Wednesday, June 28, 2017

Google Is Fighting A Losing Battle With The EU

Appealing the $2.7 billion fine won't pay off. Just ask Microsoft.


By Leonid Bershidsky
The Bloomberg View
June 28, 2017

The unexpectedly large fine the European Commission has slapped on Google -- 2.4 billion euros ($2.7 billion) -- is evidence that the search giant's relationship with European regulators is now a vicious circle of escalation. Google's reluctance to give up any revenue from its fastest-growing ad format may lead to significant, unpredictable losses in its biggest market outside the U.S.

The case in which Competition Commissioner Margrethe Vestager announced the fine on Tuesday is seven years old. It began when the U.K. shopping comparison engine Foundem complained to the commission that Google was promoting its own rival service, then called Google Product Search and later renamed Google Shopping, to the detriment of competitors. The case grew as other European and U.S. companies jumped on the bandwagon. Google thought its troubles were over in 2014 when it almost agreed on a settlement with Vestager's predecessor Joaquin Almunia -- but the complainants were acutely unhappy with the proposed document. They didn't want to buy ads that Google promised to place at the top of the search results page, insisting instead that Google display "organic" results.

One could argue whether such a thing as "organic" search is even possible with a proprietary algorithm, but that was moot -- the complainants were on the warpath, so Google decided to fight it out. Vestager apparently responded to the challenge by spending countless hours of her staff's time studying terabytes of evidence to make a solid case. In the process, the commission's investigation expanded with one case dealing with AdSense ads and another with the Android mobile operating system.

Google is nothing if not rational. It would have agreed to a compromise had the stakes been lower. But so-called product listing ads -- the kind displayed in the Google Shopping modules that appear to the right of search results if your query looks like you're trying to buy something -- have been growing faster in recent years than Google's traditional text ads. In the first quarter of this year, they accounted for more than half of retail search ad clicks, and advertiser spending on them rose 32 percent year-on-year. Making these ads less prominent or removing them from search results altogether would have resulted in a sharp revenue drop. Vestager is aware of that, and the size of the fine reflects her intention to drive home to Google that noncompliance won't be worth it.

If the commission deems that Google hasn't changed its behavior within 90 days, it will start charging an additional daily fine of up to 5 percent of Google's global daily revenue, currently about $12.5 million. Besides, Vestager said on Tuesday that Google's competitors were now liable to sue it in national courts using the commission's decision as justification for further rewards.

The economics of continuing the fight aren't really in Google's favor now. Its parent company, Alphabet, made $8.1 billion of revenue in Europe, the Middle East and Africa in the first quarter of the year. That's a third of its revenue and probably a higher share of net income, given that it barely pays any taxes in Europe (according to Google's 2016 annual report, the "foreign tax differential" reduced its effective tax rate by 11 percentage points). If Europe accounts for 40 percent of the company's net income, it delivered $2.2 billion to Alphabet in the first quarter. Vestager's fine alone eats up more than that. The maximum daily noncompliance fine would destroy almost two quarters' profit in a year. And then there are almost certain further penalties from national courts. It's worth losing some -- not all -- of the product listing ad revenue to avoid such an outcome.

Google has announced that it "respectfully disagrees" with the commission's decision and intends to look into appealing it. That's a difficult path to take -- just ask Microsoft, which fought the commission with all it could and lost all of its appeals in eight years of litigation. In fact, the commission has a strong record in abuse of monopoly position cases. From 2000 to 2011, the EU's General Court did not fully annul a single one of the 14 commission decisions that were appealed to it, though it canceled parts of four decisions. It has revised only two out of 11 fines. In subsequent years, not a single large fine has been overturned.

It's possible that Intel, hit with a 1.06 billion euro fine last year for offering rebates to computer makers for buying most of their chips from it, and not from competitor AMD, will shoot a hole in that record in 2018. After losing in the General Court, Intel appealed the commission's decision in the European Union's highest court, the Court of Justice. Last fall, one of that august body's Advocates General -- advisers whose briefs are mostly followed by the judges -- delivered an opinion in Intel's favor. This preliminary success is encouraging to Google. But then, the case against Intel appears weaker: It's harder to prove that its rebates hurt the competition or consumers than to demonstrate that Google's preferential display of its own product listings took traffic away from competitors.

Google's case isn't easy to argue. Its market position in Europe in unquestionably dominant. It has, and uses, the power to promote offerings from retailers who pay it. It hasn't seen fit to promote other comparison services.

As a consumer, I'm actually on Google's side: I've found that Google shopping works better than the competition. No one is really limited to using the service that is displayed the most prominently on the first search result page; I've gone to check out some others and was underwhelmed.

But from a risk-reward perspective, Google should probably stand down and agree a remedy with Vestager's office, in this and the other two cases. By playing nice for a change, Google can, among other things, reduce the likelihood of new investigations. Its tax arrangements in Europe are highly suspect. It promotes its own restaurant and travel listings over those of rivals. It's a big fat target, and the commission is unlikely to leave it alone if it plays the insolent American cowboy. Yes, there's always this element of anti-Americanism to punitive European rulings against big U.S. companies -- but then it's usually worth it to go local in large markets such as Europe and try to play by the rules, even if they don't always seem fair.


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