Digital advertising is the economic backbone of the Internet. It allows websites and apps to monetize their userbase without having to charge them fees, while the emergence of targeted ads allows this to be accomplished affordably and with less wasted time wasted.
This advertising is facilitated by intermediaries using the “adtech stack,” through which advertisers and publishers are matched via auctions and ads ultimately are served to relevant users. This intermediation process has advanced enormously over the past three decades. Some now allege, however, that this market is being monopolized by its largest participant: Google.
A lawsuit filed by the State of Texas and nine other states in December 2020 alleges, among other things, that Google has engaged in anticompetitive conduct related to its online display advertising business. Those 10 original state plaintiffs were joined by another four states and the Commonwealth of Puerto Rico in March 2021, while South Carolina and Louisiana have also moved to be added as additional plaintiffs. Google also faces a pending antitrust lawsuit brought by the U.S. Justice Department (DOJ) and 14 states (originally 11) related to the company’s distribution agreements, as well as a separate action by the State of Utah, 35 other states, and the District of Columbia related to its search design.
In recent weeks, it has been reported that the DOJ may join the Texas suit or bring its own similar action against Google in the coming months. If it does, it should learn from the many misconceptions and errors in the Texas complaint that leave it on dubious legal and economic grounds.
Relevant market
The Texas complaint identifies at least five relevant markets within the adtech stack that it alleges Google either is currently monopolizing or is attempting to monopolize:
Publisher ad servers;
Display ad exchanges;
Display ad networks;
Ad-buying tools for large advertisers; and
Ad-buying tools for small advertisers.
None of these constitute an economically relevant product market for antitrust purposes, since each “market” is defined according to how superficially similar the products are in function, not how substitutable they are. Nevertheless, the Texas complaint vaguely echoes how markets were conceived in the “Roadmap” for a case against Google’s advertising business, published last year by the Omidyar Network, which may ultimately influence any future DOJ complaint, as well.
The Omidyar Roadmap narrows the market from media advertising to digital advertising, then to the open supply of display ads, which comprises only 9% of the total advertising spending and less than 20% of digital advertising, as shown in the figure below. It then further narrows the defined market to the intermediation of the open supply of display ads. Once the market has been sufficiently narrowed, the Roadmap authors conclude that Google’s market share is “perhaps sufficient to confer market power.”
While whittling down the defined market may achieve the purposes of sketching a roadmap to prosecute Google, it also generates a mishmash of more than a dozen relevant markets for digital display and video advertising. In many of these, Google doesn’t have anything approaching market power, while, in some, Facebook is the most dominant player.
The Texas complaint adopts a non-economic approach to market definition. It ignores potential substitutability between different kinds of advertising, both online and offline, which can serve as a competitive constraint on the display advertising market. The complaint considers neither alternative forms of display advertising, such as social media ads, nor alternative forms of advertising, such as search ads or non-digital ads—all of which can and do act as substitutes. It is possible, at the very least, that advertisers who choose to place ads on third-party websites may switch to other forms of advertising if the price of third-party website advertising was above competitive levels. To ignore this possibility, as the Texas complaint does, is to ignore the entire purpose of defining the relevant antitrust market altogether.
Offline advertising vs. online advertising
The fact that offline and online advertising employ distinct processes does not consign them to economically distinct markets. Indeed, online advertising has manifestly drawn advertisers from offline markets, just as previous technological innovations drew advertisers from other pre-existing channels.
Moreover, there is evidence that, in some cases, offline and online advertising are substitute products. For example, economists Avi Goldfarb and Catherine Tucker demonstrate that display advertising pricing is sensitive to the availability of offline alternatives. They conclude:
We believe our studies refute the hypothesis that online and offline advertising markets operate independently and suggest a default position of substitution. Online and offline advertising markets appear to be closely related. That said, it is important not to draw any firm conclusions based on historical behavior.
Display ads vs. search ads
There is perhaps even more reason to doubt that online display advertising constitutes a distinct, economically relevant market from online search advertising.
Although casual and ill-informed claims are often made to the contrary, various forms of targeted online advertising are significant competitors of each other. Bo Xing and Zhanxi Lin report firms spread their marketing budgets across these different sources of online marketing, and “search engine optimizers”—firms that help websites to maximize the likelihood of a valuable “top-of-list” organic search placement—attract significant revenue. That is, all of these different channels vie against each other for consumer attention and offer advertisers the ability to target their advertising based on data gleaned from consumers’ interactions with their platforms.
Facebook built a business on par with Google’s thanks in large part to advertising, by taking advantage of users’ more extended engagement with the platform to assess relevance and by enabling richer, more engaged advertising than previously appeared on Google Search. It’s an entirely different model from search, but one that has turned Facebook into a competitive ad platform.
And the market continues to shift. Somewhere between 37-56% of product searches start on Amazon, according to one survey, and advertisers have noticed. This is not surprising, given Amazon’s strong ability to match consumers with advertisements, and to do so when and where consumers are more likely to make a purchase.
‘Open’ display advertising vs. ‘owned-and-operated’ display advertising
The United Kingdom’s Competition and Markets Authority (like the Omidyar Roadmap report) has identified two distinct channels of display advertising, which they term “owned and operated” and “open.” The CMA concludes:
Over half of display expenditure is generated by Facebook, which owns both the Facebook platform and Instagram. YouTube has the second highest share of display advertising and is owned by Google. The open display market, in which advertisers buy inventory from many publishers of smaller scale (for example, newspapers and app providers) comprises around 32% of display expenditure.
The Texas complaint does not directly address the distinction between open and owned and operated, but it does allege anticompetitive conduct by Google with respect to YouTube in a separate “inline video advertising market.”
The CMA finds that the owned-and-operated channel mostly comprises large social media platforms, which sell their own advertising inventory directly to advertisers or media agencies through self-service interfaces, such as Facebook Ads Manager or Snapchat Ads Manager. In contrast, in the open display channel, publishers such as online newspapers and blogs sell their inventory to advertisers through a “complex chain of intermediaries.” Through these, intermediaries run auctions that match advertisers’ ads to publisher inventory of ad space. In both channels, nearly all transactions are run through programmatic technology.
The CMA concludes that advertisers “largely see” the open and the owned-and-operated channels as substitutes. According to the CMA, an advertiser’s choice of one channel over the other is driven by each channel’s ability to meet the key performance metrics the advertising campaign is intended to achieve.
The Omidyar Roadmap argues, instead, that the CMA too narrowly focuses on the perspective of advertisers. The Roadmap authors claim that “most publishers” do not control supply that is “owned and operated.” As a result, they conclude that publishers “such as gardenandgun.com or hotels.com” do not have any owned-and-operated supply and can generate revenues from their supply “only through the Google-dominated adtech stack.”
But this is simply not true. For example, in addition to inventory in its print media, Garden & Gun’s “Digital Media Kit” indicates that the publisher has several sources of owned-and-operated banner and video supply, including the desktop, mobile, and tablet ads on its website; a “homepage takeover” of its website; branded/sponsored content; its email newsletters; and its social media accounts. Hotels.com, an operating company of Expedia Group, has its own owned-and-operated search inventory, which it sells through its “Travel Ads Sponsored Listing,” as well owned-and-operated supply of standard and custom display ads.
Given that both perform the same function and employ similar mechanisms for matching inventory with advertisers, it is unsurprising that both advertisers and publishers appear to consider the owned-and-operated channel and the open channel to be substitutes.
The American Choice and Innovation Online Act (previously called the Platform Anti-Monopoly Act), introduced earlier this summer by U.S. Rep. David Cicilline (D-R.I.), would significantly change the nature of digital platforms and, with them, the internet itself. Taken together, the bill’s provisions would turn platforms into passive intermediaries, undermining many of the features that make them valuable to consumers. This seems likely to remain the case even after potential revisions intended to minimize the bill’s unintended consequences.
In its current form, the bill is split into two parts that each is dangerous in its own right. The first, Section 2(a), would prohibit almost any kind of “discrimination” by platforms. Because it is so open-ended, lawmakers might end up removing it in favor of the nominally more focused provisions of Section 2(b), which prohibit certain named conduct. But despite being more specific, this section of the bill is incredibly far-reaching and would effectively ban swaths of essential services.
Section 2(a) essentially prohibits any behavior by a covered platform that would advantage that platform’s services over any others that also uses that platform; it characterizes this preferencing as “discrimination.”
As we wrote when the House Judiciary Committee’s antitrust bills were first announced, this prohibition on “discrimination” is so broad that, if it made it into law, it would prevent platforms from excluding or disadvantaging any product of another business that uses the platform or advantaging their own products over those of their competitors.
The underlying assumption here is that platforms should be like telephone networks: providing a way for different sides of a market to communicate with each other, but doing little more than that. When platforms do do more—for example, manipulating search results to favor certain businesses or to give their own products prominence —it is seen as exploitative “leveraging.”
But consumers often want platforms to be more than just a telephone network or directory, because digital markets would be very difficult to navigate without some degree of “discrimination” between sellers. The Internet is so vast and sellers are often so anonymous that any assistance which helps you choose among options can serve to make it more navigable. As John Gruber put it:
From what I’ve seen over the last few decades, the quality of the user experience of every computing platform is directly correlated to the amount of control exerted by its platform owner. The current state of the ownerless world wide web speaks for itself.
Sometimes, this manifests itself as “self-preferencing” of another service, to reduce additional time spent searching for the information you want. When you search for a restaurant on Google, it can be very useful to get information like user reviews, the restaurant’s phone number, a button on mobile to phone them directly, estimates of how busy it is, and a link to a Maps page to see how to actually get there.
This is, undoubtedly, frustrating for competitors like Yelp, who would like this information not to be there and for users to have to click on either a link to Yelp or a link to Google Maps. But whether it is good or bad for Yelp isn’t relevant to whether it is good for users—and it is at least arguable that it is, which makes a blanket prohibition on this kind of behavior almost inevitably harmful.
If it isn’t obvious why removing this kind of feature would be harmful for users, ask yourself why some users search in Yelp’s app directly for this kind of result. The answer, I think, is that Yelp gives you all the information above that Google does (and sometimes is better, although I tend to trust Google Maps’ reviews over Yelp’s), and it’s really convenient to have all that on the same page. If Google could not provide this kind of “rich” result, many users would probably stop using Google Search to look for restaurant information in the first place, because a new friction would have been added that made the experience meaningfully worse. Removing that option would be good for Yelp, but mainly because it removes a competitor.
If all this feels like stating the obvious, then it should highlight a significant problem with Section 2(a) in the Cicilline bill: it prohibits conduct that is directly value-adding for consumers, and that creates competition for dedicated services like Yelp that object to having to compete with this kind of conduct.
Some or all of this behavior would be prohibited under Section 2(a) of the Cicilline bill. Combined with the bill’s presumption that conduct must be defended affirmatively—that is, the platform is presumed guilty unless it can prove that the challenged conduct is pro-competitive, which may be very difficult to do—and the bill could prospectively eliminate a huge range of socially valuable behavior.
Supporters of the bill have already been left arguing that the law simply wouldn’t be enforced in these cases of benign discrimination. But this would hardly be an improvement. It would mean the Federal Trade Commission (FTC) and U.S. Justice Department (DOJ) have tremendous control over how these platforms are built, since they could challenge conduct in virtually any case. The regulatory uncertainty alone would complicate the calculus for these firms as they refine, develop, and deploy new products and capabilities.
So one potential compromise might be to do away with this broad-based rule and proscribe specific kinds of “discriminatory” conduct instead. This approach would involve removing Section 2(a) from the bill but retaining Section 2(b), which enumerates 10 practices it deems to be “other discriminatory conduct.” This may seem appealing, as it would potentially avoid the worst abuses of the broad-based prohibition. In practice, however, it would carry many of the same problems. In fact, many of 2(b)’s provisions appear to go even further than 2(a), and would proscribe even more procompetitive conduct that consumers want.
Sections 2(b)(1) and 2(b)(9)
The wording of these provisions is extremely broad and, as drafted, would seem to challenge even the existence of vertically integrated products. As such, these prohibitions are potentially even more extensive and invasive than Section 2(a) would have been. Even a narrower reading here would seem to preclude safety and privacy features that are valuable to many users. iOS’s sandboxing of apps, for example, serves to limit the damage that a malware app can do on a user’s device precisely because of the limitations it imposes on what other features and hardware the app can access.
Section 2(b)(2)
This provision would preclude a firm from conditioning preferred status on use of another service from that firm. This would likely undermine the purpose of platforms, which is to absorb and counter some of the risks involved in doing business online. An example of this is Amazon’s tying eligibility for its Prime program to sellers that use Amazon’s delivery service (FBA – Fulfilled By Amazon). The bill seems to presume in an example like this that Amazon is leveraging its power in the market—in the form of the value of the Prime label—to profit from delivery. But Amazon could, and already does, charge directly for listing positions; it’s unclear why it would benefit from charging via FBA when it could just charge for the Prime label.
An alternate, simpler explanation is that FBA improves the quality of the service, by granting customers greater assurance that a Prime product will arrive when Amazon says it will. Platforms add value by setting out rules and providing services that reduce the uncertainties between buyers and sellers they’d otherwise experience if they transacted directly with each other. This section’s prohibition—which, as written, would seem to prevent any kind of quality assurance—likely would bar labelling by a platform, even where customers explicitly want it.
Section 2(b)(3)
As written, this would prohibit platforms from using aggregated data to improve their services at all. If Apple found that 99% of its users uninstalled an app immediately after it was installed, it would be reasonable to conclude that the app may be harmful or broken in some way, and that Apple should investigate. This provision would ban that.
Sections 2(b)(4) and 2(b)(6)
These two provisions effectively prohibit a platform from using information it does not also provide to sellers. Such prohibitions ignore the fact that it is often good for sellers to lack certain information, since withholding information can prevent abuse by malicious users. For example, a seller may sometimes try to bribe their customers to post positive reviews of their products, or even threaten customers who have posted negative ones. Part of the role of a platform is to combat that kind of behavior by acting as a middleman and forcing both consumer users and business users to comply with the platform’s own mechanisms to control that kind of behavior.
If this seems overly generous to platforms—since, obviously, it gives them a lot of leverage over business users—ask yourself why people use platforms at all. It is not a coincidence that people often prefer Amazon to dealing with third-party merchants and having to navigate those merchants’ sites themselves. The assurance that Amazon provides is extremely valuable for users. Much of it comes from the company’s ability to act as a middleman in this way, lowering the transaction costs between buyers and sellers.
Section 2(b)(5)
This provision restricts the treatment of defaults. It is, however, relatively restrained when compared to, for example, the DOJ’s lawsuit against Google, which treats as anticompetitive even payment for defaults that can be changed. Still, many of the arguments that apply in that case also apply here: default status for apps can be a way to recoup income foregone elsewhere (e.g., a browser provided for free that makes its money by selling the right to be the default search engine).
Section 2(b)(7)
This section gets to the heart of why “discrimination” can often be procompetitive: that it facilitates competition between platforms. The kind of self-preferencing that this provision would prohibit can allow firms that have a presence in one market to extend that position into another, increasing competition in the process. Both Apple and Amazon have used their customer bases in smartphones and e-commerce, respectively, to grow their customer bases for video streaming, in competition with Netflix, Google’s YouTube, cable television, and each other. If Apple designed a search engine to compete with Google, it would do exactly the same thing, and we would be better off because of it. Restricting this kind of behavior is, perversely, exactly what you would do if you wanted to shield these incumbents from competition.
Section 2(b)(8)
As with other provisions, this one would preclude one of the mechanisms by which platforms add value: creating assurance for customers about the products they can expect if they visit the platform. Some of this relates to child protection; some of the most frustrating stories involve children being overcharged when they use an iPhone or Android app, and effectively being ripped off because of poor policing of the app (or insufficiently strict pricing rules by Apple or Google). This may also relate to rules that state that the seller cannot offer a cheaper product elsewhere (Amazon’s “General Pricing Rule” does this, for example). Prohibiting this would simply impose a tax on customers who cannot shop around and would prefer to use a platform that they trust has the lowest prices for the item they want.
Section 2(b)(10)
Ostensibly a “whistleblower” provision, this section could leave platforms with no recourse, not even removing a user from its platform, in response to spurious complaints intended purely to extract value for the complaining business rather than to promote competition. On its own, this sort of provision may be fairly harmless, but combined with the provisions above, it allows the bill to add up to a rent-seekers’ charter.
Conclusion
In each case above, it’s vital to remember that a reversed burden of proof applies. So, there is a high chance that the law will side against the defendant business, and a large downside for conduct that ends up being found to violate these provisions. That means that platforms will likely err on the side of caution in many cases, avoiding conduct that is ambiguous, and society will probably lose a lot of beneficial behavior in the process.
Put together, the provisions undermine much of what has become an Internet platform’s role: to act as an intermediary, de-risk transactions between customers and merchants who don’t know each other, and tweak the rules of the market to maximize its attractiveness as a place to do business. The “discrimination” that the bill would outlaw is, in practice, behavior that makes it easier for consumers to navigate marketplaces of extreme complexity and uncertainty, in which they often know little or nothing about the firms with whom they are trying to transact business.
Customers do not want platforms to be neutral, open utilities. They can choose platforms that are like that already, such as eBay. They generally tend to prefer ones like Amazon, which are not neutral and which carefully cultivate their service to be as streamlined, managed, and “discriminatory” as possible. Indeed, many of people’s biggest complaints with digital platforms relate to their openness: the fake reviews, counterfeit products, malware, and spam that come with letting more unknown businesses use your service. While these may be unavoidable by-products of running a platform, platforms compete on their ability to ferret them out. Customers are unlikely to thank legislators for regulating Amazon into being another eBay.
Politico has released a cache of confidential Federal Trade Commission (FTC) documents in connection with a series of articles on the commission’s antitrust probe into Google Search a decade ago. The headline of the first piece in the series argues the FTC “fumbled the future” by failing to follow through on staff recommendations to pursue antitrust intervention against the company.
But while the leaked documents shed interesting light on the inner workings of the FTC, they do very little to substantiate the case that the FTC dropped the ball when the commissioners voted unanimously not to bring an action against Google.
Drawn primarily from memos by the FTC’s lawyers, the Politico report purports to uncover key revelations that undermine the FTC’s decision not to sue Google. None of the revelations, however, provide evidence that Google’s behavior actually harmed consumers.
The report’s overriding claim—and the one most consistently forwarded by antitrust activists on Twitter—is that FTC commissioners wrongly sided with the agency’s economists (who cautioned against intervention) rather than its lawyers (who tenuously recommended very limited intervention).
One thing that really comes through in @leah_nylen excellent set of articles on the FTC decision to abandon the GOOG lawsuit is just how *wrong* the economists were. /1
16. But the biggest reason is the point of the post. Economists. The commission’s antitrust economists made a very strong, and entirely wrong, argument against the case, which in retrospect rested on a set of laughably inaccurate predictions. pic.twitter.com/L5ecQcurAd
Reading through @leah_nylen's incredible scoop on how FTC dropped the ball on Google in 2013. This passage from the economics memo stands out as emblematic of the ways economists have repeatedly fumbled antitrust enforcement. pic.twitter.com/lKBgVfxI4H
Indeed, the overarching narrative is that the lawyers knew what was coming and the economists took wildly inaccurate positions that turned out to be completely off the mark:
But the FTC’s economists successfully argued against suing the company, and the agency’s staff experts made a series of predictions that would fail to match where the online world was headed:
— They saw only “limited potential for growth” in ads that track users across the web — now the backbone of Google parent company Alphabet’s $182.5 billion in annual revenue.
— They expected consumers to continue relying mainly on computers to search for information. Today, about 62 percent of those queries take place on mobile phones and tablets, nearly all of which use Google’s search engine as the default.
— They thought rivals like Microsoft, Mozilla or Amazon would offer viable competition to Google in the market for the software that runs smartphones. Instead, nearly all U.S. smartphones run on Google’s Android and Apple’s iOS.
— They underestimated Google’s market share, a heft that gave it power over advertisers as well as companies like Yelp and Tripadvisor that rely on search results for traffic.
The report thus asserts that:
The agency ultimately voted against taking action, saying changes Google made to its search algorithm gave consumers better results and therefore didn’t unfairly harm competitors.
That conclusion underplays what the FTC’s staff found during the probe. In 312 pages of documents, the vast majority never publicly released, staffers outlined evidence that Google had taken numerous steps to ensure it would continue to dominate the market — including emerging arenas such as mobile search and targeted advertising. [EMPHASIS ADDED]
What really emerges from the leaked memos, however, is analysis by both the FTC’s lawyers and economists infused with a healthy dose of humility. There were strong political incentives to bring a case. As one of us noted upon the FTC’s closing of the investigation: “It’s hard to imagine an agency under more pressure, from more quarters (including the Hill), to bring a case around search.” Yet FTC staff and commissioners resisted that pressure, because prediction is hard.
Ironically, the very prediction errors that the agency’s staff cautioned against are now being held against them. Yet the claims that these errors (especially the economists’) systematically cut in one direction (i.e., against enforcement) and that all of their predictions were wrong are both wide of the mark.
Decisions Under Uncertainty
In seeking to make an example out of the FTC economists’ inaccurate predictions, critics ignore that antitrust investigations in dynamic markets always involve a tremendous amount of uncertainty; false predictions are the norm. Accordingly, the key challenge for policymakers is not so much to predict correctly, but to minimize the impact of incorrect predictions.
Seen in this light, the FTC economists’ memo is far from the laissez-faire manifesto that critics make it out to be. Instead, it shows agency officials wrestling with uncertain market outcomes, and choosing a course of action under the assumption the predictions they make might indeed be wrong.
Consider the following passage from FTC economist Ken Heyer’s memo:
The great American philosopher Yogi Berra once famously remarked “Predicting is difficult, especially about the future.” How right he was. And yet predicting, and making decisions based on those predictions, is what we are charged with doing. Ignoring the potential problem is not an option. So I will be reasonably clear about my own tentative conclusions and recommendation, recognizing that reasonable people, perhaps applying a somewhat different standard, may disagree. My recommendation derives from my read of the available evidence, combined with the standard I personally find appropriate to apply to Commission intervention. [EMPHASIS ADDED]
In other words, contrary to what many critics have claimed, it simply is not the case that the FTC’s economists based their recommendations on bullish predictions about the future that ultimately failed to transpire. Instead, they merely recognized that, in a dynamic and unpredictable environment, antitrust intervention requires both a clear-cut theory of anticompetitive harm and a reasonable probability that remedies can improve consumer welfare. According to the economists, those conditions were absent with respect to Google Search.
Perhaps more importantly, it is worth asking why the economists’ erroneous predictions matter at all. Do critics believe that developments the economists missed warrant a different normative stance today?
In that respect, it is worth noting that the economists’ skepticism appeared to have rested first and foremost on the speculative nature of the harms alleged and the difficulty associated with designing appropriate remedies. And yet, if anything, these two concerns appear even more salient today.
Indeed, the remedies imposed against Google in the EU have not delivered the outcomes that enforcers expected (here and here). This could either be because the remedies were insufficient or because Google’s market position was not due to anticompetitive conduct. Similarly, there is still no convincing economic theory or empirical research to support the notion that exclusive pre-installation and self-preferencing by incumbents harm consumers, and a great deal of reason to think they benefit them (see, e.g., our discussions of the issue here and here).
Against this backdrop, criticism of the FTC economists appears to be driven more by a prior assumption that intervention is necessary—and that it was and is disingenuous to think otherwise—than evidence that erroneous predictions materially affected the outcome of the proceedings.
To take one example, the fact that ad tracking grew faster than the FTC economists believed it would is no less consistent with vigorous competition—and Google providing a superior product—than with anticompetitive conduct on Google’s part. The same applies to the growth of mobile operating systems. Ditto the fact that no rival has managed to dislodge Google in its most important markets.
In short, not only were the economist memos informed by the very prediction difficulties that critics are now pointing to, but critics have not shown that any of the staff’s (inevitably) faulty predictions warranted a different normative outcome.
Putting Erroneous Predictions in Context
So what were these faulty predictions, and how important were they? Politico asserts that “the FTC’s economists successfully argued against suing the company, and the agency’s staff experts made a series of predictions that would fail to match where the online world was headed,” tying this to the FTC’s failure to intervene against Google over “tactics that European regulators and the U.S. Justice Department would later label antitrust violations.” The clear message is that the current actions are presumptively valid, and that the FTC’s economists thwarted earlier intervention based on faulty analysis.
But it is far from clear that these faulty predictions would have justified taking a tougher stance against Google. One key question for antitrust authorities is whether they can be reasonably certain that more efficient competitors will be unable to dislodge an incumbent. This assessment is necessarily forward-looking. Framed this way, greater market uncertainty (for instance, because policymakers are dealing with dynamic markets) usually cuts against antitrust intervention.
This does not entirely absolve the FTC economists who made the faulty predictions. But it does suggest the right question is not whether the economists made mistakes, but whether virtually everyone did so. The latter would be evidence of uncertainty, and thus weigh against antitrust intervention.
In that respect, it is worth noting that the staff who recommended that the FTC intervene also misjudged the future of digital markets.For example, while Politico surmises that the FTC “underestimated Google’s market share, a heft that gave it power over advertisers as well as companies like Yelp and Tripadvisor that rely on search results for traffic,” there is a case to be made that the FTC overestimated this power. If anything, Google’s continued growth has opened new niches in the online advertising space.
Politico asserts not only that the economists’ market share and market power calculations were wrong, but that the lawyers knew better:
The economists, relying on data from the market analytics firm Comscore, found that Google had only limited impact. They estimated that between 10 and 20 percent of traffic to those types of sites generally came from the search engine.
FTC attorneys, though, used numbers provided by Yelp and found that 92 percent of users visited local review sites from Google. For shopping sites like eBay and TheFind, the referral rate from Google was between 67 and 73 percent.
This compares apples and oranges, or maybe oranges and grapefruit. The economists’ data, from Comscore, applied to vertical search overall. They explicitly noted that shares for particular sites could be much higher or lower: for comparison shopping, for example, “ranging from 56% to less than 10%.” This, of course, highlights a problem with the data provided by Yelp, et al.: it concerns only the websites of companies complaining about Google, not the overall flow of traffic for vertical search.
But the more important point is that none of the data discussed in the memos represents the overall flow of traffic for vertical search. Take Yelp, for example. According to the lawyers’ memo, 92 percent of Yelp searches were referred from Google. Only, that’s not true. We know it’s not true because, as Yelp CEO Jerry Stoppelman pointed out around this time in Yelp’s 2012 Q2 earnings call:
When you consider that 40% of our searches come from mobile apps, there is quite a bit of un-monetized mobile traffic that we expect to unlock in the near future.
The numbers being analyzed by the FTC staff were apparently limited to referrals to Yelp’s website from browsers. But is there any reason to think that is the relevant market, or the relevant measure of customer access? Certainly there is nothing in the staff memos to suggest they considered the full scope of the market very carefully here. Indeed, the footnote in the lawyers’ memo presenting the traffic data is offered in support of this claim:
Vertical websites, such as comparison shopping and local websites, are heavily dependent on Google’s web search results to reach users. Thus, Google is in the unique position of being able to “make or break any web-based business.”
It’s plausible that vertical search traffic is “heavily dependent” on Google Search, but the numbers offered in support of that simply ignore the (then) 40 percent of traffic that Yelp acquired through its own mobile app, with no Google involvement at all. In any case, it is also notable that, while there are still somewhat fewer app users than web users (although the number has consistently increased), Yelp’s app users view significantly more pages than its website users do — 10 times as many in 2015, for example.
Also noteworthy is that, for whatever speculative harm Google might be able to visit on the company, at the time of the FTC’s analysis Yelp’s local ad revenue was consistently increasing — by 89% in Q3 2012. And that was without any ad revenue coming from its app (display ads arrived on Yelp’s mobile app in Q1 2013, a few months after the staff memos were written and just after the FTC closed its Google Search investigation).
In short, the search-engine industry is extremely dynamic and unpredictable. Contrary to what many have surmised from the FTC staff memo leaks, this cuts against antitrust intervention, not in favor of it.
The FTC Lawyers’ Weak Case for Prosecuting Google
At the same time, although not discussed by Politico, the lawyers’ memo also contains errors, suggesting that arguments for intervention were also (inevitably) subject to erroneous prediction.
Among other things, the FTC attorneys’ memo argued the large upfront investments were required to develop cutting-edge algorithms, and that these effectively shielded Google from competition. The memo cites the following as a barrier to entry:
A search engine requires algorithmic technology that enables it to search the Internet, retrieve and organize information, index billions of regularly changing web pages, and return relevant results instantaneously that satisfy the consumer’s inquiry. Developing such algorithms requires highly specialized personnel with high levels of training and knowledge in engineering, economics, mathematics, sciences, and statistical analysis.
If there are barriers to entry in the search-engine industry, algorithms do not seem to be the source. While their market shares may be smaller than Google’s, rival search engines like DuckDuckGo and Bing have been able to enter and gain traction; it is difficult to say that algorithmic technology has proven a barrier to entry. It may be hard to do well, but it certainly has not proved an impediment to new firms entering and developing workable and successful products. Indeed, some extremely successful companies have entered into similar advertising markets on the backs of complex algorithms, notably Instagram, Snapchat, and TikTok. All of these compete with Google for advertising dollars.
The FTC’s legal staff also failed to see that Google would face serious competition in the rapidly growing voice assistant market. In other words, even its search-engine “moat” is far less impregnable than it might at first appear.
Moreover, as Ben Thompson argues in his Stratechery newsletter:
The Staff memo is completely wrong too, at least in terms of the potential for their proposed remedies to lead to any real change in today’s market. This gets back to why the fundamental premise of the Politico article, along with much of the antitrust chatter in Washington, misses the point: Google is dominant because consumers like it.
This difficulty was deftly highlighted by Heyer’s memo:
If the perceived problems here can be solved only through a draconian remedy of this sort, or perhaps through a remedy that eliminates Google’s legitimately obtained market power (and thus its ability to “do evil”), I believe the remedy would be disproportionate to the violation and that its costs would likely exceed its benefits. Conversely, if a remedy well short of this seems likely to prove ineffective, a remedy would be undesirable for that reason. In brief, I do not see a feasible remedy for the vertical conduct that would be both appropriate and effective, and which would not also be very costly to implement and to police. [EMPHASIS ADDED]
Of course, we now know that this turned out to be a huge issue with the EU’s competition cases against Google. The remedies in both the EU’s Google Shopping and Android decisions were severely criticized by rival firms and consumer-defense organizations (here and here), but were ultimately upheld, in part because even the European Commission likely saw more forceful alternatives as disproportionate.
And in the few places where the legal staff concluded that Google’s conduct may have caused harm, there is good reason to think that their analysis was flawed.
Google’s ‘revenue-sharing’ agreements
It should be noted that neither the lawyers nor the economists at the FTC were particularly bullish on bringing suit against Google. In most areas of the investigation, neither recommended that the commission pursue a case. But one of the most interesting revelations from the recent leaks is that FTC lawyers did advise the commission’s leadership to sue Google over revenue-sharing agreements that called for it to pay Apple and other carriers and manufacturers to pre-install its search bar on mobile devices:
FTC staff urged the agency’s five commissioners to sue Google for signing exclusive contracts with Apple and the major wireless carriers that made sure the company’s search engine came pre-installed on smartphones.
The lawyers’ stance is surprising, and, despite actions subsequently brought by the EU and DOJ on similar claims, a difficult one to countenance.
To a first approximation, this behavior is precisely what antitrust law seeks to promote: we want companies to compete aggressively to attract consumers. This conclusion is in no way altered when competition is “for the market” (in this case, firms bidding for exclusive placement of their search engines) rather than “in the market” (i.e., equally placed search engines competing for eyeballs).
Competition for exclusive placement has several important benefits. For a start, revenue-sharing agreements effectively subsidize consumers’ mobile device purchases. As Brian Albrecht aptly puts it:
This payment from Google means that Apple can lower its price to better compete for consumers. This is standard; some of the payment from Google to Apple will be passed through to consumers in the form of lower prices.
This finding is not new. For instance, Ronald Coase famously argued that the Federal Communications Commission (FCC) was wrong to ban the broadcasting industry’s equivalent of revenue-sharing agreements, so-called payola:
[I]f the playing of a record by a radio station increases the sales of that record, it is both natural and desirable that there should be a charge for this. If this is not done by the station and payola is not allowed, it is inevitable that more resources will be employed in the production and distribution of records, without any gain to consumers, with the result that the real income of the community will tend to decline. In addition, the prohibition of payola may result in worse record programs, will tend to lessen competition, and will involve additional expenditures for regulation. The gain which the ban is thought to bring is to make the purchasing decisions of record buyers more efficient by eliminating “deception.” It seems improbable to me that this problematical gain will offset the undoubted losses which flow from the ban on Payola.
Applying this logic to Google Search, it is clear that a ban on revenue-sharing agreements would merely lead both Google and its competitors to attract consumers via alternative means. For Google, this might involve “complete” vertical integration into the mobile phone market, rather than the open-licensing model that underpins the Android ecosystem. Valuable specialization may be lost in the process.
Moreover, from Apple’s standpoint, Google’s revenue-sharing agreements are profitable only to the extent that consumers actually like Google’s products. If it turns out they don’t, Google’s payments to Apple may be outweighed by lower iPhone sales. It is thus unlikely that these agreements significantly undermined users’ experience. To the contrary, Apple’s testimony before the European Commission suggests that “exclusive” placement of Google’s search engine was mostly driven by consumer preferences (as the FTC economists’ memo points out):
Apple would not offer simultaneous installation of competing search or mapping applications. Apple’s focus is offering its customers the best products out of the box while allowing them to make choices after purchase. In many countries, Google offers the best product or service … Apple believes that offering additional search boxes on its web browsing software would confuse users and detract from Safari’s aesthetic. Too many choices lead to consumer confusion and greatly affect the ‘out of the box’ experience of Apple products.
Similarly, Kevin Murphy and Benjamin Klein have shown that exclusive contracts intensify competition for distribution. In other words, absent theories of platform envelopment that are arguably inapplicable here, competition for exclusive placement would lead competing search engines to up their bids, ultimately lowering the price of mobile devices for consumers.
Indeed, this revenue-sharing model was likely essential to spur the development of Android in the first place. Without this prominent placement of Google Search on Android devices (notably thanks to revenue-sharing agreements with original equipment manufacturers), Google would likely have been unable to monetize the investment it made in the open source—and thus freely distributed—Android operating system.
In short, Politico and the FTC legal staff do little to show that Google’s revenue-sharing payments excluded rivals that were, in fact, as efficient. In other words, Bing and Yahoo’s failure to gain traction may simply be the result of inferior products and cost structures. Critics thus fail to show that Google’s behavior harmed consumers, which is the touchstone of antitrust enforcement.
Self-preferencing
Another finding critics claim as important is that FTC leadership declined to bring suit against Google for preferencing its own vertical search services (this information had already been partially leaked by the Wall Street Journal in 2015). Politico’s framing implies this was a mistake:
When Google adopted one algorithm change in 2011, rival sites saw significant drops in traffic. Amazon told the FTC that it saw a 35 percent drop in traffic from the comparison-shopping sites that used to send it customers
The focus on this claim is somewhat surprising. Even the leaked FTC legal staff memo found this theory of harm had little chance of standing up in court:
Staff has investigated whether Google has unlawfully preferenced its own content over that of rivals, while simultaneously demoting rival websites….
…Although it is a close call, we do not recommend that the Commission proceed on this cause of action because the case law is not favorable to our theory, which is premised on anticompetitive product design, and in any event, Google’s efficiency justifications are strong. Most importantly, Google can legitimately claim that at least part of the conduct at issue improves its product and benefits users. [EMPHASIS ADDED]
More importantly, as one of us has argued elsewhere, the underlying problem lies not with Google, but with a standard asset-specificity trap:
A content provider that makes itself dependent upon another company for distribution (or vice versa, of course) takes a significant risk. Although it may benefit from greater access to users, it places itself at the mercy of the other — or at least faces great difficulty (and great cost) adapting to unanticipated, crucial changes in distribution over which it has no control….
…It was entirely predictable, and should have been expected, that Google’s algorithm would evolve. It was also entirely predictable that it would evolve in ways that could diminish or even tank Foundem’s traffic. As one online marketing/SEO expert puts it: On average, Google makes about 500 algorithm changes per year. 500!….
…In the absence of an explicit agreement, should Google be required to make decisions that protect a dependent company’s “asset-specific” investments, thus encouraging others to take the same, excessive risk?
Even if consumers happily visited rival websites when they were higher-ranked and traffic subsequently plummeted when Google updated its algorithm, that drop in traffic does not amount to evidence of misconduct. To hold otherwise would be to grant these rivals a virtual entitlement to the state of affairs that exists at any given point in time.
Indeed, there is good reason to believe Google’s decision to favor its own content over that of other sites is procompetitive. Beyond determining and ensuring relevance, Google surely has the prerogative to compete vigorously and decide how to design its products to keep up with a changing market. In this case, that means designing, developing, and offering its own content in ways that partially displace the original “ten blue links” design of its search results page and instead offer its own answers to users’ queries.
Competitor Harm Is Not an Indicator of the Need for Intervention
Some of the other information revealed by the leak is even more tangential, such as that the FTC ignored complaints from Google’s rivals:
Amazon said it was so concerned about the prospect of Google monopolizing the search advertising business that it willingly sacrificed revenue by making ad deals aimed at keeping Microsoft’s Bing and Yahoo’s search engine afloat.
But complaints from rivals are at least as likely to stem from vigorous competition as from anticompetitive exclusion. This goes to a core principle of antitrust enforcement: antitrust law seeks to protect competition and consumer welfare, not rivals. Competition will always lead to winners and losers. Antitrust law protects this process and (at least theoretically) ensures that rivals cannot manipulate enforcers to safeguard their economic rents.
This explains why Frank Easterbrook—in his seminal work on “The Limits of Antitrust”—argued that enforcers should be highly suspicious of complaints lodged by rivals:
Antitrust litigation is attractive as a method of raising rivals’ costs because of the asymmetrical structure of incentives….
…One line worth drawing is between suits by rivals and suits by consumers. Business rivals have an interest in higher prices, while consumers seek lower prices. Business rivals seek to raise the costs of production, while consumers have the opposite interest….
…They [antitrust enforcers] therefore should treat suits by horizontal competitors with the utmost suspicion. They should dismiss outright some categories of litigation between rivals and subject all such suits to additional scrutiny.
Google’s competitors spent millions pressuring the FTC to bring a case against the company. But why should it be a failing for the FTC to resist such pressure? Indeed, as then-commissioner Tom Rosch admonished in an interview following the closing of the case:
They [Google’s competitors] can darn well bring [a case] as a private antitrust action if they think their ox is being gored instead of free-riding on the government to achieve the same result.
Not that they would likely win such a case. Google’s introduction of specialized shopping results (via the Google Shopping box) likely enabled several retailers to bypass the Amazon platform, thus increasing competition in the retail industry. Although this may have temporarily reduced Amazon’s traffic and revenue (Amazon’s sales have grown dramatically since then), it is exactly the outcome that antitrust laws are designed to protect.
Conclusion
When all is said and done, Politico’s revelations provide a rarely glimpsed look into the complex dynamics within the FTC, which many wrongly imagine to be a monolithic agency. Put simply, the FTC’s commissioners, lawyers, and economists often disagree vehemently about the appropriate course of conduct. This is a good thing. As in many other walks of life, having a market for ideas is a sure way to foster sound decision making.
But in the final analysis, what the revelations do not show is that the FTC’s market for ideas failed consumers a decade ago when it declined to bring an antitrust suit against Google. They thus do little to cement the case for antitrust intervention—whether a decade ago, or today.
Critics of big tech companies like Google and Amazon are increasingly focused on the supposed evils of “self-preferencing.” This refers to when digital platforms like Amazon Marketplace or Google Search, which connect competing services with potential customers or users, also offer (and sometimes prioritize) their own in-house products and services.
The objection, raised by several members and witnesses during a Feb. 25 hearing of the House Judiciary Committee’s antitrust subcommittee, is that it is unfair to third parties that use those sites to allow the site’s owner special competitive advantages. Is it fair, for example, for Amazon to use the data it gathers from its service to design new products if third-party merchants can’t access the same data? This seemingly intuitive complaint was the basis for the European Commission’s landmark case against Google.
But we cannot assume that something is bad for competition just because it is bad for certain competitors. A lot of unambiguously procompetitive behavior, like cutting prices, also tends to make life difficult for competitors. The same is true when a digital platform provides a service that is better than alternatives provided by the site’s third-party sellers.
It’s probably true that Amazon’s access to customer search and purchase data can help it spot products it can undercut with its own versions, driving down prices. But that’s not unusual; most retailers do this, many to a much greater extent than Amazon. For example, you can buy AmazonBasics batteries for less than half the price of branded alternatives, and they’re pretty good.
There’s no doubt this is unpleasant for merchants that have to compete with these offerings. But it is also no different from having to compete with more efficient rivals who have lower costs or better insight into consumer demand. Copying products and seeking ways to offer them with better features or at a lower price, which critics of self-preferencing highlight as a particular concern, has always been a fundamental part of market competition—indeed, it is the primary way competition occurs in most markets.
Store-branded versions of iPhone cables and Nespresso pods are certainly inconvenient for those companies, but they offer consumers cheaper alternatives. Where such copying may be problematic (say, by deterring investments in product innovations), the law awards and enforces patents and copyrights to reward novel discoveries and creative works, and trademarks to protect brand identity. But in the absence of those cases where a company has intellectual property, this is simply how competition works.
The fundamental question is “what benefits consumers?” Services like Yelp object that they cannot compete with Google when Google embeds its Google Maps box in Google Search results, while Yelp cannot do the same. But for users, the Maps box adds valuable information to the results page, making it easier to get what they want. Google is not making Yelp worse by making its own product better. Should it have to refrain from offering services that benefit its users because doing so might make competing products comparatively less attractive?
Self-preferencing also enables platforms to promote their offerings in other markets, which is often how large tech companies compete with each other. Amazon has a photo-hosting app that competes with Google Photos and Apple’s iCloud. It recently emailed its customers to promote it. That is undoubtedly self-preferencing, since other services cannot market themselves to Amazon’s customers like this, but if it makes customers aware of an alternative they might not have otherwise considered, that is good for competition.
This kind of behavior also allows companies to invest in offering services inexpensively, or for free, that they intend to monetize by preferencing their other, more profitable products. For example, Google invests in Android’s operating system and gives much of it away for free precisely because it can encourage Android customers to use the profitable Google Search service. Despite claims to the contrary, it is difficult to see this sort of cross-subsidy as harmful to consumers.
All platforms are open or closed to varying degrees. Retail “platforms,” for example, exist on a spectrum on which Craigslist is more open and neutral than eBay, which is more so than Amazon, which is itself relatively more so than, say, Walmart.com. Each position on this spectrum offers its own benefits and trade-offs for consumers. Indeed, some customers’ biggest complaint against Amazon is that it is too open, filled with third parties who leave fake reviews, offer counterfeit products, or have shoddy returns policies. Part of the role of the site is to try to correct those problems by making better rules, excluding certain sellers, or just by offering similar options directly.
Regulators and legislators often act as if the more open and neutral, the better, but customers have repeatedly shown that they often prefer less open, less neutral options. And critics of self-preferencing frequently find themselves arguing against behavior that improves consumer outcomes, because it hurts competitors. But that is the nature of competition: what’s good for consumers is frequently bad for competitors. If we have to choose, it’s consumers who should always come first.
[TOTM: The following is part of a digital symposium by TOTM guests and authors on the law, economics, and policy of the antitrust lawsuits against Google. The entire series of posts is available here.]
The U.S. Department of Justice’s (DOJ) antitrust case against Google, which was filed in October 2020, will be a tough slog.[1] It is an alleged monopolization (Sherman Act, Sec. 2) case; and monopolization cases are always a tough slog.
In this brief essay I will lay out some of the issues in the case and raise an intriguing possibility.
What is the case about?
The case is about exclusivity and exclusion in the distribution of search engine services; that Google paid substantial sums to Apple and to the manufacturers of Android-based mobile phones and tablets and also to wireless carriers and web-browser proprietors—in essence, to distributors—to install the Google search engine as the exclusive pre-set (installed), default search program. The suit alleges that Google thereby made it more difficult for other search-engine providers (e.g., Bing; DuckDuckGo) to obtain distribution for their search-engine services and thus to attract search-engine users and to sell the online advertising that is associated with search-engine use and that provides the revenue to support the search “platform” in this “two-sided market” context.[2]
Exclusion can be seen as a form of “raising rivals’ costs.”[3] Equivalently, exclusion can be seen as a form of non-price predation. Under either interpretation, the exclusionary action impedes competition.
It’s important to note that these allegations are different from those that motivated an investigation by the Federal Trade Commission (which the FTC dropped in 2013) and the cases by the European Union against Google.[4] Those cases focused on alleged self-preferencing; that Google was unduly favoring its own products and services (e.g., travel services) in its delivery of search results to users of its search engine. In those cases, the impairment of competition (arguably) happens with respect to those competing products and services, not with respect to search itself.
What is the relevant market?
For a monopolization allegation to have any meaning, there needs to be the exercise of market power (which would have adverse consequences for the buyers of the product). And in turn, that exercise of market power needs to occur in a relevant market: one in which market power can be exercised.
Here is one of the important places where the DOJ’s case is likely to turn into a slog: the delineation of a relevant market for alleged monopolization cases remains as a largely unsolved problem for antitrust economics.[5] This is in sharp contrast to the issue of delineating relevant markets for the antitrust analysis of proposed mergers. For this latter category, the paradigm of the “hypothetical monopolist” and the possibility that this hypothetical monopolist could prospectively impose a “small but significant non-transitory increase in price” (SSNIP) has carried the day for the purposes of market delineation.
But no such paradigm exists for monopolization cases, in which the usual allegation is that the defendant already possesses market power and has used the exclusionary actions to buttress that market power. To see the difficulties, it is useful to recall the basic monopoly diagram from Microeconomics 101. A monopolist faces a negatively sloped demand curve for its product (at higher prices, less is bought; at lower prices, more is bought) and sets a profit-maximizing price at the level of output where its marginal revenue (MR) equals its marginal costs (MC). Its price is thereby higher than an otherwise similar competitive industry’s price for that product (to the detriment of buyers) and the monopolist earns higher profits than would the competitive industry.
But unless there are reliable benchmarks as to what the competitive price and profits would otherwise be, any information as to the defendant’s price and profits has little value with respect to whether the defendant already has market power. Also, a claim that a firm does not have market power because it faces rivals and thus isn’t able profitably to raise its price from its current level (because it would lose too many sales to those rivals) similarly has no value. Recall the monopolist from Micro 101. It doesn’t set a higher price than the one where MR=MC, because it would thereby lose too many sales to other sellers of other things.
Thus, any firm—regardless of whether it truly has market power (like the Micro 101 monopolist) or is just another competitor in a sea of competitors—should have already set its price at its profit-maximizing level and should find it unprofitable to raise its price from that level.[6] And thus the claim, “Look at all of the firms that I compete with! I don’t have market power!” similarly has no informational value.
Let us now bring this problem back to the Google monopolization allegation: What is the relevant market? In the first instance, it has to be “the provision of answers to user search queries.” After all, this is the “space” in which the exclusion occurred. But there are categories of search: e.g., search for products/services, versus more general information searches (“What is the current time in Delaware?” “Who was the 21st President of the United States?”). Do those separate categories themselves constitute relevant markets?
Further, what would the exercise of market power in a (delineated relevant) market look like? Higher-than-competitive prices for advertising that targets search-results recipients is one obvious answer (but see below). In addition, because this is a two-sided market, the competitive “price” (or prices) might involve payments by the search engine to the search users (in return for their exposure to the lucrative attached advertising).[7] And product quality might exhibit less variety than a competitive market would provide; and/or the monopolistic average level of quality would be lower than in a competitive market: e.g., more abuse of user data, and/or deterioration of the delivered information itself, via more self-preferencing by the search engine and more advertising-driven preferencing of results.[8]
In addition, a natural focus for a relevant market is the advertising that accompanies the search results. But now we are at the heart of the difficulty of delineating a relevant market in a monopolization context. If the relevant market is “advertising on search engine results pages,” it seems highly likely that Google has market power. If the relevant market instead is all online U.S. advertising (of which Google’s revenue share accounted for 32% in 2019[9]), then the case is weaker; and if the relevant market is all advertising in the United States (which is about twice the size of online advertising[10]), the case is weaker still. Unless there is some competitive benchmark, there is no easy way to delineate the relevant market.[11]
What exactly has Google been paying for, and why?
As many critics of the DOJ’s case have pointed out, it is extremely easy for users to switch their default search engine. If internet search were a normal good or service, this ease of switching would leave little room for the exercise of market power. But in that case, why is Google willing to pay $8-$12 billion annually for the exclusive default setting on Apple devices and large sums to the manufacturers of Android-based devices (and to wireless carriers and browser proprietors)? Why doesn’t Google instead run ads in prominent places that remind users how superior Google’s search results are and how easy it is for users (if they haven’t already done so) to switch to the Google search engine and make Google the user’s default choice?
Suppose that user inertia is important. Further suppose that users generally have difficulty in making comparisons with respect to the quality of delivered search results. If this is true, then being the default search engine on Apple and Android-based devices and on other distribution vehicles would be valuable. In this context, the inertia of their customers is a valuable “asset” of the distributors that the distributors may not be able to take advantage of, but that Google can (by providing search services and selling advertising). The question of whether Google’s taking advantage of this user inertia means that Google exercises market power takes us back to the issue of delineating the relevant market.
There is a further wrinkle to all of this. It is a well-understood concept in antitrust economics that an incumbent monopolist will be willing to pay more for the exclusive use of an essential input than a challenger would pay for access to the input.[12] The basic idea is straightforward. By maintaining exclusive use of the input, the incumbent monopolist preserves its (large) monopoly profits. If the challenger enters, the incumbent will then earn only its share of the (much lower, more competitive) duopoly profits. Similarly, the challenger can expect only the lower duopoly profits. Accordingly, the incumbent should be willing to outbid (and thereby exclude) the challenger and preserve the incumbent’s exclusive use of the input, so as to protect those monopoly profits.
To bring this to the Google monopolization context, if Google does possess market power in some aspect of search—say, because online search-linked advertising is a relevant market—then Google will be willing to outbid Microsoft (which owns Bing) for the “asset” of default access to Apple’s (inertial) device owners. That Microsoft is a large and profitable company and could afford to match (or exceed) Google’s payments to Apple is irrelevant. If the duopoly profits for online search-linked advertising would be substantially lower than Google’s current profits, then Microsoft would not find it worthwhile to try to outbid Google for that default access asset.
Alternatively, this scenario could be wholly consistent with an absence of market power. If search users (who can easily switch) consider Bing to be a lower-quality search service, then large payments by Microsoft to outbid Google for those exclusive default rights would be largely wasted, since the “acquired” default search users would quickly switch to Google (unless Microsoft provided additional incentives for the users not to switch).
But this alternative scenario returns us to the original puzzle: Why is Google making such large payments to the distributors for those exclusive default rights?
An intriguing possibility
Consider the following possibility. Suppose that Google was paying that $8-$12 billion annually to Apple in return for the understanding that Apple would not develop its own search engine for Apple’s device users.[13] This possibility was not raised in the DOJ’s complaint, nor is it raised in the subsequent suits by the state attorneys general.
But let’s explore the implications by going to an extreme. Suppose that Google and Apple had a formal agreement that—in return for the $8-$12 billion per year—Apple would not develop its own search engine. In this event, this agreement not to compete would likely be seen as a violation of Section 1 of the Sherman Act (which does not require a market delineation exercise) and Apple would join Google as a co-conspirator. The case would take on the flavor of the FTC’s prosecution of “pay-for-delay” agreements between the manufacturers of patented pharmaceuticals and the generic drug manufacturers that challenge those patents and then receive payments from the former in return for dropping the patent challenge and delaying the entry of the generic substitute.[14]
As of this writing, there is no evidence of such an agreement and it seems quite unlikely that there would have been a formal agreement. But the DOJ will be able to engage in discovery and take depositions. It will be interesting to find out what the relevant executives at Google—and at Apple—thought was being achieved by those payments.
What would be a suitable remedy/relief?
The DOJ’s complaint is vague with respect to the remedy that it seeks. This is unsurprising. The DOJ may well want to wait to see how the case develops and then amend its complaint.
However, even if Google’s actions have constituted monopolization, it is difficult to conceive of a suitable and effective remedy. One apparently straightforward remedy would be to require simply that Google not be able to purchase exclusivity with respect to the pre-set default settings. In essence, the device manufacturers and others would always be able to sell parallel default rights to other search engines: on the basis, say, that the default rights for some categories of customers—or even a percentage of general customers (randomly selected)—could be sold to other search-engine providers.
But now the Gilbert-Newbery insight comes back into play. Suppose that a device manufacturer knows (or believes) that Google will pay much more if—even in the absence of any exclusivity agreement—Google ends up being the pre-set search engine for all (or nearly all) of the manufacturer’s device sales, as compared with what the manufacturer would receive if those default rights were sold to multiple search-engine providers (including, but not solely, Google). Can that manufacturer (recall that the distributors are not defendants in the case) be prevented from making this sale to Google and thus (de facto) continuing Google’s exclusivity?[15]
Even a requirement that Google not be allowed to make any payment to the distributors for a default position may not improve the competitive environment. Google may be able to find other ways of making indirect payments to distributors in return for attaining default rights, e.g., by offering them lower rates on their online advertising.
Further, if the ultimate goal is an efficient outcome in search, it is unclear how far restrictions on Google’s bidding behavior should go. If Google were forbidden from purchasing any default installation rights for its search engine, would (inert) consumers be better off? Similarly, if a distributor were to decide independently that its customers were better served by installing the Google search engine as the default, would that not be allowed? But if it is allowed, how could one be sure that Google wasn’t indirectly paying for this “independent” decision (e.g., through favorable advertising rates)?
It’s important to remember that this (alleged) monopolization is different from the Standard Oil case of 1911 or even the (landline) AT&T case of 1984. In those cases, there were physical assets that could be separated and spun off to separate companies. For Google, physical assets aren’t important. Although it is conceivable that some of Google’s intellectual property—such as Gmail, YouTube, or Android—could be spun off to separate companies, doing so would do little to cure the (arguably) fundamental problem of the inert device users.
In addition, if there were an agreement between Google and Apple for the latter not to develop a search engine, then large fines for both parties would surely be warranted. But what next? Apple can’t be forced to develop a search engine.[16] This differentiates such an arrangement from the “pay-for-delay” arrangements for pharmaceuticals, where the generic manufacturers can readily produce a near-identical substitute for the patented drug and are otherwise eager to do so.
At the end of the day, forbidding Google from paying for exclusivity may well be worth trying as a remedy. But as the discussion above indicates, it is unlikely to be a panacea and is likely to require considerable monitoring for effective enforcement.
Conclusion
The DOJ’s case against Google will be a slog. There are unresolved issues—such as how to delineate a relevant market in a monopolization case—that will be central to the case. Even if the DOJ is successful in showing that Google violated Section 2 of the Sherman Act in monopolizing search and/or search-linked advertising, an effective remedy seems problematic. But there also remains the intriguing question of why Google was willing to pay such large sums for those exclusive default installation rights?
The developments in the case will surely be interesting.
[1] The DOJ’s suit was joined by 11 states. More states subsequently filed two separate antitrust lawsuits against Google in December.
[2] There is also a related argument: That Google thereby gained greater volume, which allowed it to learn more about its search users and their behavior, and which thereby allowed it to provide better answers to users (and thus a higher-quality offering to its users) and better-targeted (higher-value) advertising to its advertisers. Conversely, Google’s search-engine rivals were deprived of that volume, with the mirror-image negative consequences for the rivals. This is just another version of the standard “learning-by-doing” and the related “learning curve” (or “experience curve”) concepts that have been well understood in economics for decades.
[3] See, for example, Steven C. Salop and David T. Scheffman, “Raising Rivals’ Costs: Recent Advances in the Theory of Industrial Structure,” American Economic Review, Vol. 73, No. 2 (May 1983), pp. 267-271; and Thomas G. Krattenmaker and Steven C. Salop, “Anticompetitive Exclusion: Raising Rivals’ Costs To Achieve Power Over Price,” Yale Law Journal, Vol. 96, No. 2 (December 1986), pp. 209-293.
[4] For a discussion, see Richard J. Gilbert, “The U.S. Federal Trade Commission Investigation of Google Search,” in John E. Kwoka, Jr., and Lawrence J. White, eds. The Antitrust Revolution: Economics, Competition, and Policy, 7th edn. Oxford University Press, 2019, pp. 489-513.
[5] For a more complete version of the argument that follows, see Lawrence J. White, “Market Power and Market Definition in Monopolization Cases: A Paradigm Is Missing,” in Wayne D. Collins, ed., Issues in Competition Law and Policy. American Bar Association, 2008, pp. 913-924.
[6] The forgetting of this important point is often termed “the cellophane fallacy”, since this is what the U.S. Supreme Court did in a 1956 antitrust case in which the DOJ alleged that du Pont had monopolized the cellophane market (and du Pont, in its defense claimed that the relevant market was much wider: all flexible wrapping materials); see U.S. v. du Pont, 351 U.S. 377 (1956). For an argument that profit data and other indicia argued for cellophane as the relevant market, see George W. Stocking and Willard F. Mueller, “The Cellophane Case and the New Competition,” American Economic Review, Vol. 45, No. 1 (March 1955), pp. 29-63.
[7] In the context of differentiated services, one would expect prices (positive or negative) to vary according to the quality of the service that is offered. It is worth noting that Bing offers “rewards” to frequent searchers; see https://www.microsoft.com/en-us/bing/defaults-rewards. It is unclear whether this pricing structure of payment to Bing’s customers represents what a more competitive framework in search might yield, or whether the payment just indicates that search users consider Bing to be a lower-quality service.
[8] As an additional consequence of the impairment of competition in this type of search market, there might be less technological improvement in the search process itself – to the detriment of users.
[11] And, again, if we return to the du Pont cellophane case: Was the relevant market cellophane? Or all flexible wrapping materials?
[12] This insight is formalized in Richard J. Gilbert and David M.G. Newbery, “Preemptive Patenting and the Persistence of Monopoly,” American Economic Review, Vol. 72, No. 3 (June 1982), pp. 514-526.
[13] To my knowledge, Randal C. Picker was the first to suggest this possibility; see https://www.competitionpolicyinternational.com/a-first-look-at-u-s-v-google/. Whether Apple would be interested in trying to develop its own search engine – given the fiasco a decade ago when Apple tried to develop its own maps app to replace the Google maps app – is an open question. In addition, the Gilbert-Newbery insight applies here as well: Apple would be less inclined to invest the substantial resources that would be needed to develop a search engine when it is thereby in a duopoly market. But Google might be willing to pay “insurance” to reinforce any doubts that Apple might have.
[14] The U.S. Supreme Court, in FTC v. Actavis, 570 U.S. 136 (2013), decided that such agreements could be anti-competitive and should be judged under the “rule of reason”. For a discussion of the case and its implications, see, for example, Joseph Farrell and Mark Chicu, “Pharmaceutical Patents and Pay-for-Delay: Actavis (2013),” in John E. Kwoka, Jr., and Lawrence J. White, eds. The Antitrust Revolution: Economics, Competition, and Policy, 7th edn. Oxford University Press, 2019, pp. 331-353.
[15] This is an example of the insight that vertical arrangements – in this case combined with the Gilbert-Newbery effect – can be a way for dominant firms to raise rivals’ costs. See, for example, John Asker and Heski Bar-Isaac. 2014. “Raising Retailers’ Profits: On Vertical Practices and the Exclusion of Rivals.” American Economic Review, Vol. 104, No. 2 (February 2014), pp. 672-686.
[16] And, again, for the reasons discussed above, Apple might not be eager to make the effort.
[TOTM: The following is part of a digital symposium by TOTM guests and authors on the law, economics, and policy of the antitrust lawsuits against Google. The entire series of posts is available here.]
As one of the few economic theorists in this symposium, I believe my comparative advantage is in that: economic theory. In this post, I want to remind people of the basic economic theories that we have at our disposal, “off the shelf,” to make sense of the U.S. Department of Justice’s lawsuit against Google. I do not mean this to be a proclamation of “what economics has to say about X,” but merely just to help us frame the issue.
In particular, I’m going to focus on the economic concerns of Google paying phone manufacturers (Apple, in particular) to be the default search engine installed on phones. While there is not a large literature on the economic effects of default contracts, there is a large literature on something that I will argue is similar: trade promotions, such as slotting contracts, where a manufacturer pays a retailer for shelf space. Despite all the bells and whistles of the Google case, I will argue that, from an economic point of view, the contracts that Google signed are just trade promotions. No more, no less. And trade promotions are well-established as part of a competitive process that ultimately helps consumers.
However, it is theoretically possible that such trade promotions hurt customers, so it is theoretically possible that Google’s contracts hurt consumers. Ultimately, the theoretical possibility of anticompetitive behavior that harms consumers does not seem plausible to me in this case.
Default Status
There are two reasons that Google paying Apple to be its default search engine is similar to a trade promotion. First, the deal brings awareness to the product, which nudges certain consumers/users to choose the product when they would not otherwise do so. Second, the deal does not prevent consumers from choosing the other product.
In the case of retail trade promotions, a promotional space given to Coca-Cola makes it marginally easier for consumers to pick Coke, and therefore some consumers will switch from Pepsi to Coke. But it does not reduce any consumer’s choice. The store will still have both items.
This is the same for a default search engine. The marginal searchers, who do not have a strong preference for either search engine, will stick with the default. But anyone can still install a new search engine, install a new browser, etc. It takes a few clicks, just as it takes a few steps to walk down the aisle to get the Pepsi; it is still an available choice.
If we were to stop the analysis there, we could conclude that consumers are worse off (if just a tiny bit). Some customers will have to change the default app. We also need to remember that this contract is part of a more general competitive process. The retail stores are also competing with one another, as are smartphone manufacturers.
Despite popular claims to the contrary, Apple cannot charge anything it wants for its phone. It is competing with Samsung, etc. Therefore, Apple has to pass through some of Google’s payments to customers in order to compete with Samsung. Prices are lower because of this payment. As I phrased it elsewhere, Google is effectively subsidizing the iPhone. This cross-subsidization is a part of the competitive process that ultimately benefits consumers through lower prices.
These contracts lower consumer prices, even if we assume that Apple has market power. Those who recall your Econ 101 know that a monopolist chooses a quantity where the marginal revenue equals marginal cost. With a payment from Google, the marginal cost of producing a phone is lower, therefore Apple will increase the quantity and lower price. This is shown below:
One of the surprising things about markets is that buyers’ and sellers’ incentives can be aligned, even though it seems like they must be adversarial. Companies can indirectly bargain for their consumers. Commenting on Standard Fashion Co. v. Magrane-Houston Co., where a retail store contracted to only carry Standard’s products, Robert Bork (1978, pp. 306–7) summarized this idea as follows:
The store’s decision, made entirely in its own interest, necessarily reflects the balance of competing considerations that determine consumer welfare. Put the matter another way. If no manufacturer used exclusive dealing contracts, and if a local retail monopolist decided unilaterally to carry only Standard’s patterns because the loss in product variety was more than made up in the cost saving, we would recognize that decision was in the consumer interest. We do not want a variety that costs more than it is worth … If Standard finds it worthwhile to purchase exclusivity … the reason is not the barring of entry, but some more sensible goal, such as obtaining the special selling effort of the outlet.
How trade promotions could harm customers
Since Bork’s writing, many theoretical papers have shown exceptions to Bork’s logic. There are times that the retailers’ incentives are not aligned with the customers. And we need to take those possibilities seriously.
The most common way to show the harm of these deals (or more commonly exclusivity deals) is to assume:
There are large, fixed costs so that a firm must acquire a sufficient number of customers in order to enter the market; and
An incumbent can lock in enough customers to prevent the entrant from reaching an efficient size.
Consumers can be locked-in because there is some fixed cost of changing suppliers or because of some coordination problems. If that’s true, customers can be made worse off, on net, because the Google contracts reduce consumer choice.
To understand the logic, let’s simplify the model to just search engines and searchers. Suppose there are two search engines (Google and Bing) and 10 searchers. However, to operate profitably, each search engine needs at least three searchers. If Google can entice eight searchers to use its product, Bing cannot operate profitably, even if Bing provides a better product. This holds even if everyone knows Bing would be a better product. The consumers are stuck in a coordination failure.
We should be skeptical of coordination failure models of inefficient outcomes. The problem with any story of coordination failures is that it is highly sensitive to the exact timing of the model. If Bing can preempt Google and offer customers an even better deal (the new entrant is better by assumption), then the coordination failure does not occur.
To argue that Bing could not execute a similar contract, the most common appeal is that the new entrant does not have the capital to pay upfront for these contracts, since it will only make money from its higher-quality search engine down the road. That makes sense until you remember that we are talking about Microsoft. I’m skeptical that capital is the real constraint. It seems much more likely that Google just has a more popular search engine.
The other problem with coordination failure arguments is that they are almost non-falsifiable. There is no way to tell, in the model, whether Google is used because of a coordination failure or whether it is used because it is a better product. If Google is a better product, then the outcome is efficient. The two outcomes are “observationally equivalent.” Compare this to the standard theory of monopoly, where we can (in principle) establish an inefficiency if the price is greater than marginal cost. While it is difficult to measure marginal cost, it can be done.
There is a general economic idea in these models that we need to pay attention to. If Google takes an action that prevents Bing from reaching efficient size, that may be an externality, sometimes called a network effect, and so that action may hurt consumer welfare.
I’m not sure how seriously to take these network effects. If more searchers allow Bing to make a better product, then literally any action (competitive or not) by Google is an externality. Making a better product that takes away consumers from Bing lowers Bing’s quality. That is, strictly speaking, an externality. Surely, that is not worthy of antitrust scrutiny simply because we find an externality.
And Bing also “takes away” searchers from Google, thus lowering Google’s possible quality. With network effects, bigger is better and it may be efficient to have only one firm. Surely, that’s not an argument we want to put forward as a serious antitrust analysis.
Put more generally, it is not enough to scream “NETWORK EFFECT!” and then have the antitrust authority come in, lawsuits-a-blazing. Well, it shouldn’t be enough.
For me to take the network effect argument seriously from an economic point of view, compared to a legal perspective, I would need to see a real restriction on consumer choice, not just an externality. One needs to argue that:
No competitor can cover their fixed costs to make a reasonable search engine; and
These contracts are what prevent the competing search engines from reaching size.
That’s the challenge I would like to put forward to supporters of the lawsuit. I’m skeptical.
[TOTM: The following is part of a digital symposium by TOTM guests and authors on the law, economics, and policy of the antitrust lawsuits against Google. The entire series of posts is available here.]
On October 20, 2020, the U.S. Department of Justice (DOJ) and eleven states with Republican attorneys general sued Google for monopolizing and attempting to monopolize the markets for general internet search services, search advertising, and “general search text” advertising (i.e., ads that resemble search results). Last week, California joined the lawsuit, making it a bipartisan affair.
DOJ and the states (collectively, “the government”) allege that Google has used contractual arrangements to expand and cement its dominance in the relevant markets. In particular, the government complains that Google has agreed to share search ad revenues in exchange for making Google Search the default search engine on various “search access points.”
Google has entered such agreements with Apple (for search on iPhones and iPads), manufacturers of Android devices and the mobile service carriers that support them, and producers of web browsers. Google is also pursuing default status on new internet-enabled consumer products, such as voice assistants and “smart” TVs, appliances, and wearables. In the government’s telling, this all amounts to Google’s sharing of monopoly profits with firms that can ensure its continued monopoly by imposing search defaults that users are unlikely to alter.
There are several obvious weaknesses with the government’s case. One is that preset internet defaults are super easy to change and, in other contexts, are regularly altered. For example, while 88% of desktop and laptop computers use the Windows operating system, which defaults to a Microsoft browser (Internet Explorer or Edge), Google’s Chrome browser commands a 69% market share on desktops and laptops, compared to around 13% for Internet Explorer and Edge combined. Changing a default search engine is as easy as changing a browser default—three simple steps on an iPhone!—and it seems consumers will change defaults they don’t actually prefer.
A second obvious weakness, related to the first, is that the government has alleged no facts suggesting that Google’s search rivals—primarily Bing, Yahoo, and DuckDuckGo—would have enjoyed more success but for Google’s purportedly exclusionary agreements. Even absent default status, people likely would have selected Google Search because it’s the better search engine. It doesn’t seem the challenged arrangements caused Google’s search dominance.
Admittedly, the standard of causation in monopolization cases (at least those seeking only injunctive relief) is low. The D.C. Circuit’s Microsoft decision described it as “edentulous” or, less pretentiously, toothless. Nevertheless, the government is unlikely to prevail in its action against Google—and that’s a good thing. Below, I highlight the central deficiency in the government’s Google case and point out problems with the government’s challenges to each of Google’s purportedly exclusionary arrangements.
The Lawsuit’s Overarching Deficiency
We’ve all had the experience of typing a query only to have Google, within a few key strokes, accurately predict what we were going to ask and provide us with exactly the answer we were looking for. It’s both eerie and awesome, and it keeps us returning to Google time and again.
But it’s not magic. Nor has Google hacked our brains. Google is so good at predicting our questions and providing responsive search results because its top-notch algorithms process gazillions of searches and can “learn” from users’ engagement. Scale is thus essential to Google’s quality.
The government’s complaint concedes as much. It acknowledges that “[g]reater scale improves the quality of a general search engine’s algorithms” (¶35) and that “[t]he additional data from scale allows improved automated learning for algorithms to deliver more relevant results, particularly on ‘fresh’ queries (queries seeking recent information), location-based queries (queries asking about something in the searcher’s vicinity), and ‘long-tail’ queries (queries used infrequently)” (¶36). The complaint also asserts that “[t]he most effective way to achieve scale is for the general search engine to be the preset default on mobile devices, computers, and other devices…” (¶38).
Oddly, though, the government chides Google for pursuing “[t]he most effective way” of securing the scale that concededly “improves the quality of a general search engine’s algorithms.” Google’s efforts to ensure and enhance its own product quality are improper, the government says, because “they deny rivals scale to compete effectively” (¶8). In the government’s view, Google is legally obligated to forego opportunities to make its own product better so as to give its rivals a chance to improve their own offerings.
This is inconsistent with U.S. antitrust law. Just as firms are not required to hold their prices high to create a price umbrella for their less efficient rivals, they need not refrain from efforts to improve the quality of their own offerings so as to give their rivals a foothold.
Antitrust does forbid anticompetitive foreclosure of rivals—i.e., business-usurping arrangements that are not the result of efforts to compete on the merits by reducing cost or enhancing quality. But firms are, and should be, free to make their products better, even if doing so makes things more difficult for their rivals. Antitrust, after all, protects competition, not competitors.
The central deficiency in the government’s case is that it concedes that scale is crucial to search engine quality, but it does not assert that there is a “minimum efficient scale”—i.e., a point at which scale economies are exhausted. If a firm takes actions to enhance its own scale beyond minimum efficient scale, and if its efforts may hold its rivals below such scale, then it may have engaged in anticompetitive foreclosure. But a firm that pursues scale that makes its products better is simply competing on the merits.
The government likely did not allege that there is a minimum efficient scale in general internet search services because returns to scale go on indefinitely, or at least for a very long time. But the absence of such an allegation damns the government’s case against Google, for it implies that Google’s efforts to secure the distribution, and thus the greater use, of its services make those services better.
In this regard, the Microsoft case, which the government points to as a model for its action against Google (¶10), is inapposite. Inthat case, the government alleged that Microsoft had entered license agreements that foreclosed Netscape, a potential rival, from the best avenues of browser distribution: original equipment manufacturers (OEMs) and internet access providers. The government here similarly alleges that Google has foreclosed rival search engines from the best avenues of search distribution: default settings on mobile devices and web browsers. But a key difference (in addition to the fact that search defaults are quite easy to change) is that Microsoft’s license restrictions foreclosed Netscape without enhancing the quality of Microsoft’s offerings. Indeed, the court emphasized that the challenged Microsoft agreements were anticompetitive because they “reduced rival browsers’ usage share not by improving [Microsoft’s] own product but, rather, by preventing OEMs from taking actions that could increase rivals’ share of usage” (emphasis added). Here, any foreclosure of Google’s search rivals is incidental to Google’s efforts to improve its product by enhancing its scale.
Now, the government might contend that the anticompetitive harms from raising rivals’ distribution costs exceed the procompetitive benefits of enhancing the quality of Google’s search services. Courts, though, have generally been skeptical of claims that exclusion-causing product enhancements are anticompetitive because they do more harm than good. There’s a sound reason for this: courts are ill-equipped to weigh the benefits of product enhancements against the costs of competition reductions resulting from product-enhancement efforts. For that reason, they should—and likely will—stick with the rule that this sort of product-enhancing conduct is competition on the merits, even if it has the incidental effect of raising rivals’ costs. And if they do so, the government will lose this case.
Problems with the Government’s Specific Challenges
Agreements with Android OEMs and Wireless Carriers
The government alleges that Google has foreclosed its search rivals from distribution opportunities on the Android platform. It has done so, the government says, by entering into exclusion-causing agreements with OEMs that produce Android products (Samsung, Motorola, etc.) and with carriers that provide wireless service for Android devices (AT&T, Verizon, etc.).
Android is an open source operating system that is owned by Google and licensed, for free, to producers of mobile internet devices. Under the terms of the challenged agreements, Google’s counterparties promise not to produce Android “forks”—operating systems that are Android-based but significantly alter or “fragment” the basic platform—in order to get access to proprietary Google apps that Android users typically desire and to certain application protocol interfaces (APIs) that enable various functionalities. In addition to these “anti-forking agreements,” counterparties enter various “pre-installation agreements” obligating them to install a suite of Google apps that use Google Search as a default. Installing that suite is a condition for obtaining the right to pre-install Google’s app store (Google Play) and other must-have apps. Finally, OEMs and carriers enter “revenue sharing agreements” that require the use of Google Search as the sole preset default on a number of search access points in exchange for a percentage of search ad revenue derived from covered devices. Taken together, the government says, these anti-forking, pre-installation, and revenue-sharing agreements preclude the emergence of Android rivals (from forks) and ensure the continued dominance of Google Search on Android devices.
Eliminating these agreements, though, would likely harm consumers by reducing competition in the market for mobile operating systems. Within that market, there are two dominant players: Apple’s iOS and Google’s Android. Apple earns money off iOS by selling hardware—iPhones and iPads that are pre-installed with iOS. Google licenses Android to OEMs for free but then earns advertising revenue off users’ searches (which provide an avenue for search ads) and other activities (which generate user data for better targeted display ads). Apple and Google thus compete on revenue models. As Randy Picker has explained, Microsoft tried a third revenue model—licensing a Windows mobile operating system to OEMs for a fee—but it failed. The continued competition between Apple and Google, though, allows for satisfaction of heterogenous consumer preferences: Apple products are more expensive but more secure (due to Apple’s tight control over software and hardware); Android devices are cheaper (as the operating system is ad-supported) and offer more innovations (as OEMs have more flexibility), but tend to be less secure. Such variety—a result of business model competition—is good for consumers.
If the government were to prevail and force Google to end the agreements described above, thereby reducing the advertising revenue Google derives from Android, Google would have to either copy Apple’s vertically integrated model so as to recoup its Android investments through hardware sales, charge OEMs for Android (a la Microsoft), or cut back on its investments in Android. In each case, consumers would suffer. The first option would take away an offering preferred by many consumers—indeed most globally, as Android dominates iOS on a worldwide basis. The second option would replace Google’s business model with one that failed, suggesting that consumers value it less. The third option would reduce product quality in the market for mobile operating systems.
In the end, then, the government’s challenge to Google’s Android agreements is myopic and misguided. Competition among business models, like competition along any dimension, inures to the benefit of consumers. Precluding it as the government is demanding would be silly.
Agreements with Browser Producers
Web browsers like Apple’s Safari and Mozilla’s Firefox are a primary distribution channel for search engines. The government claims that Google has illicitly foreclosed rival search engines from this avenue of distribution by entering revenue-sharing agreements with the major non-Microsoft browsers (i.e., all but Microsoft’s Edge and Internet Explorer). Under those agreements, Google shares up to 40% of ad revenues generated from a browser in exchange for being the preset default on both computer and mobile versions of the browser.
Surely there is no problem, though, with search engines paying royalties to web browsers. That’s how independent browsers like Opera and Firefox make money! Indeed, 95% of Firefox’s revenue comes from search royalties. If browsers were precluded from sharing in search engines’ ad revenues, they would have to find an alternative source of financing. Producers of independent browsers would likely charge license fees, which consumers would probably avoid. That means the only available browsers would be those affiliated with an operating system (Microsoft’s Edge, Apple’s Safari) or a search engine (Google’s Chrome). It seems doubtful that reducing the number of viable browsers would benefit consumers. The law should therefore allow payment of search royalties to browsers. And if such payments are permitted, a browser will naturally set its default search engine so as to maximize its payout.
Google’s search rivals can easily compete for default status on a browser by offering a better deal to the browser producer. In 2014, for example, search engine Yahoo managed to wrest default status on Mozilla’s Firefox away from Google. The arrangement was to last five years, but in 2017, Mozilla terminated the agreement and returned Google to default status because so many Firefox users were changing the browser’s default search engine from Yahoo to Google. This historical example undermines the government’s challenges to Google’s browser agreements by showing (1) that other search engines can attain default status by competing, and (2) that defaults aren’t as “sticky” as the government claims—at least, not when the default is set to a search engine other than the one most people prefer.
In short, there’s nothing anticompetitive about Google’s browser agreements, and enjoining such deals would likely injure consumers by reducing competition among browsers.
Agreements with Apple
That brings us to the allegations that have gotten the most attention in the popular press: those concerning Google’s arrangements with Apple. The complaint alleges that Google pays Apple $8-12 billion a year—a whopping 15-20% of Apple’s net income—for granting Google default search status on iOS devices. In the government’s telling, Google is agreeing to share a significant portion of its monopoly profits with Apple in exchange for Apple’s assistance in maintaining Google’s search monopoly.
An alternative view, of course, is that Google is just responding to Apple’s power: Apple has assembled a giant installed base of loyal customers and can demand huge payments to favor one search engine over another on its popular mobile devices. In that telling, Google may be paying Apple to prevent it from making Bing or another search engine the default on Apple’s search access points.
If that’s the case, what Google is doing is both procompetitive and a boon to consumers. Microsoft could easily outbid Google to have Bing set as the default search engine on Apple’s devices. Microsoft’s market capitalization exceeds that of Google parent Alphabet by about $420 billion ($1.62 trillion versus $1.2 trillion), which is roughly the value of Walmart. Despite its ability to outbid Google for default status, Microsoft hasn’t done so, perhaps because it realizes that defaults aren’t that sticky when the default service isn’t the one most people prefer. Microsoft knows that from its experience with Internet Explorer and Edge (which collectively command only around 13% of the desktop browser market even though they’re the defaults on Windows, which has a 88% market share on desktops and laptops), and from its experience with Bing (where “Google” is the number one search term). Nevertheless, the possibility remains that Microsoft could outbid Google for default status, improve its quality to prevent users from changing the default (or perhaps pay users for sticking with Bing), and thereby take valuable scale from Google, impairing the quality of Google Search. To prevent that from happening, Google shares with Apple a generous portion of its search ad revenues, which, given the intense competition for mobile device sales, Apple likely passes along to consumers in the form of lower phone and tablet prices.
If the government succeeds in enjoining Google’s payments to Apple for default status, other search engines will presumably be precluded from such arrangements as well. After all, the “foreclosure” effect of paying for default search status on Apple products is the same regardless of which search engine does the paying, and U.S. antitrust law does not “punish” successful firms by forbidding them from engaging in competitive activities that are open to their rivals.
Ironically, then, the government’s success in its challenge to Google’s Apple payments would benefit Google at the expense of consumers: Google would almost certainly remain the default search engine on Apple products, as it is most preferred by consumers and no rival could pay to dislodge it; Google would not have to pay a penny to retain its default status; and Apple would lose revenues that it likely passes along to consumers in the form of lower prices. The courts are unlikely to countenance this perverse result by ruling that Google’s arrangements with Apple violate the antitrust laws.
Arrangements with Producers of Internet-Enabled “Smart” Devices
The final part of the government’s case against Google starkly highlights a problem that is endemic to the entire lawsuit. The government claims that Google, having locked up all the traditional avenues of search distribution with the arrangements described above, is now seeking to foreclose search distribution in the new avenues being created by internet-enabled consumer products like wearables (e.g., smart watches), voice assistants, smart TVs, etc. The alleged monopolistic strategy is similar to those described above: Google will share some of its monopoly profits in exchange for search default status on these smart devices, thereby preventing rival search engines from attaining valuable scale.
It’s easy to see in this context, though, why Google’s arrangements are likely procompetitive. Unlike web browsers, mobile phones, and tablets, internet-enabled smart devices are novel. Innovators are just now discovering new ways to embed internet functionality into everyday devices.
Putting oneself in the position of these innovators helps illuminate a key beneficial aspect of Google’s arrangements: They create an incentive to develop new and attractive means of distributing search. Innovators currently at work on internet-enabled devices are no doubt spurred on by the possibility of landing a lucrative distribution agreement with Google or another search engine. Banning these sorts of arrangements—the consequence of governmental success in this lawsuit—would diminish the incentive to innovate.
But that can be said of every single one of the arrangements the government is challenging. Because of Google’s revenue-sharing with search distributors, each of them has an added incentive to make their distribution channels desirable to consumers. Android OEMs and Apple will work harder to produce mobile devices that people will want to use for internet searches; browser producers will endeavor to improve their offerings. By paying producers of search access points a portion of the search ad revenues generated on their platforms, Google motivates them to generate more searches, which they can best do by making their products as attractive as possible.
At the end of the day, then, the government’s action against Google seeks to condemn conduct that benefits consumers. Because of the challenged arrangements, Google makes its own search services better, is able to license Android for free, ensures the continued existence of independent web browsers like Firefox and Opera, helps lower the price of iPhones and iPads, and spurs innovators to develop new “Internet of Things” devices that can harness the power of the web.
The Biden administration would do well to recognize this lawsuit for what it is: a poorly conceived effort to appear to be “doing something” about a Big Tech company that has drawn the ire (for different reasons) of both progressives and conservatives. DOJ and its state co-plaintiffs should seek dismissal of this action.
[TOTM: The following is part of a digital symposium by TOTM guests and authors on the law, economics, and policy of the antitrust lawsuits against Google. The entire series of posts is available here.]
It is my endeavor to scrutinize the questionable assessment articulated against default settings in the U.S. Justice Department’s lawsuit against Google. Default, I will argue, is no antitrust fault. Default in the Google case drastically differs from default referred to in the Microsoft case. In Part I, I argue the comparison is odious. Furthermore, in Part II, it will be argued that the implicit prohibition of default settings echoes, as per listings, the explicit prohibition of self-preferencing in search results. Both aspects – default’s implicit prohibition and self-preferencing’s explicit prohibition – are the two legs of a novel and integrated theory of sanctioning corporate favoritism. The coming to the fore of such theory goes against the very essence of the capitalist grain. In Part III, I note the attempt to instill some corporate selflessness is at odds with competition on the merits and the spirit of fundamental economic freedoms.
When Default is No-Fault
The recent complaint filed by the DOJ and 11 state attorneys general claims that Google has abused its dominant position on the search-engine market through several ways, notably making Google the default search engine both in Google Chrome web browser for Android OS and in Apple’s Safari web browser for iOS. Undoubtedly, default setting confers a noticeable advantage for users’ attraction – it is sought and enforced on purpose. Nevertheless, the default setting confers an unassailable position unless the product remains competitive. Furthermore, the default setting can hardly be proven to be anticompetitive in the Google case. Indeed, the DOJ puts considerable effort in the complaint to make the Google case resemble the 20-year-old Microsoft case. Former Federal Trade Commission Chairman William Kovacic commented: “I suppose the Justice Department is telling the court, ‘You do not have to be scared of this case. You’ve done it before […] This is Microsoft part 2.”[1]
However, irrespective of the merits of the Microsoft case two decades ago, the Google default setting case bears minimal resemblance to the Microsoft default setting of Internet Explorer. First, as opposed to the Microsoft case, where default by Microsoft meant pre-installed software (i.e., Internet Explorer)[2], the Google case does not relate to the pre-installment of the Google search engine (since it is just a webpage) but a simple setting. This technical difference is significant: although “sticky”[3], the default setting, can be outwitted with just one click[4]. It is dissimilar to the default setting, which can only be circumvented by uninstalling software[5], searching and installing a new one[6]. Moreover, with no certainty that consumers will effectively use Google search engine, default settings come with advertising revenue sharing agreements between Google and device manufacturers, mobile phone carriers, competing browsers and Apple[7]. These mutually beneficial deals represent a significant cost with no technical exclusivity [8]. In other words, the antitrust treatment of a tie-in between software and hardware in the Microsoft case cannot be convincingly extrapolated to the default setting of a “webware”[9] as relevant in the Google case.
Second, the Google case cannot legitimately resort to extrapolating the Microsoft case for another technical (and commercial) aspect: the Microsoft case was a classic tie-in case where the tied product (Internet Explorer) was tied into the main product (Windows). As a traditional tie-in scenario, the tied product (Internet Explorer) was “consistently offered, promoted, and distributed […] as a stand-alone product separate from, and not as a component of, Windows […]”[10]. In contrast, Google has never sold Google Chrome or Android OS. It offered both Google Chrome and Android OS for free, necessarily conditional to Google search engine as default setting. The very fact that Google Chrome or Android OS have never been “stand-alone” products, to use the Microsoft case’s language, together with the absence of software installation, dramatically differentiates the features pertaining to the Google case from those of the Microsoft case. The Google case is not a traditional tie-in case: it is a case against default setting when both products (the primary and related products) are given for free, are not saleable, are neither tangible nor intangible goods but only popular digital services due to significant innovativeness and ease of usage. The Microsoft “complaint challenge[d] only Microsoft’s concerted attempts to maintain its monopoly in operating systems and to achieve dominance in other markets, not by innovation and other competition on the merits, but by tie-ins.” Quite noticeably, the Google case does not mention tie-in ,as per Google Chrome or Android OS.
The complaint only refers to tie-ins concerning Google’s app being pre-installed on Android OS. Therefore, concerning Google’s dominance on the search engine market, it cannot be said that the default setting of Google search in Android OS entails tie-in. Google search engine has no distribution channel (since it is only a website) other than through downstream partnerships (i.e., vertical deals with Android device manufacturers). To sanction default setting on downstream trading partners is tantamount to refusing legitimate means to secure distribution channels of proprietary and zero-priced services. To further this detrimental logic, it would mean that Apple may no longer offer its own apps in its own iPhones or, in offline markets, that a retailer may no longer offer its own (default) bags at the till since it excludes rivals’ sale bags. Products and services naked of any adjacent products and markets (i.e., an iPhone or Android OS with no app or a shopkeeper with no bundled services) would dramatically increase consumers’ search costs while destroying innovators’ essential distribution channels for innovative business models and providing few departures from the status quo as long as consumers will continue to value default products[11].
Default should not be an antitrust fault: the Google case makes default settings a new line of antitrust injury absent tie-ins. In conclusion, as a free webware, Google search’s default setting cannot be compared to default installation in the Microsoft case since minimal consumer stickiness entails (almost) no switching costs. As free software, Google’s default apps cannot be compared to Microsoft case either since pre-installation is the sine qua non condition of the highly valued services (Android OS) voluntarily chosen by device manufacturers. Default settings on downstream products can only be reasonably considered as antitrust injury when the dominant company is erroneously treated as a de facto essential facility – something evidenced by the similar prohibition of self-preferencing.
When Self-Preference is No Defense
Self-preferencing is to listings what the default setting is to operating systems. They both are ways to market one’s own products (i.e., alternative to marketing toward end-consumers). While default setting may come with both free products and financial payments (Android OS and advertising revenue sharing), self-preferencing may come with foregone advertising revenues in order to promote one’s own products. Both sides can be apprehended as the two sides of the same coin:[12] generating the ad-funded main product’s distribution channels – Google’s search engine. Both are complex advertising channels since both venues favor one’s own products regarding consumers’ attention. Absent both channels, the payments made for default agreements and the foregone advertising revenues in self-preferencing one’s own products would morph into marketing and advertising expenses of Google search engine toward end-consumers.
The DOJ complaint lambasts that “Google’s monopoly in general search services also has given the company extraordinary power as the gateway to the internet, which uses to promote its own web content and increase its profits.” This blame was at the core of the European Commission’s Google Shopping decision in 2017[13]: it essentially holds Google accountable for having, because of its ad-funded business model, promoted its own advertising products and demoted organic links in search results. According to which Google’s search results are no longer relevant and listed on the sole motivation of advertising revenue
But this argument is circular: should these search results become irrelevant, Google’s core business would become less attractive, thereby generating less advertising revenue. This self-inflicted inefficiency would deprive Google of valuable advertising streams and incentivize end-consumers to switch to search engine rivals such as Bing, DuckDuckGo, Amazon (product search), etc. Therefore, an ad-funded company such as Google needs to reasonably arbitrage between advertising objectives and the efficiency of its core activities (here, zero-priced organic search services). To downplay (the ad-funded) self-referencing in order to foster (the zero-priced) organic search quality would disregard the two-sidedness of the Google platform: it would harm advertisers and the viability of the ad-funded business model without providing consumers and innovation protection it aims at providing. The problematic and undesirable concept of “search neutrality” would mean algorithmic micro-management for the sake of an “objective” listing considered acceptable only to the eyes of the regulator.
Furthermore, self-preferencing entails a sort of positive discrimination toward one’s own products[14]. If discrimination has traditionally been antitrust lines of injuries, self-preferencing is an “epithet”[15] outside antitrust remits for good reasons[16]. Indeed, should self-interested (i.e., rationally minded) companies and individuals are legally complied to self-demote their own products and services? If only big (how big?) companies are legally complied to self-demote their products and services, to what extent will exempted companies involved in self-preferencing become liable to do so?
Indeed, many uncertainties, legal and economic ones, may spawn from the emerging prohibition of self-preferencing. More fundamentally, antitrust liability may clash with basic corporate governance principles where self-interestedness allows self-preferencing and command such self-promotion. The limits of antitrust have been reached when two sets of legal regimes, both applicable to companies, suggest contradictory commercial conducts. To what extent may Amazon no longer promote its own series on Amazon Video in a similar manner Netflix does? To what extent can Microsoft no longer promote Bing’s search engine to compete with Google’s search engine effectively? To what extent Uber may no longer promote UberEATS in order to compete with delivery services effectively? Not only the business of business is doing business[17], but also it is its duty for which shareholders may hold managers to account.
The self is moral; there is a corporate morality of business self-interest. In other words, corporate selflessness runs counter to business ethics since corporate self-interest yields the self’s rivalrous positioning within a competitive order. Absent a corporate self-interest, self-sacrifice may generate value destruction for the sake of some unjustified and ungrounded claims. The emerging prohibition of self-preferencing, similar to the established ban on the default setting on one’s own products into other proprietary products, materializes the corporate self’s losing. Both directions coalesce to instill the legally embedded duty of self-sacrifice for the competitor’s welfare instead of the traditional consumer welfare and the dynamics of innovation, which never unleash absent appropriabilities. In conclusion, to expect firms, however big or small, to act irrespective of their identities (i.e., corporate selflessness) would constitute an antitrust error and would be at odds with capitalism.
Toward an Integrated Theory of Disintegrating Favoritism
The Google lawsuit primarily blames Google for default settings enforced via several deals. The lawsuit also makes self-preferencing anticompetitive conduct under antitrust rules. These two charges are novel and dubious in their remits. They nevertheless represent a fundamental catalyst for the development of a new and problematic unified antitrust theory prohibiting favoritism: companies may no longer favor their products and services, both vertically and horizontally, irrespective of consumer benefits, irrespective of superior efficiency arguments, and irrespective of dynamic capabilities enhancement. Indeed, via an unreasonably expanded vision of leveraging, antitrust enforcement is furtively banning a company to favor its own products and services based on greater consumer choice as a substitute to consumer welfare, based on the protection of the opportunities of rivals to innovate and compete as a substitute to the essence of competition and innovation, and based on limiting the outreach and size of companies as a substitute to the capabilities and efficiencies of these companies. Leveraging becomes suspicious and corporate self-favoritism under accusation. The Google lawsuit materializes this impractical trend, which further enshrines the precautionary approach to antitrust enforcement[18].
[1] Jessica Guynn, Google Justice Department antitrust lawsuit explained: this is what it means for you. USA Today, October 20, 2020.
[2] The software (Internet Explorer) was tied in the hardware (Windows PC).
[3]U.S. v Google LLC, Case A:20, October 20, 2020, 3 (referring to default settings as “especially sticky” with respect to consumers’ willingness to change).
[4] While the DOJ affirms that “being the preset default general search engine is particularly valuable because consumers rarely change the preset default”, it nevertheless provides no evidence of the breadth of such consumer stickiness. To be sure, search engine’s default status does not necessarily lead to usage as evidenced by the case of South Korea. In this country, despite Google’s preset default settings, the search engine Naver remains dominant in the national search market with over 70% of market shares. The rivalry exerted by Naver on Google demonstrates that limits of consumer stickiness to default settings. See Alesia Krush, Google vs. Naver: Why Can’t Google Dominate Search in Korea? Link-Assistant.Com, available at: https://www.link-assistant.com/blog/google-vs-naver-why-cant-google-dominate-search-in-korea/ . As dominant search engine in Korea, Naver is subject to antitrust investigations with similar leveraging practices as Google in other countries, see Shin Ji-hye, FTC sets up special to probe Naver, Google, The Korea Herald, November 19, 2019, available at : http://www.koreaherald.com/view.php?ud=20191119000798 ; Kim Byung-wook, Complaint against Google to be filed with FTC, The Investor, December 14, 2020, available at : https://www.theinvestor.co.kr/view.php?ud=20201123000984 (reporting a complaint by Naver and other Korean IT companies against Google’s 30% commission policy on Google Play Store’s apps).
[5] For instance, the then complaint acknowledged that “Microsoft designed Windows 98 so that removal of Internet Explorer by OEMs or end users is operationally more difficult than it was in Windows 95”, in U.S. v Microsoft Corp., Civil Action No 98-1232, May 18, 1998, para.20.
[6] The DOJ complaint itself quotes “one search competitor” who is reported to have noted consumer stickiness “despite the simplicity of changing a default setting to enable customer choice […]” (para.47). Therefore, default setting for search engine is remarkably simple to bypass but consumers do not often do so, either due to satisfaction with Google search engine and/or due to search and opportunity costs.
[8] Competing browsers can always welcome rival search engines and competing search engine apps can always be downloaded despite revenue sharing agreements. See paras.78-87 of the DOJ complaint.
[9] Google search engine is nothing but a “webware” – a complex set of algorithms that work via online access of a webpage with no prior download. For a discussion on the definition of webware, see https://www.techopedia.com/definition/4933/webware .
[11] Such outcome would frustrate traditional ways of offering computers and mobile devices as acknowledged by the DOJ itself in the Google complaint: “new computers and new mobile devices generally come with a number of preinstalled apps and out-of-the-box setting. […] Each of these search access points can and almost always does have a preset default general search engine”, at para. 41. Also, it appears that present default general search engine is common commercial practices since, as the DOJ complaint itself notes when discussing Google’s rivals (Microsoft’s Bing and Amazon’s Fire OS), “Amazon preinstalled its own proprietary apps and agreed to make Microsoft’s Bing the preset default general search engine”, in para.130. The complaint fails to identify alternative search engines which are not preset defaults, thus implicitly recognizing this practice as a widespread practice.
[12] To use Vesterdof’s language, see Bo Vesterdorf, Theories of Self-Preferencing and Duty to Deal – Two Sides of the Same Coin, Competition Law & Policy Debate 1(1) 4, (2015). See also Nicolas Petit, Theories of Self-Preferencing under Article 102 TFEU: A Reply to Bo Vesterdorf, 5-7 (2015).
[13] Case 39740 Google Search (Shopping). Here the foreclosure effects of self-preferencing are only speculated: « the Commission is not required to prove that the Conduct has the actual effect of decreasing traffic to competing comparison shopping services and increasing traffic to Google’s comparison-shopping service. Rather, it is sufficient for the Commission to demonstrate that the Conduct is capable of having, or likely to have, such effects.” (para.601 of the Decision). See P. Ibáñez Colomo, Indispensability and Abuse of Dominance: From Commercial Solvents to Slovak Telekom and Google Shopping, 10 Journal of European Competition Law & Practice 532 (2019); Aurelien Portuese, When Demotion is Competition: Algorithmic Antitrust Illustrated, Concurrences, no 2, May 2018, 25-37; Aurelien Portuese, Fine is Only One Click Away, Symposium on the Google Shopping Decision, Case Note, 3 Competition and Regulatory Law Review, (2017).
[14] For a general discussion on law and economics of self-preferencing, see Michael A. Salinger, Self-Preferencing, Global Antitrust Institute Report, 329-368 (2020).
[15]Pablo Ibanez Colomo, Self-Preferencing: Yet Another Epithet in Need of Limiting Principles, 43 World Competition (2020) (concluding that self-preferencing is « misleading as a legal category »).
[16] See, for instances, Pedro Caro de Sousa, What Shall We Do About Self-Preferencing? Competition Policy International, June 2020.
[17] Milton Friedman, The Social Responsibility of Business is to Increase Its Profits, New York Times, September 13, 1970. This echoes Adam Smith’s famous statement that « It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard for their own self-interest » from the 1776 Wealth of Nations. In Ayn Rand’s philosophy, the only alternative to rational self-interest is to sacrifice one’s own interests either for fellowmen (altruism) or for supernatural forces (mysticism). See Ayn Rand, The Objectivist Ethics, in The Virtue of Selfishness, Signet, (1964).
[18] Aurelien Portuese, European Competition Enforcement and the Digital Economy : The Birthplace of Precautionary Antitrust, Global Antitrust Institute’s Report on the Digital Economy, 597-651.
[TOTM: The following is part of a digital symposium by TOTM guests and authors on the law, economics, and policy of the antitrust lawsuits against Google. The entire series of posts is available here.]
Judges sometimes claim that they do not pick winners when they decide antitrust cases. Nothing could be further from the truth.
Competitive conduct by its nature harms competitors, and so if antitrust were merely to prohibit harm to competitors, antitrust would then destroy what it is meant to promote.
What antitrust prohibits, therefore, is not harm to competitors but rather harm to competitors that fails to improve products. Only in this way is antitrust able to distinguish between the good firm that harms competitors by making superior products that consumers love and that competitors cannot match and the bad firm that harms competitors by degrading their products without offering consumers anything better than what came before.
That means, however, that antitrust must pick winners: antitrust must decide what is an improvement and what not. And a more popular search engine is a clear winner.
But one should not take its winningness for granted. For once upon a time there was another winner that the courts always picked, blocking antitrust case after antitrust case. Until one day the courts stopped picking it.
That was the economy of scale.
The Structure of the Google Case
Like all antitrust cases that challenge the exercise of power, the government’s case against Google alleges denial of an input to competitors in some market. Here the input is default search status in smartphones, the competitors are rival search providers, and the market is search advertising. The basic structure of the case is depicted in the figure below.
Although brought as a monopolization case under Section 2 of the Sherman Act, this is at heart an exclusive dealing case of the sort normally brought under Section 1 of the Sherman Act: the government’s core argument is that Google uses contracts with smartphone makers, pursuant to which the smartphone makers promise to make Google, and not competitors, the search default, to harm competing search advertising providers and by extension competition in the search advertising market.
The government must show anticompetitive conduct, monopoly power, and consumer harm in order to prevail.
Let us assume that there is monopoly power. The company has more than 70% of the search advertising market, which is in the zone normally required to prove that element of a monopolization claim.
The problem of anticompetitive conduct is only slightly more difficult.
Anticompetitive conduct is only ever one thing in antitrust: denial of an essential input to a competitor. There is no other way to harm rivals.
(To be sure, antitrust prohibits harm to competition, not competitors, but that means only that harm to competitors necessary but insufficient for liability. The consumer harm requirement decides whether the requisite harm to competitors is also harm to competition.)
It is not entirely clear just how important default search status really is to running a successful search engine, but let us assume that it is essential, as the government suggests.
Then the question whether Google’s contracts are anticompetitive turns on how much of the default search input Google’s contracts foreclose to rival search engines. If a lot, then the rivals are badly harmed. If a little, then there may be no harm at all.
The answer here is that there is a lot of foreclosure, at least if the government’s complaint is to be believed. Through its contracts with Apple and makers of Android phones, Google has foreclosed default search status to rivals on virtually every single smartphone.
That leaves consumer harm. And here is where things get iffy.
Usage as a Product Improvement: A Very Convenient Argument
The inquiry into consumer harm evokes measurements of the difference between demand curves and price lines, or extrapolations of compensating and equivalent variation using indifference curves painstakingly pieced together based on the assumptions of revealed preference.
But while the parties may pay experts plenty to spin such yarns, and judges may pretend to listen to them, in the end, for the judges, it always comes down to one question only: did exclusive dealing improve the product?
If it did, then the judge assumes that the contracts made consumers better off and the defendant wins. And if it did not, then off with their heads.
So, does foreclosing all this default search space to competitors make Google search advertising more valuable to advertisers?
Those who leap to Google’s defense say yes, for default search status increases the number of people who use Google’s search engine. And the more people use Google’s search engine, the more Google learns about how best to answer search queries and which advertisements will most interest which searchers. And that ensures that even more people will use Google’s search engine, and that Google will do an even better job of targeting ads on its search engine.
And that in turn makes Google’s search advertising even better: able to reach more people and to target ads more effectively to them.
None of that would happen if defaults were set to other engines and users spurned Google, and so foreclosing default search space to rivals undoubtedly improves Google’s product.
This is a nice argument. Indeed, it is almost too nice, for it seems to suggest that almost anything Google might do to steer users away from competitors and to itself deserves antitrust immunity. Suppose Google were to brandish arms to induce you to run your next search on Google. That would be a crime, but, on this account, not an antitrust crime. For getting you to use Google does make Google better.
The argument that locking up users improves the product is of potential use not just to Google but to any of the many tech companies that run on advertising—Facebook being a notable example—so it potentially immunizes an entire business model from antitrust scrutiny.
It turns out that has happened before.
Economies of Scale as a Product Improvement: Once a Convenient Argument
Once upon a time, antitrust exempted another kind of business for which products improve the more people used them. The business was industrial production, and it differs from online advertising only in the irrelevant characteristic that the improvement that comes with expanding use is not in the quality of the product but in the cost per unit of producing it.
The hallmark of the industrial enterprise is high fixed costs and low marginal costs. The textile mill differs from pre-industrial piecework weaving in that once a $10 million investment in machinery has been made, the mill can churn out yard after yard of cloth for pennies. The pieceworker, by contrast, makes a relatively small up-front investment—the cost of raising up the hovel in which she labors and making her few tools—but spends the same large amount of time to produce each new yard of cloth.
Large fixed costs and low marginal costs lie at the heart of the bounty of the modern age: the more you produce, the lower the unit cost, and so the lower the price at which you can sell your product. This is a recipe for plenty.
But it also means that, so long as consumer demand in a given market is lower than the capacity of any particular plant, driving buyers to a particular seller and away from competitors always improves the product, in the sense that it enables the firm to increase volume and reduce unit cost, and therefore to sell the product at a lower price.
If the promise of the modern age is goods at low prices, then the implication is that antitrust should never punish firms for driving rivals from the market and taking over their customers. Indeed, efficiency requires that only one firm should ever produce in any given market, at least in any market for which a single plant is capable of serving all customers.
For antitrust in the late 19th and early 20th centuries, beguiled by this advantage to size, exclusive dealing, refusals to deal, even the knife in a competitor’s back: whether these ran afoul of other areas of law or not, it was all for the better because it allowed industrial enterprises to achieve economies of scale.
It is no accident that, a few notable triumphs aside, antitrust did not come into its own until the mid-1930s, 40 years after its inception, on the heels of an intellectual revolution that explained, for the first time, why it might actually be better for consumers to have more than one seller in a market.
The Monopolistic Competition Revolution
The revolution came in the form of the theory of monopolistic competition and its cousin, the theory of creative destruction, developed between the 1920s and 1940s by Edward Chamberlin, Joan Robinson and Joseph Schumpeter.
These theories suggested that consumers might care as much about product quality as they do about product cost, and indeed would be willing to abandon a low-cost product for a higher-quality, albeit more expensive, one.
From this perspective, the world of economies of scale and monopoly production was the drab world of Soviet state-owned enterprises churning out one type of shoe, one brand of cleaning detergent, and so on.
The world of capitalism and technological advance, by contrast, was one in which numerous firms produced batches of differentiated products in amounts sometimes too small fully to realize all scale economies, but for which consumers were nevertheless willing to pay because the products better fit their preferences.
What is more, the striving of monopolistically competitive firms to lure away each other’s customers with products that better fit their tastes led to disruptive innovation— “creative destruction” was Schumpeter’s famous term for it—that brought about not just different flavors of the same basic concept but entirely new concepts. The competition to create a better flip phone, for example, would lead inevitably to a whole new paradigm, the smartphone.
This reasoning combined with work in the 1940s and 1950s on economic growth that quantified for the first time the key role played by technological change in the vigor of capitalist economies—the famous Solow residual—to suggest that product improvements, and not the cost reductions that come from capital accumulation and their associated economies of scale, create the lion’s share of consumer welfare. Innovation, not scale, was king.
Antitrust responded by, for the first time in its history, deciding between kinds of product improvements, rather than just in favor of improvements, casting economies of scale out of the category of improvements subject to antitrust immunity, while keeping quality improvements immune.
Casting economies of scale out of the protected product improvement category gave antitrust something to do for the first time. It meant that big firms had to plead more than just the cost advantages of being big in order to obtain license to push their rivals around. And government could now start reliably to win cases, rather than just the odd cause célèbre.
It is this intellectual watershed, and not Thurman Arnold’s tenacity, that was responsible for antitrust’s emergence as a force after World War Two.
Usage-Based Improvements Are Not Like Economies of Scale
The improvements in advertising that come from user growth fall squarely on the quality side of the ledger—the value they create is not due to the ability to average production costs over more ad buyers—and so they count as the kind of product improvements that antitrust continues to immunize today.
But given the pervasiveness of this mode of product improvement in the tech economy—the fact that virtually any tech firm that sells advertising can claim to be improving a product by driving users to itself and away from competitors—it is worth asking whether we have not reached a new stage in economic development in which this form of product improvement ought, like economies of scale, to be denied protection.
Shouldn’t the courts demand more and better innovation of big tech firms than just the same old big-data-driven improvements they serve up year after year?
Galling as it may be to those who, like myself, would like to see more vigorous antitrust enforcement in general, the answer would seem to be “no.” For what induced the courts to abandon antitrust immunity for economies of scale in the mid-20th century was not the mere fact that immunizing economies of scale paralyzed antitrust. Smashing big firms is not, after all, an end in itself.
Instead, monopolistic competition, creative destruction and the Solow residual induced the change, because they suggested both that other kinds of product improvement are more important than economies of scale and, crucially, that protecting economies of scale impedes development of those other kinds of improvements.
A big firm that excludes competitors in order to reach scale economies not only excludes competitors who might have produced an identical or near-identical product, but also excludes competitors who might have produced a better-quality product, one that consumers would have preferred to purchase even at a higher price.
To cast usage-based improvements out of the product improvement fold, a case must be made that excluding competitors in order to pursue such improvements will block a different kind of product improvement that contributes even more to consumer welfare.
If we could say, for example, that suppressing search competitors suppresses more-innovative search engines that ad buyers would prefer, even if those innovative search engines were to lack the advantages that come from having a large user base, then a case might be made that user growth should no longer count as a product improvement immune from antitrust scrutiny.
And even then, the case against usage-based improvements would need to be general enough to justify an epochal change in policy, rather than be limited to a particular technology in a particular lawsuit. For the courts hate to balance in individual cases, statements to the contrary in their published opinions notwithstanding.
But there is nothing in the Google complaint, much less the literature, to suggest that usage-based improvements are problematic in this way. Indeed, much of the value created by the information revolution seems to inhere precisely in its ability to centralize usage.
Americans Keep Voting to Centralize the Internet
In the early days of the internet, theorists mistook its decentralized architecture for a feature, rather than a bug. But internet users have since shown, time and again, that they believe the opposite.
For example, the basic protocols governing email were engineered to allow every American to run his own personal email server.
But Americans hated the freedom that created—not least the spam—and opted instead to get their email from a single server: the one run by Google as Gmail.
The basic protocols governing web traffic were also designed to allow every American to run whatever other communications services he wished—chat, video chat, RSS, webpages—on his own private server in distributed fashion.
But Americans hated the freedom that created—not least having to build and rebuild friend networks across platforms–—and they voted instead overwhelmingly to get their social media from a single server: Facebook.
Indeed, the basic protocols governing internet traffic were designed to allow every business to store and share its own data from its own computers, in whatever form.
But American businesses hated that freedom—not least the cost of having to buy and service their own data storage machines—and instead 40% of the internet is now stored and served from Amazon Web Services.
Similarly, advertisers have the option of placing advertisements on the myriad independently-run websites that make up the internet—known in the business as the “open web”—by placing orders through competitive ad exchanges. But advertisers have instead voted mostly to place ads on the handful of highly centralized platforms known as “walled gardens,” including Facebook, Google’s YouTube and, of course, Google Search.
The communications revolution, they say, is all about “bringing people together.” It turns out that’s true.
And that Google should win on consumer harm.
Remember the Telephone
Indeed, the same mid-20th century antitrust that thought so little of economies of scale as a defense immunized usage-based improvements when it encountered them in that most important of internet precursors: the telephone.
The telephone, like most internet services, gets better as usage increases. The more people are on a particular telephone network, the more valuable the network becomes to subscribers.
Just as with today’s internet services, the advantage of a large user base drove centralization of telephone services a century ago into the hands of a single firm: AT&T. Aside from a few business executives who liked the look of a desk full of handsets, consumers wanted one phone line that they could use to call everyone.
Although the government came close to breaking AT&T up in the early 20th century, the government eventually backed off, because a phone system in which you must subscribe to the right carrier to reach a friend just doesn’t make sense.
Instead, Congress and state legislatures stepped in to take the edge off monopoly by regulating phone pricing. And when antitrust finally did break AT&T up in 1982, it did so in a distinctly regulatory fashion, requiring that AT&T’s parts connect each other’s phone calls, something that Congress reinforced in the Telecommunications Act of 1996.
The message was clear: the sort of usage-based improvements one finds in communications are real product improvements. And antitrust can only intervene if it has a way to preserve them.
The equivalent of interconnection in search, that the benefits of usage, in the form of data and attention, be shared among competing search providers, might be feasible. But it is hard to imagine the court in the Google case ordering interconnection without the benefit of decades of regulatory experience with the defendant’s operations that the district court in 1982 could draw upon in the AT&T case.
The solution for the tech giants today is the same as the solution for AT&T a century ago: to regulate rather than to antitrust.
Microsoft Not to the Contrary, Because Users Were in Common
Parallels to the government’s 1990s-era antitrust case against Microsoft are not to the contrary.
As Sam Weinstein has pointed out to me, Microsoft, like Google, was at heart an exclusive dealing case: Microsoft contracted with computer manufacturers to prevent Netscape Navigator, an early web browser, from serving as the default web browser on Windows PCs.
That prevented Netscape, the argument went, from growing to compete with Windows in the operating system market, much the way the Google’s Chrome browser has become a substitute for Windows on low-end notebook computers today.
The D.C. Circuit agreed that default status was an essential input for Netscape as it sought eventually to compete with Windows in the operating system market.
The court also accepted the argument that the exclusive dealing did not improve Microsoft’s operating system product.
This at first seems to contradict the notion that usage improves products, for, like search advertising, operating systems get better as their user bases increase. The more people use an operating system, the more application developers are willing to write for the system, and the better the system therefore becomes.
It seems to follow that keeping competitors off competing operating systems and on Windows made Windows better. If the court nevertheless held Microsoft liable, it must be because the court refused to extend antitrust immunity to usage-based improvements.
The trouble with this line of argument is that it ignores the peculiar thing about the Microsoft case: that while the government alleged that Netscape was a potential competitor of Windows, Netscape was also an application that ran on Windows.
That means that, unlike Google and rival search engines, Windows and Netscape shared users.
So, Microsoft’s exclusive dealing did not increase its user base and therefore could not have improved Windows, at least not by making Windows more appealing for applications developers. Driving Netscape from Windows did not enable developers to reach even one more user. Conversely, allowing Netscape to be the default browser on Windows would not have reduced the number of Windows users, because Netscape ran on Windows.
By contrast, a user who runs a search in Bing does not run the same search simultaneously in Google, and so Bing users are not Google users. Google’s exclusive dealing therefore increases its user base and improves Google’s product, whereas Microsoft’s exclusive dealing served only to reduce Netscape’s user base and degrade Netscape’s product.
Indeed, if letting Netscape be the default browser on Windows was a threat to Windows, it was not because it prevented Microsoft from improving its product, but because Netscape might eventually have become an operating system, and indeed a better operating system, than Windows, and consumers and developers, who could be on both at the same time if they wished, might have nevertheless chosen eventually to go with Netscape alone.
Though it does not help the government in the Google case, Microsoft still does offer a beacon of hope for those concerned about size, for Microsoft’s subsequent history reminds us that yesterday’s behemoth is often today’s also ran.
And the favorable settlement terms Microsoft ultimately used to escape real consequences for its conduct 20 years ago imply that, at least in high-tech markets, we don’t always need antitrust for that to be true.
[TOTM: The following is part of a digital symposium by TOTM guests and authors on the law, economics, and policy of the antitrust lawsuits against Google. The entire series of posts is available here.]
Google is facing a series of lawsuits in 2020 and 2021 that challenge some of the most fundamental parts of its business, and of the internet itself — Search, Android, Chrome, Google’s digital-advertising business, and potentially other services as well.
The U.S. Justice Department (DOJ) has brought a case alleging that Google’s deals with Android smartphone manufacturers, Apple, and third-party browsers to make Google Search their default general search engine are anticompetitive (ICLE’s tl;dr on the case is here), and the State of Texas has brought a suit against Google’s display advertising business. These follow a market study by the United K’s Competition and Markets Authority that recommended an ex ante regulator and code of conduct for Google and Facebook. At least one more suit is expected to follow.
These lawsuits will test ideas that are at the heart of modern antitrust debates: the roles of defaults and exclusivity deals in competition; the costs of self-preferencing and its benefits to competition; the role of data in improving software and advertising, and its role as a potential barrier to entry; and potential remedies in these markets and their limitations.
This Truth on the Market symposium asks contributors with wide-ranging viewpoints to comment on some of these issues as they arise in the lawsuits being brought—starting with the U.S. Justice Department’s case against Google for alleged anticompetitive practices in search distribution and search-advertising markets—and continuing throughout the duration of the lawsuits.
[N]ew combinations are, as a rule, embodied, as it were, in new firms which generally do not arise out of the old ones but start producing beside them; … in general it is not the owner of stagecoaches who builds railways. – Joseph Schumpeter, January 1934
Elizabeth Warren wants to break up the tech giants — Facebook, Google, Amazon, and Apple — claiming they have too much power and represent a danger to our democracy. As part of our response to her proposal, we shared a couple of headlines from 2007 claiming that MySpace had an unassailable monopoly in the social media market.
Tommaso Valletti, the chief economist of the Directorate-General for Competition (DG COMP) of the European Commission, said, in what we assume was a reference to our posts, “they go on and on with that single example to claim that [Facebook] and [Google] are not a problem 15 years later … That’s not what I would call an empirical regularity.”
We appreciate the invitation to show that prematurely dubbing companies “unassailable monopolies” is indeed an empirical regularity.
It’s Tough to Make Predictions, Especially About the Future of Competition in Tech
No one is immune to this phenomenon. Antitrust regulators often take a static view of competition, failing to anticipate dynamic technological forces that will upend market structure and competition.
Scientists and academics make a different kind of error. They are driven by the need to satisfy their curiosity rather than shareholders. Upon inventing a new technology or discovering a new scientific truth, academics often fail to see the commercial implications of their findings.
Maybe the titans of industry don’t make these kinds of mistakes because they have skin in the game? The profit and loss statement is certainly a merciless master. But it does not give CEOs the power of premonition. Corporate executives hailed as visionaries in one era often become blinded by their success, failing to see impending threats to their company’s core value propositions.
Furthermore, it’s often hard as outside observers to tell after the fact whether business leaders just didn’t see a tidal wave of disruption coming or, worse, they did see it coming and were unable to steer their bureaucratic, slow-moving ships to safety. Either way, the outcome is the same.
Here’s the pattern we observe over and over: extreme success in one context makes it difficult to predict how and when the next paradigm shift will occur in the market. Incumbents become less innovative as they get lulled into stagnation by high profit margins in established lines of business. (This is essentially the thesis of Clay Christensen’s The Innovator’s Dilemma).
Even if the anti-tech populists are powerless to make predictions, history does offer us some guidance about the future. We have seen time and again that apparently unassailable monopolists are quite effectively assailed by technological forces beyond their control.
Nov 2007: “Nokia: One Billion Customers—Can Anyone Catch the Cell Phone King?” (Forbes)
Sep 2013: “Microsoft CEO Ballmer Bids Emotional Farewell to Wall Street” (Reuters)
If there’s one thing I regret, there was a period in the early 2000s when we were so focused on what we had to do around Windows that we weren’t able to redeploy talent to the new device form factor called the phone.
Mar 1998: “How Yahoo! Won the Search Wars” (Fortune)
Once upon a time, Yahoo! was an Internet search site with mediocre technology. Now it has a market cap of $2.8 billion. Some people say it’s the next America Online.
AOL’s dominance of instant messaging technology, the kind of real-time e-mail that also lets users know when others are online, has emerged as a major concern of regulators scrutinizing the company’s planned merger with Time Warner Inc. (twx). Competitors to Instant Messenger, such as Microsoft Corp. (msft) and Yahoo! Inc. (yhoo), have been pressing the Federal Communications Commission to force AOL to make its services compatible with competitors’.
Dec 2000: “AOL’s Instant Messaging Monopoly?” (Wired)
There have been isolated examples, as in the case of obligations of the merged AOL / Time Warner to make AOL Instant Messenger interoperable with competing messaging services. These obligations on AOL are widely viewed as having been a dismal failure.
Jan 2007: “MySpace Is a Natural Monopoly” (TechNewsWorld)
Seventy percent of Yahoo 360 users, for example, also use other social networking sites — MySpace in particular. Ditto for Facebook, Windows Live Spaces and Friendster … This presents an obvious, long-term business challenge to the competitors. If they cannot build up a large base of unique users, they will always be on MySpace’s periphery.
Feb 2007: “Will Myspace Ever Lose Its Monopoly?” (Guardian)
Jun 2011: “Myspace Sold for $35m in Spectacular Fall from $12bn Heyday” (Guardian)
Dec 2003: “The subscription model of buying music is bankrupt. I think you could make available the Second Coming in a subscription model, and it might not be successful.” – Steve Jobs (Rolling Stone)
Predicting the future of competition in the tech industry is such a fraught endeavor that even articles about how hard it is to make predictions include incorrect predictions. The authors just cannot help themselves. A March 2012 BBC article “The Future of Technology… Who Knows?” derided the naysayers who predicted doom for Apple’s retail store strategy. Its kicker?
And that is why when you read that the Blackberry is doomed, or that Microsoft will never make an impression on mobile phones, or that Apple will soon dominate the connected TV market, you need to take it all with a pinch of salt.
But Blackberry was doomed and Microsoft never made an impression on mobile phones. (Half credit for Apple TV, which currently has a 15% market share).
Nobel Prize-winning economist Paul Krugman wrote a piece for Red Herring magazine (seriously) in June 1998 with the title “Why most economists’ predictions are wrong.” Headline-be-damned, near the end of the article he made the following prediction:
The growth of the Internet will slow drastically, as the flaw in “Metcalfe’s law”—which states that the number of potential connections in a network is proportional to the square of the number of participants—becomes apparent: most people have nothing to say to each other! By 2005 or so, it will become clear that the Internet’s impact on the economy has been no greater than the fax machine’s.
Robert Metcalfe himself predicted in a 1995 column that the Internet would “go spectacularly supernova and in 1996 catastrophically collapse.” After pledging to “eat his words” if the prediction did not come true, “in front of an audience, he put that particular column into a blender, poured in some water, and proceeded to eat the resulting frappe with a spoon.”
A Change Is Gonna Come
Benedict Evans, a venture capitalist at Andreessen Horowitz, has the best summary of why competition in tech is especially difficult to predict:
IBM, Microsoft and Nokia were not beaten by companies doing what they did, but better. They were beaten by companies that moved the playing field and made their core competitive assets irrelevant. The same will apply to Facebook (and Google, Amazon and Apple).
Elsewhere, Evans tried to reassure his audience that we will not be stuck with the current crop of tech giants forever:
With each cycle in tech, companies find ways to build a moat and make a monopoly. Then people look at the moat and think it’s invulnerable. They’re generally right. IBM still dominates mainframes and Microsoft still dominates PC operating systems and productivity software. But… It’s not that someone works out how to cross the moat. It’s that the castle becomes irrelevant. IBM didn’t lose mainframes and Microsoft didn’t lose PC operating systems. Instead, those stopped being ways to dominate tech. PCs made IBM just another big tech company. Mobile and the web made Microsoft just another big tech company. This will happen to Google or Amazon as well. Unless you think tech progress is over and there’ll be no more cycles … It is deeply counter-intuitive to say ‘something we cannot predict is certain to happen’. But this is nonetheless what’s happened to overturn pretty much every tech monopoly so far.
If this time is different — or if there are more false negatives than false positives in the monopoly prediction game — then the advocates for breaking up Big Tech should try to make that argument instead of falling back on “big is bad” rhetoric. As for us, we’ll bet that we have not yet reached the end of history — tech progress is far from over.
Near the end of her new proposal to break up Facebook, Google, Amazon, and Apple, Senator Warren asks, “So what would the Internet look like after all these reforms?”
It’s a good question, because, as she herself notes, “Twenty-five years ago, Facebook, Google, and Amazon didn’t exist. Now they are among the most valuable and well-known companies in the world.”
To Warren, our most dynamic and innovative companies constitute a problem that needs solving.
She described the details of that solution in a blog post:
First, [my administration would restore competition to the tech sector] by passing legislation that requires large tech platforms to be designated as “Platform Utilities” and broken apart from any participant on that platform.
* * *
For smaller companies…, their platform utilities would be required to meet the same standard of fair, reasonable, and nondiscriminatory dealing with users, but would not be required to structurally separate….
* * * Second, my administration would appoint regulators committed to reversing illegal and anti-competitive tech mergers…. I will appoint regulators who are committed to… unwind[ing] anti-competitive mergers, including:
Let’s consider for a moment what this brave new world will look like — not the nirvana imagined by regulators and legislators who believe that decimating a company’s business model will deter only the “bad” aspects of the model while preserving the “good,” as if by magic, but the inevitable reality of antitrust populism.
Utilities? Are you kidding? For an overview of what the future of tech would look like under Warren’s “Platform Utility” policy, take a look at your water, electricity, and sewage service. Have you noticed any improvement (or reduction in cost) in those services over the past 10 or 15 years? How about the roads? Amtrak? Platform businesses operating under a similar regulatory regime would also similarly stagnate. Enforcing platform “neutrality” necessarily requires meddling in the most minute of business decisions, inevitably creating unintended and costly consequences along the way.
Network companies, like all businesses, differentiate themselves by offering unique bundles of services to customers. By definition, this means vertically integrating with some product markets and not others. Why are digital assistants like Siri bundled into mobile operating systems? Why aren’t the vast majority of third-party apps also bundled into the OS? If you want utilities regulators instead of Google or Apple engineers and designers making these decisions on the margin, then Warren’s “Platform Utility” policy is the way to go.
Grocery Stores. To take one specific case cited by Warren, how much innovation was there in the grocery store industry before Amazon bought Whole Foods? Since the acquisition, large grocery retailers, like Walmart and Kroger, have increased their investment in online services to better compete with the e-commerce champion. Many industry analysts expect grocery stores to use computer vision technology and artificial intelligence to improve the efficiency of check-out in the near future.
Smartphones. Imagine how forced neutrality would play out in the context of iPhones. If Apple can’t sell its own apps, it also can’t pre-install its own apps. A brand new iPhone with no apps — and even more importantly, no App Store — would be, well, just a phone, out of the box. How would users even access a site or app store from which to download independent apps? Would Apple be allowed to pre-install someone else’s apps? That’s discriminatory, too. Maybe it will be forced to offer a menu of all available apps in all categories (like the famously useless browser ballot screen demanded by the European Commission in its Microsoft antitrust case)? It’s hard to see how that benefits consumers — or even app developers.
Internet Search. Or take search. Calls for “search neutrality” have been bandied about for years. But most proponents of search neutrality fail to recognize that all Google’s search results entail bias in favor of its own offerings. As Geoff Manne and Josh Wright noted in 2011 at the height of the search neutrality debate:
[S]earch engines offer up results in the form not only of typical text results, but also maps, travel information, product pages, books, social media and more. To the extent that alleged bias turns on a search engine favoring its own maps, for example, over another firm’s, the allegation fails to appreciate that text results and maps are variants of the same thing, and efforts to restrain a search engine from offering its own maps is no different than preventing it from offering its own search results.
Nevermind that Google with forced non-discrimination likely means Google offering only the antiquated “ten blue links” search results page it started with in 1998 instead of the far more useful “rich” results it offers today; logically it would also mean Google somehow offering the set of links produced by any and all other search engines’ algorithms, in lieu of its own. If you think Google will continue to invest in and maintain the wealth of services it offers today on the strength of the profits derived from those search results, well, Elizabeth Warren is probably already your favorite politician.
And regulatory oversight of algorithmic content won’t just result in an impoverished digital experience; it will inevitably lead to an authoritarian one, as well:
Any agency granted a mandate to undertake such algorithmic oversight, and override or reconfigure the product of online services, thereby controls the content consumers may access…. This sort of control is deeply problematic… [because it saddles users] with a pervasive set of speech controls promulgated by the government. The history of such state censorship is one which has demonstrated strong harms to both social welfare and rule of law, and should not be emulated.
Digital Assistants. Consider also the veritable cage match among the tech giants to offer “digital assistants” and “smart home” devices with ever-more features at ever-lower prices. Today the allegedly non-existent competition among these companies is played out most visibly in this multi-featured market, comprising advanced devices tightly integrated with artificial intelligence, voice recognition, advanced algorithms, and a host of services. Under Warren’s nondiscrimination principle this market disappears. Each device can offer only a connectivity platform (if such a service is even permitted to be bundled with a physical device…) — and nothing more.
But such a world entails not only the end of an entire, promising avenue of consumer-benefiting innovation, it also entails the end of a promising avenue of consumer-benefiting competition. It beggars belief that anyone thinks consumers would benefit by forcing technology companies into their own silos, ensuring that the most powerful sources of competition for each other are confined to their own fiefdoms by order of law.
Breaking business models
Beyond the product-feature dimension, Sen. Warren’s proposal would be devastating for innovative business models. Why is Amazon Prime Video bundled with free shipping? Because the marginal cost of distribution for video is close to zero and bundling it with Amazon Prime increases the value proposition for customers. Why is almost every Google service free to users? Because Google’s business model is supported by ads, not monthly subscription fees. Each of the tech giants has carefully constructed an ecosystem in which every component reinforces the others. Sen. Warren’s plan would not only break up the companies, it would prohibit their business models — the ones that both created and continue to sustain these products. Such an outcome would manifestly harm consumers.
Both of Warren’s policy “solutions” are misguided and will lead to higher prices and less innovation. Her cause for alarm is built on a multitude of mistaken assumptions, but let’s address just a few (Warren in bold):
“Nearly half of all e-commerce goes through Amazon.” Yes, but it has only 5% of total retail in the United States. As my colleague Kristian Stout says, “the Internet is not a market; it’s a distribution channel.”
“Amazon has used its immense market power to force smaller competitors like Diapers.com to sell at a discounted rate.” The real story, as the founders of Diapers.com freely admitted, is that they sold diapers as what they hoped would be a loss leader, intending to build out sales of other products once they had a base of loyal customers:
And so we started with selling the loss leader product to basically build a relationship with mom. And once they had the passion for the brand and they were shopping with us on a weekly or a monthly basis that they’d start to fall in love with that brand. We were losing money on every box of diapers that we sold. We weren’t able to buy direct from the manufacturers.
Like all entrepreneurs, Diapers.com’s founders took a calculated risk that didn’t pay off as hoped. Amazon subsequently acquired the company (after it had declined a similar buyout offer from Walmart). (Antitrust laws protect consumers, not inefficient competitors). And no, this was not a case of predatory pricing. After many years of trying to make the business profitable as a subsidiary, Amazon shut it down in 2017.
“In the 1990s, Microsoft — the tech giant of its time — was trying to parlay its dominance in computer operating systems into dominance in the new area of web browsing. The federal government sued Microsoft for violating anti-monopoly laws and eventually reached a settlement. The government’s antitrust case against Microsoft helped clear a path for Internet companies like Google and Facebook to emerge.” The government’s settlement with Microsoft is not the reason Google and Facebook were able to emerge. Neither company entered the browser market at launch. Instead, they leapfrogged the browser entirely and created new platforms for the web (only later did Google create Chrome).
Furthermore, if the Microsoft case is responsible for “clearing a path” for Google is it not also responsible for clearing a path for Google’s alleged depredations? If the answer is that antitrust enforcement should be consistently more aggressive in order to rein in Google, too, when it gets out of line, then how can we be sure that that same more-aggressive enforcement standard wouldn’t have curtailed the extent of the Microsoft ecosystem in which it was profitable for Google to become Google? Warren implicitly assumes that only the enforcement decision in Microsoft was relevant to Google’s rise. But Microsoft doesn’t exist in a vacuum. If Microsoft cleared a path for Google, so did every decision not to intervene, which, all combined, created the legal, business, and economic environment in which Google operates.
Warren characterizes Big Tech as a weight on the American economy. In fact, nothing could be further from the truth. These superstar companies are the drivers of productivity growth, all ranking at or near the top for most spending on research and development. And while data may not be the new oil, extracting value from it may require similar levels of capital expenditure. Last year, Big Tech spent as much or more on capex as the world’s largest oil companies:
Warren also faults Big Tech for a decline in startups, saying,
The number of tech startups has slumped, there are fewer high-growth young firms typical of the tech industry, and first financing rounds for tech startups have declined 22% since 2012.
But this trend predates the existence of the companies she criticizes, as this chart from Quartz shows:
The exact causes of the decline in business dynamism are still uncertain, but recent research points to a much more mundane explanation: demographics. Labor force growth has been declining, which has led to an increase in average firm age, nudging fewer workers to start their own businesses.
Furthermore, it’s not at all clear whether this is actually a decline in business dynamism, or merely a change in business model. We would expect to see the same pattern, for example, if would-be startup founders were designing their software for acquisition and further development within larger, better-funded enterprises.
Will Rinehart recently looked at the literature to determine whether there is indeed a “kill zone” for startups around Big Tech incumbents. One paper finds that “an increase in fixed costs explains most of the decline in the aggregate entrepreneurship rate.” Another shows an inverse correlation across 50 countries between GDP and entrepreneurship rates. Robert Lucas predicted these trends back in 1978, pointing out that productivity increases would lead to wage increases, pushing marginal entrepreneurs out of startups and into big companies.
It’s notable that many in the venture capital community would rather not have Sen. Warren’s “help”:
If big companies like Google, Facebook, and Amazon are prevented from acquiring startups, that actually reduces competition. The reason is that if there is less M&A due to legal uncertainty, there is a reduced incentive for angels & VCs to fund those startups in the first place.
just to sustain constant growth in GDP per person, the U.S. must double the amount of research effort searching for new ideas every 13 years to offset the increased difficulty of finding new ideas.
If this assessment is correct, it may well be that coming up with productive and profitable innovations is simply becoming more expensive, and thus, at the margin, each dollar of venture capital can fund less of it. Ironically, this also implies that larger firms, which can better afford the additional resources required to sustain exponential growth, are a crucial part of the solution, not the problem.
Warren believes that Big Tech is the cause of our social ills. But Americans have more trust in Amazon, Facebook, and Google than in the political institutions that would break them up. It would be wise for her to reflect on why that might be the case. By punishing our most valuable companies for past successes, Warren would chill competition and decrease returns to innovation.
Finally, in what can only be described as tragic irony, the most prominent political figure who shares Warren’s feelings on Big Tech is President Trump. Confirming the horseshoe theory of politics, far-left populism and far-right populism seem less distinguishable by the day. As our colleague Gus Hurwitz put it, with this proposal Warren is explicitly endorsing the unitary executive theory and implicitly endorsing Trump’s authority to direct his DOJ to “investigate specific cases and reach specific outcomes.” Which cases will he want to have investigated and what outcomes will he be seeking? More good questions that Senator Warren should be asking. The notion that competition, consumer welfare, and growth are likely to increase in such an environment is farcical.
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