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Microsoft’s Activision Blizzard Deal is Far From a Sure Thing

Microsoft’s plans to acquire Activision Blizzard will be subject to government scrutiny over the possibility of anti-trust violations.

Microsoft sent shockwaves through the gaming and tech sectors a couple weeks ago when it announced that it had agreed to buy arguably the biggest game publisher in the world, Activision Blizzard, for a record $70 billion.

As the publisher of such popular titles as Call of Duty, Overwatch, and World of Warcraft, the publicly traded Activision Blizzard was already a behemoth in its own right, reporting over $2 billion in revenue in the third quarter last year.

While many look at these headlines and assume that this acquisition is a foregone conclusion, the mechanics of a transaction like this are fairly complex. From an internal standpoint, both Microsoft and Activision Blizzard need to get the approval of their respective boards of directors. In the case of Activision Blizzard specifically, it also needs to get approval from a threshold amount of shareholders in order to be able to proceed with the transaction.

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However, the biggest test the two parties will face will be from the federal regulators.

The Illusion of Choice

When two companies of this size decide to merge, it raises questions about the potential impact on competition in the relevant industry — i.e. whether the combination of these two companies will give the newly merged company too much power over its competitors, ultimately resulting in harm to consumers.

Our free market economy is almost entirely reliant on the notion of competitive markets, as it theoretically drives innovation and forces companies to work harder to earn the business of consumers, which often results in more favorable prices.

The idea, as economist Adam Smith put it, is for the “invisible hand” of the market to find the optimal price where supply meets demand.

Unfortunately, history has shown us that when left to their own devices, certain markets will become more concentrated, which means that there will be fewer providers of goods because of either collusion between suppliers or consolidation (i.e. mergers, acquisitions, etc.).

An easy example: Depending upon where you live, you likely only have one or two cable/internet providers to choose from. That provides more of an “illusion of choice” rather than a true choice, as usually the consumer is forced to choose between sub-par options. This is a classic example of an oligopoly, or a “trust,” where an industry has only a handful of competing businesses that work either explicitly or implicitly with one another to ensure that they are the only competitors in the space and can keep charging prices within a certain range.

Antitrust Factors

U.S. history is littered with examples of markets that have run amok in this way. This is why there is a whole discipline of law known as “antitrust,” which refers to a set of laws passed at the turn of the 20th century to guard against monopolies that effectively gouge consumers while hurting innovation. Those laws worked to a certain extent in the age of the “robber barons,” but in the 100-plus years since, antitrust laws and enforcement have been more a suggestion than anything with actual teeth.

The two federal agencies entrusted with oversight into transactions like the Microsoft – Activision Blizzard transaction are the Department of Justice and the Federal Trade Commission, which was created to enforce antitrust law and protect consumers. Both agencies (primarily the FTC) try to review proposed mergers to analyze whether they violate the federal antitrust laws and would ultimately harm consumers through decreased competition.

Generally, there are two kinds of mergers:

Horizontal Merger: where one company buys another company that competes in the same space.

Vertical Merger: in which the company being acquired fits into the “value chain” of the other company, like a video game developer being sold to a company that just makes video game consoles.

If the FTC or DOJ believes that a proposed merger would violate federal antitrust law, it would take the companies to court to have the merger struck down or enter into a deal known as a “consent decree” where the acquirer agrees to divest certain assets or take actions to decrease the likelihood of harm to consumers.

In a perfect world, the FTC and DOJ would be able to scrutinize every merger of consequence to consumers, but they have a finite amount of resources, so they need to pick and choose which deals they take a closer look at. Couple that with an ever-growing flurry of mergers and acquisitions that swelled to over 4,100 last year, and the result is an overwhelmed system with deals being allowed to happen without scrutiny at the peril of consumers. However, as of last week, it was reported that the FTC would launch an investigation into the Microsoft – Activision deal, which shouldn’t come a surprise, because Microsoft has been under scrutiny from the FTC and DOJ since the 90s.

From an antitrust standpoint this is likely to be considered both a horizontal and vertical merger because Microsoft owns a number of game studios that produce titles for various platforms including Halo, Minecraft, and Gears of War; but it is also a hardware manufacturer, vis-a-vis its flagship Xbox console. Whereas, Activision Blizzard is one of the biggest developers of “AAA” (the highest quality and production value) games in the world.

What this Means for Gaming

Perhaps the biggest competitive concern with this deal is its potential impact on consumers of Activision Blizzard’s games. Console manufacturers tend to make certain marquee titles exclusive to their consoles to drive consumers to choose, say an Xbox over a Playstation. There might also be concerns over Microsoft owning so many of the most popular titles, including and especially Call of Duty. It stands to reason that Microsoft might pull the title from other competing platforms, tie its other products to the purchase of the title (i.e. requiring an Xbox Game Pass subscription to buy Call of Duty), or simply have too much pricing power and charge more for games that would otherwise cost less in a more competitive market.

The other (arguably more pressing) concern is that Microsoft will be able to “crowd out” competitors with its size, making the barriers to entry for companies too high. That would make it easier for a start-up game developer to build something to sell to Microsoft rather than to actually compete with them over a longer term. The ability for gaming to continue to consolidate in a virtually unfettered fashion turns big companies like Microsoft or Sony into Kirby-like characters that have a voracious appetite for smaller companies in order to squelch competition.

The real competition is happening between the handful of large companies that control the space, as they are competing against one another to buy up assets (companies). For example, a week after Microsoft announced its deal with Activision, Sony announced a $3.6 billion acquisition of Bungie, the game studio responsible for the popular Destiny title.

Without regulatory intervention or oversight, this culture of consolidation is likely to continue at a steady clip, especially with big tech companies like Microsoft sitting on growing war chests of cash. Perhaps the FTC recognizes this and sees an opportunity to roll back these “mega mergers.” While you shouldn’t expect to see your favorite games impacted anytime soon, chances are you have already felt the effects of consolidation in gaming.

If you wonder how the cost of delivering a game can go down while the price of that game goes up, look no further than consolidation. If allowed to continue indefinitely, gaming companies may start to look more like your internet providers, which nobody wants or needs. How or where this FTC investigation proceeds from here is anybody’s guess, but it doesn’t seem like Microsoft is going to get the government’s blessing anytime soon.

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