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updated 8/25/2009 1:28:03 PM ET 2009-08-25T17:28:03

Yahoo! may have thrown in the towel on the business of searching for information online. But the company is doubling down on a technology where it already has the lead over search king Google: in free e-mail service offered over the Web.

During an event at its Sunnyvale, Calif., headquarters on Aug. 24, Yahoo unveiled a new design for its Yahoo Mail service. The updated version of the e-mail service lets users merge their in-boxes with other Internet services so they can send invitations using Evite or organize photos with Xoopit without having to leave Yahoo's familiar e-mail environs.

Social networking features such as Twitter-like status updates have also gained new prominence on the upgraded site, now available to U.S. users and scheduled for a worldwide rollout in coming weeks. The idea is to keep users coming back for more Yahoo services due to the frequency with which they check their e-mail.

For more than a decade, Web-based mail services have served as the glue that keeps millions of users returning to Yahoo. The latest round of improvements is a sign that the company plans to defend its lead among Web mail services in the U.S. by making the site more relevant to consumers, who have many options for keeping in touch. While e-mail rivals Microsoft and Google appear focused on funneling e-mailers to their more profitable search engines, Yahoo executives say that e-mail can be a profitable standalone business.

(Msnbc.com is a Microsoft-NBC Universal joint venture.)

Microsoft deal frees Yahoo to focus
The enhancements to Yahoo Mail are also a chance for the company to prove its technical prowess at a time when critics see the company primarily as a media business.

Yahoo essentially quit the Web search business via a July deal with Microsoft to outsource its search capability in return for ongoing payments from Microsoft for the right to serve ads on Yahoo pages. According to Yahoo, the deal has freed up more resources to train on products such as e-mail. The search deal "allows us to invest in the rest of the audience properties at a faster pace," says Bryan Lamkin, senior vice-president of Yahoo Applications. E-mail "will be one of the key recipients of that focus."

Yahoo's e-mail service doesn't appear to be a big moneymaker in its own right. Display ads served on e-mail sites typically perform worse than those paired with, say, news articles, according to analysts. In most cases, the ads don't cover the high cost of developing and running a free e-mail service. Yahoo also has a small premium service that does away with ads in exchange for a $20 annual fee, which "hardly anybody uses," says Sara Radicati, president and CEO of the The Radicati Group.

What e-mail does accomplish for Yahoo, Google and Microsoft is to help circulate traffic to higher-profit pages, such as Web search and news. "People check their e-mail multiple times a day and that keeps driving them back to the portals and using other properties on those sites," says Cowen & Co. analyst Jim Friedland. Adds David Hallerman, senior analyst with marketing researcher eMarketer: "It's a loss leader."

Threatened by Google’s innovation
"As a standalone entity, [e-mail] is not a great business," says Brian Hall, general manager of Windows Live at Microsoft. "It has a high marginal cost per user. And while you can do interesting things from an advertising perspective, it's just never going to be a big profit generator."

Yahoo has by far the largest U.S. e-mail subscribership. Yahoo Mail had 87.2 million visitors in July, an increase of 22 percent over the previous year. Microsoft's Windows Live Hotmail grew 3 percent, to 45.9 million. Since launching in 2004, Gmail has grown its base by about 50 percent each year, with 25.3 million U.S. users, according to market researcher comScore.

Analysts say Yahoo's lead in e-mail is threatened by Google's innovation in the category. In the past year, Google has introduced roughly one new Gmail feature a week, including language translation and an "undo" feature that lets users cancel messages within five seconds of hitting the "send" button. "Google just keeps pumping out these cool capabilities," says Charles King, president and principal analyst at researcher Pund-IT.

Google also has 1.75 million businesses using its mail service and it offers an enterprise-level version of Gmail free to thousands of universities.

One of the main goals of Gmail—sending more users to the search engine, where ads are most profitable—was once the top priority at Yahoo Mail. "When I was there, it was a lot about search," says Geoff Ralston, who oversaw e-mail at Yahoo for several years after Yahoo bought his company, Four11, in 1997. "The more you could get the Yahoo Mail users searching the better," says Ralston, CEO of online music startup La La Media.

‘Most profitable’ web mailer
Microsoft's Hall says e-mail is giving the company's new search engine, Bing, a boost. According to comScore data, 51 percent of Hotmail users perform searches on Bing. Hall attributes this to new features, like a sidebar that appears in the place of an advertisement beside new messages that asks users if they want to quickly add to messages such as information movie showtimes, videos and business listings discovered through Bing search results.

Yahoo says its e-mail service is more self-sufficient. "We have reason to believe we are the most profitable Web mail company," says Lamkin, though he wouldn't break out the unit's financials or offer specifics to back up this claim. Google and Microsoft both declined to comment on whether their e-mail businesses operated at a profit or loss.

Yahoo's e-mail face lift is designed in part to keep users from straying too far from the company's collection of sites. Rather than checking social networking or photo-sharing sites like Twitter and Flickr before their e-mail, users can pull in their friends' updates and photos in one swoop.

And instead of searching their in-boxes to dredge up photos or links, a new feature made possible by Yahoo's July acquisition of Xoopit lets users find all the images in their inbox inside a single folder called "MyPhotos."

Analyst Radicati says Yahoo needs to invest in e-mail in order to stay relevant to users' lives. "Having given up search, this becomes more important."

Copyright © 2012 Bloomberg L.P.All rights reserved.

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