Virtual bullets and explosions dance across the screen, yet I’m far more focused on what’s coming in through my Playstation headset. Two of my best friends live across the country, yet we stay in touch through the team-based online shooter game Overwatch. Bemoaning the substandard play of our competitors (and occasionally other teammates) is interspersed with discussions of our families, professional lives, and significant others. It almost feels as if we are back in the college dorm room where we met a decade ago, instead of three time zones apart.
Our online gatherings, and many others like it, are now in jeopardy. You see, Overwatch is made by Activision Blizzard and the three of us play on Sony’s Playstation console. Microsoft, Sony’s chief gaming rival, has announced it will be acquiring Activision Blizzard for a whopping $68.7 billion. The deal merits rigorous scrutiny by antitrust enforcers.
Defining the Market
“Video games” can be a nebulous market, and strategic companies are more than capable of stretching the market definition to make themselves seem unthreatening to the watchful eye of antitrust scrutiny. For example, mobile games have skyrocketed in popularity and while there is some overlap, few believe a phone to be a viable substitute for a video game console today. A technically demanding game like Overwatch can’t be played competitively on a mobile device. In addition, mobile game controls lack the precision of console controllers and as of now developers exclusively make blockbuster games for consoles, with few exceptions. Mobile games also mostly operate with a different business model — free-to-play, with monetization driven by advertising and subsequent purchases of in-game currency or premium features. Enforcers will need to determine whether mobile games are part of the market or not (they’re probably not).
Video gaming is dominated by three companies (Nintendo, Sony, and Microsoft) across four platforms (Sony’s Playstation 5, Nintendo’s Switch, and Microsoft’s Xbox consoles and PCs). Today’s consoles are more than just some fancy computer hardware and a disc drive. They come with apps, a virtual storefront, and premium services enabling online play and cloud-based gaming. These combine to form an entire ecosystem with multiple ways to monetize consumers.
Of the three major companies, Nintendo is an aberrant player. The Switch lacks the processing power of the other consoles and is focused on exclusive games (Zelda, Mario, etc.) and other metrics like mobility that Sony and Microsoft mostly eschew. Nintendo has been on this unique path since the launch of the Wii in 2006, and shows no signs of deviating from their approach to more closely compete with Sony and Microsoft. Nintendo Switch users also skew younger and spend less time each week playing. Although there can be overlap, Nintendo’s market focus is a more casual consumer and serious “gamers” are usually relegated to the Sony/Microsoft duopoly. Again, it will be up to enforcers to determine whether Nintendo should be considered part of the market or not (a closer call than mobile games).
According to the NPD Group, consumers spent $60.1 billion on video games in 2021, with just $6.1 billion of that total spent on hardware (i.e., consoles). Both numbers were double-digit increases over 2020. Contrary to antiquated assumptions of gamers as children or predominantly men, market demographics tell a different story. The median age of a user is 34, 70% are over 18, and 45% are women.
As the market has grown, so too has the concentration within it. In January, video game publisher giant Take Two Interactive (Grand Theft Auto, Civilization) announced it was buying mobile giant Zynga (remember Farmville) for $12.7 billion. Perhaps the most impactful potential deal is Microsoft’s $68.7 billion proposed acquisition of Activision Blizzard. Not to be outdone, Sony announced its own big money acquisition of Bungie for a seemingly paltry $3.6 billion two weeks later.
Activision Blizzard is one of the most popular video game publishers and developers. Their flagship games should be recognizable to almost anyone and include World of Warcraft, the aforementioned Overwatch, Call of Duty, Guitar Hero, and Diablo. Two of the Playstation 4’s top-five selling games were Activision Blizzard titles. Perhaps the main competitive worry about the deal is that Microsoft will stop making Activision Blizzard blockbuster games for the Playstation and make its exclusive home the Xbox. The deal gives Microsoft the incentive to leverage these games to push gamers towards buying into the Microsoft ecosystem of Xboxes and other Microsoft services. The prospect of losing access to these titles is so threatening that $20 billion (over 13%) was wiped off Sony’s market capitalization after the Microsoft acquisition was announced.
Microsoft claims the transaction will mostly be used to bolster Game Pass, its premium Xbox subscription service for video games. Its function is akin to Netflix, with a catalog of video games available to play and download for a fixed monthly fee. Adding Activision Blizzard’s gaming blockbusters to Game Pass would make the service even more attractive for Xbox gamers. The question of whether consumers are better served by subscriptions vs. a la carte pricing remains an open one. However, antitrust enforcers should approach the deal as if Microsoft was a stage magician—don’t be distracted by what they want you to see.
In the acquisition war between Sony and Microsoft, it is consumers that stand to lose. Although multihoming (using more than one ecosystem) is possible, it can be prohibitively expensive for many users. Buying a game via either disc or download only works on one ecosystem and no one wants to pay twice for the same game. This also means consumers experience some level of lock-in as they’d lose access to their titles and game progress if they decide to switch between Sony and Microsoft. Consoles can run upwards of $500 and consumers exhibit some level of brand loyalty for their chosen console ecosystem.
Regulators and enforcers also shouldn’t be distracted if they hear bold future pronouncements about the metaverse, or a console-free cloud-enabled gaming experience. The competition harms will be felt in the present-day market of console gaming, and the deal should be evaluated in that market, not just what the future might be. Enforcers must assess how the newly combined company’s incentive and ability to harm competition in the marketplace would change if the deal goes through.
There are a lot of ways a vertically integrated video game developer can favor their own offerings outside of pure exclusivity. For example, timed release windows (where consumers on the disfavored ecosystem have to wait weeks or months until a title is available to them) or timed releases of downloadable content (DLC) packs can impair gamers not on the chosen gaming ecosystem. Overwatch recently launched crossplay so Xbox and Playstation users can play in the same games together, but pro-consumer features like that are on the chopping block now. Overwatch’s new overseers have a strong incentive to move users from their biggest rival to the console ecosystem they own.
There’s already an interesting case study given Microsoft’s acquisition of ZeniMax Studios, the parent company of popular video game maker Bethesda Softworks in 2020. Bethesda is behind several popular franchises, including the Elder Scrolls (they’re still releasing new versions of Skyrim ten years later) and Fallout. As an independent developer, the company had offered its games on both Sony’s and Microsoft’s consoles. Now under the Microsoft umbrella, it’s been announced the studio’s latest game, Starfield, will be an Xbox exclusive.
The Microsoft/Activision Blizzard deal does not happen in a vacuum. The video game industry has been marked by strong trends of vertical and horizontal integration. The simplified pipeline for making a video game involves a developer (the technical creator of the game) and a publisher (the bundler and distributor of the game). Publishers have swallowed up developers at an alarming rate. Activision Blizzard itself was a merger between a top-flight publisher (Activision) with a developer (Blizzard Entertainment) completed in 2008.
It should be noted that, so far, the master of exclusivity has not been Microsoft, but its rival Sony. Sony has invested heavily in buying up promising developers and negotiating exclusivity agreements to create a roster of Playstation-exclusive content. These exclusives are cited as perhaps the main reason Sony “won” the last generation of the console wars as Playstation 4 sales far outstripped that of the Xbox One. Now, armed with the juicy IP Activision Blizzard offers, Microsoft has the same incentive to hinder its Sony rival. A video game-esque Hammurabi’s Code will do consumers no favors.
The deal also comes at a critical moment for antitrust enforcement. A comment period is ongoing as the Department of Justice and Federal Trade Commission attempt to revise their guidelines for how they approach mergers and acquisitions. A focus of that effort is vertical deals, one in which a company acquires another up or down stream competitor. This is contrasted with a horizontal deal, where a direct rival in the same market is acquired. Decades of waving through vertical deals have given way to a renewed interest in stronger enforcement, with a focus on incentives to competitively shut out rivals. Although there is a horizontal component to the deal (Microsoft right now is a relatively small game publisher and developer), the main competitive worry will be vertical—how Microsoft could choose to leverage Activision’s game catalog in anticompetitive ways.
Another point of emphasis in rethinking mergers is monopsony—monopoly’s dastardly cousin, a monopoly among buyers. Perhaps the most pressing monopsony problem is in labor markets, where concentrated firms can conspire to keep wages and benefits low if workers have nowhere else to go. The video game industry has notorious working conditions, with inhumane “crunch” periods to finish a game part of the norm. Video game development is a relatively specialized field where workers cannot just easily jump to or from other technical roles. Enforcers should be wary about giving workers even fewer places to go.
Freed from being a niche market appealing to only a small subset of the population, video games have blossomed into one of the main forms of entertainment for millions. More competition in the industry and more diverse voices developing games would do consumers a lot of good. Microsoft claims that they want gamers to be able to play whatever games they want on whatever device they happen to have. Their commitments around fairness in app stores are encouraging, but we need far more than self-enforced business commitments—we need vigorous antitrust review. There’s a lot more at stake than just old college friends staying in touch.