The dark side of Google’s astronomic profits

Alphabet (Google's parent firm) market capitalization reached on July 2017 677 Bn. dollars, for a net income of 20 Bn. dollars in 2016… figures that look even more impressive as compared to an “old economy” large company as General Electrics, with its 231 Bn. dollars of market capitalization and a profit of 9 Bn. dollars in 2016. How can Google justify such an impressive financial performance?

At the origin, Google was one among many others firms to provide an internet search engine or browser. In presence of search costs, internet users should value a tool for ordering information, from the most relevant to the least relevant one. The major innovation of Google was to develop an original information retrieval algorithm, which gradually imposed itself as the preferred search engine for a majority of internet users. According to Netmarketshare, a consultancy firm, in September 2017 Google Chrome browser occupied 60% of the market for desktop internet searches, far above Internet Explorer (14%) and Firefox (13%). In the mobile / tablet market, Google Chrome maintains a high 57% share, being followed by Apple Safari with 32% of the market.

At the same time Google developed Android, a free OS for smartphones. According to IDC, in the last five years, the share of Android in smartphone shipments has been close to 85% of the market. Netmarketshare indicates that the Android market share of the OS for smartphones is 65% in September 2017. Both the Chrome search engine and Android are provided by Google for free (Android involves some costs however). Furthermore, the company provides for free many others useful services, such as a good mailing system, free storage space, the user-friendly Google Map, agenda, and so on.

How a company that delivers its key products / services for free can make such huge profits? Can someone speak of market power, and would-be abuses of market power, when the company charges nothing for accessing its main products and services?

Google denies any wrongdoing. The internet search technology is featuring increasing returns to scale, as it requires high infrastructure and development costs that are fixed, yet the cost of adding new users is quite low. Thus the company would justify its size by a concern of efficiency; the more users, the lower the average cost per service unit. Moreover, the more users share information on the same platform, the higher are chances that one user obtains the needed information, in a typical network effect. By bringing together as many users as possible, this would provide the highest benefit to each of them. On the mobile OS market, the benefit of inter-operability would also justify the existence of a single system, an argument formerly put forward by Microsoft in the market for desktop OS.

However, the strong position of Google in the (free) market for internet searches gave the firm access to a goldmine: internauts’ searches directly reveal internauts’ tastes. Moreover, providing Android for free might be one insidious way to encourage smartphone users to adopt the Google universe and its search engine.

A history of searches reveals the consumer profile of a person much better than any market survey. We do not talk about “self-reported” interests, but on time spend on one site or another. And because time is money, these choices reflect true preferences. Now Google can keep a trace of the places you visited, including shops, restaurants, touristic areas, and so on. These data on individuals and groups of individuals allow Google to sell advertising services on a quasi-monopolistic base. As Microsoft uses the power of its ubiquitous PC Operation System to sell PC application softwares, Google might use its dominant position in the information search market to lock the market for internet advertising. It clearly appears that the access to the first market is not free – to access its search platform, one should disclose private information about his tastes. And Google might use this information to make monopoly profits in the advertising market, by charging fees well above the marginal cost of obtaining the relevant information. The EU seems to take this issue seriously. On June 27, 2017 the European Commission imposed a 2.42 Bn. euro fine on Google for abusing of its dominant position in the search market in favoring its own comparison shopping tool, and hinted that further investigations might come.

Like in any traditional market where the average cost declines in the number of users – a natural monopoly – regulation is needed in the market for internet searches. Ideally, Google might be split in two companies. One should keep its monopoly nature, delivering the Internet searches though the information retrieval algorithm and charge a fee for providing consumer data to advertising companies. This fee must be regulated by an independent authority. The existing Ad Google department should be organized as a separate company that should compete with any other company that would provide Internet advertising services. The latter would buy the data from the internet search firm at the regulated price, and sell add campaigns to buyers. Unfortunately this solution, while solving the problem of abnormal profits, would not solve the problem of data privacy. A market mechanism where people buy services from Google and accept (or not) to sell information about their internet usage might increase transparency in this opaque market.