The Economist reckons that a possible strategic reason for Microsoft’s attempted takeover of Yahoo! is to force antitrust authorities to take a good look at market power in web search and online advertising:

But here is the twist. The only grounds on which a trustbuster could plausibly oppose Microsoft buying Yahoo!—that it is possible to exercise monopoly power in online search and advertising—surely apply even more strongly to Google. Indeed, some antitrust experts are surprised that Google has not already come under serious assault from the trustbusters, especially because, as Mr Ballmer points out, the “one player” has been “consolidating its dominance through acquisition.”

Indeed, even if Microsoft believed that it would be prevented from buying Yahoo! on antitrust grounds, it might make sense to push for the deal, if only to force the antitrust authorities to take a serious look at issues of market power in the online search and advertising market, which would inevitably lead them to Google.

Web search as a bottleneck, anyone …?

Google appears to be pretty concerned about the proposed takeover of Yahoo by Microsoft. It’s not surprising really, since Microsoft put in strong arguments to the FTC about why the Google-DoubleClick merger should not proceed, and Microsoft-Yahoo is obviously a much bigger deal. On the official Google blog, David Drummond, Google’s top lawyer, writes:

So Microsoft’s hostile bid for Yahoo! raises troubling questions. This is about more than simply a financial transaction, one company taking over another. It’s about preserving the underlying principles of the Internet: openness and innovation.

Now I can understand why Google would be concerned about this takeover, because it represents Google’s two biggest competitors joining forces. But there’s no need to spin it as “preserving the underlying principles of the Internet”. Just call it what it is — a potential reduction in competition that could hurt both Google and consumers. We know that Google “do no evil”, but they are a company after all, and we expect them to maximise profits first and foremost. So there’s nothing shameful about making a competition argument against Microsoft-Yahoo.

Update: Microsoft’s response is here. Naturally Microsoft’s spin is that this will increase competition rather than reducing it. What’s more interesting is the obvious difference in corporate cultures. Compare the style of Google’s blog post with Microsoft’s, which includes such fascinating things as:

Microsoft Corp. and its directors and executive officers and other persons may be deemed to be participants in the solicitation of proxies in respect of the proposed transaction. Information regarding Microsoft Corp.’s directors and executive officers is available in its Annual Report on Form 10-K for the year ended June 30, 2007, which was filed with the SEC on Aug. 8, 2007, and its proxy statement for its 2007 annual meeting of shareholders, which was filed with the SEC on Sept. 29, 2007. Other information regarding the participants in the proxy solicitation and a description of their direct and indirect interests, by security holdings or otherwise, will be contained in the proxy statement/prospectus and other relevant materials to be filed with the SEC when they become available.

Google’s acquisition of DoubleClick has been given the green light by the FTC, the US competition watchdog. I haven’t followed the case closely, but the FTC’s statement (pdf) is quite interesting reading because it provides a lot of insight into how the online advertising market works.

Overall, the FTC’s investigation seems to have been thorough (2 million pages of documents reviewed!) and pretty standard for this sort of thing. They followed the usual process of (i) defining the relevant market(s), and (ii) assessing whether the acquisition would result in a ’substantial lessening of competition’ in the market(s) defined. One non-traditional thing that was raised in this case was the privacy issue. Google has a lot of data about consumers, and some people were worried about how this would be used to sell advertising. The FTC acknowledged this, but quite rightly (in my opinion) concluded that antitrust investigations are not the place to make privacy policy. In other words, it’s not the FTC’s job to decide what is or is not acceptable from a privacy point of view. Their job is just to protect consumers from reduced competition.

There were a couple of other interesting points in the report. The FTC decided that ads sold by search engines are not substitutes for banner ads sold by websites. Although both are a form of advertising, the FTC reckoned that the evidence shows that these two things are not in the same market, so raising the price of one would not significantly affect the demand for the other. This is kind of like saying that champagne and milk are both drinks, but they’re very poor substitutes, which is entirely plausible depending on the preferences of consumers. In the Google case the consumers are advertisers, and according to the evidence that the FTC saw, advertisers do not regard advertising on search engines and banner ads on websites to be substitutes to any significant degree.

Another interesting thing was how sophisticated online advertising markets are becoming (see eg point D on page 6 of the FTC’s report). A number of third-parties, like DoubleClick, intermediate between websites (’publishers’) and advertisers. These third parties operate servers that serve up advertising based on various algorithms, and publishers monitor the ads that get served up and the revenues generated very closely. Data is also fed back to advertisers to track the success of their campaigns.  Marketing really does seem to be changing from a hit-and-miss affair to something more precise.

Finally, the FTC did finish with a warning to Google not to use bundling or tying to try to reduce competition. An example of this would be where Google forces advertisers to buy bundles of both Adsense ads on its search results, and banner ads on websites. Basically, Google has a lot of market share in search engine ads, but the website ads market is much more fragmented. In theory it could be profitable for Google after acquiring DoubleClick to leverage its position in the search engine ads market to improve its profits from website ads. This kind of behaviour is usually anti-competitive, and the FTC stated that they will be watching out for it in future.

Another post on the Google public policy blog attempts to put a positive spin on Google’s acquisition of DoubleClick, a placement service for online ads. Google also sells online ads through its Adsense/Adwords service. Google claims that this will not harm consumers, advertisers or website publishers. Whether or not that is true, I cannot say based on the limited information that I have. However, I think at best the Google public policy people are confused about what ‘competition’ really means, and at worst they are trying to confuse their blog readers.

Google writes:

Just yesterday, for example, Microsoft announced that it had added 20 new advertising clients after closing its acquisition of aQuantive, a DoubleClick competitor. We see this as yet more evidence that companies are competing in the online advertising space and the free market.

To me, this looks like another acquisition by one advertising provider (Microsoft) of another. I do not see how this is ‘evidence of competition’. It is evidence that the market is consolidating and usually that means less competition. Let me explain exactly why. Suppose a market is supplied by only two independent firms. Each firm receives some demand and therefore some revenues based on the price that it sets and the price that its competitor sets. Suppose a firm is thinking about cutting its price. When making this decision, it will take into account two facts: (i) it will gain some customers, and (ii) its existing customers will pay less. Thus it faces a tradeoff, which may or may not make it worthwhile to cut the price. However, most importantly, what the firm does not take into account is the fact that cutting its price also reduces the demand for its competitor’s product. Each firm only cares about its own profits, and does not care if its actions reduce the profits of its competitor.

Now suppose the two firms merge into one. In this case, when making the decision whether to cut price, the firm will care about the entire demand in the market, and not the two independent demands that were faced by the previously separate firms. To illustrate, suppose the two previous firms operate as two divisions in the merged firm and keep setting two separate prices, but suppose the firm cares about the overall profits across both divisions. For example, one division might sell banner ads (DoubleClick) and the other division might sell context-related text ads (Adsense), and there’s a separate price for each type of ad. Now, when one division thinks about cutting its price, it will have to take account of the negative effects that this will have on the other division’s sales. To the extent that the products of the two divisions are substitutes, cutting price in one division will reduce sales of the other. As I explained above, this negative effect is not taken account of when the firms are separate and set prices independently, but it is taken account of when they are merged. Thus the incentives to cut prices are weaker when the firms are merged compared to when they operate independently.

What this means is that the number of independent firms who set independent prices in a market affects the prices that arise. For simplicity the above example took the case of two firms merging into one. However, the same basic logic holds if there are many firms in the market and only two or a few of them merge. Any kind of merger or acquisition between competitors that produce substitute products results in some of the negative ’spillover’ effects that I talked about being taken into account (’internalised’) by the combined firm. This weakens incentives to set lower prices, and price rise, which will be harmful to the consumers in the market. This is the reason why competition authorities pay careful attention to mergers and acquisitions.

To sum up, I really can’t see how Google can justify mergers or acquisitions among competitors as being good for competition. Certainly, they provide no explanation on their blog. The rest of the blog post is a series of quotes from various people mostly supporting the argument that Google and DoubleClick’s services are in fact not substitutes. This is a different and more difficult issue. If two firms merge that produce entirely independent products, then none of the negative spillover effects that I mentioned will exist, because the price of one product will not affect the demand for the other. In this case a merger or acquisition will not lead to higher prices. If the firms produce products that are complements (consumers like to consume them together, like coffee and sugar) then prices could even go down as a result of a merger or acquisition. However, at first glance it appears that Google’s advertising services and DoubleClick’s are substitutes to some extent, at least from the point of view of an advertiser. The onus is on Google to prove that they are not.