Darwinian tech world makes lagging Yahoo ripe for harvesting

SAN JOSE, Calif. — After just 14 years in which it helped launch the Internet age, Yahoo has hit "middle age" and faces the fate of many other iconic Silicon Valley companies, becoming takeover bait.

Microsoft's $44.6 billion unsolicited bid for Yahoo is yet another indication of a common valley axiom: Innovate or face unwanted suitors.

"Yahoo may join the long list of distinguished companies going back to Fairchild Semiconductor known in their time for doing great stuff that couldn't keep up with the times," said Alex Soojung-Kim Pang, a research director for the valley-based nonprofit Institute for the Future.

A deal between Yahoo and Microsoft is far from assured. Yahoo's management has yet to rule on the offer, and U.S. and European regulators are sure to scrutinize any would-be deal.

But Yahoo's weakened position led to talks a year ago between Microsoft Chief Executive Steve Ballmer and Terry Semel, Yahoo's former chairman and executive. Now it has triggered a less-than-friendly takeover bid.

The valley has long understood, if not embraced, the fast-moving tech world's Darwinian approach to business: eat or be eaten.

Netscape Communications, PeopleSoft, BEA Systems and Siebel Systems are some of the companies that rose, stumbled and agreed to be consumed by rivals.

Still, it is with mixed emotions that many watch Yahoo's possible absorption by Microsoft.

Google's commanding lead in the search advertising market has triggered something of a backlash akin to what Microsoft faced in the 1990s as it muscled its way to world dominance with its personal-computer operating system.

And Yahoo's rocket to international fame is quintessential Silicon Valley. Watching it become a division of Microsoft isn't how many wanted the company's tale to end.

"From a valley perspective, I'd hate to see them go," said Philip Engelhardt, the managing partner of PhilQuo Ventures in Palo Alto. "They're a Silicon Valley original, some of the greatest young minds ever assembled.

"When that much talent comes together, you don't like to think they've failed. ... If Microsoft plays its cards right here, they will have picked up a great gem."

Started as a hobby in 1994 in a Stanford University campus trailer by doctoral students David Filo and Jerry Yang, Yahoo became a sensation by creating a way to organize information on the Internet.

And starting with its name, the company also affected a certain rebelliousness. At one point, the youthful Yang and Filo wanted a contrarian marketing line: "We help you waste your time more efficiently," recalled veteran valley forecaster Paul Saffo.

The Sunnyvale company went on to lead the early search market before expanding into areas like news and networking.

Yahoo aimed to be a one-stop Internet portal, offering everything from e-mail and instant messaging to financial information.

In 2001, Yahoo hired Hollywood executive Semel as chairman and CEO. The company set up an office in Santa Monica and looked to produce its own video shows.

While Yahoo became one of the hottest content sites online, the company missed a multibillion-dollar opportunity as Google rewrote the Internet business plan by revolutionizing the search-advertising industry.

"I think Yahoo is still a spectacular company," said Brett Bullington, who was a board member at Flickr, which was acquired by Yahoo, and JotSpot, acquired by Google. "If there wasn't a Google to measure them against, they'd be huge."

Google also copied Yahoo, but added better technology.

The Mountain View company first focused on lucrative Internet search advertising, then offered popular mail and finance, as well as productivity applications and other features.

"They actually have more eyeballs than Google does," Creative Strategies analyst Tim Bajarin said of Yahoo. "People come to their site for online-based content."

But the money is in advertising, and that comes from sophisticated search-based technology.

"Yahoo stopped thinking of itself as a technology company," said Kevin Lee, chairman and co-founder of Did-it.com, a search-engine marketing firm.

"You have to be a technology company to maintain leadership. They didn't move quickly enough in certain areas to keep up with the quality of searches that Google had."

At the start of 2007, Google commanded 52.6 percent of the search market, Yahoo had 26.9 percent and Microsoft had 10.4 percent, according to comScore.

By December, Google's share had edged up to 58.6 percent while Yahoo's slipped to 22.4 percent and Microsoft was at 9.8 percent.

Yahoo, pummeled by the slowing economy and fierce competition from Google, announced plans to cut 1,000 jobs last week, its largest layoff since the dot-com bust.

From the beginning of 2006 through Thursday, Yahoo's stock price dropped by about half, closing at $19.18 the day before Microsoft's bid.

Google, on the other hand, has seen the price of its shares jump 36 percent during the period, closing at $564.30 Thursday. After Microsoft's offer was announced Friday, Yahoo's stock shot up 48 percent. Google's shares dropped 8.6 percent after a disappointing earnings report.

A Microsoft acquisition of Yahoo would fit right in with what Johns Hopkins University business historian Lou Galambos said is "part of the great restructuring that's been going on in American business since about 1980. ... Microsoft is one of the crown jewels of American global business, and they're going to strengthen themselves by adding new capabilities."

Yahoo has closed the search-technology gap, Lee said. But even with Microsoft's help, and millions of dollars more for R&D, it will be tough to dent Google's public image of providing the best in search technology, he added.

Engelhardt — whose background is rooted in investment banking, mergers and acquisitions — said Yahoo's problems seemed to stem from the inability of the senior management to react and innovate quickly enough to keep up with competition and technological challenges.

"They spent years floundering about with their mail product," said Engelhardt, a former vice president of strategic relations at Silicon Graphics.

"The integration of their mail products with PDAs, with their mobile solutions, was years behind the curve. And they should have beaten everybody from where they started," Engelhardt said.

A combined Yahoo and Microsoft might have benefits for the valley: It could further enhance the region's leadership in search technology, analyst Bajarin said.

"If you combine the research capabilities of a Microsoft and a Yahoo, it keeps Google on its toes and it could drive innovation in search even faster," he said. "Competition drives the valley."

Engelhardt, a "former happy shareholder" of both companies, is nonetheless disappointed when he thinks about how far Yahoo has fallen and what it could have been.

"The Yahoo brand is extraordinary," he said. "The value of the name is probably worth half the purchase price."