Yahoo’s risk-taking may be its best chance

March 19, 2012, 9:00 AM UTC

Scott Thompson

By Kevin Kelleher, contributor

FORTUNE – Yahoo’s core values include “fun,” “community” and “excellence” (which the company defines as “winning with integrity”). It’s too bad they don’t include “provocation,” “confrontation” and “alienation” – because then CEO Scott Thompson would be having a banner year.

Thompson left eBay (EBAY) as head of PayPal to lead Yahoo (YHOO) in early January, saying he felt a “real sense of urgency” to turn things around at the web company. He was the company’s fifth CEO in five years, a period that saw Yahoo’s stock plunge after rejecting a takeover bid by Microsoft (MSFT) and vacillate around the $15 a share level for years as the company grew more marginal in an increasingly social web.

True to his word, Thompson began a series of bold initiatives less than three months into the job. In the process, he’s roiled the ranks inside Yahoo with talks of layoffs, set the stage for a proxy battle with the board and angered many peers in Silicon Valley with a patent lawsuit against Facebook. It’s far from clear that these moves will help turn Yahoo around. But they’ve already made the company a lot more interesting.

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It seems like years since Yahoo has done anything to capture the web industry’s interest. Early on, Yahoo was notable as the only so-called “web portal” that survived the first, volatile years of the web. It succeeded with popular features that have become mainstays of the web today: web mail, news aggregation, fantasy sports and financial data – all of them simple and easy to access.

But the web evolves quickly and by 2005, social networking was clearly the future. Here again, Yahoo positioned itself as an early leader, buying Flickr’s photo-sharing and’s social bookmarking site, turning the web giant into an early leader in social networking. And it cultivated a community of coders with its Developers Network.

But soon enough, all of these promising initiatives seemed to suffocate inside Yahoo’s bureaucratic miasma, and the company became distracted by the high drama of a protracted takeover battle with Microsoft. Since then, Yahoo has seemed adrift as Google (GOOG) and then Facebook set the agenda for web innovation. For the past three or four years, barring some frank and controversial comments by ex-CEO Carol Bartz, Yahoo has been as exciting as a rose losing its bloom.

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But that has changed this month. Thompson is showing himself to be a CEO with a talent for tipping over apple carts. First came reports that Thompson’s restructuring could cost thousands of Yahoo’s 14,000 employees their jobs. He abruptly cancelled a Florida meeting for 1,300 Yahoo sales employees. Then he tried to soothe workplace tension with a memo hectoring employees into working harder and faster.

Last week, Yahoo sued Facebook for infringement of 10 patents – including advertising, privacy, messaging and social networking – just two weeks after sitting down with Facebook to discuss licensing fees. Overnight, Yahoo became the web’s most reviled patent troll, bilking a more nimble rival in a move decried as “pathetic,” “desperate” or worse.

As if distressing employees and alienating peers wasn’t enough, Thompson is also gearing up for a proxy battle with activist investor Third Point, which wants new directors on the company’s board. Third Point, which calls itself Yahoo’s “largest outside owner,” wants to tap into several years of shareholder frustration with Yahoo’s board.

And in February, comments from Thompson upset Interpublic, a major advertiser. That may not matter if Thompson follows through on another radical plan to sell off pieces of Yahoo’s advertising technology, part of its historically core market. Thompson has said he sees future growth in the “wealth of data” in Yahoo’s businesses, which he called “exploitable” for new products and services.

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All of this is making Yahoo under Thompson look very bad indeed. But there may be a method to his madness. Controversies blow over. Layoffs are always traumatic for workers, but Silicon Valley is facing a shortage of talent. Patent battles can get ugly, but they are so common the memory of them soon passes (Until last week, most people had forgotten that Yahoo held Google over a similar patent barrel before its 2004 IPO).

If Thompson’s bold, no-holds-barred approach turns Yahoo around, all these controversies will be forgotten. It’s a huge risk to take, but it may just be Yahoo’s best chance. In the end, the exhausting work of Bartz and Jerry Yang to extract growth from an aging ad business amounted to nothing more than hospice care. Returning Yahoo to the forefront of the web is still an unlikely outcome, but the new fighting spirit at least gives it an outside chance.

The key to any Yahoo turnaround lies in Thompson’s goal of supplanting a fading display-ad business with a new focus on customer data and analytics. In the age of Facebook, tracking users’ behavior on the web is the real secret to success. But it’s a road filled with privacy landmines. People are growing wary about having their personal data exploited.

That’s why Yahoo’s push into “big data” could save it, or irreparably hurt it. If Yahoo is too aggressive in exploiting its user data, it could end up alienating the one constituency it hasn’t angered this month: its customers. If they abandon Yahoo, the show is over.