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.