Googling costs more than you think

The internet is available free to almost everyone, seemingly limitless in scope and scale; and doesn’t come with a tax bill attached. I value the role played by the internet companies. Their innovations enhance our quality of life. But I do not value them because their products are “free.” Really, they are not “free.” We pay for them through myriad transactions as advertisers pass on the costs to us.

There are different kinds of “free things.” First, there are the tax-financed free things: the NHS, the BBC, roads, national defence, policing, schools, blue skies research. The internet, originally, started this way in the US defence establishment. Second, there are the free things provided by nature but most of these require some kind of investment to extract and are depletable (forests, water supplies, fisheries, grazing land, minerals and oil) and so have to be paid for. Third, there is the “gift economy” where, for aeample, apparently “free” inkjet printers, or razors, subsequently require expensive cartridges or replacement blades.

There is a fourth variant of “free things” which fits closer to much of the Google Apple Facebook Amazon model: goods and services which are free to the final consumer but paid for by commercial advertising. A lot of free-to-air TV operates on this basis (ITV, C4, C5), commercial radio and “free” newspapers.  In the early days of their life companies like Google seriously considered adopting a consumer subscription model, like Sky’s paywall for TV and newspaper access, but judged that it would be too market limiting and the transaction costs too high.  Their decision to go down the advertising route must be regarded as one of the best business decisions in history.

Google’s success is not merely the result of adopting an advertising model but of highly innovative development of that model. The use of keywords in contextual advertising and the development of adwords has made advertising far less disruptive to the consumer than, say, watching commercial television. And it has been able from its advertising revenue to expand its “free” tools (Gmail; Google maps), develop new small companies and invest heavily in projects like autonomous cars or voice recognition.

The key point however about the Google models is that “free” is not free.  Where services are paid for by advertising they are paid for by us, since advertisers pass on their costs in a hidden charge on the goods and services we buy.

The question for policy makers is how to measure the contribution that these companies, and particularly the “free” internet services providers, make to their shareholders and wider economy. Google, Facebook and the other largest internet companies have a market cap comparable to, or larger than, traditional corporate giants like Exxon or Shell. It is reasonably easy to establish how much Exxon, say, is worth, but adding the value of its oil and gas reserves and subtracting the costs of production.

But if we take Apple, research suggests that barely a third of the costs of an iPad can be explained by the cost of the raw materials and the distribution costs. The rest is what the consumer pays for access to intellectual property in Apple’s operation, including the value of its brand.

In the case of Google, the position is even more extreme: very little labour (17,000 employees worldwide), virtually no distribution costs or raw materials. The value of the company is the sum of its advertising revenue and since the advertising involves Google in minimal cost this revenue depends on pay-outs for Google’s IP and brand.

Joan Robinson’s work on imperfect competitions and Galbraith’s more popular writing on modern capitalism explained, half a century ago, long before the internet, how various forms of monopoly protect major companies from competition. Monopoly rent accounts for much of their profits. Google has a virtual monopoly position in internet searches. A study several years ago showed that Google operated at levels of profitability four to eight times the US corporate average. Undoubtedly market dominance plays a significant role.

But we should not exaggerate. There is direct competition in the advertising market (Facebook) and indirect competition from traditional advertising markets.

This debate is characterised by unhelpful extremes. It is absurd of Google to claim that its contribution to the US (and world) economy is measured by the sum of its advertising revenue: absurd since much of the advertising would have happened in any event, albeit less efficiently.  It is equally misguided to minimise Google’s economic contribution; some have complained that its economic contribution could be negative by suppressing competition. Common sense tells us that some of its innovations are value enhancing. Google maps, one of its relatively minor products, considerably reduces the commercial and personal time spent searching for destinations.

Now, you could say, isn’t the malign nature of those companies demonstrated by their tax arrangements? Many companies and individuals have long sought to minimise their tax liabilities by shifting their declared earnings to low tax jurisdictions. The global nature of the internet makes such shifting much easier, and more difficult to detect. Isn’t this unacceptable? Undoubtedly from the standpoint of governments. And as a former government minister in a country which saw the leading Internet platforms playing derisory tax on their UK business, I naturally agree. But if nation state governments are so naïve and incompetent as to perpetuate uncoordinated national tax policies in a globalised economy who can blame companies for taking advantage?

Vince Cable will be discussing 'What's Going on with the Global Economy?' at Royal Festival Hall on Saturday 25 June as part of Southbank Centre's Power of Powerfestival. For more information please visithttp://www.southbankcentre.co.uk/whatson/festivals-series/money-weekend