Paul Graham, who made his fortune by selling a startup to Yahoo! during the dot-com bubble, has a new essay speculating on why the company is so lame. He tells a story about an early discussion with Yahoo execs about an algorithm for ranking search ads:
The reason Yahoo didn’t care about a technique that extracted the full value of traffic was that advertisers were already overpaying for it. If they merely extracted the actual value, they’d have made less.
Hard as it is to believe now, the big money then was in banner ads. Advertisers were willing to pay ridiculous amounts for banner ads. So Yahoo’s sales force had evolved to exploit this source of revenue. Led by a large and terrifyingly formidable man called Anil Singh, Yahoo’s sales guys would fly out to Procter & Gamble and come back with million dollar orders for banner ad impressions.
The prices seemed cheap compared to print, which was what advertisers, for lack of any other reference, compared them to. But they were expensive compared to what they were worth. So these big, dumb companies were a dangerous source of revenue to depend on. But there was another source even more dangerous: other Internet startups.
By 1998, Yahoo was the beneficiary of a de facto pyramid scheme. Investors were excited about the Internet. One reason they were excited was Yahoo’s revenue growth. So they invested in new Internet startups. The startups then used the money to buy ads on Yahoo to get traffic. Which caused yet more revenue growth for Yahoo, and further convinced investors the Internet was worth investing in. When I realized this one day, sitting in my cubicle, I jumped up like Archimedes in his bathtub, except instead of “Eureka!” I was shouting “Sell!”
Essentially, this is the story of the innovator’s dillemma: a company growing fat and lazy on an easy revenue source and failing to anticipate a catastrophic shift in the market. The weird thing about this is that the innovator’s dilemma usually strikes old, established companies. Yet Yahoo! was just 3 years old at the time Graham was telling this story.
The problem is that although Yahoo! was not an old company, it decided to act like one. It thought of itself as a media company, rather than a technology company, and as a consequence it hired mediocre programmers and put non-geeky executives in charge of them. And so when the tech bubble collapsed they found that the “media company” culture they’d cultivated didn’t serve them well against foes like Google and Facebook that saw themselves as software companies.