This week has been as sad as it has been bad for the United States Federal Trade Commission. The FTC v. Microsoft & Activision Blizzard preliminary injunction hearing that started on Thursday (after a status conference the day before) turned out a massive embarrassment for an agency that appears oblivious to its mandate. The purpose of this post is just to summarize some high-level observations, which are complementary to my live tweets from the San Francisco courtroom and my spoken commentary in several Twitter Spaces.
As a litigation watcher for more than a dozen years, I know that it's risky to take a definitive position at halftime. This is, however, a rare exception where it's safe and warranted. The FTC is finished with respect to this case--it has a snow flake's chance in hell now--and must tread much more carefully because its outrageous conduct has institutional implications beyond this one case. If the question wasn't viewed as a partisan matter by Democrats, the FTC's behavior should be the subject of a Congressional investigation. Simply put, instead of protecting American consumers against abusive conduct by corporations, the FTC is failing American consumers and, on top of that, flagrantly acting against American economic interests to the benefit of Japanese and Chinese competitors. The FTC did so this week even to the extent of pressuring a senior Microsoft executive to make commitments to the benefit of Sony, which possibly could be argued to constitute the non-military equivalent of high treason.
Contrary to proving that the proposed merger would result in a substantial lessening of competition, the hearing conducted by Judge Jacqueline Scott Corley of the United States District court for the Northern District of California has already shown that there would be positive effects in the markets in which the FTC alleges an SLC (consoles and cloud gaming), and also in a third one (mobile game distribution).
If one ignored--as none of us should--the specific circumstances and characteristics of the transaction in question, one might indeed ask a legitimate question: should Big Tech get even bigger? From a policy point of view, reasonable arguments can be made about whether trillion-dollar corporations that still have very significant organic growth rates should additionally be allowed to accelerate their growth by spending billions or, like in this case, tens of billions on acquisitions. I am not saying that such deals should necessarily be prohibited--just that I can relate to a philosophical concern over a concentration of power. and a discussion could be had. There is, however, a right way and a wrong way to tackle that subject. The right way would be to have a political debate and a decision at the end of a democratic process. The wrong way is to stretch and bend (if not worse) the law as it stands.
The FTC brought a motion for a preliminary injunction in San Francisco, not because it wanted to but because the deal might otherwise have been closed without further notice. Microsoft and Activision's joint opposition brief revealed that Sony, which dominates the global market for video game consoles (and certain aftermarkets), was actually not afraid of vertical input foreclosure. That Sony-internal email was read aloud at the start of the San Francisco hearing:
Actually, per Jim's email:
— Lulu Cheng Meservey (@lulumeservey) June 22, 2023
"It’s not an Xbox exclusivity play at all...
I’m pretty sure we will continue to see COD on PS for many years to come...
I’m not complacent and I’d rather this hadn’t happened, but we’ll be OK, more than OK."https://t.co/NoWwi9OlUK
That email exudes the confidence of a company with enormous market power. It is damning for the FTC's "case", which was an ultra-long shot anyway:
No vertical merger has been prohibited in the United States in decades.
The purpose of antitrust law is not to shield a dominant player (Sony) from competition and to sustain its margins in an aftermarket (distribution of games made for its platform).
A theory of harm relating to a nascent market (which in this case is not even a market in a competition law sense, as even one of the FTC's own key witnesses practically conceded) must meet a reasonably high standard, as the alternative would transform merger control into a fantasy game.
The FTC's console market theory of harm and its software variant (multi-game library subscription services) face the first two hurdles, and those are not additive but multiplicative. The regulators in charge of 40 countries--even the UK CMA, which is otherwise the FTC's sole remaining ally--have rejected those console-related theories. Presumably even the FTC would have dropped it, but it made its bed in December (when it brought a complaint with its in-house court) and must lie in it.
For the cloud-gaming theory of harm, which is at issue in the UK (where the CMA is hardly going to be able to defend it in court), the first two challenges as outlined above are joined by the third (nascent-market theories).
After two full hearing days and extensive briefing (the parties also filed the pre-hearing versions of their proposed findings of fact and conclusions of law, which I studied in detail), the FTC has not made headway. It is, in fact, further away from being granted a PI than it was then this started.
The FTC's numerous attempts to disprove Microsoft's defenses have been fairly ineffectual. Microsoft may very well have recognized internally that content is king with respect to consoles and other platforms, but that is like a law of nature and Sony's PlayStation has far more exclusive content than Microsoft's Xbox. There may very well be contexts in which Microsoft focuses more on competition with Sony than with Nintendo, but that will not be outcome-determinative either.
While the FTC needs to make a strong showing and Microsoft (along with Activision Blizzard) would merely have to fend off the PI motion, the first two hearing days (with three more scheduled for next week) have shown that there is no foreclosure intent on Microsoft's part with respect to Call of Duty and that cloud gaming services are not a relevant antitrust market.
On Thursday, Microsoft corporate vice president (Xbox) Sarah Bond explained that Microsoft was limited in its ability to point to Call of Duty in its Xbox marketing efforts due to contractual restrictions that apparently resulted from an agreement between Sony and Activision. Basically, due to the Sony-Activision deal, Microsoft was not able to reference CoD except in places where the audience already had an Xbox, at least for the most part.
The three key takeaways from Friday are the following ones:
Shortly before the lunch break, Microsoft Gaming CEO Phil Spencer testified, at the prompting of his company's counsel, that they would not withdraw CoD from the PlayStation. Judge Corley then reminded him of the fact that he was testifying under oath and wanted to clarify again--clearly not because she didn't believe him but because it was so central to this case--that CoD would remain on the PlayStation. Mr. Spencer did not hesitate for even one second: "Absolutely. Will raise my hand."
Just minutes before that key intervention by Judge Corley, I wrote on Twitter that her questions didn't bode well for the FTC. Not because of a bias but because she clearly identified the issues that have the potential to resolve the case. The FTC would rather want to muddy the water, but that is not working out.
The FTC realized that this oath--combined with all of the deficiencies of the FTC's "case"--spelled doom for its console market theory of harm. The agency's Deputy Chief Trial Counsel James Weingarten made the wrong choice, however, when he sought to expose limitations or loopholes in that central promise:
There was outrage on Twitter that a U.S. government agency acted in court as if it was negotiating a better deal for Sony. Mr. Weingarten asked Mr. Spencer whether that commitment would also be extended to other Activision games than CoD. I want to be fair, and that's why I told people right away that his questions were rhetorical. Mr. Weingarten didn't want Microsoft to make further-reaching commitments: he wanted to salvage his "case" by getting Mr. Spencer to decline to make additional promises or widen the scope of the existing one. That said, the FTC should be held accountable for such outrageous conduct. Even though I am sure Mr. Weingarten wanted a no for an answer, that intense situation in the courtroom could have resulted in a commitment to the benefit of a foreign Microsoft competitor.
The current FTC has previously been criticized for colluding with foreign regulators (such as the CMA in this context) to scuttle the Microsoft-Activision deal and to torpedo other mergers (Illumina-Grail is a deal that was closed without regulatory approval but still the subject of litigation). It has become known that unusually extensive communication took place between the FTC and the CMA during the Phase 2 investigation of the deal in the UK. Now the FTC has gone considerably further by pressuring a Microsoft executive to make concessions to a foreign competitor. Again, I am saying so even though it was clear to me that the FTC did not really want to optimize the deal terms for Sony. It's bad enough that the FTC recklessly took into account the possibility of damage to the American economy as a result of its litigation tactics.
When the FTC kept insisting and even wanted Mr. Spencer to make a promise under oath with respect to cloud-gaming services, Judge Corley said she didn't need that and decided to cut off the FTC's questioning.
The Google manager who used to be in charge of the failed Stadia cloud gaming service (a failure primarily due to Google's lack of commitment, which didn't inspire confidence in game makers to support the service), Dov Zimring, was called by the FTC. Unlike Sony, Google is not a vocal complainant, but it is against this deal. It would rather do more $360 million deals with an independent Activision to cement its Android app distribution monopoly. So Mr. Zimring was trying to support the FTC, such as by attributing Stadia's failure to its lack of CoD (when the market leader, GeForce Now, and Microsoft's xCloud service are not currently offering CoD either, though they will be able to stream CoD after the acquisition has been consummated).
Microsoft's lead counsel is Beth Wilkinson, and a lawyer from her firm, Anastasia Pastan, conducted an extremely effective cross-examination of Mr. Zimring, who denied knowledge of things that he must actually known. Mrs. Pastan was not frustrated: she just kept going. The most important result of Mr. Zimring's testimony was that he said cloud streaming competes with console gaming. That admission completely undermines the FTC's claim that cloud gaming is a market of its own. The fact that not just Microsoft executives and experts, but even someone working for a company opposing the deal--and who was called by the FTC--said so makes it a particularly valuable concession.
There will be further testimony next week, including Microsoft CEO Satya Nadella and Activision Blizzard CEO Bobby Kotick. There will be expert testimony, and it is worth noting that the FTC's economic expert, Harvard professor Robin Lee, published several papers, one of them specifically focused on the videogame industry, in which he argued that exclusive content was good for competition between platforms. Plus, his paper on the videogame industry included Nintendo in his console market definition.
Closing argument will be on Thursday, and late on Friday the parties will have to file their revised proposed findings of fact and conclusions of law, reflecting their views of what was and what wasn't proven during the hearing. Seriously, the FTC appears unable to prove anything that really matters. It's a disaster for them. They should never have opposed the transaction in the first place.
Judge Corley will decide soon. I guess the decision will be handed down either shortly after Independence Day or even before. The CMA will then be the sole remaining hold-out, unable to defend its crazy April 26 decision on appeal and facing the risk of being "closed over" by the target date set forth in the merger agreement (July 18).
The FTC and the CMA should work out a solution that benefits gamers and cloud-streaming services. As did the European Commission before them. They are only making things worse by not acting constructively. And why would lawmakers give the FTC more powers if it doesn't even responsibly use the ones it already has? The FTC has made more than one error of judgment in connection with this transaction. What I saw the FTC do yesterday was really disconcerting. They are not going to turn this around next week. It may be unrealistic, but I wish they could just recognize that they are on the losing track and figure out a consumer-friendly solution.
