Friday, June 30, 2023

FTC motion for preliminary injunction against Microsoft's purchase of Activision Blizzard will predictably be denied next week: multiple requirements clearly not satisfied

Yesterday's closing argument in Federal Trade Commission v. Microsoft & Activision Blizzard was lively, and that is primarily so because Judge Jacqueline Scott Corley of the United States District Court for the Northern District of California had interesting and challenging questions for both parties--plus a great sense of humor. However, a litigation is not a talk show. In a talk show, there can be multiple winners, and here the outcome will be binary: the merger won't be blocked (that's what I expect to happen) or it would be. While Judge Corley could hardly have done more to ensure a level playing field in her courtroom, the legal framework is highly unfavorable to the FTC: it has multiple hurdles to overcome, any single one of which can be dispositive (i.e., single-handedly trigger the denial of the motion).

By 5 PM local time (Pacific Time) today, the two sides will have to file the updated versions of their proposed findings of fact and conclusions of law. Throughout the hearing they were probably already keeping track of the extent to which any of the factual allegations were proven. This is about a likelihood assessment and an equitable balancing, and it is about predictions (of what will happen in the future in a world where the merger happens versus one in which it is abandoned). It's not a criminal trial with a "beyond reasonable doubt" standard. But the FTC's problem is that once the court determines that the FTC is not--or at least not realistically--going to prove an essential point in the main proceedings, it's game over--and the same applies if the court has very significant doubts about a couple of indispensable elements of the FTC's case. At that point, too, there is no reasonable likelihood of success, and even if the court went beyond that and balanced the equities, the FTC could still lose at that stage of the analysis.

The parties will make another filing on Monday (about the admission of exhibits). I believe July 5 and 6 are the most likely days for a decision by Judge Corley. She is free to rule at any time of day, any day of the week, but it would make sense for her to enter an order very late by her local time, just to be safely outside trading hours. Her initial order will be sealed (as it will take time to sort out redactions), but the result will show up on the docket, and it's going to be a denial of the merger block that the FTC is seeking.

In a way, the FTC theoretically had multiple bites at the apple: all in all, the FTC proposed five different antitrust markets, and if its theory of harm (vertical foreclosure) succeeded with respect to any one of them, the deal would be blocked. So, practically, there are five theories of harm in the case. But we can simplify that part based on how things went at the hearing:

As I explained in my Twitter commentary, the FTC's console market theory of harm is dead in the water. Those are theoretically two theories of harm, one for a narrow high-performance videogame console market and one for a slightly broader one that includes Nintendo. It would take the inclusion of gaming PCs--and I agree with Judge Corley that in a foreclosure context the fact that many people already have a PC on which to run most of the relevant games cannot be ignored--to defeat those console theories at the market definition stage, but there are plenty of other problems anyway.

The FTC claimed yesterday that it was about protecting consumers, not Sony but that is just lip service to its mission of protecting American consumers. On several occasions, the FTC's incompetence (with respect to how the gaming business works) was on full display. Yesterday, the FTC discredited itself particularly when one of its lawyers talked about a hypothetical scenario of partial foreclosure in which there would be a unqiue game element, such as a character, that would be available only in the Xbox version of Call of Duty post-acquisition. That shows the FTC knows nothing about current market realities. At the moment, there are multiple PlayStation-exclusive goodies in CoD, and the PlayStation is the market leader. So if the FTC was concerned about any of that, it would have to look into Sony's dealings with game makers.

The FTC's view that it's better to have an independent Activision Blizzard negotiate such deals with platform makers is ignorant of basic commercial realities. As I explained a few days ago, the dominant market leader (which is Sony, particularly on a global scale) can strike such exclusive deals more cost-effectively than any challenger, cementing its leadership and avoiding competition on the merits.

The other three markets are services markets: multi-game library subscriptions, cloud-gaming subscriptions, and a market in which one would find services that offer one or both of those types of services.

The closing argument basically had two parts: console and cloud. Or arguably three, but the balance of the equities won't be reached with respect to consoles anyway.

Multi-game library subscription services can hardly be deemed a relevant antitrust market here. A different judge of the same court threw out a class action over Apple Arcade (Pistacchio v. Apple) for that reason, and the plaintiffs did not even appeal the decision. That may be the reason why there wasn't much debate yesterday over whether multi-game library subscriptions are a distinct product or just a price structure. So the discussion was generally about "cloud" during the second part.

The FTC would have us believe that it just has to raise an interesting question so it gets to kill a merger. Not so:

  • All that makes a question interesting in this context is a reasonable likelihood of success. The fact that "cloud" is a buzzword doesn't count. The fact that companies including Microsoft invest in cloud services doesn't suffice either.

  • For a given theory of harm--here, foreclosure of cloud-gaming services--the FTC must satisfy multiple requirements to prevail. So on the bottom line an FTC theory is only interesting enough to warrant an injunction if the court sees a reasonably strong indication of the FTC being able to satisfy all of the requirements.

The short version is that "cloud" is interesting, but by far not interesting enough (in the above sense) to order an injunction.

Market definition

I don't see that the FTC's cloud-gaming services market (or any derivative thereof) is supported by the facts. But if the closing argument is any indication, Judge Corley--no matter what her conclusion regarding that proposed market may be--is not going to stop there even though she could if she wanted to.

Google's testimony that cloud-gaming services compete with console games and PC games could be held against the FTC's market definition. In the hypothetical (though unimaginable) scenario in which Judge Corley were to block the merger, Google's testimony and other reasons for which cloud-gaming services are not a relevant antitrust market would likely be emphasized in an emergency motion asking the appeals court to lift such an injunction.

It would appear erroneous to me if the FTC was deemed to have established a relevant antitrust market for cloud gaming. The same pragmatic approach that Judge Corley has to the console market definition (where she focuses on what consumers would do if prices went up or content became unavailable on a given platform) is antithetical to the assumption of there being a relevant antitrust market for cloud gaming. The President of the UK Competition Appeal Tribunal, Mr Justice Marcus Smith, explained at the initial case management conference that after reading the decision more than once he couldn't see a technical reason for which gamers could not simply install some games locally. It would not at all surprise me, however, if Judge Corley left that question open (such as by expressing some and possibly even serious doubt without disposing of the cloud theory at that point), as there is no shortage of other issues.

Essential input

It strikes me as crystal clear that the FTC has failed to make a credible showing that Activision's content is a critical ("must have") input. As Judge Corley rightly noted yesterday, it is very much about CoD (even though the FTC would now also like to place some more emphasis on the Diablo franchise).

Let's get real:

The games market is highly fragmented and will be even after this transaction. I'm not deying that if Microsoft wanted to buy Tencent after acquiring Activision Blizzard, the question of market concentration would become interesting to say the least. But not now.

The FTC's expert totally failed to show that CoD is an essential input for the console business. Microsoft's economic expert Dr. Elizabeth Bailey clearly impressed Judge Corley with her data-driven analysis, particularly focusing also on how committed gamers actually are to CoD. Most gamers don't really spend a huge numer of hours playing that game over the course of a year.

All that the FTC's expert Professor Robin Lee attempted to show was that complete foreclosure with respect to CoD would have competitive implications (in my view, even his own results are actually procompetitive) for the console business. He did not analyze partial foreclosure, and in particular he did not analyze (whether for full or partial foreclosure) potential switching rates with respect to cloud-gaming services.

So the FTC really has nothing of substance to offer in support of its claim that Activision content (basically meaning CoD) is a critical input for cloud-gaming services, while services like Nvidia's GeForce Now and Microsoft's xCloud don't have and apparently don't need CoD (or any other Activision games).

Let that sink in: the FTC wants the court to kill the merger without any credible indication (I'm not even talking about hard evidence) that CoD has the potential to tip the cloud-gaming market.

This, too, is the kind of reason for which I believe the appeals court would likely lift an injunction (which, again, I don't see happening) in no time.

Incentive to foreclose

The FTC can't even show an incentive to foreclose with respect to consoles. There is no specific argument concerning cloud services. No verifiable numbers. Nothing.

That may not be Judge Corley's style, but some other judges would probably tell the FTC in this context that it is now paying the price for the fact that cloud gaming was only an afterthought in its original complaint. The CMA altered course and refocused on cloud after dropping its console theory in late March. The FTC is, for procedural reasons, stuck with its December complaint, but also with the decisions it made in its in-house adjudicative proceeding. So the FTC is basically standing on the wrong foot: most of what it has relates to the laughable console theory, and while I don't consider the cloud theory strong, it is now the one that appears at least a little more interesting and the FTC has almost nothing to show to support it.

It does not reflect favorably on the judgment of the decision makers involved that the FTC placed its primary bet on the proposterous console market theory (protecting a market leader). But the FTC made its bed and must now lie in it.

I don't think the court would even have to reach this question here, but if it does (as it very well may), I can't see how evidence that is anecdotal at best could serve to justify a finding that Microsoft has an incentive to foreclose cloud-gaming services (and I'm not even referring to Microsoft's agreement with cloud-gaming providers yet, but to the fact that during the hearing no calculation was discussed that the court could rely on).

Impact of foreclosure on competition

As the FTC can't show that CoD is a critical input for cloud gaming, it's impossible to argue that the competitive process would be seriously jeopardized by hypothetical foreclosure. But that is what Judge Corley told the FTC yesterday it had to show: she wanted to know how consumers would be harmed.

Competitive response

The FTC can't deny that other cloud-gaming providers have various ways of responding and adjusting to this merger (even more so since they've known for almost 1.5 years about the possibility of this merger closing). Just like in the console market, where Sony can improve its product and/or lower prices and/or offer other attractive content, there are plenty of options in the cloud-gaming business. The assumption that without CoD they will all be unable to compete is, frankly, absurd.

Remedies already in place

The FTC has from the beginning--this even goes back to the pre-hearing status conference--urged Judge Corley to ignore Microsoft's 10-year agreements with the likes of Nvidia. But the amount of time spent discussing the subject yesterday suggests strongly that those contracts will be considered. Maybe Judge Corley will decline to resolve the legal question of whether such remedial contracts and commitments should be considered when the FTC is seeking a preliminary injunction under Sec. 13(b) of the FTC Act. But she appeared inclined to take such market realities into consideration.

At least the effect of existing agreements and other enforceable commitments cannot be reasonably ignored. If Nvidia and some others can stream CoD, then exclusivity is no longer achievable by withholding it from others.

The pragmatic perspective is that there is no evidence of a merger having survived such a preliminary injunction, and that anything that determines the likelihood of success on the merits should be considered. At the very least those remedial agreements, the commitments to the European Commission, the offer to Sony etc. should be factored in at the final stage, which is the equitable analysis. If the FTC wants to block a merger, it has to convince the court that remedies would not be acceptable.

If Judge Corley finds against the FTC on multiple grounds (as I believe she could, though I don't know what she plans to do), the FTC may realize that an appeal is futile. If the decision was or appeared narrow, the FTC would probably raise this legal argument again.

The policy problem that I have with the FTC's anti-remedy attitude is that the regulatory process is actually meant to bring about such solutions. Judge Corley also told the FTC yesterday that the regulators have arguably already won if there are remedies in place as a result of their review processes.

What the FTC and also the CMA in the parallel proceedings in the UK are trying to do is a radical departure from long-standing practice, which is that regulators normally welcome an amicable resolution (such as a consent decree in the U.S.). While the current FTC and the current CMA may have a strong preference (first choice) for blocking major deals, that is the last resort under the law--and that is one major reason for which both those agencies are not on the winning track in court.

Balance of the equities

Toward the end of yesterday's closing argument, Judge Corley also indicated to the FTC that apart from all other considerations there could be a problem with the balance of the equities. Judge Corley explained that harm to the merging parties (private equities) cannot be dispositive, but when a deal has procompetitive effects, blocking the deal does raise questions with a view to the public equities.

Given the myriad issues that the FTC's push for an injunction has, I don't know if the part about balancing the equities will be very elaborate. If she wanted, Judge Corley could definitely address some interesting points in that context. Here, the FTC wants to block a vertical merger, which in and of itself is a long shot to say the least, and it wants to do so on the basic of a speculative theory involving a nascent market (if it even is a market). It would take years for that "market" to become really large, and Microsoft will hold Activision Blizzard separate, so a future divestiture is a possibility. I frankly can't see a clearer case for telling a regulator that there is no reason not to let the parties close the deal at this point.

It could also be held against the FTC that it has been unreceptive to access remedies that could solve the problem. Like the CMA, the FTC just argues that a merger means one independent economic operator less, but that can't be the standard. The question is how much less competition there is if the merger goes through.

Given all the agreements and commitments that are in place here, this really is an interesting case also from an equitable point of view. The alleged harm would not materialize, and the "market" would not reach a tipping point, anytime soon. While it's obviously not the law that the government has to show immediate irreparable harm (a substantial lessening of competition is enough), a preliminary injunction that effectively kills a merger (and deprives consumers of the procompetitive benefits that it would bring) does not appear equitable where there is no urgency not only in a traditional preliminary injunction sense (meaning that something bad would have to happen in the weeks or at least months ahead) but even for years to come.

The FTC is asking the court for too much given how speculative its theory is.

No smoking gun

It's safe to say after five hearing days that the FTC has not found a smoking gun among millions of documents. An email in which a mid-level manager talks about a mere possibility ("spend Sony out of business") is not impressive. It is actually way less meaningful than Sony's internal reaction, which initially was that they'd be just fine.

The absence of internal calculations for the profitability of those 10-year access agreements with the likes of Nvidia doesn't mean much either. Especially in the case of companies like Nvidia and Nintendo, which are large and sophisticated, I believe there must be a strong presumption of those commercial agreements being meaningful just based on who entered into them.

Recent developments in UK and Canada

During the hearing yesterday, I tweeted about a decision by the Competition Appeal Tribunal of the UK to deny a stalling motion by the CMA as well as about a letter by the Canadian Competition Bureau to Microsoft's counsel in the FTC case, requesting that the letter be (as it indeed was) filed with the district court.

The UK decision shows that the CATribunal is doing its best to keep the UK open for business, while the CMA is seeking to avoid a decision on the merits and apparently realized that the FTC was going to lose the U.S. case (the timing of the CMA's motion is hardly a coincidence). Time is not on the side of the UK. Activision's announcement that the center of gravity of its European operations is going to be in Barcelona is an example of how the CMA's regulatory excess harms UK interests in the post-Brexit situation. I always believed and still believe that Brexit also creates opportunities for the UK, but the fact that the CMA can make crazy decisions like the one of April 26 is definitely part of the downside of Brexit.

I personally--and I have no idea whether any of the decision makers share that view in the slightest--believe that the CMA's renewed attempt to stall, which is contrary to clear directions ("strategic steer") from the UK Prime Minister that regulatory processes should not hold up business, weighs in favor of "closing over" the UK regulator after the FTC has been defeated in court. But as I also said in a Twitter Space today, the great work that the CATribunal is doing would weigh in favor of a short extension of the deal in order to let the UK appellate hearing go forward (it starts on July 28) and await the decision, which the court said would come before October.

As for the Canadian letter, it is just an expression of solidarity by one regulator with another, especially between regulators of neighbor countries and also probably in light of the historic ties between Canada and the UK. The letter says there is "likely" a competition issue in the eyes of the CCB, but they did not block the merger while the window of opportunity was open. The letter is not going to make an impact, not even psychologically.

Now let's wait for Judge Corley's decision. The FTC has failed to surmount any of the relevant hurdles. The cloud-gaming part of the decision will not be as damning for the FTC as the console part may be (given how absurd that one is), but I just can't see how it would entitle the FTC to a preliminary injunction. In the private lawsuit over this deal, Judge Corley did not just ask questions for the purpose of enabling a party's counsel to make the strongest arguments. She tends to be very transparent, and given that she indicated problems with several parts of the FTC's theory of harm while a single failure would doom the motion, I'm convinced that the FTC has failed to make a showing of a reasonable likelihood of success on the merits.

Tuesday, June 27, 2023

Mr Justice Mellor declares Lenovo the overall winner of FRAND dispute with InterDigital, awards fee-shifting but InterDigital is awarded interest of $46 million

In March I described the outcome of the InterDigital v. Lenovo FRAND dispute before the High Court of Justice for England and Wales as a resounding victory for the defendant and predicted that other net implementers, such as OPPO, stood to gain from it. Of course, such decisions can and this one is indeed going to be appealed--which is also a safe assumption with respect to an even higher-profile recent FRAND ruling by the same court, Mr Justice Marcus Smith's Optis v. Apple decision, which I heard Optis intends to appeal.

My description of the outcome as a major win for Lenovo has been validated by a follow-up judgment. According to Lenovo's press release, the actual decision should become available later, and the court declared Lenovo "undoubtedly the overall winner," a finding that entitles Lenovo to recovery of the bulk of its litigation costs.

A press release by InterDigital highlights two other aspects of the decision: primarily the fact that the amount to be paid by Lenovo goes up from $138.7 million to $184.9 million due to interest on past royalties, and also the fact that the court granted the parties the right to appeal certain aspects of the judgment.

Mr Justice Mellor's original judgment expressed surprise over the fact that InterDigital had not sought interest on past royalties. Lenovo had been using InterDigital's IP for well over a decade without paying. In the March decision, Mr Justice Mellor invited InterDigital to seek interest now, and determined that $46.2 million was the correct amount.

I heard that the interest award must be paid now sa opposed to be placed into escrow.

The March decision was mentioned at a Brussels event related to the European Commission's proposal for a regulation on standard-essential patents (SEPs). Someone close to Apple referenced it in the context of whether small and medium-sized enterprises (SMEs) are at risk of paying supra-FRAND royalties as they lack the resources and sophistication to defend themselves as effectively as larger players. Someone from the net licensor camp clarified that SMEs were not involved in the license agreements with third parties that Mr Justice Mellor declined to accept as comparable agreements because the licensees were smaller companies than the ones that Lenovo pointed to (such as Apple, Samsung, and LG). So the ones who argue that legislative intervention is needed to shield SMEs from SEP abuse can't point to the UK InterDigital v. Lenovo ruling as evidence of SMEs being overcharged--the "smaller" licensees referenced in that decision were still pretty sizable. However, a reasonable argument can be made that if SEP holders were to go after SMEs (which is not the case yet, at least not to a noticeable extent), SMEs would likely--actually, almost definitely--end up paying supra-FRAND royalties.

InterDigital's problem remains (as the interest award changes nothing about it) that the company tends to cave to large implementers: the likes of Apple and Samsung get discounts that are not just high but next to irrational. As a result, InterDigital's headline rates have a credibility problem when companies like Lenovo or OPPO (with OPPO clearly being a high-volume implementer as well) are sued.

InterDigital has only one revenue stream: license fees, and most of that revenue comes from a small group of companies: major smartphone makers. The rest of the industry took note of the fact that Apple is not paying InterDigital more than in the past, and while litigation with Apple could have been costly and protracted, the terms of that agreement do nothing to persuade a company like OPPO (whose devices sell at a much lower average per-unit price than Apple's) to cave to InterDigital's demands. And unlike Lenovo, OPPO is in a far stronger position to convince courts that it is a willing licensee.

Monday, June 26, 2023

Economics of platform owners' exclusive deals with third-party game makers in light of Microsoft-Activision merger reviews

The prize for the economically most nonsensical question I've ever heard an attorney ask a witness in an antitrust case goes to an institution that I hope will recover--the sooner, the better--from its current crisis: the United States Federal Trade Commission (FTC). There's an FTC v. Microsoft & Activision Blizzard preliminary injunction hearing ongoing, and at about halftime it's already clear that the FTC is losing and short of the greatest miracle in any comparable situation is not going to turn this around. On Day 2 (Friday, June 23), the presently misguided agency's Chief Deputy Trial Counsel asked Microsoft Gaming (Xbox) CEO Phil Spencer how Microsoft could afford a $70 billion acquisition if, based on what Mr. Spencer had testified before, it could not afford (from a profitability point of view) making third-party games exclusive to the Xbox the way Sony can by virtue of its dominant market position.

To explain why that comparison is not even apples to oranges but completely nuts would not take a blog post. A family may not be ale to afford a night in a presidential suite of a big-city 5-star hotel for tens of thousands of dollars even if it can afford buying a $1 million house. That's the difference between consumption and investment: the money spent on the luxury accomodation for one night is gone, while buying a house either saves rent every month (if the owners live in it) or generates passive income.

The FTC's desperation in that merger case makes its lawyers go off the deep end. It's a major embarrassment. Obviously lawyers aren't economists or business administrators, but that entire litigation department's focus is on antitrust case, and antitrust is at the intersection of economics and law. Mr. Spencer noted that the premise of the question was "incorrect" and that was a diplomatic way of putting it. Then the headline of my previous post on that case, which noted the "evidentiary and intellectual bankruptcy" of the FTC's "case" against Microsoft-Activision was also rather mild: an argument can be intellectually bankrupt, or even a naive fallacy or miscalcuation, without being completely crazy. Here, foreclosure with respect to a title like Call of Duty is not an option regardless of whether it would be compensated for by means of an exclusive agreement between independent companies or results from an acquisition.

The purpose of this post is to explain the economics of third-party exclusives, from the perspectives of platform owners and app (game) makers. And to do so in light of the Microsoft-Activision merger reviews.

I'm going to explain this in simple and general terms, unlike economist who would of course transform all of those considerations into multi-line formulae with plenty of Greek letters.

What makes this relevant in connection with that particular merger is more than the FTC's least logical question. It's also that the San Francisco hearing (which I'm attending in person) revealed that the impetus for Microsoft to acquire ZeniMax (best known for its Bethesda Softworks game label) came from a clear and present danger of that company's then-upcoming and much anticipated Starfield game otherwise having become a PlayStation-exclusive title.

In a couple of days, the FTC's economic expert witness, Harvard professor Robin Lee, is going to testify (via video deposition, apparently), and he may contradict his own papers on the effects of content exclusivity on competition between platforms, including but not limited to a 2013 paper that focused specifically on videogame consoles. Microsoft doesn't want to withdraw Call of Duty from the PlayStation anyway, but in the past Robin Lee argued that content exclusivity enabled new entrants to gain a foothold in a platform market by overcoming the chicken-and-egg problem that customers won't buy consoles without games and game makers won't make games for consoles without an installed base.

While the 2013 Lee paper correctly argued that exclusive content may enable a new entrant to compete with the incumbent(s), or smaller players to attract enough users to keep their platforms alive, it is also a fact--and a huge problem--that a dominant player can strike exclusive content deals at a lower cost, thereby increasing its market share: exacerbating the impact of increasing returns, and serving as an accelerant of network effects that could ultimately burn down competition in a given area.

Mr. Spencer explained in his testimony that "compensating [a game maker] for skipping a platform" is cheaper when the one who secures the exclusive is the dominant market leader. Let's look at the various reasons for why that is so, and while I've never personally done a deal like that, I launched an iOS-only trivia game in 2017 and experienced the problem of not being on a platform with a larger installed base (Android). So in a way I'm speaking from experience here, not just from a theoretical vantage point of a litigation watcher with an interest in a functioning competitive process.

While the discussion here is about deals between platform makers and a third party, the logic can be applied mutatis mutandis (meaning with the required adjustments) to first-party titles that are made by a game maker itself. It's just easier to understand the dynamics when the game maker is an independent economic operator as opposed to a division of one of them.

1. Direct opportunity cost of unavailability of title on other platform(s)

Let's start with the simplest model--and his oversimplifies it, but holistic analysis actually makes the problem even worse. Assuming we have a two-horse race (like Android and iOS) and one platform represents two thirds of the market and the other one third. Let's assume that purchasing power is the same on either platform (which is definitely not the case in mobile, but may be the case with consoles), and that a given game for which an exclusive deal is being negotiated is equally appealing to the user bases of either platform. In practice, the latter is rarely the case: for instance, a game may be more appealing to Asian than European customers, and platform market share distribution may vary from continent to continent. But let's keep it simple.

Let's simply assume that customers have either platform A (the 66% player) or B (the 33% player). In practice, there will be some users who "multihome" and then the question is whether they are equally willing to buy a game on either platform. And there may be a different type of platform, such as gaming PCs, so if Player A acquires an exclusive only with a view to consoles, Player B's customers may then have a third way of playing a game, even if not on their preferred device type for gaming.

Player A owns 66% of the market (sort of "our Sony" for the purposes of this analysis) and has to compensate a game maker for skipping, with respect to a given title, the Xbox; conversely, if we adopt Sony's and the FTC's market definition and have a two-horse race before us, Player B ("our Xbox") has to compensate the same game maker for skipping the PlayStation.

In this simplest of all models, Player A has to pay only half as much for an exclusive deal as Player B, given that it must compensate for the opportunity cost from forgoing only 33% of the market opportunity versus 66% if Player B strikes the exclusive deal.

Now, if we assume Player A capitalizes on this cost advantage not just with respect to one title, but in many cases, then after a cycle (for instance, five years), its market share may--not necessarily only, but in no small part also due to those exclusive content deals--have grown from 66% to 72%, and that of Player B may have shrunk from 33% to 27%. Then the relative cost advantage of Player A increases form a factor of 2.0 to one of 2.7. The result would be even more exclusive deals, and after a few cycles, the market would not just be dominated but plainly monopolized by Player A.

Player A has twice the revenue opportunity with a given game to generate--just from game sales, not even counting console sales and the revenues involving other content (than that particular game) those device sales entail--the income to pay for what will cost only half as much: an exclusive deal.

The solution to this competitiveness problem is not that one looks at whether Player B has other business units (in Microsoft's case, that would mean Windows, Office, or Azure) that can cross-subsidize the platform we are focusing on here. For a short period, that may be an option, but it's not sustainable and a publicly traded company sooner or later comes under pressure not to operate a bottomless pit. Even Meta, despite Mark Zuckerberg's preferential voting rights, ultimately felt forced to cut costs in some loss-making areas.

2. Partial exclusives (also including exclusive marketing rights)

The FTC and its sole ally in this context, the UK CMA, are certainly right that partial exclusives can also have anticompetitive effects. It's just a non-issue here as a 10-year total-parity promise has been offered. And if the FTC and CMA are truly concerned about that, they should be investigating Sony's dealings with game makers and clear, with or without commitments, a deal that is actually meant to result in less content exclusivity on the bottom line.

Sony negotiated certain preferential rights with Activision Blizzard. PlayStation gamers get some digital goodies that Xbox gamers do not receive. And as Xbox VP Sarah Bond explained in her testimony on Thursday, Microsoft faced various restrictions concerning its ability to reference or showcase the Xbox version of CoD in its marketing efforts--due to Sony's deal with Activision.

For partial exclusivity, the cost is much lower. Here, the product remains, in principle, available on both platforms. There isn't a simple opportunity cost calculation anymore. It's more about abstract goodwill on the part of consumers and the maker of the other platform. Some gamers may be annoyed that those using a different console get experience points (the primary criterion for progress in many games) twice a fast, but how many will dislike the game for that reason? Hard to tell. Marketing restrictions like the ones explained by Mrs. Bond mean that some free promotion (or cooperative advertising) opportunities are foregone, but that, too, is not easily quantifiable.

What is, however, ridiculous is any suggestion that--as Sony told the CMA and probably regulators around the globe--Microsoft might purposely inject bugs (program errors) into the PlayStation version of CoD or not thoroughly test and bug-fix that version of the game. In that case, it's actually easy to imagine that the damage to the reputation of not only that title but also Microsoft as a whole would far outweigh the benefits, particularly since end users who experience issues with a given game on one platform aren't likely to assume they'll get better results on the other platform. Sometimes even the opposite is the case: some people claim that Google apps for iOS are sometimes of higher quality than their Android versions, though Google makes Android.

3. Single-platforming existing titles vs. upcoming ones

For a game maker--or an acquirer of one--it is a far, far more difficult decision to single-platform an existing title, thereby alienating if not infuriating many gamers who suddenly can't play the game anymore on the platform they own. The cost in terms of customer goodwill is high.

4. Multiplayer matchmaking

In our 66%:33% scenario, there would probably be a critical mass of gamers for random matchmaking on either platform around the clock. However, if people don't just want to play against random opponents but wish to play with particular friends, then the problem of friends not having the device that is required to play the game is only half as big for a title that is exclusive to Platform A as for one that is exclusive to Platform B. This, of course, presupposes for simplicity's sake that everyone's circle of friends has, on average, the same distribution between the two platforms. With consoles that may be the case in a given geographic market, but there could also be correlations (for instance, low-income consumers having mostly low.-income friends, who may in turn share a preference for a less expensive type of device).

The fact that a person can play with only a minority as opposed to majority of their friends has implications for user engagement and customer satisfaction, reducing the likelihood of in-game purchases and future purchases (new versions). It also relates to the next item, word of mouth.

5. Word of mouth and viral marketing

Multiplayer functionality is only one of the reasons for which someone who already plays a game may invite or otherwise encourage friends to play it as well. Even single-player games get word of mouth if people believe their friends may be interested in playing it and show it to them.

Word of mouth works far more effectively for a game that is exclusive to the larger platform than one that is available only on the smaller platform. Word of mouth is a degressive but exponential formula. Think of all the people who used to promote Candy Crush or Farmville to their friends via Facebook messages (at a time when that marketing method used to work). Those games were accessible over the web. If one had needed a particular device, then many recipients of those messages would not have been able to download the respective game.

From the game maker's perspective, word of mouth is extremely valuable as it brings down the average User Acquisition (UA) cost. If word of mouth is weakened by an exclusive deal with a small platform, and if the platform maker cannot compensate for that with money and/or special marketing support, that fact alone makes an exclusive deal with the larger platform maker--or not entering into any exclusive arrangements at all--more attractive.

6. Mainstream media advertising and PR

In our hypothetical 66%:33% example, there probably are websites and other media (YouTube channels etc.) for either platform. So if a game succeeds on one platform, then there will be media outlets that will take note and generate additional demand through their reporting.

But with a view to mainstream media, a game that is available only on a platform with a 33% share (let alone with a, say, 20% or 25% share) is much less likely to get press coverage than one that is available on all platforms or on the dominant platform. In one case, a mainstream media outlet knwos that 66% of its readers can play the game if they like; in the other case, only 33%.

The same problem exists with respect to the economic viability of mainstream media advertising. Imagine a TV commercial for a game: if the game is available only on a platform with a low market share, the game maker pays for 100% of the reach but only 33% of the audience will be able to buy the product at all.

7. Mind share and other long-term considerations

A game maker who enters into an exclusive arrangement with a smaller platform forgoes a larger part of the "mind share" opportunity. That is more of a long-term consideration, but one that major game makers will also take into account. Market share between platforms may shift; new platforms may emerge. That is why game makers are interested not only in revenues but also in having a large user base.

8. Merchandising and other ancillary revenue opportunities

A successful game franchise can also tap additional revenue opportunities such as merchandise or novelizations, possibly even movies based on the game. For example, Fortnite merchandise is quite popular. Those opportunities are either a linear function of the size of the user base or the likelihood of, for instance, Netflix wanting to make a movie based on a game will be drastically diminished if a game is available--even if maybe very popular--on a platform with low market share.


As the FTC's own economic expert already wrote a decade ago, if the choice is between exclusive content being generally prohibited or generally allowed, there are some ways in which smaller platforms and new entrants can benefit from the option of having exclusive content. In fact, Sony's acquisition of Psygnosis was key to the launch of the PlayStation.

The Xbox needs some exclusive titles in the current environment, but that is in no small part the case because of Sony's aggressive "IP" strategy. Given those market realities, one cannot blame Microsoft making at least some titles exclusive, including titles made by acquired companies such as Bethesda. Removing existing titles, especially very popular ones and even more so if they are multiplayer games that people may wish to play with friends, from a much larger platform is, however, clearly not a viable path. Even the UK CMA had to recognize so. The regulators in charge of 40 countries have ruled out that this would make sense for Microsoft to do with respect to CoD, leaving the FTC as a sort of flat-earth society.

The acquisition of Activision Blizzard King is primarily about mobile games, and in the console space it will actually result in less--not more--content exclusivity. Part of the reason Sony opposed the deal is because Sony, for the reasons explained herein, knows it would be in a strong position to negotiate at least partial exclusivity with respect to Call of Duty, if not even total exclusivity at some point.

If one focuses on just the PlayStation-Xbox rivalry (as Sony and the FTC propose), there is a clear and present danger of the videogame market already having reached a tipping point of increasing returns and Sony being able to engage in ever more vertical input foreclosure to the detriment of consumers. In the short term, certain "console warriors" (gamers with a passion for their platform and a desire to see their platform making its rivals disappear into oblivion) may consider this a victory, but in the long run the only thing that protects them is healthy competition between platforms.

What restrictions has Sony imposed? Has Sony precluded game makers from fully exploiting the capabilities of rival hardware? Those questions are more deserving of regulatory scrutiny than a procompetitive merger that creates opportunities for game makers large and small, and for cloud streaming providers of all sizes, too.

Sunday, June 25, 2023

EU proposal on standard-essential patents envisions "Competence" Center that will never get to build competence on SEPs: major misnomer

It is par for the course in politics that action plans, measures, or entire institutions are named euphemistically or at least optimistically in the sense that they reflect a laudable goal for the future rather than a present reality. For example, the "America Invents Act" primarily made it easier to challenge patents through PTAB IPR petitions, for which there were good reasons, but which has nothing to do with encouraging more patent filings and incentivizing more inventions.

The European Commission's Directorate-General for the Internal Market (DG GROW) chose a nonjudgmental name for its proposed regulation on standard-essential patents (SEPs). It would have been unusual for the EU to do otherwise. But there is one label that is pervasive throughout the highly controversial proposal and doesn't withstand scrutiny: "Competence" Center.

It's actually just the smaller of two problems with that name that the EUIPO--which would be more accurately called EUTMO (a trademark office)--knows nothing about patents and particularly not about standard-essential patents. The EUIPO's outgoing Executive Director, Christian Archambeau, once even said the EUIPO would never have patent competence.

That smaller problem could theoretically be solved. The quality of life in the coastal town of Alicante (near Barcelona) is high, and relative to what the governments of the EU Member States pay their employees, EU public servants are well-paid. Licensing professionals who run patent pools or serve as expert witnesses and arbitrators are too much in demand and would probably not be interested, but at least the EUIPO would not be in a worse position to recruit talent than the European Patent Office (which is not an EU institution, and which according to rumor declined to get involved with this SEP regulation initiative).

So what's the bigger issue about?

It's that the proposed EU SEP Regulation makes it practically impossible for the "Competence" Center to acquire SEP competence. Ever.

Even if they hired people with the potential to learn about SEPs in technical and/or economic terms, it's not going to happen because all that they're going to do is of a purely administrative nature:

  • The envisioned SEP register will contain SEPs that are reported by the SEP holders (or by third parties) and the results of essentiality checks performed by external technical experts ("evaluators"). Even the database system will presumably be set up by consultants.

  • The FRAND determinations for entire standards or for particular licensor-implementer relationships will be made by external consultants ("conciliators").

So what will the EUIPO's SEP "Competence" Center really do?

It's just going to be an outsourcing operation. They'll see which of those SEP evaluators (who perform essentiality checks) and conciliators (who propose FRAND rates) are reliable in terms of meeting deadlines and showing up for appointments. They won't even have or acquire the internal knowledge to assess whether those external consultants do good work, except that over time there will be some statistics as to how often a SEP evaluator's findings are affirmed by another evaluator in the event a peer review is performed. Only a reasonably large statistical sample would yield meaningful results, given that a disagreement between two peer reviewers is not as instructive as a decision by an appellate body (where the appellant will challenge particular errors as opposed to a second review taking place without the benefit of an appeal that raises particular issues).

Contrary to a "Competence" Center, that is an Outsourcing Operation, or a Database Secretariat.

The executive branch of the EU government won't become more knowledgeable about SEPs, at least not significantly so. There won't be a better basis for future policy decisions--given the flaws of the proposal that is currently on the table, progress of that kind would be highly desirable and room for improvement abounds--or for giving advice to small and medium-sized enterprises (SMEs) with respect to SEP licensing.

The proposed regulation purports to tackle a problem that the underlying impact assessment is unable to show: patent hold-up. The "researchers" on whose work DG GROW relied even stated explicitly that there is no hard evidence for either hold-up or hold-out. Some of the provisions make no technical or legal sense, such as that an essentiality check of a single patent shall serve to clarify the essentiality or non-essentiality of a entire patent family. Fundamental rights would be violated, such as access to justice--an issue that I highlighted early on (shortly after the first draft leaked in March) and which has recently been raised by the president of the UPC appeals court, Judge Dr. Klaus Grabinski. "Back to the drawing board" is the best advice one can give DG GROW in this situation--and the fact that the so-called "Competence" Center won't ever become truly competent is one of various reasons for that suggestion. There's no shortage of reasons, actually...

Saturday, June 24, 2023

Game over at halftime for FTC: San Francisco injunction hearing in Microsoft-Activision merger case exposes evidentiary and intellectual bankruptcy of misguided agency's case

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:

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.

Wednesday, June 21, 2023

Proposed EU SEP Regulation is explicitly not based on any evidence of patent hold-up or hold-out, apart from unverifiable anecdotes

This is a follow-up to my recent commentary on IP Europe's call for a do-over of the proposed EU standard-essential patent (SEP) regulation. There really is an evidentiary issue because a proposal with potentially far-reaching consequences (throughout and beyond the European Union) can only be justified by and with reasonably hard evidence. There's always going to be someone who disputes that the evidence is strong enough--that's politics. But in this case I think there can be no reasonable doubt about a failure of proof.

While the proposal talks a lot about transparency, it is ultimately about the circumstances and parameters that will--or will not--result in patent injunctions if a SEP holder and an implementer cannot agree. In the vast majority of cases, litigation isn't necessary, and that fact is often overlooked. In the minority of cases where SEPs are actually enforced in court, the central question is almost always just whether an injunction will issue after an infringement of a valid SEP has been identified.

Put differently, no one would care about an asymmetry of information or anything else like that if there were no injunctions. But "no injunctions" is not the answer. It definitely wasn't the answer the European Court of Justice gave in 2015 when it decided the preliminary reference in Huawei v. ZTE. The answer was--in other words--that neither hold-up nor hold-out are acceptable. EU competition rules protect against hold-up, but their purpose is not to incentitive hold-out either.

From an innovation policy point of view, both types of conduct are harmful. Hold-up will result in a misallocation of resources by allowing SEP holders to overleverage their intellectual property rights. That means money will be siphoned off of those who implement standards to make products. Hold-out, however, has the effect of sometimes highly profitable implementers eating the seed corn of those whose innovations involve contributions to standards. That, too, is a misallocation of resources.

The European Commission's Directorate-General for the Internal Market (DG GROW) acted as if there was an urgent need to act. But there isn't. As always, there are some interested parties who want someone to put a thumb on the scales in their favor, and they don't want to wait. But where's the clear and present danger? It's not like small and medium-sized companies are being sued into oblivion by ruthless SEP holders. DG GROW's official impact assessment only quotes from some submissions by unidentified companies telling stories of all sorts, some of which are not at all plausible. Unverified and unverifiable anecdotes shouldn't count as evidence, especially when there are known astroturfing operations that orchestrate questionable submissions and interviews.

I've criticized conflicts of interest on the part of a couple of the "researchers" contracted by DG GROW in this context, and I've voiced disagreement (and will voice even more disagreement) with their findings going forward. But I do want to give them credit for this perfectly honest paragraph that comes down to saying there is no evidence there for either hold-up or hold-out:

"Existing empirical evidence on the causal effects of current SEP licensing conditions is largely inconclusive. Empirically observable outcomes do not indicate the existence of pervasive 'opt-out' from standards-related innovation as a consequence of SEP licensing conditions; i.e. it does not appear that the observed challenges in SEP licensing are sufficiently severe as to systematically discourage potential contributors from participating in standards development, or discourage potential implementers from creating products that use technology standards subject to potential SEPs."

So if we ask ourselves what DG GROW should really do to enable the EU Council and the Parliament to legislate on the basis of a particular proposal, the number one priority must be an analysis of the hold-out vs. hold-up question. The answer is not that DG GROW simply--and conveniently--ignores what its own researchers say: they don't have that kind of evidence in the record. At least not yet.

The issues are not only evidentiary, but also structural. I mentioned before that I was on a SEP panel at a Concurrences-King's College London conference last week. None of us five panelists thought that the EU proposal was flawless and workable in its current form. One of them, a UK patent litigator, had a different focus. All others raised issues that are problems regardless of whether one philosophically wants the EU to go in that direction or not. In fact, the two academics on our panel cannot be blamed for being unreceptive to implementers' concerns.

It would probably be unprecedented, but it would be an honorable and reasonable decision to go back to the drawing board. The question of hold-up vs. hold-out should be analyzed. Researchers commissioned by the EC could be provided with real-world evidence by industry (SEP holders as well as implementers). And to the extent that a few SMEs claim there are issues, their stories should be independently evaluated by law scholars and economists as opposed to taking at face value what may simply have been submitted by some at the behest of astroturfers.

Some argue that there is evidence for hold-up, but none for hold-out. Some suggest the opposite. My perspective is actually a centrist one. I would encourage the Commission and the researchers it relies on to look into both issues. Where companies took licenses under the threat of an injunction, the question is whether the terms were supra-FRAND or simply market rates. At the same time, cases in which companies refused for many years (in one extreme case that is publicly known even for well over a decade) to take licenses, also need to be analyzed. The first step is to understand the two kinds of problems; the second one is to understand whether one of those problems--and if so, which one--is so prevalent that intervention is warranted.

If there was a pressing problem, the paragraph that I quoted from the impact assessment study would not have been written that way.

Saturday, June 17, 2023

Non-smoking gun found: PlayStation chief wasn't really worried about losing Call of Duty, ripping major hole in FTC's argument to block Microsoft's purchase of Activision Blizzard

Right before the midnight Pacific Time deadline, Microsoft and Activision Blizzard filed their (joint) opposition to the Federal Trade Commission's motion for a preliminary injunction:

Federal Trade Commission v. Microsoft and Activision Blizzard (case no. 3:23-cv-2880-JSC, N.D. Cal.): Defendants' Memorandum of Law in Opposition to Motion for Preliminary Injunction

The above PDF contains all of the publicly available exhibits. The only public exhibit that is missing from the PDF for technical reasons is a shareholder report by Sony that can easily be obtained elsewhere. As usual, the expert reports are not made public.

While heavily redacted, the following passage from the court filing is revealing and potentially damning (click on the image to enlarge or read the text below the image):

"First, there is no evidence to support to support the FTC's central tehory that Xbox will take COD away from PlayStation. The FTC does not cite a single document or witness even suggesting this will happen. On the contrary, Jim Ryan, the CEO of Sony Interactive Entertainment ('SIE') and the chief commercial opponent of this deal, said privately on the day it was announced [REDACTED]"

It is not unheard of that an executive reacts to a merger announcement in one way and later, with a view to regulatory reviews, takes the opposite side. I remember a private email exchange I had with someone well over 10 years ago about a merger, and in that case the person stated clearly in the email that the merger was about an incumbent eliminating a nascent competitor--but a few months later he'd meet with the European Commission and say the opposite.

If it is well-documented that Sony wasn't truly worried about vertical input foreclosure, why is the FTC still clinging to that console market theory of harm? Why isn't the venerable agency instead trying to achieve a great outcome for competition and for gamers?

The console market theory of harm--according to which Microsoft's Xbox would cause anticompetitive harm to Sony's PlayStation--has been universally rejected. The regulators in charge of 39 countries have approved the deal, and in a 40th country--the United Kingdom--a blocking decision (which is now being appealed) issued, but the console market theory of market was previously thrown out.

Judge Jacqueline Scott Corley of the United States District Court for the Northern District of California agreed (further to a motion by the merging parties) to schedule up to five trial days, the first one of which will be Thursday (June 22). Having read the FTC's complaint and TRO motion as well as the defendants' opposition brief, I can't see how the FTC would possibly prevail.

I downloaded the public version of the opposition brief immediately upon its filing and, in parallel to reading it, commented on it in a 45-part Twitter thread that mostly consisted of quotes from the brief:

I'll also discuss it in detail in a Twitter Space at 12 noon Eastern Time today that will be recorded.

In this blog post I'll just summarize quickly what the issues and the defending parties' "attack vectors" are.

Legal standard; term and type of injunction; evidentiary burden

The FTC and the merging parties refer to the Ninth Circuit's 1984 discussion in FTC v. Warner Communications: in order for the FTC obtain a preliminary injunction, the evidence must "raise questions going to the merits so serious, substantial, difficult and doubtful as to make them fair ground for thorough investigation, study, deliberation and determination." But the defendants say the FTC can't get there on the basis of "scant proof." Instead, it has the burden of proof to obtain the "extraordinary and drastic remedy [of] a preliminary injunction prior to a full trial on the merits" (as the D.C. Circuit explained in its 1980 FTC v. Exxon decision).

The issue here is not that what the FTC is seeking is downright impossible under the law, but that five case-specific factors up the ante for the agency:

  1. The FTC is not seeking a "hold separate" PI, but wants to kill the merger. Practically speaking, the merger is indeed dead if the FTC prevails here. The FTC makes it sound like the trial before its in-house Administrative Law Judge (ALJ) is just around the corner (starting August 2), but the PI would in fact be in place for about a year or two. After the August trial, it will take the ALJ several months to render a "recommended decision" (which used to be called "initial decision" until the FTC changed it, apparently just in time for this case). If he blocks the deal, it will take an appeal to a federal appeals court to get that decision reversed; if he throws out the FTC's complaint (which would be the logical thing to do given its apparent shortcomings), the commissioners can just make the decision themselves, which would add a considerable amount of time to the process (possibly even another year) and the outcome of their vote would be a foregone conclusion, meaning that an appeal would be required then.

    Microsoft has so far held all of its acquired game studios separate. A divestiture in a hypothetical scenario in which the FTC were to prevail further down the road would be feasible. And even though it would take years, the harm that the FTC alleges, based on an expert report that apparently looks like it's from an alternative universe, would not even really materialize by then.

    In a strictly legal sense, this goes to the equitable analysis. But it's obvious that the burden of proof must be reasonably heavy here, as the likelihood of the FTC's doomsday scenario will also go into the balance of the equities.

  2. Vertical mergers have not been blocked in the U.S. for decades. The FTC and DOJ normally didn't even try--and when they did so in recent decades, they just lost in court.

    My personal opinion is that the pendulum should indeed swing back.

    I am philosophically way closer to the FTC and its current chair than it may seem at first sight (the opposite of "objects are closer than they appear" in a car's side-view mirror). There has undeniably been underenforcement, even in connection with horizontal mergers. Thought leaders pushing for a trend reversal--I specifically also mean Lina Khan--were and are needed--but that is why I find it doubly unfortunate that they're picking the wrong target: a deal that actually spurs competition between large companies, and where the acquirer appears exceedingly cooperative. They don't want a good thing to happen, and they'll most likely lose without achieving anything that will help them next time.

    Case in point, the UK CMA has now granted fast-track approval to Amazon's acquisition of iRobot, the company that makes the Roomba home robot. That deal has been described as "the most dangerous, threatening acquisition in [Amazon]'s history". It's conceivable that if the CMA had not tilted at the windmill named Microsoft-ActivisionBlizzard and (rightly!) faced major backlash for doing so (raising the question of whether Britain was "closed for business"), it might have been able to spend some political capital on that one.

    The burden of proof is particularly high for attempts to block vertical mergers in the United States.

  3. Courts also tend to be rather skeptical of nascent-market theories where harm is predicted to occur further down the road, looking beyond the horizon of what is reasonably predictable.

  4. The opposition brief also notes the following:

    "Defendants are aware of no case where a court has blocked a merger to protect a dominant firm's position."

    It is counterintuitive at best that even according to the FTC's own theory, the allegedly terrible consequences of the merger would simply be that the market leader loses a few percent of its market share. Frankly, that would be a strong basis for a motion to dismiss, but obviously the roadmap here is that the PI hearing will start next week.

  5. Many mergers are cleared on the basis of companies convincing regulators (or, if need be, courts) that they don't have an incentive and, therefore, don't intend to engage in certain kinds of behavior, particularly foreclosure. But "[t]his is the exceptional case where the Court can rely on actions rather than words." There are agreements in place, and they are in fact even being implemented as my timeline chart (the most recent version you can find here) also indicates. People are already playing games via cloud streaming as a result of those actions.

Market definition

As always, antitrust analysis starts with market definition, i.e., with identifying the area in which there is, in fact, competition.

When I saw the FTC's in-house (administrative) complaint in December, I was instantly reminded of an Apple Arcade class action in the Northern District of California that was thrown out (never to be seen again). When I made that connection in my headline, it was unforeseeable and, in fact, unlikely that the FTC's PI motion would later be brought in the same district. But that makes the Pistacchio decision more relevant now. It was about gerrymandering a market definition by focusing on a particular payment method as opposed to product or service offerings that can substitute each other. Multi-game subscription services are clearly just one of many means of paying for games.

In December, the FTC started with three markets: consoles; multi-game subscription services; and cloud-gaming services. In the Northern District of California, it can't come up with entirely new theories of harm because it must argue that it is reasonably likely to prevail on the theories in the in-house adjudicative proceeding. But the FTC is now trying to modify those market definitions a bit. The FTC has thrown two more market definitions into the mix: one where the console market is not limited to Sony and Microsoft, but does include Nintendo (however, it still doesn't include PCs), and another where any service that offers multi-game subscriptions and/or cloud streaming of games is included.

The opposition brief presents strong reasons for rejecting those new market definitions as well.

However, looking at it in statistical terms, it's fairly possible that one or more of the FTC's proposed markets may survive the market definition stage.

Theories of harm in the various proposed markets

The console market and multi-game subscription service theories that have failed everywhere else in the world are not even worth discussing further here. Those theories made no sense even before that "non-smoking gun" was found in the form of some Sony-internal communication.

On the cloud gaming side, a Sony statement comes in handy, too:

The FTC must basically tell the court to attach no weight to the agreements Microsoft has signed and begun to implement with rival cloud streaming providers and the commitments vis-à-vis the European Commission into which Microsoft has entered (which are valid worldwide). And even the FTC's own expert once argued (PDF) that the exclusive availability of games on particular platforms was actually procompetitive.

Just like the CMA, the FTC faces the problem that Activision Blizzard has been very clear about not intending to make its games available through multi-game subscription services and on cloud-gaming services in a way that would cannibalize its traditional sales.

As counterintuitive as it may seem, the ones who are fighting this transaction are doing competition a disservice, and those who are advocating its clearance are promoting competition, innovation, and customer choice.

The FTC will file its reply brief in a few days, and then the parties will submit their proposed findings of fact and conclusions of law, which will discuss in more detail how either side seeks to persuade Judge Corley.

Friday, June 16, 2023

OPPO effectively defends 5G standard-essential patent against Nokia's opposition: EPO upholds claims based on minor clarification; Mannheim trial scheduled for 6/27

The patent spat between Nokia and OPPO is about two weeks away from its second anniversary. It became known this month that Nokia obtained injunctions against a dozen German resellers of OPPO and OnePlus devices. The parties' efforts to invalidate each others patents (not only the ones that are actually being asserted) are a major part of the earth-spanning dispute. Last month OPPO invalidated another two Nokia patents and a written decision in favor of Nokia's opposition to one OPPO patent came down as well.

This week, OPPO achieved something that might have paved the way for a Mannheim injunction against Nokia this summer. At the end of an opposition hearing held on Tuesday (6/13), the European Patent Office (EPO) upheld, with only a minor clarification added to the claims and the description, one of OPPO's patents-in-suit (click on the image to enlarge):

The patent-in-suit is EP3672346 on an "information transmission method, terminal and network device." The Mannheim Regional Court's Second Civil Chamber (Presiding Judge: Dr. Holger Kircher) will hear the OPPO v. Nokia infringement case over this 5G standard-essential patent the week after next (June 27 to be precise). That trial could get really interesting.

All that it took for OPPO (lead patent attorneys: Bardehle Pagenberg's Tobias Kaufmann and Dr. Patrick Heckeler) to fend off Nokia's opposition was the following insertion into the claim language as well as the first page of the description:

determining, by the terminal, that the time interval is not less than a preset time interval;

An interval defined by a standard is only meaningful if a minimum period of time is predefined. Presumably the relevant determination here is made by the end-user device, so I assume that this insertion is not going to change anything about the essentiality analysis. While OPPO has already exited the German market, I doubt that Nokia would want to do so, and that's why Nokia must defend itself against OPPO's offensive cases or it might have to settle before it gains decisive leverage in another jurisdiction.

Wednesday, June 14, 2023

UPDATED TIMELINE: U.S. court to hear FTC request for preliminary injunction against Microsoft-ActivisionBlizzard next week, merger technically can't close in June but on track for July

By the end of next week, the UK Competition & Markets Authority (CMA) will probably have lost its only ally against Microsoft's purchase of Activision Blizzard: the U.S. Federal Trade Commission (FTC) may still be against the deal, but I believe it will have lost decisively. I consider it highly likely that the United States District Court for the Northern District of California will deny the FTC's motion for a preliminary injunction (PI) that was filed on Monday. A temporary restraining order (TRO) has issued (unsurprisingly), and a two-day PI hearing will be held in about a week (Thursday, June 22, and Friday, June 23). The court will probably rule at the end of the hearing, or very shortly thereafter.

Against that backdrop, the earliest closing date--if Microsoft is prepared to close over the CMA's objection--will be Monday, July 3, which means that two weeks would still be left under the existing merger agreement to find middle ground with the CMA, which presumably knows that its April 26 decision is indefensible on appeal.

Here's my updated timeline chart (click on the image to zoom in and make it look crisper):

Now let's talk about the latest developments since yesterday's post. You can find my real-time commentary on this rapidly-evolving merger topic on Twitter, so for my Twitter followers some of the below is not new.

First, FTC v. Microsoft & Activision was related (i.e., merged for procedural purposes) with the class-action-style lawsuit in the same district, and the same judge--United States District Judge Jacqueline Scott Corley--is now presiding over the proceedings, particularly also next week's PI hearing. She recently denied a PI that was requested by the "gamers" who act as plaintiffs for the lawyers who are the driving force (and have received at least some logistical support from Sony).

The basis on which the PI was denied in the private action was that even if the court had agreed with the class-action lawyers on irreparable harm (negative consequences for consumers from the consummation of the merger), such hypothetical harm would not have been immediate. The likelihood of success on the merits (i.e., the question of whether those plaintiffs could prevail after a full trial) was never reached. In fact, the PI hearing was purely about irreparable harm and its non-immediacy.

In the FTC case, the focus will be very much on the likelihood of success on the merits. In the equitable analysis, it could--and in my view should--still weigh against the grant of the PI that any of the alleged effects of the merger are far-fetched and (even if they were--as they are not--realistic) far off. The balance of hardships here comes down to the FTC seeking to kill a merger that has a July 18 closing date while any of the hypothetical effects on competition would not materialize for quite some time to come, especially in light of the fact that Microsoft offered contractual commitments for 10 years. That 10-year period would be more than enough for the case to be litigated (even for the exhaustion of all appeals) and Microsoft theoretically being forced to divest some or all of the acquired assets at that stage.

The FTC chose to bring a complaint before its in-house Administrative Law Judge (ALJ), which is constitutionally controversial. In light of the Supreme Court's recent Axon decision, it is even harder for the FTC to explain why it didn't sue in federal court. Now the FTC runs to the court in San Francisco and wants it to kill a $70B deal, while the only reasonable venue choice would have been to start a federal lawsuit in December.

At one of the hearings in the private lawsuit, Judge Corley made reference to her colleague Judge Edward Davila's denial of a PI that the FTC was seeking against Meta's acquisition of virtual reality fitness app maker Within. I discussed the Meta-Within decision in early February. That case was, relatively speaking, a stronger one for the FTC than its opposition to the acquisition of Activision Blizzard King (ABK). The substantive issues are different, but there is an abstract parallel here in the sense that the FTC espouses some wild theories without any hard facts to back them up.

Realistically the FTC won't have any "smoking gun" to present at the PI hearing. They will presumably just serve a lot of weak tea on those two days. The FTC's console theory of harm has been rejected by the regulators in charge of 40 countries (even the CMA dropped it). It also raised cloud gaming, which was more of an afterthought in the beginning but will probably be put front and center now because of the CMA decision. As you can also tell from my timeline chart, the CMA decision came down a few weeks prior to the mid-May PI hearing in the private lawsuit, but the clearance decisions by the European Commission, China's SAMR, and South Korea's KFTC were announced only subsequently (second half of May). The CMA and the FTC are outliers, and it can be inferred from the public redacted version of the FTC's filings that Microsoft and ABK essentially forced the FTC's hand by saying they might close the deal as early as this week's Friday, triggering the proceedings in federal court that I believe will simply take the FTC out of the game, isolating the CMA.

There may be some discussion of the CMA decision now, but the fact of the matter is that the United States District Court for the Northern District of California is not the appeals court for the CMA: the UK Competition Appeal Tribunal has jurisdiction over appeals from CMA decisions, and the CAT will hold its appellate hearing in late July and early August (as my timeline chart also shows). I was in London earlier this week for a conference (where I was invited--on very short notice--to speak) and seized the opportunity to attend a CAT hearing in person. I must admit I'm honored and humbled by the fact that Mr Justice Marcus Smith, the President of the CAT, stayed at that conference even after his AI-centric keynote speech and listened to the panel session to which I made my little contribution. I had a good time there, and the UK in general seems to be very much open for business, but the CMA's antics are one of the issues that must be addressed there.

I believe it won't be hard for Judge Corley to see that the CMA decision is unlikely to stand. For just one example of many, even the class-action lawyers alleged a Microsoft cloud gaming market share of "only" 40%, while the CMA arrived at a 70% figure, which is not only an exaggeration but a lunacy. The combination of the CMA decision being obviously flawed and the global picture--approximately 40 countries in favor--is dynamite.

On Tuesday, Judge Edward J. Davila--the Meta-Within judge--helped out Judge Corley by entering a TRO:

Federal Trade Commission v. Microsoft and Activision Blizzard (case no. 23-cv-2880-JSC, N.D. Cal.): Order Re: Temporary Restraining Order and Preliminary Injunction

A few hours earlier I had tweeted (while waiting for a flight at Heathrow Airport) the following:

The FTC almost always gets a TRO, but the current FTC also loses almost every merger case when it really matters.

Given that Judge Corley is already familiar with this merger and that the FTC's complaint is egregiously weak, this case could have become an exception to the rule that the FTC always gets a TRO. But given the size of the transaction and all the publicity surrounding this merger, it's easy to see why the court didn't want to humiliate the FTC by denying a TRO. The FTC's TRO motion mentioned that most defendants even stipulate to a TRO, and given that Judge Davila entered the order even before Microsoft or Activision Blizzard had made any filing (other than lawyers signing up), we don't even know how much resistance the merging parties would have mounted.

The TRO order does not address the merits in the slightest. It's purely procedural. It's just a scheduling order. Microsoft and ABK will file their opposition briefs on Friday (and they can take until right before midnight Pacific Time). The FTC will reply by noon Pacific Time on Tuesday.

The TRO will be in place after the PI decision. Assuming that the court rules at the end of the PI hearing and throws out the motion (which is my prediction), that means the end of Friday, June 30. Practically that makes Monday, July 3, the earliest practical closing date. The next day is Independence Day.

The additional time after the PI decision would theoretically enable the FTC to appeal a denial to the United States Court of Appeals for the Ninth Circuit, and to seek emergency relief there.

There will be more than two weeks left between the PI hearing and the contractual closing date. I won't give up hope that a solution can be worked out between Microsoft and the CMA. Otherwise, after the FTC is defeated in federal court, "closing over" is obviously a possibility, though the parties in that scenario should not find it hard to agree on a short extension to await a CAT decision.

The merger is on the right track, and I continue to believe that it will consummate.