FTC Sues to Block Microsoft’s Acquisition of Activision-Blizzard, Challenging a Vertical Transaction in the Video Game Industry

On December 8, 2022, the Federal Trade Commission (FTC), by a 3-1 vote with Commissioner Christine Wilson dissenting, issued an administrative complaint to block Microsoft’s proposed acquisition of Activision Blizzard Inc. (Activision), the maker of the highly popular Call of Duty video game franchise.¹ This continues the FTC’s track record of aggressive antitrust enforcement against vertical transactions, including those in the tech sector.

The Parties and the Transaction

Microsoft is a technology company and maker of the Xbox video game console. Microsoft also offers a leading video game subscription service called Xbox Game Pass. Activision is a developer of video games for consoles, PCs and mobile devices. It is the maker of the highly popular “AAA” video game franchises Diablo, Overwatch and, most prominently, Call of Duty, which the FTC contends is one of the most successful console-game franchises ever.² On January 18, 2022, Microsoft entered an agreement to acquire Activision for a total estimated value of $68.7 billion, which would make it the largest video game studio acquisition in history.³

The FTC Complaint

In its complaint, the FTC asserts that the Microsoft-Activision transaction would “creat[e] a combined firm with the ability and increased incentive to withhold Activision’s valuable gaming content from, or degrade Activision’s content for, Microsoft’s rivals.”⁴ Thus, the FTC alleged, the transaction was likely to substantially lessen competition in three relevant markets: (1) “high-performance consoles”; (2) “multi-game content library subscription services”; and (3) “cloud gaming subscription services.”⁵ They contended this would result in consumer harm in the form of “reduced consumer choice, higher prices or lower quality products, and less innovation.”⁶

The FTC argues that “AAA” games—the games with the highest quality, highest development costs and most substantial promotion—are a substantially important input for both gaming consoles and gaming subscription services.⁷ AAA content helps increase adoption and engagement for consoles and gaming subscription services. Consoles and gaming subscription services thus compete for AAA content and, to differentiate their offerings, may seek to offer certain AAA games exclusively.⁸

Activision, the FTC claims, is a particularly important “top tier” independent game publisher able to reliably produce AAA games; part of a “Big 4” consisting of Activision, Electronic Arts, Take-Two, and Ubisoft.⁹ Activision content like Call of Duty is especially valuable to any game console or subscription service due to the ability of Activision’s content to drive sales and engagement.¹⁰ The FTC points out that 10 of the top 15 console games sold between 2010-2019 were Call of Duty games, and the latest game in the franchise—Modern Warfare II, released in 2022—generated $1 billion in sales in its first ten days of release.¹¹

The FTC contends that Microsoft could take a number of actions to harm its rivals after it owns Activision. It could withhold Activision’s content entirely from rival consoles and subscription services, or degrade access to Activision’s content through timed exclusivity or offering downloadable content available only on Microsoft’s products.¹² Microsoft could also degrade the quality of Activision content on other consoles and subscription services and reduce efforts to optimize Activision content for rival products.¹³

The FTC further argued that Microsoft would have an increased incentive to disadvantage its rivals by withholding or degrading Activision content. While pre-merger Activision had the incentive to maximize sales of its video game titles by selling them broadly, post-merger Activision’s incentives would change due to the significant profits Microsoft would gain from additional Xbox or Xbox Game Pass sales by making Activision’s content exclusive to drive adoption of Microsoft’s products.¹⁴

Microsoft’s Answer

Microsoft filed its answer to the FTC’s complaint on December 22, 2022, in which it took issue with many of the assumptions underlying the FTC’s case. In the answer, Microsoft sought to minimize its presence in video gaming, arguing “[t]his case involves a transaction between the third-place manufacturer of gaming consoles and one of many publishers of popular video games.”¹⁵ Further, Microsoft argued it had virtually no presence in mobile gaming, the fastest-growing gaming segment, and sought to buy Activision to expand its presence in that segment by making Activision’s games “more accessible to consumers, by putting them on more platforms.”¹⁶ This included, asserted Microsoft, making Call of Duty, “more broadly available.”¹⁷ Microsoft argued that paying $68.7 billion for Activision made no “financial sense” if the revenues it earned from selling Call of Duty on other platforms—including PlayStation—went away or if it alienated the millions of Call of Duty players by degrading the game’s experience on other platforms.¹⁸

Analysis

Although the complaint alleges that Microsoft competes with the “Big 4” to offer AAA games,¹⁹ the FTC complaint does not allege that the loss of horizontal competition violates Section 7. Rather, the Activision complaint is the latest effort by Chair Khan’s FTC to challenge vertical transactions, including those in the tech sector. Microsoft’s proposed acquisition is that of a customer buying an important supplier—a vertical acquisition—and vertical cases are typically harder for the antitrust regulators to bring. The Antitrust Division’s unsuccessful attempts to block AT&T’s acquisition of Time Warner²⁰ and United Health’s acquisition of Change Healthcare²¹ are recent cases in point. But Nvidia abandoned its proposed acquisition of Arm and Lockheed Martin abandoned its proposed acquisition of Aerojet Rocketdyne after the FTC sued to block those deals.²²

The typical concern in vertical mergers is with risk of foreclosure of competitors. The theory in the Microsoft-Activision case is input foreclosure—that the merged firm will withhold or degrade a key input supplied to competitors in a downstream market. In any vertical case, the key question is whether the merged firm has both the ability and incentive to pursue a strategy of foreclosure by cutting off supply or supplying on worse terms. In other words, will the merged firm make more money in the upstream market by selling more and/or raising prices after its competitors are foreclosed than it loses in profits on foregone sales of the input to competitors? This turns in large part on whether the merged firm has sufficient market power in the upstream or downstream market for a foreclosure strategy to succeed and whether the input is critical for rivals to effectively compete in the downstream market.

Whether the FTC succeeds in Microsoft-Activision where the Antitrust Division failed in AT&T-Time Warner likely depends on three key issues:

Market Definition: In alleging harm in a market of “high-performance consoles,” the FTC argues that the market was limited to only the current generation Xbox and PlayStation consoles within a US geographic market. In the alternative, FTC argues harm in a broader market that includes Nintendo Switch, though FTC asserts Switch is “highly differentiated” from Xbox and PlayStation. In either case, FTC’s purported market excludes gaming PCs and mobile devices, as well as older generation Xboxes and PlayStations, and limits the market to the US. How the market is drawn and what the shares are—the FTC’s complaint is silent about market shares—will be relevant to how a court views Microsoft’s ability to implement a successful foreclosure strategy. Indeed, in its answer, Microsoft asserts it is the “third place” console with only 16 percent share in 2021—presumably in a global market—with virtually zero share in mobile gaming.²³

Value of Content: A second issue is whether Activision content is truly critical to a console or video game subscription service. In AT&T-Time Warner, Judge Leon did not believe Time Warner’s content was “must have” such that competing video services needed it to effectively compete. Given the significance of the Call of Duty games to the video gaming industry, the court may reach a different conclusion. How this issue will be resolved will depend on the facts and evidence adduced at the hearing about the importance of Activision’s content.

Evidence on Exclusivity: A third issue is the question of whether Microsoft would have an increased incentive post-merger to make Activision content exclusive to Xbox and Xbox Game Pass. Microsoft insists it will not do so and has committed publicly to making Call of Duty available on both PlayStation and Nintendo’s Switch (the latter for the first time) for ten years if its acquisition goes forward. The FTC is skeptical of these commitments and notes in its complaint that after Microsoft acquired ZeniMax Media (the owner of the game studio Bethesda Softworks) in 2021, it decided to make several of Bethesda’s upcoming “AAA” releases exclusive to Microsoft. While in its answer, Microsoft admits it has decided to make three future Bethesda games exclusive, Microsoft argues those games are primarily games designed to be played “alone or in small groups,” unlike Call of Duty. Instead, Microsoft has continued to release updates to Bethesda’s games that are played by “broad communities of gamers” on both Xbox and PlayStation. How this issue is resolved will also depend on the evidence—both economic evidence and what internal Microsoft documents may say on its future intentions.

It is not clear whether the FTC’s challenge to Microsoft-Activision represents an attempt to move beyond the theories reflected in the now-withdrawn (by the FTC, though, not DOJ) Vertical Merger Guidelines and that have been accepted (at least at a conceptual level) by the courts. For example, it is possible that the FTC will argue that the mere loss of Activision games on non-Microsoft platforms is sufficient to violate Section 5 of the FTC Act by reducing “consumer choice.”²⁴ Nevertheless, the administrative complaint also alleges that withholding or limiting access to Activision games will result in higher prices and that by “weakening competition” Microsoft will be able to “increase[e] its profits.”²⁵ These are traditional vertical merger harms, so the focus on loss of consumer choice may be just a backstop to a traditional Section 7 case.

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The Microsoft-Activision case signals a continued willingness by FTC to intervene to halt—rather than remedy—vertical acquisitions when it believes important content is at stake, and it may represent an attempt to rely on a broad view of Section 5 of the FTC Act that looks beyond traditional Section 7 theories. Whether the judiciary follows suit remains to be seen.

© Arnold & Porter Kaye Scholer LLP 2023 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.