fruitless, if not ruinous. In 2004, Semel began building a large operation with posh offices in Santa Monica, Calif., near Hollywood, for Yahoo's media activities, such as video-heavy Web sites. "Santa Monica was a huge and costly distraction…at a time when they needed to focus on other things," most of all search technology, says one former Yahoo executive.

Perhaps just as important, Semel never meshed with the engineering culture of Silicon Valley that drives innovation more than anyone at the top. Famously spending weekday evenings in a San Francisco hotel suite, then flying home to Southern California on many weekends, Semel was seen by some as too aloof, uninterested in the technology that Yahoo needed to keep pace with a fast-rising Google and a raft of startups. "He doesn't have a core understanding of technology, and he never did," says a former senior executive.

All the Right Moves?

It's not that Yahoo had no clue. Indeed, it seemed to be making the right moves on the technology front after Semel arrived. It bought search engine Inktomi in late 2002 to bolster its effort to catch Google. The next year, it snapped up Overture, which had come up with the novel idea of placing paid ads on other Web sites. But a year earlier, Google had also seized on that idea as its business model—but with a critical twist: The ads people clicked on more often, not just those for which advertisers paid more, would get higher placement on the page. With that key change and a search engine that produced much more relevant results for users, advertisers got much better returns on ads placed with Google.

Then, on Aug. 19, 2004, Google went public. According to some former Yahoos, that was a turning point for the company's culture as well. Yahoo became a company obsessed with Google rather than one looking to make the next leap on the Net. "Yahoo became super-paranoid," says one former search manager. "We switched from charting our own course to looking over our shoulder."

By the end of 2005, Yahoo realized the search ad operation it created out of Overture was foundering and started a crash program called Panama. But throughout 2006, it kept running into delays.