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How Does Yahoo Make Money?

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The problems are all too visible at Yahoo! Inc. (Nasdaq: YHOO) and have been for a while. They’ve been trying to fruitlessly grab at market share in an industry that has long been in the hands of much more inventive and dominating forces.

The best question about Yahoo right now is not necessarily, “How does Yahoo make money?” but rather, “How does Yahoo still make money?”

how does yahoo make moneyInvestors have known for a long time that Yahoo is in trouble. CEO Marissa Mayer is often criticized for her handling of a once much more powerful online brand name since she stepped into the role 2012. But the problems didn’t start with her.

In fact, they began well before she was even on the short list of CEOs the board considered as the turnaround exec.

The biggest issue is Yahoo’s falling revenue. Yahoo’s revenue peaked in 2008 at $7.2 billion and has slipped every year since then. In 2014, Yahoo earnings reported revenue of $4.6 billion.

This six-year, 36% revenue decline has come from a couple of sources. There was, of course, a crisis in Yahoo management that began with an activist investor push to dethrone former CEO Terry Semel in 2007, which lead to a succession of CEOs who couldn’t quite right the ship. Mayer is the latest in that line.

But internal problems aside, there was a bigger industry trend that hammered Yahoo. Yahoo’s principal revenue generator is selling ad space. Yahoo revenues began their descent with the changing advertising landscape.

There’s no better illustration of the problem than in the newspaper industry, which felt the pain of this shift around 2006. Newspapers had been profitable for a long time because before the advent of the Internet, advertisers were fighting over limited ad space in print.

The Internet changed the game forever. Suddenly, there was an infinite amount of ad space. Print advertisers no longer had leverage in setting the prices, and their business models collapsed.

Just look at the New York Times Co. (NYSE: NYT). In 2006, when advertising revenue peaked, 70% of the company’s revenue came from its advertisements while the other 30% came from circulation – mainly subscription fees.

In 2014, advertising revenue made up 44% of that split, while circulation made up about 56%. That can fully be attributed to the challenges of selling ad space on the web, and the lesser role of advertising in print.

But Yahoo purely sells ads on the web. It doesn’t have the ability to milk revenue from a legacy print publication, or jack up subscription fees like The New York Times has tried to do.

So, how does Yahoo make money now?

Here’s the simplest answer…

How Does Yahoo Make Money?

Yahoo’s revenue comes primarily from “search” and “display” advertising revenue. This is largely handled through an ad marketplace launched last year called Yahoo! Gemini, which consolidated Yahoo’s now defunct Yahoo! Ad Manager, allowing advertisers to create ads across devices.

It works this way: Advertisers will create an ad with a graphic and some ad copy and a link to their website.

They will then run an ad campaign that allows them to set a budget on a Cost per Click (CPC) basis – meaning they don’t pay until a Yahoo user engages with their ad, or a Cost per Mille (CPM) basis – they pay per thousand views, more popular among larger advertisers simply trying to fight for market share and make their already-recognized name more visible.

Yahoo will then place those ads across its properties, depending on what demographics and keywords the ad campaign stipulated, as well as the budget. Yahoo has a number of properties – Yahoo! Sports, Yahoo! Style, etc., that run content on a feed. The ads will be integrated into that feed on desktops, tablets, and smartphones.

They will also be placed in relevant searches, and in Yahoo! Mail users’ inboxes.

This is the bulk of Yahoo’s business. To Mayer’s credit, she has tried to make advertising easier for Yahoo customers. She’s consolidated the platform with Gemini. She’s built up mobile advertising from nothing.

She acquired Flurry last year to handle analytics for mobile advertisers. And she acquired Brightroll to allow for video advertisements on Yahoo’s streaming video content.

So the answer of, “How does Yahoo make money?” is pretty clear. It’s all in the ads. But why is Yahoo in trouble?

Why Yahoo Is Struggling to Make Money

how does yahoo still make moneyYahoo began rebuilding its empire in the wake of the dot-com bust. From 2001 to 2008, revenues at Yahoo grew from $717.4 million to $7.2 billion – a tenfold increase.

And what’s more, Yahoo was still able to grow ad sales in the years whenThe New York Timesand other newspapers saw their ads shrink because, at least on this front, Yahoo was ahead of the curve. Yahoo was in the mix of players who correctly identified online ads as the next frontier for the industry.

But as Yahoo was crushing names like The New York Times, they rested on their laurels and let the more innovative players revolutionize the ad game.

You see, it wasn’t enough to identify the web as the new ad medium, Yahoo needed to make its brand name the most attractive platform to advertise on. It didn’t.

Google Inc. (Nasdaq: GOOG, GOOGL) crafted the superior algorithms to deliver the most attractive search ad platform – and that’s how GOOG has come to dominate one end of the online advertising market. Google has 64.5% of the search market share, while Yahoo has only 12.8%, according to the most recent data from comScore.

Then there’s Facebook Inc. (Nasdaq: FB). Facebook is the preeminent social networking site. It has figured out how to not only draw in a pool of more 1 billion users who are actively engaged, but it has also figured out how to seamlessly integrate ads into the social media experience.

These are where companies want the bulk of their ad dollars going. They want their ads to run on the number one search giant and on the most successful social media platform with a highly engaged user base. Yahoo offers neither of these.

That’s why revenue has been falling. And it’s why investors are wondering, “How does Yahoo still make money?”

To Mayer’s credit, she’s trying to step up the ad game. But it just may be too late.

“The world has passed them by and they’re too stupid to recognize,” Money Morning Chief Investment Strategist Keith Fitz-Gerald said. “Yahoo is never, ever going to achieve the glory that it once had.”

The Bottom Line: So while the answer to “How does Yahoo make money?” is clear, Yahoo’s future isn’t. Mayer has identified where the money is going to be made in online advertising and where advertisers are going to spend money – primarily mobile and video – and she’s adjusting accordingly. But when Facebook and Google were revolutionizing the ad game, Yahoo wasn’t. Yahoo is right now simply moving with the trends, not creating them. And that’s why, while Yahoo can still make money, it can do little more than remain a second-tier player in the online ad marketplace.

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