Alphabet (GOOG) holds an effective monopoly on the online search and online search advertisement market, maintained through anticompetitive tactics and contracts, and used to significantly raise Google product prices. Or so claims the House Subcommittee on Antitrust. The Justice Department seems to agree: an antitrust lawsuit is imminent. Foreign jurisdictions, including the E.U., have ruled and issued fines against Alphabet in the past, and are poised to enact sweeping adverse regulatory changes in the coming months. The U.S. is likely to follow suit. A breakup is possible, if perhaps unlikely.
In my opinion, further regulatory and legal changes, charges, rulings, and actions concerning the company are soon forthcoming. These should negatively affect Alphabet’s overall business model, revenues and earnings, ultimately resulting in significant shareholder losses. Although this isn’t certain, it is certainly possible, and I don’t believe that these issues are currently reflected in the company’s share price. As such, Alphabet is simply not investable at these prices, at least until there is greater regulatory and legal clarity.
Alphabet – Monopoly and Antitrust Concerns Overview
Let’s start with a quick definition / explanation of monopolies and antitrust.
U.S. regulators define a monopoly as a firm with significant market share, generally more than 50%, and durable market power, meaning the long term ability to raise prices or exclude competitors. U.S. antitrust focuses on consumer harm, especially higher prices, but takes into consideration exclusionary and predatory acts, including exclusive supply agreements, tying disparate products, predatory pricing, or refusal to deal with a competitor.
There is evidence that Alphabet maintains an effective monopoly, as defined above, in the online search and online search advertisement market. Let’s have a quick look at each of these markets. Information taken from the previously mentioned House report, U.K. government sources, and assorted journalistic accounts.
Alphabet Online Search Monopoly
The Google search engine is Alphabet’s largest product or service, and effectively synonymous with the company itself. Google is the leading industry player in both the U.S., with over 87% market share, and the world, with over 92% market share. These are very high percentages, and are prima facie evidence of the company’s search monopoly.
Google’s search dominance is maintained through a variety of predatory tactics; these include:
- Contractual agreements requiring Google Search as the default search engine for the vast majority of desktop and mobile devices. Fined 5.1 billion USD by the E.U. in 2018 for these practices.
- Self-preferencing or bundling, with Google Search as the default search engine for the company’s own web browser, Chrome. Google Search itself also prioritizes the company’s other product offerings, including Google Shopping and Youtube. Fined 2.9 billion USD by the E.U. in 2017 for these practices.
- Data misappropriation, with Google lifting content directly from third-party providers.
- Mergers and acquisitions, especially when combined with self-preferencing (acquisition of ITA Software – Google Flights)
Said dominance directly leads to monopoly power, allowing Google to increase prices for the variety of products (mostly ads) sold through/using/on its search engine. Google’s revenue per search impression is about four times as great as that of its nearest rival, Bing, through a combination of more and more expensive ads. Google has held a dominant position in the online search market for more than a decade, strong evidence of the durability of its monopoly power.
Google’s search business, and the company’s practices therein, are considered monopolistic by many foreign jurisdictions, including the E.U.. Although U.S. regulators and the relevant legal authorities have yet to make the same determination, they seem eager to do so.
Alphabet Online Search Advertisement
Alphabet earns the vast majority of its revenues (83%) from selling online advertisement, especially search advertisement: ads appearing when users to Google’s search engine search for specific keywords. The online search advertisement market is composed of several intermediaries that publishers and advertisers use to buy, sell, and place ads. Alphabet has a +50% market share across the entire ad stack / set of intermediaries:
(Source: U.K. Competition and Markets Authority)
Alphabet’s vertical integration and commanding market share in the entire ad stack is evidence of the company’s monopoly in said industry, at least in my opinion and that of many foreign jurisdictions and U.S. lawmakers.
Alphabet’s online search advertisement dominance was created and is maintained through a variety of anticompetitive tactics, including:
- A combination of self-preferencing, effective exclusivity agreements, and conflict of interest. In the past, publishers which used Google’s sell-side software were prohibited from publishing ads from competitors (Bing, Yahoo). Fined 1.6 billion USD by the E.U. in 2019 for these practices.
- Mergers and acquisitions, especially of the ad exchange DoubleClick in 2007.
Alphabet uses its monopoly power in the online search advertisement market to structure the market to its advantage, ultimately resulting in higher prices for the company’s products. Alphabet’s ads are sold for a 30%-40% higher price when compared to comparable Bing ads, something which U.S. lawmakers and foreign regulators believe to be evidence of the company’s monopoly power. U.S. Federal prosecutors are focusing on the company’s search business, so any action here would be focused on Congress, the Executive, or foreign jurisdictions.
Alphabet – Monopoly and Antitrust Concerns Implications
In my opinion, and taking into consideration the evidence presented above, Alphabet holds a monopoly over the online search and online search advertisement markets, which is maintained through predatory and anticompetitive tactics, and which is ultimately used to increase prices.
More importantly, both U.S. political parties, Congressional subcommittees, the Department of Justice and the broader Executive branch, combined with many other foreign jurisdictions, seem to agree, and are taking action to combat Alphabet’s (perceived) monopoly power. These actions could significantly weaken the company’s business model, forcing it to lower prices, leading to lower revenues and earnings, and ultimately causing shareholder losses.
The House Subcommittee on Antitrust’s report is calling for regulatory changes to prevent self-preferencing, mandated software interoperability, a tightening of merger scrutiny, outright tech breakups, and more. Both parties agree that the tech giants operate as monopolies, although there is significant disagreement on possible solutions, with Democrats preferring a tougher set of standards and rules. A bipartisan agreement toughening antitrust regulations seem likely, if perhaps not certain.
As mentioned previously, the U.S. Department of Justice is also preparing an antitrust suit against the company, and will likely be joined by several state attorney generals. Prosecutors are considering breaking up the company. The suit has the support of President Trump, who said that:
“In recent years, a small group of technology platforms have tightened their grip over commerce and communications in America,” Trump declared at a White House event with Attorney General William Barr and Republican attorneys general from several states. “They’ve used this power to engage in unscrupulous business practices while simultaneously waging war on free enterprise and free expression.”
If prosecutors, Congress, and the President prevail, expect a significant reduction in Alphabet’s revenues, earning, and share price. Although an exact estimate of these is ultimately dependent on the specifics of the regulatory/legal changes and rulings, one can make some educated guesses.
Fines, if any, would almost certainly run in the billions of dollars, taking into consideration the company’s size, revenues, and earnings, and the dollar amount of fines for similar companies exhibiting similar behavior in the past.
Google’s online search market share could feasibly drop by about 20% if U.S. regulators implement search preference menus, in which users select their preferred search engine from a pre-selected list.
Google sells its ads for about 30%-40% more than Bing, a figure which E.U. regulators and U.S. lawmakers believe is due to the company’s search market monopoly. Measures taken to weaken said monopoly, including the aforementioned implementation of a search preference menu, could reduce this figure, reducing revenues and earnings for the company. After all, advertisers could be less willing to pay for Google ads if the company’s peers had stronger market shares and more competitive products. Both Bing and DuckDuckGo, Google search’s largest peers, are still profitable with these lower prices, so Google would almost certainly remain so as well.
As Alphabet derives 83% of its revenues from selling ads, the two figurs above imply that the company could see its revenues decrease by about 36%-43% from a strong antitrust response from the authorities.
Google’s ad sales are also somewhat dependent on the company having a commanding market share across the entire ad stack. As such, mandated business separations, or tougher regulations and laws concerning exclusivity agreements, self-preferenciation, or default placements, could significantly reduce ad sales and revenues for the company, reducing revenues even further.
Regulators could also force a company breakup, although the effect of this would be somewhat uncertain. Insofar as Alphabet engages in self-preferencing and uses its size / monopoly power to stifle competition and increase prices, a forced breakup would be harmful to the company and its shareholders. On the other hand, some forced breakups, including those of Standard Oil, AT&T (T), and most Electric Utilities, were beneficial for shareholders in the past, as large monolythic organizations are rarely agile or innovative enough to compete in the market, develop new products, or grow their market share. I think that the preponderance of evidence points towards a breakup being a negative for Alphabet and its subsidiaries, although other analysts disagree.
From the figures above, it seems clear that a worst-case scenario for Alphabet involves a +36% drop in revenues, combined with an even greater hit on earnings and share price, although actual results are strongly dependent on the specific regulatory and legal actions taken.
Although I won’t claim to know the ultimate resolution or impact to Alphabet’s antitrust issues, I do believe that these could potentially cause significant shareholder losses, and I don’t see this reflected in the company’s current share price or in the broader market sentiment.
Conclusion – Avoid
Alphabet faces antitrust scrutiny, including lawsuits, from U.S. regulators, lawmakers, and government officials. These could lead to reduced revenues and earnings for the company, ultimately causing significant shareholder losses. I believe that these are possible and, as such, would avoid investing in the company at this time.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.