Edward M. Iacobucci University of Toronto Faculty of Law

Transcription

1 UNIVERSITY OF CHICAGO LAW SCHOOL LAW AND ECONOMICS WORKSHOP Tying in Two-Sided Markets, with Application to Google Edward M. Iacobucci University of Toronto Faculty of Law Tuesday, October 7 th, 2014 Seminar Room F - 3:30 P.M.

2 Tying in Two-Sided Markets, with Application to Google Edward M. Iacobucci September 2014 PRELIMINARY DRAFT: NOT FOR CITATION 1

3 I. Introduction The perception of tying as an anticompetitive threat has evolved over time. The naïve, pre-chicago School view was that tying could allow a seller with market power in one good, the tying good, to extend its market power into a second good, the tied good. To take a canonical example, if a seller has a monopoly selling jars, while lids could be competitively supplied, the seller could extend its monopoly into lids by bundling the sale of lid to the sale of a jar. Assuming that every buyer needs both a jar and a lid, a single seller could replace the competitive market for lids, which prima facie raises competition concerns: the tie on its face forecloses competition. The Chicago School challenged the conventional wisdom, not by denying that a monopolist could in theory extend a monopoly from one good into another through tying, but by questioning its incentives to do so (see, e.g., Bork (1978), Bowman (1957), Director and Levi (1956)). Take the jar-lid example. Suppose that customers are homogeneous, as are the lids across producers, and buyers value the jar-lid bundle at 10. Suppose that a jar costs 3 to produce, as does a lid. A competitive market would supply a lid at a price of 3. This implies that the profit-maximizing price for the monopolist selling a jar only is 7, which leaves it with profits of 4. Alternatively, the jar monopolist could bundle lids with jars, selling the bundle for 10. As Chicago theorists pointed out, this leaves the seller no better off with or without tying. In both cases, the monopolist earns only 4. There is thus no incentive for the seller to impose the tie. This is sometimes called the single monopoly profit theory. As the Chicago School recognized, the results may change if the assumptions are relaxed (Bowman 1957). If, for example, consumers are heterogeneous, the tying and tied goods are not necessarily consumed in fixed proportions, and consumption of the tied good reflects a buyer s 2

4 overall valuation of the tying-tied good combination, it is possible that tying could increase profits because of price discrimination. Consider printer-toner tying. If inelastic demanders for printer-toner combinations buy more toner, tying toner to printers and charging a supracompetitive markup on toner allows printer sellers to extract more surplus from relatively inelastic demanders. Bundling one product with another may also facilitate price discrimination where demand for the two products is not perfectly correlated across consumers. Suppose that some people prefer business news, while others prefer sports news. Rather than attempting to charge business readers a high price for business news and a low price for sports news, and viceversa for sports readers, a newspaper may bundle the sections into a single newspaper and charge an average price for the bundle. This allows the seller to extract more surplus from consumers than an unbundled strategy would (Stigler 1963). While price discrimination motives for tying have long been recognized, more recently post-chicago theorists have shown that relaxing the assumption that competitive conditions in the tied good market are exogenous also challenges the single monopoly profit theory. For example, scale economies may affect competitive conditions in the tied good market, which in turn implies that tying may affect competitive conditions in the tied good market. Whinston (1990) showed that tying may deny scale to potential competitors in the tied good market, allowing the tying good seller to realize monopoly profits from customers in the tied good market who may otherwise only have purchased the tied good from a competitive supplier, had one existed. For example, a hotel on an island with market power in selling rooms may bundle its restaurant services to its rooms for its guests (Carlton and Heyer 2008, attributing example to Rob Gertner). It may not extract more profits from guests by doing so; the single monopoly profit theory suggests that the room-food combination will have one monopoly profit (if any) 3

5 that the seller can extract from such guests. But suppose that there are natives to the island that would dine at restaurants without buying rooms at the hotel. Tying the restaurant to the hotel may leave an insufficient number of potential patrons for a competitive restaurant to achieve scale, which implies that locals will have to patronize the hotel restaurant, and the hotel restaurant can realize monopoly profits from local diners. It is also possible that tying may influence competitive conditions in the tying good market. Carlton and Waldman (2002) point out that, in some circumstances, tying may deter the emergence of a substitute for the tying good. This was of central importance in the case against Microsoft in the U.S. Microsoft tied Internet Explorer to Windows. It is possible that it did so in order to protect its market power in Windows, the tying good. The concern was that browsers, and associated universal interfaces, may have ended up, in effect, competing with Windows and its associated applications. It therefore attempted to suppress rival browsers by bundling Explorer to Windows. This potentially affected competition in the tying good market by retarding the evolution of the tied good to the point where it would be a viable substitute for the tying good. Thus, there are different reasons to doubt the single monopoly theory. One class of theories turns on the use of tying to exploit existing market power more effectively, such as the use of tying to facilitate price discrimination. The other class relies on tying to foreclose competition in either the tying or tied good market. This article suggests an alternative theory of tying that also results in a change in competitive conditions in the context of two-sided markets. If a tying good seller has market power in the sale of a platform in a two-sided market, it may profitably, and anticompetitively, leverage its market power by bundling the sale of a second platform in a possibly related, but 4

6 distinct, two-sided market. The basic reason for this is the following. The single monopoly theory holds, when it does, because the seller can charge a buyer a higher price for the tying good when the would-be tied product is supplied competitively. In the context of two-sided platforms, there are two, potentially distinct sets of buyers across would-be tying and tied goods: there are the upstream buyers of the platform, and the downstream buyers. The single monopoly theory can hold only if both upstream and downstream buyers are identical across platforms, and each platform is required to be used in fixed proportions. This is more restrictive than the single-sided market context, and enhances opportunities to make profits in the tied good market by excluding competitors. The analysis below shows that anticompetitive exclusion of potential rivals with tying in the two-sided platform context does not require scale economies of the sort contemplated by Whinston (1990). At root, both theories depend on negative crossmarket externalities: in the hotel example, hotel guests impose a negative externality on islanders by accepting the tied restaurant services; in the two-sided context, downstream buyers of the tying-tied platform bundle impose a negative externality on upstream buyers. The balance of the article proceeds as follows. Part II reviews briefly the economics of tying in two-sided markets, and then expands on the reason why the single monopoly profit response to allegations of tying will generally fail in this context. Part III then turns to the European Commission s recent settlement with Google over aspects of its product offerings. In particular, Part III focuses on the complaint by the Commission that Google favours its own specialized search services over others following a general search. Part III explains how this can be thought of as a kind of tying, and, despite commentary to the contrary (Manne and Wright (2011), Bork and Sidak (2012)), why the single monopoly profit theory would not hold in this context. Part III discusses some of the key questions that would have to be answered before any 5

7 final conclusions on the Google case are appropriate, including the question of Google s market power. Part IV concludes. II. Tying in Two-Sided Markets and the Single Monopoly Profit Theory a) The Literature Two-sided platforms serve at least two different sets of customers, providing each with an opportunity to interact with one another. They are ubiquitous: consider television stations (advertisers and viewers); credit cards (banks, merchants, consumers); newspapers (advertisers, readers); video game consoles (video game makers, gamers); and of course, internet search engines (searchers, advertisers). The economics of two-sided platforms are complex for the following reason: the seller when setting prices and conditions for one side of the market must take into account the effects of those choices on demand on the other side of the market (see, e.g., Evans 2003). A video game console manufacturer that charges programmers a fortune to sell licensed games may find itself with few programmers, which in turn will lead to few buyers of its consoles. As Caillaud and Jullien (2003) put it, there is a chicken-egg problem in twosided markets, with participants on each side of the platform willing to participate only if significant numbers on the other side are also willing to participate. Some commentary has considered the role of tying in two-sided markets, but has overlooked the basic insight of this paper. Amelio and Julien (2012) suggest that tying may be relied on by a seller in order, in effect, to subsidize one side of the market, which in turn enhances profits on the other side of the market, without inviting selection problems that 6

8 negative cash prices would generate. 1 Rochet and Tirole (2003) specifically consider tying in credit card markets. Merchants who accept credit cards from a particular platform may also be required to accept debit cards from that platform. Rochet and Tirole suggest that tying may correct a distortion on interchange fees that might otherwise arise across debit and credit cards. Choi (2007) argues that a platform with market power may profitably tie another platform. Choi argues that, with multi-homing permissible, that is, where consumers may use multiple platforms, such tying may enhance welfare by inducing more multi-homing. Finally, commentary has considered whether Google has tied certain services to its search engine, with some commentators suggesting that this is not problematic because of the single monopoly profit theorem (see, e.g., Bork and Sidak 2013), and others stating that the theorem does not apply because Google does not charge searchers (Lianos and Motchenkova 2013). I focus on this case further below, but note here my conclusions that the single monopoly profit theorem does not hold in the Google context, but nor is it especially significant that Google charges zero for search. The balance of this Part will develop a simple theory on the anticompetitive effects of tying in two-sided markets not found in existing literature, and the next Part will apply it to Google. b) Tying in Two-Sided Markets The key premise on which the single monopoly profit theory rests is that the seller deals with the same set of customers either with or without tying. The seller can either allow competitive markets to supply the tied good and charge tying customers a higher price to reflect this choice, or can tie but then charge tying customers a price that reflects the absence of choice 1 On a similar note, Iacobucci (2008) points out that warranties, which are a form of tying, may provide greater value to high-value customers than mere cash discounts, and thus allow subsidies in markets with significant lock-in and hence supra-competitive profits in aftermarkets without undesirable selection effects. 7

9 in buying the tied good. In two-sided markets it is plausible to expect the seller to deal with different sets of customers when it imposes a tie and when it does not, which may make leverage from one platform to another profitable. Consider the following stylized example. There are two two-sided platforms that are relevant in this example. There is a boat show in which the seller of the show deals with two different kinds of customers: boat manufacturers who purchase display booths at the show; and customers, who pay the show an entrance fee. There is also a boat trailer show; trailer manufacturers pay the seller for the right to exhibit their products, and customers pay an entrance fee. To resemble the canonical jar-lid illustration of single monopoly profit theorem, suppose that all consumer attendees of the boat show have exactly the same preferences, and would also want to attend the trailer show; the shows are complements and there is no value to attending only one of the shows. 2 Suppose that buyers value attending the boat-trailer show combination at $20, conditional on both boat and trailer manufacturers attending each show. Suppose that all boat sellers value participation in the boat show at $50, conditional on buyers attending. 3 Finally, assume that all trailer sellers value participation in the trailer show at $40, conditional on buyers attending. Suppose that the seller has (exogenously given) monopoly power in the boat show, but that trailer shows could be competitively supplied. 4 Consider first the case without tying. 2 If this strong version of the complementarity assumption does not hold, the basic story that follows could remain valid as long as there are some buyers for whom the platforms are complements; I discuss this further below in the context of the Google case. For now I assume complementarity in order to consider conditions in which the single monopoly profit theorem is plausible in the two-sided platform context, and to show that it does not hold even in these conditions. 3 Given homogeneity in preferences, assume that either all buyers will attend or none will. That is, that buyers will rationally herd to a single show. 4 There are network externalities across buyers: if other buyers attend a particular show, sellers are more likely to attend. This complicates the assumption of competitive supply of trailer shows. Think of it this way: buyers will coordinate and attend one and only one single trailer show, while potential suppliers of trailer shows will make costless offers to host the show. I discuss the possibility of network externalities in the Google context below. 8

10 Suppose that competitive conditions push down the price of attending the trailer show to sellers to the cost of accommodating the additional booth, which is a constant $30 for both the boat and trailer show, while the cost to buyers is pushed down to the marginal cost of accommodating another attendee, which is $9 per show. Without tying, trailer sellers each realize surplus of $10, as long as the boat show provider does not price either boat or consumer participants in the boat show out of the market (which of course the boat show provider would not rationally do). The surplus to trailer show consumers depends on the price to attend the boat show since, by assumption, there is utility to attending both shows, but not to attending one show or the other. If there is no tying, the monopolist boat show provider will charge boat manufacturers and attendees the entire value these buyers each realize. Boat sellers, assuming consumers attend the boat show, will pay $50. Boat buyers, given a competitive price of $9 for attending the trailer show, can be charged $11 for attending the boat show. Thus, without tying, the boat show charges $50 to boat sellers, and $11 to boat buyers, while the trailer show costs $30 to trailer sellers, and $9 to trailer buyers. Without tying, buyers realize no surplus, nor do boat show sellers. The boat show provider s monopoly position allows it to extract all the value from show attendance from all customers with whom it interacts, both boat sellers and boat-trailer buyers. The boat show monopolist realizes profits of $20 from each boat seller, and $2 from each boat and trailer buyer-attendee. The only participants that realize surplus, other than the boat show provider, are the trailer sellers, who do not deal with a monopolist and instead pay a competitive price of $30 for participation in the trailer show and realize $10 in surplus. 9

11 The boat show can use tying to compel trailer sellers also to deal with the boat show provider, thus exposing trailer sellers to market power and increasing the show provider s profits. To demonstrate, suppose that the boat show ties attendance by consumers at the boat show to attendance of the trailer show. That is, the boat show sells a single ticket that allows consumers to attend both boat and trailer shows (it could physically blend the shows to ensure attendance at both). The total value to boat-trailer buyers is $20, assuming that boat and trailer sellers also attend, so the price for the joint ticket is $20. The value to boat sellers, assuming boat buyers attend the boat show, is $50, and hence the price of selling at the show is $50. Trailer sellers only want to participate in the show where trailer buyers show up, which requires them to show at the boat show monopolist s trailer show. They are willing to pay up to $40 for attendance, and that is what the monopolist will charge them. To summarize, with tying, the only party realizing surplus is the monopolist, who realizes $20 per boat show seller, $2 per boat-trailer show consumer attendee, and $10 per trailer show seller. Tying unambiguously increases the monopolist s profits. This is because tying expands the set of buyers from whom the monopolist extracts surplus, rather than simply possibly increasing the surplus it realizes per customer. The key reason for this is that the set of buyers varies across platforms. Boat-trailer buyers want to attend both shows, and indeed realize no value (by assumption) unless they attend both this makes the two-sided platform case examined here closely analogous to the jar-lid example. Consistent with the logic of the single monopoly theorem, tying does not affect the surplus that the boat show monopolist extracts from boat-trailer show consumers: without tying, the buyer attends the trailer show at a competitive price, which increases its willingness to pay for the boat show, which of course invites the boat show monopolist to charge a higher price for 10

12 admission to the boat show. However, customers on the other side of the platform, boat and trailer manufacturers, vary across the boat and trailer show. Without tying, the boat show monopolist does not deal at all with trailer sellers, which makes it impossible for the monopolist to extract surplus from trailer sellers; moreover, competition makes it impossible for any show provider to realize surplus from trailer sellers. With tying, however, the boat show monopolist extends its monopoly power from the boat show to the trailer show, which allows it to extract value from trailer sellers. Just as foreclosure theories of tying allow sellers to increase their customer base at the expense of would-be competitors, the platform tying here allows sellers to expand their customer base at the expense of would be competitors. In this simple example, there are no social losses from tying. Tying allows the seller to extract a greater share of total surplus (indeed, in this example, 100% of the social surplus), but at no cost to total surplus. It is straightforward, however, to make the argument that the monopolist has an incentive to bundle platforms even if this reduces total surplus. This is because while bundling may reduce overall surplus, it allows the seller to gain a bigger share of the total surplus by adding a class of customers confronting monopoly conditions; this latter effect may dominate. To illustrate, suppose that there is a class of potentially competitive trailer show providers who are better at providing trailer shows than the boat show provider. Suppose that, if the trailer show is provided by one of the superior alternatives, the boat-trailer show combination is worth $21 to boat-trailer buyers, but the boat show supplier s boat-trailer combination is only worth $20. Tying the trailer show platform to the boat show platform creates social costs of $1 per buyer. This also costs the boat show monopolist: it can earn only $2 in profit from each boattrailer show consumer attendee, while failing to tie would allow it to earn $3 from each boat- 11

13 trailer show attendee (the superior alternative trailer shows are competitively supplied at a price of $9). Sacrificing profit from the consumer attendees of the shows, however, leaves an entirely new set of customers, the trailer sellers, contributing to the monopolist s profits: without tying, the monopolist realizes zero from trailer sellers; with tying, the monopolist realizes $10 in profits from each trailer seller. Depending on numbers, it is entirely plausible that the loss-perconsumer show attendee is offset by the gain in profits from adding customers to the monopolist s ambit. The simple example illustrates a more general point. Tied selling to one side of a twosided platform across two-sided platforms risks losing profits from that side of the market, since reduced choice will generally lessen the quality of the bundle relative to unbundled platforms, and this will tend to reduce demand on that side of the market for the tied seller s platform bundle. But the seller will often be willing to sacrifice profits from one side of the platform if it expands the customer base on the other side of the platform: rather than having monopoly power over only one platform, the tied seller can leverage its power into another, distinct platform and a distinct set of customers. There is a special case where tying one platform to another will not be profitable for the monopolist, and where the single monopoly profit theorem holds. Suppose in the boat and trailer show example that boat manufacturers are trailer manufacturers, and vice-versa, and suppose for some reason that these sellers also require attendance at both shows to realize value. That is, suppose that all participants on the seller side of the show platforms want to participate in both the boat and trailer shows, just as consumers in the example want to attend both shows: both sides of the platform do not gain anything unless they participate in both platforms. In this special case, tying does not expand the seller s customer base: without tying, the boat show 12

14 monopolist sells to boat-trailer manufacturers and boat-trailer buyers; with tying, the boat show monopolist sells to boat-trailer manufacturers and boat-trailer buyers. This overlap of customers who require access to both platforms to realize value means that there is little to gain to the monopolist from tying the trailer show to the boat show. Not tying would imply that manufacturers could participate in the trailer show for a competitive price of $30. This low price allows the boat show to charge a higher price for the boat show to boat manufacturers, just as a low competitive price for consumer attendees of the trailer show allow the boat show seller to increase prices to boat show consumer participants. The boat show monopolist can, in this special case, realize monopoly profits on both sides of the boat show platform by unbundling and charging more to attend the boat show. The single monopoly profit theorem holds in this special case. Note that the single monopoly profit theorem in the two-sided platform context does not hold simply because the customer base is identical on both sides of the platform across potentially bundled platforms. It must be that consumption of the platform on both sides of the platforms arises in fixed proportions; that is, consumption of one platform requires consumption of the other. It is only in this circumstance that competitive conditions for one platform allow the monopolist to charge higher prices for the other platform. If, for example, boat and trailer manufacturers and consumers each have positive demand for participation in boat and trailer shows, but demand for each is independent of demand for other, then the single monopoly profit theory will not hold. Adding new customers from tying is sufficient for the single monopoly profit theorem not to hold in the two-sided platform context, but is not necessary. 13

15 III. The Google Case Google has been subject to multiple competition investigations across jurisdictions. A variety of concerns have been advanced, ranging from the concern that Google, because of its extensive search data, is an essential facility (see discussion in Lao 2013), to its practice of including paid advertising results more prominently than organic results (Lianos and Motchenkova 2013), to Google requiring or inducing advertisers to rely on Google exclusively for their online advertising, to Google s favouring its own vertical search services (that is, specialized search services, like yelp for restaurant reviews, or Amazon for retail products) over rival vertical search services. The Federal Trade Commission in the US investigated, but ultimately decided unanimously in 2013 not to pursue a case against Google. The European Commission also investigated, and Google agreed to change certain practices as a consequence. 5 I focus in this Part on one aspect of the Commission s investigation and agreement with Google: Google s practice of favouring its own vertical search services over rivals. This Part first reviews the nature of the complaint, reviews commentary on the case, and then shows how the analysis of tying in two-sided markets in Part II illuminates the case against Google. Google s practices potentially fit the theory of extending a monopoly in one two-sided platform into another. The analysis here shows that, conditional on plausible assumptions that I discuss in detail below, there is an economic logic to a claim that Google extended its monopoly power in general search into vertical search. a) The Complaint The complaint that is the present focus is that Google favoured its own specialized search services over those of other providers when providing general search results, a prominent 5 See 14

16 concern in the European investigation. 6 The concern of the Commission is that specialized search engines, or vertical search, are hurt by their obscurity in Google s general search results, which in turn discourages investment in vertical search independent from Google. To provide more context for the question of whether and how Google has tied specialized search to general search, consider the following example. The user first uses Google for a general search for toronto to naples flights, and then chooses a vertical search engine to choose a specific airline, date and flight. The results of the general search are presented in Figure 1. 6 See 15

17 Figure 1 Now examine the vertical search that results when one clicks on the Google flights link: 16

18 Figure 2 It is clear from Figure 1 that Google does not require searchers to rely on its vertical search engine following the general search: there are a number of links to outside services, including flightnetwork.com and expedia.ca. But it is also clear that Google visually favours its 17

19 own vertical flight search service, providing it with prominent real estate in the centre of the page, with embedded search boxes and a border around it. Definitions of tying generally include the practice of not only requiring buyers of the tying good to purchase the tied good, but also of inducing buyers to purchase the tied good. For example, discounts on a tying-tied good bundle that make the bundle cheaper than the tying-tied good combination if purchased separately may attract antitrust scrutiny. By this definition, it is plausible to describe Google as tying vertical search to general search: while there are no price discounts from relying on Google s vertical search service, there is a clear inducement to click on it; the Google vertical search engine is the most prominent vertical search link displayed in Figure 1, which is a kind of inducement. Given the zero price of search, discounts are not available (negative prices lead to selection problems: Amelio and Julien, 2012), so visual prominence is the means by which Google induces selection of its tied good. Experimental evidence confirms the behavioural tendency of searchers to be drawn to such visually prominent links (Edelman and Lai 2013). Accepting the hypothesis that Google has market power in general search, and that its practice amounts to tying, does it have an incentive to extend its market power from general search into vertical search? I argue that the answer to this question is yes, but not for reasons that existing commentary on the case advances. b) Views in the Literature Bork and Sidak (2012) reject the idea that Google has market power, but also reject the idea that if Google had market power that it would be profitable for it to tie vertical search to general search. For one, they are sceptical that vertical, specialized search is a distinct product 18

20 from general search, but even if it were, they argue that Google would have no incentive to extend its market power from general search into vertical search. They state at p. 675, The single-monopoly-profit theorem shows that, in a vertical chain of production, the vertically integrated monopolist can earn monopoly profit only in one of the markets either the upstream or downstream market, but not both. Different stages in the vertical process are complements to one another. If retailers increase the markup on a particular product, the manufacturer s profits will fall. Likewise, when a manufacturer increases the wholesale price of a product, the retailer s profits will fall If a monopolist controlled both the manufacturing and retailing of a particular product, it would maximize profits by charging the monopoly price in one of the stages of the vertical process and the competitive price in the other stage Total monopoly profits cannot exceed the monopoly profits from any one stage. Consequentially, under the (hypothetical) framework that general search is an upstream monopoly and vertical search is the competitive downstream market, if Google were already earning monopoly rents in general search, it could not increase its total profits by acquiring market power in specialized search. Google therefore has no incentives to limit competition in vertical search. Bork and Sidak also consider, assuming general search and vertical search are horizontally and not vertically related, whether Google could extend its monopoly power from general search into vertical search. They reject this, stating at pp : In horizontal applications, the single-monopoly-profit theorem implies that firms typically cannot extend monopoly power over one product to other products without sacrificing total profit By the logic of Google s critics, Google is trying to leverage market power in general search to increase the share of users of its specialized search. That is, Google is supposedly altering its search results and driving away some general search users, so as to encourage a larger percentage of its remaining users to use Google s specialized search The competitive nature of vertical search prevents Google from earning a monopoly profit from advertising in specialized search. Therefore, the argument against Google collapses to the following nonsensical proposition: Google is sacrificing a monopoly profit in general search to gain market share in a more competitive market. Bork and Sidak draw a distinction between vertical and horizontal conceptions of Google s linkages of vertical to general search. They argue that the single monopoly profit theorem holds in both contexts, but seemingly for different reasons: upstream firms that tie 19

21 downstream products cannot make more than a single monopolist s profit; while firms that tie goods horizontally generally reduce their profits relative to untied provision of the goods. The single monopoly profit theorem depends in part on the degree of complementarity between tying and tied goods. It is crucial to the single monopoly profit theorem that the goods are complements, and, more than that, are complementary in fixed proportions. For searchers who rely on general search as an entrée to vertical search, the general and the vertical are complementary searches used in fixed proportions. This is what is important, not whether one wants to frame the relationship between general and specialized search as vertical (i.e., general search is an input into vertical search) or horizontal (i.e., general and vertical search are two distinct products possibly complementary in consumption). Bork and Sidak (2012) argue that, accepting for the sake of argument that Google has market power, Google would have no incentive to tie relatively competitive vertical search services to its monopolistic provision of general search. This is not persuasive. If Google has market power in general search, and specialized and general search are used in fixed proportions, then tying reduces competition in vertical search. In the jar-lid example, it may well be that lids could be competitively supplied, but if the jar monopolist ties the sale of lids to the sale of jars, it will clearly be within the jar-lid monopolist s power to raise the price of lids above competitive levels: tying insulates the monopolist from competition in the tied good. It is a separate question whether it has incentives to do so. Bork and Sidak discuss the potential costs to Google of tying vertical search to general search. If tying specialized search services is accomplished by placing relatively disfavoured paid or Google-associated links in a more prominent position in general search, then there are potential costs to Google even if it has market power in general search. If the value of general 20

22 search to searchers falls because of tying and a lower quality of the search results, there is the potential for fewer general searches the drop in quality is analogous to an increase in price. The extent of the fall depends on the elasticity of demand for search with respect to search quality. It is this effect of tying that could reduce profits, not the attempt to leverage into a more competitive, specialized search market. It is not the case, however, that the fall in profits associated with degrading the quality of general search necessarily reduces overall profits. With ordinary products consumed in fixed proportions, if the tying-tied good bundle is worth less to the user than the tying and tied goods being sold independently, then it is true that tying will often reduce a monopolist s overall profits. Think again of the jar-lid example. If consumers prefer to purchase unbundled jars and lids, then the jar monopolist is better off not tying, allowing consumers to buy lids independently, and charging a higher price for jars. But with two-sided markets, tying may have different effects such that degrading the product to one side of the market may nevertheless be profitable. I elaborate on this point below, but note for now that if tying vertical search to general search allows Google to realize profits from vertical search advertisers with whom it would not have dealt absent the tie, then reducing the number of general searchers may nevertheless be profitable. Other commentary rejects the single monopoly theorem s application to Google. Lianos and Motchenkova (2013) conclude that Google may have sought to foreclose competing services ancillary to general search. For example, they state at p. 16, By biasing its search results against competing vertical services, Google may thus cause their exclusion from the market because of lower end-user and advertising revenues (input foreclosure). The single monopoly profit theorem will not limit the incentive of Google to proceed with this vertical input foreclosure strategy: first because Google is not charging end users for the organic search, and second because the strict conditions of the monopoly profit theorem do not apply in this context. 21

23 The authors cite Elhauge (2009), who points out that strict conditions, such as consumption of the tying and tied goods in fixed proportions, and the constancy of competitive conditions in both the tying and tied good markets, must be met for the single monopoly profit theorem to hold. The authors do not, however, provide specific reasons why the theorem fails to hold in this context, which has important policy implications: if, for example, tying accomplishes price discrimination, there is little reason to intervene; if it reduces competition, antitrust authorities should have concern. c) Taking the Two-Sided Structure of the Market Seriously In a footnote, Bork and Sidak raise another argument why Google s conduct does not raise concerns: they state at footnote 44 that, [W]ith consumers paying a price of zero, there is no risk of Google using monopoly power in general search to charge a higher price to consumers in specialized search. Both are free to consumers. Interestingly, Lianos and Motchenkova reject application of the single monopoly profit theorem in part because Google does not charge users for either general or specialized search. Thus, both Google supporters and detractors invoke the zero price it charges for search as grounds for backing their arguments. Neither argument takes the two-sided nature of the market sufficiently seriously. The fact that Google charges zero to one side of the market, searchers, does not necessarily imply that the single monopoly profit theorem does or does not hold. Google realizes profits not from searchers but from advertisers. The important question for the application of the single monopoly profit theorem is whether the total profits to Google from searchers and advertisers together are higher with tying than without, regardless of which side of the market is responsible for generating those profits. 22

24 The analysis of tying in two-sided markets set out in Part II fits Google in a manner that suggests that the single monopoly profit theorem is unlikely to apply. The reason why the theorem does not hold, and why Google could find it profitable in these circumstances to tie, is that general search and specialized search are each two-sided platforms. General search brings together two different players: advertisers on the general search results page, and users who view the advertising. Specialized search also results in the interaction of advertisers and users. In these circumstances, tying specialized to general search expands the set of customers with whom Google deals. Rather than selling advertising only to advertisers in general search, and ceding advertising revenues in specialized search to competitive specialized search engines, tying better assures Google of selling both to general and specialized search advertisers. It leverages market power in general search into specialized search. The fact that searchers pay zero for search has nothing to do with the failure of the single monopoly profit theorem. It is true that under the theorem, sellers with market power in the tying good compensate for a failure to tie by charging a higher price to buyers, thus capturing some of the consumer surplus associated with competitive supply in the tied good. But even though Google does not charge searchers, it does charge advertisers. The question is whether permitting the untied supply of vertical search allows Google to charge general search advertisers an additional amount that offsets profits from forgone sales to vertical search advertisers that would buy from Google if it were to tie. Tying specialized to general search plausibly degrades the search experience for consumers, thus reducing their surplus from the general-specialized search combination. While this is not reflected in lower prices for general search, given that Google does not charge, it would presumably be reflected in smaller numbers of general-specialized searchers. This, all 23

25 other things equal, reduces advertising revenues in general search: there are fewer searchers on one side of the general search platform, which implies less demand for advertising on the other side. But while this may cost Google in general search advertising, tying allows Google to gain advertisers in specialized search with whom it may not otherwise have dealt at all. It is plausible that the losses in general search revenues are offset by gaining access to a different set of advertisers in specialized search; leveraging market power is plausible. The zero price condition is neither necessary nor sufficient for the single monopoly profit theorem not to hold. Putting the argument a different way, even if Google were to charge a positive price for general search, and even if it were forced to charge a lower price for general search where specialized search is tied, reflecting reduced competition in specialized search (or reflecting the degraded search experience given Google s self-interested bias in displaying search results), tying could still be profitable. This is because lower profits from lower prices to consumers, and perhaps advertisers, in general search are plausibly more than offset by expanding the number of buyers from Google of advertising space in specialized search. Just as the boat show tying the trailer show was plausibly profitable even where consumers prefer competitive supply of trailer shows, tying general search to specialized search is plausibly profitable because of the effects on the other side of the platform. The Google example illustrates a key reason why two monopoly profits may be better than one in the two-sided context. Even if one side of the market considers the tying and tied goods to be complements consumed in fixed proportions, the other side does not necessarily view them in the same way. While searchers may, by hypothesis, view general and specialized search as complements used on a one for one basis, advertisers may vary across search types. Figures 1 and 2 illustrate. Flight service advertising dominates general search results in Figure 1, 24

26 while hotel advertising from hotels in the destination city is an important segment of advertising in specialized search in Figure 2. Without tying specialized to general search, Google risks losing the hotel advertisers in Figure 2 to competitive specialized search engines. With tying, it extends its market power in general search to specialized search. The tie of specialized search to general search reduces competition in specialized search: searchers are drawn to Google s specialized search over the alternatives. But, as the single monopoly profit theorem suggests, this is not sufficient to conclude that social welfare is lower under tying; the jar-lid example could involve tying and the elimination of competition in the lid market, but no social losses. In the two-sided context, however, the practice plausibly reduces competition, increases Google s profits, and reduces consumer and total welfare. I have shown that tying could reduce competition in specialized search to the benefit of Google s bottom line. There are two kinds of potential social losses from the extension of market power from general into specialized search. Searchers may lose surplus from the degradation of the general search experience that is associated with the artificial prioritization of Google s specialized search rather than a purely organic display of general search results. This would not only tend to reduce the value of each general search, but in addition could reduce the quantity of general-specialized searches to the detriment of searcher welfare. Advertisers in general search also lose since there are fewer searchers to whom to advertise, a loss that would also reduce Google s profits all things equal (which may be offset by profits from specialized search advertisers, however). The primary loss, however, is likely to fall on specialized search advertisers. Rather than buying advertising in a competitive market for specialized search, they must buy from Google at supra-competitive prices. While Google makes more profits in specialized search as a 25

27 consequence, which in turn may offset the loss of searchers and some revenues in general search, the losses to advertisers could exceed the gains to Google in the usual way that market power creates social harms. d) Discussion of Key Assumptions i) Market Power It is a key assumption for the anticompetitive theory of tying that I describe to hold that Google has market power in general search. If general search were robustly competitive, any degradation of the general search experience would severely threaten Google s market share. It is, however, necessary to be precise in identifying the specific side of the market over which Google may or may not have market power. Google clearly has sufficient market power over the advertising side of the market for it to have incentives to tie specialized to general search: its marginal cost in selling advertising is presumably close to zero, yet Google charges positive prices for advertising. But this does not address market power on the other side of the market. Google does not charge searchers for search, and so does not charge supra-competitive prices, but market power could exist. For example, with market power, Google might be able to degrade the search experience without losing a significant number of customers. Even if there are profits to be had from tying specialized to general search from specialized advertisers, if there is robust competition to attract general searchers, then Google may not be able to implement the tie without suffering drastic losses in general searcher market share. Edlin and Harris (2013) are sceptical that Google has market power. Unlike other cases in the technology space, such as the cases involving Microsoft s dominance in operating systems, switching costs in general search are low: as a matter of theory, alternative search 26

28 engines, such as Bing and Yahoo, are just a click away and cost the user nothing, which would seem to undermine the claim that Google has market power; moreover, as an empirical matter, Edlin and Harris point out that many users rely on multiple search engines, sometimes even within the same search sequence, and also bypass general search engines by clicking directly on the webpage of interest frequently (using bookmarks, for example). Moreover, as Manne and Wright (2011) suggest, it is not clear that online search is itself a product market over which Google has market power; there are a wide variety of sources of online advertising, for example, not just general search. On the other hand, commentators have responded that Google has a very high market share of search of about 68% in the US, and a share closer to 90% in Europe (Lianos and Motchenkova, 2013). Moreover, the stock of information that Google has about search patterns gives it an advantage over other search engines (Lianos and Motchenkova, 2013, Lao 2013). Finally, Edelman (2014) and Edelman and Lai (2013) emphasize that searchers may rely on familiar patterns of search given the zero price of such services, which gives Google market power. It is ultimately an empirical question whether Google has the requisite market power over general searchers to impose a profitable tie to exploit market power over advertisers, but there is evidence to suggest that it is plausible. ii) The Two Product Requirement for Tying For tying to raise legal issues, there must be two products. In this case, the question is whether general search and vertical search are two separate products. From the searchers perspective, it is appropriate to see general and specialized searches as distinct. Specialized searchers in fact may not begin with a general search at all, but rather may go straight to 27

29 specialized search engines. That there are independent providers of specialized search supports the conclusion that it is a distinct product from general search. From advertisers perspectives, there is some ambiguity, not because general search and vertical search are necessarily linked, but because advertisers may or may not pay for ads shown on a general search that precedes a specialized search. If all users of general search move from general results to a specialized search engine, they may not click at all on the advertising on the general results page, which may imply that Google receives no revenue at all for general search and the specialized search is the sole product. However, this is not a plausible basis for concluding that there is only a single product. For one thing, advertisers may pay Google either on a per-click basis, or a page view basis. If the latter, Google realizes revenues from general search advertising even if the user does not click on its advertisers links. For another, general searchers may click on general search advertising before ultimately proceeding to specialized search. That is, searchers may take a detour on their way to the specialized search engine by viewing a general search advertisement. General and specialized search are distinct products. iii) Complementarity of General and Specialized Search The theory of tying in two-sided markets that I have outlined depends to a certain extent on the complementarity of the tying and tied two-sided platforms. The boat-trailer show example depends to a point on the complementarity of the shows to consumers: if consumers seeking to attend the boat show have no more desire to attend the trailer show than any other consumer, then it is much less likely to be profitable for the boat show to tie to a trailer show. Trailer show-only consumers would seek out a competitive trailer show, and boat consumers forced to buy a ticket for a trailer show that they do not want to attend may not be willing to buy the show bundle. 28