Yahoo

Google, the most-sued intellectual property infringer in the world, just settled a class action lawsuit with authors and publishers for $125m and a revenue sharing deal going forward;  this deal has much broader implications than most would think for Google, for other companies suing Google for theft, and for the pending Google-Yahoo ad partnership.

Implications for Google: After steadfastly maintaining that they had done nothing wrong and that they were protected by the concept of fair use, Google has now de facto conceded that it was broadly infringing on authors' and publishers' copyrights, while also signalling it feared losing in court. 

Famed philosopher of power, Nicocolo Machiavelli, would have to smile at Google's maestro market power performance in the storied Google-Yahoo affair.

• As Machiavelli would have advised, Google is laser focused on enhancing its market power.
• Let's review this modern-day Machiavellian plot.  

First, Google successfully thwarted what it recognized as the single most serious potential competitive threat to Google -- a Microsoft-Yahoo merger or search alliance.

• From the start, Google publicly made clear that it was opposed to a Microsoft-Yahoo combination and bent on stopping it. 

Second, given the deep ties between Google and Yahoo's founders -- Google understood Yahoo's founders were emotionally, philosophically, and culturally opposed to aligning with Microsoft.

Yahoo's earnings provide another excellent window into why the DOJ has serious antitrust concerns with the proposed ad partnership between Google and Yahoo.

• Yahoo's discussion of its 4Q08 earnings provides the DOJ with substantial fresh evidence that Yahoo continues to lose revenue and profit share to Google.
• Moreover, Yahoo's earnings report showed Yahoo was clearly caught off guard that the Google-Yahoo ad agreement did not get cleared by DOJ, as evidenced by the big whipsaw in Yahoo's headcount plans.

I.  Evidence Yahoo is losing revenue/profit share to Google:

While Yahoo tried to put the best face on Yahoo's search business growth, in the comparisons that matter to the DOJ, Yahoo slid much further behind Google.

From 3Q07 to 3Q08, Yahoo grew overall revenues by $.018b or 1%, and search revenues $.063b or 17%, while Google grew search revenues $1.310b or 31%.

• In other words, in the last year, Google grew 20 times more revenue than Yahoo in absolute terms.

In 3Q08, Yahoo's operating income was $.070b, a decrease of 53% from 3Q07, while Google's operating income was $1.743b, an increase of 32% from 3Q07.

Kudos to Cade Metz of the Register who has some dead-on and pertinent insights to the pending Google-Yahoo decision by DOJ  in his July piece: "Eye of newt: Inside Google's Adwords auction." Don't miss the whole article. Below are some wonderful snippets.  

• "If AdWords is an auction, it's an auction where your $10 bid may lose out to a bid of 5 cents, where you may be banned from bidding unless you outbid the rest of the field, where some bids are ignored from time to time and others are ignored all the time, where you don't know the rules - and the rules are always changing."...

• "But, again, this isn't eBay. It's not the bids - or, at least, not the bids alone - that determine where you finish. Each bid is multiplied by a mysterious something known as a "quality score," and its this black-box calculation that decides where your ad ends up. The trick is that quality score varies from advertiser to advertiser, from keyword to keyword, and sometimes from day to day. And no one knows how it all works except the Oompah Loompahs inside Googleplex."

• "But Google isn't just playing favorites. It's driving prices higher by limiting the number of clicks available at low prices."

   

Bottom line:

Google's 'auctions' are certainly not how a competitive market works.

Yahoo's reported job cuts of over 1,000 of their 14,300 employees is a helpful window into the real prospects for the pending Google-Yahoo ad partnership that is under serious investigation by the DOJ.  

First, the job cuts signal Yahoo is pessimistic about getting the proposed ad agreement with Google approved by the DOJ.

• If Yahoo was confident the deal was near approval, Yahoo would be more patient in awaiting the beginning of an ~$800m annual revenue infusion to begin in 4Q08, not obviously hunkering down to go it alone.
  • To put this ~$800m in perspective, 1,000 job cuts would save Yahoo about $100m annually, or the equivalent of a couple of months of the Google ad deal.
• In other words, if the ad deal was likely to get approved, Yahoo would be doing what it told the DOJ it would do -- investing not disinvesting.

Second, the job cuts underscore how dependent Yahoo would be on the Google ad partnership. 

• Google's proposed ad bailout of Yahoo was masking what Yahoo knew all along, that Yahoo is clearly losing the competition with Google.
  • So "if you can't beat em, join em." 
  • Being on the good side of the "mono-pole" is better than being on the bad side of the "mono-pole." 

Finally, the job cuts are evidence of "The Google Effect" more than "The Walmart Effect."

Google's earnings provide an excellent window into why the DOJ has serious antitrust concerns with the proposed ad partnership between Google and Yahoo.

• Google's discussion of its 4Q08 earnings provides DOJ with substantial fresh evidence that Google is:
  • Exercising substantial pricing power; 
  • Not running fair and competitive 'auctions;' and 
  • Anti-competitively self-dealing.

I.   Pricing Power Evidence:

Any economist will explain revenue is simply volume times price. In 4Q08, virtually all of Google's revenues continued to come from search monetization. Google reported that its 'volume' i.e. "aggregate paid clicks... increased approximately 18%" over 3Q07. Google reported that 'revenues' increased by 31% over 3Q07.  

Most of Google and Yahoo's defense of their ad agreement has been to claim it creates 'efficiencies.' The problem with that defense is that most all of the claimed "efficiencies' -- are negative in nature -- not positive justifications for approval.

New Negative Network Effect:

• The essence or core activity of the proposed ad agreement is removing Yahoo search queries from the Yahoo monetization engine and running them through the Google monetization engine.  
• Less queries drains Yahoo's Panama engine of what it needs to get better and produce more "relevant" targeted advertising -- so the more queries diverted away means less and less Yahoo Panama monetization efficiency.
  • In other words, Yahoo gets paid a market-premium by Google for suffering competitive dis-economies of scale -- for the benefit of the ad partnership. 
• On the other hand the more search queries to Google increases Google's monetization efficiencies and network effects -- effectively enabling Google to efficiently and anti-competitively widen its lead over all its competitors.
  • In other words, Google trades sharing revenue with its partner Yahoo -- for economies of scale and network effects which increase Google's pricing power.    

Cartel/Monopoly revenue efficiencies:

Given the Wall Street Journal's reporting that "Google, Yahoo seek to avoid suit over ad deal" -- what provisions are needed in a court-enforced consent decree between the DOJ and Google-Yahoo in order to protect competition?

Consent Decree Principles to Protect Competition:

• Prohibit any agreements between Google and Yahoo, which generate substantial negative efficiencies or negative network effects.
  • (At core, the proposed ad agreement embodies a negative efficiency-transfer dynamic. 
    • In other words, the agreement decreases Yahoo-Panama's efficiency in quality-improvement and relevance-learning, while simultaneously increasing Google's efficiency in quality-improvement and relevance-learning, by transfusing the efficiency-lifeblood of search engine advertising quality and relevance-learning -- search queries -- from Yahoo to Google.) 

Google's three-year-old video subsidiary, YouTube, now generates more searches than any other site or competitor in the U.S. -- surpassing #2 Yahoo in August per Comscore's U.S. expanded search rankings.

• Another way to look at this milestone is that Google:
  • is now both #1 and #2 in search,
  • is seeking an ad outsourcing partnership with the #3 and #8 players in search -- in the proposed Google-Yahoo ad partnership,
  • to go along with Google's existing ad outsourcing partnerships with the #5, #6, #7, #9, and #11 players in U.S. search.  
• Kudos to Ms. Klaassen of Ad Age and Mr. Helft on the NYT Bits Blog and for flagging this search ranking milestone.

The new ComScore August 2008 search rankings spotlight the awesome search cartel reach Google has assembled:

Google's CEO Eric Schmidt had the temerity to suggest that journalism consider becoming a not-for-profit enterprise -- at a recent Google program for magazine executives.

• See Ad Age's article: "Google's Schmidt says Internet 'cesspool' needs brands -- Says the solution is quality content; tells publishers and editors to 'increase your relevance'. 
  • From the article: "...when asked where the industry ends up if there aren't outlets willing to pay journalists to create quality content, Mr. Schmidt was a bit Palin-esque, saying that he didn't have an answer but one thing to look at is whether journalism should be a for-profit enterprise."

Google's CEO must think journalism-business people are stupid.