Yahoo! Runs in Place

Reports on Panama are good, but Google raises the search bar.
Author:
Publish date:

Yahoo!'s

(YHOO)

recently launched ad-ranking system is showing some signs of life, but it's a little early to call the search race even.

The highly anticipated system, dubbed Panama, was put into effect on Monday, and it takes into account the relevancy of an ad along with how much an advertiser pays if it's clicked.

Unlike Yahoo!'s old system, which placed ads simply on the basis of how much an advertiser bid -- and which mirrors the system used by search market leader

Google

(GOOG) - Get Report

-- the new method is intended to help Yahoo! increase the amount of money it makes on each search by having Web surfers click through on more links.

UBS analyst Ben Schachter said he entered some search terms under the old system and then entered the same terms in the new system to gauge the results of ads displayed. In a research note on Wednesday, he wrote, "Overall, it seems that for some commercial search terms more brand-name results are featured moreprominently than before." UBS makes a market in Yahoo! shares.

This could bode well for Yahoo!, since Web surfers may be more inclined to pursue ads for well-known brands instead of less popular alternatives that were willing to shell out more for better placement. Schachter also expects Yahoo! to "attack low-hanging fruit first, like brand names, and focus on more complex adjustments like landing page quality later."

Yahoo! has also said that the relevancy of ads will improve over time as the new system learns which ads are more successful in enticing users to click on them. The financial benefits from the upgrade to Panama are not expected to roll in until the second half of 2007.

Investors, meanwhile, have greeted the launch of once-delayed Panama with cheer, and Yahoo! seems near ecstatic about the accomplishment. Shares rallied more than 6% after the company's January conference call when investors overlooked soft guidance to focus on Yahoo!'s announcement that it would flip the switch early on the new system in February.

Shares of Yahoo! were recently up nearly 2% to $29.91.

Some Yahoo! employees at the company's Sunnyvale, Calif., campus were reported to be in tears when the company announced the debut of the new ad ranking system.

But despite the optimism about what has been generally billed as Yahoo! catching up with Google, it seems Yahoo! still has a way to go. During Google's recent fourth-quarter conference call, Google co-founder and head of technology Sergey Brin revealed just how well-oiled of a machine the company's search capabilities have become.

During the last quarter, Google stripped ads from what it saw as less commercial searches, dropping the number of searches that have ads placed to them by several percentage points. Yet it continued to increase the amount of money per search it made, thanks to better targeting. "These are the kinds of improvements that we make all the time and really improve both the quality and the monetization of our system," Brin said.

And Google continues to make the quality of search and user experience better by focusing on what Web surfers get after clicking on an ad. The company introduced an upgraded landing page quality system over the quarter, which "removes the low-quality landing pages from our ad results and improves users' experience after they leave Google and click on an ad," Brin said.

"This in turn encourages users to click on more ads, because they have better and more useful content when they do so," he added.

It's this constant legwork that goes into refining search that first brought Google into the limelight. A fledgling start-up in 1999, the company became a household name because of a near magical ability to help users navigate an ever-growing Internet with remarkable ease.

And the company, which now keeps reinvesting its massive profits in technology and infrastructure despite Wall Street's groans about capital expenditures, is not about to let up on that front anytime soon. It's an approach that has kept not only Yahoo! but

Microsoft

(MSFT) - Get Report

at bay.

Of course, leading the pack has its own share of problems. Google has to continue to innovate, which means taking risks and trying new things. That's inherently more costly and difficult than sitting back to see what works and than copying it. And much of the confidence about the effectiveness of Yahoo!'s Panama stems from it being an ad-ranking approach that has panned out beautifully for Google.

Despite the attention that Panama is now getting, Google has hardly sat still during the time Yahoo! fumbled while trying to get it right. If investors are happy to see Yahoo! playing catch-up, it may not be long until they have a chance to see it again.