Playing catch-up with the juggernaut of search

When Jerry Yang, Yahoo's founder, was reinstalled as chief executive last June, he promised a speedy return to Yahoo's glory days at the height of the dotcom boom, when millions of newly wired-up Americans were using it as their gateway to the internet.

It is clear, though, that Yahoo's problems are more intractable than he suggested at the time. Taiwan-born Mr Yang stands to make $1.64bn (£833m) on his stake in the company, if the Microsoft deal goes through. (His Stanford University collaborator, David Filo, with whom he is technically still on a leave of absence from their graduate studies, stands to make $2.4bn.) But even with that sum, Mr Yang will be left – like many investors – ruing what might have been.

The root of the problem: another Stanford project-turned-internet phenomenon, Google. While the now-dominant search engine is only two years younger than Yahoo (their roots are in 1996 and 1994, respectively), it has made its rival appear to hail from a different era.

Dan Cryan, researcher at Screen Digest, the technology consultancy, said Yahoo was trapped into its old model as a one-stop internet shop, but, instead of consolidating around a handful of mega-sites, web use fragmented. Yahoo was slow to realise, slower to adapt, and is still slow at innovating.

"These grand portals like MSN and Yahoo are left over from an earlier period in the development of the internet," Mr Cryan said. "Things have moved on a lot since then, and the idea of aggregating audience is looking like a historical model."

When Google made a search engine that found what you wanted, it was easy to bypass Yahoo – and so began a downward spiral from which Yahoo and Microsoft are yet to break free. Google proved itself better at making money out of search queries, since it sold ads targeted to appeal to just what their users wanted. When that made Google a must for the pioneering businesses spending money on online advertising, it gave Google the financial muscle to accelerate its lead.

Google and Yahoo began to share their technology with independent websites, plugging their advertisers into a wider network of websites, but advertisers found Yahoo's smaller network less effective. In 2006, when Google snagged a revenue-sharing deal to serve up search-related ads on the MySpace social networking site, Yahoo was rolling out Project Panama, aiming for an improved search technology but infuriating customers and Wall Street by being a year late and over budget. An internal memo by a disillusioned executive said Yahoo was spread too thin to invest in any one thing properly.

Last June, when Terry Semel was ousted as chief executive, speculators piled into the stock expecting Microsoft to pounce. But Jerry Yang surprised Wall Street by appearing reluctant to deal. Now that ever-worsening financial results have caused many speculators to bale out, Microsoft made its move with canny timing.