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Hal Varian Answers Your Questions - Freakonomics - Opinion - New York Times Blog:

... Last week, we solicited your questions for Google chief economist Hal Varian. Here are his answers. Thanks to Hal for his generosity and to all of you for the good questions.

Q: Google’s recent announcement that it will be investing in energy research suggests that management now thinks it can earn better returns from investing in fields other than its core search business. Is Google turning a corner and planning to diversify beyond its Internet roots?

A: Google’s work in the energy area is primarily under the auspices of Google.org, which is our non-profit side. (See this page for details). But we also see a business opportunity here: Google’s data centers use a lot of energy — if we can figure out how to economize on that energy use, we can save a significant amount of money.

Q: In the classic supply/demand scenario, price equalizes quantity demanded by consumers with quantity supplied by producers. How do you see this economic model evolving as we move toward consumption of virtual, yet tangible products, such as iTunes movies and music?

A: Instead of the “perfect competition” that one sees with commodity products, highly differentiated products such as movies and music exhibit “monopolistic competition.” Each movie appeals to a different audience, and, in principle, they each have a little bit of price-setting power. On the other hand, when there is free entry, pure economic profits are eroded. One common outcome in such markets is differential pricing, where the product is sold in a variety of forms for a variety of prices. Indeed, if you look at a Hollywood film, it is sold in theaters, hotels, airplanes, DVDs, pay TV, and free TV at several different prices. This “versioning” is a typical outcome in such markets.

Q: How can we explain the fairly entrenched position of Google, even though the differences in search algorithms are now only recognizable at the margins? Is there some hidden network effect that makes it better for all of us to use the same search engine?

A: The traditional forces that support market entrenchment, such as network effects, scale economies, and switching costs, don’t really apply to Google. To explain Google’s success, you have to go back to a much older economics concept: learning by doing. Google has been doing Web search for nearly 10 years, so it’s not surprising that we do it better than our competitors. And we’re working very hard to keep it that way!

Q: Does the current search market share anything with the early volatile market, which saw engines like WebCrawler and Lycos rise to the top and then become overtaken every year or so?

A: As we put it, the competition is only a click away. That’s why our corporate goal is to invest 70 percent of our time and effort into improving our search and ad performance. ...

This is a rich and revealing conversation. I think it should start lots more discussions. There was more conversation on the Official Google Blog.

In fact, it has. Over at Crooked Timber, Eszter Hargittai has a great response:

The Official Google Blog takes one of the questions and posts an expanded response to it. The question:

How can we explain the fairly entrenched position of Google, even though the differences in search algorithms are now only recognizable at the margins?

Varian addresses three possible explanations: supply-side economies of scale, lock-in, and network effects. He dismisses all of these (see the post for details) and then goes on to say that it’s about Google’s superior quality in search that makes it as popular as it is.

I don’t buy it, especially the dismissal of the lock-in factor. While I realize that it seems as though another search engine is just a simple click away (and sure, technically it is), I have observed too many Internet users in my research to know that in reality it is not that simple at all. First, there is the lock-in that comes from having Google as the default search engine in some browsers (e.g., Firefox). Of course, related issues apply to other search engines as well. Why does Yahoo! still enjoy a sizeable market share in search at least in the U.S. one might ask? It is probably related to the fact that more people seem to have a personalized version of Yahoo! as their start page in their browsers than any other customized starting page. Or maybe it is because Yahoo! also offers sufficiently good search results.

This then leads us to another issue: the assumption that users carefully consider or realize that there are differences in what search engines return in response to their queries. There is room for much more research here (some of it one of my students may pursue soon), but based on what we know so far, some people tend to have a tremendous amount of trust in results presented by Google. One could say this is due to Google’s superior quality, but research has found that even when results are manipulated and the less relevant ones are offered up on top, some users will click on them presumably because they believe them to be the most relevant. (I’d really like to see that study replicated on users of other search engines to see how this compares across services. Also, additional tweaks to that study design could help us learn more about these issues.)

We still have a lot to learn about the extent to which users actually consider the quality of search engines when using them. Presumably as long as they find (or think they have found!) what they are looking for they will be satisfied. However, again, research (e.g., here, with more in the works) suggests that some users are very bad about assessing the quality of the material that shows up on pages linked from search engine results, which then puts into question their ability to evaluate search engine results quality.

I am not suggesting that Google is not a good search engine nor am I even suggesting that it is not necessarily the best search engine (although how one defines quality in this domain is tricky). I would love to see some really careful studies on this actually. What I am suggesting is that equating market share in searches should not be confused with quality of search results. I know that there are some very talented folks at Google working on search quality some of whom I know and with whom I have had very interesting and helpful conversations. I’m grateful for the work that they do. Nontheless, that’s a different issues. My point here is that I would not dismiss lock-in factors and others in explaining the service’s popularity based on what my research has taught me about how people use search engines.

I have to add one more note here as it is related and it is something I have been trying to insert into discussions of this sort for years. It may be helpful to remember that most search engine market share data look at proportion of searches not proportion of searchers. Since power users are more likely to be Google users (various data sets I work with supply evidence for this), I suspect that if we were to look at market share based on user figures Google’s share would be smaller than it seems based on figures about proportion of searches. I’ve been commenting on this for years, but the statistics that continue to be discussed concern searches not searchers. Of course, both figures may be relevant, but which one is more relevant depends on the particular questions asked. When discussing quality, it seems that proportion of users would be just as important to consider (if not more) than proportion of searches since presumably all users would want to use the highest quality search engine. Point being, if Google is so superior and that explains its popularity then why doesn’t it have a much larger market share especially regarding proportion of users?

UPDATE: As I note in the comments, answering the issues raised above by explaining why people turned to Google in the first place doesn’t work. The Web, its users and the relationship between the two in 2008 differs considerably from the 2001/02 scene so explaining migration to Google at that time says little about the potential to move from one search engine to another today.

UPDATE 2: Perhaps worth noting here is that I think of “lock-in” not in the completely restrictive sense of the term. Of course, I know that there is no technical lock-out from other options, my point was that given how people use the Internet for information seeking, something similar is going on nonetheless.

As always, the comments on Crooked Timber have some great stuff in it.

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Comments (2)

Jardinero1 on February 28, 2008 1:10 PM:

The questions that crosses my mind is: Why does Google have an economist? What is it that an economist does that enhances Google's value to its customers and shareholders?

As for Google.org here is what they say they do:

"In 2004, when Google founders Larry Page and Sergey Brin wrote to prospective shareholders about their vision for the company, they outlined a commitment to contribute significant resources, including 1% of Google's equity and profits in some form, as well as employee time, to address some of the world's most urgent problems."

WTF? One percent of equity and profit per annum? Do you have any idea of what the cumulative, compound effect of such an expenditure on the company that will be? If Larry and Sergei want to do that on their own time and own dime, that's fine with me. But why does a for-profit corporation operate a not-for-profit corporation to research something on which hundreds of billions are invested annually by other for-profit corporations who make a market in just such problems? Does this obviously retarded, schill... I mean economist, not know how to ask this question?

The more I learn about Google and the more I read about Larry and Sergei, the more I begin to equate them with some hapless lotto winner who is broke and living in squalor a few years after winning. They are brilliant, to be sure, but I don't think they know how to run a multi-billion dollar corporation. I don't know how to run one either but I am smart enough to know that about myself. These two are sitting smugly behind the wheel of one and I believe they will eventually drive it off a cliff.

Thanks for putting the Varian-Hargittai point-counterpoint together. I think Hargittai is right, and Google is pretty well-entrenched. Here are the main factors my co-author and I explore in our Federal Search Commission piece:

1) The Search Engine Algorithm. The heart of a search engine and the key to its success is its search algorithm. Effective algorithms are protected by a veil of secrecy and by various intellectual property rights. As a result, new entrants cannot easily appropriate existing algorithms. Moreover, many algorithms are trade secrets. Unlike patents, which the patent holder must disclose and which eventually expire, these trade secrets may never enter the public domain. Search algorithms may be analogous to the high-cost infrastructure required for entry into the utility or railroad markets.

2) Network Effects in Improving Search Responsiveness. The more searches an engine gets, the better able it is to sharpen and perfect its algorithm. The result is that each additional user decreases the cost of a better quality service for all subsequent users. Thus, incumbents with large numbers of users enjoy substantial advantages over smaller entrants.

3) Licensing Costs. A key to competition in the search market is having a comprehensive database of searchable materials. The ability to obtain exclusive legal rights over searchable materials, however, may substantially increase the cost of obtaining and displaying this data and the metadata needed to organize it. Exclusion rights entail licensing (or legal advice) fees, which in the aggregate may raise fixed cost substantially. Google’s notable fight to obtain favorable fair use treatment for an index of books, for example, obscures its exclusive licensing deals with audiovisual content providers. To what extent exclusion power through licensing is the industry norm is the subject of a host of legal battles taking place on various fronts. If such licenses become the industry practice, only the wealthiest players will be able to afford to develop a comprehensive database of searchable material.

4) Consumer Habit. Many searchers are accustomed to using a certain number of providers, use them relatively habitually, and are reluctant to switch, despite the existence of alternatives. Exactly how high are search engine switching costs is an empirical question that has not been satisfactorily answered to date. Google did manage to displace Yahoo!, but only after developing much better technology. [And, as Hargittai notes, the web is much different now.] Thus, to switch a substantial number of users, a new entrant has to supply a product of significantly better quality, again, steeply raising fixed cost. Another factor that may raise switching costs is the trend toward personalized search. The correlation between the quality of search and the length of use in personalized search is likely to further lock users in with an existing provider.

There is another factor: if you are an advertiser, who are you going to want to buy ads from? The dominant player with the leading database of consumer behavior, or an upstart? This is the flip side of factor 2, and again serves to entrench Google.

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This blog, the result of a collaboration between myself and the Institute for the Future of the Book, is dedicated to exploring the process of writing a critical interpretation of the actions and intentions behind the cultural behemoth that is Google, Inc. The book will answer three key questions: What does the world look like through the lens of Google?; How is Google's ubiquity affecting the production and dissemination of knowledge?; and how has the corporation altered the rules and practices that govern other companies, institutions, and states? [more]

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