YAHOO!

Case Study
It was April of 1995—a key decision point for Jerry Yang and David Filo. These two Stanford School of
Engineering graduate students were the founders of Yahoo!, the most popular Internet search site on the
World Wide Web. Yang and Filo had decided that they could transform their Internet hobby into a viable
business. (Yahoo!’s first business plan was developed by Tim Brady as part of a course project at the
Harvard Business School. The plan was continuing to evolve during discussions between Jerry Yang and
David Filo at Yahoo!).

While trying to decide between several different financing and partnering options that were available to
them, they attended a meeting with Michael Moritz, a partner at Sequoia Capital. Sequoia, one of the
leading venture capital firms in Silicon Valley, had been discussing the possibility of investing in Yahoo!.
Michael Moritz leaned forward in his chair. As he looked across the conference table at Jerry and Dave,
he laid out Sequoia’s offer to fund Yahoo!: As you know, we have been working together on this for some
time now. We have done a lot of hard work and research to come up with a fair value for Yahoo!, and we
have decided on a $4 million valuation. We at Sequoia Capital are prepared to offer you $1 million in
venture funding in exchange for a 25 percent share in your company. We think that with our help, you
have a real chance to make Yahoo! something special. Our first order of business will be to help you
assemble a complete management team, after which we should be able to really start helping you to
develop and manage your site’s vast amount of content. Right now, the biggest risk that you guys run is
not making a decision. You have to make a decision, because if you don’t, someone else is going to run
you over. I am going to give you a deadline: tomorrow. If you don’t want to do business with Sequoia,
that’s OK. I’ll be disappointed, but that’s OK. But you are going to have to call me by 10 a.m. tomorrow
morning to tell me yes or no.

Yahoo!’s Growing Popularity

At first, Yahoo! was only accessible by the two engineering students. Eventually, they created a Web
interface that allowed other people access to their guide. As knowledge of Yahoo!’s existence spread by
word of mouth and e-mail, more people began using their site, and Yahoo!’s network resource
requirements increased exponentially. Stanford provided them with sufficient bandwidth to the Internet,
but bottlenecks came from limitations in the number of TCP/IP connections that could be made to the
two students’ workstations. Additionally, the time required to maintain the site was becoming
unmanageable, as Yang and Filo found themselves continually updating their Web site with new links.
Classes and research fell behind as Yang and Filo devoted more and more time to their ever-expanding
hobby.

Competing Services

A number of businesses already existed in the Internet search space. While none offered the same service
that Yahoo! did, these companies could definitely pro- vide potential competition to any new business
that Yahoo! would start. Among the competitors were Architext, soon to be renamed Excite, Webcrawler
at the University of Washington, Lycos at Carnegie Mellon, the World Wide Web Worm, and Infoseek,
founded by Steven Kirsh. AOL and Microsoft in 1995 rep- resented larger competitors who could enter
the market either by building their own capability or acquiring one of the other start-ups.
Leaving Stanford and Starting the Business

Yang and Filo had been in Silicon Valley long enough to realize that what they really wanted to do was to
start their own business. They split much of their free time between their Internet hobby and sitting
around thinking up possible business ideas

By fall of 1994, the two received over two million hits a day on their site. It was then that Jerry and Dave
commenced the search for outside backing to help them continue to build up Yahoo!, but with only
modest hopes.

If they were going to abandon their academic careers (as they soon did, six months shy of their
doctorates), they reasoned that they should hold out for some control. Filo and Yang had three main
potential options to explore: (1) sell Yahoo! outright; (2) partner with a corporate sponsor; (3) start an
independent business using venture capital financing.

The Search for Funding

Looking to receive funding and create a credible business out of Yahoo!, Filo and Yang began preliminary
discussions with potential partners in October 1994. One of the first people who contacted them was John
Taysom, a vice-president of marketing at Reuters, the London-based media service.

Yahoo! also talked to Randy Adams, founder of the Internet Shopping Network (ISN), a company that
styled itself as “the first online retailer in the world.”

Another company that approached Yahoo! was Netscape Communications Corporation. Founded in April
1994 by Jim Clark, who also founded Silicon Graphics, and Marc Andressen, who created the NCSA Mosaic
browser with a team of other UIUC students and staff.

Corporate Partnerships

Yahoo! was also feeling tremendous pressure to partner or accept corporate sponsorship from other large
content companies and online service providers like America Online (AOL), Prodigy, and Compuserve.
These companies offered the carrot of money, stock, and/or possible management positions. They argued
that if Yahoo! did not partner with them, as large players they could develop their own competing services
that would cause Yahoo! to fail. One potential disadvantage with corporate funding was the potential
taint that came with such sponsorship. Yahoo! had started as a grass-roots effort, free of
commercialization. A second disadvantage was the lack of control that the two Yahoo! founders would
have over their creation. “Building Yahoo! was fun, particularly without adult supervision. (Dave) and Jerry
were also worried that selling to AOL would have ‘most likely killed’ Yahoo! in the end.”

With partner discussions beginning to heat up, Yang requested help from Tim Brady, a friend and second-
year Harvard Business School student. As a class project, Brady generated a business plan for Yahoo!
during the 1994–1995 Christmas vacation. (See the Appendix for excerpts of the business plan circa 1995.)

In February 1995, Filo and Yang were weighing a number of possibilities and in no hurry to accept any of
them, when Michael Moritz made them an offer. Sequoia Capital would fund Yahoo! for $1 million and
would help them to assemble a top management team. In return, Sequoia would receive a 25 percent
share of the company. Additionally, Moritz gave them only 24 hours to accept the deal before it was pulled
off the table. “I felt a need to deliver them from the agony of indecision,” claimed Moritz. With the
deadline quickly approaching, Yang and Filo sat down to weigh their options. The decisions that they made
that night would determine the direction of their careers as well and the future of Yahoo!

The Decision for partnership

Sitting in their tiny office on the Stanford campus, Jerry and Dave shared a late- night pepperoni and
mushroom pizza as they explored their options and tried to come to a decision. It was already getting
pretty late, and they only had until noon the next day to make their decision “remember they were given
24 hours to make a final decision page 1, offer by Sequoia”.

Yang took a bite from his pizza as he looked over the terms sheet that Sequoia had given them. We have
some pretty tough decisions to make, and Michael has really forced the issue now with this 24-hour
deadline. As I see it, we have a couple of options. The first is to accept Sequoia’s offer and launch Yahoo!
as our own company. We would be giving up a significant percentage of Yahoo!, but we really need the
money if we are going to survive. Moritz and the rest of the resources at Sequoia could also prove to be
invaluable as we try to assemble the rest of our management team.

Our second option is to accept corporate sponsorship. This would allow us to get the funding we need
and still retain 100 percent ownership of Yahoo!. However, I am worried about selling out to corporate
America. We were fortunate to be able to develop our site in an educational setting as a noncommercial
free site. I am afraid if we accept the corporate sponsorship, it will taint Yahoo!’s image.

Finally, we could agree to merge with an existing corporation. The word is that Netscape is pretty close to
their IPO, and Architext has some really big time investors behind it. If we merge with Netscape or
Architext in exchange for stock options, it could mean a lot of money for us in the next couple of years.
It’s true that we could make some money if we sell to Netscape or Architext, but we would have to give
up primary control of Yahoo! if we did. We would never know what we could have done if we would have
maintained control of the site ourselves.

There is also a fourth option you forgot to mention. I’m excited by Sequoia’s offer, but I’m wondering if
maybe we are giving up too much of our company. A fourth option could be to not decide tonight and
look for better terms with another VC firm. I know Michael said that we should decide quickly, but I would
hate to give up 25 percent of our company, only to find out in a week that another firm would have offered
us $3 million for the same percentage. I know that time is really important, and we like working with
Michael Moritz. On the other hand, I don’t want to be regretting our decision two months from now. As
they grappled with the alternatives facing them, Filo and Yang began to envision life outside of the
Stanford trailer in which Yahoo! was born. It was well past 2 a.m., and they had to make a decision in less
that ten hours. What should they do?

Yahoo! Business Strategy

Yahoo!’s goal is to remain the most popular and widely used guide to information on the Internet. The
Internet is in a period of market development characterized by extremely high rates of both user traffic
growth and entry of new companies focused on various products and services. By virtue of its early entry,
Yahoo! has developed its current position as the leader in this segment. Yahoo!’s ability to expand its
position and develop long-term, sustainable advantages will depend on a number of things. Some of these
relate to its current position and others relate to its future strategy. Today, Yahoo! solves the main
problem facing all Internet users. It is next to impossible for users, faced with millions of pieces of
information scattered globally on the Internet, to easily find that what is relevant to them without a guide
like Yahoo! Not only is the amount of information huge, it is expanding almost exponentially. All
enhancements to Yahoo! will be governed by the goal of making useful information easy to find for
individuals.

We believe that Yahoo’s enormous following has been generated by the following list:

• Yahoo! was the first company to create a fast, comprehensive and enjoy- able guide to the
Internet, and in so doing, built a strong brand early and created momentum.
• The unique interest-area based structure of Yahoo! makes it an easier and more enjoyable way
for the user to find relevant information than the classic search engine approach where key words
and phrases are used as the starting point.
• Develop and integrate the leading technology required to maintain a leadership position.
• Extend the reach to a broader audience through establishment of contractual relationships with
Internet access providers such as MSN, America Online, and Compuserve and very popular web
sites.
• Retain the users (“readership”) of Yahoo! through constant enhancements to the content and
interface of the guide.

Market Analysis

Market Analysis The Internet, whose roots trace back almost 20 years, is experiencing a period of
incredibly rapid growth in the area of online access base and user population. According to IDC and a
recent report by Montgomery Securities, there are approximately 40 million users of the Internet, a
majority using it only for email. However, it is estimated that about 8 million people have access to the
Internet and World Wide Web. Most of these access the Web from the work- place because of the
availability of high bandwidth hardware and communications ports there. It is expected that over the next
two to four years as higher bandwidth modems, home-based ISDN lines and cable modems are adopted,
that both the growth and penetration of Web access into the home will increase dramatically. IDC
estimates that by 2000, 40 percent of the homes and 70 per- cent of all businesses in the United States
will have access to the Internet. In the Western European and Japan markets, the comparable penetration
rates might be as high as 25 percent and 40 percent respectively. If this holds true, there will be as many
as 200 million users on the Internet and Web by the year 2000.

Market Segmentation and Development

We believe that between now and the year 2000 there will be three principal user groups driving the
growth of the Web:

• Large businesses using the Internet for both internal wide area information management and
communication as well as intrabusiness communication and commerce.
• Small home based businesses using it for retrieval of information relevant to the business as well
as for vendor communication and commerce.
• The individual user/consumer using it initially to find and access information which is relevant to
their personal entertainment and learning and later to make purchases of products and services.
Internet Market Size

Estimates of the amount of current and projected revenue for Internet related business vary. However,
primary research conducted by both Montgomery Securities as well as Goldman Sachs indicate that the
total served market for Internet hardware, software, and services will total approximately $1B in 1995,
up from approximately $300M in 1994. Projections are that these categories might grow to a total of $10B
by the year 2000. Several research firms including Forrester and Alex Brown & Sons have estimated the
revenues to be produced by Web-based advertising at approximately $20M in 1995, $200M in 1996, and
over $2B by the year 2000.

Competition

Yahoo! intends to effectively beat any emerging competitors by:

• Establishing broader distribution earlier than any other competitor in order to maintain the
Yahoo! guide as the most widely used in its class.
• Broadening the product line faster than the competition through the introduction of vertical
market focused guides and personalizeable editions of the guide.
• Staying ahead of the competition with regular core product updates which continue to make it
faster, easier to use, and more effective.
• Delivering high quality audiences and compelling results to advertisers.

The main risks facing Yahoo! are:

• The introduction of competitive products internally developed by access providers.

• Ability to develop an international presence and leading brand internationally before the
competition. At the present time, Yahoo! is being pursued by a number of very high visibility and
capable international affiliates.
• Ability to introduce key new products faster and better than the competition.
• The ability to increase traffic and enhance the Yahoo! brand.