Google spokesperson, Adam Kovacevich’s favourite example of a well-researched article on the now-aborted Yahoo-Google deal is “The Plot to Kill Google” that appeared in Wired Magazine in January 2009.  The lengthy article takes great pains to reveal Microsoft’s attempts to scupper “a small deal that it [Google] was convinced would benefit consumers, the two companies and the search-advertising market as a whole” and paints Google a company of well-meaning nerds whose only fault is their inability to schmooze with powerbrokers in Washington.  Towards the end however, one gets the feeling that Google seems to have a robust team of lobbyists itself.  The article is co-written by a member of the New America Foundation – a think-tank chaired by Google CEO Eric Schmidt.

Once the poster child of the internet revolution with its geeky appeal and its open-collar, open-source appeal, Google Inc promised to be everything that Microsoft wasn’t – new, innovative, nimble and most importantly “not evil”.  Of late however, the “up-start” label is beginning to wear thin in light of a market cap of $125 Billion, more than $4 Billion in reported net income in 2008 and a 63.5% s share of search queries originating the US.  The company’s incredible profitability isn’t of itself a sign of wrong-doing, but Google’s tremendous growth has lead industry watchers to fear a monopolisation of the “search advertising” space.  Google has steadfastly fended off allegations of being a monopoly with significant barriers to entry, while maintaining that “competition is just a click away.” But like the Wired Magazine article, one gets the sense that the Google defence doesn’t present the whole truth.

In a question regarding the company’s dominant share of search and its implications for market power, Google Chief Competition Counsel, Dana Wagner, replied that “Search is free,”: an argument that works well in the absence of a broader understanding of Google’s business.  Contrary to popular belief, Google is not so much a “search” company as it is an “advertising” company.  Of course, the search is what brings users to the platform – in the same way that programming brings listeners to radio, but in both cases – the money comes almost entirely from advertisers.

An examination of Google’s financial statements reveals that the company earns between 97 and 99% of its revenues from advertising, with the remaining one percent to three percent coming from licensing out its proprietary search technology to third party search sites like Ask.com.  However, search-dominance offers Google significant control over the “search-advertisement” market in much the same way that captive listeners give a radio station negotiating power with content providers and advertisers alike.

Search-advertising refers to the sponsored links that appear on the right hand side of the browser screen when a user types in a search query.  While the results churned out on the left are considered to be “natural” or “algorithmic” search results; advertisers bid (via auction) for the accompanying space on the right that is related to the search query.  Thus, a search for a digital camera will generate popular sites, blogs and reviews on the left along with advertisements from web-merchants, camera magazines, retailers on the right.  Once a user clicks on the ad, the advertiser is charged a certain fee based on a prior agreement.  Search advertising is considered particularly lucrative for advertisers and Google because the user is considered to be an “active” target who is already considering a purchase that can be measured and quantified, rather than a carpet-bombing technique adopted on standard formats like television and newspapers.

Thus, by dominating the search market (which is “free”) Google gains control of valuable advertising space that is auctioned off to the highest bidder. The greater the number of searches, the greater the amount of advertising, and the higher the revenues for the company.  In 2008, “Adwords”- Google’s advertising arm for ads placed on Google owned websites like Google.com, Gmail, Google Scholar etc – contributed 67% to the company’s gross revenue while Ad-sense, which refers to advertisements placed on third-party websites accounted for 30%.  Thus, the Yahoo deal – which was marketed as a “small deal” that would replace some of Yahoo’s advertisement inventory with Google’s Ad-words – would only serve to consolidate an online advertising empire that includes sites like business.com and AOL.

As per US anti-trust law, companies are rarely punished for so-called “meritocratic monopolies” – market control that comes from simply being better than one’s competitors; and to be fair, Google’s growth and power thus far have been derived from out-witting their better-established competitors.  However, under the provisions of the Sherman Antitrust Act, entities can be penalised for indulging in monopolistic behaviour – i.e. leveraging their market power to either kill off their rivals or fleece customers.  Critics point out that the Sherman Act runs counter to established business-wisdom, as the reason that companies strive to control market-share is the hope that market-share shall somehow translate into pricing power.  Supporters of anti-trust litigation view as the precise reason why regulatory controls are so important.

Up to the point of the proposed Yahoo deal, Google was generally viewed as a benign internet overlord; an incredibly powerful company that often supported issues like net neutrality, open-source software and the freeware which didn’t directly translate into profit-making opportunities.  In fact, Google representatives often spoke of their commitment to preserving and improving the internet “eco-system”.  Google also points out that ad-prices are set by internet auction, eliminating any power that they had to fix prices.  However, a recent complaint filed by tradecomet.com questions these very assumptions. Read the whole complaint here. For a exhaustive list of lawsuits filed against Google – check here.

In their complaint, Tradecomet, a specialised search engine for B2B (business to business) users, alleges that Google indulges in blatantly exclusionary tactics under Section Two of the Sherman Act that prevents monopolistic practices.  According to the petition filed, Trade-comet runs a service called Searchtool that functions as a specialised search engine that provides businesses looking for specific information that cannot be found as easily on Google’s generic search.  While Google initially welcomed Tradecomet’s advertising business, the complaint states that Google blatantly raised Tradecomet’s advertising costs by 10,000% – from a few cents to between $5 and $10 per advertisement when Google realised that Searchtool represented a credible threat to their search monopoly.
Tradecomet defined the market as “Search-based Advertising in the US” – arguing that such advertising is materially different from other forms like display advertising because of its “active” nature and the fact that there were no direct substitutes for this advertising conduit.  They also argued that new-entrants into the “search-advertising” business faced significant barriers to entry in the form of Google’s proprietary web-based technology that had become a de-facto industry standard.  By virtue of its monopoly of scale, Google was systematically depriving its competitors of scale and thereby ensuring a perpetuation of the monopoly.  This, the complaint alleges, illustrates how Google uses its leverage in the search market to squeeze out competitors in the pure search and search-based advertising markets.

It may be added that contrary to Google’s claims, Web 2.0 has significant barriers to entry for those attempting to add to the physical infrastructure of the internet.  While start-ups can launch websites at very low cost, those in the data-storage business require huge fixed costs in the form of server farms and data centres.  The most recent Google Data plant in Oregon, for instance, is located on 30 acres of land and at full capacity would use enough energy to power a mid-sized European town.  Another plant is planned near Helsinki, on a site bought at a cost of 40 million euro.

The success of these barriers can be gauged from the company’s staggering operating margin of 31.5% for 2008 – a level seen only in tightly controlled markets like beverages industry. Yahoo – by contrast – made a net loss last year.  Google’s massive dominance of the online market has lead some commentators to believe that a Yahoo-Microsoft deal is probably the only way Google will survive in this present form. Without a credible competitor, it is only a matter of time before they find themselves in a Microsoft-Netscape style brouhaha.