Ali Partovi is an angel investor, startup advisor, and serial entrepreneur. He co-founded iLike, acquired by Myspace in 2009, and previously LinkExchange, acquired by Microsoft for $265mm in 1998. His portfolio has included such successes as Zappos, Tellme, Ironport, and Facebook. He was among the first to recognize the importance of the Facebook Platform, and, as this article suggests, also among the earliest to grasp the business opportunity of search.
Earlier this month, Paul Graham wrote a terrific article, “What Happened to Yahoo,” blaming Yahoo’s demise on two factors. First, “easy money” from banner ads led Yahoo to ignore search in the late ‘90s. Second, ambivalence about being a technology company meant Yahoo hired sub-par engineers and didn’t empower them to innovate. While I agree with Graham’s points, there’s a broader story to be told.
The story begins in 1996 with an 18-year-old college dropout named Scott Banister, who came up with a simple but elegant concept that turned out to be one of the best business ideas in history.
This is the true story of the search business model — a concept that John Battelle and other search historians have erroneously attributed to Bill Gross for Goto.com. Although Gross deserves the lion’s share of credit for recognizing a good idea and more importantly for implementing it, the credit for developing the idea itself belongs elsewhere. But first, let’s recall the world of search in the late ‘90s.
The origins of search advertising: “Keywords”
In the days before Google, Yahoo was the dominant search company – they had the vast majority of all search query traffic and seemed completely invincible. The other top search drivers were Excite, Altavista, Netscape, MSN, and AOL. All, including Yahoo, were victims of what Graham calls “easy money.” Thanks to the dot-com bubble, it was so easy to make money selling banner ads (to VC-backed dot-com startups) that everybody was distracted from the real opportunity in search — even when it was presented to them plainly.
While the big guys were collectively ignoring search, a few startups were acutely aware of its strategic importance: those who catered to small businesses. These were Viaweb (Paul Graham’s startup), Submit-It (Scott Banister’s startup), and LinkExchange (where I worked).
In 1997, Viaweb created turnkey e-commerce stores for merchants, and they saw in search a way to help drive sales to these stores. They conceived a product search engine that prioritized listings from companies that paid them a percentage of sales, using actual conversion data to maximize revenue. They called it “Revenue Loop.”
Paul Graham’s essay recounts his first meeting with Yahoo in early 1998. He presented Revenue Loop as a way to extract more value from Yahoo’s search traffic, and surprisingly, Yahoo “didn’t seem to care.” Yahoo proceeded nevertheless to acquire Viaweb. Later, while working there, Graham observed first-hand that Yahoo didn’t appreciate how strategic search was: they dismissed it as representing only 6% of Yahoo’s traffic. “As long as customers were writing big checks for banner ads, it was hard to take search seriously.”
Graham modestly adds, “I didn’t realize either how much search traffic was worth.” Quite the contrary: I remember sitting with Paul Graham in 1997 and agreeing with him that search was the most valuable, strategic position on the Internet; I remember fantasizing about joining forces and selling our combined companies to Yahoo. Why did he and I see the importance of search when the search companies themselves didn’t? Because we had a unique advantage: context. We interacted daily with the folks that Yahoo didn’t even recognize as its customers yet: the small businesses that were dying to get listed on Yahoo search.
But we weren’t the first to appreciate the true value of search.
Submit-It, founded a few years earlier in a dorm room by Scott Banister, helped website owners submit their URLs to multiple search engines and directories. Banister saw how badly his customers wanted to secure placement on search results. In 1996, he brilliantly conceived an idea he called “Keywords”: to sell search listings based on pay-for-placement bidding – more or less the same as today’s AdWords. Banister began pitching the idea to anybody who would listen to him, including, among others, Bill Gross of IdeaLab, and the principals of LinkExchange: Tony Hsieh, Sanjay Madan, and me.
Bill Gross apparently saw the vision: he acted on it by launching Goto.com in 1998 (Goto later became Overture, now part of Yahoo).
Tony, Sanjay, and I also loved the idea, because we had the benefit of the right context. LinkExchange offered traffic-generating services to almost a million small website owners. Every day our customers emailed us, “Can you help my website get listed properly on Yahoo search?” It was no leap for us to appreciate the elegance (and enormous economic value) of simply auctioning the top spots for any given search query. LinkExchange proceeded to acquire Submit-it; and I became obsessed with the idea of realizing Banister’s vision via deals with the world’s top search drivers, starting with the big gorilla, Yahoo.
From 1997 to 2000, we visited Yahoo more than a dozen times to pitch the Keywords idea: pay-for-placement, keyword-targeted text ads on the side of search results. Despite repeated rejection, we pitched every member of Yahoo’s executive team multiple times, each time finding new ways to present the concept and new data to support how profitable and huge the opportunity might be, all in vain.
Like Paul Graham’s reaction when he first pitched them “Revenue Loop,” my initial sentiment was that perhaps we were doing a terrible job explaining the idea. But soon I realized that Yahoo simply didn’t see the value of search. They were sitting on one of the most strategic assets in the world, yet apparently didn’t even know it.
And Yahoo was not alone. Remarkably, none of the other big search players knew its true value either. During the same period, we pitched every other portal our concept of paid listings alongside search results, and every one decided they had other priorities – generally stemming from more money to be made selling banner ads.
In late 1998, Microsoft bought LinkExchange for $265 million, telling us they liked the “Keywords” vision. As Microsoft employees, we continued pitching the Keywords deal not only to Yahoo, but also to the up-and-coming Google. I wasn’t surprised to find that these companies were wary of partnering with Microsoft. My greater surprise was the seemingly insurmountable resistance we faced within Microsoft itself.
After almost two years of fighting bureaucratic obstacles, we finally got the green light to launch “Keywords” as an MSN Search feature in 2000. It started growing rapidly, and the MSN Ad Sales division feared (correctly) that it would cannibalize banner ad revenue. They therefore decided (incorrectly) to shut down Keywords after a few months. If Yahoo’s demise stemmed in part from being ambivalent about technology, perhaps Microsoft’s error stemmed in part from being ambivalent about ad sales: we couldn’t get the senior execs interested enough to intervene. Ten years later, the Wall Street Journal covered this story in a front-page article entitled, Microsoft Bid to Beat Google Builds on a History of Misses” (here is a reprint of the WSJ article).
In hindsight, the simplicity, elegance, and enormous profitability of AdWords seem obvious. Yet Yahoo and every other major search player were so distracted by the “easy money” of the dot-com bubble that they were completely incapable of seeing the much greater long-term opportunity in search.
Acquiring talent: missed opportunities
Graham’s essay attributes Yahoo’s demise to a second factor: hiring sub-par engineers and not empowering them to innovate. While I can’t comment on Yahoo’s engineers, I would certainly agree with the general premise that a sub-par engineering team can kill a company.
However, Graham adds, “in theory, you could beat the death spiral by buying good programmers instead of hiring them” (i.e., via acquisitions). But he doesn’t give Yahoo credit for actually doing this. Perhaps he is again being modest, omitting to mention that Yahoo did acquire, in Viaweb, some of the most talented hackers in the history of the Internet, including Graham himself.
The problem is that you can’t just acquire talent; you also have to empower them after an acquisition. It’s not enough to give people financial incentives; you need to put them in charge. The world’s best entrepreneurs and engineers will forfeit “unvested” money and leave a company that doesn’t recognize and act on their potential to lead.
Clearly, in the case of Viaweb, Paul Graham was not empowered enough at Yahoo. Despite having relocated from Boston to California, he and the rest of Viaweb’s talented engineering team eventually left Yahoo.
Similarly, when Microsoft bought LinkExchange, they acquired a team with quite a few talented young individuals, including Scott Banister (subsequent founder of IronPort), Tony Hsieh (subsequent CEO of Zappos), Alfred Lin (subsequent COO of Zappos), and a contractor named Max Levchin (subsequent founder of PayPal and Slide). All were under 25 years old, and not one received a meaningful role at Microsoft. Not one stayed at Microsoft more than a few months. They walked away from (collectively) tens of millions of dollars of unvested stock, and went on to create (collectively) several billion dollars of value in their new ventures.
Retaining the talent is critical to making acquisitions work, and the key to retaining people is to empower them. For more recent examples, witness some of Google’s acquisitions: Evan Williams (Blogger) and Dennis Crowley (Dodgeball) left Google respectively to start Twitter and Foursquare, whereas Chad Hurley (YouTube) and Farzad “Fuzzy” Khosrowshahi (XL2web – now Google Spreadsheets) have stayed. It’s no surprise that YouTube and Google Docs are still on fire whereas Blogger and Dodgeball are not.
For a large company, acquiring startups can be extremely successful, if you give the entrepreneurs the leeway not only to run their businesses, but also to innovate (and perhaps even to innervate and rejuvenate the rest of the company). It will be interesting to watch whether Google is successful at retaining the talent from its most recent spate of acquisitions.
While Graham attributes Yahoo’s demise to a combination of two factors, I’d argue that easy money from the dot-com bubble was the dominant factor. Easy money was the Achilles heel not only of Yahoo, but also of other companies of the era. No matter how talented the hackers and the execs of a company are, the dynamics of a bubble can make it virtually impossible to eschew easy money and focus on building lasting value.
The lessons from the bubble era are still relevant today: an existence built on “easy money” or “easy traffic” can be dangerous to big companies and startups alike.
Just as the dot-com bubble created a perilous environment for many companies in the late 90s, similar perils have emerged over the past few years around the Facebook app platform and its allure of easy traffic and easy money. We experienced this first-hand at my last startup, iLike. The “easy traffic” we enjoyed in the first few weeks after the Facebook platform launched led us to be overly optimistic about our future, and left us with a difficult dilemma between trying to sustain our Facebook-generated traffic vs. building lasting value elsewhere.
Although it was ostensibly intended to be a place where companies could build lasting value, the changing dynamics of the Facebook app platform have in fact systematically rewarded developers who chase easy money and easy traffic instead. Seeing this, many of the largest social app developers have successfully transitioned their businesses. Some have built value off-Facebook (notably Flixster, once known for its viral movie quizzes on Facebook, has transformed into a mobile leader in movies, with over 20 million downloads across iPhone, Android, and Blackberry; likewise, LivingSocial, once known for its viral “Pick Your 5” app, is now a GroupOn competitor). Others have sold their companies (notably Slide, iLike). It will be interesting to see whether Zynga is able to pivot off Facebook (or sell), and whether Facebook is able to change the dynamics of its app platform into a place where lasting equity value can be built.