An Analysis of Google-Admob

Merger Review in Technologically Dynamic Industries: An Analysis of Google-AdMob

I. Introduction

The Federal Trade Commission concluded its investigation into Google’s purchase of AdMob on May 21, 2010, after an extensive review in which the FTC sought to assess competitive effects in a particularly challenging context. One challenge facing the FTC was that the mobile advertising industry in which these firms participated was and is a rapidly changing, nascent industry. AdMob, which the FTC described as the leading firm in the industry, had been in existence for only four years when the FTC completed its review of the merger.2 The difficulty inherent in identifying and weighing potential anticompetitive effects in a very fluid environment was evidently one the FTC was not shy about confronting.

Another challenge, less evident at the beginning of the review process but certainly more salient now, is that the competition in mobile advertising is linked to competition in other markets. The acquisition of another mobile advertising firm by Apple near the end of the FTC’s merger review provided clear evidence that competition to monetize software loaded on smartphones was part of a larger competition between mobile operating systems (“mobile OS” vendors such as Apple, Google, and Microsoft.

In this article, we discuss some of the economic issues that arise in undertaking a competitive effects analysis in technologically dynamic industries such as mobile advertising.

1 Kostis Hatzitaskos is a Manager, Neill Norman is a Senior Manager and Andrea Shepard is a Vice President at Cornerstone Research. 2 See ADMOB, http://www.admob.com/home/about (last visited Nov. 16, 2011).

This article originally appeared in Threshold, vol. XIV, no.1, Fall 2013, American Bar Association This information or any portion thereof may not be copied or disseminated in any form or by any means or downloaded or stored in an electronic database or retrieval system without express written consent of the American Bar Association. 52 THE THRESHOLD Volume XII, Number 1, Fall 2011

II. Merger Review in Rapidly Evolving Industries

Mergers in rapidly changing industries pose a challenge to the antitrust agencies and the parties because there is often substantial uncertainty about the path the industry will take even in the near term. The usual steps in merger analysis – defining a relevant market, assessing potential unilateral and coordinated effects, and determining the likelihood of entry – may require confronting substantially more uncertainty in a fluid, innovation-driven industry. At the same time, there are large and potentially durable welfare effects from failing to prevent mergers that would reduce the incentive to innovate. High rates of innovation can both make the effects of the merger more difficult to assess and make predicting the effects correctly particularly important.

Before turning to the more difficult issues presented in the Google-AdMob merger, we first turn to the simple context of the Thoratec-Heartware merger to explore how merger analysis has responded to the need to account for both the effect of innovation on the expected path of industry evolution and the effect of innovation on competition.

Thoratec-HeartWare

Rapid innovation does not always make the application of standard competitive effects analysis difficult. Sometimes the likely path of competition that an industry will follow can be foreseen with some confidence even though the industry is experiencing innovation and change. The proposed Thoratec- HeartWare merger, which was abandoned by the parties after the FTC announced its intent to challenge the transaction, is a case that has been cited by the FTC as an example of how to apply the competitive effects analysis called for in the updated Horizontal Merger Guidelines.3 In 2009, Thoratec Corp. supplied the

3 Joseph Farrell, Janis K. Pappalardo, & Howard Shelanski, Economics at the FTC: Mergers, Dominant-Firm Conduct, and Consumer Behavior, 37 REVIEW OF INDUSTRIAL ORGANIZATION, 263, 265–266 (2010). See also Richard A. Feinstein, Antitrust Enforcement in the Health Care Industry, Prepared Statement of the FTC before Congress (Dec. 1, 2010), available at http://www.ftc.gov/os/testimony/101201antitrusthealthcare.pdf.

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only FDA approved left ventricular assist device, a mechanical heart assist device implanted in patients with end-stage heart disease. While supplying the currently dominant device, Thoratec was also developing a next generation device. HeartWare International, Inc., a small research firm with no FDA-approved products, was also developing a next generation product in competition with Thoratec and several other medical device companies. In early 2009, the companies announced the planned acquisition of HeartWare by Thoratec Corp.4

The FTC review focused on competition involving next generation devices and the effect the acquisition might have on the prices as well as any potential reduction in the pace of innovation. This required the FTC to forecast whether HeartWare was likely to be an important supplier of next generation devices. Despite rapid innovation in these heart assist devices, which might have made this kind of forecast highly speculative, the regulatory requirements for approval of medical devices together with the FTC’s extensive interviews of investigators utilizing the devices in clinical trials provided the FTC with some guidance as to the path the industry would likely follow. The FTC concluded that, of the firms developing next generation products, “only HeartWare poses a potential threat [to Thoratec].”5 The FTC also concluded that if and when the FDA approved Heatware’s new device, commercial supply of HeartWare’s product could be expected to “rapidly erode Thoratec’s monopoly.”6 The FTC reasoned that the merged firm would anticipate the cannibalization of its profits from the introduction of the HeartWare device and would therefore have an incentive to delay its introduction. If, however, HeartWare remained an independent firm, it would have no monopoly profits to erode and would therefore push to get its product on the market as soon as possible. Given the available evidence on the probable path of innovation from the device approval

4 Compl. at ¶ 12, In the Matter of Thoratec Corp., No. 091 0064 (F.T.C. Jul. 28, 2009) available at http://www.ftc.gov/os/adjpro/d9339/index.shtm [hereinafter Thoratec Complaint]. . 5 Thoratec Complaint, supra note 4, at ¶ 3. 6 Id.

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process and the FTC’s field investigation, the FTC decided it could adequately predict the path competition would most likely take and filed a complaint to block the merger.

Although the analysis in this case was aided by information that may not be available in all instances, it is important to note that the FTC’s reasoning depended on a nuanced view of the likely innovation process. For the FTC’s logic to be correct, it is not enough that it correctly foresee that HeartWare would win the innovation competition by producing a superior device. It must also be the case that the hypothesized delay imposed by the merged firm in the introduction of HeartWare’s winning design would not allow a third competitor to introduce an effective competing device during the period of delay. If the competition were closely contested, the merged firm could not preserve its profits by delaying introduction of the new device. Although there appear to have been several other companies pursuing innovative treatments for end-stage heart failure, how this would have played out has the merger proceeded is impossible to know. At the time of writing, HeartWare’s device has still not received FDA approval.

Google-AdMob

The information available to the FTC for assessing future competition in the mobile advertising industry was quite different in the case of the Google- AdMob merger. There was no regulatory process to provide information on the probable path of innovation or on which firms would be future participants in mobile advertising. Nor was there a well-defined trajectory of innovation that suggests successive product generations as one sees, for example, in the microprocessor industry. While this heightened uncertainty was acknowledged by the FTC in its investigation of the Google-AdMob transaction,7 the FTC

7 Federal Trade Commission, Statement of the Commission Concerning Google/AdMob at 2, FTC File No. 101-0031 (May 21, 2010) [hereinafter FTC Closing Statement] available at http://www.ftc.gov/os/closings/100521google-admobstmt.pdf (“In any nascent market there will be uncertainty about the path of competition and the durability of early leads in market share. In

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nonetheless undertook an extensive merger review and, despite closing its investigation, apparently concluded that the deal had the potential to have substantial anticompetitive effects.8 According to reports, the FTC had been poised to block the merger,9 only to close its investigation after Apple entered the mobile advertising industry by acquiring an AdMob competitor.

To understand the difficulty facing the Commission in its review of this merger, it is helpful to have some background on the industry. The small but rapidly growing mobile advertising industry exists to monetize applications and other software on mobile devices. Mobile ads are advertisements that appear on smartphones and on tablet computers. The ads appear in mobile search results, on websites specifically designed for mobile devices, and in applications installed on mobile devices (“apps”). The birth and growth of this industry is the result of the introduction and proliferation of internet-capable mobile phones (generically, “smartphones”). Smartphones have captured a steadily increasing share of U.S. mobile phone sales since Apple introduced the iPhone in 2007, currently comprising 37.4% of mobile phone sales and expected to comprise 50% of mobile phone sales by September 2012.10 The expanding use of smartphones has, in turn, triggered rapid growth in the mobile advertising industry, from $368 million of revenue in 2009 to $877 million in 2010.11

order to fully protect consumers, however, the Commission must subject mergers in nascent markets to the same level of antitrust scrutiny as mergers in other markets.”). 8 Id., at 1 (“[A]ctions by Apple should mitigate the anticompetitive effects of Google’s AdMob acquisition.”) (emphasis added). 9 Thomas Catan & Jessica E. Vascellaro, Regulator Concerned by Google Ad Deal, THE WALL STREET JOURNAL, Apr. 4, 2010. 10 Horace Dediu, The U.S. Smartphone Landscape, ASYMCO (Nov. 6, 2011), http://www.asymco.com/2011/11/06/the-us-smartphone-landscape/. 11 Olga Kharif, Google Gains Market Share in U.S. Mobile Ads, BLOOMBERG BUSINESSWEEK, Dec. 3, 2010.

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At the time of the merger AdMob was a small startup that provided a service (called “ad serving”) that matched mobile apps that offered spaces in which advertisements could appear with advertisers that had advertisements to be placed in those spaces. The advertiser would pay the ad server for placing the ad and the server would, in turn, pass a share of that payment on to the app developer. The ad serving industry was crowded, rapidly growing, and highly fluid when the proposed acquisition was announced in late 2009. At that time, AdMob faced over 18 competitors in the United States, including AOL, Google, Jumptap, Microsoft, Millenial, Nokia, Quattro, and Yahoo.12

A number of factors made it difficult for the FTC to assess the relative strength of these competitors and the likely competitive effects of the merger. Market share information was sparse and market participants questioned the validity of the few public estimates available.13 Further, information on differentiating product characteristics and substitution in demand between firms was scarce. Determining which of the many participants in the industry were close competitors was further complicated by the ease with which the participating firms could and did change business models, a fluidity that is a common characteristic of nascent industries. Existing firms could change their business models in response to the evolution of demand and quickly reposition themselves to be closer competitors than they had been. For example, InMobi was focused on mobile web ads in 2009, not ads within apps, but was serving ads to both mobile webpages and apps in 2010.14 Finally, entry into the industry was

12 John Furrier, 2009 Mobile Advertising Revenue & Market Share Leaders, SILICON ANGLE, Dec. 11, 2010, http://siliconangle.com/blog/2009/12/11/2009-mobile-advertising-revenue-market- share-leaders/; Mobile Advertising Industry Surveys, GOMO NEWS, archived Jan. 11, 2010, http://web.archive.org/web/20100111074010/http://www.gomonews.com/mads/. 13 Mobile Marketer, Jumptap Disputes IDC Revenue Estimates for Mobile Ad Networks, Nov. 30, 2009, http://www.mobilemarketer.com/cms/news/ad-networks/4744.html. 14 Robin Wauters, Mobile Ad Network mKhoj Rebrands as InMobi, Eyes Expansion in Europe, TECHCRUNCH, Aug. 5, 2009, http://techcrunch.com/2009/08/05/mobile-ad-network-mkhoj- rebrands-as-inmobi-eyes-expansion-in-europe/; Michael Arrington, Indian Startup InMobi May Be The Big Winner in Apple-Google Ad Brawl, TECHCRUNCH, June 16, 2010, http://techcrunch.com/2010/06/16/indian-startup-inmobi-may-be-the-big-winner-in-apple-google- ad-brawl/.

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ongoing and continued throughout the FTC’s review process: Google and AdMob faced at least 22 competitors by the time the merger was approved, some of which were significant.15 InMobi, for example, had served markets outside the U.S. and had developed the largest mobile advertising network in Asia.16 As of 2011, InMobi was the second largest mobile advertising network worldwide.17 In combination, these factors introduced substantial uncertainty into any prediction as to the likely path of competition in the mobile advertising industry.

To understand the nature of competition in the industry and the direction it might take, the FTC sought extensive third party discovery.18 But despite the FTC’s best efforts, the industry was evolving too rapidly for its review process to keep pace. Market participants who met with the FTC on multiple occasions noted that the industry changed so quickly that some information they had provided to the FTC became stale from one meeting to the next.19 Other industry participants approached by the FTC felt that the industry was too fluid for anyone, even people intimately familiar with the technology and the competing firms, to confidently predict the effects of the merger.20 Indeed, the entry by Apple that led

15 Mobile Advertising Industry Surveys, GOMO NEWS, archived July 23, 2010, http://web.archive.org/web/20100723100043/http://www.gomonews.com/mads/. 16 The InMobi Story, HEADSTART! NETWORK, Dec. 31, 2009, http://headstart.in/2009/12/14/the- inmobi-story/. 17 InMobi Raises Massive $200M to Overtake Google in Mobile Ads, VENTUREBEAT, Sept. 15, 2011, http://venturebeat.com/2011/09/15/inmobi-raises-massive-200m-warchest-to-overtake- google-in-mobile-advertiser/. 18 AUTH?, Antitrust Panel Discusses FTC Investigation of Google/AdMob Merger, X THRESHOLD No. 3, 42 (Summer 2010) (“Google/AdMob had argued to the FTC that third parties were competitive in this space, so Mr. Long [Deputy Assistant Director of the FTC Bureau of Competition’s Mergers I Division] recalled that the agency conducted extensive third party discovery. Mr. Breed [Counsel for AdMob and associate at Hogan Lovells] added that this case was so interesting because of the rapid change of pace in the industry, and the factual developments occurring after the parties complied with the FTC’s second request.”). 19 Wayne Skipper, Google, Admob, and the FTC, CONCENTRIC SKY BLOG (May 7, 2010), http://www.concentricsky.com/blog/2010/05/google-admob-and-the-ftc (“The mobile space is clearly in its infancy and is changing rapidly. At every touchpoint with the FTC, we felt like the market had shifted enough that what we’d said previously was already out of date.”). 20 Ignorance and Hubris at the FTC, THE WERTAGO TEAM BLOG (May 3, 2010), http://wertagoteam.com/blog/2010/05/03/ignorance-and-hubris-at-the-ftc (“There is no way the FTC knows enough to support a decision to block the deal. . . . More generally, it seems obvious

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the FTC to reverse course exemplifies the difficulty of conducting a merger review in a rapidly changing industry.

Nevertheless, after examining the facts, the FTC determined that Google and AdMob were the two leading firms in the industry or – and the public statements are somewhat ambiguous on this point – in a segment of the industry described as “performance ads.”21 Mobile ads typically allow the user to select them to go to a site on the internet, performing the mobile equivalent of a “click through.” Performance ads charge advertisers by the number of click-throughs. The other prevalent pricing model in the industry is to charge (usually a lower price) by the number of times the ad is displayed to a mobile device user. Based on its understanding of competition in the industry, the FTC appeared to be willing to challenge the merger.

Had it done so, the parties would almost certainly have disputed the claim that Google and AdMob were uniquely close competitors or that there was a narrow relevant market for performance ads. It seems likely that this claim would have been contested based on an assessment of switching behavior by advertisers. It is standard practice, for example, for advertisers to standardize the different price quotations for ads priced per click and per view to make them comparable,22 a practice that suggests they view advertisements sold under different pricing terms as substitutes.

Perhaps a more difficult hurdle for the FTC to overcome was the record of entry. The ongoing entry into the industry prior to and throughout the merger

to us that the computer, web, and mobile technology sectors are so competitive and fast-moving that NO ONE has the knowledge, expertise, economic insight, or clairvoyance to say with much confidence precisely what effect the AdMob acquisition will have on competition in the market or on consumer welfare.”). 21 FTC Closing Statement, supra note 7, at 1. 22 Google AdSense Help, What is Effective CPM?, http://www.google.com/adsense/support/bin/answer.py?answer=32865 (last visited Nov. 7, 2011).

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review would seem to provide evidence that entry would preclude the exercise of market power. Indeed, entry has continued at a remarkable pace despite the merger and despite the entry of Apple, an entry the FTC considered a substantial competitive threat to the merged firm. The industry has not become a duopoly dominated by Apple and Google. By one count, there are currently over 30 competitors in the mobile ad services space.23

In the end, it was the entry of Apple that caused the FTC to rethink its conclusion. Apple acquired Quattro, launched its iAd ad network, and revised the licensing terms it offered to developers publishing apps on the iPhone. The revisions banned apps from transmitting to third parties certain data that are critical to the effective operation of mobile advertising networks.24 At that time the iPhone had at least a 25% share of smartphone sales. By limiting the access of competing ad servers to iPhones, Apple could limit access to a substantial share of the addressable market. The FTC concluded that Apple’s ownership of the iPhone platform could limit access to competing ad servers, giving Apple “the unique ability to define how competition among ad networks on the iPhone [would] occur and evolve.”25 In May 2010, the FTC voted unanimously to close its investigation,26 concluding that Apple’s presence as a competitor would “mitigate the anticompetitive effects of Google’s AdMob acquisition.”27

23 GoMo News Mobile Advertising Directory, GOMO NEWS, http://www.gomonews.com/mads/ (last visited Nov. 7, 2011). 24 AUTH?, Apple Draws Scrutiny From Regulators, WALL STREET JOURNAL, May 4, 2010. 25 FTC Closing Statement, supra note 7. See also Erick Schonfeld, Before the FTC Blocks the Google-AdMob Deal, Maybe It Should Read Apple’s iPhone Licensing Agreement, TECHCRUNCH, Apr. 29, 2010, http://techcrunch.com/2010/04/29/google-admob-apple-antitrust/ (“While other ad networks are not barred specifically from the iPhone and iPad, language in the terms of service (TOS) could effectively neuter them. Section 3.3.9 of the iPhone Developer Program License Agreement prohibits apps from containing third-party software that collect and send data to other companies and services ‘for processing or analysis.’ . . . If ad networks like AdMob cannot collect data from the apps which use them, it makes it very difficult to serve and target ads.”). 26 FTC Closing Statement, supra note 7, at 1. See also Brad Stone, U.S. Approves Google’s Deal for AdMob, N.Y. TIMES, Apr. 21, 2010. 27 FTC Closing Statement, supra note 7, at 1.

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One reason that the FTC changed its assessment when Apple entered may have been that it felt that Apple and Google would each provide a competitive check on the other. The fear that Google would be able to achieve the position in mobile advertising that it has achieved in online search advertising must have been reduced once it became clear that Google faced a strong competitor in Apple. Whatever weight it gave to that theory, the FTC’s public statements about the merger suggest that the FTC considered the effect that competition among mobile platforms would have on competition in mobile advertising.

III. Mergers and Platform Competition

The growth of the mobile device market has led to fierce competition among the suppliers and adopters of the Android, Apple, and Microsoft mobile operating systems in a battle that has been named the “smartphone war.” This competition, which is reflected in patent acquisition and litigation as well as in product innovation, has affected a broad range of industries and firms, including the device manufacturers supplying smartphones and other mobile devices, the software developers writing applications for these devices, and the participants in the mobile advertising industry. The effects on competition in the mobile advertising industry were acknowledged in the FTC’s public statements about its Google-AdMob decision:

“AdMob also competes with Google in the sale of mobile advertising on Google’s Android platform. Competitive harm from the acquisition appears unlikely there as well. Android and iPhone compete against each other as platforms, and the availability of free of low-cost applications helps drive that competition.”28

The economic logic underlying these statements seems to invoke a view of systems competition that goes beyond the standard competitive effects analysis of conduct within a single industry. By recognizing that the competition in mobile advertising can affect competition in mobile platforms, the FTC is extending

28 FTC Closing Statement, supra note 7, at 2.

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competitive effects analysis to take account of competitive effects in markets other than the one in which the merger occurs. While this is not new territory, it makes for a more complex analysis. In this instance, the agency’s reasoning appears to recognize that how Google competes in mobile advertising will affect and be affected by competition in mobile operating systems.

Google’s business model is to make money from internet and mobile advertising. To be successful in the mobile segment, Google needs access to mobile devices and to information about those mobile devices.29 Targeting restaurant ads effectively, for example, requires knowing where the user is located. Even more fundamentally, formatting an ad correctly requires knowing the kind of device on which it will be displayed. The access to mobile device information necessary to serve ads effectively can be compromised by contractual restraints placed on application developers by the mobile OS/platform owner. As evidenced by Apple’s iOS app developer contracts, the platform owner can limit the access to crucial information that facilitates ad service by its competitors.

One way Google can defend against this strategy is by ensuring that it has access to the large share of mobile devices that are based on its Android platform. Broad deployment of the Android operating system, however, depends on Google’s ability to persuade OEMs to adopt it. One powerful inducement to adopt the Android operating system is its price; the Android operating system is offered free of charge by Google.30 Another is to ensure that there will be many apps available for Android-based devices so that end-users will choose to buy Android devices.31

29 Peter Kafka, Is Apple Closing Off the iPhone to Rival Ad Networks?, ALL THINGS DIGITAL (Apr. 12, 2010), http://allthingsd.com/20100412/is-apple-closing-off-the-iphone-to-rival-ad- networks/. 30 Jung-Ah Lee, Google Promises to Continue Offering Android for Free, WALL STREET JOURNAL, Nov. 8, 2011, available at http://online.wsj.com/article/BT-CO-20111108-703901.html. 31 Wilson Rothman, App showdown: Android vs. iPhone, MSNBC.COM, 2011, available at http://www.msnbc.msn.com/id/38382217/ns/technology_and_science-wireless/t/app-showdown- android-vs-iphone/.

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The supply of apps depends on providing an incentive for app developers to write applications compatible with Android. Providing app developers with a revenue stream from hosting mobile ads on Android-based gives them an inducement to develop apps for Android. Many apps are currently offered to users free of charge. Some of these are offered as part of a freemium strategy: the free version has limited functionality and is supplied to give the user a chance to decide whether the paid, premium version is something he or she wants to buy. Other apps are simply free. The supply of free apps depends on some way to monetize them. The supply of paid apps is also affected by advertising. Ad revenues for paid apps will increase the number of apps developed and reduce their price.32

The implication for Google in the mobile advertising market is that it has an incentive to share advertising revenue with app developers that is stronger than it would be if the mobile advertising market were not linked to broader competition between mobile device OS vendors. Thus, even if Google somehow had market power in competition with other mobile advertising firms, it would face a competitive constraint to exercising that power by raising prices to application developers or advertisers. Advertisers and application developers would respond by switching ads to Apple or to other mobile OS platforms in the first instance and by writing applications for other platforms in the second. Both these effects would have a negative impact on Google’s ability to profit from mobile ads.

Assessing the strength of this competitive restraint would require careful empirical analysis, but the economic logic is clear. The implication for merger analysis is also clear. In assessing mergers involving firms that supply components of a system, it may be necessary to consider the effects of the merger on innovation in markets beyond the immediate one in which the merging firms

32 Hillel Fuld, Best Practices for Maximizing Mobile App Revenue, GIGAOM (Feb. 6, 2011), http://gigaom.com/2011/02/06/best-practices-for-maximizing-mobile-app-revenue/.

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compete. In this case, the FTC acknowledged that Google’s incentive to compete in operating systems gave it an incentive to limit anticompetitive conduct in mobile advertising.

This logic also implies that the agencies responsible for merger review in these settings need to consider the effect that blocking the merger would have on competition in other markets or industries. There may be instances in which an agency believes it is reasonable to err on the side of blocking a merger with uncertain competitive impact because blocking the merger is unlikely to harm competition. In coming to that decision in a case like the Google-AdMob merger, it may be necessary to ask whether blocking the merger will cause significant competitive harm in other markets or industries. A complete assessment of the competitive harm from blocking the Google-AdMob merger would require an analysis of its effects on competition in mobile operating systems. Google’s support of the Android operating system is contingent upon its ability to make a profit in mobile advertising. One would need to assess whether blocking a merger that an agency judged would make Google a stronger competitor in mobile advertising could also adversely affect competition in mobile operating systems.

This brings us back to the problem of assessing mergers in innovative industries. Assessing a merger in such an industry may require forecasting the direction of technological change and the path of competition in more than one market or industry.

64 The Threshold is published periodically Co-Editors-in-Chief: by the Mergers and Acquisitions Committee of the American Bar Beau Buffier Association Section of Antitrust Law. Shearman & Sterling LLP The views expressed in the Newsletter 212-848-4843 are the authors’ only and not [email protected] necessarily those of the American Bar Association, the Section of Antitrust Gil Ohana Law, or the Mergers and Acquisitions Cisco Systems Committee. If you wish to comment on 408-525-6400 the contents of the Newsletter, please [email protected] write to American Bar Association, Section of Antitrust Law, 321 North John Scribner Clark, Chicago, IL 60610. Weil, Gotshal & Manges LLP 202-682-7096 [email protected]

The views expressed in this report are solely those of the authors, who are responsible for the content, and do not necessarily represent the views of Cornerstone Research.