Archives For network effects

One of my favorite stories in the ongoing saga over the regulation (and thus the future) of Internet search emerged earlier this week with claims by Google that Microsoft has been copying its answers–using Google search results to bolster the relevance of its own results for certain search terms.  The full story from Internet search journalist extraordinaire, Danny Sullivan, is here, with a follow up discussing Microsoft’s response here.  The New York Times is also on the case with some interesting comments from a former Googler that feed nicely into the Schumpeterian competition angle (discussed below).  And Microsoft consultant (“though on matters unrelated to issues discussed here”)  and Harvard Business prof Ben Edelman coincidentally echoes precisely Microsoft’s response in a blog post here.

What I find so great about this story is how it seems to resolve one of the most significant strands of the ongoing debate–although it does so, from Microsoft’s point of view, unintentionally, to be sure.

Here’s what I mean.  Back when Microsoft first started being publicly identified as a significant instigator of regulatory and antitrust attention paid to Google, the company, via its chief competition counsel, Dave Heiner, defended its stance in large part on the following ground:

All of this is quite important because search is so central to how people navigate the Internet, and because advertising is the main monetization mechanism for a wide range of Web sites and Web services. Both search and online advertising are increasingly controlled by a single firm, Google. That can be a problem because Google’s business is helped along by significant network effects (just like the PC operating system business). Search engine algorithms “learn” by observing how users interact with search results. Google’s algorithms learn less common search terms better than others because many more people are conducting searches on these terms on Google.

These and other network effects make it hard for competing search engines to catch up. Microsoft’s well-received Bing search engine is addressing this challenge by offering innovations in areas that are less dependent on volume. But Bing needs to gain volume too, in order to increase the relevance of search results for less common search terms. That is why Microsoft and Yahoo! are combining their search volumes. And that is why we are concerned about Google business practices that tend to lock in publishers and advertisers and make it harder for Microsoft to gain search volume. (emphasis added).

Claims of “network effects” “increasing returns to scale” and the absence of “minimum viable scale” for competitors run rampant (and unsupported) in the various cases against Google.  The TradeComet complaint, for example, claims that

[t]he primary barrier to entry facing vertical search websites is the inability to draw enough search traffic to reach the critical mass necessary to become independently sustainable.

But now we discover (what we should have known all along) that “learning by doing” is not the only way to obtain the data necessary to generate relevant search results: “Learning by copying” works, as well.  And there’s nothing wrong with it–in fact, the very process of Schumpeterian creative destruction assumes imitation.

As Armen Alchian notes in describing his evolutionary process of competition,

Neither perfect knowledge of the past nor complete awareness of the current state of the arts gives sufficient foresight to indicate profitable action . . . [and] the pervasive effects of uncertainty prevent the ascertainment of actions which are supposed to be optimal in achieving profits.  Now the consequence of this is that modes of behavior replace optimum equilibrium conditions as guiding rules of action. First, wherever successful enterprises are observed, the elements common to these observable successes will be associated with success and copied by others in their pursuit of profits or success. “Nothing succeeds like success.”

So on the one hand, I find the hand wringing about Microsoft’s “copying” Google’s results to be completely misplaced–just as the pejorative connotations of “embrace and extend” deployed against Microsoft itself when it was the target of this sort of scrutiny were bogus.  But, at the same time, I see this dynamic essentially decimating Microsoft’s (and others’) claims that Google has an unassailable position because no competitor can ever hope to match its size, and thus its access to information essential to the quality of search results, particularly when it comes to so-called “long-tail” search terms.

Long-tail search terms are queries that are extremely rare and, thus, for which there is little user history (information about which results searchers found relevant and clicked on) to guide future search results.  As Ben Edelman writes in his blog post (linked above) on this issue (trotting out, even while implicitly undercutting, the “minimum viable scale” canard):

Of course the reality is that Google’s high market share means Google gets far more searches than any other search engine. And Google’s popularity gives it a real advantage: For an obscure search term that gets 100 searches per month at Google, Bing might get just five or 10. Also, for more popular terms, Google can slice its data into smaller groups — which results are most useful to people from Boston versus New York, which results are best during the day versus at night, and so forth. So Google is far better equipped to figure out what results users favor and to tailor its listings accordingly. Meanwhile, Microsoft needs additional data, such as Toolbar and Related Sites data, to attempt to improve its results in a similar way.

But of course the “additional data” that Microsoft has access to here is, to a large extent, the same data that Google has.  Although Danny Sullivan’s follow up story (also linked above) suggests that Bing doesn’t do all it could to make use of Google’s data (for example, Bing does not, it seems, copy Google search results wholesale, nor does it use user behavior as extensively as it could (by, for example, seeing searches in Google and then logging the next page visited, which would give Bing a pretty good idea which sites in Google’s results users found most relevant)), it doesn’t change the fundamental fact that Microsoft and other search engines can overcome a significant amount of the so-called barrier to entry afforded by Google’s impressive scale by simply imitating much of what Google does (and, one hopes, also innovating enough to offer something better).

Perhaps Google is “better equipped to figure out what users favor.”  But it seems to me that only a trivial amount of this advantage is plausibly attributable to Google’s scale instead of its engineering and innovation.  The fact that Microsoft can (because of its own impressive scale in various markets) and does take advantage of accessible data to benefit indirectly from Google’s own prowess in search is a testament to the irrelevance of these unfortunately-pervasive scale and network effect arguments.

We have just uploaded to SSRN a draft of our article assessing the economics and the law of the antitrust case directed at the core of Google’s business:  Its search and search advertising platform.  The article is Google and the Limits of Antitrust: The Case Against the Antitrust Case Against Google.  This is really the first systematic attempt to address both the amorphous and the concrete (as in the TradeComet complaint) claims about Google’s business and its legal and economic importance in its primary market.  It’s giving nothing away to say we’re skeptical of the claims, and, moreover, that an approach to the issues appropriately sensitive to the potential error costs would be extremely deferential.  As we discuss, the economics of search and search advertising are indeterminate and subtle, and the risk of error is high (claims of network effects, for example, are greatly exaggerated, and the pro-competitive justifications for Google’s use of a quality score are legion, despite frequent claims to the contrary).  We welcome comments on the article, and we look forward to the debate.  The abstract is here:

The antitrust landscape has changed dramatically in the last decade.  Within the last two years alone, the United States Department of Justice has held hearings on the appropriate scope of Section 2, issued a comprehensive Report, and then repudiated it; and the European Commission has risen as an aggressive leader in single firm conduct enforcement by bringing abuse of dominance actions and assessing heavy fines against firms including Qualcomm, Intel, and Microsoft.  In the United States, two of the most significant characteristics of the “new” antitrust approach have been a more intense focus on innovative companies in high-tech industries and a weakening of longstanding concerns that erroneous antitrust interventions will hinder economic growth.  But this focus is dangerous, and these concerns should not be dismissed so lightly.  In this article we offer a comprehensive cautionary tale in the context of a detailed factual, legal and economic analysis of the next Microsoft: the theoretical, but perhaps imminent, enforcement action against Google.  Close scrutiny of the complex economics of Google’s technology, market and business practices reveals a range of real but subtle, pro-competitive explanations for features that have been held out instead as anticompetitive.  Application of the relevant case law then reveals a set of concerns where economic complexity and ambiguity, coupled with an insufficiently-deferential approach to innovative technology and pricing practices in the most relevant precedent (the D.C. Circuit’s decision in Microsoft), portend a potentially erroneous—and costly—result.  Our analysis, by contrast, embraces the cautious and evidence-based approach to uncertainty, complexity and dynamic innovation contained within the well-established “error cost framework.”  As we demonstrate, while there is an abundance of error-cost concern in the Supreme Court precedent, there is a real risk that the current, aggressive approach to antitrust error, coupled with the uncertain economics of Google’s innovative conduct, will nevertheless yield a costly intervention.  The point is not that we know that Google’s conduct is procompetitive, but rather that the very uncertainty surrounding it counsels caution, not aggression.