[Senate Hearing 110-568]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 110-568
 
   THE GOOGLE-YAHOO! AGREEMENT AND THE FUTURE OF INTERNET ADVERTISING

=======================================================================

                                HEARING

                               before the

                       SUBCOMMITTEE ON ANTITRUST,
                 COMPETITION POLICY AND CONSUMER RIGHTS

                                 of the

                       COMMITTEE ON THE JUDICIARY
                          UNITED STATES SENATE

                       ONE HUNDRED TENTH CONGRESS

                             SECOND SESSION

                               __________

                             JULY 15, 2008

                               __________

                          Serial No. J-110-106

                               __________

         Printed for the use of the Committee on the Judiciary



                     U.S. GOVERNMENT PRINTING OFFICE
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                       COMMITTEE ON THE JUDICIARY

                  PATRICK J. LEAHY, Vermont, Chairman
EDWARD M. KENNEDY, Massachusetts     ARLEN SPECTER, Pennsylvania
JOSEPH R. BIDEN, Jr., Delaware       ORRIN G. HATCH, Utah
HERB KOHL, Wisconsin                 CHARLES E. GRASSLEY, Iowa
DIANNE FEINSTEIN, California         JON KYL, Arizona
RUSSELL D. FEINGOLD, Wisconsin       JEFF SESSIONS, Alabama
CHARLES E. SCHUMER, New York         LINDSEY O. GRAHAM, South Carolina
RICHARD J. DURBIN, Illinois          JOHN CORNYN, Texas
BENJAMIN L. CARDIN, Maryland         SAM BROWNBACK, Kansas
SHELDON WHITEHOUSE, Rhode Island     TOM COBURN, Oklahoma
            Bruce A. Cohen, Chief Counsel and Staff Director
      William Castle, Republican Chief Counsel and Staff Director
                                 ------                                

   Subcommittee on Antitrust, Competition Policy and Consumer Rights

                     HERB KOHL, Wisconsin, Chairman
PATRICK J. LEAHY, Vermont            ORRIN G. HATCH, Utah
JOSEPH R. BIDEN, Jr., Delaware       ARLEN SPECTER, Pennsylvania
RUSSELL D. FEINGOLD, Wisconsin       CHARLES E. GRASSLEY, Iowa
CHARLES E. SCHUMER, New York         SAM BROWNBACK, Kansas
BENJAMIN L. CARDIN, Maryland         TOM COBURN, Oklahoma
                     Jeffrey Miller, Chief Counsel
                William Castle, Republican Chief Counsel


                            C O N T E N T S

                              ----------                              

                    STATEMENTS OF COMMITTEE MEMBERS

                                                                   Page
Hatch, Hon. Orrin G., a U.S. Senator from the State of Utah......     4
Kohl, Hon. Herb, a U.S. Senator from the State of Wisconsin......     1
    prepared statement...........................................    79
Leahy, Hon. Patrick J., a U.S. Senator from the State of Vermont.     3
    prepared statement...........................................    80
Schumer, Hon. Charles E., a U.S. Senator from the State of New 
  York...........................................................     4
Specter, Hon. Arlen, a U.S. Senator from the State of 
  Pennsylvania...................................................     2

                               WITNESSES

Callahan, Michael J., Executive Vice President and General 
  Counsel, Yahoo! Inc., Sunnyvale, California....................     6
Carter, Tim, President and Chief Executive Officer, 
  AsktheBuilder.com, Cincinnati, Ohio............................    12
Crowley, Matthew, Chief Marketing Officer, Yellowpages.com., 
  Glendale, California...........................................    13
Drummond, David, Senior Vice President of Corporate Development, 
  and Chief Legal Officer, Google, Mountain View, California.....     8
Smith, Brad, Senior Vice President and General Counsel, 
  Microsoft, Redmond, Washington.................................    10

                         QUESTIONS AND ANSWERS

Responses of Michael J. Callahan to questions submitted by 
  Senator Kohl...................................................    32
Responses of Matthew Crowley to questions submitted by Senator 
  Kohl...........................................................    36
Responses of David Drummond to questions submitted by Senator 
  Kohl...........................................................    39
Responses of Brad Smith to questions submitted by Senator Kohl...    46

                       SUBMISSIONS FOR THE RECORD

Callahan, Michael J., Executive Vice President and General 
  Counsel, Yahoo! Inc., Sunnyvale, California, statement.........    50
Carter, Tim, President and Chief Executive Officer, 
  AsktheBuilder.com, Cincinnati, Ohio, statement.................    60
Crowley, Matthew, Chief Marketing Officer, Yellowpages.com., 
  Glendale, California, statement................................    64
Drummond, David, Senior Vice President of Corporate Development, 
  and Chief Legal Officer, Google, Mountain View, California, 
  statement......................................................    71
Small Business & Entrepreneurship Council, Karen Kerrigan, 
  President and Chief Executive Officer, Oakton, Virginia, letter    81
Smith, Brad, Senior Vice President and General Counsel, 
  Microsoft, Redmond, Washington, statement......................    82


   THE GOOGLE-YAHOO! AGREEMENT AND THE FUTURE OF INTERNET ADVERTISING

                              ----------                              


                         TUESDAY, JULY 15, 2008

                                       U.S. Senate,
Subcommittee on Antitrust, Competition Policy and Consumer 
                                                    Rights,
                                Committee on the Judiciary,
                                                   Washington, D.C.
    The Subcommittee met, pursuant to notice, at 10:31 a.m., in 
room SD-226, Dirksen Senate Office Building, Hon. Herb Kohl, 
Chairman of the Subcommittee, presiding.
    Present: Senators Kohl, Leahy, Schumer, Cardin, Hatch, and 
Specter.

 OPENING STATEMENT OF HON. HERB KOHL, A U.S. SENATOR FROM THE 
                       STATE OF WISCONSIN

    Chairman Kohl. We will call this hearing to order at this 
time.
    Today we are going to examine the Internet advertising 
market. We have read daily news accounts of Microsoft's efforts 
to buy all or part of Yahoo! and proxy wars being fought for 
control of Yahoo!'s future.
    No one knows the outcome of those events, but today we will 
examine what we do know. Google and Yahoo!, the two largest 
competitors in search-based advertising, have reached an 
agreement where Yahoo! will outsource a portion of its 
advertising business to Google and the two companies will split 
the proceeds. Yahoo! contends that this will add $800 million 
annually and enable them to become a stronger independent 
competitor to Google. Critics, on the other hand, ask how the 
agreement could possibly be good for competition. They argue 
that Google is paying its largest competitor a premium not to 
compete as vigorously as Yahoo! had previously. And the higher 
ad rates it will earn will encourage Yahoo! to compete even 
less. So we are forced to ask today whether this agreement will 
reduce Yahoo! to nothing more than the newest satellite in the 
Google orbit.
    While we will need to study this deal carefully, what is 
indisputable is the vital importance of Internet advertising to 
the national economy. As we increasingly rely on the Internet 
for commerce, entertainment, communication, and news, 
advertising on the Internet has become ever more essential to 
business. In 2007, more than $21 billion was spent on Internet 
advertising in the United States, more than the amount spent on 
advertising on cable television, broadcast TV networks, radio, 
or billboards. And it has tripled in just the last 5 years.
    Google, Yahoo!, and Microsoft perform essential functions. 
Not only do they serve as gateways to the Internet, but in 
doing so, they help businesses and consumers find each other 
with the most relevant advertising ever seen. So the stakes are 
very high in maintaining a vibrant and competitive Internet 
advertising sector. One type of Internet advertising, the 
advertising that is displayed with Internet searches, is 
particularly impacted by the Google/Yahoo! deal. The two 
companies together have a 90-percent market share in Internet 
search advertising, with Google alone controlling more than 70 
percent of that market. In examining the competitive impact of 
this deal, we will need to find answers to a number of 
important questions: What will be the effect of Yahoo! 
outsourcing a portion of its search advertising to its biggest 
competitor? Will it lead to higher advertising rates or will it 
work to advertisers' benefit by giving them a bigger audience? 
Do other types of Internet advertising factor into this 
equation?
    The history of the development of the computer industry 
gives us reason to be cautious as we evaluate this deal. A 
decade ago, today's witness Microsoft came dangerously close to 
quashing competition throughout the high-tech economy. We are 
pleased that Microsoft has reformed its business practices, but 
this experience teaches us the importance of acting and acting 
early to ensure that competition is preserved in this vital 
sector of the economy.
    [The prepared statement of Senator Kohl appears as a 
submission for the record.]
    I turn now to Senator Arlen Specter for any comments.

STATEMENT OF HON. ARLEN SPECTER, A U.S. SENATOR FROM THE STATE 
                        OF PENNSYLVANIA

    Senator Specter. Well, thank you, Mr. Chairman. This is a 
very important hearing. The Internet has come to be such a 
major factor in our communications, very, very important, and 
we are dealing here with some of the giants in the field. The 
agreement would give Yahoo! the option to display Google ads on 
its side of the search results, non-exclusive. And there are a 
lot of ramifications. As noted over the weekend, Microsoft, 
with the support of Yahoo!'s shareholder Carl Icahn, made yet 
another offer to acquire Yahoo! but Yahoo! declined. Now it is 
reported that Mr. Icahn will mount a proxy fight at the August 
1st Yahoo! shareholders meeting in an effort to complete a deal 
with Microsoft.
    We are really in such a transitional age, it is hard to 
keep up with all of the technical advances. And it is a point 
of amazement to me to open up the Internet and put in the name 
of Senator Pat Leahy or Senator Herbert Kohl or my own name and 
see the splash of information that comes out. And high-tech and 
advertising have become the order of the day. And then when you 
have the entry into the field of people like Mr. Icahn, proxy 
fights, it is a little hard to understand all of what is going 
on.
    Let me particularly commend Senator Kohl. Among the four of 
us here, he is the only non-lawyer. That has come to be an 
advantage in the U.S. Senate. It clears the head. He looks at 
these issues from a little different perspective, not burdened 
with all the antitrust courses which Senator Leahy took at 
Georgetown and Senator Schumer took at Harvard. And it is 
fortunate to have that kind of a perspective on this kind of an 
issue. So good work.
    Chairman Kohl. Thank you, Senator Specter.
    Senator Leahy, would you like to make a few comments?

  STATEMENT OF HON. PATRICK J. LEAHY, A U.S. SENATOR FROM THE 
                        STATE OF VERMONT

    Senator Leahy. Well, I must admit when I see Senator 
Specter saying about clearing one's head not being a lawyer, I 
recall once when scuba diving with my wife, and this 9-foot 
nurse shark, the largest one we had ever seen, usually 
harmless--that is the operative word, ``usually.'' It came 
shooting right at us. We kind of ducked. It went right over us 
and thought, That is great, it left. It turned around and it 
comes right back at us. I was sucking in so much air, I thought 
maybe the tanks would collapse. And we got back on the boat, 
and I said to my wife, who is a registered nurse, I said, 
``Well, don't worry, dear. That shark gave you professional 
courtesy because a nurse shark, you are a nurse.'' She said, 
``No, darling. You are a lawyer. The shark gave you 
professional courtesy.''
    [Laughter.]
    Senator Leahy. But I do enjoy seeing the information, and 
once in a while it is accurate that you read about each other. 
And once in a while it is not. But I think the point that has 
been made by both Senator Kohl--and I compliment him for 
holding this hearing--and Senator Specter is that the Internet 
opens new means of communication, new ways to buy and sell 
products, all the things you all know better than anybody else. 
And that free and easily accessed content on the Internet, 
especially the free content, is being driven by a successful 
and competitive online advertising industry. We would not have 
it without that.
    The online advertising industry in the U.S. I understood 
surpassed $21 billion last year. That is something everybody 
thought was an experiment just a few years ago, one of the 
fastest growing areas. And more and more people are using the 
Internet--business, schools, my 10-year-old grandson who goes 
on to check his school schedule and things like that. And more 
and more people are going to try to move their messages online.
    Now, the question for us here is whether these 
advertisers--and it could be Orvis or the Vermont Teddy Bear 
Company, thinking about companies in my own State, or it could 
be a major corporation like an auto company or something like 
that--will find options at competitive prices because the 
business there is dynamic. The antitrust laws, rooted as they 
are in the fundamentals of competition in innovation and 
pricing, are nimble enough to keep up with changing business 
models and technology.
    But we have this drama being played out in the courting of 
Yahoo! by both Microsoft and Google, and that is going to have 
lasting effects. The Google agreement with Yahoo! may relate 
only to text advertisements, but if it stifles competition in 
this market, that will quickly spill into emerging online ad 
markets such as delivery to mobile systems, telephones and 
others.
    The ability of a single company to dominate the online 
advertising marketplace also raises the specter that one 
company will accumulate vast amounts of personal viewing data. 
That worries me as much as any one item. It worries me whether 
it is private industry doing it or whether it is our Government 
doing it because of the privacy concerns. This is an issue I am 
going to remain focused on as the online advertising market 
continues to develop.
    Senator Specter and I held a hearing about the gathering of 
information within the data bases in the Federal Government on 
this and how the Antitrust Subcommittee has taken a leading 
role in looking at the competition issues. And I really want to 
thank Senator Kohl for staying vigilant on this. When he told 
me he was holding this timely and important hearing, I thought 
it was a great idea.
    I will hold off and listen to the witnesses, and thank you, 
Herb.
    [The prepared statement of Senator Leahy appears as a 
submission for the record.]
    Chairman Kohl. Thank you very much, Senator Leahy.
    Senator Hatch?

STATEMENT OF HON. ORRIN G. HATCH, A U.S. SENATOR FROM THE STATE 
                            OF UTAH

    Senator Hatch. Well, thank you, Mr. Chairman. I welcome all 
of you witnesses here today. This is a very important set of 
issues, as you know, and I could outline them, but I am sure 
everybody knows what we are talking about or at least has some 
idea. We want to take every consideration here that we can. 
These involve tremendous entities that do tremendous things in 
our society, and there are tremendous antitrust issues 
involved.
    So I just want you to know I take a great deal of interest 
in this, and as my colleagues will, and I hope that we can 
arrive at the right conclusions. But we are grateful to have 
all of you here to help enlighten us here today, and we look 
forward to hearing your testimony.
    Thank you, Mr. Chairman.
    Chairman Kohl. Thank you very much, Senator Hatch.
    Senator Schumer?

 STATEMENT OF HON. CHARLES E. SCHUMER, A U.S. SENATOR FROM THE 
                       STATE OF NEW YORK

    Senator Schumer. Well, thank you, Mr. Chairman, and first 
let me join my colleagues in just thanking you for being such a 
diligent and conscientious Chair of this Subcommittee, on which 
I am proud to serve, and making sure that there is an antitrust 
law here and it is vibrant and active and important. And I also 
want to thank all the witnesses for coming today to talk with 
the Subcommittee. I care a lot about this issue. You know, the 
Internet is developing every day, changes. It is exciting to be 
sort of at the beginning of laying a whole new way that people 
communicate and that changes all the time. And our job here, 
because changes now may affect things 20, 30, 50 years into the 
future, is to make sure it stays as competitive and as consumer 
friendly as possible.
    And second, of course, I have a parochial interest. 
Internet advertising is a large industry in New York and a 
growing industry in New York, and we in New York base some of 
our future on that industry. We cannot just rely on one 
industry.
    And so for all those reasons, I am interested, and that is 
why I have followed developments in this industry closely over 
the last few years. I want to commend the companies testifying 
for maintaining a robust public debate on some of the most 
important issues in this critical sector.
    Yahoo! and Google have consistently moved the debate 
forward and have been fierce competitors. And for the most 
part, consumers have benefited as a result. And let me say 
this: Regardless of whatever happens with this deal, I am 
confident that Yahoo! and Google will wake up the next morning 
and prepare for the next battle. I am not concerned that this 
deal will spell the end of either company. But what I am 
concerned about is whether this deal is good for everyday 
Internet users. That is really what the Internet is all about: 
connecting each citizen on his or her own to information and 
commerce more efficiently than was ever possible before. And I 
feel confident, Mr. Chairman, that this arrangement could well 
result in Internet advertising that is more tailored to 
Internet users' wants and needs. And I also appreciate the 
reassurances from Google and Yahoo! about what they will to 
protect consumer privacy, and, of course, we will be watching, 
I know, under Chairman Leahy's watchful eye to make sure that 
those pledges are followed through.
    I am also sensitive to two of the antitrust concerns that 
have been raised. I hope this arrangement will not lead to a 
price floor or any unlawful price fixing for search 
advertising, as some have alleged. And I hope that this deal 
will not stifle Yahoo!'s development in the field.
    So I look forward to the testimony. I thank you for having 
the hearing, Mr. Chairman, and I know we will continue to 
follow this very important and really seminal issue.
    Chairman Kohl. Thank you very much, Senator Schumer.
    We would like now to introduce our panel of witnesses. Our 
first witness today will be Michael Callahan. Mr. Callahan is 
the General Counsel for Yahoo!, where he has worked since 1999. 
Prior to joining Yahoo!, Mr. Callahan held positions with 
Electronics for Imaging, Inc., and the law firm of Skadden 
Arps.
    Following him will be David Drummond. Mr. Drummond is the 
Senior Vice President for Corporate Development and Chief Legal 
Officer at Google. In this role, Mr. Drummond works with 
management teams at Google to evaluate new business 
opportunities, including alliances and mergers.
    Next we will be hearing from Brad Smith. Mr. Smith is the 
Senior Vice President and General Counsel for Microsoft. While 
at Microsoft, Mr. Smith has played a leading role in the 
company's intellectual property, competition, and other public 
policy issues. He also served as Microsoft's Chief Compliance 
Officer.
    Following him we will be hearing from Tim Carter. Mr. 
Carter is a master carpenter and plumber as well as syndicated 
columnist on building. He is the founder of AsktheBuilder.com, 
an online resource for building and home repair.
    And then we will be hearing from Matthew Crowley. Mr. 
Crowley is the Chief Marketing Officer for AT&T's 
Yellowpages.com. Prior to his position with Yellowpages.com, 
Mr. Crowley worked at SBC's SmartPages.com and Pacific Bell 
Smart Yellowpages.
    We thank you all for appearing before this Subcommittee. I 
remind you all please to limit your opening testimony to 5 
minutes.
    Now I ask all of you to stand and take the oath with your 
right hand raised. Do you affirm that the testimony you are 
about to give will be the truth, the whole truth, and nothing 
but the truth, so help you God?
    Mr. Callahan. I do.
    Mr. Drummond. I do.
    Mr. Smith. I do.
    Mr. Carter. I do.
    Mr. Crowley. I do.
    Chairman Kohl. Thank you so much.
    Mr. Callahan, we would be delighted to hear from you.

STATEMENT OF MICHAEL J. CALLAHAN, EXECUTIVE VICE PRESIDENT AND 
      GENERAL COUNSEL, YAHOO! INC., SUNNYVALE, CALIFORNIA

    Mr. Callahan. Thank you, Chairman Kohl, Ranking Member 
Hatch, and members of the Subcommittee. My name is Michael 
Callahan, and I am Executive Vice President and General Counsel 
of Yahoo! Inc. I appreciate the opportunity to be here today to 
discuss the dynamic and growing Internet advertising space and 
the commercial agreement between Google and Yahoo!.
    Yahoo! welcomes this hearing, and we are confident that the 
more one learns about this agreement, the more clear it becomes 
that it is good for competition--good for consumers, good for 
advertisers, and yes, good for Yahoo!.
    The purpose of this commercial arrangement and the intent 
of Yahoo! moving forward is to help make our company an even 
stronger competitor to Google, to Microsoft, and to others in 
the dynamic and rapidly growing online advertising world. As I 
am sure you know, this has been an interesting time for our 
company, to say the least.
    While I don't want to dwell on the very public proxy fight 
in which we are currently engaged, I do want to spend a brief 
moment on it because it will give you a flavor for how 
intensely competitive the search business has become. All of 
the companies at this table are laser focused on being 
significant players in search. With this business arrangement, 
Yahoo! will continue to execute on its long-term corporate 
strategy. Microsoft, on the other hand, has turned to activist 
shareholder Carl Icahn, in the apparent hope that this will 
force a fire sale of Yahoo!'s core strategic search business.
    Our priority at Yahoo! is to build value for our 
stockholders. That continues to be our core mission. What we 
will not do, however, is allow our business to be dismantled or 
sold off piecemeal on terms that would be disadvantageous to 
Yahoo! stockholders and to the market as a whole. I trust that 
this will give you context to understand the extraordinary 
value we all place in the paid search portion of the online 
advertising business and how very competitive it is and will 
remain, and why there are so many misconceptions--advanced by 
our competitors--about the agreement we have entered into with 
Google.
    Let's start by reviewing what this agreement is not as well 
as what it is.
    First, this is not a merger. Far from it. We will 
increasingly compete with Google and they with us. This is a 
commercial arrangement between two companies who will remain 
autonomous and compete aggressively-in search and display 
advertising, mobile, news, e-mail, finance--you name it. Yahoo! 
is here to stay, and we intend to compete across countless 
platforms, including search, for years to come.
    Second, Yahoo! is not exiting search, nor are we ceding any 
portion of that space to Google. This will not, as some claim, 
result in Google controlling 90 percent of the search business. 
To the contrary, we will continue to do everything we can to 
grow our share and also strengthen our competitiveness in 
search and search advertising. This deal is just one more 
important step along that path, and with all due respect to 
Google, we have every intention of fighting them and winning--
in this and in other areas--for years to come.
    Furthermore, this agreement does not affect algorithmic 
search at all. When a user comes to Yahoo! and performs a 
search, the algorithmic results returned will still be entirely 
Yahoo!'s. Yahoo! serves close to a quarter of the searches that 
consumers make today, and we expect to be serving that or more 
after this deal is implemented.
    Third, this agreement is non-exclusive and gives Yahoo! 
complete discretion over how, where, and when we will choose to 
use Google advertising on our sites. There are no minimum 
requirements either, and Yahoo! is free to make similar deals 
with other companies. In other words, this gives Yahoo! the 
option to show Google ads, but does not tie our hands in any 
important respect.
    Fourth, the claim some have made that Yahoo! and Google are 
price-fixing is entirely false. Prices for search terms are set 
by open and fair market-based auctions, and advertisers only 
pay when consumers click on their ads.
    This agreement is truly win-win. It benefits consumers, 
advertisers, publishers, and Yahoo!. Consumers will now get 
more relevant advertising on Yahoo!'s site. Advertisers will 
reach more consumers, and Yahoo! will become an even stronger 
competitor in the broad advertising marketplace.
    To put this agreement in perspective, it is helpful to 
recall that until 2004 Yahoo! completely outsourced both its 
algorithmic and sponsored search to a variety of companies, 
including algorithmic search to Google. More recently, other 
companies had outsourced their search functions to Yahoo!. In 
fact, Microsoft outsourced its sponsored search to Yahoo! just 
a few years ago and still does in some places around the world.
    In 2004, Yahoo! made the strategic decision to bring 
algorithmic and sponsored search in-house, and that decision 
has not changed. Since then we have invested hundreds of 
millions of dollars to improve our search products and compete 
better in the marketplace.
    For example, just last week, we announced BOSS, an open 
platform build-your-own search service, which we believe will 
unleash a wave of innovation, and our efforts to create an 
open, robust exchange to bring publishers and advertisers 
together are also well on their way. These efforts are 
consistent with our complete commitment to continued growth in 
search and display advertising.
    With the additional operating cash-flow from this 
agreement--anticipated to be between $250 million and $450 
million in the first year--Yahoo! will accelerate our 
innovation and better compete against Google, Microsoft, and 
others in the online advertising marketplace.
    Over the coming weeks, Yahoo! will continue to work with 
our advertisers, our users, outside groups, and government 
authorities to explain this agreement and address any questions 
about the facts of the arrangement. We have kept the Department 
of Justice informed along the way and will continue to 
cooperate with them and this Subcommittee. We are confident 
that the more one knows about this agreement, the more it 
becomes clear that it will increase competition, stimulate 
creativity, and benefit consumers, advertisers, and the online 
advertising industry overall.
    Thank you again for inviting me to appear here today, and I 
look forward to answering any questions you may have.
    [The prepared statement of Mr. Callahan appears as a 
submission for the record.]
    Chairman Kohl. Thank you, Mr. Callahan.
    Now we will hear from the Google representative with us 
today, Mr. Drummond.

STATEMENT OF DAVID DRUMMOND, SENIOR VICE PRESIDENT OF CORPORATE 
 DEVELOPMENT, AND CHIEF LEGAL OFFICER, GOOGLE, MOUNTAIN VIEW, 
                           CALIFORNIA

    Mr. Drummond. Thank you, Chairman Kohl, Senator Hatch, 
members of the Subcommittee. Thanks very much for inviting me 
here today.
    The Internet is a dynamic, competitive environment due to 
the openness that has always been its hallmark. Our non-
exclusive commercial agreement with Yahoo! will maintain and 
expand that competition. It creates new efficiencies that will 
benefit consumers, advertisers, and publishers, while 
protecting privacy and spurring innovation.
    When Yahoo! chooses to use our technology, consumers will 
see more relevant ads that better connect them to the products 
and services they are interested in. Advertisers will benefit 
from better ad-matching capability, improving the way that they 
reach their customers. And web publishers who place Yahoo!'s 
ads on their sites will also see more revenue from better ad 
matching. That is why large and small advertisers, ad agencies, 
and publishers have expressed their support for this agreement, 
including such names as Publicis, Digitas, Overstock, and even 
Microsoft's own in-house ad firm, Avenue A/Razorfish, who 
called it ``good news for advertisers.''
    Now, the fundamental point I would like to make today is 
that this agreement promotes ongoing competition among 
advertising. Let there be no doubt about this point. Google and 
Yahoo! will remain fierce competitors--in search, in online 
advertising, and many other products and services. Yahoo! has 
said that it will reinvest revenue from this agreement into 
improving its search engine and its other services. This 
continued competition will help fuel innovation that is good 
for the Internet, good for Internet users, and good for the 
economy.
    Now, the fact that this arrangement is made between 
competitors is not unusual. Commercial arrangements between 
competitors are commonplace online and in many other 
industries. Antitrust authorities have recognized that 
consumers can benefit from these arrangements, especially when 
one company has technical expertise that enables another one to 
improve their product quality. And we are also excited that as 
part of this agreement, Yahoo! will make its instant messaging 
network interoperable with Google's. That is a big step 
forward, making instant messaging more like e-mail, with users 
able to communicate across platforms more easily.
    Now, I would also like to clear up a few things about this 
agreement.
    First, unlike the other alternatives, such as Microsoft 
acquiring Yahoo!'s search assets or taking over all of Yahoo!, 
this agreement will not remove a player from the field, from 
the competitive field. Yahoo! will remain in the search 
advertising business and will continue to be a vigorous and 
aggressive competitor.
    Now, some would also have you believe that the agreement 
will result in Google controlling nearly all of search 
advertising. The agreement does no such thing. Yahoo! will 
continue to operate its own search platforms, so adds to its 
longstanding and deep base of advertisers, and continue to 
operate its own ad auction. The agreement merely gives them the 
option to show Google ads in cases where Google ads are likely 
to generate more value. It is important to note also that this 
agreement is limited to the U.S. and Canada and excludes 
emerging fields such as mobile.
    Second, the agreement does not increase Google's share of 
search traffic because Yahoo! will continue to run its own 
search engine. So, simply put, Yahoo! will have every 
incentive, as you heard from Mr. Callahan they have every 
intention, to continue to expand their search advertising 
business.
    Third, the agreement will not set an illegal price floor. 
Microsoft would have you believe that the additional revenue 
that Yahoo! and Google might make from the agreement will come 
solely as a result of increased advertising prices. Nothing 
could be further from the truth, and this reflects a 
fundamental misunderstanding of how search monetization 
actually works. The fact is we expect that the primary driver 
of additional revenue will be more relevant ads being delivered 
to more users, who will then click on those ads in greater 
numbers. In other words, we are not looking to sell ads at 
higher prices. We are looking to sell more ads. This is good 
for everyone. Users are going to see more relevant ads. 
Advertisers will connect with more interested users, and Yahoo! 
and its partners will sell more advertising space.
    Fourth, the agreement also upholds Google's deeply held 
commitment to protecting user privacy. As Google supplies ads 
to Yahoo! and its partners, personally identifiable information 
of Internet users will not be shared between the companies.
    So let me conclude today with some frank talk about what is 
going on here. The most energetic critic of this agreement is 
Microsoft, who, of course, is a significant competitor of ours 
and not exactly a mom-and-pop shop. This is the same Microsoft 
whose CEO said he was going to ``kill Google'' along with a lot 
of other salty language I cannot repeat in this setting. And it 
is also the same Microsoft that has a 90-percent share of 
operating systems, a 90-percent share of productivity software, 
and an 80-percent share of the browser market--a desktop 
monopoly that Microsoft could use to harm the next phase of the 
Internet, namely, cloud computing. Most importantly, this is 
the same Microsoft that is actively trying to buy or at least 
destabilize Yahoo!, thereby eliminating one of its biggest 
competitors.
    Now, if you think all of that gives Microsoft an incentive 
to oppose this agreement, you would be right. And let's also 
remember that Microsoft came before this Committee 10 months 
ago with a host of extremely dramatic arguments about our 
acquisition of DoubleClick, even though they themselves had 
recently acquired DoubleClick's largest competitor. The 
regulatory agencies were right to reject Microsoft's arguments 
then, and they will be right to reject them again.
    So, in conclusion, openness, interoperability, and 
competition are central to Google's culture, the vibrancy of 
the Internet, and the growth of free markets. Unlike with the 
desktop, competition on the Internet is always just a click 
away.
    Thanks, and I look forward to taking your questions.
    [The prepared statement of Mr. Drummond appears as a 
submission for the record.]
    Chairman Kohl. Thank you very much, Mr. Drummond.
    We will now hear from your good friend at Microsoft, Mr. 
Smith.
    [Laughter.]
    Senator Leahy. He may differ.

  STATEMENT OF BRAD SMITH, SENIOR VICE PRESIDENT AND GENERAL 
            COUNSEL, MICROSOFT, REDMOND, WASHINGTON

    Mr. Smith. Thank you for the introduction by my colleagues 
at the table. Thank you Senator Kohl, Senator Hatch, other 
members of the Subcommittee.
    Let me be the first to acknowledge that Microsoft is not 
disinterested when it comes to the issues before this 
Committee. No competitor ever is. None of us are disinterested. 
But we do know a lot about this market, and using that 
information, we can help identify the questions that are 
important for reviewing this agreement.
    I think the principal question is this: Can a single 
company establish effective control of the pricing of 90 
percent of the market for search advertising by entering into 
an agreement with its single largest competitor?
    Now, the technology is complicated, but the antitrust 
issues are straightforward. That is what I would like to 
address this morning.
    First, search has become the gateway to the web. Many 
Americans sit down at a computer, and the first thing they look 
at is a search page. When they get the results, they use those 
results to determine what else they are going to look at or 
perhaps use or buy from a company across the country.
    Search advertising has become the fuel that is supporting a 
lot of the content on the Internet today, as Senator Leahy 
referred to earlier. It may be a sports score, it may be a news 
story, it may be entertainment; but all of this free content is 
frequently paid for, including by search advertising. It has 
become a very large market. By 2011, it is estimated that the 
market for search advertising will exceed $16 billion. That 
will come close to rivaling the $20 billion that is paid today 
on all advertising for all cable television across the country.
    We believe the Internet today is at a moment of historical 
importance in its evolution. If you look at the market for 
search advertising, there are three principal competitors: 
Google has 70 percent of this market, Yahoo! has 20 percent, 
and Microsoft has less than 10 percent. So the fundamental 
question is: What effect will this new agreement between Yahoo! 
and Google have on the future of competition on the Internet? 
We believe the effects will be four-fold.
    First, it will lead to an unprecedented level of 
concentration when it comes to search advertising. In the 
history of advertising, no single company has managed to take 
control of pricing of 90 percent of all of the advertising in 
any medium--not in television, not in radio, not in publishing. 
It should not happen on the Internet.
    Second, this is going to mean fewer choices for 
advertisers. Today there are many advertisers that choose to 
advertise on Yahoo! either instead of or in addition to 
advertising on Google. And yet under this agreement, many of 
these advertisers are going to lose that choice. They are going 
to have to go buy ads from Google simply to get the very same 
ad placed in the very same place on a Yahoo! search page.
    Third, this agreement will mean higher prices. The whole 
basis for this agreement is the opportunity for Yahoo! to raise 
its prices. When Yahoo! has filed its statements with the 
Securities and Exchange Commission, it has referred to the 
opportunity for ``better monetization.'' Mostly that is a fancy 
way of describing a price increase. When Yahoo! says it sees an 
$800 million opportunity to increase revenue, that is money 
that is going to come out of the pockets of American companies, 
large and small, companies that are buying cheaper ads on 
Yahoo! today.
    Finally, this agreement does raise important questions for 
privacy. It is not just what is shared between the companies, 
but what information flows from users to Google. If search is 
the gateway to the web, as most believe it is, then this 
agreement creates the prospect of a single company--Google--
taking control of that gateway. It raises the prospect of 
information from up to 90 percent of search advertising flowing 
to Google.
    If this agreement goes forward, this Congress may not need 
to enact a Federal privacy policy. We will have a national 
privacy policy. It will be Google's privacy policy.
    So, in sum, let me say we acknowledge that this technology 
continues to change rapidly, but for 118 years, since the 
Sherman Act was enacted, one rule of the road has remained 
constant. We are all encouraged to work harder in order to 
succeed. We are all encouraged to offer consumers a better 
product. But no one is permitted to buy control of up to 90 
percent of the market by entering into an agreement with its 
single largest competitor. The question before this Congress, 
and indeed the Department of Justice and the country as a 
whole, is whether that principle should be abandoned now.
    Thank you.
    [The prepared statement of Mr. Smith appears as a 
submission for the record.]
    Chairman Kohl. Thank you, Mr. Smith.
    Mr. Carter?

STATEMENT OF TIM CARTER, PRESIDENT AND CHIEF EXECUTIVE OFFICER, 
              ASKTHEBUILDER.COM, CINCINNATI, OHIO

    Mr. Carter. Chairman Kohl, Ranking Member Hatch, and other 
members of the Subcommittee, I sincerely appreciate this to 
address you about this very important topic.
    The future of Internet advertising is brilliant. In fact, 
some might say it is possibly one of the fastest growing 
segments of our national economy. The proposed agreement 
between Google and Yahoo!, as seen from my eyes as a consumer 
and an Internet publisher, is a very good idea. There are many 
more winners who benefit from this business transaction than 
those who make claims about being harmed.
    People like you and me have problems each day. We seek out 
solutions to those problems, and with the advent of the 
Internet, it has never been easier or faster to discover 
precise and accurate solutions to those problems.
    In my opinion, one of the reasons for Google's success 
stems from the fact they are an excellent matchmaker. They 
created a streamlined search engine that displays search 
results as well as contextual advertising that matches the 
exact search term typed by tens of millions of consumers each 
day, many of whom are your constituents. Google is not the sole 
search engine that does this.
    The advertising that is part of the search results is 
purchased by small and large companies alike. To the best of my 
knowledge, this method of displaying a highly targeted ad is 
quite possibly the key component to the paradigm shift that is 
happening right now in the advertising industry. Never before 
could companies be in front of so many consumers who needed 
their product or service at that exact instant in time. The old 
methods of advertising usually had some type of delay built in.
    Billions of dollars are being spent on Internet 
advertising, and the market is growing. It is growing because 
it is a win-win situation. Consumers who quickly solve their 
problems win. The company selling the solution to the consumer 
wins. The Internet company that sold the ad wins. And, finally, 
a website that displays a syndicated ad wins.
    Yahoo! has valuable real estate on their website pages that 
is seen by tens of millions of people each day. They can sell 
or lease that virtual real estate to whomever they please or 
even fill the space with things they create. I do the exact 
same thing at AsktheBuilder.com, filling my pages with my 
columns and videos, ads sold by others, and ads I sell myself.
    Yahoo! is a public corporation, and it is paramount that 
they do what is best for their stockholders. If they can lease 
space on their website to some other company and derive revenue 
for doing virtually nothing, why would you or anyone stop them? 
Who is getting harmed? Surely not the people who are clicking 
the ads! They willingly click them hoping to discover a 
solution to the problem they have.
    Let's take this one more step down the antitrust pathway. 
When and where will you stop sliding down this slippery slope? 
I had a discussion with a fellow Internet entrepreneur named 
Dan Gray. He said, ``Tim, are you next? When you become the 
most visited home improvement website on the Internet, will the 
Government come in and tell you that you can't display Google 
ads? If that were to happen, it would be the most un-American 
thing I could imagine.'' Dan is right.
    If memory serves me right, antitrust actions were initiated 
when some company or a small group of companies enriched 
themselves at the expense of others who were harmed financially 
by the actions of the company or the company. That cannot be 
said about the proposed deal between Google and Yahoo!. The 
tens of millions of consumers each day who visit the Yahoo! 
website are going to see ads that solve their problems. Many 
will click those ads. Hundreds of thousands of businesses who 
sell the products and services to these consumers will increase 
their revenues when those ads are clicked. Those companies end 
up paying more taxes, and our economy grows.
    Who is harmed in this transaction? Perhaps some other 
company or companies that decided to follow a different pathway 
in the business jungle. My father-in-law taught me long ago 
that there is no substitute for brains. Furthermore, I have 
discovered that healthy competition is a great thing.
    This proposed deal has the potential to increase the 
revenues of Yahoo! by hundreds of millions of dollars each 
year. The ad revenue that Yahoo! receives from Google will flow 
into Yahoo! with virtually no expenses. If the management of 
Yahoo! is wise, they will reinvest this money back into their 
company to provide the healthy competition that we as consumers 
want and need. The deal may also force other companies in the 
Internet business world to work a little harder. My experience 
as a builder is that a little hard work never really hurt 
anyone.
    Thank you again for taking the time to consider my opinions 
in this very important issue.
    [The prepared statement of Mr. Carter appears as a 
submission for the record.]
    Chairman Kohl. Thanks for your statement, Mr. Carter.
    Mr. Crowley?

    STATEMENT OF MATTHEW CROWLEY, CHIEF MARKETING OFFICER, 
             YELLOWPAGES.COM., GLENDALE, CALIFORNIA

    Mr. Crowley. Thank you, Chairman Kohl, Ranking Member 
Hatch, members of the Subcommittee. I appreciate the 
opportunity to speak to you today about the important issues 
raised by the proposed agreement between Google and Yahoo!. I 
am Chief Marketing Officer for Yellowpages.com--Yellowpages.com 
is a subsidiary of AT&T. We have an interest in this deal on 
several fronts.
    First off, AT&T is a large purchaser of search engine 
advertising. We spend millions of dollars a year advertising 
our products and services through search--, in particular, 
Google and Yahoo!.
    Second, we operate Yellowpages.com which essentially is the 
Internet extension of the print Yellow Pages. The print Yellow 
Pages is the means by which consumers and local businesses can 
connect to each other--Yellowpages.com is essentially that 
extension.
    In addition to the Internet advertising solutions that we 
provide to small businesses, we also are a one-stop shop for 
small businesses for digital advertising. We offer several 
websites--search engine market, we place advertising--agency on 
Google and Yahoo!, helping them choose their key words and 
advertise online. So as you can see, we have an interest--our 
products and services, as well as for tens of thousands of 
businesses,--places search advertising for them, and 
particularly today relevant to Google and Yahoo!.
    The other meaningful aspect of this deal is that AT&T has 
had a longstanding business relationship with Yahoo!--Yahoo! 
continues to remain viable, a viable competitor in this space.
    So that being said, we think that we have two issues, 
concerns with the proposed agreement. One is we do--and the 
second is--innovation decrease--not just with Yahoo! but across 
the Net. So I will start with pricing.
    Today Yahoo! and Google operate two independent 
marketplaces for--search advertising. Google is the dominant 
player in the market with 70 percent. Together, Yahoo! and 
Google make up 90 percent of the market. Even though Google is 
the dominant player at 70 percent, Yahoo! is still a formidable 
alternative for advertisers to place their search engine 
marketing budget. We can compete and we can compare Google and 
Yahoo! to each other and select the best price.
    Under this proposed agreement, Yahoo! will offer over large 
portions of its inventory to Google. We expect that the 
agreement, it has been said, is worth $800 million. It is not 
insignificant. With Google, we have an opportunity to place 
advertising. With Yahoo!, we have an opportunity to place 
advertising. But in this case, inventory on Yahoo! will be 
diminished. We expect then with a decreased supply of inventory 
on Yahoo!, prices will go up.
    Google is not necessarily an alternative for that because 
their prices are higher. If you try to buy these ad words, 
these search terms through Google, Yahoo! is already replacing 
what they call ``lower-value advertising'' with higher-value or 
more expensive advertising through Google, so the price is 
higher over there.
    So as we see it, there is decreased inventory available on 
Yahoo! and a more expensive channel to purchase our advertising 
through Google. And Google has been generally more expensive, 
and even today there was an article that came out in the New 
York Times blog suggesting that this could increase prices for 
Google paid ads on Yahoo! by 22 percent.
    Our other concern is around Yahoo!'s viability as a 
business and innovation within the Internet industry in 
general. So today Yahoo! has all the incentive in the world to 
compete aggressively with Google to earn its share of the 
market. Under this proposed agreement, Yahoo! will hand over or 
cede a significant portion of its advertising to Google and 
accept what we could call fast money from Google for this ad 
space. That decreases Yahoo!'s incentive to innovate and 
compete. It also decreases Yahoo!'s information by no longer 
processing these advertising transactions by which they can 
continue to increase their service and increase their offering. 
So we see that this ultimately increases prices, decreases 
Yahoo! as a viable competitor, and is not good for the search 
advertising business and not good for the small businesses that 
we represent as their agency.
    Thank you.
    [The prepared statement of Mr. Crowley appears as a 
submission for the record.]
    Chairman Kohl. Thank you, Mr. Crowley.
    For you, Mr. Callahan, from Yahoo!, I have this question: 
Critics of this agreement have argued that Yahoo! is getting 
paid by its largest rival not to compete as vigorously. In 
fact, they argue that Yahoo!'s success will now be tied to how 
well Google performs. Don't your critics have a point, Mr. 
Callahan?
    Mr. Callahan. Mr. Chairman, as we reviewed this agreement 
and decided to enter into it, the approach for Yahoo! is that 
we believe we will reinvest the proceeds from this transaction, 
from the agreement as it goes forward, to invest in our current 
search business, our search and display advertising business, 
and indeed continue to vigorously compete with Google. We are 
not ceding any part of our algorithmic search business, which 
we built from scratch about 4 years ago, and I think the 
history of competition on the Internet from our perspective 
supports that.
    From 2000 to 2004, Google supplied all of Yahoo!'s web 
search, algorithmic search. In 2004, through a series of 
acquisitions and internal product development, we went from 
zero in web search to approximately 20 percent to 25 percent, 
depending on whose data you use.
    If you move that history forward the last 4 years, if you 
will forgive me a prop, in Thursday's Wall Street Journal, 
``Yahoo! wields new tool to battle Google,'' and it is our BOSS 
product, which is an open platform web search initiative to 
continue our ability and, we believe, fund our ability with 
this agreement to continue to aggressively compete with Google.
    Chairman Kohl. Thank you.
    Mr. Smith, from Microsoft, your competitors seem to suggest 
that this collaboration is just a normal part of doing 
business. If the agreement is put into practice, what do you 
think the search advertising business will look like in a year 
or two?
    Mr. Smith. I think we are going to see a market that is 
less competitive than exists today. I think that is the 
reality, and I think virtually all of us in this industry know 
that is the reality. We have had lots of conversations, 
certainly in our company and with other companies, even with 
Yahoo!. On June 8th, we met with Yahoo! in San Jose, and Jerry 
Yang, the CEO of Yahoo! looked across the table, looked us in 
the eye, and said, ``Look, the market, the search market today 
is basically a bipolar market.'' He said, ``On one pole there 
is Google, and on the other pole there are Yahoo! and 
Microsoft, both competing with Google.'' He said, ``If we do 
this deal with Google, Yahoo! will become part of Google's 
pole. And Microsoft,'' he said, ``would not be strong enough in 
this market to remain a pole of its own.''
    Mr. Chairman, you asked the question when the hearing 
started, would this agreement turn Yahoo! into a satellite in 
Google's orbit? I think everybody knows the answer is yes.
    Chairman Kohl. Well, now, that is a pretty strong comment 
that you just made, Mr. Smith, and, of course, you are under 
oath and you do recollect quite accurately, I am sure you will 
state exactly what Mr. Yang said?
    Mr. Smith. I just stated exactly what Mr. Yang said, and it 
made such a strong impression on us that a few minutes later, 
when we broke, the four of us from Microsoft walked down the 
hall to a separate conference room, and we sat down and we 
said, ``I can't believe that Jerry just said those things.'' 
And Steve Ballmer turned to me and said, ``Think about that. He 
said, `There is only going to be one pole in the market.' I 
guess that would be a mono-pole, wouldn't it?'' It made a very 
strong impression.
    Mr. Callahan. Mr. Chairman--
    Chairman Kohl. Well, Mr. Callahan, do you have some answers 
to provide us this morning?
    Mr. Callahan. I am sorry to interrupt. I did want to, 
without addressing Mr. Smith's comments directly, I was a 
participant in that meeting as well, so I can add to the drama 
a little bit at the San Jose airport on June 8th. And while I 
am not going to address Mr. Smith's characterization of Mr. 
Yang's statement, I will say this: Our board of directors, as 
part of the evaluation of our strategic alternatives, has made 
a conscious decision to stay and search, to compete against 
Google and against Microsoft, and this agreement will enable us 
to continue to do that. How the market turns in the future will 
depend upon how successful we are in continuing to compete. And 
with the initiatives that we have had underway for years and 
the initiatives that we see in the convergence of search and 
display advertising going forward--which I think is an 
important point that I would like to make to the Subcommittee--
the current discussion here is about search-based advertising. 
Yahoo! believes that as the future of this market evolves, 
advertisers are interested in purchasing a combined search and 
display.
    And if you would forgive me for a moment, I have a prop; I 
could show sort of what is the difference between the search 
and display advertisement. But we believe that advertisers look 
for a combined purchase online. We have a compelling strategy, 
different than Google, and perhaps different than Microsoft, to 
build that in the future.
    So as you look here, if you will forgive me one moment, 
this is the current typical Yahoo! search page today, which 
is--it says ``Yahoo!-sponsored search'' on the top. And if you 
could imagine, there is a space here for a banner button, which 
we call display advertising, which is not search based. Then 
there is web results, which are from Yahoo!. And here is 
``Yahoo!-sponsored search,'' which we show depending upon how 
the page is put together.
    Following implementation of the agreement, this is a 
possible Yahoo! search page. This would be continued Yahoo! 
search listings here; continued Yahoo! web search, a product 
that we built from scratch 4 years ago through acquisition; 
continued Yahoo!-sponsored search listings here; and perhaps, 
if we decide to find a better-quality ad than Google, sponsored 
search listings along here.
    Chairman Kohl. Yes, I appreciate what you are saying. 
Clearly what you are saying contradicts what your boss said. 
And, you know, that is pretty explosive stuff, and we will have 
to consider that.
    Now we turn to Mr. Hatch.
    Senator Hatch. Well, thank you, Mr. Chairman.
    Mr. Callahan, in the information that Yahoo! provided the 
Subcommittee, your company argues that Yahoo! and Google will 
``compete aggressively against one another in search and 
display advertising.'' Now, I have to ask: How can that be? 
Does not this agreement give advertisers the incentive to 
bypass Yahoo! entirely and only bid with Google since the 
agreement creates the strong possibility that an ad will be 
placed on both Yahoo! and Google's search result pages? Simply 
put, why bother bidding on Yahoo!'s site when it can go to 
Google and get two for one?
    Mr. Callahan. Thank you for the question, Senator. I 
believe that advertisers will benefit from this agreement on 
both the Yahoo! system and on the Google system. As you know, 
on the Google system they have the opportunity, although not 
the guarantee, for increased distribution and the reason that 
is is Yahoo! maintains complete flexibility if and when to 
source certain ads from Google or backfill certain ads from the 
Google system. But if an advertiser wants to reach the Yahoo! 
system--and I think Mr. Carter's testimony about the desire to 
advertise on both--then they need to go through the Yahoo! 
system to be guaranteed to reach that. Google will not know 
when Yahoo! is going to pull certain ads, and Yahoo! is going 
to do that in a strategic way where we can find a quality ad 
for us to replace an ad that perhaps for Yahoo! would not be--
or does not exist if no one has bid.
    Senator Hatch. Let me put it this way: Will Google ads only 
be in the lower right-hand corner?
    Mr. Callahan. No. I am sorry. That was merely an 
illustration.
    Senator Hatch. OK.
    Mr. Callahan. The agreement maintains--and it is an 
important part--Yahoo! complete flexibility to implement this 
transaction and the way the ads are shown on our site.
    Senator Hatch. Mr. Smith, welcome back to the Committee as 
well, all of you. You have been here before.
    Mr. Smith. Recently, yes.
    Senator Hatch. Well, we always enjoy having all of you 
here.
    Microsoft used Overture, which is owned by Yahoo!, to place 
most of the ads displayed by MSN search engine until 2006. MSN 
received a portion of the fees for displaying Yahoo!'s ads. Was 
not that agreement similar to the one being proposed by Yahoo! 
and Google? And if the Microsoft-Overture contract did not 
amount to price-fixing, how can you argue now that the Google-
Yahoo! agreement amounts to per se price-fixing?
    Mr. Smith. Well, there was--very good question, Senator. 
But there was one critical difference--
    Senator Hatch. It needs to be asked. That is why I am 
asking it.
    Mr. Smith. There was a critical difference. We were not in 
the market for search advertising at that time, so we were 
relying on Yahoo! or, in that case, Overture to provide that 
service to us. We are now in this market. All three of us are 
in this market. So any agreement between any of us is in a 
different category because we are competitors. And if you look 
at the pages that Mr. Callahan showed, they really drive home 
this point.
    The first page, as he said, is a Yahoo! page today. 
Actually, if you look at it carefully, it is what displays when 
somebody types in the word ``flowers,'' and you get a lot of 
ads from people who sell flowers. And in the second page, the 
page that will exist in the future, someone types in 
``flowers,'' and, in fact, the three ads that he showed being 
provided by Google, it is the exact same three ads as were 
there before. It is from the exact same three companies. It is 
in the exact same place on the Yahoo! search page. The only 
difference is now those three companies cannot buy their ad 
from Yahoo!. They have to buy the ad from Google, and they are 
going to pay more money.
    I just think it is inescapable that those three companies 
are going to pay more money. And because they are direct 
competitors in the same market, in a way that we were not when 
we were relying on Overture, it is a very different situation.
    Senator Hatch. Thank you.
    Let me ask Mr. Carter or Mr. Crowley, won't you be tempted 
to just use Google? Wouldn't that be more convenient for both 
of you?
    Mr. Carter. Senator Hatch, that is a great question. I 
think I can--I first have to say it is kind of interesting to 
be in this room with these titans of industry, and here I am, I 
am actually one of their customers, because I buy ads from all 
three of these gentlemen next to me. And would it surprise you 
sitting at the dais to know that on either one of their 
websites right now, when they talk about these expensive ads, 
what if I told you I can buy ads on their websites right now 
for pennies a click--not nickels, not dimes, not dollars. 
Pennies. And every business that is out in America right now 
can do the same thing.
    So I do not want to hear all this belly aching about this 
is expensive. If you want to buy the big, highly targeted key 
words, sure, there is a lot of competition for those. But way 
out on a long tail where a lot of consumers are actually typing 
these very long key word phrases, you can actually buy ads for 
very little money.
    But to make a long story short, I am not worried about it 
at all. My business depends entirely upon free search. The way 
that people come to my AsktheBuilder.com website is through 
search. I absolutely want Yahoo! and Microsoft to both be 
viable against Google. The reason that Google is so powerful in 
search right now is only one reason. I happen to be a 
previously elected government official. I just resigned about 4 
months ago because I got a big project going on. But the reason 
that you are here today, Senators, is because you were elected 
to come here. Well, your constituents and all the other 
consumers in America are voting right now which search engine 
is solving their problems more quickly. And at this instant in 
time, it just happens to be Google. Yahoo! or Microsoft or some 
other two young kids who are in a garage right now might 
supplant all three of these guys. That is possible. Look at 
what has happened. Look how quickly we had these giant 
industries develop. Never in the history of America has that 
happened, ever. And it can still happen.
    So if I were these three gentlemen and their companies and 
their board of directors, I would be worried each day. But to 
answer your question, Senator Hatch, I am not worried at all 
because I am convinced that all three companies are working as 
hard as they can, maybe some harder than others, and as a 
result, they are getting more consumers who like the services 
that they provide.
    Mr. Crowley. So if I may, if there is time, Senator, I will 
also respond. As an advertiser, I do have concerns. Today, 
whether it is pennies or dollars, when you add this up, it is a 
multi-billion-dollar industry. And if prices go up by 5 
percent, 10 percent, 20 percent, those prices are borne by the 
small and medium businesses that need to carry that freight, by 
the large businesses that carry that freight. We are the ones 
that are actually paying for the free Internet. And ultimately 
that translates into prices that consumers have to pay for 
goods and services. So it is quite meaningful.
    The other thing that is concerning is, as Mr. Carter 
stated, Google is the dominant play in search today. And by 
doing this type of deal now, it weakens Yahoo! in terms of 
their ability to compete. It provides a safety net for them not 
to innovate. And advertisers like me and advertisers like Crete 
Truck Sales in Wisconsin or Countertops of Utah in Sandy, Utah, 
those who come to us to place their search engine advertising 
will have less choice, higher prices. That is not good for 
them, and that is not good for the future of this industry. And 
when I look at the page over there, what I see is not 
additional choice. Today I can go to Yahoo!. Today I can go to 
Google. I have that option. I can buy them at competitive rates 
from two independent marketplaces. In the future, for both AT&T 
and for our businesses, we would have to pay higher rates to 
compete for less inventory on Yahoo! and at higher rates in the 
Google marketplace.
    Thank you.
    Chairman Kohl. Thank you.
    Senator Specter, go ahead.
    Senator Specter. Thank you, Mr. Chairman.
    Mr. Callahan, the arguments made by Mr. Crowley seem to me 
pretty impressive, especially when backed up with a 90-percent 
share, which Google and Yahoo! would have. That is a very 
dominant factor. This hearing has been very both interesting 
and illuminating, and we are going to have to followup with 
staffs because we cannot possibly get into all the details 
here. But it seems hard on the surface to accept the argument 
that if you have a combination which gives a market share of 90 
percent that it is not anticompetitive. We are going to 
followup because this is something I want to pursue. But give 
me a 30-second answer to how 90 percent just does not dominate 
so decisively as to hurt consumers?
    Mr. Callahan. Thank you, Senator. The 90-percent figure 
would be accurate if Yahoo! was exiting the business. Yahoo! is 
not going to exit this business. We will continue to sell 
sponsored search advertising, we will continue to be in web 
search, and we will continue to aggressively compete with 
Google in all aspects of advertising. There will be no change 
in how we execute going forward, other than additional 
resources for us to invest.
    Senator Specter. You are talking about Yahoo!, what Yahoo! 
is going to do?
    Mr. Callahan. Yes, sir.
    Senator Specter. But you are representing Google. How do 
you know what Yahoo! is going to do--oh, vice versa? Well, Mr. 
Drummond, the question is to you. How will you maintain that 
kind of vigorous competition?
    Mr. Drummond. Apologies. I thought it had been directed to 
Mr. Callahan. I think he made--that was a very good answer and 
similar to the one I would have given myself. Again, this 
agreement gives Yahoo! complete flexibility about what to do. 
It is not consolidation. There is no merger. We are not--
    Senator Specter. It has flexibility, but still, if you 
exercise it, you are 90-percent plus. That is what the consumer 
has to be concerned with, what your power is.
    Mr. Drummond. If they exercise it.
    Senator Specter. Well, but you have the power to exercise 
it. Let me move to Mr. Smith for just a minute. Now you have 
Carl Icahn entering the picture, and Carl Icahn wants Microsoft 
to acquire Yahoo!. Apparently Yahoo! is worth more money in 
Microsoft's hands than it is in Yahoo!'s hands, or else they 
would not want to have a proxy fight about it. That adds 
another dimension to an already extremely complicated picture. 
Microsoft is trying to buy Yahoo!, and now you have a 
collaborator inside of Yahoo! to help you.
    What are the machinations of that kind of an acquisition to 
add complexity to what this Subcommittee already has to 
consider?
    Mr. Smith. Well, it obviously reflects a fluid situation, 
Senator, and we appreciate that. There is a proxy contest going 
forward, and that is governed by the regulations of the 
Securities--
    Senator Specter. Never mind fluid. It is Yahoo! is more 
valuable in Microsoft's hands than Yahoo! is in Yahoo!'s hands.
    Mr. Smith. I do not know that--
    Senator Specter. Doesn't Carl Icahn think that?
    Mr. Smith. Mr. Icahn has spoken for himself. Let me 
describe what Microsoft did and the position that we took.
    Senator Specter. Carl Icahn has spoken for himself, but 
aren't you working hand in glove?
    Mr. Smith. No. Microsoft made a proposal last week for a 
search deal with Yahoo!, and we provided that to Yahoo!. It was 
conveyed to them, and they turned down that proposal.
    Senator Specter. They turned it down, but if Icahn wins, 
doesn't Microsoft get Yahoo!?
    Mr. Smith. Not necessarily. I mean, first of all, we have 
all recognized that, regardless of who wins the proxy contest, 
no one can guarantee the outcome. There will be a new board. 
The board will have to do its fiduciary duty. You know, we--
    Senator Specter. If Icahn wins the proxy fight, you can 
pretty much tell he will have control of Yahoo!, won't he?
    Mr. Smith. If his slate--
    Senator Specter. Microsoft will buy Yahoo!.
    Mr. Smith. If the nine directors that he has put forward 
win, the nine directors will govern the board of Yahoo!.
    Senator Specter. We may have to have another hearing, Mr. 
Chairman. I have one question for Mr. Callahan, and I will wrap 
up immediately. I saw the yellow light.
    This is very interesting testimony from Mr. Smith on only 
one pole if this deal goes through. You were at the meeting. I 
did not hear you contradict that.
    Mr. Callahan. I disagree with how Mr. Smith characterized 
what Mr. Yang thinks about the market.
    Senator Specter. Never mind the characterization. What was 
said?
    Mr. Callahan. I don't recall that Mr. Yang said what Mr. 
Smith had indicated. But I will say this--
    Senator Specter. You don't recall?
    Mr. Callahan. I am sorry--
    Senator Specter. Does that mean Mr. Smith could be right?
    Mr. Callahan. I don't think it would be appropriate for me 
to comment on Mr. Smith's accuracy or not about how he relayed 
the conversation.
    Senator Specter. Well, wait a minute. You were at the 
meeting. You are a witness.
    Mr. Callahan. Yes, sir. It was a long--
    Senator Specter. What do you say, Mr. Witness?
    Mr. Callahan. What I believe is that Yahoo! sees a 
competitive future with this agreement in place, and--
    Senator Specter. Was there a comment made about only one 
pole?
    Mr. Callahan. I don't recall that comment, sir.
    Senator Specter. Are you standing by your testimony, Mr. 
Smith?
    Mr. Smith. Absolutely. Absolutely.
    Senator Specter. I have not heard the Chairman talk about 
the oath being administered, and I have known Senator Kohl 
since he was elected in 1988. That is pretty tough talk coming 
from a non-lawyer.
    Chairman Kohl. Excellent. Thank you.
    [Laughter.]
    Chairman Kohl. We are getting into serious business here, 
folks. We will have to recess for 10 minutes. There is an 
ongoing vote.
    [Recess from 11:35 a.m. to 11:52 a.m.]
    Chairman Kohl. We will startup again, and we will ask 
Senator Hatch to resume his questioning.
    Senator Hatch. Well, first of all, this has been an 
extremely interesting hearing to me, and we never get a real 
chance to ask all the questions we want to ask. But, Mr. 
Callahan, how will you decide if it is in Yahoo!'s best 
interest to place a Google ad on Yahoo!'s search result pages?
    Mr. Callahan. What Yahoo! plans to do, once the agreement 
is through regulatory review, is to implement sending some 
search terms to Google to backfill ads where Yahoo! does not 
have the same quality ad that could be returned by Google and 
one that would have increased relevance, generate a click. And 
we believe that benefits consumers to the point that Mr. Carter 
had made, that consumers come to the Internet to look for 
solutions to problems. That would create a more relevant ad and 
a better-quality ad. And we think it is good for advertisers as 
well.
    Senator Hatch. Let me ask you and Mr. Drummond this 
question: Mr. Smith in his written testimony argues that under 
this agreement, ``Yahoo! will never have an incentive to sell 
an advertisement for less than Google is offering.'' 
Specifically, a price floor will be created and that this is 
per se price-fixing--that has already come up--based under the 
Supreme Court's decision United States v. Socony-Vacuum.
    I would like you to respond to that argument, because it is 
an interesting argument and it has been raised by a lot of 
people.
    Mr. Callahan. Yes, I can speak first and then turn to Mr. 
Drummond.
    Senator Hatch. I would be happy to have you--well, both of 
you should respond, and then I would be happy to have Brad 
Smith respond.
    Mr. Callahan. OK. There is no pricing coordination between 
the companies as part of this deal. Key word prices--so that 
price, as Mr. Carter indicated, for cents or whatever it may 
be--that get bid will be conducted on a separate Yahoo! auction 
and a separate Google auction. And when Yahoo! has an ad that 
is drawn from the Google system, that ad will be priced at 
whatever the price was on the Google system.
    Senator Hatch. That sounds good, but as a practical matter, 
wouldn't it really basically come down to--
    Mr. Callahan. I don't think we know that, sir. The bid 
price for the ad would depend upon whatever the auction is. It 
would depend on how many advertisers are in that system, what 
the particular key word is, and then, in fact, whether or not 
there is a click generated, because advertisers only pay when 
there is a click. There is no payment from the advertiser is 
the ad is shown, only if it is clicked, which comes back to our 
argument why we believe this will, long term, benefit consumers 
with a more relevant ad in the cases where Yahoo! may decide to 
draw that ad from Google.
    Senator Hatch. OK. Mr. Drummond?
    Mr. Drummond. Sure. Let me just add to that. I think there 
is a fundamental misconception that is being sort of put out 
here about search monetization, and there is this notion that 
Google just has high prices and--
    Senator Hatch. That is what I have--
    Mr. Drummond.--that is the reason--that is the reason why 
Google is successful. So it is amazing that people could 
possibly be successful if all we did was take the same old ads 
that everybody else has and we price them higher. Does anybody 
think that is a successful business strategy? It is not.
    It turns out that what this--this is not, as in the Socony-
Vacuum case, a market about a commodity that different 
purveyors might sell in a spot market. This is a very 
complicated--it is about as far from a commodity as you can 
imagine. It is a very complicated--in terms of the outcome, 
whether an advertiser is going to generate leads and then 
ultimately sales from an ad is a very complicated process. And 
it turns out it is very hard to do, and it depends on search 
traffic, it depends on the types of advertisers, and, most 
importantly, it depends on the quality of the ad and how good 
it is. And it turns out when you get it right, when you start 
figuring out how to do that, what you do is you create more 
clicks, you create more ads that are relevant, that advertisers 
want to see. It is the absolute opposite of what was going on 
in Socony, which was reducing output. It is the opposite. It is 
increasing output because now you are going to have--because 
you have done a better job with the targeting, you now have 
more matches, that is, more consumers are put in touch with 
advertisers, and that is good for everyone.
    So the fundamental misconception here is that the 
incremental revenue that Yahoo! and Google might make in this 
deal has to do with just a price increase. What is going on 
here, as I said in my oral testimony and in my written 
testimony, what is going on here is that there are more ads 
being seen, there are more ads being clicked on, there are more 
relevant ads. And, ultimately, what is important to the 
advertiser is that they get leads from this and that they get 
ultimately sales from this.
    Now, you could have--you know, the dynamics of each auction 
are going to be very, very different. There are different 
players in them. There are different search traffic behind it. 
And there could be cases where the price ultimately is higher, 
and Google could be higher on Yahoo!. But what is important to 
understand ultimately is the value that is being created, so 
what we have here is an increasing pie that Yahoo! and Google 
will share in, and that is good. It is more output. It is more 
supply into the market.
    Senator Hatch. Mr. Smith, you can take some time to answer 
that if you would like, but it just brings to mind if this 
agreement is non-exclusive and Yahoo! is free to make deals 
with other companies, does not this undercut your argument that 
the agreement creates a per se price floor? For instance, 
Microsoft just purchased Aquantive for $6 billion. Does that 
not mean that others will be interested in this market and 
eager to form agreements with Yahoo!? I think it is a relevant 
question, but you can answer to their comments as well.
    Mr. Smith. First, price-fixing agreements are never 
exclusive. They all tend to be non-exclusive, and they are 
usually done with a spirit of ``the more, the merrier.'' That 
is why the Government takes such a hard line against them. And 
while lots of things in this industry are complicated, I don't 
think that the issue that is before this Committee is anything 
but straightforward.
    If this agreement goes into effect, then if Google makes 
more money, then Yahoo! will make more money. If Google raises 
prices, Yahoo! is going to earn more revenue. That is not the 
way the marketplace is supposed to work. And I think Mr. 
Callahan's own use of his props showed it very clearly. He was 
showing the exact same ads, not better-quality ads, not new ads 
that are not existing today, but the exact same ads from the 
exact same advertisers showing up in exactly the same place. It 
is just that they go through Google and they cost more money. 
That is not complicated.
    Senator Hatch. Mr. Chairman, could I ask another question?
    Chairman Kohl. Go ahead.
    Senator Hatch. I don't mean to--
    Chairman Kohl. Go ahead.
    Senator Hatch. OK. Well, Mr. Drummond, in your testimony 
you state that Google does not control the prices charged to an 
advertiser. How can you say that when Google does not determine 
the winner of its auctions based solely on the amount the 
advertiser is willing to pay? Do you not take into account 
``quality scores''? Can you explain what ``quality scores'' are 
and how they affect who is declared the winner of your 
auctions?
    Mr. Drummond. Sure. Actually, we are actually quite glad 
that we pioneered this concept of quality scores in auctions 
for search, and it has actually been a big part of our success, 
which has now, I should add, been copied by Yahoo! and 
Microsoft, who both use them, as well as minimum bids in the 
auction.
    The point of these are to set neutral auction rules that 
apply to everyone who is in the auction, and think of it this 
way: Is it a better experience for a--is it a better overall 
experience to have an advertiser for a camera go in and say, 
``I will pay $50 for an ad on vacation,'' when it could well be 
that that is not a particularly relevant--in other words, when 
people go on vacation, they want places and so forth, right? So 
by attaching, by saying it is not just by how much you bid but 
also the quality of your ad, how relevant it is likely to be--
and we have a variety of things that we have done over the 
years to try to figure out those signals and try to make them 
better, if you factor that into the auction, it turns out that 
you get better ads, you have more people clicking on them, and 
advertisers are then going to come up--going to actually 
compete with each other, not only just on price but to make 
sure that the ads are very relevant. That is good for them, and 
ultimately it generates more value overall and more revenue.
    These are neutral rules that apply to the ad auction. They 
are the same--we have some differences between the companies, 
but all three companies use these, both of these rules. And we 
are not behind the scenes manually manipulating them any more 
than we are manipulating the algorithms that drive our search 
results. It is an article of faith really at Google that, you 
know, we build this auction, we build our search results, and 
we use computers--we really like computers--to make these 
decisions and to make these calculations and to drive these 
outcomes.
    So we have never done any of this manipulation of quality 
scores or bid prices to affect the outcomes of auctions, and we 
never will.
    Senator Hatch. Mr. Carter, when you are marketing your own 
products, do you believe that you have ever been unfairly-well, 
have you ever unfairly lost a bidding competition because of 
these so-called quality scores?
    Mr. Carter. Not at all. And, Senator, that is a great 
question. I would like to explain very quickly exactly how all 
this works from a layman's standpoint and one who is actually 
buying the ads from these three gentlemen to my right. Here is 
what is so amazing about this process.
    What happens is I can actually-if I am extremely creative 
in my ad writing and it is compelling text and it really solves 
the consumer's problem, I actually may be paying very, very--a 
much smaller amount for my ad than a competitor that is paying 
three, four, or five times the amount. He is willing because, 
remember, it is a free auction. In other words, I am going in 
and saying--for my crown molding e-book, I may say, ``I will 
pay you 25 cents a click.'' I may have competitors who say, ``I 
will pay you $1 a click, Google.'' So here is a competitor who 
is willing to pay more. But you know what? If my ad is better 
written and more people click it, say 100 people a day click my 
ad for 25 cents, Google gets $25 or Yahoo! gets $25, or 
Microsoft, whatever is collecting the money. But that person 
who is willing to spend a dollar for a click, four times more 
than me, and his ad is only clicked, say, five times, Yahoo!, 
Microsoft, or Google only gets $5.
    So they have created technology that recognizes that that 
is happening dynamically in the auction, and if you were either 
of these three companies, what would you do? You would force 
that ad, my ad, which is getting more clicks, higher up in the 
stack. So these three companies are not controlling the pricing 
of the auction. It is we as consumers, all of us businesses out 
there that are buying these ads, we are competing against each 
other. All that they are doing is matching us up. They are just 
matching up the people who are coming to search with those of 
us who create these ads, you know, and those of us who can 
write the right ad, the really compelling ad.
    So, no, I have not been ever treated unfairly. In fact, I 
wish I could give more money each day to these companies.
    Senator Hatch. Well, I have to leave. That is a very unique 
comment there, is all I can say.
    [Laughter.]
    Senator Hatch. We love that form of generosity in the 
Federal Government.
    I have got to leave, but, Mr. Smith, do you have anything 
to add on this, on this quality score issue, or anything else, 
for that matter?
    Mr. Smith. Well, I think the important thing to focus on 
here is this is not about Google's overall business, this is 
not about the model in and of itself for the way auctions take 
place. That does have an important impact because prices are, 
in fact, set in what is in truth, I think, a combination of 
bidding by advertisers and the minimum prices that are set. In 
fact, our understanding is that Google sets a different minimum 
price for each advertiser and different quality scores as well.
    Those are important, but that is really not the heart of 
the issue. The heart of the issue is the agreement, and the 
heart of the issue is whether two competitors that account for 
this kind of market share should be able to come together and 
enter into this type of agreement.
    Senator Hatch. Well, thank you all. This has been very 
interesting to me. I want to thank the Chairman for allowing me 
to go on here. I have a lot of other questions, but these 
hearings are--you folks are among the most intelligent people 
who appear before the Judiciary Committee. That may not be 
saying much, but we still think--
    [Laughter.]
    Senator Hatch. We always enjoy having you. It is wonderful.
    Mr. Carter. Thank you, Senator.
    Mr. Smith. Thank you.
    Chairman Kohl. Thank you very much, Senator Hatch, for your 
excellent questioning.
    Mr. Drummond and Mr. Callahan, as part of this agreement, 
the parties have agreed to allow the Justice Department a 
hundred days to review the agreement. Clearly, Justice would 
not have taken this unusual step unless they believed that 
there were legitimate questions about this agreement that need 
to be addressed.
    Mr. Drummond and Mr. Callahan, if the Justice Department 
says it has problems with the agreement, then are you prepared 
to either abandon or change the agreement? Mr. Drummond?
    Mr. Drummond. Well, let me just first say that we actually 
voluntarily called the Justice Department and kind of gave them 
the opportunity to look at it. We just felt that although we 
believe it absolutely is pro-competitive, you know, in terms of 
all the attention in the space and the size of two companies, 
it made sense to have them review it. We are cooperating with 
them on a day-to-day basis, giving them all the information 
they need and explaining the agreement to them. We are 
confident that they are going to, once they understand it and 
go through all of the facts, they will see it the same way. If 
they have any issues with it, we will work through those issues 
with them, most certainly.
    Chairman Kohl. Mr. Callahan?
    Mr. Callahan. Yes, sir, I would echo Mr. Drummond's comment 
and also add that, given the attention that had been on the 
Yahoo! situation from the time of Microsoft's unsolicited 
proposal through this weekend's coordinated--what at least we 
see as a coordinated approach to Yahoo! between Microsoft and 
Carl Icahn and the disruption of a proxy fight, the annual 
meeting that is coming, we did reach out to the Department of 
Justice, as Mr. Drummond indicated, and I think I would echo 
his comments that we would look forward to working through any 
issues.
    Chairman Kohl. Mr. Crowley, we have spoken a lot today 
about the strength of Google in search advertising, yet there 
are, as we know, other forms of Internet advertising, such as 
display. Google has a very small share of these types of ads. 
Doesn't the fact that advertisers do have other ways to 
advertise on the Internet make it unlikely that this deal will 
cause ad prices to rise? And if prices were to rise for search 
ads, as you suggest, wouldn't advertisers just switch to 
display ads?
    Mr. Crowley. Thank you for the question. No, we don't 
believe and I don't believe that display ads are an adequate 
alternative to search marketing. Display ads are generally 
brand advertisers. They are generally wrapped around the page. 
There is a phenomenon called ``banner blindness'' where 
Internet users have been trained not to look at the display 
banners but to look into the search results.
    So there is a place for display advertising on the web, no 
doubt. It is a different type of advertising than sponsored 
search. And from the small businesses that we sell our 
advertising solutions to, we do not see that as a viable 
alternative. There was, in fact, a point in time where we did 
sell display banner advertising to small businesses, and we got 
out of that business and replaced it with the search engine 
marketing solution that we offer today because that is where 
the demand was and that is where the value was at the time we 
made that decision.
    Chairman Kohl. Mr. Callahan, as we have discussed this 
morning, Yahoo! estimates that it will eventually earn $800 
million more annually with this outsourcing arrangement. 
According to industry estimates, this is an increase of more 
than 50 percent from what Yahoo! currently earns. If that is 
the case, why would Yahoo! ever terminate this arrangement? In 
fact, if Google does a much better job of making Yahoo! money, 
will there not be every incentive in the long run for Yahoo! to 
outsource all of its Internet advertising to Google?
    Mr. Callahan. In the analyst conference call around June 
12th, we did note that we saw this as a potential revenue 
opportunity of $800 million on an annual basis, but that we 
expected in the first year following implementation 
approximately $250 million to $450 million of operating cash 
flow. And our incentive under this agreement reflects how the 
agreement is structured, that we have the option to use the ads 
where we think it helps on the quality and obviously helps 
Yahoo! generate this additional cash-flow. Our incentive is to 
sell as many Yahoo! ads as possible. We keep all of the revenue 
from those ads. Our incentive as we go forward is to maintain a 
robust marketplace in search advertising, and that depends upon 
advertisers like Mr. Carter but also user traffic. And creating 
user traffic and drawing user traffic is based upon a relevant 
page, which is the overall relevance that is helped by better-
quality ads, and some of those may come from Google.
    Chairman Kohl. Well, Mr. Smith, wouldn't you agree with the 
premise of my question?
    Mr. Smith. I absolutely would agree with the premise of 
your question, Senator, because to the extent that prices on 
Google continue to rise, then it is clear that Yahoo! will have 
every incentive to send more ads to Google.
    Now, it is certainly true as well, as Mr. Callahan 
suggests, that in some cases their prices may already be as 
high as they are on Google and they will not send those. But 
where they are lower, every incentive is to send ads. When you 
put that together, it really does constitute an effective floor 
on prices. Yahoo!'s prices may never be lower than Google's 
prices because whenever they are, Google will set the price and 
Yahoo! will send them the ads.
    It is bad news for advertisers.
    Mr. Crowley. Chairman Kohl, if I may comment on that?
    Chairman Kohl. Yes, Mr. Crowley.
    Mr. Crowley. Mr. Drummond did mention that this is hard, it 
is complicated, and I think that is the point: that it is 
difficult, it is not easy to do, and we want to see Yahoo! 
competing vigorously, fairly in the market to bring their 
services up to par, to be an adequate alternative to Google. 
And by renting out their real estate to Google and accepting 
the money from Google and decreasing that incentive to innovate 
and compete, we think it is bad for the market and bad for the 
future.
    Chairman Kohl. Mr. Smith, let's be as frank as we can in 
this hearing this morning. Is it not true that your opposition 
to this agreement between Yahoo! and Google is highly motivated 
by the fact that Microsoft wants to acquire Yahoo! yourself? 
And wouldn't such an acquisition be just as anticompetitive as 
the deal we are talking about this morning?
    Mr. Smith. A fair question, certainly, Senator, and let me 
say a few things in response.
    First, yes, Microsoft has obviously been strongly 
interested in coming to some kind of important transaction with 
Yahoo!. Now, there have been different terms, different forms 
that have been discussed over the last 6 or 7 months, but we 
clearly have that interest, and that is unquestionable.
    But, second, we would have serious concerns about this 
agreement regardless of whether there was any possible 
transaction with Yahoo!, and there may not be a possible 
transaction with Yahoo!. It has not worked very well so far, as 
everybody has seen. So independent of whether there is ever an 
opportunity for Microsoft to do anything with Yahoo!, we do 
have concerns about this kind of arrangement.
    But then, third, it is also a fair question: What would the 
world look like, what would this market look like, if Yahoo! 
and Microsoft were to come together in some way around search 
and search advertising? We believe that would create a more 
competitive market because this is a very scale-based business. 
It does require very substantial capital investments. One needs 
to have a critical mass of market share in order to ensure an 
ongoing and sustainable level of competition. And if Microsoft 
and Yahoo! were to team up in some way, you know, we would 
bring together 20 to 30 percent of the market. We would have a 
critical mass, and the market would be more competitive.
    So our view is that if you put a small number 2 and an even 
smaller number 3 together to balance this gigantic number 1, 
that is going to lead to a more competitive balance and more 
competition that is sustainable.
    Mr. Drummond. Senator, do you mind if I just respond to 
that?
    Chairman Kohl. Yes, Mr. Drummond.
    Mr. Drummond. Let me just say that there really are two 
alternative scenarios here, and I guess when you start 
thinking--you have got to think about which one is better. You 
have an independent Yahoo! that makes an arrangement with 
Google that is going to lead to better ads for consumers, so 
they get better information than they had before because of 
Google's ad technology. Advertisers are going to get more leads 
than they had before. The pie of advertiser value grows 
incremental from what we have today. And Yahoo! actually is 
able to generate additional--you know, gets a share of that, 
the lion's share of that, I should say, and reinvests that into 
the rest of their businesses and stays as an independent 
competitor in this market.
    Or you can have a situation where Yahoo! is gobbled up by 
Microsoft, eliminating them from the competitive playing field, 
and Mr. Smith wants you to believe that the only business that 
our three companies are engaged in is search. Well, it turns 
out that is Google's primary business, but it turns out also 
that both Microsoft and Yahoo! have very large display 
advertising businesses. Yahoo! is number 1. Microsoft is number 
2. They have hundreds of millions of e-mail customers between 
them. They are two of the leading instant messaging companies, 
and on and on and on.
    So this is not about search entirely. It is about the 
Internet in general. I think there would be significant 
concerns about a combination of those two companies.
    Chairman Kohl. Mr. Carter?
    Mr. Carter. Senator Kohl, I can tell you that from my 
standpoint as a publisher and as a consumer, I want all three 
of these companies to survive. I do not want anybody to be 
gobbled up by anybody because as a buyer of ads and as a 
business that can actually take that same advertising, please 
understand, I am currently doing the exact same deal with 
Google, and I was approached by Yahoo! several years ago to do 
what we are here talking about today, meaning I display Google 
ads on AsktheBuilder.com. It took me 5 or 10 minutes to put the 
code on my website to do that. Then, instead of me out there 
trying to sell my own ads, I am able to go back and write more 
columns or write more content or make more videos so that I can 
have more ads.
    So I want all three of these companies to survive and to 
thrive, and I can tell you that the marketplace is making that 
happen now. And once again, I will just reiterate, the reason 
that I feel that Google is so powerful in the search marketing 
area is because they did such a good job early on in being able 
to match those ads with the search term that people were 
searching for. And that is really what the crux of the matter 
is, in my opinion. And we absolutely want to see Yahoo! improve 
their search algorithms. I want to see Microsoft work 24 hours 
a day to improve theirs. And I want to see who the number 4 
player is. I don't know who that is. Maybe Dogpile is going to 
come back to life. Maybe AltaVista is really going to get 
juiced up again. But the point is there are other search 
engines that are out there, and I am telling you, history will 
prove it right, and we may all be dead in this room when it 
happens. But I am telling you that there will be a company that 
is going to crush all three of these people.
    [Laughter.]
    Mr. Carter. It will happen. They don't want to hear that, 
but history has shown that to us. And we have got a rich 
history in this country.
    And remember, once again, all I want to add is that if you 
block this deal, if you go down that pathway, am I going to get 
a letter from you 1 day? I mean, that is a question I will ask 
you, because I am on my way to becoming the most popular home 
improvement website, Yahoo! is the most popular, most visited 
website right now. So are you going to then say, ``Tim, sorry, 
you cannot do Google ads anymore''? Come on. That is un-
American.
    Chairman Kohl. OK. Mr. Callahan?
    Mr. Callahan. Yes, Mr. Chairman, I thought I should 
comment. There has been some discussion about Yahoo!'s future, 
and I thought it would be appropriate for me to say that, 
consistent with what we have said from the beginning, Microsoft 
had made an unsolicited proposal and then subsequently withdrew 
it. They made a joint proposal to acquire a search business and 
restructure the company with Mr. Icahn over the weekend, and we 
rejected that. Consistent throughout that process has been 
Yahoo!'s board's focus on stockholder value, and I would like 
to reassure Mr. Crowley and Mr. Carter and others that we will 
continue to innovate with this agreement in place, continue to 
compete, and continue to build a stronger Yahoo! for the 
future, however that path may take us.
    Mr. Crowley. Senator Kohl, if I may? Like Mr. Carter, I 
agree. I want three viable, four viable, five viable 
alternatives in the search market. Mr. Carter also stated that 
it is working today. My concern is that I don't know that there 
is just two options, as Mr. Drummond has suggested. I don't 
know that there are not other alternatives for Yahoo! to get 
funding or to continue to innovate. And in this situation, we 
see it as a concern because you have got Yahoo!, who is wanting 
to innovate, we are wanting to compete, getting out of a large 
part of their business, ceding it to their largest rival.
    If you take a comparison, let's just look at an auto deal. 
What if the by far No. 2 auto dealer gave up a significant 
amount of its floor space to the dominant auto dealer in the 
market, but then said that they were going to use the proceeds 
from those sales to come back and compete with that same auto 
dealer? It just--it does not seem to make a whole lot of sense, 
and I think there are better ways for Yahoo! to compete, and I 
think there are better ways for us to have a better search 
marketing ecosystem.
    Chairman Kohl. All right. One last question, folks. 
Generally, bid prices for search advertising are lower on 
Yahoo! than on Google. If Google's higher prices are now used 
to sell ads on Yahoo!, does not this deal eliminate the choice 
for small advertisers who would rather allocate their marketing 
budget to Yahoo!? Mr. Smith.
    Mr. Smith. Well, that is precisely one of our concerns, and 
while Mr. Callahan talks about Yahoo! taking the proceeds and 
reinvesting, the reality is that advertisers who find that 
their ads are no longer being winnable at Yahoo! are going to 
have a lot of incentive to just shift their business to Google. 
And the Yahoo! folks have talked about various ways they would 
like to avoid that, but I think that result is, in fact, 
unavoidable the way this agreement has been set up.
    The reality is when Google's prices rise, Yahoo! makes more 
money. That is not the way the number 1 and two players in a 
market are supposed to interact.
    Chairman Kohl. Yes, Mr. Carter?
    Mr. Carter. Senator Kohl, I think the reason for the facts 
of why those prices are lower is because there are fewer people 
in that auction at Yahoo!, and with no disrespect to Mr. Smith, 
the same is happening at Microsoft, meaning when I buy ads on 
both of those search engines, I can get clicks for less money. 
But that being said, if I can get--from my standpoint as a 
businessman, I make more money than when I am buying from 
Yahoo! and Microsoft. So, in other words, that is why I want 
all three of them--and just like Mr. Crowley said, I want a 
fourth and a fifth search engine to come into the marketplace 
because I want there to be even more competition than there is.
    So I can tell you that the marketplace is controlling these 
prices, and don't forget, sir, that each of these websites--
Microsoft, even Google, even Yahoo!--they have other real 
estate on their pages that they can devote to revenue. And one 
of the points that Mr. Callahan said earlier is really, really 
important. Please understand that when a person at Yahoo! 
clicks a Yahoo! ad, Yahoo! keeps all the money, just like at my 
website. When I sell ad space of my own, I get all of the 
revenue. I do not have to split it with Google or anyone else. 
So that is really, really key here. Remember, you are only 
talking about a small slice, potentially, of the real estate on 
these pages. And if Yahoo! discovers that all of a sudden they 
are making more money by selling these particular ads, they are 
going to either turn off the Google ads, like I do--I turn off 
Google ads on my own pages. They probably don't like to hear 
that, but I get more money from certain advertisers. Too bad. 
You know, maybe they need to do a better job and get better 
prices in the auction.
    So it is a very dynamic thing, and you have to go very, 
very slowly here, because you may end up hurting somebody like 
me 5 years from now, and I will not be real happy about that.
    Chairman Kohl. All right. Gentlemen, that will conclude 
testimony at the hearing. We will leave the record open for a 
week. I would like to thank all of our witnesses for being 
here.
    Today's hearing demonstrates the importance of this market 
and that this deal does raise significant competition concerns. 
So we will continue to examine this transaction closely in the 
days and weeks ahead. We will also be following the news 
regarding the possibility of future consolidation in this 
market and its impact on competition.
    We thank you all for being here. The hearing is adjourned.
    [Whereupon, at 12:24 p.m., the Subcommittee was adjourned.]
    [Questions and answers and submissions for the record 
follow.]

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