FTC to Block Microsoft-Activision Merger
Chair Lina Khan has sued Microsoft to block its acquisition of gaming giant Activision. This is the second big tech merger under review.
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Today the Federal Trade Commission sued Microsoft to block its acquisition of Activision. That’s the second challenge ever to a big tech merger, so that’s what I’m writing about.
I’ll also go over a few other important developments in antitrust.
The trial of Meta’s acquisition of metaverse company Within began today.
Congress is nearing failure in the attempt to deliver on antitrust legislation.
The Biden administration encouraged the Supreme Court to attack Google’s core business model.
“The largest digital platforms are enormous and there are a number of antitrust investigations and actions that indicate a widespread concern about competition problems with those platforms. However, it is not correct to equate ‘big’ with ‘bad.’” - Microsoft consultant and former Obama antitrust enforcer Fiona Scott Morton
The Nice Monopolist
A little less than a year ago, Microsoft announced the biggest tech merger of the year, a $69 billion takeover of video game maker Activision, which makes popular games such as Call of Duty, World of Warcraft, Diablo, and Overwatch. At the time, I characterized the deal as ‘bringing a cannon to a knife-fight,’ because Microsoft doesn’t actually make money through its video game division and doesn’t need to. It simply cross-subsidizes its entry and dominance in gaming from its various other revenue streams, whether that’s Microsoft Office, Windows, or cloud computing.
And this is not a fair fight. While Microsoft’s market capitalization is $1.8 trillion, its main rival in gaming, Sony, has a market capitalization of $100 billion.
Today, the Federal Trade Commission announced it will be suing to block the deal. The FTC argues that Microsoft, if it completes the acquisition, could use Activision’s ‘must-have’ content to privilege its own services, including its Xbox gaming platform, its Game Pass subscription service, and its cloud-based game offering. It could deny this content to its rival, Sony, to encourage consumers to use its Xbox console instead of Sony’s Playstation, and more broadly, Microsoft products and platforms instead of those of rivals.
This is a legitimate threat. People buy video game systems based on the games available on those systems. How must-have are Activision games? Call of Duty, from its launch in 2003 up through 2020, has generated $27 billion in revenues, and comprised 10 of the top 15 console games sold between 2010–2019. That’s… a lot. It’s also a multi-player game, so it has lock-in, because people want to play with their friends. If you can’t get Call of Duty on a platform, you will likely buy a different platform. And that’s the leverage Microsoft is trying to get with the purchase of Activision.
This acquisition fits in with the strategy of Microsoft has been using for years. It has bought ten publishers recently - and then made many games by those publishers exclusive to its platforms. This strategy is exactly why the Federal Trade Commission is challenging the firm. “Microsoft has already shown that it can and will withhold content from its gaming rivals,” said Holly Vedova, Director of the FTC’s Bureau of Competition. “Today we seek to stop Microsoft from gaining control over a leading independent game studio and using it to harm competition in multiple dynamic and fast-growing gaming markets.” Basically, this is another vertical merger challenge.
The competitive dynamics of this industry reflect a rapidly consolidating space. There are only two real high-powered consoles, Microsoft’s Xbox and Sony’s Playstation. (There’s also Nintendo’s Switch, but it is really a different market segment.) People can play on personal computers and phones as well, and one can play multi-player games across platforms if the publishers allow it. Microsoft has tried to capture power over distribution not just through its Xbox console, but via its Game Pass subscription service, as well as its cloud offering where you don’t have to download a game to play.
In gaming, content is king, and content is also very expensive. The top independent studios who make expensive must-have content are Activision, Electronic Arts, Take-Two, Ubisoft, and Epic. Microsoft is both a rival and partner with these studios, since it wants to keep their content on its platform, but also competes with them to sell games. The more compelling the content on Xbox, Game Pass, or its cloud-service, the more appealing to develop for Microsoft, and the more bargaining power Microsoft has against rivals.
The basic goal behind the merger is a bit of offense and a bit of defense. The offensive rationale is that Microsoft wants to monopolize the video game market, which is roughly $200 billion a year of revenue.
With this purchase, Microsoft will be the third biggest gaming firm in the world, controlling the X-Box console platform and a lot of game development and intellectual property (as well as Activision’s in-game advertising business line).
The key strategic rationale behind this deal is to build up a walled garden for Microsoft’s gaming division, which runs a Netflix-style subscription service called Game Pass. Game Pass, at $14.99/month with likely heavy subsidies by Microsoft, is a very good deal for gamers, and developers, or at least, it is right now. Last year, Microsoft bought Bethesda Softworks, a gaming studio, and is adding its stable games to the Microsoft ecosystem. Bethesda now does exclusives for Microsoft, and it is likely that Activision games will eventually offer some exclusives as well. The idea here is to battle with Sony, which is the second biggest gaming firm with its PlayStation platform, over control of key titles.
So far, I’ve just discussed consoles. But there’s another set of powerful entities looking at gaming as their profit center - the phone monopolists. Apple and Google both have app stores on their phones, and can tax app developers - including games - at 30% of their revenue. So the defensive rationale of Microsoft building up its moat in gaming is all about breaking the power of Apple and Google over the mobile realm. In a recent Wall Street Journal piece, Microsoft President Brad Smith argued that Apple and Google have ironclad control of the mobile gaming sector because of their chokehold on App Stores. As Smith wrote, acquiring “Activision Blizzard would enable Microsoft to compete against these companies.”
A Microsoft antitrust consultant, Fiona Scott Morton, followed up with a brief written for the company fleshing this out in detail. In a rather astonishing argument, Scott Morton claimed Microsoft, if it can complete the acquisition, will have the ability to lobby its way into opening up the mobile sector. Microsoft and Activision together would have the “technological and legal skills,” she writes, to move regulators to target the monopoly power of Apple and Google, and then “build a rival app store.” Basically, Microsoft can out-corrupt the corrupt monopolists. I can’t take an argument like that particularly seriously, but clearly people at Microsoft do.
And then there’s the politics.
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A key rationale for the deal is that, well, Microsoft is nice. Big tech has been in the cross-hairs of policymakers for years, but Congress basically left Microsoft alone in its investigation of big tech firms Apple, Facebook, Google, and Amazon. Here’s the Wall Street Journal making the point with a headline last April.
Microsoft executives believe this narrative, and think it’s because they have a diplomacy-first mindset. But the truth is simpler. Apple, Facebook, Google, and Amazon have all grown recently, and expanded into areas harming existing incumbents. Microsoft’s monopoly is old, and so it doesn’t have to step on any toes to keep it. The firm is certainly crushing competitors in security and business software, but that’s to be expected. That’s Microsoft’s turf.
In fact, the reason Microsoft can afford to get into gaming is precisely because it was the original big tech monopolist, and while it was pushed back by a series of antitrust suits in the late 1990s, it never faced real competition in its main lines of business.
Microsoft still has durable market power in key segments of the software industry, garnering roughly $20B a year from its operating system Windows and $35B a year from Office. Operating systems and spreadsheets/word processors should be commodified by now, 35 years after they went mainstream. That Microsoft is still making insane margins - and the software is in some ways less user-friendly than it used to be - suggests that there is not real competition here.
The cross-subsidization of its entrance to video gaming is coming from the tens of billions of dollars it pulls out of the economy every year due to its market position. Nevertheless, the firm doesn’t see itself as a monopolist, and policymakers in D.C. don’t feel particularly threatened by it.
To get this deal done without a challenge, Microsoft used this reputation to its advantage. It used a ‘be nice’ strategy. It signed a neutrality deal with the Communications Workers of America, essentially saying to unions they can unionize the company. CWA’s President came out encouraging the merger, with an oped titled “For once, the FTC is considering a merger that helps the workers.” This is a meaningful concession, and likely took some legal arguments off the table. It’s harder to make a labor buyer power claim if the buying firm is helping to increase the bargaining power of its workers. Microsoft also claimed it would give Sony and Nintendo access to must-have content, like Call of Duty, for ten years. Of course, this promise is undercut by Microsoft having made a similar promise to EU regulators when it bought Bethesda games, including Starfield and Redfall. The firm lied and quickly made those games exclusive.
Ultimately, concessions can’t fix this deal. It’s not just that concessions almost never work. The basic goal of this deal is to consolidate the industry, and whether that is done by a ‘nice’ monopolist or a mean one, that’s unlawful. Microsoft is in a race to take video gaming and turn it entirely into a set of walled gardens, like Netflix/Disney/Amazon/etc have done to Hollywood. Combining distribution and production is known as ‘vertical integration,’ and vertically integrating a creative industry into a small set of oligopolists is quite dangerous. In Hollywood, it’s basically impossible now for independent producers to create content and get distribution on a streaming service without giving up most of the intellectual property and revenue. In gaming, we’ll have the same problem. There will be a few walled gardens, and that’s it.
Gaming is already most of the way there, but it’s not entirely consolidated. In fact, if there’s one criticism one can make of this merger challenge, it’s… what took you so long? Gaming firms have been buying up rivals for decades, and trying to Netflix-ize the space. Blocking this merger is a first step to reverse this trend. One could easily note that we need a lot more than just one merger challenge here, and that’s true. But, well, if Microsoft, the ‘nice’ monopolist, with its trillions of market capitalization and endless amounts of good will, loses this case, then it sends a long-overdue signal to everyone in the economy.
Meta Merger Trial Begins
In July, the FTC challenged Meta’s acquisition of virtual reality fitness app creator Within. Today, an eight-day hearing in San Francisco started where a judge will hear the case. Antitrust lawyer Lee Hepner, who is a colleague, was in the courtroom and tweeted out the proceedings.
It’s a significant case for the FTC for a number of reasons. For one, it’s the first challenge to a big tech merger. I don’t know that it actually matters that much if the FTC wins or loses, because it’s clear the government will keep bringing cases. But if Meta loses, it’ll make it harder for big tech firms to buy their way into markets.
Two, there’s a creative legal theory at work, which is that a dominant firm like Meta can serve as ‘potential competition’. It’s a theory that hasn’t been used in decades, but it’s quite reasonable. Meta controls more than 70% of the virtual reality headset market. It has the resources to build a fitness app, and would do that if it couldn’t buy into the market. And the government proved this today, showing that, prior to the acquisition, Zuckerberg sought to work with Peloton around fitness in the virtual reality space. Presumably, that need disappeared once Meta bought the leading fitness app.
Meta rejected the government’s case, naturally enough. The firm argued that every part of the virtual reality market is competitive, that the FTC’s market definition is wrong, and that the purchase of Within is warranted because having a headset producer and game publisher under the same roof is efficient. It’s basically a standard ‘everything the antitrust agencies say is stupid’ defense. But it may work, because nearly every witness works for either Meta or Within, and has an incentive to pretend that what they wrote down in documents about the competitive dynamics in the market was silly and overwrought. But it may not. It often depends on the judge.
I also found this line amusing, which makes Meta sound like a pretty bad place to build anything.
Congress Near Failure
Back in October, the House of Representatives had a shocking vote to strengthen antitrust law, with 39 Republicans and 203 Democrats joining together to improve the law. That showed a majority of members supported stronger antitrust law. But of course, moving law requires passing both houses, and while there were the votes to pass antitrust bills, and while Senator Majority Leader Chuck Schumer had publicly promised to hold a vote to pass antitrust bills, he simply… didn’t. Instead, Schumer is using Senate time to confirm judges, which he could do next month or the month after. But Schumer has always disliked antitrust law, and needed to find a way to kill the tech bills. So that’s what he’s doing, simply running out the clock.
Today, there was a last-ditch effort to move antitrust legislation through the Senate, using a procedure called hot-lining, which allows any Senator to object to a bill. Conservative Republicans Mike Lee and Tom Cotton, who were behind stronger antitrust rules, proposed to move an antitrust bill that would let state attorneys general have antitrust suits heard in their own home courts. Libertarian Rand Paul objected. He cited the U.S. Chamber of Commerce, and then argued that stronger antitrust would allow the Biden administration to impose critical race theory across the economy.
This collapse follows another attempt to move antitrust legislation falling apart yesterday. In that case, the JCPA, a bill to help newspapers, was removed from a legislative vehicle that would have passed. The reason is Facebook, the ACLU, left-wing groups Free Press, and right-wing outlets like Breitbart managed to throw up enough noise to make Senators pull the bill. Behind all of them was Rupert Murdoch, who I’m told opposed the bill.
There’s a slight chance these could move in the next few weeks, but if they don’t, it’s really too bad. I had hoped something would pass. We’ll strengthen the law eventually. Right now, there may not be the consensus to do that. But we’ll get there.
Google’s Absentee Ownership
Since 1996, businesses have been able to build sites and apps premised on the idea that they will not be held responsible for what users do with them. This is due to a law called Section 230 of the Communications Decency Act.
Because of this law, the internet is, as I noted in 2020, a dumpster fire of scams. For instance, Google has earned millions of dollars from companies selling fake health care plans, and has allowed advertisers to put up ads for fake customer service for Netflix as well as fake Microsoft Windows support. Facebook regularly facilitates counterfeiters buying ads on its platforms, and facilitates online scams.
Why? It’s pretty simple. The law lets these firms make money doing so. Section 230 immunizes corporations from any consequences for the content of ads bought on their platform; they can’t be sued for facilitating fraud and counterfeiting, so they don’t have any incentive to do anything about it.
That may be about to change. The Supreme Court is hearing a case, Gonzalez vs Google, in which the family of a victim murdered by ISIS terrorism is suing YouTube for radicalizing people into becoming terrorists. Google defended itself by saying it is immune from liability for promoting videos it hosts, as it is protected by Section 230. Putting aside the merits of the underlying claim, the Department of Justice just weighed in with a statement on how it sees Google’s liability. The government argued that Google, while not liable for the ISIS videos themselves, can be sued for the use of its algorithm to promote those videos, as well as selling ads against those videos. If the Supreme Court goes for this interpretation, it would significantly narrow the scope of Section 230.
If you can be held responsible for promoting content and selling ads against it, that’s a major and long overdue change in the legal underpinnings of the internet. It’s not clear how the Supreme Court will rule, but one thing is for sure - Google lobbyists are very unhappy.
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Matt, could you sometime put together an article that deal with the notion that "It's my/our company and if we want to sell it and we can find a buyer, why shouldn't that be our right?" Even hostile takeovers seem "hostile" only to the point that the buyer finally finds the right price.
And a second point. While we say that we favor free markets, corporations understand that a monopoly position is good for them, and free markets be damned. (I think) we know that free markets lead to more industry innovation than does monopoly, but competition requires nimbleness, and I am not sure enough managers of today have this nimbleness
This is great, thanks. I'm more worried about Microsoft rolling up the software development space than anything else, but this acquisition is ludicrous. This also feeds their id management & tracking systems. I shudder to think how that fits with AB's honestly pretty predatory games (microtransactions, loot boxes, etc).
It's not just the console space either. PC gaming has had launcher battles for decades, all trying to see who you are & what you're playing, make sure you're playing "legitimate" games, and of course serving ads. Microsoft doesn't have to participate in that as long as it can force that windows xbox service, and every acquisition makes it more tolerated.