How to break up Google, without breaking up Alphabet

When the anti-trust case against Google was announced this week, the share price of its parent, Alphabet, went up. Suggesting that investors expect that either the case won’t stick, or that if it does, the remedy won’t be effective.

And indeed, although the authorities have said that all possibilities are open, the remedies mentioned so far look weak. Giving users of Apple or Android devices a choice of search engines on first set-up might reduce Google’s market share, but probably only slightly, given its strong name recognition. As for a forced break-up of business divisions, while it could be powerful to force Facebook to divest Instagram and What’s App, there is no equivalent for Alphabet – splitting off a cloud computing business, for example, won’t do much to a search monopoly.

It’s the advertising, stupid

The real heart of Google’s business model is advertising. Google has a dominant share of search-related ads. It operates an auction system for those ads, based on keyword searches. As I’ve written previously, charges can typically be $40 per click or more for some keywords like “car insurance”. Auction theory says that the value (monetary or emotional) to the winner of the item purchased, net of the price paid, can be next-to-nothing. Google auctions set the price at the second-highest bid, which ensures that some value is always left for the winner, though it still may not be much.

So, the emergence over the last two decades of search ads has been double-edged: it has allowed businesses of almost every type to target customers in a way that was never before possible, generating greater efficiency and profit, but Google’s auction system is set up to be able to capture the lion’s share of that profit.

The best anti-trust remedy

The best way for regulators to address monopoly power in advertising, is to directly introduce competition into the ad-auction process. Competition, that is, among sellers of ad space. Designing auction systems for regulators is a job for people who know more about it than I do, but here’s a straw man to get the debate going.

In this straw man, the regulators require Google to have a preliminary auction, every week, for all of the keywords across its entire US search universe, divided into seven equal parts, each of which has to go to a different bidder. Google can bid for one of the parts, and gets to keep all the proceeds of the auction.

The seven winners, call them ad wholesalers, then on-sell keyword searches to advertisers, either using exactly the system Google now does, or any other method, no collusion allowed.

So, if ninety-eight people search for “car insurance” on Google, fourteen of them (allocated randomly or sequentially) will see an ad from the advertiser who transacted with the first wholesaler, another fourteen the ad (which may or may not be different) from whoever transacted with the second wholesaler, and so on.

Giving market power back to advertisers

What will this do to the prices that advertisers are prepared to pay? (And hence, to the prices that the wholesalers pay to Google?) One simple answer is that advertisers now face seven different vendors of an identical product, so there is competition where there was none before, and the price will come down.

That’s probably the right answer, though there is something else going on here as well. Under the current system, an advertiser is actually buying two things: clicks that may lead to sales; and the diversion of clicks away from competitors. Under this straw man proposal, an advertiser can still get both those things, by bidding high enough to transact with all seven wholesalers. But, many advertisers may be happy to simply get the first, by transacting with one or two wholesalers only. The existence of this second kind of advertiser will tend to bring the price down.

The old-fashioned ad world was like this straw man: some advertisers might have bought up all the prime-time TV slots and best billboard slots to keep out competitors, but for many, the aim was merely to buy up enough to get their message out.

How to break up Google, without breaking up Alphabet

In summary, the issue is Google’s monopoly power over search ads; its dominant position in search is just a means to that end.

So the way to regulate the market is not to focus on Google’s dominant position in search, which is a difficult thing to change. Much better to directly address the market for search-based ads, possibly by requiring a two-stage auction like the straw man described here. Advertisers would get some market power back from the search engine, and those who don’t want to pay to squeeze out their competitors, but simply want to pay a lesser amount to get their product out there, could do so.

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