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Microsoft's Acquisition of Activision Blizzard King: Too Big to Pass the Antitrust Test?

Mainak Mukherjee and Tanisha Mishra are third-year students at National Law University and Judicial Academy, Assam.

Introduction

Microsoft recently announced its plan to purchase Activision Blizzard King for a whopping $68.7 billion deal. If it goes through, the deal will be the largest ever in the gaming industry and will help Microsoft become the third largest gaming company in the world. However, given its enormous size, the transaction has raised a few eyebrows and sparked debate about its anti-competitive implications. Consumers fear that this deal will result in a monopoly where Microsoft severely affects the competition in the gaming market by making all Activision Blizzard-developed games exclusive to Microsoft platforms—personal computers and Xbox consoles. The Federal Trade Commission [‘FTC’], the executive regulatory body in charge of reviewing the antitrust implications of such mergers and acquisitions, is expected to have a close look at this deal, and possibly review it. In this article, the authors will analyze the deal’s antitrust implications and whether Microsoft’s acquisition of Activision will indeed result in a monopoly.

The Monopoly Debate

Recently, the FTC and Department of Justice [‘DoJ’] announced that they would rewrite the merger guidelines, which is why the Microsoft-Activision deal is expected to face some strict scrutiny. The Hart-Scott-Rodino Act of 1976 makes the FTC and DoJ the two main regulatory authorities which oversee and review transactions that affect commerce in the United States. Additionally, the Sherman Act, 1890 and the Clayton Act, 1914 are the two major antitrust legislation in the US.

While Microsoft acquiring a game developer does not come as a surprise after its recent spree of acquisitions, the Activision deal has left consumers worried about its potential impact on killing competition in the market. Activision Blizzard is one of the most popular video game developers in the market, with famous titles like (a) Call of Duty, (b) Overwatch, (c) World of Warcraft, and (d) Candy Crush under its belt. These games attract players from various platforms—Sony; Nintendo; Android; Apple. This is where the monopoly debate comes in, as it is feared that once Microsoft adds these famous titles to its gaming library, it will have the power to impact the supply and accessibility of these titles to non-Microsoft platforms. Before we proceed with the legal analysis of this debate, it is important to determine if this deal will be treated as horizontal or vertical integration. This shall be discussed in the following heading.

Deal Categorization: Horizontal or Vertical?

Horizontal integration is the merger of two companies that provide similar supply chain functions for a common product, whereas vertical integration is the merger of two companies that provide different supply chain functions. For example, if Coca-Cola and Pepsi merged, it would have been a horizontal integration; however, if Coca-Cola merged with a company that manufactures containers, it would be vertical integration. Microsoft is a gaming platform developer, whereas Activision is a company that manufactures games that are played on gaming platforms. Since Activision lies below Microsoft in the chain and is not a company that is directly competing with the services of Microsoft, the acquisition must be categorized as vertical integration.

Horizontal integration tends to attract more legal scrutiny than vertical; however, few vertical integrations have the potential to impact competition in the market adversely. Vertical mergers can adversely affect competition as they affect the buyers in the downstream market, which are then passed on to the final consumers. For example, if Coca-Cola acquires the only premium container manufacturer in the market, it could be difficult for Pepsi to sustain its container project.

Recently, the FTC in the matter of Nvidia Corporation, a corporation, Softbank Group Corporation, a corporation, and Arm, Ltd., a corporation, sued Nvidia to block its $40 billion acquisition of Arm on antitrust grounds. Nvidia, a graphic processing manufacturer, announced that it would acquire Arm, a neutral supplier of chipsets used in all graphic processors (even by Nvidia’s rivals). The FTC saw this as a vertical integration that would stifle competition in the market as the proposed acquisition would “...substantially lessen competition in multiple markets because it will create a combined firm with both the ability and the incentive to use its control of Arm to diminish competition by undermining Nvidia’s rivals”. Based on the FTC’s complaint, the deal was later terminated by Nvidia and Arm. The Microsoft-Activision deal is somewhat similar to Nvidia’s proposed acquisition of Arm since it concerns a vertical integration of a neutral game producer—Activision Blizzard; however, it remains to be seen if the FTC will adopt a similar strict approach in reviewing the Microsoft deal. In the following heading, we discuss the relevant market.

Determining the Relevant Market

Determining the relevant market helps to find the smallest possible market that would be affected by a “small but significant non-transitory increase in price” [‘SSNIP’]. However, in the case of gaming consoles, it is challenging to establish a relevant market. For example, if console makers increase the price of Call of Duty, consumers would probably start purchasing another alternative first-person shooter [‘FPS’] game such as Battlefield. However, if console makers increase the price of all FPS games, consumers will switch to third-person shooter games, which serve as an alternative to FPS. Nevertheless, suppose console makers increase the price of all games that are available in the market. In that case, it could pave the way for two possible outcomes: one is where consumers begrudgingly pay the high price due to a lack of suitable alternatives, or they switch to personal computers or mobile phones to play these games. While the first issue establishes the console market as the relevant market, the second does not, and it questions the reasonability of the classification of the relevant market.

Although the mobile gaming industry is growing very fast, comparing a mobile device with a console gaming platform is unreasonable. The argument remains the same for personal computers. Therefore, the perceived alternatives to console gaming platforms are unreasonable, rendering the whole relevant market determination unreasonable.

The Antitrust Evaluation of the Microsoft-Activision Deal

In Eastman Kodak Co. v. Image Tech. Servs., Inc., 504 U.S. 451, 486 (1992), the Court adopted a holistic approach to comparing the pro-competitive advantages with the anti-competitive implications of the deal. While this analysis was followed in a plethora of cases, in Brunswick Corp. v. Pueblo Bowl-O-Mat, the Court held that this analysis must be done from the perspective of end consumers. In this analysis, the same approach is going to be followed where both the anti-competitive implications and the pro-competitive advantages of the deal are discussed to arrive at a conclusion.

Anti-competitive fears:

1. Market Share

Activision Blizzard King is known to be one of the oldest and most prominent producers of games. Activision’s presence is not only in the console segment but also in mobile platforms, PC, digital online channels, distribution, and online subscriptions. Its market share in the console segment is 40.93%, entirely controlling the segment of distribution with a 100% market share, and is leading in the segments of mobile platforms, digital online channels, and online subscription with a market share of 21.22%, 35.26%, and 89.45% respectively. After the merger, Microsoft will be able to control more segments as it (Microsoft) happens to be the market leader in the relevant market of consoles with a 53% market share. Therefore, this deal will result in a deadly combination, powerful enough to harm competition.

While there have been new entrants in the upstream market, who change with time, bringing better versions and adapting to the market needs, games manufactured by Activision seem to be classics and adhere to trends in the older times. Nevertheless, Activision has a significant market share in every segment, depicting its high market penetration.

Sony is a powerful competitor of Microsoft in the console market. Moreover, it acquires 23.3% of its total games from Activision, implying that if this deal is approved, Microsoft will have the control to weaken its competitor.

2. Intent to foreclose competition

In the case, American Tobacco Co. v. the United States, the Court while determining the intent to monopolize, held that “as per section 2 of the Sherman Act, when two parties combine or conspire to acquire or maintain the power to exclude competitors from any part of the trade, then they can be charged for monopolizing. Provided that, the parties have such a power that they are able to exclude actual or potential competition and they have the intent and purpose of exercising that power”

With such a significant acquisition, Microsoft’s actions may eliminate competition in the market. Activision produces games such as Candy Crush, Call of Duty, and Overwatch, available on all platforms. After the merger, Microsoft may refuse to honour deals previously made between Activision and other platforms, thereby affecting the supply of these games. Perhaps, on the contrary, it may charge highly exorbitant prices from non-Microsoft consumers for access. However, given the popularity of these titles on all non-Microsoft platforms, it can be argued that Microsoft would want to cut down on its overall revenue earned through games being operable on other non-Microsoft platforms by making these titles exclusive to only Microsoft.

Moreover, Microsoft has been on the news for introducing a platform exclusively for games called “Gamepass” which is a replica of Netflix—Gamepass will be a subscription-based gaming platform. Acquiring Activision is a cost-effective way to achieve that goal. It can make a few of these titles exclusive to game pass subscribers, and thereby eliminate competition in the market as consumers will be left with no choice but to purchase the Gamepass. All in all, Microsoft will have the opportunity to control or limit access and become a monopoly in the market for the games Activision has produced and will produce in the future.

3. Prejudicial Pricing

This acquisition will affect the competitors, but it will also affect the consumers at large. When the games are exclusively available on Xbox, the console owned by Microsoft, Microsoft may tend to charge high prices. However, this can be conducive for the competition as Microsoft charging high prices can result in new entrants seizing the opportunity to enter the gaming market to charge less than Microsoft, resulting in profits for these newcomers. Although, even with new entrants competing in the market, the classic games such as COD, Overwatch, Diablo, due to their high demand and popularity, will make customers pay a lot more than usual because of not being available in other segments.

Moreover, Microsoft can also wish to increase its market share; for example, Nintendo, a gaming console, acquires most of its games from Electronic Arts. It is not a customer of Activision. Therefore, to attract customers from Nintendo, and also to increase its customers worldwide, Microsoft may charge significantly less. This prejudicial pricing will discourage new entrants, and harm the competitors.

Pro-competitive rewards:

In stark contrast to its fears, vertical mergers also have the capacity to bring competitive advantages to the market. The two major benefits are mainly (i) cost reduction; and (ii) double marginalization elimination.

1. Reduction of cost

Reduction of cost benefits the consumer in the form of a reduced price of the product. A merged business can rely on its resources and significantly cut down on third-party costs—delivery, shipping, and quality standards which overall increase the efficiency and quality of products—in reducing costs.

While the Microsoft-Activision deal is expected to cut down on cost, it remains to be seen if the company is willing to charge less for its products, especially given its track record of a pro-profit approach as opposed to a pro-consumer one. For example, after it acquired Lionhead Studios, Microsoft ran behind profits despite a cost cut. In addition, it did not pay heed to consumer-friendliness. All this resulted in the shutdown of the studio.

Therefore, it will not be surprising to see Microsoft adopt the same pro-profit approach where they try to maximize and increase their profits despite a cost-cut and not work towards consumer-friendliness.

2. Elimination of double marginalization

Similarly, as far as the elimination of double marginalization is concerned, merged companies coordinate their prices to capture the majority of the surplus without affecting their sales. For example, assume that consumers want to buy a toothbrush and toothpaste. Two separate companies make the two products. The toothbrush cost is $4, while the toothpaste costs $3. The consumer has a budget of up to $10. Now, in a perfectly competitive market, where the toothpaste and toothbrush companies do not have market power, the consumer walks away with a $3 surplus—$10-($4+$3) =$3. However, even if one of the two companies has market power, it will yield a fair result as that one company will try to capture the market surplus. In this scenario, if the toothbrush price is increased by $3 because of its market power, the consumer will still buy the product because it is still within his budget. This process is called single marginalization. Nevertheless, if both companies have market power, they will try to capture the surplus amount by increasing their prices. In such a scenario, everyone loses as the consumer does not get their desired products, and the companies cannot sell the products. This is known as double marginalization, which could have been avoided had both the companies coordinated their pricing.

While Microsoft can significantly cut down on its cost after the merger, it remains to be seen if they reduce the prices of their Activision-developed games in the market, especially in this era of cut-throat tech competition. Elimination of double marginalization is expected to have little or no impact; considering the price of Activision games and Microsoft consoles, consumers will eventually have to break the bank to purchase these products, thereby leaving no surplus.

Conclusion

The anti-competitive concerns of the deal are expected to outweigh its pro-competitive effects. The FTC must act tough on this deal to preserve the competitive norms in the market. Additionally, it should also ensure that the scrutiny of this deal serves as the perfect precedence for other such future harmful deals concerning the gaming industry.

Moreover, when companies become too big to fail, they become capable of acting against the market competition. In Spectrum Sports, Inc. v. McQuillan, the court held that a firm’s conduct would be unlawful when it monopolizes the market or dangerously threatens to do so. Dangerous probability of success is one of the criteria in determining the “attempt of monopolisation” under Section 2 of the Sherman Act. The case recommended that the relevant market and the firm’s ability to lessen competition be considered while analyzing if, after the merger, the firm will be in a position to achieve success dangerously. While being dominant or achieving success is not anti-competitive, a merger quite big as Microsoft-Activision’s coupled with anti-competitive conduct and intent to monopolize is expected to impact competition adversely.

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A very indepth & analytical article on the proposed deal . The well researched paper has touched upon many a contours & intricacies of competition law en route ' Microsoft's proposed acquisition of Activision Blizzard King ' in a lucid yet richly analytical manner . Kudos to the Authors & The Editorial Board for sharing this piece . May this presentation provide much insight for Review not only for FTC but to CCI , times ahead !

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