Media Briefings

Google And Microsoft: Different Leaders For Different Markets

  • Published Date: October 2008


Leading firms can play completely different roles in markets where there is a strong threat of entry of new competitors and those where the potential for rivals is weak, according to research by Professor Federico Etro, published in the October 208 issue of the Economic Journal. This finding has significant implications for how the activities of such firms are monitored and regulated by the competition authorities.
For example, Google and Microsoft are leaders respectively in the online advertising market and in the software market. But while Google currently faces competition from a fixed number of rivals in online advertising (virtually only Yahoo! and Microsoft), the software market is characterised by open access to a fringe of effective and potential entrants (including the open source community).
This difference is crucial. On one side, a leader like Google is able to exploit the absence of entry threats by putting high mark-ups on its advertising services (at least double those of their main competitors), generating high prices in the industry, which ultimately hurts consumers worldwide.
On the other side, a leader like Microsoft is forced by entry pressures to maintain low mark-ups (the price of Vista is estimated at 5-20% of the theoretical monopolistic price), which ultimately induces large welfare gains for the consumers worldwide.
Both Google and Microsoft retain large market shares but in markets with different entry conditions. For this reason, competition authorities should be more concerned about the moves of the former, as they were about the agreement with Yahoo! (to deliver relevant Google ads alongside Yahoo!'s own search results), which would have reduced competition and increased prices for publishers and advertisers. Even after the withdrawal of that deal under pressure from the US Department of Justice, Google remains dominant and unconstrained by endogenous entry threats.
Professor Etro’s research belongs to the recent efforts to characterise ‘endogenous market structures’ – that is, structures of markets where firms interact strategically and entry is ‘endogenous’ or free. The main focus of the study is about competition in the market when a leading firm plays as a first mover – a Stackelberg leader, after the name of the famous German economist.
The main result is that the leader is always more aggressive than its followers as long as there is a substantial entry pressure. The lower prices of the leader are associated with its larger market share: in such a case, high concentration and limited entry are a consequence of strong competitive forces and not of market power.
The study derives the conditions under which free entry of firms induces the leader to dominate most of a market through low pricing: this happens when firms produce highly substitutable goods and the average costs of production are decreasing (a typical feature of the software market).
Finally, Etro shows that, as long as entry is endogenous, the aggressive strategy of the leader brings better outcomes for consumers. Such a result is in contrast to what happens when the leader faces an exogenous number of rivals (as in online advertising).
This leads to the policy implications of the article: in investigations concerning abuse of dominance, mergers or similar agreements, a preliminary examination of the entry conditions is crucial to verify whether large market shares of the leaders can be a symptom of dominance or just of competitive pressure on the leaders. Only when entry is not feasible in the medium run, the antitrust investigation should move forward.
The article generalises previous results by the same author on competition for the market (‘Innovation by leaders’, Economic Journal, April 2004): in this case, it shows that leaders tend to invest more in R&D as long as intellectual property rights are well protected and entry in the race for the next innovation is endogenous.
A general introduction to the endogenous market structures approach to micro- and macroeconomics is available in Etro’s recent books: ‘Competition, Innovation, and Antitrust’, 2007; ‘Endogenous Market Structures and the Macroeconomy’, 2009.
ENDS
Notes for editors: ‘Stackelberg Competition with Endogenous Entry’ by Federico Etro is published in the October 2008 issue of the Economic Journal.
Professor Etro is an economic consultant and affiliated with the University of Milan, Bicocca, Italy.
For further information: contact Federico Etro on +39-334-1733119 (email: federico.etro@unimib.it); visit www.intertic.org; or Romesh Vaitilingam on 07768-661095 (email: romesh@vaitilingam.com).