Project Network Hunt Report: Yahoo! (YHOO), Part I
Would you like to own a company capable of returning two dollars in cash for each dollar invested in its operations? How could a company generate so much cash? By becoming a ubiquitous and essential enabler on the Internet: "the only place anyone has to go to find anything, to connect to anyone, or to buy anything."
Business Description.
In 1994, two Stanford EE graduate students, David Filo and Jerry Yang, developed a customized database that was subsequently developed into the first online navigational guide to the Web. Forming a company in 1995, Yahoo! had its IPO in 1996. Already a global brand, Yahoo! is a knowledge company that adapts to emerging opportunities. Transforming from its origin as a search engine to become an Internet portal, now Yahoo is morphing into an international media platform that provides its large and growing audience of 166 million with content, commerce, and media from a single trusted source. As the first online guide, Yahoo quickly became the leader in traffic, advertising, and household and business reach. Not yet done, Yahoo! Everywhere expands Y!'s global reach as its connectivity penetrates from fibersphere to ethersphere: to all communication devices, accessed by any means at any time. Yahoo! Inc. is a global Internet communications, commerce, and media company that both offers a branded network of services to millions of users daily and provides online business services designed to enhance it's client's Web services, including audio and video streaming, store hosting and management, and Web site tools and services.
Yahoo!'s Mission.
"To be the only place that anyone has to go to find and get connected to anything or anybody, with content, things to buy, and other people to communicate with-one seamless place, connecting users, information, and merchants worldwide."
Strategic Analysis
Yahoo's strategies adapt and emerge as opportunities become compelling. As an example of their adaptive fitness, consider that Y! began by using its own search engine, then adopted AltaVista's, Inktomi's, and Google's search engines, in turn, as their increasingly better products emerged. Yahoo's team began by analyzing (and it continues to analyze) its industry's attractiveness and its position among its competitors to determine its strategy and its best approach to gaining competitive advantage.
Industry Attractiveness. Like the Internet itself, the portal industry segment is still young and beautiful. Included among its attractive features are: (a) exponential growth in traffic, membership, and e-commerce, with each, at least, doubling by 2003; (b) ability to scale business rapidly; (c) efficient Internet advertising uses data to target customers and measure results, and then builds communities around brands; (d) unusually high margins resulting from its light business model; (e) first-mover advantages that build brand awareness that extends to new services; (f) the aggregation of switching costs; and (g) rapid response time to threats or new opportunities.
Competitive Position in Industry
Pure play portal competition, already far behind, is vanishing. Y!'s closest competitor was Lycos. In Q2, Lycos's number of unique users were 60% fewer than Y!'s, and it reported less than 1/3rd of the page views, revenues and income. Terra Systems of Spain acquired Lycos recently, which will make it difficult to compare the two in the future. Excite was also absorbed. Go.com narrowed its ambitions to being a Disney-linked entertainment niche. AltaVista is abandoning its portal strategy to refocus on being a search engine. Already the dominant Internet portal pure play, when its competitors give up the pure-play-portal game, this means that Yahoo achieves hegemony, becoming a natural monopoly in the realm of global Internet portals.
If the definition of "industry" is broadened to include the new media industry, here its competitors include AOL/Time-Warner, Microsoft's MSN Network, and News Corp's newly forming SkyMobile/Gemstar/TV Guide "platco." Of course, Yahoo remains the apple of the Internet's eye. Each of its competitors has broader foci than just new media or diverse foci on multiple media. As these competitors are discussed, keep in mind Yahoo's advantages, particularly its light business model, ability to scale, and rapid response to competitors and new opportunities.
Assuming the merger's completion, AOL/Time-Warner will provide ISP access that is coupled with its own diverse and proprietary content. The merger promises the attractive advantage of cross-selling advertising across a very large base of print, TV, and Internet audiences. AOL won the prestigious clients last year, recruiting GM to Yahoo's Ford for advertising, Amazon.com to Barnes & Noble for selling books, and Intuit to H&R Block for tax returns. Their disadvantage will be integrating the companies. The new CEO, Gerald Levin, must understand and embrace the new Internet media model, reduce the old media debts, improve gross margins, and integrate the two cultures. Although this formidable combination cannot be dismissed, Yahoo's lighter business model, its ability to increase its global scale and scope, and its enabling platform approach of introducing content and commerce from many non-proprietary sources provide it with significant competitive advantages. Yahoo's CEO Tim Koogle prefers his strategic plan's emphasis on open and comprehensive collaboration, which creates an open and broad set of partnerships, giving users' more choice.
Microsoft's MSN Network is in third place in most Web metrics. Gate's embroilment with the Justice Department may further cloud his vision and impair the company's execution, particularly given the pull to keep its OS/Office business current and competitive. Its cable strategy is suffering from the current inability of WinCE to handle set-top boxes. In its MSNBC alliance, it has already chosen a less powerful media partner than Time Warner. Although richly endowed with talent and money, Microsoft's reputation for cannibalizing rather than collaborating with partners and its poor quality control compare unfavorably with Yahoo. Of course, Microsoft remains the world's number 2 Brand, a financial powerhouse, and some say it is the most powerful company in the world.
Although not a competitive threat within the Internet niche, if Murdock succeeds in his ambitious plan for a new global new media "platco" by acquiring DirecTV, etc., then it may offer diverse services and achieve a substantial global presence using TV as its basic platform. Their strategy is more similar, and thus, more competitive with Yahoo. The pure play here remains Gemstar for its light business model, advertising, and t-commerce potential. The difference here, in part, comes down to a TV-centric versus an Internet-centric company. Will it be geeks or couch potatoes who dominate advertising and commerce? Or is there room for both?
This global new media competition deserves investors' continuing attention. The roll out of broadband will intensify the competitive overlap. The advantages of being first-to-scale-and-scope, with its "bigger is better" network effects, may prove decisive in various global and local battles. The relative rate of technology advances remains a wild card. Either unexpected or earlier than expected advances can provide crucial cost efficiencies and, better yet, the demand-side scaling that result from new killer applications. True innovation gives us what we don't yet know we need. Fortunately, the industry potential of new media is so large that it will accommodate multiple differentiated competitors.
Yahoo is placed in an Internet segment that promises exceptional growth, and it has far outdistanced its immediate competitors. Yahoo's laser focus on its Internet platform strategy, its ability to scale and leverage into new opportunities, and its demonstrated ability to execute when combined with the rapid growth of the Internet, the still unfolding promise of advertising, commerce, content, community and new business services, the approach of broadband delivery through the Internet, and the proliferation of new emergent services and applications that it will bring to consumers, when taken all together, predict an alluring and glittering future for Yahoo as the bellwether Internet portal company. Its past is more golden than mere glitter: last month, Deloitte and Touche ranked Yahoo! as the fastest growing company in Silicon Valley, with revenues growing from about 1.4 MM in 1995 to 589 MM in 1999, up 43,085 percent.
Yahoo's Platform Strategy
From the beginning, Yahoo's management saw that the Internet offered an exceptional opportunity. They grabbed it, creating an interactive global platform for the distribution of information, commerce, and media to a large and growing audience. Their vision: build an interactive platform to attract, grow, and retain a large, global audience that they could then monetize. The "platform" was to be a consistent browser GUI, a virtual "place" that served as a distribution portal to meet the daily needs of their customers by offering comprehensive services from many collaborative partners, but also that was integrated to be a single trusted "place" by providing a consistent-look-and-interactive-feel. According to Chairman and CEO Tim Koogle, Yahoo's management believed that if it were the successful first-mover, then it could ride the advancing wave of Internet growth until it became a comprehensive, global, branded network-business. The plan: get big fast, become the only essential, trusted place, and then make big bucks! How? Think, "network effects."
To execute on this enormous opportunity, Y! envisioned six interrelated objectives:
1. To build a large, global, branded network-business.
2. To integrate a comprehensive set of content, communication, business, and commerce services.
3. To attract, retain, and continue to grow the single largest audience.
4. To make their services, not only desirable, but also essential to the life styles of their audience.
5. To use their large audience to appeal to advertisers, content suppliers, and merchants worldwide.
6. To execute and, thus, drive a big business with truly outstanding financial returns.
Best of all, Koogle foresaw that the interrelations among the objectives would create a virtuous cycle of increasing returns that he called "self-reinforcing scale." By aggregating content under their Yahoo! brand, they could attract a large audience that, in turn, would attract informers, advertisers, and merchants that would improve the quality of the service offerings that, in turn, would attract a larger audience that, in turn, would attract more service partnerships that, in turn, would be transformed into profits and exceptional cash flows.
The key to such demand-side scaling was the Internet: while requiring relatively light up-front costs, it enabled transactions with millions of customers with almost no incremental costs associated with sharing information or enabling transactions. Y! reduces the costs of searching, contracting and coordinating by providing a single trusted place. Not only that, within the fastest growing medium in history, Yahoo! was not the information or content creators, not the commercial companies with inventory to advertise, sell, and distribute, not the many old and new economy businesses whose services they would enable, not the communities that would arise from within their audience, but it was the ubiquitous and essential enabler of it all.
Network effects increase as a function of a site's increasing popularity because everyone wants to be where everyone else is. If you want to join a community, you want to be included in the one that is "in." Interacting with friends and families by Mail, Messenger, or Chat cascades through friends and family groups. Communicating with friends and family is the principle social driver of Web growth. At work, not only is communicating with your local work group important, which led to LANs, but also so is being linked to others at different locations within a corporation, which led to WANs. The Internet was born, grew to its Web toddlerhood, and is currently becoming untethered, unleashing from its restraining wires, becoming wirelessly mobile at its periphery. Yahoo!
Everywhere provides connectivity everywhere to leverage communication that leverages information that leverages productivity.
As a network of networks, the Internet itself demonstrates network effects: small networks increase in value exponentially when they connect to a large one. Metcalfe's law posited that as nodes increase arithmetically, value expands exponentially. In addition to Yahoo's large and valuable network of customers, it has a value network of content providers, a value network of advertisers, and a value network of commerce providers. Each of these value networks increase in value with any increase in the number of providers because each addition proclaims Yahoo's "popularity." "More is better" because it confirms that Yahoo is the only place you need to go to find any audience, advertise anything, or sell anything. The value provided to these service networks also increases as customers are added; just as the value of the services increases for customers as new services are added. Positive feedback loops are created both within and between customer and provider networks.
Steadily increasing network effects that interact across systems of network effects, like the value nets of content, advertising, and commerce and Yahoo's users, produce the phenomena known as "Increasing Returns." Increasing returns ensure that the network that has the most users continues to get more users as it continues to attract more service providers, who further increase the value of the network for the growing base of millions of users.
When increasing returns reach critical points, whether of inflection or tipping, they ensure the continued growth of the leader at the expense of the laggards until lock-in occurs. Locked-in network effects create a sustainable competitive advantage. In the U.S., the first-to-scale victors in the Internet battles were Yahoo!--for Internet portals, AOL--for proprietary networks, Amazon.com--for books and other small items, and eBay--for auctions. Such locked-in network effects dominate newer entries, even by companies with their own claim to scale. Thus, neither Yahoo, with its free listing and huge audience, nor Amazon.com, with its commercial experience, could unseat e-Bay as auction-leader once it had achieved critical mass.
Principle of New Frontiers
As the Internet portal that was first-to-scale in the world, Yahoo long ago reached critical mass, the point of no return that locked-in its sustainable competitive advantage as the global portal. In 1996, the year of Its IPO, Yahoo began creating local presences in Canada, Japan, England, Ireland, and Germany. All national nets grow in value when they are connected either to the larger net of the U.S, which hosts the majority of Web sites, or to the global Internet. But what has yet to be widely recognized is that each of Yahoo's current twenty-three local presences provides a new opportunity to be first-to-scale in niche businesses in that locale.
As a corollary of the Law of Network Effects, my Principle of New Frontiers posits: in a global new frontier of wide-open spaces where no one has yet achieved critical mass, the first-to-scale company that achieves critical mass will dominate the niche. Yahoo is winning in auctions in Japan, where it has 1.5 million items compared to eBay's 2,800. As Fool poster John Wong put it, "Critical mass seems to work just as well for Yahoo in Japan as it does for eBay in the U. S." Thus, each new territory opens a gold rush for Internet space. New scaling claims are being staked that may lead to achieving critical mass in niche markets within each local presence. Of course, a global brand and a scalable integrated platform for distribution of comprehensive services give Yahoo global competitive advantages.
In a TMF interview, Tom Gardner asked Tim Koogle how they had beaten Excite, Lycos, Go.com, and AltaVista by such a large margin. Koogle replied that they had always identified the business as a consumer-based franchise and media business with a global opportunity [strategy]. This meant they needed to build a strong brand and execute [competitive advantages]. They devised a flat horizontal structure that distributed decision-making. According to Koogle, " . . . what it means is you're making a lot of decisions in parallel and what that means is you can execute faster and that's a real key in our environment because it's growing real fast, changing all the time, and there is a lot of competition." In closing, Tim added, " . . . so I think it always comes down to execution."
Thus, from the beginning, not only did Yahoo and Koogle understand the exponential power of network effects as an engine of growth and value, but also they understood the implication of network effects on a global scale: how network effects create new opportunities for local popularity that permit new winners in demand-side-first-to-scale battles. And, above all, Koogle understood the signal importance of execution. You can listen to Koogle outline Yahoo's strategy and see his slideshows here for Q2 and Q3:
netroadshow.com
netroadshow.com
Executing the Strategy in the Last Two Quarters:
Yahoo does execute its strategy. To demonstrate Yahoo's continued ability to scale its growth during the so-called "dot.com meltdown," its advance in the last six months can be summarized from details supplied in its Q2 and Q3 results. This year, Koogle set five business objectives for Y!. How well did Y! meet those key business objectives?
(a) Mobile Services. In Q2, Yahoo added nine new network and device partners, for a total of 23 wireless alliances in 11 countries. It launched 7 new mobile services, for a total of 19, including Yahoo! Auctions, Yellow Pages, People Search, Driving Directions, and WAP. In Q3, services increased to 21; the number of alliances jumped to 37, including France Telecom, Mitsubishi, and Optus Mobile among its 13 new wireless and device partners; and coverage worldwide jumped by 10 to a total of 21 countries. This is significant growth in Yahoo! Everywhere. It is strategically significant because 75 million, which is 45% of Y!'s 166 million, users have mobile devices. Not only that, but more and more services are becoming voice-enabled and, thus, retrievable by phone.
(b) Rich Media and Voice Services. In Q2, Yahoo voice-enabled its Yahoo! Messenger, Chat, and Club services and added both voice and digital pictures to Yahoo! Greetings. It broadcast web events, like the Victoria's Secret fashion show from Cannes to 2 million viewers. It released Yahoo! Player, which is a free streaming media player, with an embedded browser, for MP3 files and CDs. In Q3, strong growth continued in the use of voice services, doubling to one billion minutes in September from 500 million in June. In September, Y! distributed 15 million hours of streamed audio and video services, up from 13 million in June, and Mail, Messenger, and eGroups carried 6.1 billion messages, up from 4.4 billion in June. On 10/10/00, Y! launched several new voice services: Yahoo! By Phone provides access to My Yahoo! content; Yahoo! Mail incorporated voice telephony, permitting retrieval of Mail by phone; and an updated Messenger gives consumers the ability to place PC-to-phone call anywhere in the continental U.S. In digital music, Y! entered a licensing agreement with the Recording Music Industry of America that doubled its user's playing of music. Y! added the NFL to its NBA, WNBA, and college team programs, providing audio broadcasts of 475 teams' games.
(c) Enabling Commerce Transactions. In Q2, Yahoo added 800 new stores to its Yahoo! Shopping, for a total of 11,300. In Q1, Yahoo changed its income model from rental to receiving a share of the money from transactions that it enables. Yahoo launched MyShopping, an integrated, personalized service that allows customers to track items, prices, and purchases across stores. Also, Y! began a program in which large retailing companies provide free Internet access in conjunction with bundling their shopping services with Yahoo's communications. Customers include Kmart and Spiegel. In Q3, Yahoo! Shopping and Store enabled 16% q/q or 300% y/y more transactions; Yahoo! Auctions enabled more transactions , with 24% q/q and 400% y/y growth. Overall, one billion dollars in global transaction were enabled. In August, Media Metrix reported that Yahoo! Shopping was the Web's # 2 shopping destination. Y! launched co-branded, free Internet service services with Barnes and Noble and Costco. With CIBC National Bank, Y! launched Pay Direct, an online person-to-person payment solution integrated into Auctions. Y! also provided a one-site centralization of personal financial data from more than 200 institutions, permitting bank, credit card, and investment data to be scanned at the only place you need to go. Y! Finance, ranked #1 by Media Metrix in August, began offering real-time ECN quotes.
(d) Business and Enterprise Services. Yahoo expanded its growing suite of content and business services, opening new accounts, such as Allegiance Telecom, Ariba, BASF, Copper Mountain Networks, Eddie Bauer, Intuit, Macromedia, Royal Dutch Shell USA, Spiegel, Pharmacia & Upjohn, and Williams Communications, among its 1,100 streamed audio and video corporate events. Leveraging Yahoo's unrivaled workplace popularity ["Popularity" announces the presence of a network effect.], Corporate Yahoo! was introduced, a customized portal that enables companies to integrate Corporate communications with Yahoo's personalized Internet content and services behind corporate firewalls. With Spinway, Yahoo offers a turnkey free-Internet-access service solution, like Kmart's Blue-Light. Yahoo also introduced its Website Services, a comprehensive package for creating and maintaining a Web site. In Q3, Corporate Yahoo! added four more clients to its Q2 four, with four more to roll out before year end. Clients include Applied Materials, Honeywell, Alcatel, Inktomi, Network appliances, and the State of North Carolina, which earned Government Technology magazine's "Best of the Web" award for 2000. Y! hosted and distributed 1,055 audio and video corporate events, including new accounts with Proctor & Gamble, Samsung, Schering-Plough, TWA, and United Steelworkers.
(e) Globalization. In Q2, expansion of Yahoo's global franchises continued, with Yahoo! India becoming the 23rd local business operation outside the U.S. Investments were made in Australia's SEEK, the leading online employment site, in Taiwan's China Times Group, and in Germany's Quelle, an offline retail catalogue company to create an online gift destination as a joint venture. Several local sites expanded services through new partnerships, for example, for auctions in Germany, for online banking services in Hong Kong and Taiwan. In 18 countries, Yahoo! Chat was voice-enabled and Yahoo! Photos had local language versions launched. In Q3, Y! deepened its global offering, including Club in 10 countries, Invites in 12 countries, Shopping in several Asian countries and in Spain. Y! made investments in Mingpao.com, a media company in Hong Kong, and in PhoenixNet, an Asian satellite broadband enabler.
In Q2 andQ3, these data indicate that Y! executed its business model by vigorously pursuing its business objectives of extending its mobile services, enriching its media and voice services, enabling commercial transactions, expanding it business/enterprise services, and increasing and deepening its global reach and penetration. Although Y!'s stock price declined, the business itself demonstrated impressive growth.
The Business Model Itself Provides Competitive Advantage
The Gorilla Game emphasizes the significance of a discontinuous innovation that creates a technology product that provides a compelling business advantage to the company whose open, but proprietary, architecture becomes the standard for a new wave of technology. There is a fundamental difference between this product-oriented approach of the Gorilla Game and the investment thesis of an Internet service provider. This key difference is that the origin of value creation for an Internet service provider is not a discontinuous product innovation, but is instead the creation itself of its innovative business model. Yahoo's business model is the wellspring of its competitive advantage.
Y!'s strategy created innovative and compelling value through a collaborative business web (see Digital Capital by Tapscott, Ticoll, & Lowy, 2000). A business web (b-web) is defined by Tapscott et al (p. 4) as "a distinct system of suppliers, distributors, commerce service providers, infrastructure providers, and customers that use the Internet for their primary business communications and transactions." A b-web is the mechanism for increasing "digital capital"-the knowledge- and relationship-based currency of the new economy of digital networks. Digital capital (p. 5) results from the internetworking of three types of knowledge assets: (a) human capital (what people know), (b) customer capital (who you know, and who knows and values you), and (c) structural capital (how what you know is built into your business system).
The URLs and browsers of the World Wide Web enabled the Internet to open its riches to a wider audience. The knowledge assets of the WWW permitted entrepreneurs to create a set of innovative business models that used the Internet for its infrastructure. The b-web includes five classes of participants: customers, commerce providers, content providers, infrastructure providers, and context providers. Y! is a context provider that not only supplies the interface to the customer but also defines the business proposition, manages customer relationships, pilots its competitive advantage, leads its b-web's choreography, sets its rules, and, thus, realizes the most economic value from its b-web. Y!'s unique value proposition, which is rendering the old, pre-Internet ways of searching, buying, and communicating obsolete, is that it offers its customers a convenient, comprehensive, integrated place to find anything or anyone, to buy anything, or to communicate with anyone. Yahoo! gives its audience unparalleled choice. As a branded, single, trusted, essential place where its customers can meet the needs of their lifestyles, Y! leverages its economic growth by attracting, retaining, and deepening its relationship with a huge and growing global audience.
If, by the time you finish this report, you fail to understand how to leverage a huge audience by continuing to scale in size as you continually expand the scope of services offered, then you will not understand Yahoo's ability to capitalize on its popularity-induced global network effects. Still, the scaling of possibilities remains so large for Y! that it represents a real option on the future. Yahoo must select the most promising of its new business opportunities and choose among the world's leading companies for its partnerships. Like time-compressed imagery of a rose opening its petals, Yahoo's demand-side scaling is an unfolding process of beauty bared. |
