Reg-U-Later? Google / Yahoo! and the governments

While reading news and commentary on the financial crisis spreading its way around the globe I was struck with a difficult and somewhat scary thought. It is distinctly possible that national (or extra-national) governing bodies such as Congress, the EU or even the Canadian Competition Bureau might try to impose strict regulation on Google’s growth in the coming months. What would be the effect on the Internet and search advertising markets if that happened?

The US and UK governments are dealing with the deepest economic downturn since the 1930’s. The failure of several large financial institutions (starting last year in the UK) coupled with the federal bail-out of insurance giant AIG and complicated by the extraordinary US trade deficit and absurd levels of personal debt, makes the global economic outlook appear bleak at best. Regulators are wondering what might have been had there been stronger restrictions on the actions of financial institutions over the past seven years. The tone of the economy and of public opinion virtually guarantees greater regulation will be imposed on the financial sector after the post-bubble financial fallout has finished falling.

In the midst of our global economic angst, Google’s sweetheart advertising deal with Yahoo! is being scrutinized by the US Justice Department, EU antitrust regulators and the Competition Bureau in Canada. Organizations representing online advertisers and newspaper publishing associations are lobbying these legislative bodies to closely examine the deal and (perhaps) prevent it from moving forward.

There is a lot of pressure on the regulators to get it right. On one side, both Yahoo! and Google suggest this deal is the only way to keep Yahoo! alive and out of the hands of Microsoft. On the other side, advertisers, search marketers and off-line competitors are justly wary of giving Google a virtual monopoly on the paid search advertising market. Given the sudden and stunning results of two decades of laissez-faire economics, some form of governmental intervention is suddenly more likely than not.

That’s an easy statement to make but, what does it mean? Google is the most significant source of information in the world. There are not enough words in the variety of human languages to express how radically important Google has become in the flow of information. It is not likely any governmental regulator fully understands Google’s impact and even less likely they understand how Google functions. Even most people working at Google only have a fractional understanding of the full reach, power and effect of Google’s ranking algorithms. To complicate matters, every once in a while, algorithmic surprises like last week’s United Airlines story come up.

Google has done a relatively fair job trying to regulate itself but leaving a fox in charge of a chicken coop is rarely a good idea, especially if those chickens have few other coops to choose from. That’s the message lobbyists are giving the regulators. Without a credible competitor, Google rules the paid search roost, a prospect that worries many in the online advertising industry.

The situation makes a pretty tempting target for government regulators looking to look proactive. Apparently others in the industry are thinking along the same lines today. While writing this post, I noted a similar thought-stream in a post by Nathania Johnson at Search Engine Watch, “Google Goes on the Defensive About Yahoo Ad Deal Cost Projections“.

What would government regulation look like or accomplish?

There are several different governmental organizations in several different countries known to be looking at the Google / Yahoo! ad deal. There might be several different interpretations of the deal’s impact based on different realities and understandings.

For instance, the UK has far stricter laws governing how business is conducted online and how advertisers phrase their messages. Those laws will certainly be considered by UK and EU regulators. Canada has traditionally not intervened with the conduct of online business and has a weaker history of antitrust action. American regulators at least appear to be trying to wrap their heads around online business but after fifteen years of evolution the business of online advertising is as amazingly complicated for bureaucrats as the implications of online advertising have been for the traditional media.

If regulators from differing jurisdictions choose to intervene and come up with different decisions, Google and Yahoo! will have to either retool their agreement to meet all of the regulators’ concerns or create different rules for serving ads in different national or regional jurisdictions. One region might block the deal while another gives it a pass, in which case Yahoo! would have to limit its use of Google ads in certain countries.

If the advertising deal is blocked or restricted in key areas, Yahoo! might have problems filling in its bottom line. Yahoo! is hoping to enjoy an extra $250 – $450 million in short-term revenues from the inclusion of higher paying Google Ads. While a Canadian decision against the deal would have symbolic but limited impact, a UK or US decision delaying or blocking the implementation of the agreement could force even further chaos for the already beleaguered company.

Governmental interest in this file could have other implications for Google. As Google matures and moves towards supplying advertising to other mediums both online and offline, the reach and influence of information provided by Google will expand exponentially. Just today T-Mobile scheduled a press conference next week to unveil the first mobile phone based on Google’s Android software.

Google is also one of the global leaders in cloud-computing, the introduction of server-side software. Many believe the Internet will soon be able act as a functional component of a compact-device computational operating system. Instead of using large laptops and even larger desktop computers to store productivity or O/S software, developers want to store the bulk of computer software on remote servers in order to make personal computing devices much smaller. Productivity software found at Google Docs is an example of Google’s efforts to create the cloudosphere. Google Android is another. Google coming under official scrutiny for one thing makes it more likely they will be super-scrutinized for others in the future. Though the intent is to try to keep everything transparent and “honest” such attention slows things down and often forces open companies to draw curtains across transparency.

Perhaps official attention is inevitable and hopefully it’s well considered. From Search to News to AdWords to YouTube and beyond, Google has become so disruptively good at delivering content and advertising it can’t avoid official attention.

Timing is such that it likely won’t benefit from the official inattention digital media has so long enjoyed either. Newspaper publisher associations and advertising bureaus worry about Google enough to hire lobbyists. Microsoft is known to be waging war against Google via lobbyists. The goal of political interference can’t be to force the government into regulating Google’s behaviour. Nobody is that idealistic. The true goal is a bit more cynical than that; to try to delay Google’s plans by unrolling as much red-tape as possible for as long as possible.

Being the smart kids they tend to be, the Googlistas are playing it cool. Unless forcefully instructed otherwise, they are going ahead with their part of the agreement in October. They have reacted in typical Google fashion by writing an open letter blog post outlining their interpretation of the agreement and their intentions around it.

Google’s chief economist, Hal Varian wrote the preemptive response to regulators in the Google Official Policy Blog yesterday refuting many of the fears held by the deal’s detractors. In his post, Varian suggests advertisers will still be in control of the PPC system post-deal.

On rising bid-costs:

“… ad prices are not set by Yahoo! or Google, but by advertisers themselves, through the auction process. Since advertisers set prices themselves via an auction, the prices must ultimately reflect advertiser values.”

On Yahoo! selecting the highest paying ads to display:

“Yahoo! won’t be able to see the current auction prices for Google ads, just as Google won’t be able to see Yahoo’s prices.”

On Google ads pushing Yahoo! ads off the Yahoo! network:

“This contradicts Yahoo’s own statements that their plan is to serve Google ads on search results pages where they have few relevant ads to serve. Yahoo! also has a strong economic incentive to keep serving as many of their own ads as possible, since they get to keep all of the revenue from those ads, while Yahoo! only receives a part of the revenue from ads served by Google.”

On Cost Per Click vs. Advertisers’ Return on Investment:

One of the reasons Google’s ad system has performed so well for advertisers is that our ads tend to be highly relevant to user queries, which makes it more likely that a user will click on an ad and purchase the advertiser’s product. We have found that advertisers are generally willing to pay more per click so long as those clicks result in more sales. We anticipate that our agreement with Yahoo! will bring more relevant ads to Yahoo! users — which is better for both advertisers and users.

Summing Up:

“Google doesn’t set advertising prices — advertisers do. Prices must reflect how much a sale is worth to an advertiser, and that will continue to be the case after our agreement with Yahoo! is implemented.”

The Google / Yahoo! ad distribution agreement might have saved Yahoo! from Microsoft for now. For Google, it was a smart way to expand its market reach and keep Microsoft from quickly assuming the role of serious competitor in the search space. The deal is not a death-grip. Yahoo! is still owned by its shareholders and is ruled by a board whose unity is very much in question. Anything can happen on the Yahoo! front including the board entertaining another offer from Microsoft.

As the most used application providers on the Internet, Google, Yahoo! and Microsoft are in unique historic, social and economic positions. What happens with these companies literally affects the way the world unfolds. Preventing monopolistic or anti-competitive behaviour is important but that has to be weighed against slowing innovation.

Competition vs. innovation… It’s not that clear cut however while it might have been a smart deal for Google on a competitive front, the ad-deal with Yahoo! might have forced opened lines of official inquiry Google would rather have avoided all together.