Google-Yahoo: Unintended Consequences

Posted by Internet Guru

November 6, 2008

From left, Yahoo CEO Jerry Yang and Google CEO Eric Schmidt.

By quashing the planned search advertising deal on antitrust grounds, the government may get even less competition

Opponents of a planned search advertising deal between Google and Yahoo! may have little cause to celebrate the proposal’s demise. Advertisers fretted the alliance, announced in June, would make Google even more dominant in the most lucrative corner of online advertising. The deal unraveled Nov. 5 after Google retreated under the threat of a Justice Dept. lawsuit to block it.

Yet, advertisers still face what they feared in the first place: an even stronger Google (GOOG).

The paradoxical outcome highlights the difficulty of applying traditional antitrust doctrine to swiftly innovating technology markets. The Google-Yahoo deal would have netted Yahoo up to $450 million a year in operating cash in return for running Google ads on some of its pages.

Justice Dept. Wasn’t Mollified

As Justice reviewed the plan to ensure that it wouldn’t violate antitrust rules, advertisers and rivals such as Microsoft (MSFT) quickly objected, saying it would give Google too much control of search-related advertising.

Google has upwards of 70% of the market, and Yahoo (YHOO) has at least 10%. Advertisers were afraid search ad prices would rise and that Yahoo ultimately would find Google ads so much more profitable than its own that Yahoo would ultimately cede control of its search operations. According to sources close to the deal, the latter was the key concern of antitrust officials.

To assuage government concerns, Google and Yahoo offered concessions that included a cap on revenue Yahoo would get from Google and a shortening of the term of the deal from 10 years to two. None mollified Justice. And Google had no desire to fight a lawsuit. “We’re not going to let the prospect of a lengthy legal battle distract us from our core mission,” Google Chief Legal Officer David Drummond said Nov. 5. “That would be like trying to drive down the road of innovation with the parking brake on.”

For its part, Yahoo argued that the search ad market isn’t as distinct from other forms of online advertising as Justice assumed. “The government in this case does not understand our industry,” said Yahoo CEO Jerry Yang, speaking at the Web 2.0 Summit in San Francisco. “They have a definition of the marketplace that’s too narrow.”

Time Warner Deal Unlikely

The result: By most accounts, the status quo will leave Google an even more dominant force in the search ad market. Without the additional hundreds of millions of dollars, Yahoo—whose search market share has fallen in the past year—presents even less of a competitive foil to Google. And Microsoft has been losing ground to Google even faster. “Google will continue to grow market share,” says Edward F. West, CEO of LookSmart (LOOK), an advertising network that runs ads on search results at other sites, such as CNET (CNET) and Ask.com, owned by IAC Interactive (IACI).

At the same time, Yahoo now has few alternative ways to reverse its slide while satisfying restive investors. A long-rumored deal for Yahoo to buy Time Warner’s (TWX) AOL unit continues to be unlikely, according

to sources close to the companies.

Bernstein Research analyst Jeffrey Lindsay believes it’s even less likely now because the lost revenue from the Google deal leaves Yahoo without enough cash to pull it off. Moreover, Yahoo’s Asian properties are a less viable way to generate cash. They were valued at up to $10 billion earlier this year, but the market meltdown and credit crisis have made divesting them unlikely.

The Microsoft Option

One of the few other options left to Yahoo is one it has repeatedly rejected: a sale of all or part of its operations to Microsoft. Yahoo shares rose 4% on Nov. 5 on speculation by analysts and investors that Microsoft eventually will return with another offer. However, sources close to the companies say there are no current talks, and Microsoft has repeatedly said it’s not interested in making another offer. In any case, such a bid also would face an antitrust review.

Many analysts believe Microsoft will in fact return with a new bid, but probably not until after the start of the year, when the Administration of Barack Obama takes over, to avoid having its offer stuck in regulatory limbo under the lame-duck Bush Administration. “There is no other company that needs Yahoo as much as Microsoft, and Microsoft does not have a Plan B in search,” says Sandeep Aggarwal, an analyst at financial-services firm Collins Stewart.

Even if that deal happens, the result might not be much better for advertisers than a Google-Yahoo pairing. The market would have one less competitor, even if the resulting entity is stronger. “Advertisers will also frown on Microsoft trying to buy Yahoo’s search arm,” says Bryan Wiener, CEO of digital ad agency 360i. He says they would prefer Microsoft keep Yahoo’s search unit independent. But that doesn’t appear to be part of Microsoft’s plan, based on its past proposals.

Antitrust Actions Can Be a Distraction

The outcome of the failed Yahoo-Google deal—an even more dominant leader—illustrates how difficult it is for antitrust regulators to contend with quickly evolving technology markets. “The traditional antitrust models don’t take rapid change in technology industries into account,” says Melissa Maxman, a partner and head of Baker & Hostetler’s Antitrust Practice Group and a former assistant U.S. attorney general.

Antitrust actions can, however, end up distracting their targets. By many accounts, Microsoft became less aggressive after its antitrust battles in the 1990s in cases that took several years to settle. Some analysts believe the scrutiny distracted Microsoft from pursuing key Internet initiatives strongly enough to counter Google’s growing power. “Businesses tend when they become this prominent to become more defensive and do less experimentation,” says Mark J. Botti with the law firm Akin Gump Strauss Hauer & Feld.

By exiting the deal, Google clearly hoped to avoid falling victim to that dynamic. Still, with a new and likely more aggressively antitrust Administration about to take power, Google increasingly may be under a regulatory microscope. “I think we’re going to see more of this,” says Ben Schachter, an analyst with UBS (UBS). “It hasn’t limited their opportunities so far. But could it? Absolutely.” For now, however, Google remains as dominant as ever.

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