May 13, 2008 3:00 am

Google triumphant

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Eric Schmidt was doing his level best late last week not to gloat. With Microsoft dropping its attempted takeover of Yahoo, the Google chief executive had just seen his arch-rival abandon its most direct attack yet on Google's growing dominance of online search and advertising.

"I'm happy to be crowned winner," Mr Schmidt said, before quickly adding: "But as we've learned in the election cycle, it goes back and forth."

The political analogy may have been ill-judged. Like Hillary Clinton after last week's primary results, Microsoft has never looked more on the defensive. For a company that has always scorned the idea of big mergers in the past, the pursuit of Yahoo was the clearest admission yet that the software company was running out of options as it tried to counter the rise of Google.

"The failure of the Microsoft/Yahoo merger eliminates the biggest short-term threat" to Google's unrivalled position on the web, says David Yoffie, a professor at Harvard Business School. For now, its momentum "seems unstoppable". Michael Cusumano, a management professor at Massachusetts Institute of Technology, describes Google's now-unchallenged dominance even more bluntly: "They're sitting on a goldmine."

The scale of Google's victory over Microsoft in online advertising, sealed by the failure of the Yahoo takeover approach, is hard to exaggerate. By next year, half of the world's online advertising - set to reach $55bn (£28bn, €36bn) in total - is expected to flow through Google's systems. Of that, slightly more than two-thirds will come from advertisements that run on Google's own websites. The rest represents advertising that the internet company, acting as a broker, places on other companies' sites in return for a small cut of the action.

It is a stunning victory that raises two overriding questions. Will Google be able to use the respite provided by the disarray at Microsoft and Yahoo to carry its dominance of search over into other areas of online - and broader digital - advertising? And should it now be a cause for alarm that one company is in a position to control so much of the lifeblood of the internet?

To some extent, the Microsoft/Yahoo debacle merely confirms something that had already become apparent: the internet search wars ended almost as soon as they began, and Google won. It accounted for around 70 per cent of the estimated $16bn of advertising placed on search engines last year, a share that continues to rise.

Microsoft and Yahoo were late to see the danger, beginning their own search initiatives four to five years ago. A merger would at least have created a second player with the scale to try to compete, says Sir Martin Sorrell, chief executive of WPP, the advertising group. Separately, the two now face continued erosion, he adds. Sir Martin also takes issue with a potential partnership with Yahoo, currently under discussion, that would give Google an even bigger share of the search advertising market.

The eventual limits of the fast-growing search market, which accounts for almost half of all online advertising, are still impossible to discern, but it is already a business that stands comparison with the technology industry's most fabled success stories. On the current trajectory, Google's revenue - almost all of it coming from search - will probably surpass the income that Microsoft generates from the Windows operating system some time next year.

There is no guarantee that the search company will alight on another idea as powerful as its advertising system, says Mark Anderson, a veteran technology commentator. Yet that may not matter for some time, he and most other industry insiders say. "I think it's enough for the next 10 years," says Mr Anderson. "When God gives you a golden goose, you have to hold it tight."

Google has spent much of the money from this gilded fowl, and the time afforded it by the failure of its competitors to mount a tougher challenge, preparing for what comes next. Through the acquisitions of DoubleClick and YouTube, it has placed big bets on display advertising and online video. These deals have been the most visible part of its attempt to stake out a position in some of the most promising new areas of digital advertising, says Rishad Tobaccowala, a new media expert at Publicis, the advertising and marketing group.

This is most evident in the video and mobile worlds. Through YouTube and its test of a digital advertising system with EchoStar, the satellite television company, Google has put itself in a position to catch the wave of traditional television advertising as it moves to the web.

In mobile, meanwhile, Google has spent a frenetic year preparing the ground for what it claims will be a bigger business than even its current PC-based one. That has included fighting to open up part of the mobile spectrum in the US so that users get guaranteed access to its services, investing $500m in a high-speed WiMax network, grabbing a prime spot for its services on Apple's iPhone and launching its own mobile technology platform, known as Android. "They have understood better, they have positioned themselves better, for where the world is going than anyone else," says Mr Tobaccowala.

This does not mean that success is guaranteed. "The best technology doesn't always win," says Prof Yoffie. "History is littered with better technologies that have been left by the wayside."

The biggest danger may well be that fear of Google's growing power will prompt a backlash from the very companies it will need on its side as it tries to expand out of search. "The mobile carriers are very concerned about letting Google dominate advertising on mobiles the way it has on the PC," says Prof Yoffie. That echoes the earlier struggles of another tech industry giant: Microsoft found it hard to break into the mobile industry for similar reasons, while the traditional media industry kept the software company at arm's length for years after the arrival of the internet out of fear that it would become a gatekeeper with the power to intercede between media companies and their customers.

The parallels with Microsoft are compelling and help to explain why Google is becoming widely feared, says one person who has worked closely with Google for a number of years. Microsoft used its dominance of computer operating systems to build a second market in software applications, eventually dominating that market too.

"These days, the applications are newspapers and television and video games and communication devices," this person says. According to this view, as these information services are digitised and move to the internet, Google's advertising system will become the financial platform on which many of these businesses depend - in much the way that Microsoft's operating system became the backbone for the technology ecosystem of the PC.

Despite the discomfort this causes, however, Google's status as the internet's most effective money-maker makes it hard to ignore. That helps to explain Yahoo's plan to cast itself as a more trustworthy ally of other internet companies - and why many will be hoping it recovers to become a stronger competitor to Google.

So if Google is about to enter a golden age that rivals the heyday of Microsoft on the PC or IBM on the mainframe computer, should this be a cause for concern? Both of those technology companies were criticised in their industry for growing so powerful that they eventually squashed innovation, drawing the attention of antitrust regulators. Does a similar fate await the young idealists who have vowed to "Do no evil" with their search engine?

The case against a dominant Google is summed up by Sir Martin at WPP. Without the prospect of a strong rival that would have been created by a combination of Microsoft and Yahoo, advertisers could be left with little choice, he warns.

For their part, Google executives make a number of claims for why their particular corner of the advertising business is not susceptible to monopolisation - and why bringing even more advertising into their system should actually help customers.

"What we've seen in the past when we've done substantial expansions of our network, advertisers have really benefited, they've been really happy to be able to get increased reach for their targeted ads," says Sergey Brin, one of Google's founders. "For them it just means more sales with clear and accountable profit margins,"

Larry Page, his co-founder, adds that since Google merely runs an auction in which advertisers bid against each other, rather than actually setting the prices for advertising placed on its sites, it cannot affect pricing. "In general having more inventory available to advertisers is very positive for them - they have one powerful interface where they can bid on one type of advertising and have that against as wide a range of inventory as possible," he says.

Yet this heavy focus on the financial efficiency of Google's brand of online advertising ignores the fact that many customers want more choice in the types of advertising they use and more ability to negotiate unique ways to present their message, says Prof Yoffie. "Google doesn't have the reputation for being the easiest company to deal with, and with less competition it will be even less easy," he adds.

That will not matter as long as advertisers are able to switch their business to other online advertising networks, counters Mr Schmidt. "Advertisers always have multiple choices so it always makes sense for them to use more than one," he says. "It is incorrect to assert that there's lock-in or an opportunity for dominance in the advertising space."

Switching between advertising suppliers in a market as concentrated as internet search may not be as simple as this suggests, though. Big advertisers that want to buy a large volume of "clicks" a week may find that other search engines cannot guarantee them the volume they need, says Sandeep Aggarwal, an analyst at Collins Stewart in San Francisco.

Also, the cost of building the technology to connect with Google and learning how to get the best out of its search system means that many of its customers have made a big investment, says Prof Yoffie. "There are real switching costs," he adds.

Even some of Google's admirers agree that the limited choice in search - and, potentially, other areas of digital advertising - does not sit well with customers. "Generally, advertisers like to have four or five suppliers in a market," says Mr Tobaccowala.

The argument for overlooking this, he adds, is that most big advertisers direct only a very small percentage of their budgets to search - and besides, the upheaval under way on the internet is so great that any lopsidedness in a particular part of the industry may well prove insignificant in the long run. "With all that change, I'm less concerned about one company climbing on the others," Mr Tobaccowala says.

That is certainly how Google's leaders see it. The search company and its rivals are racing to invent the future of advertising, says Mr Page, and this rapid innovation is by far the dominant force in shaping the competitive landscape.

If Google tries to rub salt into Microsoft's wounds by pressing ahead with an alliance of its own with Yahoo, it will get a chance to find out whether regulators agree with this sanguine view.

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