Subscription, Cloud Platforms and Video Game Dominance
The story of Microsoft's proposed acquisition of Activision Blizzard
If you’re anything like me or my friends, one of the ways you passed the time during the 2020 lockdowns was by playing video games. One of the more popular ones happened to be Activision’s Call of Duty: Warzone, which at that time, I thought was nothing more than the latest example of a gaming developer attempting to cash in on the battle-royale hype train that had the entire gaming industry in a chokehold. I should have known Warzone was going to popular given the fact that Activision is a powerhouse in addition to Call of Duty (CoD) being one of the best-selling video game franchises of all time. If you’re unfamiliar with Activision let me provide some information. They are a massive game publisher, being the 5th largest video game company in the world by revenue, and they own some of the most successful intellectual property in gaming including, Call of Duty, Candy Crush and Warcraft. To add further perspective, at one point these titles have been the most popular game on gaming consoles mobile devices and PCs respectively. Even though that I didn’t see the potential of Activision, many others did, including Phil Spencer, the CEO of Microsoft Gaming. This ultimately led to Microsoft’s proposed acquisition of Activision-Blizzard for total of $68.7 billion in an all-cash deal. If this deal closes, it will be the largest video game acquisition in history, making Microsoft the third biggest gaming company in the world. However, a deal of this size comes with a lot of attention, specifically from government regulators. The United Kingdom’s Competition and Markets Authority (CMA), the European Union’s Commission and the United States’ Federal Trade Commission (FTC) were among those who at the very least, reviewed this deal due to potential antitrust concerns. Before looking into what claims the regulators made regarding the negative effects of this deal, it is important to first consider the commercial advantages this acquisition may provide for both parties.
The Commercial Advantages of the Deal
Focusing first on Activision Blizzard, the incentive to sell is quite obvious: Their shareholders are getting a nice chunk of change. In the months prior to the deal being announced on January 18th, 2022, the stock was trading around $60-70. The $68.7 billion sum Microsoft offered works out to a price of about $95 per share. If I was an Activision shareholder, the decision is a no brainer! I can’t imagine many scenarios where I would decline an offer which is giving me a 36% premium for my shares. Despite this, some may be quick to point out that the stock had traded consistently above $95 previously. Although this is true, I suspect shareholders may have had doubts about the existing leadership’s ability to take the company back to those heights due to the multiple scandals that were plaguing the company. These included a lawsuit from California accusing the company of creative a culture of constant sexual harassment, further allegations of sexual misconduct, namely a Wall Street Journal article which stated that CEO Bobby Kotick was aware of much of this conduct and failed to inform both the public and the boards, and employee unrest in the form of labour protests. Given these circumstances, it makes sense why shareholders would want to secure profits now as opposed to hoping for the stock to rebound to all time highs.
Now taking a view as to why Microsoft may be interested in acquiring Activision Blizzard. It is first important to give a little overview of Microsoft itself. It is a massive company with many subsidiaries, among them Microsoft Gaming (more commonly referred to as Xbox). Aside from making consoles, their gaming division also has a cloud gaming service known as Xbox Cloud gaming (XCloud). This service makes it possible for consumers to play games that they otherwise wouldn’t be able to due to system requirements. They also have a video game subscription known as Xbox Game Pass with over 25 million subscribers. This service gives consumers access to over 100 games for a monthly fee of $11. In addition to these two services, they also own several game studios and have impressive gaming IP of their own, including Halo and Minecraft. At this point some of the potential commercial advantages Microsoft may be obvious. The addition of a prestigious game publisher to their already significant list of game studios is likely to help them obtain a larger market share in the gaming console market, and Activision’s 4% market share of the mobile gaming market will help them expand there as well. Despite both these markets being significant, Microsoft appears to be motivated mainly by the potential to bolster both their gaming subscription and cloud gaming services. An internal email showed that in 2019 a Microsoft executive noted that they are “… In a very unique position to be able to go spend Sony out of business.” Microsoft clearly wants to build up a library of content for Game Pass, already having purchased massive video game producer Bethesda since this email was written in addition to targeting other companies such as Square Enix, Sega and Bungie among others. Let me just say, as someone who used to play a lot of video games, Game Pass is already an extremely good deal, especially when considering that the current cost of a premier game is $70. The addition of fan favourite franchises such as Call of Duty is sure to increase the attractiveness of this product to consumers. The email goes on further to draw comparisons between the video streaming services market and the video gaming subscription market, and I believe such analogies are useful for illustrating the potential of Game Pass. Take Netflix for example, they were one of, if not the first company in the online streaming space and for a time, had a near monopoly. However, one of the biggest problems facing them today is that studios such as Universal, Disney and Warner Brothers will not license their best content to them anymore, preferring to house their best T.V shows and movies on their own streaming platforms. For example, one of the most watched shows on Netflix, Criminal Minds, will not be on the platform after August 2023, as Paramount wants to house the show on their own streaming service, Paramount+. To make matters worse, the content which studios are still willing to license to Netflix is coming at a premium price now that streaming is mainstream, and studios are aware of the value of their content libraries. Having launched Game Pass in 2017, Microsoft benefits from the being the first mover in this market, as the email notes they “… have a 2 year and 10 M[illion] sub lead [over PlayStation’s game subscription service].” More importantly however, they will have a significant advantage due to owning most of the content available on their subscription platform. The importance of this cannot be understated. Referencing Netflix once again, in 2022 they made a generated $31.6 billion in revenue, but had to spend 53% of that on acquiring and producing content. Although the game subscription market isn’t quite the same size of the video streaming one, it is growing rapidly, and this acquisition helps solidify Microsoft’s position within it. Additionally, having the most attractive content library will undoubtedly put them in a great position to capitalize on the cloud gaming market as well. Aside from the gaming related markets, Microsoft has also stated that it hopes that this acquisition will improve their ability to create a universal store and increase the attractiveness of their advertisement network.
Regulatory Response
We’ve now reached the point where the deal leaves the boardroom and enters the courtroom (see what I did there?) Having completed competition law this past year, I feel like I have a decent knowledge base regarding the CMA’s merger review proceedings, so here is a simplified version of the process:
1. Microsoft announces that they intent to purchase Activision Blizzard. At this point the CMA may decide to launch a Phase 1 merger inquiry. [OJ1] The objective of such is to determine whether the proposed acquisition has the potential to lead to a ‘Substantial Lessening of Competition’ (SLC) within the markets in which said acquisition is relevant.
2. If the CMA determines that there is a potential for a SLC, they will offer the acquiring companies a chance to propose amendments to the deal or a plan of action that address these competition concerns. If the companies do not propose anything, or the CMA determines that the proposals wouldn’t serve as a sufficient remedy to the concerns identified during phase 1, they will refer the merger for a Phase 2 merger inquiry.
3. During a Phase 2 investigation, the CMA conducts an in-depth investigation into the proposed acquisition to determine whether the deal will in fact result in an SLC. This is a long process which involves the analysis of multiple factors such as the position of the acquiring firm in the market, the position of their competitors’ and much more. During this, the CMA is still open to proposals that will address the concerns they uncover. Once the investigation is complete, the CMA will issue a final report outlining which remedies – if any – should be applied in order to rectify the SLC. This may be behaviour remedies such as agreements permitting the merged entity from engaging in certain activities, or even an outright prohibition of the merger.
4. If Microsoft is unhappy with the CMA’s decision, they can file an appeal with the Competition Appeals Tribunal in order to have the decision altered or even made redundant. (This is where this case is currently)
In their final report, the CMA proposed two ways in which the acquisition may result in a weakening of competition in the market (called ‘theories of harm’).
1. Microsoft may harm the market for console gaming services by degrading or withholding Activision content from other gaming consoles and multi game subscription (MGS) services. For example, by refusing to make the games available on non-Xbox consoles or making certain game features exclusive to Xbox devices. They may also raise the wholesale price of Activision content on other consoles, thus forcing competitors to increase their prices if they wish to maintain the same margins.
2. Microsoft may harm the cloud gaming services market by foreclosing on their rivals, thus harming their ability to compete. As Microsoft has a strong position in this market due to them having a leading gaming console, leading cloud platform and leading PC operating system (OS), the addition of Activision's content library would further strengthen MS's advantages over rivals, making it harder for new companies to enter the market.
Regarding video game consoles, the CMA determined that Microsoft would not have an incentive to foreclose on the market by making CoD exclusive to Xbox as this would potentially result in significant financial losses. Similarly, the degradation of Activision titles on PlayStation wouldn't be commercial advantageous either as there was no evidence that a meaningful amount of PlayStation users would switch to Xbox as a result. In the case of the market for MGS services, they determined that it was unlikely that premier Activision content would have been made available on these services absent the merger and thus it could not be said that the potential addition of these franchisees to Game Pass would harm competition.
So far CMA and EU decisions are practically identical. However, the CMA ultimately decided to prohibit the transaction while the EU approved it. So, like what gives England? It all comes down to the second proposed theory of harm: The foreclosure of rivals in the cloud gaming market. Although both regulators had concerns regarding this, the EU Commission considered the remedies proposed by Microsoft to "fully address the competition concerns identified" and even stated that they “represent a significant improvement for cloud game streaming." In contrast, the CMA thought that the proposed remedies had limitations which would prevent them from providing a comprehensive solution to the SLC that the acquisition would give rise to. What remedies did Microsoft Propose? To summarize, the ‘Microsoft Cloud Remedy’ outlined that:
1. Microsoft would commit to license Activision games royalty free to certain cloud gaming providers for a period of 10 years. This would apply to all current and future PC and console franchises.
2. Microsoft would also grant a royalty free license to certain streaming services to stream ‘Eligible Games’. These would be made perpetual to match the Consumer Licence
3. Microsoft consented to being monitored by a 'Monitoring Trustee' who will ensure their compliance with the remedy and report to the CMA regularly among other tasks. They also committed to implementing fast track dispute resolution mechanism that would be carried out under the International Chamber of Commerce Rules of Arbitration.
Despite these commitments, the CMA identified two main limitations within this remedy. One relating to the extent to which it can address concerns relating to certain existing and future business models, and the other relating to the extent to which it would be effective in supporting cloud gaming services using non-Windows operating system’s (OS).
Ability to Address Concerns Relating to Certain Existing and Future Business Models
The first limitation the CMA noted was that the design of the Microsoft Cloud Remedy does not make any provision for a direct commercial relationship between the cloud gaming service and the publisher of the Eligible Games. They went on to highlight that this may restrict the ability of the cloud gaming service to employ certain existing and future strategies and business models, such as joint marketing agreements. Furthermore, as Microsoft would have both the ability and the incentive to foreclose rival cloud gaming services in relation to Activision games, it follows that they may not have any incentive to enter into such agreements. I think this is a weak argument for multiple reasons. To start, when comparing how Microsoft is likely to behave post merger with how Activision would behave in the merger’s absence, the differences are minimal. In fact, this merger may even bring benefits for consumers. For instance, the Cloud Remedy expressly states that Activision games will be available on certain competitor cloud platforms. As noted by the CMA, although Activision likely would have made its premier games available on cloud gaming services within the next 5 years, it was unlikely that they do so for services which are based on a MGS model. Thus, the fact that titles such as CoD are likely to appear on XCloud, is a real consumer benefit. More importantly though, the main differences between how Microsoft will likely act and how Activision would have acted, are all directly, or indirectly related to the marketing/promotion of platforms and I find the notion that Microsoft should expressly agree to engage in such agreements ridiculous. I respect the CMA's desire protect consumers, however, their expectation that such agreements should be (at least to some degree) standardised is quite hypocritical as they themselves criticize the Cloud Remedy for seeking to do the same thing in respect of the terms of which so called "Eligible Games" are made available. Businesses should be – and generally are – free to contract with whom they please, save for certain situations such as where their conduct would be considered abusive. And when considering the gaming landscape overall, it is hard to categorize the actions that Microsoft would likely take as abusive. Let's assume that they make Activision titles exclusive to their own MGS service thus preventing other MGS based cloud streaming services from accessing this content. Similar exclusionary practices are employed constantly by Sony and Nintendo, the leaders in the market for video game consoles. "But Joel!" you cry, "That's a different market, you're comparing apples to oranges!" Let's look at how disconnected these markets actually are. Although the CMA's report analyzed the strengths Microsoft may have in the cloud gaming market as a result of their product ecosystem, in conducting their analysis I believe they failed to consider one very important factor: The unwillingness of consumers to switch platforms. The reality of the cloud gaming market today is that majority users are not subscribing to these services primarily for cloud streaming purposes. This is evident when you consider where these users are coming from. The CMA determined that combined, MS's and Sony's cloud gaming services have between 80- 99 percent of the market share. Both are based on a MGS model. Meaning consumers are signing up for a subscription which gives them access to play a library of games on their device and as an additional feature, they also have the ability to play these games remotely. Therefore, it stands to reason that the majority of XCloud and PlayStation Cloud users were already Xbox and PlayStation users respectively. I'm sure that SOME users do not fall into this category, however those people are undoubtedly the minority. As previously mentioned, Microsoft doesn't have an incentive to withhold CoD from other (non-cloud) platforms. Additionally, the CMA noted that it was unlikely that a meaningful amount of PlayStation users would switch to Xbox in response to partial foreclosure strategies. Considering that there is at the very least, a non insignificant overlap between these users and those of cloud gaming services, I fail to see how the exclusionary practices of Sony and Nintendo are considered fair competition, while the mere possibility that MS would do so is cause for the prohibition of this acquisition. Remember, these users would still have access to play CoD on their consoles not to mention, if Sony introduces bring-your-own-game compatibility to their cloud streaming service, users would be able to play remotely as well.
Effectiveness in Supporting Cloud Gaming Services using non-Windows Operating System’s
The second limitation the CMA identified wasn’t any more convincing. They noted that the commitments made by Microsoft to ensure that other operating system’s will be supported, only cover games for which Microsoft chooses to make alternative versions. The worry being that once the merger has closed, Microsoft will simply choose not to produce non-Windows versions of Activision games, thus putting non-Windows based cloud gaming services at a disadvantage, or even force them to use Windows. This argument hinges on the assumption that “Activision would continue to develop non-Windows PC Versions of at least some of its game absent the merger.” However, the fact of the matter is that Activision largely doesn’t develop non-Windows PC versions of their games. The last time a Call of Duty title was developed for macOS was in 2015, and no editions have ever been developed for Linux. In fact, out of their ‘Iconic Franchises’, only StarCraft and World of Warcraft have had non-Windows versions. Although these titles are still played and receive updates, they are not recent releases at all, having come out in 2010 and 2004 respectively. This causes me to wonder how the CMA can rely on the above assumption. It also makes me wonder how they arrived at that conclusion in the first place. Activision is not alone in this behaviour either, I looked at the top 100 most played games on Steam, and only 46% of them were compatible with a non-Windows OS. This a byproduct of the fact that the VAST majority of PC gamers use Windows. The result is a positive feedback loop, as developers prioritize making their game compatible with OS that has the most users, and users will flock to the OS that has the largest library of games available. Thus, even if Microsoft stops supporting non-Windows operating system’s following the merger, the notion that this would have such a negative effect on the cloud gaming services market, to the extent that the only acceptable remedy is the outright prohibition of the merger is ridiculous.
Conclusion
The grounds on which the CMA blocked this merger are very weak. Yes, Microsoft is the market leader in respect of cloud gaming services, but this is by virtue of their world leading gaming, cloud, and PC OS products. If the CMA has an issue with Microsoft’s position, instead of investigating hypothetical anticompetitive practices, they should investigate real ones which may be occurring today. For example, in regard of the positive feedback, Microsoft is not innocent. Some of their actions have directly contributed to the current state of the market. To name one, their decision to keep the DirectX Graphics API exclusive to Windows and Xbox. This exclusivity means that gaming companies who, perhaps already have an Xbox version of their game develop, can release a Windows version of that same game much more cheaply than a macOS or Linux version. I do realize that doing such investigations may not actually be possible. The UK’s competition law desperately needs to be updated to enable regulators to effectively protect consumers, especially in regard of digital markets. And even when the law is eventually updated, it will not be simple as there will always be difficult cases with complicated issues of contention. For instance, it will not be easy to determine the point at which the exclusivity of software constitutes a refusal to deal as opposed to simply being a competitive advantage. However even considering these difficulties, the CMA should not employ shortcuts when carrying out their duties. What I mean by that is this. In their Final Report, the CMA does raise legitimate concerns in respect of the advantages Microsoft had due to its massive size. And when further investigating these concerns, and considering how to address them, the CMA should tackle the problem head on. If the issue is that Microsoft’s many businesses allow them to act irrespective of their competitors, the solution may be to require the divestiture of some these subsidiaries. To be clear, I’m not saying that this should be done, but I am saying that the Final Report does a better job of arguing that this is necessary than it does of demonstrating that this deal will have substantial negative effects on the cloud gaming services market. My analysis of this deal results in the following conclusion: If we agree with the notion that Microsoft’s position in the cloud gaming services market would be dominant following the merger, then it likely is ALREADY dominant now. I have not seen any evidence which suggests that the addition of Activision’s content library will meaningfully enhance Microsoft’s ability to foreclose on competition. In this regard, it almost feels as if the decision to block the deal was made first, and then the CMA worked backwards from there to find the justification to do so.
In any event, as this deal has now cleared merger control in both the USA and the EU, instead of being viewed as the ‘Silicon Valley of Europe’ the UK is now being considered the ‘Death Valley’ for corporations. The CMA and Microsoft have both agreed to pause the ongoing appeal proceedings, however, as merging parties are unable to submit new remedies after a final report has been issued, the CMA is in an awkward position. Microsoft must now modify the deal in some way in hopes of securing approval, but from what I understand, the outlook on this is positive as it is unlikely that they would have agreed to pause the appeal proceedings otherwise.
Joel’s Fun Corner!
While doing the research for this, one question that I could not find a satisfactory answer to is WHY ultimately the EU felt that the MS Cloud Remedy was adequate. It would have been very interesting to compare the reasonings of both regulatory bodies, especially due to the UK's stated strong desire to become a European Hub for technology and economy following their exit from the European Union. I find it quite state that after all the fuss about wanting to be in control of the countries own economic policy, with an implication that it would become more favourable for corporations, the CMA was in opposition of this deal. However, I did find two interesting theories which I want to mention. The first is an article by Marlene Jugl which suggested that the EU's competition procedures were being influenced by a new form of lobbing which involves the exploitation of the regulator’s limited capacity. Basically, corporations hire consulting companies who specialize in economics. These consultants then 'spam the regulator' with a barrage of economic reports to increase their burden. The hope is to reduce effectiveness of the commission’s ability to defend its decisions. Thus, when face with a challenging situation, the regulator is more likely to rule in the firm’s favour to avoid being challenged in court on procedural grounds. The article is quite an interesting read and I’ll link it down below. The other was supported not by quantitative and qualitative analyses, but instead by the good old fashioned rumor mill. Although less credible, I do have to admit, a little more entertaining. As it happens the CMA's Senior Director of Merger Reviews, Colin Raftery, previously used to work at Cleary Gottlieb, the law firm which represents Sony. I didn't talk about it that during this piece but during the proceedings, Sony was making a LOT of noise trying to get the deal blocked. Not only in the UK but also in the US and EU. Anyways a reporter from one of "The most famous news agencies," said that Mr. Raftery was, “The guy that basically made the decision for the CMA.” Pretty scandalous stuff, eh?
Thank you for reading and feel free to reach out to me with any comments, tips, or just feedback on my analysis/general writing at joel.oketch02@gmail.com
P.S (Activision Stock is trading at $5 below the deals closing price, free money if you ask me!)