Sunday, February 04, 2007

A Long-Delayed Ad System Has Yahoo Crossing Its Fingers

BURBANK, Calif., Feb. 1 — Starting around 3 p.m. Pacific time on Monday, a group of Yahoo executives will begin shuttling among three “war rooms” at the company’s search marketing unit here.

They will be scrutinizing an array of moving charts and graphs projected on walls and checking with a team of 30 to 40 engineers for any signs of trouble as Yahoo flips the switch on a new search advertising system.

“It’ll be a good event if it is a nonevent,” said Brian Acton, senior director of engineering at Yahoo Search Marketing.

Yahoo’s investors and advertisers, on the other hand, will be looking for something eventful to start happening, if not on Monday, then in the weeks and months after.

The much-delayed ad system, known as Project Panama, is Yahoo’s effort to close the wide gap with Google in the race for search advertising dollars, a fast-growing and incredibly lucrative business that Google dominates. As such, Panama is the most important new product for Yahoo in years.

“You are talking about something that could potentially affect the single largest and most profitable business segment that Yahoo has,” said Mark Mahaney, an analyst at Citigroup.

Among those who will be keeping close tabs on Panama is Yahoo’s chief executive, Terry S. Semel.

“I think we will be watching this closely for many Mondays,” he said. “It has been and continues to be our No. 1 company priority.”

That is no surprise. Some analysts who follow Yahoo say the delay of Panama is the biggest reason Yahoo shares dropped from a high of more than $35 early last year to just over $22 in October. They have since regained some ground, closing Friday at $28.77.

In its simplest terms, Panama is Yahoo’s attempt to place ads in front of users that are more likely to be clicked on. Until now, Yahoo gave top billing to the advertisers who were willing to bid the most to have their ads listed alongside a particular search result.

Google has a different formula, which Yahoo is trying to emulate. It ranks ads on a mix of bid prices and relevancy to the user. That leads users to click on ads more frequently, and since advertisers pay only when a user clicks on their ad, Google, on average, makes more money on every search than Yahoo does.

And since Google is better at matching ads with users, the system is more efficient for advertisers, too, creating a sort of virtuous circle that gives Google a powerful edge.

“I spend a majority of my dollars on Google,” said Amy Wong, global online marketing manager for the software security firm Trend Micro. “I’m glad to see that Yahoo is trying to get their act together.” Ms. Wong said she would like to distribute her ad dollars more evenly among Google, Yahoo and Microsoft, the third major player in search advertising.

Mr. Mahaney estimated that in 2006, Google made 4.5 cents to 5 cents on every search, while Yahoo generated only 2.5 cents to 3 cents a search. The difference adds up to billions every year.

As critical as the success of Panama is for Yahoo, it is not the only challenge facing the company. As Google’s share of all searches has grown steadily over the last year, Yahoo’s has remained largely flat. The company also faces increasing competition in its display advertising business.

In addition, while Yahoo is going through a reorganization aimed at making it more nimble and more accountable, crucial posts remain unfilled, and some investors are waiting for the company to lay out a clear strategy.

“Panama is very important to Yahoo, but it is not the only thing they need to focus on,” said Ellen Siminoff, a former Yahoo executive who is now chief executive at Efficient Frontier, a search marketing firm.

For now, however, all eyes are on Panama.

Mr. Semel acknowledges that Yahoo was late in starting the project. He said that happened partly because Yahoo’s search advertising system, which the company acquired through its takeover of Overture Services for $1.6 billion in 2003, was performing well, and it took time for executives to realize just how much better Google’s system was.

But once Yahoo assembled the Panama team in mid-2005, “things did come together quite quickly,” Mr. Semel said.

Those who worked on the project described the effort as a huge undertaking. They compared it to rebuilding an airplane in midflight, as engineers had to keep the old advertising system running while they put the new one together.

The first phase of the project, which went into operation in mid-October, two months later than planned, includes a completely new system for advertisers.

It provides them with a digital dashboard where they can manage their marketing campaigns, aim ads geographically and test their effectiveness. It includes interactive tools that suggest to advertisers what to bid based on their budget and the number of users they want to attract. Most of those features are already available from Google and Microsoft.

Yahoo engineers say Panama has some unique features, like a “quality index” that gives advertisers a sense of how the system will rank an ad, and sophisticated analytical tools that give advertisers insights on why certain campaigns are effective.

Yahoo says the system can be upgraded without disrupting it. It is intended to be flexible enough eventually to handle video and audio ads and to distribute ads to mobile devices. And while Yahoo gives few specifics, it says Panama will some day play a role beyond search advertising.

“Panama is a foundation for us to start sewing together all our advertising assets,” said Tim Cadogan, vice president of Yahoo Search Marketing.

Yahoo has been moving advertisers to the new system gradually and expects to complete the task in the United States in March. And while some advertisers have run into problems, the new system has generally been well received.

“In terms of ease of use, Google is still the leader, but Yahoo and Microsoft have made great strides in coming up to par,” said Matthew Greitzer, director of search marketing at Avenue A Razorfish, an online ad agency.

But the part that matters most to Yahoo’s bottom line will come Monday, when the new ad-ranking algorithm begins its work.

Last Thursday, the company ran a test in which searches originating on the West Coast ran the new ad ranking system. The team started at 3 a.m., and by lunchtime, the engineers gathered in the war rooms, many with bags under their eyes, and appeared satisfied things were running smoothly.

“Our tests today went beautifully,” said Mark Morrissey, vice president for product at Yahoo Search Marketing.

Just about everyone inside and outside Yahoo expects the system to generate more revenue for the company, but no one knows exactly how much more. Last month, Yahoo cautioned investors not to expect the financial impact of Panama to show up until the second half of the year.

That is in part because as the system is introduced, some advertisers will end up paying less and some more for each click, as ads vary in how likely they are to attract a click from a searcher. Search marketing experts say that in general, the well-known brands will get better placement for their ads at lower bids, because people are more likely to click on them. The reverse will be true for lesser-known brands.

But those dynamics may vary depending on keywords and how carefully advertisers aim their pitches. Yahoo says a customer service team has been working with advertisers to help them understand how to make ads more relevant.

Regardless, it will take time for the marketplace to adapt to the new system and for Yahoo to fine-tune it.

Whatever Yahoo’s gains turn out to be, they will not necessarily come at the expense of Google.

“If this is successful, advertisers will not shift from Google or MSN, but rather from other mediums, such as e-mail, display advertising and offline budgets,” said Stuart Larkins, vice president for search at Performics, a division of online advertising firm Doubleclick.

No matter how good Panama may be, it is unlikely to catch up with Google’s system in the near term. Google has been perfecting its ad-ranking software for years. And on Wednesday, Google’s chief executive, Eric E. Schmidt, said the company was placing fewer ads in front of users, yet receiving more clicks. That means not only that the ads are more relevant, but also that the experience of users is better.

Even Yahoo executives acknowledged that the version of Panama they are introducing on Monday is only a first step.

“I don’t think it gets us ahead,” Mr. Cadogan said. “It gets us to a place where we can compete more effectively.”

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