A Guide To The Action At Eric Schmidt's Testimony, Part 1

People who think of Google as the provider of free search to the world may have difficulty understanding why the FTC has launched an investigation, or why Chairman Eric Schmidt was pressured to testify before the Subcommittee.
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This is part one of a two-part series.

Part 1: Why Hold a Hearing?


Next month the Senate Subcommittee on Antitrust, Competition Policy, and Consumer Rights will hear testimony from Eric Schmidt, Google's Executive Chairman and former CEO. People who think of Google as the provider of free search to the world may have difficulty understanding why the FTC has launched an investigation, or why Chairman Eric Schmidt was pressured to testify before the Subcommittee.

The first part of this post describes the extent of Google's operations and describes in broad terms why there is any need for an investigation or for testimony in front of the Subcommittee. It's a brief introduction to the complex and far flung world of Google, for people who may not be familiar with the breadth of the company's operations. It also provides a very short introduction to the specific legislation that will be used to assess the legality of Google's actions.

The second part of this post reviews in more detail what the Subcommittee will probably be examining in their questioning of Mr. Schmidt.

Google 101

Google is not a charitable foundation that provides free search. Google is a well-run and spectacularly profitable corporation, which does provide search without explicit monetary charge to consumers. It charges corporations to participate in paid search through its auction of keywords, which can be used to obtain prime locations on the search results page. The more users Google has for search, the more bidders it can attract for its keyword auctions. The more bidders it attracts, the the bids it receives for keywords. The more it gets paid for keywords, the more services it can provide free to users, and the happier its users are. The happier its search users are, and the more users it has, the more bidders it can attract and the more Google can charge for keywords. We (party 1) use Google (party 2) to find sellers (party 3). Party 3 pays, partly to be found, but mostly "to not be not found" -- that is, party 3 pays to avoid being rendered invisible on the internet, even invisible to companies searching explicitly for it. This third party payer business model is not unique to Google, but no company exploits the power of this model as well as Google does today.

Some people have compared Google to Robin Hood. This is not fair to either Google or Robin Hood. Robin Hood stole from the rich; Google may have the power to extort very high fees from corporations, but it does not steal. On the other hand, Robin Hood gave to the poor; Google keeps most of what it extorts for itself. Google's profits before taxes last quarter were in excess of $3 billion, on income last quarter of approximately $9 billion, with net profit margins before taxes of 33% and gross margins of 65%. Google's net profit margins are almost double the S&P average. Well done. But not Robin Hood.

So far, so good. Profitability is good. Extraordinary margins are good. But Google has enormous market share in search, in excess of 70 in the US, and higher in Europe, Canada, and Australia. The results in enormous market power. How the power was obtained and how it is used are both legitimate areas of concern under American antitrust law.

Additionally, Google has expanded into an enormous array of other software services, described on its web page Everything Google > Products:

  • Web-based (5) -- e.g., its well-known Web-Search product and Chrome, its own browser
  • Mobile Based (3) -- e.g., Mobile search and Maps for Mobile
  • Media (7) -- e.g., YouTube, Books, and Picasa (photo editing and sharing)
  • Geographic (4) -- e.g., Earth (to view almost anything) and Maps (for maps and directions)
  • Home and Office (12) -- e.g., Docs (documents, spreadsheets, and presentations) and Gmail
  • Social (5) -- e.g., Blogger and Orkut (a networking tool, like Linkedin)
  • Specialized Search (8) -- e.g., Patent Search, Scholar (scholarly search), and Finance
  • Innovation (3) -- sort of a catch-all for support of research and development.

Likewise, Google is expanding into a wide range of other businesses, too important to be listed simply as products. They will provide travel industry support software through their acquisition of ITA, and they will provide TV set-top decoder boxes and mobile phones through their acquisition of Motorola Mobility. Google is a major player in Cloud Computing, and, no doubt, they will continue to move into other areas. Google+ is preparing to go head-to-head with Facebook. Android is going head-to-head with the Apple iPhone.

Again, so far, so good. Google is hardly America's first conglomerate.

As I note repeatedly, an investigation is not an accusation, and support for investigation does not presume guilt.

So Why Have a Hearing?

So why are the Department of Justice, the Federal Trade Commission, and the Senate Judiciary Subcommittee on Antitrust, Competition Policy, and Consumer Rights all interested in Google? The company provides consumers with free search, and consumers appear to love it. What could be wrong with that?

The following points simply provide background for assessing Google.

  • Search is not free to everyone. Corporations pay billions of dollars to improve their search page positioning by bidding on keywords in keyword auctions. This is Google's primary revenue source and the source of virtually all of its current profits.
  • Search may not be free to consumers. Corporations that pay for positioning may pass those charges on to consumers, and if Google's market power in search allows them to charge monopoly prices for keywords, then the charges passed to consumers may be quite high.
  • Search may not be as fair and unbiased as consumers assume (1). By sending consumers to the winners of keyword auctions, Google may confuse consumers. If Google also sends consumers to inferior sellers, this may violate terms of the Federal Trade Commission Act prohibitions against unfair and deceptive business practices. Indeed, while promising fair and unbiased search, while promoting companies that purchase keywords, or promoting its own products and services, Google may be violating the FTC act by misrepresenting its own practices in search.
  • If Google has acquired market power with an intent to create a monopoly, that violates American antitrust law.
  • If Google has maintained its market share by unfairly limiting consumers' ability to choose another search engine, that may also violate American antitrust law.
  • If Google has maintained its monopoly by limiting the ability of websites or advertisers to do business with competing search engines or advertising platforms, that may also violate American antitrust law.
  • If Google has used its market power to preclude competitors from entering search or from competing fairly in search, or has used its control over Android or over YouTube, to limit competitors' ability to compete effectively with Google search, that may violate American antitrust law.
  • If Google has used its market power to subsidize businesses in other areas, with the intent to preclude competitors, or has used its market power in search to develop a monopoly in other areas, that may be illegal under American antitrust law. Likewise, if Google has used its market power in free search to misdirect consumers to its own websites, rather than to competitors' websites unfairly, this may also violate American antitrust law.

So many questions, so few definite answers ...

There are many areas of concern, and the stakes for the future of American online business, American business more generally, and the health of the Internet itself, will all be affected by Google's actions. That's what the Subcommittee Hearing is asking Eric Schmidt to testify, and why the FTC has launched an investigation. We have many questions, and not enough answers. Hopefully, Mr. Schmidt's testimony will help us find answers. The Subcommittee's ability to obtain testimony under oath will be valuable in determining what Google is doing and whether it has obeyed the law, and whether it can be held to obey the law in the future.
In the next post I will provide much more detailed and much more technical and legalistic coverage of what is likely to be covered at Mr. Schmidt's hearing and what the Subcommittee is likely to be seeking to learn.

The mission of the Federal Trade Commission includes both consumer protection and the protection of competition. As explained on their website, "When the FTC was created in 1914, its purpose was to prevent unfair methods of competition in commerce as part of the battle to "bust the trusts." Over the years, Congress passed additional laws giving the agency greater authority to police anticompetitive practices. In 1938, Congress passed a broad prohibition against "unfair and deceptive acts or practices." In particular, Section 5 of the FTC Act prohibits "entities from engaging in unfair or deceptive acts or practices in interstate commerce." Google is self-evidently engaged in inter-state commerce, and if a reasonable person could be deceived by the placement of a company in Google's search results, and if a reasonable person could be harmed as a result, then there is a possibility of an FTC Section 5 violation.

The Sherman Antitrust Act, or simply the Sherman Act, forms the basis of much of contemporary American law regarding competition. Section 1 of the Sherman Act deals with the behavior of Trusts, or cartels and cooperating oligopolies, that restrain trade through fixing of prices and division of markets; that is, Section 1 deals with groups of companies that agree not to restrain competition between themselves. While Section 1 deals principally with the activities of a group of firms, Section 2 deals with the monopoly behavior of a single firm. Section 2 explicitly acknowledges that a firm may enjoy the benefits of monopoly power if that monopoly is achieved legally, that is, solely as a result of superior products; it does however place limits on the actions that a firm can pursue specifically to achieve its monopoly. Additionally, while a firm that enjoys a monopoly in one business may use earnings from its monopoly to develop additional businesses, it can not use these subsidies to interfere with competition, to preclude entry by competitors, or to achieve a monopoly in these new businesses.

This is part one of a two-part series. Read part two here.

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