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How the DoJ 'got it wrong'

It's telling that despite his expertise with auctions and his experience with a system designed to mimic AdWords, even Preston McAfee has no way of knowing how AdWords truly works. "I don't really know what Google's doing," he told us. "They don't tell us anything about how it works, [though] we've reverse-engineered some of it."

But at the same time, he provides some insight into the way Yahoo! does things, and he has some strong opinions about what constitutes an antitrust market in the world of online advertising — opinions that, he says, contradict those of the Department of Justice.

Google likes to say that in antitrust terms, search advertising is merely one piece of a much larger online ad market. But McAfee says otherwise. "[Google] is not [just] a small part of overall commerce [on the web]," he said. "That's a normal antitrust defense. Whenever there are soft-drink mergers, they want to include milk [in the their market]." Search advertising, he explains, is quite different from traditional display advertising. "The needs of emotional-market or brand advertisers — people who are really worried about reputation —  are very different from performance advertisers, who are mostly concerned with sales," he said.

"There's some stuff in display advertising that you can do that's performance-based. I don't want to say that search by itself is an antitrust market...but if I'm trying to drive traffic into the web space, I think [Google] is one of the best games in town."

That's a bit of an understatement. For so many web businesses, Google is an essential part of their operation. McAfee even goes so far as to say that Yahoo! is not a "substitute" for Google. "The Department of Justice gets this wrong. Are Google and Yahoo! substitutes? The answer is 'not really,'" he said. "There's a little bit of multihoming: You search for something on Google and you don't find it, you come to Yahoo!, and vice versa... We see it in the data. But the majority of people are doing one or the other. If i'm advertising on Google and I stop and go to Yahoo!, I'm not reaching the same customers."

Asked what he meant by the reference to the Department of Justice, McAfee indicated that in conversations with him, the DoJ had argued that Google and Yahoo! were substitutes. Whatever the DoJ's view, McAfee is clear on his: Google and Yahoo!, he says, are analogous to local newspapers.

"If I advertise in the New York Times, I don't reach many people in Philadelphia. If advertise in the Philadelphia Inquirer, I don't reach New York. Some people get both papers. Some read both on the train everyday. But really, those are different markets. They are not substitutes. Yes, they both drive sales, but they don't drive sales to the same people."

The test for substitution, McAfee says, is to raise prices. "If someone raises the price, do I move to the other provider? [With Google], I think the answer is 'No.' If my gas station raises the price, I can get drive a mile further and get the same gas. It's a substitution. If Google raises the price, I have to find a way to reach the same customers. [The way] is not Yahoo! search. That's probably not a substitute."

The ultimate question then is: how much control does Google have on prices?

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