11/30/2012 12:05 pm ET Updated Jan 30, 2013

Proposed Remedies for Regulating Google, Part 3: Deception and Abuse of Market Power

Part one of this series, "When Fear turned to Loathing," addressed Google's history of abuse and the current status of investigations of the company. Part two of this series, "Forms of Abuse of Power and Forms of Remedy," characterized and classified the types of Google's abuses and outlined some of the remedies that will prove necessary. This third part of the series provides more detail on the remedies for deception and abuse of monopoly power. The final part will deal with abuse of consumers' privacy and provide some concluding remarks.

5. Dealing with Consumer Deception

The two simple regulatory changes described in part two, banning keyword auctions and banning vertical integration of search engine providers, will solve many of the problems of consumer deception by search engine providers.

  • Unlabeled sponsored search or poorly labeled sponsored results should not be permitted, but this ceases to be a problem when sponsored search is ended.
  • Dangerous sponsored links should be eliminated, such as those promoted by Google during the drug importation scandal but this likewise ceases to be a problem when sponsored search is ended.
  • Manipulation of search results, for self-serving preferencing to promote Google's own products will also cease to be a problem when search companies are no longer allowed to own competing unrelated businesses.

Manipulation of search results, for self-serving preferencing and de-preferencing, in order to promote political friends and allies, and to harm or hide opponents and Google's own misdeeds, could still be a problem. We have discussed this in an earlier posting. Perhaps this will be tolerable when a smaller, poorer Google can no longer afford to manipulate national elections. Still, search is vitally important to free access to information and to the preservation of an informed electorate in a well-functioning democracy. Search bias and misrepresentation are not easily detected by consumers, any more than the long-term ill effects of cigarette smoking; therefore a Federal Search Commission, as proposed by Pasquale and Bracha, may still be required to protect consumers against harm they cannot easily detect for themselves.

6. Extortion through Monopoly Pricing

The monopoly power of search engine vendors is the most dangerous problem and the most invisible problem of the current market for paid search. The power of these systems, as first experienced with airline reservations systems vendors like Sabre and Apollo, has been discussed previously. I first discussed this as a possible justification for regulation of Google and Bing and as the basis of a possible antitrust suit against Google. More recently I prepared an analysis of this category of business, which can be described as a mandatory participation third-party payer business, where it is possible to enjoy monopoly power over pricing without necessarily having what would traditionally be seen as a monopoly in the market.

The most interesting thing about these markets is that price wars work backwards and competition actually causes prices to increase! Party-1, the searcher and potential consumer of products and services, uses Party-2, the platform operator, to find Party-3, the buyer of keywords and the provider of goods and services. To eliminate confusion we will refer to Party-1 as the consumer and Party-2 as the seller. If Party-1 becomes dependent upon the platform for help in finding Party-3, then Party-3 becomes dependent upon the platform for access to consumers. As competition between two platforms increases, they compete for consumers by charging the consumers ever-lower prices. In general the prices charged to consumers can go below zero, and platform operators provide significant subsidies to the consumers who use their search platforms; that is, these services seem to become free-er than free for consumers. As we note below, nothing is every free-er than free for consumers.

Free goods and services for consumers is a good thing, of course, but subsidies have to be paid for somehow. The platform operators obtain the funds to cover the subsidies they pay to consumers by increasing the fees they charge to providers. This is not necessarily value adding in and of itself; providers who buy their own trademarks are not paying to be found, but paying protection money so that they will "not be not found." As competition between platforms increases, and as the platforms raise the subsidies that they provide to consumers, the prices the platforms charge to the providers who want higher positions actually increases.

The money paid by companies to purchase keywords most definitely also needs to be paid for somehow, and the ultimate source of funds is the consumer. Consumers pay higher prices, not because they are charged for search, but because companies' costs for keywords, just like costs for fuel or for labor, increases the cost of doing business and increases prices.

To repeat, competition between platforms increases rather than decreases the prices charged for keywords. This is not just a logically consistent argument. It is not merely one supported by mathematical and economic analysis. It is also supported by years of experience in prior third-party payer markets like credit cards and airline reservations systems. Competition in third-party payer systems actually does raise the prices charged to sellers. Importantly, in the presence of some price elasticity this is passed along as increases in the prices paid by buyers of all the goods and services they purchase. Buyers do pay more. There is no obvious visible cost to consumers, since there is no clearly marked line item called "increase in price due to increase in costs caused by payments to third party payer business models." But the increase in sellers' costs of doing business, and the resulting increase in prices paid by buyers, are both real.

For any welfare economists who might be reading this, paid search and keyword auctions are also welfare destroying. When companies overpay for keywords, they pass some of this increased cost through to consumers in the form of higher prices. As a result of higher prices, some consumers do not make purchases that they would otherwise have made. Reducing consumer purchases also eliminates the value or consumer surplus that consumers would have obtained from the purchase and eliminates the profit the seller would have gained. Finally, it creates deadweight loss, lost sale opportunities that would otherwise have been profitable. Overcharging for long-distance phone service in order to subsidize local service led to the situation in which it made more sense to take the train from Philadelphia to D.C. rather than make a tw- hour phone call; distorting markets always destroys welfare. This is one of the reasons that telecommunications was deregulated to permit competition in the 1980s, and one of the reasons that search needs to be regulated now to limit the distortion caused by platform operators' almost unlimited ability to charge for keywords.

The banning of keyword auctions would solve the problem of monopoly pricing for ads at the top of the search results list (ads are what Google formerly called sponsored links). It would not decrease the quality of search results in any way****.

Although paid search should be banned, search vendors should be allowed to place ads, clearly marked as ads, on the right side of the page of search results.

End Notes

****Google claims that the use of quality scores and sponsored search is required to ensure the quality of results, and they frequently demonstrate this by showing what would happen if users were given a page in which quality scores were not used to rank results. This, of course, is an absurd basis for comparison. The true comparison should be between search where results were ranked solely by quality, and search where results are ranked by quality and bid. Ranking by quality alone always produces superior results for the user than ranking that includes bid information as well.

The only purpose of including bid amount is to create a monopoly revenue source. Quality scores are introduced because they maximize Google's expected revenue; Google is paid by click, so placing the sites most likely to attract clicks on top ensures that Google earns as much as it can. There is nothing wrong with revenue maximization, of course! It is simply important to call a thing what it is, and not another nothing. The use of quality score plus bid does not produce superior results for the user than the use of quality scores alone. In some instances, when a truly bad bidder is able to bid truly high amounts, as with the drug smuggling scandal, the combination of low quality score plus high bid can still produce dangerous results.

Google claims that the combination of bids for keywords, adjusted by quality scores, is for decluttering the page and placing the best results on top. However, this is the job of accuracy in organic search, and indeed can be fully accomplished through quality scores without requiring bids.