Will the FTC Allow Microsoft to Buy Yahoo?

The big news this morning is that Microsoft has made a nearly $45 billion bid to buy Yahoo.

In general, regulators might frown on such a deal: after all, wasn’t Microsoft the behemoth that was going to take over the entire technology world in the late 1990s? And yet, as the Associated Press reports, most analysts believe that regulators in the U.S. and Europe are unlikely to stop the deal. Why?

In a word: Google.

What could Google possibly have to do with a proposed Microsoft–Yahoo merger? To answer this question, you need to stop and consider the current state of the Internet search-engine industry.

It’s difficult to use a single yardstick to measure how competitive an industry is. For much of the last century, regulators would use the four-firm concentration ratio, which measured the total market share of the top four firms in an industry. Unfortunately, that didn’t give a measure of the precise extent to which one of those firms might dominate the industry. For example, suppose that in two different industries, the top four firms each have a total of 80% of the market. However, in Industry A, each of the four firms has a 20% market share, while in Industry B, one firm has a market share of 50% and the others each have a 10% market share. The four-firm concentration ratio would treat these two industries equally.

Nowadays, the usual method used by the FTC is to examine the Herfindahl index, which is calculated as the sum of the squared market shares of each firm in an industry. By squaring the market shares, the HI rises when market power is concentrated in one or two companies. For example, in Industry A (described above), the HI would be equal to 20² + 20² + 20² + 20² = 1,600; but in Industry B, the HI would be equal to 50² + 10² + 10² + 10² = 2,800.

According to comScore, which tracks Internet usage patterns, there were approximately 9.6 billion “core” searches performed in 2007. Of those, Google accounted for about 58%, Yahoo for 23%, Microsoft for 10%, Time Warner for 5%, and Ask for 4%. This is clearly a very concentrated industry already; but since Google’s position is so dominant, it might actually help consumers if Google had a larger adversary within the industry.

Discussion Questions

1. Calculate the HI of the search industry before and after a potential merger between Microsoft and Yahoo. By how much does the HI of the industry increase?

2. Google and Yahoo get their search-based revenue from advertisers who place ads based on what people are searching for. However, using Google or Yahoo is free to Internet surfers. If you were a regulator, how would that fact impact your decision to support or oppose a merger between Microsoft and Yahoo?

3. Microsoft’s core business is selling operating system software. How might the acquisition of Yahoo affect that aspect of its business? Might regulators be concerned that having Yahoo become a part of Microsoft could increase Microsoft’s market share in its main market as well?