Some Internet Mergers Deserve a Careful Look

Robert Hahn and
Robert Hahn
Robert Hahn Director of Economics - Smith School of Enterprise and the Environment at the University of Oxford, Former Brookings Expert
Robert E. Litan

May 1, 2007

The Internet has become an integral part of our economy – unleashing powerful innovations that are transforming business, our economy, and the way we work. Perhaps the most underappreciated innovation is Internet advertising, which has become the growth engine that makes it possible for us to access the likes of YouTube and MySpace for free. Indeed, the ability of innovators seeking to develop the next big gathering spot on the Internet is likely to depend on their ability to generate ad revenues.

Since the future direction of Internet innovation could depend on ad revenues, a merged entity that controls most of the ads appearing on web pages could have an enormous impact on the way business is conducted on Web. That is why federal antitrust officials examining the proposed Google-DoubleClick merger should make a “second request” for information. Such requests are routinely made when proposed mergers appear to threaten to harm competition, or at the very least, when they present important and novel issues that require more information in order for antitrust officials to make thoughtful decisions about their impact on competition. In our view, the Google-DoubleClick merger meets the second test, if not the first as well.

Google recently acquired YouTube, a transaction that was approved with only limited review. Now, Google seeks to further expand its reach with a transaction that could raise more fundamental issues, which antitrust authorities themselves have pledged to examine in all mergers under their Merger Guidelines. In particular:

What is the relevant market? Is the market that regulators should review the entire advertising market as Google has asserted? Or is the right market the online advertising market or even a subset of online ads? Do the search-related text ads and the newer image ads that Google places on third-party web sites constitute a different product market than the kind of graphical display ads served up to websites by DoubleClick? Could advertisers substitute another kind of online advertising if prices rise, or might the merger lead to a virtual stranglehold on net advertising?

These are vital questions, and their answers will go a long way to determining the appropriate outcome. As a generalization, the broader the market, the less likely it is that the proposed merger will adversely affect competition; conversely, the narrower the market, the greater should be the concern.

What are the barriers to entry? Even if the merging parties may end up with a sizeable share of a relevant market, the merger may still pass muster if it is relatively easy for others to enter the market. This is because the prospect of entry can prevent the merged entity from raising prices to adversely affect consumers. Thus, a critical question in any antitrust inquiry is what the barriers to entry for a new entrant are and whether they are low enough that competitors could constrain the behavior of the merged company.

Presumptively, there are reasons for believing that the barriers to entry to the delivery of effective on-line advertising are far from trivial. A full-service online advertiser capable of competing with a Google/DoubleClick requires large investments in data centers, networks, and engineering talent. Yahoo!, the second-place company in online advertising, had been losing ground to Google even before the proposed DoubleClick acquisition. Will a new entrant, or perhaps a merged rival like Microsoft-Yahoo!, be able to compete in this new business environment?

How will the merger affect consumer data? What does it mean when a single company can observe and capture consumer information on an unprecedented scale? Does unequaled knowledge of customer behavior on the Internet give one company a strategic, or unfair, advantage in any particular line of business?

We are not in a position, without far more information, to prejudge the outcome of the antitrust review, which could go either way. But we are confident that the antitrust authorities are now in the same boat. They cannot come to a reasoned decision about the likely impact of this merger without acquiring more information to enable them to answer the questions we posed. The Internet is too important for the authorities not to get this information, and they should get it soon.

The authors are the founders and co-directors of the AEI-Brookings Joint Center for Regulatory Studies. They have each consulted for various telecommunications and information technology companies during the course of their careers.