Preventing Increasing Concentration and Domination in the Video Game Industry

Insights into the FTC’s Merger Lawsuit Against Microsoft Acquiring Activision

On December 8, the Federal Trade Commission (FTC) filed a lawsuit to block Microsoft's acquisition of Activision, marking the first time the tech giant has drawn the attention of U.S. antitrust authorities since its infamous and protracted lawsuit initiated by the Department of Justice (DOJ) in the 1990s, which aimed to address Microsoft's monopolization of the PC operating system and internet browsing markets. The FTC's complaint against Microsoft’s acquisition attempt makes it clear that the agency recognizes the potential harm of this merger and is taking appropriate action to safeguard competition in the industry and further its efforts to rejuvenate antitrust enforcement - in this case, specifically against vertical mergers. In this post, I analyze the FTC’s lawsuit and examine its merits. Enjoy.

Microsoft's proposed acquisition of Activision, the largest in the video game industry, would grant the corporation significant power and sway in the sector. If allowed to proceed, the merger would make Microsoft the third-largest video game company, with a market share of 17%. The FTC has outlined several concerns in its complaint, the most pressing of which is Microsoft's potential withholding of Activision's popular games from other video game console manufacturers, particularly Sony's PlayStation, making them exclusive to Microsoft’s Xbox system. The FTC alleges that Microsoft could “engage in several strategies to degrade access to Activision content on rival consoles and subscription services, including timed exclusivity, exclusive downloadable content available only on Microsoft's products,”¹ which would give Microsoft the ability to “reduce efforts to optimize Activision content for rival products.”² Such actions by Microsoft would be considered a harm known as foreclosure in antitrust parlance. To be harmful and facilitate Microsoft’s goals, exclusivity does not have to be total exclusivity, where the game never reaches a rival platform. Instead, exclusivity could also encompass purposefully delaying the arrival of the game on the rival platform or releasing an inferior version.

The Problem with Exclusives in the Video Game Industry

The harms outlined in the FTC's complaint against Microsoft are well-founded and have significant consequences. Activision holds a considerable amount of influence within the video game industry. The corporation is the owner of numerous top-performing games, including the highly lucrative Call of Duty, which has generated over $27 billion in revenue, and is consistently one of the best-selling games every year. Being allowed to acquire Activision would give Microsoft control over Activision’s entire gaming portfolio, including what systems and platforms would be able to play the company’s games. While some of the FTC’s claims of Microsoft withholding titles from rival consoles seem to contradict what has been reported in the news,³ Microsoft has already blatantly shown it is willing to withhold new titles and make them exclusive to its own Xbox console. For example, on December 23, Microsoft revealed new titles from Bethesda Games (a company it acquired in 2021) would only be available on Xbox.⁴ Microsoft’s strategy to acquire game studios and make titles exclusive to platforms it controls is a recurring strategy it employs. Tom Warren at The Verge aptly details Microsoft’s strategy as one the company routinely uses to “shore up Xbox (and Game Pass) exclusives.” 

Similarly, the increase in exclusive titles means that consumers as well also face the threat of becoming locked into a specific console platform as the incentives for switching become much higher. Therefore, limiting the growth of exclusive titles is essential to ensuring vibrant competition in the video game industry.

The problem of exclusive titles is further compounded by the presence of network effects, where the popularity and desirability of a console are enhanced by the number of exclusive titles.⁵ In fact, exclusive titles are what, in part, have led to the popularity of the PlayStation. Currently, Sony’s PlayStation 5 has 280 exclusive titles, five times that of Microsoft. 

Understanding Vertical Mergers

Due to the industries they respectively occupy, the lawsuit involving Microsoft and Activision represents a challenge to a vertical merger, a type of corporate consolidation that occurs between firms operating at different levels of the distribution chain. In this particular case, Microsoft, a manufacturer of video game consoles and developer of the dominant PC operating system, is seeking to acquire video game developer Activision. Given the federal government’s recent attempts at litigating vertical mergers, the outcome of this lawsuit carries significant weight for the FTC and is effectively a must-win.

Since the 1970s, vertical merger litigation initiated by the federal government nominally does not exist.⁶ Before the Department of Justice challenged the merger between AT&T and TimeWarner (now known as Warner Media), the last vertical merger challenge by the DOJ was in 1977.⁷ Due to some bad lawyering, the government lost in the district court, and the D.C. Court of Appeals, in an opinion written by a reactionary conservative judge, affirmed the district court's decision.⁸ A similar situation has occurred with the FTC. Before the current lawsuit against Microsoft and the agency’s 2021 action against the Illumina-Grail merger, the last vertical merger case litigated on the merits was in 1979.⁹

Vertical mergers have been a particularly important topic for conservative consumer welfare advocates. In general, consumer welfare advocates want vertical mergers to be per se legal in all circumstances as they have asserted that the harmful effects derived from them, such as “[p]redation,” are “extremely unlikely[.]”¹⁰ They also claim that vertical mergers embody efficiency, which can allow the firm to pass savings to consumers. Plenty of research has shown that these claims are false.¹¹

Vertical mergers are not benign as consumer welfare advocates claim. Among the many harms mergers cause, vertical mergers can specifically: 

• Increase the market power of the combined company, allowing the firm to raise prices, reduce quality, and stifle innovation.

• Create conflicts of interest, as the combined company may have the incentive to favor its own products or services to sell to its newly created upstream or downstream subsidiary over those of its buying or selling competitors. This conflict of interest can be taken further by allowing a firm to entirely cut off access to critical inputs such as information and data, which can be essential for innovation and competition.

• Heighten and create barriers to entry for new competitors.

The FTC's lawsuit against Microsoft and Activision aims to ensure a competitive and fair video game market by preventing the concentration of market power through this method of corporate consolidation. As such, the outcome of this lawsuit has wider implications for the regulation of vertical mergers. A victory for the FTC in this lawsuit would create new and strengthen existing precedents to restrict vertical mergers and also serve as a sharp deterrent against such corporations seeking to dominate their respective markets by employing a similar tactic in the future.

The staggering size of the transaction and market positions of both firms clearly indicate that the FTC is right to challenge the lawsuit - but this is not for lack of effort on the part of Microsoft to thwart it. The company signed a neutrality agreement with the Communications Workers of America, generally stating that they will not interfere with unionization efforts. Microsoft has even demonstrated its willingness to collaborate with Nintendo by offering to develop Call of Duty for their console, and the company has expressed openness to similar partnerships with Sony, the manufacturer of PlayStation and the major rival to Xbox.

Litigation Rather than Settlement

By proceeding with litigation and blocking the merger outright, the FTC is correctly avoiding what is known as behavioral remedies and is not allowing Microsoft to justify the (potential) harms caused by the merger to be counterbalanced with the alleged benefits it is providing to workers and to its competitors.

Concerning the balancing of harms, the agency did have a difficult decision to make. President Biden has made a point to attempt to be the most pro-labor administration in multiple generations. But here, the FTC is seemingly overruling the wishes of the CWA workers who wish the merger to be approved. But antitrust law prohibits the kind of analysis CWA and Microsoft are trying to invoke - that is, compare the benefits to workers derived from the merger outweigh the potential market harms to consumers and rivals.

Antitrust law prohibits precisely this kind of calculus (known as cross-market balancing) - in this case, the labor market for the workers and the product market consisting of the video games. The primary problem is that cross-market balancing opens the floodgates for defendants to justify their monopolistic and unfair conduct with a near-unlimited set of possibilities. Ironically, it is workers themselves that often incur the brunt of the deleterious effects of cross-market balancing as a firm could justify the harms to labor, on the grounds of the supposed benefits of lower prices provided to consumers. Such a situation occurred when the NCAA was trying to justify its restrictions on pay to college athletes on the grounds of the asserted (but dubious) benefits that restriction provided to consumers.¹²

Similarly, allowing cross-market balancing positions the court to (even more than it already does) act as a legislature making political and economic decisions about how the economy should be structured rather than Congress. Congress was clear, it wanted monopolistic conduct to be inhibited and prohibited. As the Supreme Court aptly stated in its United States v. Topco decision: 

If a decision is to be made to sacrifice competition in one portion of the economy for greater competition in another portion, this too is a decision that must be made by Congress and not by private forces or by the courts. Private forces are too keenly aware of their own interests in making such decisions and courts are ill-equipped and ill-situated for such decisionmaking. To analyze, interpret, and evaluate the myriad of competing interests and the endless data that would surely be brought to bear on such decisions, and to make the delicate judgment on the relative values to society of competitive areas of the economy, the judgment of the elected representatives of the people is required.¹³

Concerning behavioral remedies, when they are used, the merger is approved but with certain conditions, such as the defendant corporation agreeing to certain guarantees and not engaging in an (often vague) list of practices. For decades, behavior remedies have been the primary regulatory tool for antitrust enforcers. The problem is that extensive research has shown that behavioral remedies do not deter firms from engaging in the proscribed practices and do not inhibit other unlawful conduct.

Behavior remedies also present a number of challenges. One issue is the difficulty of monitoring corporate conduct. Antirust agencies already have significant responsibilities. Engaging in long-term and frequent monitoring of corporate behavior concerning a proscribed practice places additional unnecessary strain on an agency’s limited resources and heavy workload. Another challenge is that behavioral remedies may not address the root cause of the violative behavior, and may simply treat the symptoms of the cited problem rather than address the underlying issues. For example, if the issue is increasing concentration - rather than just monitoring for future unlawful behavior, a simpler and easier remedy is to just prohibit the merger. 

The FTC Could Have Written a Stronger Complaint

The Biden Administration has made a concerted effort to revitalize antitrust enforcement through the signing of an executive order in July 2021, and it is expected that agencies such as the FTC will make every effort to adhere to this directive and set a strong precedent for future lawsuits. But, while the FTC's action against Microsoft and Activision is justified, given the size of the proposed merger and the dominant position of the acquiring party, there are certain shortcomings in the agency's complaint that deserve further examination. Upon reviewing the complaint, I identified three primary deficiencies.

First, the complaint does not mention the “trend toward concentration” that has taken place in the video game development industry over the last decade or so. A cursory glance at the List of Video Game Developers Wikipedia page briefly details just how many companies have been acquired. Microsoft specifically has been particularly aggressive with its acquisitions of video game publishers - having acquired one major publisher and 11 video game developers over the last decade.

The “trend toward concentration,” in combination with the high entry barriers the FTC details in its complaint, is a powerful aspect of Clayton Act jurisprudence. In Brown Shoe v. United States, the seminal case in merger enforcement jurisprudence, the Supreme Court heavily detailed the “trend toward concentration” as a critical part of the prophylactic nature of the Celler-Kefauver Act of 1950, which amended and significantly strengthened Section 7 of the 1914 Clayton Act to limit mergers as a method of competition. The FTC’s failure to detail this aspect of the industry unnecessarily leaves a lot of favorable Supreme Court jurisprudence on the table. Surely, the FTC can make use of this jurisprudence later, but the complaint is one of the most important documents in litigation - it sets the tone and frames the entire lawsuit. Moreover, the quality and degree of detail in a complaint can (and often does) determine the outcome of the lawsuit.

Second, the FTC’s complaint hardly discusses the horizontal effects of this merger, and when it does, the agency only mentions that Microsoft develops games and not the enhanced market power it would acquire if the deal with Activision closed. Besides Microsoft owning the console on which some Activision games are playable on, Microsoft is also a game developer that is a direct rival to Activision. Microsoft develops similar games as Activision (simply consider Microsoft’s Halo and Activision’s Call of Duty). It is understandable that the FTC would desire to make this lawsuit a test case as part of its efforts to revitalize vertical merger enforcement - which, as previously explained, has basically been non-existent since the 1970s. Nevertheless, given the size of this merger, I think it is unwise for the agency to disregard any favorable factual information. Rather than take such a big gamble on a merger of this size and scale, the agency should have positioned its lawsuit with as strong of a  foundation as possible, even if its primary goal is not fully achieved.¹⁴

Third, the discussion on the harms of foreclosure (which the word is never actually used) could be stronger. There are multiple types of foreclosure that are problematic with this merger. First, is what is described in the complaint, where Microsoft can deprive rival consoles and platforms of Activision’s games. There is also the kind of foreclosure of the kind analogous to the situation where a dominant firm refuses to engage in business with another (known as a refusal to deal). In this case where because Microsoft has such a larger gaming portfolio, the company no longer needs or desires to have games from rival companies on its Xbox system, which would rival both its in-house developed games like Halo and also its newly acquired Activision games. This problem seems unlikely, but consider what Apple does. Apple heavily monitors its iOS app store, sees what apps are doing well, then copies them, and then (because it controls the iOS system) gives its apps features that only its apps can have – think of avoiding the 30% fee Apple charges, or the ability to be a default app on the iPhone. Similar aspects could happen with Microsoft, such as lessening the amount of money given to developers from its subscription or being able to manipulate the gaming subscription or discoverability aspects of its game story to favor its games. Subtle actions like these incentive users away from rival applications and services. In this circumstance as well, there are a limited number of console outlets - it's either the Nintendo Switch or, for the high-performance games, only Sony. In other words, independent developers not only face a bigger rival that owns a critical distribution channel, but now Microsoft has more power to squeeze them and make more demands.

Along similar lines, what’s also odd and perhaps it is redacted in the complaint, the actual amount of potential foreclosure that the complaint focuses on is never actually quantified. Historically, quantifying foreclosure has been a critical piece of information used to determine how substantial the merger is.¹⁵

Fourth, and perhaps more fundamentally, is that the agency should have completed its overhaul of the merger guidelines it initiated, in partnership with the Department of Justice, in January 2022. The merger guidelines issued by the DOJ and the FTC play a crucial role in merger enforcement. Combining a combination of controlling jurisprudence and agency preferences, the guidelines outline the factors that the agencies consider when reviewing proposed mergers and acquisitions. The primary goal of the guidelines is to provide transparency to the public as to how the agencies will analyze mergers and select cases that should be blocked as violations of Section 7 of the Clayton Act. As such, they serve as an essential deterrent against companies attempting to engage in mergers or acquisitions that would negatively impact competition and enhance a firm’s power, ultimately protecting the interests of consumers and promoting fairer methods of competition. While the merger guidelines issued by the DOJ and FTC do not have the legal authority of a statute (commonly known as the “force of law”), they have traditionally been accorded considerable deference by the federal courts. Without updated guidelines, the agency is operating on a weaker legal footing and potentially exposing itself to an unfavorable and hostile outcome.

Thanks for reading.

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Image Credit: Onur Binay via Unsplash.

1. Complaint at ¶ 104, In the Matter of Microsoft Corp./Activision Blizzard, Inc. (Dec. 8, 2022), https://www.ftc.gov/system/files/ftc_gov/pdf/D09412MicrosoftActivisionAdministrativeComplaintPublicVersionFinal.pdf.

2. Id. at ¶ 106.

3. James Bachelor, Did Microsoft Break its Promise to the EU About Bethesda Exclusives?, Games Industry.biz (Dec. 12, 2022), https://www.gamesindustry.biz/did-microsoft-break-its-promise-to-the-eu-about-bethesda-exclusives-for-the-record.

4. Tom Warren, Microsoft Completes Bethesda Acquisition, Promises Some Xbox and PC Exclusives, Verge (Mar. 9, 2021), https://www.theverge.com/2021/3/9/22319124/microsoft-bethesda-acquisition-complete-finalized.

5. For additional insights on network effects, see Daniel A. Hanley, A Topology of Multisided Digital Platforms, 19 Conn. Pub. Int. L.J. 271, 280-91 (2020), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3651606.

6. In a general sense, it only exists to the extent that the vertical merger also has “horizontal effects.” Steven C. Salop, Invigorating Vertical Merger Enforcement, 127 Yale L.J. 1962, 1964-65 (2018), https://scholarship.law.georgetown.edu/cgi/viewcontent.cgi?article=3020&context=facpub. 

7. United States v. Hammermill Paper Co., 429 F. Supp. 1271 (W.D. Pa. 1977).

8. United States v. AT&T, Inc., 916 F.3d 1029 (D.C. Cir. 2019).

9. Fruehauf Corp. v. FTC, 603 F.2d 345 (2d Cir. 1979).

10. Robert H. Bork, The Antitrust Paradox: A Policy at War with Itself 232 (1978).

11. See Salop, supra note 6.

12. Ted Tatos & Hal Singer, The Abuse of Offsets As Procompetitive Justifications: Restoring the Proper Role of Efficiencies After Ohio v. American Express and NCAA v. Alston, 38 Ga. St. U. L. Rev. 1179 (2022); see also Sandeep Vaheesan, Challenging the NCAA Cartel: When Consumer Welfare Equals Worker Exploitation, Harv. L. Rev. Blog (June 9, 2020), https://blog.harvardlawreview.org/challenging-the-ncaa-cartel-when-consumer-welfare-equals-worker-exploitation/.

13. John E. Kwoka & Diana L. Moss, Behavioral Merger Remedies: Evaluation and Implications for Antitrust Enforcement, Am. Antitrust Inst. (2011), https://www.antitrustinstitute.org/wp-content/uploads/2011/11/AAI_wp_behavioral-remedies_final.pdf; see also John Kwoka, Mergers, Merger Control, and Remedies: A Retrospective Analysis of U.S. Policy (2014).

14. This is not to say that enforcement agencies should not initiate lawsuits that are difficult to win and are effectively a toss-up. Indeed, enforcement agencies gambling on perceptively tough litigation can provide important avenues to advance the law should the agency prevail. Consider the DOJ’s recent legal victory against Bertelsmann. In that case, the DOJ placed almost the entire case on problems of the merger stemming from increased buyer power - the first of its kind involving a merger lawsuit. This victory undoubtedly strengthens merger law. Risks should be taken.

15. See, e.g., Ford Motor Co. v. United States, 405 U.S. 562, 568 (1972).