July 2007

The Economics of Internet Advertising: Implications for the Google-DoubleClick Merger

Internet advertising is the growth engine that sustains the availability of free applications such as YouTube and MySpace. Without Internet advertising revenues, many believe that innovators would cease to develop these immensely popular programs. On the flipside, advertisers will only advertise on Web pages that have a strong following or that they believe have the potential to attract many visitors. What would happen if a new entity were created that controlled most of the ads appearing on the Internet? The Google-DoubleClick merger may do just that. Given the important role of advertising in Internet innovation, how should federal antitrust officials decide on the important issues involved in assessing the merits of the merger, such as the relevant market and barriers to entry? How should they assess issues specifically related to Internet advertising, such as the effect of one company's control of significant consumer data? By focusing on the potential costs and benefits of the Google-DoubleClick merger, panelists at this Joint Center conference examined the economics of Internet advertising and the role of such advertising in Internet competition.

Robert W. Hahn
AEI

The Internet has become an integral part of our economy, unleashing powerful innovations that are transforming the way we work and play. Perhaps the most underappreciated innovation is Internet advertising, which has become the growth engine that makes it possible to access the likes of YouTube and MySpace for free. Without online advertising, content providers would have to raise revenues from end users only.

Since the future of Internet innovation could depend on ad revenues, a merged entity that controls most of the ads appearing on web pages could have an enormous impact on the way business is conducted on the web.

Google is now seeking to purchase DoubleClick, a leader in online advertising. It is a transaction that raises some fundamental questions warranting the attention of antitrust officials: What is the relevant market? Should regulators review the entire advertising market? Or perhaps just the part dealing with online advertising? To answer this question, it would be useful to know whether advertisers think of different kinds of ads, such as graphic display ads on sites such as nytimes.com or espn.com and the kind listed on the side of search sites like Google or Yahoo! as interchangeable. If they tend to be close substitutes, they are arguably part of the same economic market.

Another key economic issue is whether there are significant barriers to entry in the relevant market. If entry barriers are low, then regulators may be less concerned with mergers. The barriers to entry to the delivery of effective on-line advertising appear to be far from trivial. A full-service online advertiser capable of competing with a Google/DoubleClick requires large investments in data centers, networks, and engineering talent.

There are other important issues in this merger as well. For example, how will the merger affect consumer data? What does it mean when a single company can observe and capture consumer information on an unprecedented scale? Does unequaled knowledge of customer behavior on the Internet give one company a strategic, or unfair, advantage in any particular line of business?

Finally, what are we to make of the recent activity by potential competitors? After the announcement of the Google-DoubleClick purchase for 3 billion, Microsoft announced a planned purchase of aQuantive, Inc., an online-advertising agency for 6 billion, Yahoo! announced its intent to acquire Right Media, a display-advertising firm, and AOL announced plans to acquire ADTECH AG, a leading international online ad-serving company. What do these strategic moves mean for competition in this general space?

David Evans
LECG

The Internet advertising industry is a typical two-sided market, with advertisers on one side, and web-viewers on the other. One method of advertising is by display on the website of an "integrated publisher" such as nytimes.com or msn.com. Online advertisement firms facilitate advertising by marketing advertising tools to each side of the market and connecting advertisers to publishers.

Currently, Google and DoubleClick are major players in the Internet advertising market. Google's acquisition of DoubleClick would allow consolidation of advertising tools as well as data about Internet users. This acquisition would provide Google with greater market power, and could potentially harm consumers.

Thomas Eisenmann
Harvard University

Google's share in the Internet search market has been steadily rising, while its major competitors' shares have been steadily falling. Google's increasing dominance is probably not due to the quality of its search engine but to its advertising. About 40 percent of web searches are commercial in nature. Therefore, with all other things equal, the search engine with the best advertising attracts the most users.

An important question for competition authorities is whether the search market is a winner-take-all market--will Google's share continue to rise until it captures the entire market? What conditions will prevent this from occurring? How would the acquisition of DoubleClick affect these conditions? The answers to these questions depend on the shape of the revenue-per-search curve.

Lorin Hitt
University of Pennsylvania

Acquiring DoubleClick would allow Google to play a larger role in the "display advertisement" market, raising questions of potential anticompetitive effects. Perhaps the new Google would use its increased market power or its expanded set of Internet user information to raise prices and squelch competition.

The structure of the advertising industry is complex and dynamic, and these concerns may be misplaced. While the new Google would be a major player in the Internet advertising market, it would not be the only one. Indeed, the industry is young and has been very dynamic, with innovation and frequent new entrants. In the past, Google has used its access to abundant consumer information not to raise prices but instead to improve service.

Robert Hall
Stanford University

The DoubleClick acquisition should be considered from the perspective of what is best for the consumer. Modern acquisition analysis seeks to discover the effect of coordination on the business policies of the two companies. If the anticipated effects are lower costs or improved quality of service, the merger could be pro-consumer. Privacy concerns have also been raised. The best way to address privacy issues is to implement privacy-specific tools rather than block the acquisition.

Joint Center research assistant David Burk prepared this summary.