31 October 2024

Contents

Introduction

Owning well-established businesses with strong competitive advantages often attracts increased regulatory scrutiny. This has affected various areas of our portfolio, with big tech companies being a particular focus for regulators. Google, a large holding for us, currently faces several legal challenges. We’ve owned Google since strategy inception (1 Jan 2019; plus a long time prior) and regulation was the primary risk identified in our original underwriting. We have closely monitored these cases over the years, reviewed many of the primary case materials and trial exhibits, and have recently consulted multiple US antitrust legal experts to assist our analysis. The trial exhibits are often treasure-troves of disclosures that we do not normally get as investors. In this piece, we outline our views on these cases and the potential impact for Google.

Google has an effective global monopoly in general search (Google), mobile operating systems (Android), browsers (Chrome), general search text ads, supply-side ad platforms (DoubleClick for Publishers and AdSense), ad exchanges (Google AdX), and ad networks for open web display advertising (Google Display Network/Google Ads). The same is true for the US market except for mobile operating systems where Android has only 42% share versus 72% globally. A jury also found that Google monopolizes app stores within the Android market, though we contend this finding. Under US law, there is nothing inherently wrong with being a monopolist if this position has been reached through fair competition. Sometimes a monopoly is the best outcome for consumers (i.e. natural monopolies). The issue arises when the monopolist abuses their position and engages in anti-competitive practices (such as exclusive contracts, bundling the monopoly product/service with those in other markets, predatory pricing, etc) and forecloses a market. European law is different and places obligations on monopolies, even if achieved legally.

Simplified Search Funnel (LHS) and Digital Advertising Value Chain (RHS) Source: GS Statcounter, Datanyze, NetMarketShare, DOJ, Apptopia, Kalakau Avenue Estimates Note: Less relevant elements removed for simplicity; Search funnel excludes desktop vertical search such as Amazon/travel sites/ social media, while these are included in the digital advertising value-chain

Google has indeed engaged in anti-competitive practices over the years and is rightfully being held accountable. There are three key ongoing cases:

1. US Search and Distribution: This case, brought by the DOJ, focuses on Google's abuse of its monopoly in general text search, its control over the search distribution funnel, and the resulting harm through higher ad prices and reduced search competition/innovation. Judge Mehta recently found Google guilty, and the DOJ has presented proposed remedies. The remedy trial is scheduled for 2025, with Google having two chances for appeal—the final opportunity being the Supreme Court, should it choose to hear the case.
2. US AdTech: This case was also brought by the DOJ and alleges that Google abused its monopoly position in the supply-side ad platform, ad exchange, and open web display advertising markets. The trial has concluded and a decision is expected in November after closing arguments are given. The remedies are not likely to be separated in this case and we expect a Judge Brinkema to make a ruling on those in January 2025. Google will have similar appeal avenues here.
3. Epic vs Google (Play Store): This is an antitrust suit brought by Epic for Google’s abuse of its monopoly position in the Android app store market. Google lost this case in a jury trial and the judge imposed various remedies. Almost all have been put on hold pending the appeal outcome.

US Search & Distribution

Overview

Google has fortified its stronghold on search by controlling the search distribution funnel (see chart above) through acquisitions and contracts, maximizing flows to its search engine. Android, used on 72% of mobile phones globally, typically comes with Chrome as the default browser. Chrome also dominates desktop browsers with a 65% share. On all Chrome installations, Google is the default search engine. For Android phones, the Google Play Store is indispensable. Google leverages this by tying Chrome, Maps, YouTube, Gmail, and other Google apps to the Play Store, while mandating the use of Google-approved Android versions. In most cases, Google sweetens the deal with revenue sharing. This strategy extends beyond Android—Google pays Apple, mobile carriers, and various other browser owners for default search engine status on their platforms. As a result, Google is the default search engine on nearly 100% of mobile devices and about 85% of desktops. Around 65% of these (52% in the US) are covered by a contractual agreement for default status (”covered queries”).

Google's obsession with controlling the search funnel dates back to the company's early days. Ironically, the 2001 antitrust case against Microsoft partly helped Google dominate search. Without this case, Microsoft would have continued tying Internet Explorer to Windows, potentially helping MSN Search become the dominant engine. Google recognized its good fortune.

This focus on control became ingrained in Google's DNA during the rise of smartphones. Initially, US mobile carriers controlled default apps on the phones they distributed. Fearing interference between Google and its users, Google approached the FCC, offering to bid $5b in a spectrum auction if the winning bidder allowed device manufacturers to choose the default apps. Though Google didn't win the bid, it shifted choice away from the carriers.

Despite this, Google initially struggled, falling behind in contracts to be the default on Nokia phones, while Android-based phones were shunned by most telcos except T-Mobile. However, Google secured default status on BlackBerry and iPhone[1].

The development of the Android Open Source Project also stemmed from Google's desire to control the funnel. Fearing iPhone dominance could one day threaten Google's default status, they released an open-source version of Android to proliferate an alternative smartphone operating system. Once Android achieved scale, Google reasserted control by developing its proprietary version and requiring manufacturers to use it in exchange for access to the Play Store.

Google obsesses over funnel control for good reason — being the default matters. For instance, Google's share of desktop Edge users (where Bing is the default) is ~23% compared to 76% on Windows desktop overall. While this difference is stark, we shouldn't overestimate its impact based on this alone. Edge users might simply prefer Microsoft products rather than just sticking with the default.

Real-world examples exist where the default has been changed from Google to other engines. Mozilla Firefox has conducted various experiments over the years to analyze the impact of moving away from Google. They've trialled both Yahoo and Bing as the default for a random selection of users. The results? Bing retained 30-60% of users after a few months, and Yahoo 20% , with the rest switching mostly back to Google. Given that Bing already had a ~10% share of Firefox users and Yahoo 3%, this represents a 20-50% share loss for Google when Bing became the default and 17% when Yahoo became the default. The trial noted that the share loss would be greater on mobile (70%) than on desktop (30%) given it is slightly easier to change the default engine on desktop (though the reference exhibit is unfortunately sealed). The issue here is that Firefox users also have a selection bias. They are typically more tech-savvy and are incrementally more likely to understand how to change the default engine.