Monday, December 22, 2008 Reasons Behind Yahoo!'s Four-Year Slump


12/22/08 - 10:33 AM EST
YHOO , C , AAPL , HPQ (Cramer's Pick) , GOOG , MSFT

By Eric Jackson

The press has shown little mercy in criticizing Yahoo! (YHOO Quote - Cramer on YHOO - Stock Picks) this year. And deservedly so.
The four reasons most often cited for the Internet company's missteps over the last four years have namely been the people at the top:

(1) Terry Semel;
(2) Jerry Yang;
(3) Sue Decker;
and (4) the Board of Directors.

They all received glowing press coverage when Yahoo! was riding the general ad market recovery and shift to digital ads in 2002 to 2004. But now they are being slammed in various business media for their actions, and in some cases inactions, that have since led to stagnation and decline.

It's normal to blame organizational failures on the leaders at the top -- consider Dick Fuld at Lehman Brothers, Vikram Pandit at Citigroup (C Quote - Cramer on C - Stock Picks) or even a market-maker like Bernie Madoff. Group leaders and their choices are, in the end, responsible for group actions and outcomes.

But there are four other reasons to account for Yahoo!'s decline in the past four years: (1) A lack of product leadership; (2) self-isolated leadership; (3) a culture tolerating non-performance; and (4) the use of a matrix organizational structure.

Each of these problems traces back to choices made, consciously or not, by senior leadership. Until Yahoo! recognizes and understands these issues, the company won't be changed. This is why the choice of the company's next CEO is so important.

The right CEO will see these issues clearly from Day One and change them; the wrong CEO will be oblivious to them. Unfortunately for Yahoo! shareholders, the people selecting the next CEO will be the people on the board who've missed the four reasons for the company's recent poor performance of late.

Even though they had moved on to exciting new jobs, they expressed regret about the current state of Yahoo!, especially since they felt that they had gained a lot from their time at Yahoo!. Each person agreed that the company was fixable and that the decision about who will be named as the next CEO was critical. Most were pessimistic that the company would achieve its potential.

Here are their top four reasons for Yahoo!'s decline:

1. Lack of Product Leadership

Google (GOOG Quote - Cramer on GOOG - Stock Picks) had search. Apple (AAPL Quote - Cramer on AAPL - Stock Picks) had the Mac. Yahoo! has always had a collection of multiple products, and that has been a blessing and a curse.

It's a blessing because -- unlike AOL, which had just the dial-up business -- Yahoo! has always had multiple revenue streams that were mutually reinforcing (e.g., home page, Finance, Mail, Search). It's never been a one-trick pony.

But the multiple products are a curse because, from Yahoo!'s founding, the company has had its fingers in a lot of pies, and that has hindered it from developing a corporate focus. Through Bubble 1.0 and Bubble 2.0, the Yahoo! M&A machine was always humming to suck up venture-backed firms at healthy valuations. Integrating them cohesively was a different story and left a string of disparate businesses under the Yahoo! roof.

Several former Yahoo! employees complained about the lack of vision and the lack of product leadership from the top executives to string all the pieces together. Said one, "I always wanted to know 'what's our North Star?'" They felt that there was a lack of focus from the executive team about what Yahoo! did that created value and what it should be moving toward to better create more value.

In their views, the next CEO needs to be great at products. The core of Yahoo! is a great user experience and great products. Discussions about undertaking a search deal with Microsoft (MSFT Quote - Cramer on MSFT - Stock Picks), spinning off Asian assets, and closing the revenue-per-search gap with Google are secondary.

2. Self-Isolated Leadership

Several years ago, I worked with Dartmouth Business School Professor Sydney Finkelstein on building a consulting practice based on the research from his book Why Smart Executives Fail. He researched more than 60 one-time industry-leading companies that in the end drove off a cliff in terms of their performance.

These companies' executive team members always looked great on paper: the best business schools, the perfect career trajectory, many achievements to point to. Yet, these same people were responsible for bringing down their companies. One key reason for this -- common across all the failures -- is that the top executives got rid of or discouraged anyone around them who voiced a different perspective than theirs. This appears to have happened at Yahoo!.

According to those I spoke with, executives often didn't engage in detailed discussions with lower-level managers responsible for areas that were under-performing. "I would have liked to talk to them more," said one ex-Yahoo!. "I had one good conversation with [one Yahoo! executive] and one good one with [another executive] in [the last few years]. That's it. I know others tried to educate them on the issues. Nothing came of it."

There was not enough debate about key decisions made at Yahoo!. The last six months have seen a steady drain of senior talent. One employee contrasted that with how President-elect Barack Obama has selected key members of his Cabinet: "He's put former rivals around him in Clinton and Richardson, who definitely don't agree with him on some issues. You know they're going to speak up. You also could see any of them leading the country if necessary. We definitely don't have that depth of talent on the Yahoo! senior team."

One group that Yahoo! executives were not shy about consulting in the last four years: the consultants. "There were way too many consultants and too many planning sessions. We needed more execution," said a former employee.

3. Tolerating a Non-Performance Culture

It's obvious that every company has a unique culture. No one working there would be able to tell you step-by-step how it was created, and yet they all live and breathe it every day. The best cultures give that company an amazing advantage vs. its peers. The worst cultures hang around the company's neck and are next to impossible to shake.

"When I first started at Yahoo!, people cared. They'd challenge you if they disagreed. That changed," said one ex-employee. Another added, "Transparency about problems or mistakes used to be rewarded. Not anymore. There were some people who made mistakes and ended up getting promoted."

Over time, it appears most employees stopped pushing for the changes they wanted to see. When they tried and it fell on deaf ears, they backed down. "I think a lot of people also knew they wouldn't get similar jobs elsewhere and decided to keep quiet." The tone got set from the top, and it trickled down to permeate the organization.

4. Matrix Organizational Structure

One of the recommendations that Yahoo!'s consultants made a few years ago was to institute a so-called matrix organizational structure across the company. A matrix structure was popular about 10-15 years ago, especially in engineering-oriented companies. It seeks to overcome the complexity of a large global organization by assigning multiple bosses to employees in different geographies working on similar product or functional tasks. In other words, you report up to two or more bosses -- a product or functional boss and a geographical boss.

The intent of a matrix structure is that you understand what your local peers are working on as well as what your functional peers are working on globally. In theory, the company becomes tighter-knit, despite its size.

In practice, matrix organizational structures have greatly fallen out of favor in the last five years because they create confusion about who is responsible for certain actions. The "shared" ownership of tasks and projects across multiple groups and bosses means that it's difficult to go back and assign blame for and learn from failures. Whose throat do you choke? "It was hard to point out who specifically was responsible for mistakes because of that," said one former employee.

Thankfully, this structure has recently been done away with and products have now been centralized. Combined with the risk-averse culture described above, the legacy of this structure has been deadly for Yahoo!.

Yahoo! executives and directors aren't the first "smart" ones to fail. Otherwise, Professor Finkelstein wouldn't have a book full of stories on Enron, Worldcom and Webvan. The solutions for Yahoo! senior executives, based on the lessons in the book, are:

  • admitting when you/the company have screwed up and dissecting the underlying reasons for the failure;
  • encouraging others to admit their mistakes and learning from the mistakes instead of shooting them or encouraging them to cover up mistakes;
  • surrounding yourself with other smart people who often will disagree with you in search of the best answer for the company; and
  • demanding accountability from everyone in the company including yourself.
The right new CEO can spearhead this kind of effort for change. Mark Hurd at Hewlett-Packard (HPQ Quote - Cramer on HPQ - Stock Picks) is probably the best example of this type of turnaround. He didn't have to fire the old senior team and board. They got with the program early on and supported it further once they started to see evidence that the ship was turning.

The rest of Yahoo!'s senior team and board will have to buy into a new approach as well, admitting their own past mistakes at the same time. This assumes they pick the right person to serve as Chief Yahoo!, and that remains a big question mark.

At the time of publication, Jackson's fund had no position in YHOO. Jackson owns a small long position personally.

Eric Jackson is founder and president of Ironfire Capital and the general partner and investment manager of Ironfire Capital US Fund LP and Ironfire Capital International Fund, Ltd.

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