United States v. Google
Everything You Need to Know About the Tech Trial of the Century
I just sent out my annual letter to investors covering Alphabet’s increasing regulatory risk and the impending decision in United States v. Google LLC (2020).
The DOJ sued Google for illegally monopolizing the markets for general search services, search advertising, and general search text advertising. It’s the agency’s first large monopolization case since United States v. Microsoft Corp. 26 years ago. The evidentiary phase of the trial began in September 2023. The DOJ argued its case first. Google began its defense in October and closing arguments will be heard this week until May, 3. Afterwards, Judge Amit Mehta will rule in the coming months.
Below I present everything NEW that came out during the trial and what should happen next.
Everything NEW We Learned During the Trial
A big chunk of the trial was hidden from the public and happened behind closed doors. However, towards the end, more highly sensitive information became public.
It was revealed that when Bing was competing to be the default search engine on Apple devices, it was willing to “take a multibillion-dollar short-term loss” to outbid Google. However, Apple declined the higher offer and did so freely without coercion. Apple stayed with Google because it considered Google “the best” search engine for its users coupled with the most attractive long-term economics for itself.
During testimony, Microsoft’s head of advertising, Mikhail Parakhin, said he felt Bing was used as a bargaining chip to pry more money out of Google – something that alludes more to Apple's power than Google's. Parakhin added:“It is no secret that Apple is making more money on Bing existing than Bing does” but regarding if they were treated unfairly by Apple he had to admit that “Bing’s mobile search is not as good as Google's”. He further said it would be “uneconomical for Microsoft to invest more” unless Bing “gets a more significant, or firmer guarantee of distribution”. The latter statement made observers skeptical how Bing could claim any unfair treatment in the market for search distribution when they had not invested properly into product quality. Parakhin blamed Bing being behind on Google's foreclosure of necessary scale, but Neeva founder Sridhar Ramaswamy contradicted and said one could compete successfully with as little as “2.5% of general search users”, a threshold Bing handily exceeds in the U.S. Moreover, Google’s VP of search, Pandu Nayak, testified that “innovations in language understanding have become increasingly important to gains in search quality, while the sheer volume of search queries has become less important.”
Nayak’s statements alluded to the main dispute between the DOJ and Google: whether Google Search is leading because of an illegally secured scale advantage OR because it’s a genuinely better product.
The evidentiary phase brought up many examples where consumers preferred Google because they deemed it a genuinely better product than Bing or Yahoo. Mozilla’s CEO, Mitchell Baker, testified that when they changed the default on Firefox to Yahoo, “we found our users trying all sorts of different ways to get back to Google, and we experienced lots of people leaving Firefox”. He added:“users made it clear that they look for and want and expect Google.” Google's lead litigator pointed towards a user backlash when Samsung sold a phone in 2010 with Bing as the sole and unchangeable, pre-installed search provider. Bing is also the default in the Edge browser, which comes preloaded on Windows devices. Nonetheless, Microsoft VP Jonathan Tinter had to admit, 75% of Edge users switch their default search engine from Bing to Google and CEO Satya Nadella confirmed Bing’s share of search queries on Windows devices is “in the teens” with the most queried word on Bing being “Google”.
These testimonies undermine the DOJ's “power of defaults” argument that users won't change defaults even if they’re unhappy. While it’s correct that users generally don’t change their default search engine (if it’s Google), they are sometimes eager to do so (if it’s not Google). Tech lobbyist Matt Schruers criticized that “the U.S. government appears to be targeting a product that people are generally satisfied with and attempting to drive them towards using the product of an even larger corporation that is less favored”. Google’s defense added the DOJ’s claims were “all in the hopes that forcing people to use inferior products in the short run will somehow be good for competition in the long run”.
This leads to an obvious question:
“If consumers freely switch to, but not away from, Google, why does the allegedly unassailable monopolist need to pay Apple billions to maintain default status?”
The Economics Behind the Apple Default Contract
A formerly only estimated number became public during trial: the exact amount Google pays Apple.
Google paid Apple $18 bn in 2021 for default status in form of a revenue sharing agreement. This amounts to 17% of Apple’s 2021 operating profit. A witness also let slip that this equates to a 36% share, i.e. Google Search revenue on all Apple devices amounted to $50 bn in 2021 or 34% of all Google Search & other ad revenues in 2021.
Google's propensity to pay should be derived from the expected value it accrues from the contract.
In this regard, a 36% revenue share means:
If Google expects to lose more than 36% of its Apple users once it stopped paying for default, it should continue to pay.
If Google expects to retain more than 64% of its Apple users who’d need to actively switch back from another default search engine once payments cease, it could stop to pay (from an overly simplified, short-term financial perspective).
Further assuming Google was prohibited from entering into any distribution contract with Apple, then:
losing 50% of its Apple users would lead to a $7 bn net revenue hit (5%/9% of F21 gross profit/operating income).
losing 75% of its Apple users would lead to a $20 bn net revenue hit (13%/25% of F21 gross profit/operating income).
For Apple, the deal also makes economic sense. Its share (36%) is higher than Google Services’ operating margin (35% in F23) and if Apple wants to distribute the best search experience, it should at times be willing to take less money from Google in the short run than from a more aggressive lower quality bidder (which is exactly what happened with Bing). The more one thinks about the Google-Apple default contract, the more it looks like an ordinary business decision negotiated at arm's lengths.
Moreover, the DOJ's allegation leads to a paradox: if default distribution contracts are indispensable to compete effectively, they’re not only vital for rivals but for Google itself, making it perfectly justifiable to take part in the bidding process. How then, can a legitimate act to stay the quality leader be illegal? And if Apple is indeed the kingmaker in search, then allowing Bing to pay for distribution but not Google means the government would pick winners and losers, antithetical to the gist of antitrust.
Thus, after the closing arguments, the court will weigh the procompetitive justifications Google presented for its contract with Apple. From the plaintiff’s view, Google presented two:“First, that existing competition between search rivals for search defaults (“competition for the contract”) justifies any harms to consumers within the relevant markets; second, that Google’s conduct benefits consumers through lower smartphone prices or more innovative browsers.” It's sometimes debated whether harms in one market (search) can be relieved by benefits in another (devices), but generally speaking, a U.S. court could be more receptive to Google's second argument than the EC. Once Google was excluded from “competition for the contract”, the next best bid (from Bing) would drop materially. For illustrative purposes, if Apple needed to regain a default deal revenue shortfall of $10 bn solely through annual iPhone sales in the range of 200m devices, iPhone prices for consumers would need to go up by ~$50.
Lastly, I’m not convinced the DOJ has laid out any clear consumer harm by Google's practices in court. In the plaintiff’s post-trial brief, the DOJ proclaims “consumers have little choice” and “lose out on better products” but provided no evidence for this during the trial.
The DOJ originally called for “structural relief as needed to cure any anticompetitive harm”, but towards the end of the trial it also entertained a choice screen as a remedy. This measure would forbid Google from paying for default status but allow it to pay for inclusion in the choice screen. Smaller rivals like Bing could still bid for default and Apple then had to choose which option it prefers. Please see below two choice screens on new Android devices which are already live in the European Union.
Judge Amit Mehta will rule in the coming months. From a purely fact based perspective building on historic precedents and all evidence presented in court, I think Google should win. However, given this is a high-profile case and the public sentiment is “Big Tech = bad”, it appears more likely that Google loses in first instance but could ultimately prevail on appeal.
One thing seems clear though: whichever side loses will appeal as the stakes for both sides are too high. The case then goes up to the DC Circuit and could ultimately be escalated up to the Supreme Court.
…
[end of the abstract]
The full Investor Letter is available online here* (*by clicking the link, you confirm your status as a QUALIFIED INVESTOR) and QUALIFIED INVESTORS resident or domiciled in Germany can subscribe for all full updates here.
If you don’t want to miss anything, you can follow me on Twitter: @patient_capital
To learn more about the investment fund I advise or access my previous annual letters to investors you can click the button below.
This document is for informational purposes only. It is no investment advice and no financial analysis. The Imprint applies.