International Think-Tank on Innovation and Competition
THE CHICKEN OR THE EGG DILEMMA AND THE DOMINANCE OF GOOGLE
February 1st, 2011
see also the VOX column: UNDERSTANDING GOOGLE'S ANTITRUST PROBLEMS (January 30, 2011)
The dominant firm in online advertising is currently being investigated by a number of antitrust authorities. As usual, the problem is "the chicken or the egg" dilemma: has Google reached its dominance only with merit (innovating) or are there abuses that strenghten its dominance? Analyzing this market, it emerges that possible abuses may concern both search and display advertising, with particular reference to preferential treatment for Google’s own services in its free (‘universal’) search, manipulation of the opaque bidding system for sponsored links, and exclusivity clauses for advertisers.
In November 2010 the European Commission has started an investigation on potential abuses concerning the preferential treatment for Google services in its free search engine, the manipulation of the pricing system for the sponsored links, and exclusivity clauses or other restrictions for advertisers using Google services. Complaints have been also filed in front of the US, German and Italian authorities, mainly regarding unfair competition with publishers and other content providers. The French competition authority has also carried out a consultation concluding in December 2010 that Google holds a dominant position both in search-related advertising and contextual advertising and that “competition law can apply limits to Google's actions and provide a response to the competitive stakes brought to light by the actors, without the need to implement sector-wide regulations.” Some constraints to the activity of Google have been decided also in Italy in January 2011, but the main antitrust debate will take place at the EU level. For this reason it is important to understand the structure of online advertising and reasons for which Google may be engaged in abusive conducts.
Companies spend over US$ 600 billion worldwide on brand recognition annually. Today, only around 13% of that total is spent on online advertising, which is an entirely separate market destined to grow rapidly over time. As well known, Google is the leading search engine in the world, with a global share of search traffic around 85 %, against 7 % for Yahoo! and 4 % for Bing, but with even higher market shares in Europe. Beyond this, Google dominates the lucrative business of placing text ads next to search engine results. Google AdWords accounts for about 70 % of search advertising revenue worldwide. Payments are based on so-called Vickrey auctions between advertisers on the keywords that match the content of the webpages or searches: charges are typically for each click on the ad, and the highest bid for each keyword association wins (with the price given by the second highest bid). The auction process is made more complex by the different places where the ad can appear on the search page (on positioning auctions see Varian, 2007, Position auctions, International Journal of Industrial Organization, and Edelman, Ostrovsky & Schwarz, 2007, Internet Advertising and the Generalized Second-Price Auction, American Economic Review), and remains largely obscure to advertisers and competitors. The lack of transparency of this pricing and ranking scheme could easily hide abusive forms of exclusionary behaviour, predatory strategies against competing services specialised in providing users with specific online content (price comparisons), price discrimination or even exploitative pricing toward selected advertisers. For instance, an exclusionary behaviour was identified by the French national competition authority when Google suspended the AdWords account of a French company providing online services (Navx); Google was subsequently forced by the competition authority to re-establish the account. These and other forms of manipulation of the pricing system for the free and sponsored links should be carefully investigated at EU level. In the last 2 years Google has introduced new services, some of which raise serious concerns about copyright protection (Google Books), privacy (Youtube and Google Maps) and/or antitrust law. This is particularly evident in terms of predatory pricing or free riding against content providers, whose information is freely aggregated and displayed by Google News. On this front, the Italian and French competition authorities have obliged Google to guarantee that press publishers will be able to request and obtain exclusion from Google News, but without being de-listed from the general search. Similar agreements should be extended to the rest of Europe.
Besides search advertising, the second field of dominance of Google is in display advertising. Google leads the industry in directly placing banner ads on third-party publishers, accounting for three quarters of the direct channel, that is, the valuable ad inventory that large web publishers directly negotiate with the advertisers. Of course, a lot of the advertising space available on large websites and all of the space available on small websites cannot be sold in direct negotiations. Therefore, most advertising is typically sold through indirect intermediaries that buy the so-called “remnant” ad inventory from publishers and sell it to advertisers. Google plays a major role also in this market for intermediation services, providing a vertically integrated platform between online web publishers and advertisers: Google's AdSense 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 (so-called “contextual advertising”) and pays the web publishers with a percentage of its revenues, but in the absence of any audit or data certification available for the same publishers. Meanwhile advertisers buy inventories from the platform through a bidding system characterized by the same lack of transparency mentioned above.
Through these services, Google controls at least 80 % of the worldwide market for advertising, and, as confirmed by the sector inquiry by the French antitrust authority, is protected by high barriers to entry.
A first source of these is due to the importance of scale in search, and the huge lead time that the dominant player has because of the massive amount of data it can draw on to improve its organic search, which is due to the high volume of the search queries that are made and to the fact that Google is a laggard in the industry with respect to the anonymisation of user data (nine months versus for example Bing’s six months).
A second source of barriers to entry is peculiar to the field of display advertising: alternatives to Google can be hardly offered to publishers using Google’s services. Switching to a different publisher tool involves high sunk costs in terms of substantial investments in software, in training the staff, coding all of the publisher’s web pages, creating novel datasets, transferring ad campaigns to the system and so on, with all the associated business risk.
This leaves space for multiple potential abuses by the dominant firm, including exploitative pricing on advertisers (with negative indirect consequences on all sectors depending on advertising), exclusivity clauses for advertisers using Google services and restrictions that Google can place on advertisers that wish to use the services of competing platforms.
For these reasons, an in-depth investigation by the EU antitrust authority is welcome to solve this chicken or the egg dilemma, that is to discern if Google reached its dominance only with merit or there are abuses that strenghten its dominance.
