Last spring, Yahoo was under assault. Microsoft had launched a hostile takeover, activist investor Carl Icahn was promising to sweep out the company's recalcitrant management team, and large shareholders were filing a barrage of lawsuits accusing the company of acting irresponsibly in turning Microsoft away. Yahoo had only one option: run to Google. The search giant offered Yahoo a Faustian bargain—in return for a huge chunk of cash, Yahoo would outsource its advertising operations to its primary rival. Yahoo accepted, and experts estimate that the company could get a much-needed infusion of cash from the deal, as much as $1 billion annually. There's only one potential holdup: the Department of Justice.
While both companies maintain they're doing nothing illegal, they agreed last week to suspend their collaboration while the DoJ finishes its review, which is expected to take a couple more months. Google already commands about 70 percent of the search engine market. A deal in which it takes over ads for Yahoo—which controls another 20 percent of the market—would seem to create a monopoly. Nevertheless, the government isn't likely to stand in the way of the deal, and Google looks sure to further expand its power and reach in the ad market. This could be bad news not only for advertisers but also for the many Web sites that depend on revenue from ads. In the long run, the deal could also mark a turning point for Google—the moment its public image shifted from that of an innovator to a monopolist whose every move is suspected and dissected.
In scrutinizing the Google-Yahoo project, regulators are asking one main question: Will it raise the prices of ads on the Internet? Generally when two big producers in a market join up, competition declines, and prices rise. But Google, Yahoo, and their defenders say that the market for search engine ads is completely different. Search ads are pegged to keywords. If you want to run a Google ad for your Web shoe shop, you choose terms ("shoes," "sneakers," "pumps," etc.) for searches on which you'd like your ad to appear. Many other shoe companies want their ads to come up on the same keywords, of course, so Google runs an auction to determine which ads to display most often and in the highest positions. The shoe company that pays Google the most gets prime billing. In other words, Google and Yahoo argue, search companies don't determine ad prices—the advertisers set their own prices. If an advertiser is willing to pay Google 50 cents every time someone clicks on an ad pegged to the keyword "shoe," he's not going to raise his bid just because his ad might also come up on Yahoo.
There's also some fear that a Google-Yahoo collaboration could push advertisers to abandon Yahoo's ad platform, further narrowing the search market. After all, if ads you place with Google will run on both search engines, why would you bother dealing with Yahoo at all? Google says that's unlikely. Yahoo has promised that it will run Google's ads only on a small portion of its search terms. (Under the terms of the agreement, Yahoo will display Google ads when users search for a term—say, "red roses in Alabama"—for which it has no ads of its own to display.) The only way for advertisers to guarantee that their ads come up on Yahoo, then, is to place ads at Yahoo. In this way, Google argues that the deal would be better for advertisers. Because Google will provide Yahoo with "more relevant ads," advertisers will likely see "a better return for every dollar they invest" in online advertising, Google's advertising president, Tim Armstrong, wrote in a blog post last month.
The Association of National Advertisers, a trade group that represents more than 9,000 consumer brands, disputes Google's claims as speculative. In a letter that the group sent to the Justice Department last month, it put forward a different scenario: If Yahoo can boost its cash flow by running a small number of ads from Google, why wouldn't it decide, over time, to run more and more ads from Google? The ANA predicts that will happen—and in time, "all search engines will increasingly rely on Google as a source of advertising."
There's another big flaw in Google's defense of the Yahoo deal: It's not exactly true that search engines give advertisers complete control over the price they pay for ads. Search engines use algorithms to determine an advertiser's "relevance" to a given keyword—the less relevant your ad, the higher you've got to bid for that keyword. Search companies do this to make sure that a given ad goes with a given search term. This makes sense—you wouldn't want every keyword to trigger ads for Viagra just because Pfizer has a huge advertising budget.
The trouble is that Google doesn't give much guidance on how it calculates relevance. This measure—what Google calls a "quality score"—has been the subject of enormous controversy among advertisers. Google's secret algorithms can decide that one shoe company must pay at least 10 cents for the keyword "shoe" while another must pay 50 cents. To advertisers, these price differences often seem arbitrary, unfair, and even self-serving. Worse, Google isn't very good at explaining itself to advertisers who feel slighted by its pricing decisions. Last month, New York Times columnist Joe Nocera recounted the saga of Dan Savage, an entrepreneur who runs Sourcetool.com, a directory of sites that sell industrial products. Google hiked up Savage's minimum price for ads overnight, and when he pressed the company for an explanation, he was told to "please refrain from repeatedly contacting our team." Savage—who filed a complaint with the Justice Department—now believes that Google was trying to hurt his company in order to prop up Business.com, a Sourcetool rival that's also one of Google's advertising partners.
Did Google hurt Sourcetool on purpose? Probably not—but Savage's concern suggests the kind of fears we'll see if Google were to dominate Web advertising even more than it does today. As it is, advertisers like Savage have few options when they're looking to run ads; Google is already the biggest game in town. But if Google begins to run Yahoo's ads, too, there'll be no recourse—you either take Google's terms or forget about anyone seeing your ads.
It's not only advertisers who ought to worry about Google gobbling up Yahoo: A more powerful Google will also hold greater sway over the millions of Web sites that depend on advertising for their revenue. Many big sites—newspapers and online magazines like Slate, for instance—and millions of small sites (blogs, e-commerce sites, startup firms) run ads provided by Web companies like Google, Yahoo, and Microsoft. As Michael Arrington—the founder of the tech industry blog TechCrunch, one of the most successful new publishers on the Web—points out, Google doesn't share much revenue with sites that run its ads. "The only thing keeping them even close to honest is the fact that Yahoo and Microsoft will occasionally compete for those partners," he argues. Once Yahoo is gone, Google will be able to decrease the revenue given to blogs and other small publishers—a potentially huge blow to a vibrant new medium.
Despite these fears, few in the industry believe that the government will stop the Google deal. When it came into office, the Bush administration rolled over on prosecuting Microsoft, and since then, it has shown little interest in fighting monopolies. The government raised few objections when Google acquired the advertising firm DoubleClick, and Google has been lobbying the government aggressively to approve the Yahoo deal.
Google is also helped by the fact that its biggest adversary, and the biggest critic of the Google-Yahoo proposal, isn't exactly the most admirable company in tech. Given Microsoft's own sorry antitrust history, its promise to help the government fight the deal is something like Hannibal Lecter counseling the FBI on how to catch a serial killer. But if you worry that Google is taking over the world, it's hard not to cheer for Steve Ballmer's Lecter. Google's critics—not only its search rivals but also entertainment companies, publishers, and consumer advocacy groups who've all become alarmed over its growing market power—see the deal as their best chance to initiate a vast antitrust charge against its operations. As Brad Smith, Microsoft's general counsel, told a congressional panel in July, "Never before in the history of advertising has one company been in the position to control prices on up to 90 percent of advertising in a single medium. Not in television, not in radio, not in publishing. It should not happen on the Internet."
At a press conference last month, Google CEO Eric Schmidt argued that the only people who are really worried about the deal are folks who've been brainwashed by Bill Gates and Steve Ballmer. "We are quite certain Microsoft is busy helping everyone get upset about things," he said. That's not really true, but Schmidt's Microsoft reference may remind lawmakers that in the tech industry, giants fall quickly. Ten years ago, Gates and co. looked indomitable. As we look back, though, it's clear that Microsoft let its power get to its head. Blinded by the profits it was reaping from Windows, it didn't notice other innovations coming along—the Internet, Web software, and the awesome profits to be had in search. Google sees itself as a wiser company. But in pushing to join forces with its nearest rival, it may be repeating the last tech giant's biggest mistake.