Will Digg Save Yahoo?

All the noise from new CEO Carol Bartz to the contrary, Yahoo! (YHOO) is in trouble. Display ads are increasingly viewed as weak offerings in the online space. Ironically, online news aggregator Digg may save Yahoo! and its display ad cohorts.

First, the bad news for Yahoo. According to findings by online advertising company the Rubicon Project, the price of display ads fell by 20% to 30% during the first quarter of 2009 vs. the fourth quarter of 2008. Ouch. Rubicon also found that online display ad inventory soared by 150% between the two quarters, further depressing display ad prices. The vast majority of Yahoo's revenues come from display ads. This would seem to spell serious trouble for Bartz.

But hold the phone, folks. Digg just rolled out a new advertising system that holds tremendous promise. Digg, like Yahoo, has largely relied on display ads for revenues. So to make its display advertising more effective, Digg created a system that allows users to vote on the ads. Popular ads pay less to get on Digg, Unpopular ads pay more.

This system holds a lot of promise for two reasons First, it effectively mimics the wildly successful Google AdWords auction system that is the backbone of Google's lucrative pay-per-click revenue model. Second, evidence has started to pile up that users who are involved in the selection ads to be displayed on sites they view are more likely to pay attention to those ads and click on those same ads.

Yahoo has long been fighting the losing battle against plunging click-through rates on display ads. By moving towards a more social model of advertising which involves the audience, Yahoo could easily improve its advertising performance enough to give revenues a serious boost. Piqqem Sentiment on Yahoo has risen by 100 basis points since March 31.

That could happen through better pricing ability, higher click-through rates on banners, or both. In any case, watch this Digg system as Yahoo! could quite easily roll it out for large chunks of its network. It won't replicate Digg or Yahoo!'s own version Buzz, but it could easily be close enough to matter. And it might be all the more important should Microsoft's (MSFT) Bing sustain momentum and grab the number two search spot from Yahoo.

Disclosure: Long GOOG, no position in YHOO