SEBASTIAN DAVENPORT HANDLEY
Google’s antitrust battle with
the European Union seems to be heating up. In recent weeks, the company has
rebutted the European Commission’s charges that it uses its
internet search engine to give its shopping services an unfair advantage over
rivals, improperly uses its AdSense ad-placement service to restrict
third-party websites from displaying search advertisements from Google’s
competitors, and unfairly exploits the dominant position of its Android
operating system with smartphone manufacturers and mobile network operators
(see its November 3 and November 10 blog posts.)
We think Google’s rebuttal of
the charges against its shopping and ad-placement services are effective, and
it has even made some changes to its products to address issues raised by the
European Union. But we think it is unlikely that Google will be able to prevail
in the Android case unless it abandons its contention that E.U. authorities
should adopt a U.S. perspective.
Instead, it should try to persuade them that
competition in the mobile space is radically different from that in traditional
markets and consequently, the European Union — and the United States, for
that matter — should revamp their antitrust laws.
Companies like Google operate
simultaneously in multiple ecosystems, as do their competitors. As such, any
analysis of competitive dynamics must be done across ecosystems — something the
European Union hasn’t done. Instead, it has just focused on the
mobile-operating-system market. Given that Google has a European market share
of more than 90% in general internet search services, licensable
smart mobile operating systems and app stores for the Android mobile operating
system, E.U. antitrust authorities seem to believe that Google needs to be
policed from stifling innovation in the marketplace.
In its response to the
European Union, Google argues that its Android operating system has made it
cheaper and faster for device manufacturers to bring devices to market, lowered
prices for smartphones, and increased the distribution opportunities for apps.
In other words, Google bases its reply on the prevailing perspective in the
United States with respect to antitrust enforcement.
The Mobile Industry Stack
To understand the issues
involved in this tussle, it is important to understand that firms like Google,
Apple, Amazon, and Facebook are simultaneously competing and cooperating in
multiple fronts — a phenomenon we call interlocking ecosystems.
Since mobile devices play an important role in making it possible for these
interlocking ecosystems to work smoothly, it is critical to understand the
mobile industry stack.
The typical stack is comprised
of layers of functionality, each of which delivers a unique value proposition
for customers. Every layer of the stack depends on the layer below to deliver
its promised function. Since the layers communicate using application program interfaces (APIs) provided by
vendors operating in the layer below, those vendors that dominate one layer can
use their power to control how the layer above develops. In a notorious
instance, Microsoft reportedly hoped to “cut off Netscape’s air supply” by threatening to withhold
crucial technical support from Intel. When a company uses its own products for
each layer (e.g., Apple), the industry stack is vertically integrated. When
different suppliers provide the required functionality for each layer, the leadership
of the stack is divided.
Android is Google’s
open-source operating system (OS), which means that it can be adopted by any
device manufacturer and modified to provide different functionality. As a
result, 90% of device manufacturers in Europe use Android as their OS. Some
modify the OS; in those cases, it is called an Android fork.
The next layer of the stack,
the application layer, is the most important for the majority of today’s
consumers. People pay for, download, and use third-party applications via the
Google Play Store. One of the most popular apps is Google Search, which is also
the primary source of Google’s advertising revenue and therefore is vital to
Google’s business model.
Google requires mobile-device
manufacturers to sign an “anti-fragmentation agreement,” which states that
manufacturers that want to pre-install Google proprietary apps (including
Google Play Store and Google Search) on its devices cannot include Android
forks on those same devices. Consequently, device manufacturers that adopt the
Google stack must bundle both Google Search and Google Play, which essentially
locks out the other search engine providers and store fronts. In other words,
while Google supports divided technical leadership for part of the stack, it
tightly controls the applications layer.
From a stack perspective,
Google provides free functionality at a lower level of the stack and makes up
for it by charging for the higher-level functionality. To subsidize the free
Android OS, Google has ensured that consumers provide data and exclusively use
its search application (supported by paid advertising) in the higher layer.
From Google’s perspective,
this approach has the benefit of increasing efficiency in the mobile industry
stack. Google has at once freed device manufacturers from having to invest in
developing complex operating systems, allowed them to focus on their core
competence of designing and manufacturing of devices, and thereby lower their
costs. As Kent Walker, Google’s senior vice president and general counsel, argues, Android has made it cheaper and faster for device
makers to bring new devices to market. At the same time, Google suggests, it
has enabled consumers to benefit immensely by falling device prices, access to
a variety of devices, and ease of use of thousands of apps.
Competition Policy: U.S. vs.
E.U.
Google’s argument relies
heavily on the prevailing American perspective of competition policy. In the
United States, legal precedents, as well as enforcement efforts, approach
competition policy with consumer welfare as its lodestar. This approach argues
that promoting efficiency with which firms operate leads to enhanced consumer
welfare since improved efficiency leads to lower costs which in turn leads to
lower prices. In that context, preserving competition in the marketplace is
only a means to an end. As one observer puts it, “efficiencies are the goal;
competition is the process.” By this logic, Google’s approach to the mobile
stack is efficiency enhancing whereby consumers benefit.
Unfortunately for Google, the
E.U. antitrust enforcers have a slightly different perspective. They, too,
start off with consumer welfare as the long-run goal, but they insist that
moves by rivals that could be efficiency enhancing in the short run could be
detrimental in the long run, especially if those moves could thwart
technological innovation and competition. In other words, E.U. authorities put
more stress on what one might call dynamic efficiency in markets.
The differing U.S. and E.U.
antitrust perspectives can lead to different outcomes when confronted with the
same set of facts. For example, in the case of the proposed merger between GE
and Honeywell, U.S. antitrust authorities gave it a go-ahead based on projected
cost efficiencies whereas the E.U. authorities denied it since it has the
potential to lower competition in the long run.
In the case of mobile
operating system, the European Union makes three arguments, all of which have the notion of dynamic efficiency
at their core.
One, the European Union argues
that since “Google has made the licensing of the Play Store on Android devices
conditional on Google Search being pre-installed and set as default search
service,” rival search engines are not able to get a foothold in the devices
sold in the European Union. Moreover, it has also reduced the incentives of
manufacturers to pre-install competing search apps, as well as the incentives
of consumers to download such apps. This is important because the European
Union’s research has shown that consumers rarely change or delete pre-installed
apps (unless the pre-installed app is of particularly poor quality). In other
words, Google’s approach reduces the likelihood of future competition in
search.
Two, the European Union argues
that Google’s “anti-fragmentation agreement” also has the effect of reducing
dynamic efficiency. It says: “Google’s conduct prevented manufacturers from
selling smart mobile devices based on a competing Android fork, which had the
potential of becoming a credible alternative to the Google Android operating
system. In doing so, Google has also closed off an important way for its
competitors to introduce apps and services, in particular general search
services, which could be pre-installed on Android forks.”
Three, in the European Union’s
view, Google reduces dynamic efficiency through its moves to grant significant
financial incentives to some of the largest smartphone and tablet makers as
well as mobile network operators to persuade them to exclusively pre-install
Google Search on their devices. Again, this has the effect of denying competing
search devices a toehold in the market.
Incidentally, none of these
arguments is novel or without merit. The European Union has before it instances
where similar issues played out to the detriment of dynamic efficiency in other
markets. For instance, in its dealings with PC manufacturers in the early
1980s, Microsoft used a seemingly innocuous pricing approach to ensure that
manufacturers had no incentives to install a rival operating system. This led
to Microsoft achieving a near-monopoly position that has lasted to this day.
Moreover, Google itself has demonstrated how keen it is to preserve its ability
to collect data through its search engine. It has used its dominant position to
ban the privacy app called Disconnect from its Play Store
since the app can shield users against invisible tracking tools. Through its
anti-fragmentation agreement, Google can probably ensure that the privacy app
does not get any traction in the market.
How Google Should Respond
Based on Microsoft’s
experience with European Union in the context of its browser and more recent
decisions that the European Union has made with respect to other firms in the
context of mergers and acquisitions, it is unlikely that Google will prevail in
the E.U case if its persists with its present arguments. Google, however,
could argue that one of the E.U. assumptions about competition is flawed.
E.U. authorities claim that
Android is dominating the mobile OS market. While it is true that Google is
dominating the OS market, OS is only one part of several ecosystems in the
digital universe. For example, in the home-automation market, Amazon, Apple,
Google, and Microsoft are all competing for market share. The OS layer is only
a small part of the overall solution. The conversational layer (functional layer of the
stack that allows consumers to talk to machines and execute commands) is
currently dominated by Amazon and Apple. There are thousands of such
ecosystems, and Google is certainly not dominating all of them.
Google is one of the digital
titans, a group that includes, Alibaba, Amazon, Apple, Baidu, Facebook, and
Tencent. These companies use their digital superiority to participate in
countless ecosystems by investing in R&D, developing partnerships, or by
using APIs in shrewd and unexpected ways. In doing so, they may dominate one
market and, at the same time, be a new entrant in a different market. They
apply their data assets, algorithms, third-party developers, and managerial and
engineering talent across multiple ecosystems.
We live in a world where
companies compete by being part of an ecosystem, a world where the winners can
change at any time because there are always newer, shinier, and more innovative
solutions in the works. Regulators are making a mistake by simply looking at
one ecosystem and declaring Google the winner. That is like declaring a Super
Bowl winner based on the team that scored the most points in the first quarter
of the season opener! This approach doesn’t account for adjustments and
improvements made by the opposing team or by future opponents.
Note how this argument takes
EU’s dynamic efficiency concerns and turns them around. The key question to ask
is this: Do we seek to preserve dynamic efficiency at each ecosystem separately
or do we seek to preserve it at the intersection of multiple ecosystems? There
are no easy answers to this question. Still, it will have the effect of making
the E.U. competition authorities to think more deeply and give Google an out.
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