Google searches for a partner in quest for world domination

Published on Tuesday 29 April 2008 21:42

Fierce competition for the lucrative advertising dollar may hit the online consumer, writes FEDERICO ETRO.

ADVERTISING is big business. Even with a looming global economic downturn, companies spend more than $600 billion worldwide on brand recognition annually. Today only about 12 per cent of that total is spent on online advertising, but the figure is set to grow, and grow fast: half a million new internet users a day, increased connectivity of mobile devices and even TV to the worldwide web, websites' increasing reliance on advertising to generate revenue, and the promise of reaching target groups with ever-greater precision are just a few of the reasons for the migration of advertising dollars to the new medium.

The high stakes are prompting a scramble for internet real estate, with the dominant search engine Google taking steps to reinforce its position, and smaller rivals Yahoo!, Microsoft, AOL and NewsCorp (the owner of MySpace) looking for combinations that would allow them to close the gap with the market leader. Recent weeks and months have seen the internet and computer giants collide over the ownership of Yahoo! in particular. Microsoft's stakes are particularly high, by being the only player to openly bid for the company and even mulling over the possibility of launching a hostile takeover. Yahoo!'s first reaction was lukewarm and it immediately started looking at other alternatives, such as a possible bid by Rupert Murdoch's NewsCorp or even a possible partnership with its arch rival, Google. However, eyes are still mainly focused on Microsoft's next move. It warned this month that if its 26 April deadline was not met, it would seek to oust Yahoo!'s board and take its offer directly to shareholders, perhaps at a lower price. The deadline passed on Saturday with no sign that the two sides were negotiating. What the outcome of this trench war will be is unclear and I try not to predict it. Rather, I want to look at what either result would mean for advertisers and in particular for us, the consumers.

Google is the top search engine in the world, with a market share of 90 per cent-plus in a number of EU countries, and exceeding 50 per cent in the United States. Beyond search queries, Google dominates the lucrative business of placing text ads next to search engine results, an area where Yahoo! and Microsoft, working independently, have been unable to catch up. Google AdWords accounts for about 70 per cent of search advertising revenue worldwide. DoubleClick, recently bought by Google, leads the industry in contextual advertising (the placing of banner ads on third-party websites), accounting for more than 75 per cent of the direct channel, that is, the valuable advert inventory that large web publishers directly negotiate with advertisers.

A similar alignment prevails in the market for so-called "remnant" advertising inventory, sold through intermediaries who buy from publishers and sell to advertisers. This can be seen as a separate market from the direct channel, and, again, Google plays a dominant role, with Yahoo! and Microsoft straggling behind.

Google's vertically integrated intermediation platform between online publishers and advertisers, AdSense, absorbs more than 80 per cent of the revenue in the indirect channel, targeting advertising to relevant websites and paying web publishers a percentage of its revenues. Advertisers buy inventories from the AdSense platform through bids on the keywords that match the content of the web-pages. DoubleClick has been offering an alternative ad-serving/management product, Dart, for both publishers and advertisers, with a market share of around 75 per cent. DoubleClick's recent acquisition by Google leaves it with at least 80 per cent of the worldwide market for online advertising.

It would be odd if this did not lead to price increases: before the merger, competitive forces kept online advertising rates under control (DoubleClick could not increase prices because many consumers would have quickly switched to AdSense, and Google was similarly disciplined by the prospect of customers switching to DoubleClick's products); following the merger, these competitive constraints no longer apply.

For consumers and advertisers, the consequences of the current consolidations are uncertain. A merger between Yahoo! and Microsoft would create synergies in research and development without affecting the prices of either company's main products, which are complements rather than substitutes. It would allow the two to join forces and develop search engine capabilities and online services that could constitute a genuine, competitive alternative to Google, whose dominance in pay-per-click Internet advertising is now combined with DoubleClick's dominance in advert-serving services. Giving content creators and advertisers a realistic alternative to Google would ultimately lead to reduced costs and greater consumer choice.

By contrast, a Google/Yahoo! tie-up, or even limited outsourcing of advert placement by Yahoo! to Google, such as that announced by Yahoo! two weeks ago in the US, would radically reduce competition, while generating no significant "efficiencies" to benefit advertisers and consumers. Any combination of the two would likely violate EU anti-monopoly rules, with an outsourcing deal that sidelines Yahoo! as a competitor allocating approximate 90 per cent of search advertising to Google, virtually ending prospects for competition. Even more importantly from an anti-monopoly point of view, locking Yahoo!'s search query share and online traffic into Google's ad platform would ensure that no-one could reach the scale necessary to mount a credible competitive alternative.

Whether Microsoft succeeds in combining with Yahoo! is crucial for the future of the market for online advertising: such a merger would enhance choice for content creators, advertisers and consumers, creating a much-needed alternative to Google.

&#149 Professor Federico Etro teaches on the Scottish Graduate Programme in Economics at the University of Edinburgh.