Yahoo starts to think out of the box

It took more than 30 years and cost the lives of an estimated 30,000 people to build the Panama Canal.

With hindsight, that makes Yahoo’s choice of name for its own Project Panama seem somewhat audacious.

Begun two years ago, this was an ambitious technology project that was designed to put Yahoo on level terms with Google in a key area of competition on the Internet: its ability to maximise revenues by serving up the adverts that Internet users are most likely to find relevant – and therefore to act on.

Though an end may now be in sight, the delays to the system have been the single most important factor behind the slip in fortunes this year of the world’s biggest Internet portal company.

Terry Semel, chief executive, conceded this week that the already delayed Panama would not go “live” for many advertisers before the end of this year. Advertisers would not welcome such a big change in the middle of the holiday shopping season, he said, though in defence of Yahoo’s progress he added: “I’d put it up against any major product launch, ever.”

The longer Yahoo has waited for Panama, the more its fortunes have suffered. At the heart of the problem has been something known as “marketplace design” – what Prabhakar Raghavan, head of research at Yahoo, calls “the fancy name for how you do your ordering of ads on search results”.

As the first search-based advertising network, Overture Services – the southern Californian company later bought by Yahoo to form the basis of its own search network – adopted a straight-forward approach to this issue. The more an advertiser bid to have its message displayed when a user typed a particular keyword into a search engine, the higher the ad appeared in the list of commercial messages that are returned alongside search results.

Google, adopting the same advertising model later on, added an extra twist to this formula. The ranking of adverts was based on a formula that took into account the number of times an ad was “clicked” on by users as well as the price-per-click that had been bid. That way, adverts that paid less per viewing, but which produced far more clicks, rose in the rankings and increased overall revenues.

That simple difference has been the biggest factor behind Yahoo’s inability to match the efficiency of Google’s search ads. “They seem to monetise 35-40 per cent less,” says Rishad Tobaccowala, chief innovation officer of Publicis Groupe Media – meaning that the average search on Yahoo generates that much less in advertising revenue than a similar search on Google. This has hurt not just Yahoo but other online publishers that have relied on its network to feed adverts to their own audiences. Partly as a result, Google has had more success of late in signing up new partners to carry its adverts, including its deals with MySpace and AOL.

Microsoft, which launched its own rival search advertising network this year (in the process taking its MSN business away from Yahoo) has already copied the Google approach. Yet while Panama will give Yahoo the choice of doing the same, Mr Raghavan says it is too simplistic to expect a straightforward switch from one formula to the other.

“If you talk to an economist, they’ll say that’s not the right thing to do either,” he says of the price- multiplied-by-clicks method. “Once you make that your scheme, advertisers react – they change their bids.”

Armed with its new system, Yahoo will need to experiment with new approaches, meaning an overnight narrowing of the gap with Google seems unlikely.

The Yahoo overhaul has extended to far more than just marketplace design – one reason why it has taken so long. As a complete overhaul of the system built by Overture, it is meant to serve as the technology platform for Yahoo’s move into other forms of advertising beyond search, such as video. It also involves a new user interface that is designed to give advertisers more control over where and when their messages appear on the web.

Creating a more efficient marketplace may be the most important factor in Yahoo’s efforts to extend its advertising network to far more parts of the web, but it is far from the only one, according to Mr Tobaccowala. In its management shake-up this week, Yahoo appointed Sue Decker, its chief financial officer, to run a new advertiser and publisher division with a clear remit to broaden the distribution of Yahoo’s network to a far bigger audience beyond Yahoo’s in-house websites.

One factor in Yahoo’s ability to compete with Google will be whether it can bring its wider range of advertising formats – such as display and classifieds – into play. This has already contributed to its two biggest advertising tie-ups this year.

Combining search-related adverts with these other forms of advertising to create new interactive methods that work more effectively than any one approach alone will be key to Yahoo’s counter-attack.

Another important factor will be relationships forged with other online media groups.

Mr Tobaccowala compares this to the problem that Pepsi faced when it owned its fast-food restaurants. It was easy for Coca-Cola to sell to rival fast-food outlets by playing to the fears of a competitor.

Google has played that card successfully against Yahoo but is likely to find it less effective as it branches further into the media “content” business itself, most notably with its acquisition of YouTube.

Google’s dominance of the search business has also raised concerns about its potential to act as a powerful gatekeeper in the world of digital media – something even Microsoft, painting itself as the underdog, has started to play on.

For advertisers the outcome of this battle is of more than academic interest. The search advertising market, where the leader has a 70 per cent market share and the number two has 20 per cent, is too loaded towards one network, says Mr Tobaccowala.

If Yahoo could claw back even 10 per cent of the market, that would change the dynamics of competition.

“To a certain extent, everyone is rooting for them,” he says.

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