On April 26, 2023, the Competition and Markets Authority (CMA) blocked what would otherwise have been the largest deal in the gaming industry to date. The decision highlights several important trends, such as:
- In dynamic markets, regulators are focusing in on whether a deal harms or could harm future competition (i.e., innovation based on predications raising significant uncertainties). The CMA speculated that the deal would “alter the future of the fast-growing cloud gaming market” and preferred to maintain the status quo with the block.
- Regulators are focusing more and more on non-horizontal relationships and supply chain issues, particularly if one party is vertically integrated. Whereas in the past, concerns could often be remedied via behavioral commitments, more and more deals with a vertical component are now being outright prohibited.
- While the industry expects the European Commission (Commission) to accept the behavioral remedy (license package) offered by Microsoft, this case shows once again that the CMA and the Commission can reach different conclusions when reviewing the same transaction.
Gaming is the United Kingdom’s largest entertainment sector in terms of revenue. In early 2022, Microsoft announced its plans to acquire Activision Blizzard (Activision) for nearly $69 billion, making it the biggest deal ever in the gaming industry.
While Microsoft is best known for its Windows operating system (OS), it is also active in gaming through its Xbox console and 24 game development studios, several of which it acquired in recent years. Through the Xbox console, Microsoft competes most closely with Sony’s PlayStation and to a lesser degree with Nintendo’s Switch.
Importantly, with Xbox Cloud Gaming and Azure, Microsoft also has a global cloud computing infrastructure.
Cloud gaming is a relatively new alternative to consoles and PCs. Whereas the more traditional methods of gaming require users to download and run games locally on their devices, cloud gaming services dispense with the need for powerful (and often expensive) hardware. These games run on remote servers and can be streamed directly to any device with a stable high-speed internet connection and a display (e.g., a smart TV).
Activision, on the other hand, has no cloud gaming infrastructure. Rather, it is a leading video games publisher whose most popular titles include Call of Duty, World of Warcraft and Candy Crush. These games run on PCs and consoles, as well as on mobile devices.
Therefore, while there are actual horizontal overlaps between Activision and Microsoft (with both developing and selling games), the CMA investigation focused on the vertical effects of the proposed transaction in console gaming and in cloud gaming services.
THE CMA’S DECISION
The first theory of harm considered a scenario where Microsoft would make the game Call of Duty either exclusive to Xbox or only available to its rival PlayStation on worse terms. The concerns that the CMA expressed in its provisional findings have in the meantime been dismissed after revisiting the evidence submitted by Microsoft and Activision. The CMA therefore held, in unanticipated addendum provisional findings (nearly two months after the provisional findings were issued), that Microsoft had no incentive to implement a (partial) foreclosure strategy by either offering PlayStation games, in particular Call of Duty, with lesser quality, at a higher price or not at all (i.e., making Activision’s games exclusive to Microsoft).
As a result, the CMA concluded that the deal would not result in a substantial lessening of competition (SLC) in console gaming services in the United Kingdom.
The second theory of harm considered the ability, incentive and potential impact of Microsoft harming its cloud gaming rivals by making Activision games exclusive to its own cloud gaming offering.
Against the backdrop of robust growth projections due to lower hardware requirements and thereby lower costs, the CMA found cloud gaming to be “transformative” and an “important disruptive force” in the gaming industry, with the potential to replace expensive consoles and gaming PCs altogether for at least some users.
Microsoft was deemed to hold a strong position not only in the gaming industry more generally (with its “gaming ecosystem,” including the Xbox console, its Game Pass and development studios, as well as the Windows OS for which the majority of PC games are designed), but also in cloud gaming services more specifically (with 60% to 70% market share). The CMA inferred from this that Microsoft could stream games via Xbox Cloud Gaming and Azure from Windows servers without having to pay its Windows licensing fee or adapt games designed for Windows to an alternative OS—and without having to pay a third-party cloud platform fee. Microsoft would therefore have the ability to make games exclusive to its cloud gaming offering and thereby slow the development of the fast-paced cloud gaming market.
The CMA also found that Microsoft would have an incentive to make Activision’s games, which were deemed to be important for the growing cloud gaming market, exclusive to Xbox Cloud Gaming and Azure. The CMA explained that the cloud gaming market was characterized by elements of direct and/or indirect network effects and that Microsoft could try to gain market power by offering exclusive games on its cloud gaming service. Importantly, the CMA considered that without the deal, Activision would make its games available to all cloud gaming service providers on its own terms.
The fact that Microsoft had signed agreements with cloud gaming providers NVIDIA, Boosteroid, Ubitus and Nware (the latter post-prohibition) to make games available on their platforms could not resolve the CMA’s concerns regarding the effects of the merger. The CMA explicitly relied on paragraph 7.15 of its Merger Assessment Guidelines and criticized that the agreements applied only to a few providers and that there was “material uncertainty” around their scope, terms and enforceability. In the CMA’s view, the market is characterized by few emerging rivals (none of which are as well-positioned as Microsoft) and significant barriers to entry and expansion. The CMA found that, absent the merger, Activision’s games were likely to become available on and would be a particularly important input to cloud gaming services and any alternatives were likely not sufficient enough to offset the loss incurred to cloud gaming rivals by the foreclosure of Activision content.
For similar reasons, the CMA did not accept the behavioral remedies proposed by Microsoft to allay the concerns. Microsoft committed to licensing Activision games royalty-free to certain cloud gaming providers for a period of 10 years. Moreover, Microsoft would have given any consumer who acquired an Activision game from it online the right to stream that game in the cloud gaming services that were covered by the remedy. Importantly, Microsoft also offered to appoint a monitoring trustee to monitor and ensure compliance with the remedy, as well as a fast-track dispute resolution mechanism.
The CMA saw two significant limitations with the proposed remedy. First, it criticized that gamers would have to purchase a game first in order to stream it on certain cloud gaming services and that the latter would thus be precluded from accessing Activision’s games through other strategies, such as multigame subscription services. Second, the CMA pointed out that the remedy did not include PC OSs other than Windows. It argued that since cloud gaming services wishing to stream Activision’s games would have to be compatible with the Windows OS version of those games, non-Windows-based cloud gaming services would be put at a disadvantage. The CMA also found the duration of 10 years to be insufficient and expressed doubts as to the feasibility of monitoring and enforcing the remedy.
For the above-mentioned reasons, the CMA expected the merger to result in an SLC in cloud gaming services in the United Kingdom because of vertical effects in the form of input foreclosure, which would ultimately harm current and future gamers.
This decision underscores the CMA’s position—since Brexit—as a global antitrust authority reviewing the largest deals alongside the Commission and US authorities.
Microsoft has already said that it will appeal the CMA’s decision before the Commission Appeals Tribunal (CAT). The appeal itself will not focus on the substance (i.e., Microsoft will apply for judicial review of the CMA’s decision). If Microsoft is successful in arguing that the CMA acted illegally, irrationally or improperly, the CAT could require the CMA to reassess its approach in concluding on the theory of harm concerning cloud gaming services.
Several countries have unconditionally cleared the deal, including Japan, South Africa and—only one day after the CMA’s prohibition—Ukraine. Alongside the appeal before the CAT, Microsoft still awaits regulatory approval in other jurisdictions, most notably the European Union (where the Commission has until May 22, 2023, to decide on the remedies) and the United States (where a private plaintiffs’ challenge is to be heard on May 12, 2023, and an administrative trial at the Federal Trade Commission’s internal court is set to start August 2, 2023). If the deal does not receive clearance from all authorities by July 18, 2023, Microsoft will potentially have to pay a break fee of $3 billion to Activision, unless the parties agree to extend the long stop date in the meantime.
Although the CMA has blocked the deal on the grounds of what looks like a well-established foreclosure theory of harm (cf. ICE/Trayport), its decision is also the expression of more novel and overall, rather vague concerns over the strengthening of a digital ecosystem. More importantly, however, the case reveals a worrisome stance on behavioral remedies, which have traditionally played an important role in removing vertical concerns.
In its press release, the CMA voiced its general skepticism towards behavioral remedies, which in its words would necessitate an “ongoing regulation of the sector, replacing market forces in a growing and dynamic market with mandated regulatory obligations ultimately overseen, and enforced by, the CMA – in this case at a global level.” The CMA has not accepted any behavioral remedies in the past three years during in-depth investigations. It famously rejected behavioral remedies in its review of the acquisitions of Farelogix by Sabre and Giphy by Meta (formerly Facebook) and instead prohibited these deals. By blocking Microsoft’s proposed takeover of Activision, the CMA reinforces this trend.
The Commission thus far seems to have taken a different approach. In its Google/Fitbit clearance, the Commission demonstrated its willingness to accept more complex behavioral remedies, including the possibility of an extension of the initial duration and the appointment of a monitoring trustee. In a similar vein, it has accepted behavioral access remedies to remove its concerns over vertical input foreclosure in Meta/Kustomer, whereas the CMA cleared that same deal unconditionally. It remains to be seen whether the two agencies’ approaches will continue to diverge in the future.