Yahoo--What went wrong?

Ellen Siminoff, a recent Stanford M.B.A. graduate, came aboard to plot the business's expansion. A recruiter tapped Jeff Mallett, then a vice president at Novell, to head business operations. The same recruiter also brought in a little-known high-tech executive named Tim Koogle, who came to work in their 800-square-foot office in the summer of 1995.

Their company, Yahoo, rocketed to a market value of $134 billion, and the young leaders became legends, defining Silicon Valley start-up life. They worked furiously at their jobs but played as well, getting together to watch football games and having one another over for dinner. In an amazingly short time, the six--Filo faded into the background, as chief engineer--transformed Yahoo into one of the best-known brand names on the Internet, now used by 185 million people worldwide. From day one, the group adopted a defiant, anti-corporate image, wearing jeans, putting their feet on their desks and eating at taco joints.

On Wednesday, the game abruptly ended. With its stock down 92% from its peak and advertising sales plunging, Yahoo (yhoo) said it would launch a search for a new chief executive from outside the company. Koogle will remain as chairman. The unexpected move amounted to a humbling acknowledgment of something people close to Yahoo have increasingly been saying: that the tightknit, us-against-the-world management style that fueled Yahoo's astronomical rise may also have exacerbated its decline.

"Their culture helped them build a superb site and a really edgy brand, but it also held them back from making forward-looking business decisions," says Holly Becker, an analyst at Lehman Brothers. "The culture that served them so incredibly well until the middle of last year is now letting them down."

Business partners and former executives say the small group's intense closeness made it hard for Yahoo to retain or attract experienced managers. Over a long acquisition spree, Yahoo spent billions to buy GeoCities, Broadcast.com and numerous smaller companies--yet many of the targets' top executives wound up leaving Yahoo, unable to penetrate its inner sanctum. Yahoo's top European and Asian executives and a slew of middle managers also left, amid complaints that the top team wouldn't delegate authority.

"They're very insular," says Stephen Hansen, former chief financial officer at GeoCities, a company acquired by Yahoo in 1999. "They see the world through the Yahoo lens."

A Yahoo spokeswoman strongly disagrees, saying the company has always brought in and retained talented executives. She says that Yahoo is always open to new ideas and that it has been working particularly hard in recent years to further strengthen its ranks. "If we have a reputation for being closed-minded, we wouldn't see all these excited new executives who want to come here," adds the spokeswoman, Nicki Dugan.

In a particularly painful lost opportunity, Yahoo bungled a chance last March to buy eBay, the auction company that today is one of the few profitable Internet companies. Yahoo, which serves like a giant Yellow Pages for the Web, offers its directory free and makes its money primarily by selling advertising and other marketing programs targeted at its Web audience. It has recently been diversifying by running online stores for retailers, creating Web sites for corporations and offering a number of other online transaction services.

Yahoo had realized that its own auction site, which it started after eBay, was lagging behind its rival. The companies began exploring a possible deal. But people familiar with the matter say the talks foundered on disagreement over the role that would be played by Meg Whitman, eBay's CEO. Whitman wanted to report directly to Koogle, these people say, adding that while Koogle had no problem with that, Mallett insisted the veteran Hasbro executive should report to him.

eBay declines to comment on the talks, as does Yahoo. Bob Kagle, an eBay director and a general partner at Silicon Valley venture firm Benchmark Capital, declines to discuss the talks but says: "Yahoo had a very defined culture that they're very proud of and comfortable with. Among other things, they were not comfortable with the impact that integrating another large and successful company might have on that culture."

Koogle, asked about critics' suggestions that Yahoo's top-management insularity is now a weakness, said in an interview Wednesday that the CEO search was the answer. "This should address that head-on," he said.

The search adds to the growing list of challenges facing Yahoo. Its sales force is struggling to replace the tens of millions of ad dollars dot-coms were lavishing on the portal just a little over a year ago. Some of its international operations, considered critical to growth, are in turmoil: The heads of four Yahoo international units have resigned in the last month.

The fall in Yahoo's stock, the currency that attracted workers and business partners when it was soaring, has cut the company's market value to below $10 billion. The stock fell $3.25 to $17.69 in 4 p.m. Nasdaq trading Thursday, a trend that leaves the company vulnerable to a takeover attempt. Last week, it adopted a shareholder-rights plan to fend off any such attempt.

From the start, Yahoo's casual, thumb-your-nose image was more than a way of life. Executives codified it into a marketing machine. They realized they had more than a technology: They were creating a media brand name. They came up with funny publicity stunts and aired irreverent commercials featuring quirky characters using their search engine in unusual ways.

Gooey Yahoo
For all their intensity, the brass exploited the irreverent image internally as well, creating offbeat job titles: Chief Yahoo, for a founder, and Gooey Yahoo, for an employee whose aim was making the site warm and fuzzy. They wrapped everything with their trademark yellow and purple.

The top-down style worked fine in a rising market. Yahoo had no trouble luring talent. It was still small enough that top executives could be personally involved in many matters. As recently as a couple of years ago, Siminoff and Singh were negotiating all the ad deals themselves, sometimes bringing in Mallett to close them, ad executives say. "Yahoo culture used to be what everyone imagined the Internet to be," says Jim Meskauskas, chief Internet strategist at online media-buying firm Mediasmith.

When the dot-com boom arrived, Yahoo was besieged by companies begging to advertise on its site. It went on a hiring binge. From 386 employees in 1997, it went to 803 in 1998 and 1,992 in 1999.

That's when Yahoo's management style began to look like a liability, some advertisers say. A sense developed that decisions always had to go to the top. New employees, often fresh out of school and sometimes ill-informed, were always having to check with higher-ups before agreeing to terms. "You can't run a 3,000-person company, a $2 billion company, with a core management team of four or five people," says Bill Bishop, co-founder and executive vice president of CBS Marketwatch, a Yahoo advertiser. "It doesn't work."

The Yahoo spokeswoman notes that several of the company's general managers are responsible for the financials of their units. She says Yahoo believes very strongly in "pushing decision-making down to the lower levels."

Yahoo acquired lots of other Internet companies, but it became apparent to executives at these companies that their input wasn't welcome in the inner circle. The result was that Yahoo lost some of the sort of talent that it badly needs today, now that Old Economy realities are hitting the young company.

Take Thomas Evans, chief executive of GeoCities, a company that operated a network of personal home pages. Yahoo bought it for $4.7 billion in 1999. A former president of U.S. News & World Report, Fast Company and Atlantic Monthly magazines, Evans was a veteran of the advertising and media business. In several meetings, Yahoo's top brass tried to persuade Evans to accept a midlevel job developing relationships with advertisers, people familiar with the situation say, offering him far less responsibility than he had hoped.

In one meeting, they say, Evans warned the young executives they were alienating the clients they would someday need the most. "Ad sales are a cyclical business," he said to Yahoo's president, Mallett, according to two people at the meeting. Referring to the company's aggressive sales tactics, he said: "People hate you. You're arrogant and condescending. When there's a downturn in the market, they'll cut you first." People who were present say Mallett exploded in anger, retorting: "You don't get it. You're old media." Evans left GeoCities--and Yahoo--when the acquisition was closed.

Asked about the incident, Evans says all he wishes to say is that "I didn't think I would be able to have the kind of impact that would have helped the situation or changed their thinking."

Michael Barrett, another former GeoCities executive, says, "If you look at any talented executive at any company [Yahoo] bought, the positions they offered them were so far below the position they had that it spoke volumes. The not-built-here mentality has driven their culture."

The Yahoo spokeswoman declines to comment on the incident but notes that Yahoo acquired several smaller companies in specific areas, and some of their executives didn't necessarily have the right skills for a larger corporation. A few months later, Yahoo paid $5.7 billion for Web broadcasting concern Broadcast.com. It appeared the pattern might be broken when Yahoo executives seemed to take a liking to Broadcast's president, Todd Wagner. "He walked like Mallett, he talked like Mallett," says one former Broadcast executive. It didn't last. Wagner, like the rest of Broadcast's top brass, left shortly after the acquisition was closed. Wagner didn't respond to an e-mail seeking comment. The Yahoo spokeswoman says Wagner left on good terms.

Starting to change
Yahoo was one of the first Internet companies to expand abroad. As managing director of Yahoo Europe, it hired Fabiola Arredondo, a veteran of JP Morgan and BMG, the entertainment arm of Bertelsmann AG. But it wasn't long before she butted heads with officials in Yahoo's Santa Clara headquarters, and a decision to pull Yahoo Europe's IPO was made against her wishes. Arredondo said in mid-February that she is quitting the company. Yahoo declines to comment.

Yahoo now appears to be making some progress in growing out of its prolonged adolescence. Last year it brought on Sue Decker, former research chief at Donaldson Lufkin & Jenrette, as chief financial officer. Agency executives say Yahoo is hiring scores of new sales-staff members, but this time people with experience in the ad industry. "They have been very proactive in saying they need to grow to the next level and are going to have to bring very senior people in from the outside," says Jana Rich, a recruiter for Korn/Ferry International. Yahoo points out that it has been bringing in such new talent as its financial chief and Jim Brock, senior vice president of major initiatives. People familiar with the company say its founder, Yang, is reasserting himself. For most of its history, he was content serving as Yahoo's unofficial ambassador, speaking at conferences and schmoozing with business partners. Now he is taking a bigger role, such as directly addressing investors, analysts and the media on the Wednesday conference call announcing the search for a new CEO. He has hired people to work directly for him.

At a board meeting Feb. 27, Yahoo directors debated whether they could risk bypassing Mallett for the CEO spot. "They were wrestling over the risks of losing Jeff versus the benefits of putting someone new in," says one informed person.

Their decision highlights a shift in what has long been a laid-back board, which operated with few formal procedures or prepared materials. This person says Yahoo directors used to get only a one-page agenda with a few bullet points before meetings, rather than the extensive briefing materials prepared at most companies ahead of such sessions. Now, under CFO Decker, directors are given detailed presentations about operational results.

Joann S. Lublin contributed to this article.