Eight months ago, Yahoo!CEO Jerry Yang had a chance to sell his company to Microsoft for $43 billion. He refused. Now Yahoo's market value stands at $18 billion. This raises a question: Why is Jerry Yang still running this company? "Nobody knows this company better than Jerry Yang," Yahoo Chairman Roy Bostock says. "He put in place a strategic plan in 2007 and under extraordinary circumstances has been executing well against it. Jerry is the right person to continue to lead Yahoo." Bostock says the company's board has no regrets about the way Yang handled the Microsoft offer. "We analyzed the offer eight ways to Sunday, with advisers from Goldman Sachs and Lehman, and we determined that the initial offer of $31 per share significantly undervalued the company," he says. "Not one of our investors encouraged us or suggested we should sell the company at $31 per share. Not a single investor." He adds that Yahoo was willing to sell at a higher price, and that Microsoft, not Yahoo, walked away from the deal (as you'd expect, Microsoft blames Yahoo).

No matter how it happened, Yahoo's failure to hook up with Microsoft may rank as one of the greatest boneheaded moves in the history of tech, and it has left Yang furiously scrambling to come up with a Plan B for turning around his ailing Internet company.

How exactly this might happen is difficult to imagine. Sales are barely growing. Profits are in decline. Executives are defecting. Yahoo still draws huge traffic— 141 million unique visitors in the U.S. in August, second only to Google, according to researcher ComScore. Worldwide, Yahoo ranks third, behind Google and Microsoft, ComScore says. But lately Yahoo seems to stumble from one idea to the next, with no grand vision or plan. It's trying to make an advertising partnership with Google. It's considering buying part of AOL from Time Warner. In September, Sunnyvale, Calif.-based Yahoo launched a goofy brand campaign called "Start Wearing Purple" (Yahoo's corporate color) to fire up the troops. Days later, Yang told employees the company is hiring management consultant Bain & Co. to help Yahoo "get fit" and "be more agile." Translation: layoffs are coming. So much for the morale boosting.

A decade ago, Yahoo seemed destined to rule the Internet. Formed in 1994 by Yang and his fellow Stanford grad student David Filo, Yahoo by 2000 had $1.1 billion in annual revenue and was growing at a 90 percent clip. Google at that time was generating only $19 million in sales. By 2005, Google eclipsed Yahoo and kept accelerating, while Yahoo stalled. This year, Google will post $22 billion in revenue, nearly triple Yahoo's $7.5 billion, according to Clayton Moran, an analyst at Stanford Group, a Boca Raton, Fla.-based brokerage. Yahoo's third-quarter revenues, to be reported this week, will be $1.9 billion, up from $1.77 billion a year ago, while net income will drop to $130 million from $150 million last year, Moran estimates.

How did Yahoo fall so far behind? The short answer is that Google figured out how to do search advertising—the technology that lets advertisers place ads next to the results of searches for keywords—better than Yahoo. Search advertising has become the biggest part of the online ad business, representing about 41.8 percent of all online advertising in the U.S., or about $10 billion this year, according to researcher eMarketer. Google handles the lion's share of these ads—73.5 percent in the U.S., versus 13.3 percent for Yahoo, eMarketer says.

Yang took over as CEO in June 2007, replacing Terry Semel, a veteran media executive who'd joined in 2001. Yang had little executive experience (his previous title was "Chief Yahoo") but he's a cofounder, a guy who "bleeds purple," as they say around Yahoo. He also owns 4 percent of the company. But Yang's passion and personal connection may also have kept him from being able to let go of his baby when Microsoft made its offer in February of this year. After three months of wrangling, Microsoft withdrew its offer.

With Microsoft gone, Yang now is trying to strike a deal with Google whereby that company would provide some of Yahoo's search ads. Problem is, advertisers are complaining to the Department of Justice about the deal, because they say the Google-Yahoo partnership would "control 90 percent of search-advertising inventory" and that "the cost of search advertising is likely to rise." A Google spokesman says the deal will enable advertisers and publishers to provide more-relevant ads, and "benefits competition by preserving Yahoo as an independent competitor and giving them additional revenue to invest in their products and services." Microsoft, the only other significant competitor in search advertising, is also urging the government to block the deal. A decision from the DOJ could come any time. Meanwhile, Yahoo also is talking with AOL—another struggler—about acquiring part of that company in a deal that might best be described as "misery loves company."

Microsoft CEO Steve Ballmer recently made an off-the-cuff, public comment that seemed to indicate to some he might still be interested in Yahoo. Yahoo shares jumped, but Microsoft quickly refuted Ballmer's statement. The blogosphere teems with speculation about grimmer possible outcomes for Yahoo, including Yahoo getting snapped up by a private-equity fund and sold off in pieces. Jerry Yang would have no one to blame but himself.

© 2008