Yahoo! was king of the net -- then came Google

Holed up in a rickety construction trailer on the campus of Stanford University, two graduate students were supposed to be finishing their doctoral studies. Instead, Jerry Yang and David Filo began messing around on the world wide web—at the time, a largely unexplored phenomenon.

Both in their early 20s, Yang and Filo were surrounded by empty pizza boxes, discarded papers and student detritus. They started fiddling with quirky home pages.
Yang put up his golf scores, his name in Chinese characters and a list of his favourite websites. As they stumbled on new finds, this index began to grow. It was initially called “Jerry and David’s guide to the World Wide Web” but then, in 1995, Yahoo! was born.

Throughout the rest of the decade, Yahoo! was the undisputed leader on internet “portals”. When the company went public in 1996, its shares rocketed by 154% in a day and within three years, Yang and Filo were worth $8-billion each. Things were going like a dream—until a little-known private competitor called Google came along.

“Google came out with a smarter search engine,” says Mark Malseed, co-author of The Google Story. “It was much more based on relevance. They made much of their ‘purity’; their philosophy was that you shouldn’t be able to pay to come out higher.”

For a time, a tightly fought tussle between Yahoo! and Google enthralled Silicon Valley. But Google quickly gained the upper hand, staffing up with cheap talent laid off by larger Silicon Valley firms when the dotcom bubble burst in 2000. By the beginning of this year, Google accounted for three-quarters of all searches on the internet. The word “Google” entered the Oxford English Dictionary.

With a market value of $160-billion, Google’s power has become awe-inspiring. Its profits rocketed by 40% to $4,2-billion last year and it swallowed the popular video-sharing website YouTube.

Its success has been greeted with alarm by the corporate establishment. Microsoft, based 1 280km to the north in Seattle, has watched Google diversify into free-of-charge “apps”—applications such as spreadsheets and word processors that encroach on classic Bill Gates territory.

Through Microsoft’s $44,6-billion takeover bid for Yahoo!, announced on Friday, the technology establishment hit back at Google’s seemingly unstoppable rise.

“We’ve been getting unsolicited feedback this morning from publishers and advertisers that this is the right kind of stuff,” said Microsoft’s general counsel, Brad Smith, on a conference call with analysts. “This will create a more powerful number two in the marketplace.”

The deal, Microsoft’s chief executive, Steve Ballmer, suggested, was the only way to make up the gap between Google and the rest of the marketplace. “Sure, we could have hired more engineers. But the market continues to grow and the leader continues to get stronger.”

Ballmer, who is Gates’s closest lieutenant, is worth $15-billion. But in a milestone widely remarked upon in Silicon Valley, his wealth was surpassed last year by Google’s founders, Larry Page and Sergey Brin, who each own more than $16-billion-worth of shares.

Analysts say the bid is a highly unusual move for Microsoft. “This is a very uncharacteristic deal for them,” says Michael Gartenberg, an analyst at Jupiter Research. “Ballmer has always had disdain for deals of this size.”

It is far from an out-of-the-blue idea. Yahoo!‘s painful struggles have been all too public for years. Although it is still the most visited page on the web, its share of global searches has been steadily shrinking. Microsoft, which holds third place in the search market through its MSN website, tried to talk Yahoo!‘s management into a deal in late 2006 and early 2007, to no avail. Tie-ups between Yahoo! and eBay and Disney have been mooted but have come to nothing.

To many, Yahoo!‘s slide has been of its own making. A software update known as Project Panama, which was supposed to tailor advertising to searches far more effectively, suffered a series of catastrophic delays. The company dabbled in social networking, auctions, photo sharing and videos without much conviction or focus. Its blundering efforts to comply with the Chinese government in surrendering the identity of email users prompted a congressman to compare Yahoo! to a “moral pygmy”.

Inside Yahoo!, unease became increasingly apparent. In a leaked memo dubbed the “peanut-butter manifesto”, a senior Yahoo! executive, Brad Garlinghouse, complained that the firm was spreading its resources far too thin like a sandwich spread stretched to cover too many slices of bread.

In a bid to restore urgency, Yang retook control of Yahoo! last year, ousting long-serving chief executive Terry Semel. But progress has been slow and Yahoo!‘s shares have trickled downwards.

“Every day the stock does not make progress, every day it continues to wallow, some kind of deal becomes more likely to occur,” said Scott Kessler, an analyst at Standard & Poor’s after Yahoo! revealed a 24% slump in profits earlier this week.

The pressure is on. Yahoo! responded non-committally to Microsoft’s takeover offer on Friday, saying only that its board would evaluate the bid “carefully and promptly”. But shareholders are likely to want to sell.

Together, Microsoft and Yahoo! will be able to attract more advertisers to their combined family of websites. It is unlikely they can match Google’s acknowledged mastery in “pure” internet searches. For Microsoft, buying Yahoo! amounts to an effort to restore its once unshakeable position at the top of the technology tree. But for Yahoo!, selling out will be a galling end to a once glorious, ground-breaking road.

To reassure unsettled staff, Yang addressed his entire workforce on a hurriedly arranged conference call on Friday. In its proposal, Microsoft suggested it could make $1-billion of annual cost savings—a figure that is bound to cause alarm about job cuts.

A tie-up of such magnitude is bound to attract the interest of regulators in the United States, and the European Union is also likely to investigate. Few, however, believe that the obstacles will be insurmountable.

Bloggers said the battle for online supremacy would be transformed. BusinessWeek‘s Tech Beat column said: “If it goes through, we suddenly have a two-horse race on the net, with Microsoft-Yahoo! the one force with a chance to slow down search giant Google.”

The players

Steve Ballmer

The Microsoft chief executive has been with the company for 28 years, and his associations with its founder, Bill Gates, go back even further—they were Harvard students together. He was the first business manager hired by Gates, and after a series of executive posts within the company became president in 1998, then chief executive two years later. Ballmer is the man driving Microsoft’s mission to win the battle for the internet. His “Dance Monkeyboy” video—in which he jumps around the stage at a Microsoft rally—is a firm favourite on YouTube.

Jerry Yang

Born in Taiwan, Yang (39) lost his father when he was two and moved to California in 1978. He set up Yahoo! with David Filo in 1994, developing their ideas about the internet from a trailer. Their website directory was first called “Jerry and David’s Guide to the World Wide Web”, before they hit on Yahoo!, taking their inspiration from the savage creatures in Gulliver’s Travels. Yang’s decision last year to take direct control was interpreted as a move to bolster confidence after the share price fell amid problems with the advertising system.

Larry Page and Sergey Brin

Page and the Russian-born Brin, both 34, met at Stanford where Page decided to focus his studies on the internet, then in its infancy, and to examine the mathematics behind links between web pages. Brin joined him on the project and the two started developing algorithms that could massively improve the efficiency of searching the pages of the internet. The result was Google. The two founders now take a salary of just $1 a year but are sitting on multibillion-dollar paper fortunes through their shares in Google. By October 2007, Google became the fifth-largest company on the US stock market with a market capitalisation of $219-billion.

—guardian.co.uk Â

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