Yahoo Under Repair

Cracks in the Yahoo facade were starting to show before Yahoo's troubling earnings report in early January. The dot-com collapse had shrunk the Internet advertising landscape. According to the Internet Advertising Bureau, online ad spending declined 7 percent between the second and third quarters of 2000, the last period for which statistics are available. "[Yahoo's] revenue has really been juiced up by dot-com spending, and that is going to dry up," Lehman Brothers analyst Holly Becker said in October. "I'm concerned that it will take longer than most people expect" for Yahoo to pick up the slack from the dot-com fallout. A full one-third of Yahoo's revenues are generated by pure-play dot-com advertisers, and many of them will be unable to honor their contracts.

A softening in the advertising market also means that Yahoo can no longer play dictator with customers, who find they now get far more favorable terms. At the start of 2000, Yahoo was charging clients $9 for every 1,000 people who viewed an ad. Now, Yahoo is charging as little as $3 per 1,000 visitors, according to Tribal DDB's Tim McHale. (A Yahoo spokeswoman disputes this assertion, claiming ad rates have stabilized and in some instances gone up.) Where once a major portal deal was considered mandatory for any company harboring big dreams, it's now widely viewed as too expensive even at bargain-basement prices. "I don't have anyone coming in here saying, 'Get us on Yahoo,'" says David Sable, CEO of Impiric, a direct marketing firm that helps companies buy portal ads.

Even analysts, who in the fall were saying that they could find nothing wrong with Yahoo's addiction to ad dollars, are now changing their view. Three months ago, Solomon Smith Barney's Lanny Baker argued there was nothing wrong with turning Yahoo into the next NBC, which gets 100 percent of its revenues from ads. But now Baker says Yahoo needs to diversify or it will be vulnerable to the cyclical nature of the market. Nineteen of the 34 analysts who follow Yahoo rate the stock a "hold" or a "sell" despite its depressed price of $33 per share as of Jan. 19.

Should Yahoo have moved more aggressively to diversify sooner? Yahoo's Mallett, a boyish-looking, fast-talking 36-year-old, says no. "We saw a third of the way through 2000 that the dot-com environment was changing, the advertising environment was changing, and we made the appropriate adjustments."

And - counterintuitive as it seems - Yahoo could benefit from the downturn. As smaller dot-coms close their doors, some advertisers are likely to turn to established sites like Yahoo. "We think we are in a position now to take even more share out," says Mallett.

But others aren't too sure. Bear Stearns analyst Jeffrey Fieler, for instance, faults the company for failing to act quickly when advertising revenue started to dive. "In retrospect, you could be critical of them not doing that," Fieler said. "But in early 2000, people were throwing money at the company. It's hard to be disciplined in that environment."

It's uncanny how bad news helps focus a company. "It's been on the radar for years, the fact that the advertising model can't be relied on," says a former Yahoo software developer who recently left the company after four years in its search division. But finding new revenue hadn't been an urgent matter within Yahoo, he said. Only a few months ago top executives had downplayed the importance of diversity. Following Yahoo's gloomy financial forecast in January, however, executives seem to be changing their view, albeit slightly.

"Were going to diversify our revenue mix by growing our commerce and enterprise business by adding more channel partners and more service offerings," says CEO Tim Koogle.

Indeed, one reason the company expects to be far less profitable this year is that it will spend roughly $100 million on new business initiatives in 2001, meaning that two-thirds of Yahoo's new expenditures in 2001 will go to these efforts. Yahoo, says Baker of Salomon Smith Barney, is finally "putting their money where their mouth is."