Time to loosen Google's grip?

By Steven Pearlstein
Tuesday, December 14, 2010; 11:25 PM

In case you hadn't noticed, Google isn't just a Web search company any longer. In addition to online advertising, it's moving into operating system and application software, mobile telephone software, e-mail, Web browsers, maps, and video aggregation. It's also in the process of assembling the world's biggest digital library of books and visual materials.

Google portrays each new line of business as a logical extension of its core mission to expand digital horizons in ways that allow people to use the Internet to improve their lives. It's a noble goal, and Google does it very well - so well, in fact, that it boasts a market value of $190.2 billion, a profit margin of 30 percent, and cash and marketable securities on its balance sheet worth $33 billion.

The question now is how much bigger and more dominant we want this innovative and ambitious company to become. Google has already achieved a near-monopoly in Web search and search advertising, and has cleverly used that monopoly and the profits it generates to achieve dominant positions in adjacent or complementary markets. Success in those other markets, in turn, further strengthens Google's Web search dominance and reduces the chance that any other competitor will be able to successfully challenge it.

There is nothing improper or illegal about Google's monopoly - like Microsoft and IBM before it, it earned that dominance fair and square. And given the dynamic nature of the technology sector, it would probably be counterproductive to prevent Google from using its money and talent to expand into new areas.

Where I have a problem, however, is in allowing Google to buy its way into new markets and new technologies, particularly when the firms being bought already have a dominant position in their respective market niches.

That was certainly the case with the company's recent acquisitions of You Tube, DoubleClick and AdMob. It is the case with Google's proposed $700 million acquisition of ITA Software, the leading provider of software used in online searches for airline flights, which is currently under review by the Justice Department. And it surely would have been the case with Groupon, the local Web advertising company, had the hot startup decided last month to accept Google's reported eye-popping $6 billion offer.

In theory, antitrust laws were meant to restrict such acquisitions by a monopolist. In practice, however, it hasn't worked out that way. Decades of cramped judicial opinions have so limited application of antitrust laws that each transaction can be considered only in terms of how it affects the narrowly defined niche market that an acquiring company hopes to enter.

Since Google generally has little existing presence in the market segments of the companies it buys, regulators fear that they will be unable to prove to skeptical judges that any one transaction will substantially lessen competition.

One at a time, these deals might appear to be relatively benign. But taken together, they allow Google to increase the scale and scope of its activities and to further enhance its controlling position across a range of sectors.

Moreover, by swooping in and buying these promising firms, Google forecloses on the possibility that they might be purchased by companies such as Microsoft or Facebook, which could use them to mount a serious challenge to Google's dominant position. Such a motive is suggested by the extraordinary premiums that Google has been willing to pay for its purchases. (As a matter of disclosure, Washington Post Co. Chairman Donald E. Graham serves on Facebook's board.)

The ease with which Google has been able to extend its dominance reflects, in large part, the inability to adapt century-old antitrust laws to the quite-different economics of a high-tech economy that is susceptible to winner-take-all competition.

Some of this has to do with the fact that in high-tech industries, most of the costs are upfront, fixed expenses, such as developing the software program or writing the original algorithms. Once those are paid for, the "incremental" or "variable" cost of producing another copy of the software or doing an extra Web search is almost nothing. In such markets, economies of scale loom large and companies with the most customers are able to use that advantage to lower prices, improve quality and increase their lead even further.

These are also markets where customers tend to prefer the company that has the most other customers - what economist call a "network effect." If you're looking for a social-networking site, for example, you'll probably prefer the one that most of your friends and acquaintances also use. Or if you're looking to sell your used piano, you probably want to use the online auction site where the most buyers tend to congregate. As a result, a few companies get very big very fast, the others die away and new competitors rarely emerge.

Antitrust regulators are well aware of these new economic realities. They hold conferences on them, cite them in speeches and use them to justify modest changes in merger guidelines. They were broadly cited in the groundbreaking antitrust case against Microsoft brought during the Clinton administration. But so far, neither the Justice Department nor the Federal Trade Commission has been willing to use them to mount a broad challenge to Google and its strategy of using acquisitions to expand and protect its existing monopoly.

Regulators are painfully aware of the legal as well as the political risks of mounting such a challenge. But it is worth remembering that aggressive enforcement of the antitrust laws has been a crucial part of the history of technological innovation in this country, enforcement that allowed AT&T to be supplanted by IBM, IBM by Microsoft and Microsoft by Google.

It's easy to see why Google would want to use well-chosen acquisitions to try to delay or prevent that next round of creative destruction. What's harder to understand is why we would let them do it.

© 2010 The Washington Post Company