Thursday, June 22, 2006

Market share, market power, and network neutrality

J. Gattuso writes about a recent proposal by James DeMint (R-SC):

Submitted as an amendment to the telecom bill now being marked up by the Senate Commerce Commitee, DeMint’s proposal would make it unlawful to “prioritize or give preferential or discriminatory treatment in the methodology used to determine Internet-search results based on an advertising or other commercial agreement with a third party.” Any person found in violation would face a maximum fine of $5 million or imprisonment for up to one year.


For the record, this is a terrible idea. And, I’m willing to bet that Sen. DeMint thinks so too. Instead, the amendment seems intended to underscore Google’s uncomfortable position in the net neutrality debate. While the company has spearheaded the call to for net neutrality for telephone and cable firms, its own practices — and power — mirrors that of those companies.


Google’s business model to a large degree is based on tiering — providing preferred ad placement for those who can pay for it. Its clearly not a system where anybody “no matter how large or small” has equal access. Its based, like it or not, on money.

None of this matters, says Google. There’s a big difference, it says, between its actions and those of the "phone and cable monopolies." But is there? The phone companies and cable companies do have an overwhelming share of broadband connections. But market shares in the search engiine market aren’t dramatically different. Three firms — Google, Yahoo and Microsoft — account for 84 percent of all searches. Ninety-five percent of “toolbar” searches are by two firms, Google and Yahoo. Of course, this companies aren’t in lockstep — they compete among each other. And they may be challenged by newcomers, who now have small market shares. Yet, the same arguments, when raised regarding broadband networks, are rejected.

This certainly doesn’t mean that Google should be regulated. Or that it will be. Yet, there are some who have seriously proposed the idea. And once lawmakers start imposing mandates, its hard to predict where they will stop. Once network owners are regulated, it simply wouldn’t be that big a step to regulate other Internet players, starting with the biggest. Sen. DeMint’s proposal may not be meant to be taken seriously. And this week it won’t be. But someday, thanks in part to Google, it could.

First, let us dispose of the "universal slippery-slope argument" against regulation, which goes like this: "If you regulate X, what's to stop you from regulating Y?" This statement can apply to arbitrary X and Y, and is therefore not a serious argument against anything. Gattuso does not make exactly this argument (though he slides perilously close in the final paragraph), but stating the universal version illustrates the obligations that Gattuso must discharge in order to make his case.

A reasonable slippery slope argument must place a bound on X and Y, and then make the case that this bound is the necessary distinction. In other words, you need to say:

  1. "If you admit that X is regulable because X satisfies the property P, then Y is also regulable because it also satisfies P."
  2. "P is the only reasonable distinction in this case."

The second clause is necessary because otherwise, your opponent can simply propose a different (and better) bound P, which excludes Y while including X. In the course of his essay, Gattuso proposes the following two P in order to substantiate his slippery-slope argument:

  • P(X) = "X is an 'Internet player'"
  • P(X) = "X has sufficient market power that it is not subject to strong competitive pressures."

I think it is transparently obvious that the first of these is not a relevant distinction; "Internet players" is a category so broad and vague as to be analytically useless.

However, the second bullet point deserves some consideration, because it is also the distinction that network neutrality advocates propose. Distilled to its essence, Gattuso's argument is as follows:

  1. The justification for regulating telecom companies is that their market power insulates them from competitive pressure.
  2. Google, Yahoo, and Microsoft have large market share.
  3. Therefore, Google, Yahoo, and Microsoft also have market power insulating them from competitive pressure.
  4. Therefore, by the same reasoning, one should be able to regulate search engines.

Notice that between steps (2) and (3), the above argument jumps from market share to market power, effectively conflating the two. But market share is, at best, an indirect proxy for market power. Market power depends on a number of factors, but in the end two overarching factors dominate:

  • Barriers to entry: How hard is it for competitors to get started in the market?
  • Switching barriers: How hard is it for buyers to switch between sellers of the good in that market?

These are the two factors that determine how easily somebody can start competing with you, and how easily you can lose your customers to the competition. If anybody can start up a competitor and all your customers can flee overnight, then you're in a competitive market. If it takes many man-years of labor, political connections, and billions of dollars of capital to start a competitor, and it will cost your customers a lot of time and money to switch, then you're not in a competitive market.

High market share does not necessarily mean that a seller has market power. Google might be the most popular search engine because it has tremendous market power which insulates it from competition, or it might be the most popular because it simply provides a better product in an efficient and competitive market.

So, let's consider the barriers to entry and switching barriers in the search engine market, and in the telecom market.

Stop laughing.

OK, perhaps some of you are not already laughing, in which case I will have to explain it. If you want to start a new search engine, all you have to do is download Nutch, hire a programmer to customize it for your needs, and put it on the web. If you want to switch from one search engine to another, all you have to do is type a different URL into your location bar.1

Of course, I'm being slightly disingenuous here. If you want people to use your search engine instead of the competition, it will have to be significantly better, in some way, than what people use today. And that will be pretty hard. But that's also a feature of competitive markets, so that does not, in itself, indicate market power.

Contrast this with broadband Internet access. Let's take barriers to entry first. How hard would it be for me to start a new broadband Internet provider that competes with cable and DSL? I don't know the details, but I'm pretty sure it would involve either (1) enormous capital outlays to dig trenches and lay down wire, and also possibly schmoozing with municipal officials to get permission to do these things, or (2) taking advantage of "common carrier" regulations that James Gattuso and other pro-telecom pundits despise.

Now let's take switching barriers. How hard is it to switch broadband providers? OK, in most U.S. jurisdictions you can do it, but it will take you a few weeks of waiting, several hours of your time, and on the order of a hundred dollars. And you won't be able to choose from any of dozens of providers, as you can with a search engine; you've probably got two choices (aside: if you're willing to assert that two choices provides "sufficient competitive pressure to produce an efficient outcome", then I will assume that you'd also be happy with a political system in which you are legally obligated to vote for a Democrat or a Republican. You've got two whole choices, after all!).

In case the foregoing has been too verbose, here's the ten-second recap:

  • Search engine market: ten days to start a new search engine, ten seconds to switch search engines, dozens of search engines available to most consumers.2
  • Broadband Internet market: years to start a new broadband provider, weeks to switch broadband providers, two providers available to most consumers.

Which looks more competitive to you? Do these two markets look even vaguely similar?

So, we see that Gattuso's slippery slope is not, in fact, slippery at all. Google, Yahoo, and Microsoft do not have the same kind of market power that broadband Internet access providers do. (Microsoft, however, does have a very different kind of power arising from its outsized market share in the operating system market, but I don't want to get into that in this post.) Given the property that he suggests, a strong distinction can still be made between search engine providers and network carriers.

Finally, as an aside, I'd like to note that a few weeks ago, shortly after my post on network neutrality, I received PR spam written by a telecom flunky named Scott Cleland and distributed by Peter Klaus of Fleishman-Hillard public relations, containing much the same argument as that espoused by Gattuso above. I am not suggesting that Gattuso is a mouthpiece for Fleishman, but I do want to suggest that this talking point --- conflating search engines' market share with anti-competitive market power --- is going to see wider circulation in the future.

[1] Oh, is everybody using Firefox with the default search engine? (And by "everybody", I assume you mean "roughly 10% of all Internet users", because that is the current number; and Google's definitely not the default search engine for Internet Explorer.) All you have to do is hire a programmer to download the Firefox source, change a couple of configuration files, and rebuild it, and now you've got a browser with the search box pointing to your search engine. Or, even better, it's easy enough to distribute a Firefox extension that people can install in their search box with a single click.

[2] I am pretending, here, that Google's users are its customers. Of course, most of Google's users are not customers; its real customers are advertisers, which suggests a somewhat different analysis (although not necessarily different conclusions). However, Gattuso and DeMint both initiated this "users are customers" fiction and I'm going along with it for now.

Friday, June 16, 2006

Haloscan begone

Not that you care, but Haloscan's JavaScript for comments has been semi-busted lately, so I've decided to remove it. This means, regrettably, losing some older comments, but, oh well, c'est la vie. If Blogger ever gives me a way to selectively add code to my template based on a date predicate (unlikely), then I'll re-add Haloscan for older posts.

This post is here more to bookmark the date of the switchover than anything else.

Thursday, June 15, 2006

Computers are terrible

I just spent an hour of my life on the phone, talking my family through the process of connecting my sister's iBook to the family's wireless network. This involved relaying the WEP key multiple times over the phone, resetting the router, checking with the ISP to re-enter the network settings into the router, and downloading, unpacking, and upgrading the router firmware. Ultimately the router's broken-ass firmware was at fault, and hence upgrading it to version 5.3 was the solution. Curse you, Netgear MR814v2 router, and curse the horse you rode in on.

But although the router was at fault, it can't take all the blame for the situation. The crufty complexity of all the surrounding systems made it hard to isolate the problem. I could write an arbitrary amount on how broken all this was, but I don't have time. Suffice it to say I am annoyed.

Tuesday, June 06, 2006

How to try out eMusic

Executive summary, in bullet-list form:

  • eMusic is a good service.
  • However, it's not obvious how to browse the catalog before signing up.
  • Here is how: follow this link.

Details follow.

I won't have time to do any substantial posts in the near future, but I felt like sharing this little tip. I'm a big fan of eMusic, for reasons that I will not discuss at length for fear of sounding like a shill. It's not a perfect service --- why not OGGs and FLACs, eMusic? --- but it's DRM-free and good enough that I am willing to recommend it to friends.

However, they make one really huge mistake: they don't encourage users to browse the catalog before signing up for a trial account. That doesn't sound too bad, except that signing up for a trial account involves forking over your credit card info and other identifying information up front.

If you want to browse eMusic's catalog without signing up, you have to go to their home page and click the "Log in" link (as of this writing, this link's in the far upper right corner). Then, click on the "Browse" tab at the top of the login page. Ta-da: the catalog's fully accessible, so you can browse and listen to low-quality samples. Downloading full tracks will require you to sign up for an account, of course.

eMusic doesn't really restrict its catalog to users; it just makes the catalog obscure so that most non-users won't find it. I can imagine all kinds of reasons why they chose to do this, but IMO it's just an utterly boneheaded business decision. Many potential users will simply go away after they see that the entire front page directs them to a signup screen rather than the catalog. I was just on IM tonight with someone who had been meaning to try eMusic, but didn't sign up for exactly this reason.