Google rises at Yahoo's expense

Two years ago, the biggest search companies were about the same size. Now Google is twice as large and growing fast. What happened?
Written by Elinor Mills, Contributor
The contrast between the financial results announced last week for the two top search engine companies couldn't have been more stark.

Yahoo's first-quarter revenue was $1.67 billion, less than half Google's $3.66 billion. Google, once again, blew away Wall Street expectations, while financial analysts openly wondered how long Yahoo CEO Terry Semel would stay in the Internet company's corner office.

Contrast those divergent fortunes with two years ago: The companies were pulling in about the same amount of revenue; they looked primed to battle for Internet domination; and the jury was still out on whether Google's largely unproven management had the chops to take on a seasoned pro like Semel, a longtime entertainment executive whose hand prints are on Hollywood's Walk of Fame.

Now few would argue the answer to that management question was, in fact, a resounding "yes."

"Google has a racecar. Yahoo has a Honda," said Stephen Arnold, author of The Google Legacy. "It goes back to the (search) algorithm, the engineering team and this constant improvement the Google people do. And I don't see any way to close the gap quickly."

So what happened? While a wide range of factors from personnel decisions to luck played a role, most pundits think it came down to this: A smart bet on advertising and technology inside the Googleplex and a bad bet on an online media empire, built from scratch, that would be run out of a Yahoo office in Santa Monica, Calif., about 400 miles away from the company's Silicon Valley headquarters but close to the entertainment industry.

"Yahoo did not execute in a couple of key areas for a number of years," said John Battelle, author of The Search: How Google and Its Rivals Rewrote the Rules of Business and Transformed Our Culture and publisher of Searchblog. "They didn't revise, update, and leverage Overture (search advertising technology)," and they failed to improve the search experience and quality for consumers and advertisers, he said.

"They would acknowledge it was a mistake," Battelle added, "and it's proving to be a costly one."

Google, on the other hand, recognized the potential for pay-per-click ads early and has steadily improved its search and advertising technology. And search, of course, is a big deal. Americans conducted 6.9 billion searches online in February and nearly half of those were on Google, according to researchers at ComScore. Google has 48.3 percent search market share in the U.S. compared with Yahoo's 27.5 percent, ComScore said. Nielsen/NetRatings has the gap even wider, with Google at 55.8 percent share and Yahoo at 20.7 percent.

"At the end of the day, what drives value is search and AdSense distribution."
--John Battelle, author and blogger

Google's share is rising at the expense of Yahoo and Microsoft. While Google's share rose 6.1 percentage points last year, Yahoo's fell 0.6 percentage points and Microsoft's dropped 1.1 percentage point, ComScore numbers show.

Not only was Yahoo slow to recognize the importance of search to Web surfers--something that now seems obvious to many--but its ability to turn searches into dollars has badly trailed Google's. It wasn't until Yahoo's new Panama search ad system was launched this February that ads were ordered on the results page based on things like relevancy and not just the advertiser's bid price.

Google's lead in technology pushed it to No. 1 in search market share and attracted the largest number of AdWords advertisers. Meanwhile, its AdSense system--which allows publishers to make money from ads on their Web sites that are contextually related to content--created another revenue stream for Google.

"At the end of the day, what drives value is search and AdSense distribution," Battelle said. "Google has undisputed network effects--huge distribution, leverage and tons of data they can feed back into the system...That is a formidable position to (have) in the market."

How we came to this
Yahoo, founded in 1995, had a three-year head start on Google when it was launched as a human-created directory. Google has always relied on software spiders to crawl the Web and create its index. Hard as it is to believe now, Yahoo invested in Google early on and used its engine to power Yahoo search results until early 2004 when it began using its own search technology.

Google founders Larry Page and Sergey Brin were unsure what business model they would use when they started their business. After snubbing merger talks in 2001 with Overture, the first search provider to use ads, Google launched its own pay-per-click model in early 2002. Overture sued for patent infringement and the case was later settled. Yahoo acquired Overture in 2003.

Except for one quarter in 2003, Google's revenue lagged Yahoo's. That changed after the first quarter of 2005, when Google posted $1.26 billion in revenue to Yahoo's $1.17 billion. The gap has been growing ever since.

"Yahoo is still trying to play catch-up, and Google hasn't taken their foot off the gas pedal," said Derek Brown, an Internet analyst at Cantor Fitzgerald. "Yahoo has been very slow to recognize changes in the marketplace, in a nutshell...They were late to recognize that search itself was becoming a big deal."

Yahoo executives often describe their outfit as a media company, creating and packaging content. But efforts at original content have largely been a disappointment. Yahoo announced in December that Lloyd Braun, the Santa Monica-based head of Yahoo's media and entertainment group, was leaving the company. Yahoo has also jumped on the social media bandwagon, integrating user-generated content from its large number of users into its network of sites and services, but it has failed to establish any significant partnerships with other social-networking companies to expand its advertising system.

"Yahoo seems to struggle with the idea that they should have content they own and control," said Danny Sullivan, who founded the Search Engine Land blog. "Only lately has Yahoo come to the idea that they could put ads on other people's properties. Google has done that far longer. With AdSense, Google has made the Web their playground...Their job is to take a percentage of everybody else's ad revenue."

Despite all that gloom, there are still some bright spots at Yahoo. It's still the most visited site on the Internet, and executives there say ad sales from the company's new search advertising platform, Panama, are expected to boost revenue in coming quarters. "We are very pleased with the initial progress of Panama," Chief Financial Officer Susan Decker said in an interview last week. Revenue per click, which reflects how much advertisers are willing to pay for the keywords associated with the ads, did not decline as much as was expected, Decker added.

But ultimately, as the revenue gap grows, the idea of Yahoo catching Google gets harder and harder to imagine.

"Google has an advertising platform that allows it to monetize it at a rate nobody else can," said Scott Devitt, an analyst at Stifel Nicolaus.

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