International Think-Tank on Innovation and Competition
The Dominance of Google in Online Advertising
June 25, 2008
Advertising is at the basis of any process of business creation and diffusion, and its efficiency is crucial for all sectors. It is calculated that worldwide spending on total advertising is currently around 400 billions Euros, of which at least 25 billions are currently spent in the online field (half of which in the US, a third in the EU). Since 1994, when HotWire sold the first banner for advertising, and 1995, when Infoseek introduced search-based advertising, online ads have been constantly growing in all of their different forms: search advertising associated with search engines (40 % of online advertising), display advertising (30 %), classified listings on web sites (20 %), email advertising (2 %) and others. The market is destined to increase its share in the advertising market for the following reasons: 1) the Internet is rapidly growing and the large majority of websites generate revenues from advertising (with the notable exception of transaction websites as eBay); 2) other devices as mobiles and televisions will be always more often connected to the Internet; 3) software innovation allows more efficient mechanisms to reach targeted consumers on the basis of the characteristics of search through the keyword bidding system (it is calculated that 40 % of search queries involve potential commercial transactions) and of the websites (contextual advertising) today, and on the basis of the characteristics of the Internet users (behavioral advertising) in the near future.
Advertising in general is a two-sided market, in the sense that there are platforms that attract viewers and sell access to these viewers to the advertisers. These typically multi-home and pay for access based on the amount of space they obtain and who they reach. Online advertising provides new ways to attract viewers, and new and better ways to link advertisers to their targets. This happens in the two main sub-markets of online advertising, search and display advertising, whose structures will be the focus of our attention.
Let us start with search advertising, which accounts for 40 % of online advertising in U.S. and 45 % in the EU. Many search queries on the Internet are a potential source of business transaction, therefore advertisers place their ads next to search engine results through Vickrey auctions on the keywords that match the content of their ads and lead Internet users to click on their advertisement: charges are typically for each click on the ad, PPC (price per click), and the highest bid for each keyword association wins, but the price is given by the second highest bid. Therefore, the revenue per search, RPS, on a particular platform is given by RPS=APS x CPA x PPC, where APS is the Ads per search and CPA is the clicks per Ad.
The market is characterized by strong network effects in the sense that the search engine that reaches most Internet users is more valuable to advertisers. Consequently there is a strong competition for the market to develop the leading search engine, but a limited competition in the market between the main search engines, which allows these, and the dominant one in particular, to apply substantial mark ups. As well known, Google is currently the leading search engine in the world, with 53 % search traffic in U.S. at the beginning of 2008, against 17% of Yahoo!, 7 % of Microsoft's Live, 6 % of AOL and 3% of Ask, but with even higher market shares (often above 90 %) in other parts of the world. Notice that Yahoo! has been the leader in the U.S. until 2002. Before 2000 Yahoo! was followed by Altavista, in 2001 by Microsoft and in 2002 by Google, which subsequently took the lead. Competition for the market is crucial since access to search engines is free and simple (even if most PCs come with a search toolbar preinstalled, in most of the cases Google), and most users employ the search engine that is regarded as the most valuable (for the quality of the search results and ad relevance), even if they often use more than one. In the absence of substantial product differentiation (limited to search tools and page layouts), network effects and lock in effects naturally lead to a single dominant player in the market for search advertising. Today Google dominates the lucrative business of placing text ads next to search engine result, and the lack of genuine entry pressure in the competition in the market allows it to apply higher prices to advertisers than its main competitors. This is done with a bidding system that reproduces an almost perfect price discrimination: its Google AdWords (launched in 2000) accounts for about 70 % of search advertising revenue worldwide.
Let us move to the second main aspect of online advertising, display advertising. This market is only partially about directly placing banner ads on third-party publishers, which represents the direct (or reserved) channel, the valuable ad inventory that large web publishers directly negotiate with the advertisers (through their direct sale forces). Most of the advertising space available on large websites and typically all of the space available on medium size and small websites cannot be sold in direct negotiations. Therefore, most of online advertising is typically sold through indirect intermediaries that buy the so-called "remnant" ad inventory from publishers and sell it to advertisers. This can be seen as a separate market from the market for the direct channel. Google and its recent acquisition DoubleClick play a major role in the market for intermediation services for remnant ad inventory. Google provides vertically integrated intermediation platform between online web publishers and advertisers: Google's AdSense, which publishers use to dedicate ad space to Google contextual ads, reaches more than 80 % of the ad revenue in the indirect channel with integrated ad networks. The Google platform targets advertising to the relevant websites, and pays the web publishers with a percentage of its revenues that is roughly around 80 %; meanwhile advertisers buy inventories from the platform. Yahoo! and Microsoft have very small contextual platforms. DoubleClick offers an ad serving and ad management product, DART, for publishers (DFP) and advertisers (DFA). Such a publisher tool manages the inventory of a website, receives the ads from ad networks and delivers them in the relevant inventory (according to the behavioral history of Internet users), usually at a fixed cost per thousand impressions (so-called CPM) which is a small percentage of the price that the web publisher charges on the advertisers. The market share of ad revenue served by DoubleClick's DFP in the indirect channel with non-integrated ad networks is around 75 %. Since almost 60% of online advertising taking place through the indirect channel adopts integrated intermediation, after the merger Google and DoubleClick control about 80 % of the worldwide market.
The two intermediation services offered by Google and DoubleClick are highly substitutable and, as a matter of fact, many web publishers use both for different inventories in their websites and in different moments. For these publishers the two services are interchangeable (they can easily recode some space on the website served by one channel to be served by the other channel), therefore the merger has substantially relaxed competition between the two services and, in the absence of valid threats from third alternatives, has allowed them to increase prices. As a consequence, the market power of Google is even stronger after the merger with DoubleClick. In an editorial for the british newspaper The Scotsman (Google Searches for a Partner in Quest for World Domination, The Scotsman, April 30, 2008), Federico Etro, President of Intertic has expressed concern for the antitrust implication of Google moves, starting from the merger with DoubleClick: "It would be odd if this did not lead to price increases: before the merger, competitive forces kept online advertising rates under control (DoubleClick could not increase prices because many consumers would have quickly switched to AdSense, and Google was similarly disciplined by the prospect of customers switching to DoubleClick's products); following the merger, these competitive constraints no longer apply. For consumers and advertisers, the consequences of the current consolidations are uncertain. A merger between Yahoo! and Microsoft would create synergies in research and development without affecting the prices of either company's main products, which are complements rather than substitutes. It would allow the two to join forces and develop search engine capabilities and online services that could constitute a genuine, competitive alternative to Google, whose dominance in pay-per-click Internet advertising is now combined with DoubleClick's dominance in advert-serving services. Giving content creators and advertisers a realistic alternative to Google would ultimately lead to reduced costs and greater consumer choice. By contrast, a Google/Yahoo! tie-up, or even limited outsourcing of advert placement by Yahoo! to Google, such as that announced by Yahoo! two weeks ago in the US, would radically reduce competition, while generating no significant "efficiencies" to benefit advertisers and consumers. Any combination of the two would likely violate EU anti-monopoly rules, with an outsourcing deal that sidelines Yahoo! as a competitor allocating approximate 90 per cent of search advertising to Google, virtually ending prospects for competition. Even more importantly from an anti-monopoly point of view, locking Yahoo!'s search query share and online traffic into Google's ad platform would ensure that no-one could reach the scale necessary to mount a credible competitive alternative. Whether Microsoft succeeds in combining with Yahoo! is crucial for the future of the market for online advertising: such a merger would enhance choice for content creators, advertisers and consumers, creating a much-needed alternative to Google."
It is even too evident that efficiency in the market for advertising has a positive impact on all sectors of the economy. The traditional advertising market has been always rather competitive, but, as we have seen, the current rapid development of the online advertising lacks the fundamental constraint of entry pressure. Nevertheless, market forces are in action. The current battle for the online advertising market between Google, Yahoo! and Microsoft is at a crucial point. Important mergers and alliances are reshaping its market structure. Microsoft has been trying to buy Yahoo! to create a viable competitor to Google-DoubleClick, but Yahoo!'s board of directors has stopped Microsoft's attempt by exploring strategic alternatives, including exploration of potential commercial deals with Google (with a test of Google's product for search service to deliver relevant Google ads alongside Yahoo!'s own search results). Needless to say, in a market where entry cannot be regarded as endogenous yet (at least in the price competition) an alliance between the number one and the number two would reduce competition even further with negative consequences on the advertising business and ultimately on consumers. At this point, only a merger between Microsoft and Yahoo! could create the conditions to compete effectively with the dominant force of Google, and it would create a strong competitive pressure which is necessary to increase competition, efficiency and innovativeness in the whole sector.
