The Effect of Market Forces on Arbitrage and Efficiency [The Yahoo Case Study]

image I just read Paul Graham’s excellent post on what happened to Yahoo and this one paragraph jumped out at me:

I didn’t realize the answer till later, after I went to work at Yahoo. It was neither of my guesses. The reason Yahoo didn’t care about a technique that extracted the full value of traffic was that advertisers were already overpaying for it. If they merely extracted the actual value, they’d have made less.

[From What Happened to Yahoo]

There are two very important lessons here that companies of all sizes should take away and the first is that much of the web economy is built on arbitrage, the selling of something for more than you buy it for. When you are in an arbitrage business and the market forces do not demand efficiency and economy then it’s unlikely that efficiency will become a priority until a competitive force decimates you.

This is probably one of the most difficult challenges that technology companies face, high margins create a cultural dynamic that is very difficult to overcome and it ignores development of new businesses that are built on delivering efficiency to the marketplace, which then makes the company ill-prepared to deal with critical shifts in the market.

The second lesson is that even exceptionally smart people have limited ability to forecast what will be important shifts in the market beyond the immediate future; history proves conclusively that the conventional wisdom at any time on any subject is often wrong. Yahoo has become less relevant because they could not see the shift in search, which is ironic given that their business was founded on the notion of search.

[Editor’s Note: Jeff cross-posted this at his personal blog. –mrh]

About Jeff Nolan

My name is Jeff Nolan and I write Venture Chronicles. What started, in 2002, as a simple initiative to understand this thing called “blogs” that I kept hearing about has evolved into something much more significant. Home About Venture Chronicles About Venture Chronicles My name is Jeff Nolan and I write Venture Chronicles. What started, in 2002, as a simple initiative to understand this thing called “blogs” that I kept hearing about has evolved into something much more significant. Along the way to becoming a bona fide blogger I started to understand the implications of user generated content. At the time I was a venture capitalist for SAP, the enterprise software company, and in my travels in the enterprise software market it became evident that blogging would be a powerful communication channel for enterprises to use, what we now call social media, and a powerful information collection mechanism for bottom up corporate intelligence. Combined with search technology, social networking software, and wikis, I was witnessing the inception of an entirely new generation of knowledge management software. I am currently the VP Product Marketing for Get Satisfaction, the simple and effective way to build online communities that enable productive conversations between companies and their customers. Over 50,000 companies use Get Satisfaction to create a social support experience, build better products, realize SEO benefits, and take advantage of brand loyalty behaviors that results in strong word of mouth marketing experiences in the market. I can be reached at jnolan-at-gmail-dot-com.