Playing by the Rules

Regulators across the globe have been quite active this past week, with notable news coming from the two most anticipated legal battles in gaming. We have previously written about Epic’s lawsuits with Apple and Google over app store marketplace practices and regulators’ challenges to Microsoft’s $68.7b acquisition of Activision Blizzard, but given the recent announcements we are providing an update on the situations along with our latest thoughts and takeaways.

Epic vs Apple

High-level: Both Apple and Google banned Fortnite when Epic Games broke the terms of service by intentionally offering a direct payment option (in an effort to bypass the 30% platform fees). Earlier this week, a US appeals court determined that Apple’s action did not violate antitrust rules. However, Apple can no longer prevent apps from offering links to third-party payment alternatives. This has massive implications on marketplace revenue for both Apple and Google now that their 30% fee can potentially be circumvented.

The legal conflict between Epic and Apple has now been in the public arena for almost three years. As a reminder, this was initiated when Apple and Google (note: we will focus on Apple as that has been the higher profile case) banned Fortnite from their respective mobile app stores after Epic Games broke the terms of service by offering direct payment methods. It was immediately clear that this was not an error by Epic, but rather a calculated demonstration of what they perceived to be unfair and monopolistic practices from mobile game distribution platforms.

After the ban in 2020, Epic released a video online mimicking Apple’s famous Macintosh ad from 1984 (watch it here, side by side). Epic accused Apple of being the bad guy this time around, instead of the hero. The video ends with the hashtag, #FreeFortnite, which quickly became the top trending tag worldwide on Twitter back in 2020.

From Epic’s perspective, hardware providers’ ability to limit their devices to first-party app stores and require developers to facilitate transactions with platform-owned payment gateways enabled them to take an “excessive” 30% cut on transactions. Epic positioned themselves as fighting on behalf of all developers for more freedom over distribution and equitable economic arrangements.

In September 2021, a federal judge in the US issued a decision that provided both Epic and Apple with some concessions.

• Apple: Existing App Store practices (such as locking device users into first-party marketplaces and requiring app developers to use Apple’s proprietary in-app payment systems) did not violate antitrust rules as defined by the Sherman Act.
• Epic: Apple cannot prevent apps from linking out to third-party payment platforms (a practice called “anti-steering”), unlocking a path for developers to avoid the distribution platform’s 30% fee.
  

Unsurprisingly, neither group was entirely satisfied with a compromise and the decision was appealed. After months of additional deliberation, a federal appeals court in the US effectively upheld the existing ruling earlier this week.

Apple has not truly won and is up for a series of battles to defend its market share: In response to the ruling, Apple has declared “victory” in the case as they won 9 of the 10 decisions around monopolistic practices. Even Epic’s CEO, Tim Sweeney, tweeted that “Apple prevailed at the 9th Circuit Court.” However, we believe this undermines a critical victory for Epic and mobile app developers across the board given the anti-steering provisions (one of the most important and contentious points) landed in Epic’s favor.

Opening up the ability for apps to link out to third-party payment platforms means reduced revenue for Apple (potentially billions of dollars given the App Store generated upwards of $85b in 2022), a larger rake for developers, and potential discounts for consumers. This is a win for Epic.

Sweeney’s relatively pessimistic messaging is likely posturing for the next wave of appeals. It is doubtful that Epic will back down from their position that app stores are acting in an anticompetitive manner, and we will likely see dissent amongst regulators across geographies. In the meantime, the US regulators (a strong signal for the rest of the world) have made their position clear.

CMA Blocks Microsoft’s Acquisition of Activision Blizzard

High-level: The UK’s Competition and Markets Authority (CMA) has joined the US Federal Trade Commission (FTC) in blocking Microsoft’s $68.7b acquisition of Activision Blizzard by citing anti-competitive behavior, specifically in the cloud gaming market. Given the small size and nascency of the cloud gaming market (~$2.4b in 2022), this logic is unsound.

Microsoft’s $68.7b acquisition of Activision Blizzard has been a contentious topic since it was initially announced in January 2022. The debate around whether or not this consolidation of distribution and content powerhouses will negatively impact the gaming industry continues to rage on, but at this moment the most pressing topic is the legality of this record-breaking deal. For some context on the magnitude of this acquisition, based on data at the time of the deal’s announcement, Microsoft would become the second largest gaming company in the world by revenue (up from fourth).

In December 2022, the US Federal Trade Commission (FTC) was the first governing body to officially block the acquisition. The primary rationale was that the deal would give Microsoft the option to suppress competition in the distribution of gaming content given the company’s existing Xbox, xCloud, and Game Pass offerings. We have previously argued that even the consolidated entity (as shown in the data above) is not large enough to constitute monopolistic control (only ~11.6% post-acquisition).

Since this announcement, regulators have been relatively quiet as Microsoft continues to make their case that the transaction should be allowed.

The CMA is blocking the acquisition based on potential: The first major regulatory update came this week, as the UK’s CMA aligned with the FTC’s conclusion that this acquisition should be blocked. While we at Konvoy maintain our position that this transaction should be allowed to go through (as we’ve previously written), we understand that there are credible arguments around negative impacts resulting from vertical integration in the creation and distribution of games. That being said, we do not believe that the CMA’s rationale is a compelling or relevant reason to shut down the deal.

According to the CMA’s press release: “Allowing Microsoft to take such a strong position in the cloud gaming market just as it begins to grow rapidly would risk undermining the innovation that is crucial to the development of these opportunities.” The regulator’s primary concern seems to be Microsoft’s early advantage in a cloud gaming market that might become large. In their own words, they estimate that Microsoft already owns 60% to 70% of a tech segment that could be worth $13.7b in three years.

Microsoft is helping create a market which would likely not exist without it: The reality is that cloud gaming is still a small and emerging category. Although Microsoft is undoubtedly the leader in the space, they are effectively spearheading the market given historical failures by competitors. Blocking an acquisition because it helps a large tech company gain adoption for a new and innovative product makes very little sense from our perspective.

Underlying the move is also an assumption that Activision Blizzard content will be unfairly leveraged by Microsoft to bolster their cloud gaming offer, either by making it exclusive content on xCloud or providing some unique benefits within their own platform. Though there is the potential for that to happen, Microsoft has repeatedly stated they would keep Activision Blizzard content available to other providers. Again, the CMA is attempting to block the deal based on what might happen, not on what will or has happened.

It is also a bit unclear who the CMA is trying to protect with this ruling. The most viable competitors are other tech giants with substantial cloud computing resources such as Google (already shut down their Stadia offering), Nvidia (GeForce Now), and Amazon (Luna). Extrapolating that Microsoft’s acquisition of Activision Blizzard is anticompetitive for some of the largest tech companies in the world seems like a major illogical jump for an unproven distribution channel.

At Konvoy, we have also seen startups repeatedly struggle to enter this market given foundational business model limitations. Some major tech companies are able to sell cloud gaming subscription services as a loss leader given they own the infrastructure. Smaller players are forced to outsource computing resources to these larger cloud competitors and factor in unit economics from the beginning, which often requires them to charge users by the minute or hour (an inferior user experience).

With this in mind, we believe the CMA has presented a weak argument for blocking Microsoft’s acquisition of Activision Blizzard. By focusing on Microsoft’s ability to solidify an early lead in a small and emerging game distribution channel, the regulator is basing their weak argument on multiple theoretical risks. The CMA’s position shows a misguided and misinformed understanding of the current cloud gaming ecosystem.‍

Takeaway: The latest announcements from Epic / Apple and Microsoft / Activision Blizzard reflect two very different regulatory approaches. In the case of Epic / Apple, the courts have generally decided to be more hands-off and allow the free markets to sort out the economic dispute. On the other hand, the CMA has aggressively intervened by citing that Microsoft would have clear economic incentives to act in an anti-competitive manner by making their content exclusive. We expect regulators will continue to become increasingly aggressive as the gaming industry grows and receives more widespread attention.