Here at Level Up, our inbox is chock full of press releases, PR pitches, notes from my editors, a fan mail or two, and the occasional bit of Viagra spam that slips through our email filters. But every so often, something genuinely compelling comes across the transom--so compelling, in fact, that we have no choice to share it with you. In February, we appeared on the G4TV show X-Play to discuss Electronic Arts' bid to acquire Take-Two. A viewer of the program, Justin Blankenship, is also a regular reader of Level Up, and he wrote us to share his thoughts about the deal. His words were sufficiently compelling that we asked him to shape them into a formal post, which we present to you following our introduction.
What made Blankenship's opinions particularly intriguing is that from Fall 2001 until early 2004 he was employed as a lawyer at the Federal Trade Commission in Washington, D.C. More specifically, he worked in the Mergers 2 division, which reviewed mergers in the chemical, technology, and entertainment fields for potential violations of Section 7 of the Clayton Act, in search of potential anti-competitive concerns that would hurt consumers. So as part of his division's jurisdiction, Blankenship examined similar mergers while at the FTC, and in his email to us, he expressed his opinion that the FTC would take a hard look at the EA Sports/2K Sports part of this deal for antitrust reasons. " Although you've yet to see antitrust law rear its head in a videogame merger, this is the best case I've seen where it could happen," Blankenship says below. Read on to find out why EA could have more problems on its hands than just Take-Two's wily CEO Strauss Zelnick and the merry band of arbitrageurs holding out for a higher sale price.
There seems to be a lot of chatter in the videogame industry about the inevitability of Electronic Arts' takeover of Take-Two. Although EA's offer may eventually prove too lucrative for Take-Two to pass up, I wouldn't assume that this deal will get a rubber stamp from government antitrust regulators. I'm specifically referring to comments by Wedbush's Michael Pachter, who stated: "Currently [EA and Take-Two] compete in pro basketball, college basketball and hockey. So by taking out all of that, EA has a monopoly in sports. If these guys have a monopoly, they're not going to cut pricing on sports games as quickly. We've been seeing sports games come down [in price] before Christmas the last couple of years. That'll never happen again."
Until 2004, I worked in a division of the FTC that spent a lot of time looking at technology-related mergers, and had at least taken a good look at mergers like this one. I also have every reason to suspect that my former colleagues would give this deal a hard look, especially in light of Mr. Pachter's comments, of which I'm sure they're aware.
Section 7 of the Clayton Act forbids the acquisition of stock or assets when "the effect of such acquisition may be substantially to lessen competition, or to tend to create a monopoly." (15 U.S.C. § 18) This case, like most merger cases in antitrust, would likely be resolved by the definition of the market (anyone interested in the details of this analysis can refer to the Joint DOJ/FTC 1992 Horizontal Merger Guidelines). If a given market is defined narrowly, it means there are fewer competitors, and concentration levels are consequently likely to be much higher. In a broader market, more competitors are included, concentration levels are lower, and competitive issues are far less likely.
Market definition is easy in markets where all competing products are interchangeable, such as commodities markets. Videogames, however, are what the guidelines refer to as "differentiated products." No two titles are identical and each one appeals to different consumers for a variety of reasons, making the economic analysis more complicated. While all videogames compete with one another for gamer dollars in a broad sense, it's also clear that certain games compete more closely with certain other games.
For example, picture Consumer X walking into the store intent on buying a hockey videogame. If he sees two hockey games on the shelf, he's likely to make his choice based on game features if price is comparable. If that game were priced $10 higher than the other, however, the consumer is faced with deciding whether those preferred features are worth $10 more. If not, Consumer X is far more likely to buy the cheaper hockey game than he is to spend his gaming dollars on a fantasy role-playing game. In other words, although all of the videogames in the store are competing with one another on some level, those two hockey games are competing much more closely.
Those two games are also much more likely to act as price constraints on one another than other games. If Hockey Game A raises its price, then it's likely to lose sales to Hockey Game B, and vice versa. In that case, there is a compelling economic argument that you could define a narrow market of "hockey videogames" for antitrust purposes, because at least for those consumers who want to purchase a hockey videogame, those are their choices.
If a government agency has problems with a merger, it's likely because it believes the economic data supports a narrowly defined market (e.g., licensed professional hockey videogames or hockey videogames). The parties to the merger will argue to define the market more broadly (e.g., videogames as a whole, or sports videogames as a whole). Under a broad market definition of all videogames, the merger poses no problems, because the loss of one product in a market of thousands of competitors is a ripple in the sea. However, under a narrow market definition, no other third party can make a licensed professional hockey game (with real player names, team names, stats, etc.) other than EA/Take-Two, granting it an effective monopoly.
The concept of market definition turns on economic evidence, which I'm not privy to, but if Mr. Pachter's comments are accurate, EA and Take-Two's sports games are price constrained by one another. In other words, vigorous competition between their respective basketball and hockey games is what causes the prices of those games to decrease more rapidly--much more so than competition from other videogames in the market. In that case, it's entirely probable that government regulators could define a narrow submarket of "NHL-licensed hockey games," "NCAA-licensed basketball games," and "NBA-licensed basketball games." If so, what you're effectively seeing here is almost a complete elimination of competition in those narrow submarkets.
If you take the example of Consumer X from above, and imagine that the same publisher has the right to set the prices of both Hockey Game A and Hockey Game B, you see the obvious problem for consumers. That publisher is free to raise the price of Hockey Game A because they know that the vast majority of consumers who wanted Hockey Game A will either buy it for the higher price, or buy Hockey Game B instead. Or, what you're more likely to see, is that where both Hockey Game A and Hockey Game B may have fallen in price before the holidays in an effort to appeal to more consumers, a single publisher now has every economic incentive to keep the prices of both games closer to $60 through the holidays.
I've used hockey games as an example so far because that's the cleanest example. EA's NHL series and Take-Two's 2K series are now the only competing professionally licensed NHL games on the market. But there are also overlaps between EA and Take Two in college and professional basketball videogames. Although it appears that EA has already acquired a de facto monopoly over college basketball games when 2K sports failed to reach a new agreement with the Collegiate Licensing Company, if 2K were to renew its license, EA would now be assured of maintaining its monopoly in college basketball thanks to the merger. Sony remains a competitor in the NBA market with its first-party product, but only on the Playstation 3 console and the PlayStation Portable handheld. After the merger, EA would be the only developer of NBA licensed games on the Xbox 360, Wii, and presumably any non-Sony portable platforms.
Even if EA/Take-Two were able to persuade government regulators to adopt a broader market definition, the merger still seems problematic. Although EA/Take-Two wouldn't have a clean monopoly in a broader market of sports videogames, the merged entity seems to be reaching critical mass. In addition to the new exclusives in NHL games and NCAA basketball games, and the third-party exclusive for NBA games, EA/Take-Two would also acquire 2K's third-party exclusive license for MLB games. Add that to a portfolio that already includes exclusive licenses for NCAA football, the PGA, NASCAR, FIFA, and the NFL, and you've got a juggernaut in the sports videogame market and a wall of exclusive licenses preventing any other developer from competing on equal footing.
Even without a total monopoly, one could expect that a publisher with that many sports titles under its belt could potentially abuse that market power to the detriment of its few smaller competitors. The concentration levels in a sports videogame market would be well over the thresholds of concern defined in the DOJ/FTC Horizontal Merger Guidelines.
How would a review of this merger likely unfold? Although both the Department of Justice and the Federal Trade Commission exercise joint jurisdiction over antitrust merger review with certain industries allocated to each agency via a complicated clearance process, I have reason to believe from past experience that this deal would end up at the FTC.
Although I don't believe we've ever seen the government step in to take any sort of action in a videogame merger in the past, the facts of this case are unique for the reasons I set forth above. Past antitrust reviews of videogame mergers have ended up presenting no legal concerns for three main reasons:
- There's still a lot of competition among developers in the overarching videogame market, although this is changing rapidly as we're seeing two competing behemoths (EA and Activision/Blizzard) form before our eyes (another reason this deal is likely to get a hard look).
- There's usually a possibility of new developers entering the market and restraining prices (the success of one-time small developers like Valve and Blizzard are common examples of how one-time nobodies can swoop in and become dominant players).
- Videogame prices tend to cluster for much of a generation, with little variation ($60 for 360/PS3, $50 for Wii).
Furthermore, a hostile bid for a software company could leave you with a shell when talent walks out the door. In an industry where game prices are fairly uniform across the board, it's usually hard to identify any potential anticompetitive effects that harm consumers. Where you see an obvious anti-competitive effect here, as identified by Mr. Pachter, is in the price of sports games declining more slowly in the future than they otherwise would in the face of spirited competition.
This case is also unique because the sports game industry provides a unique piece of economic evidence: the Madden model. An economist could easily plot the rate of price reductions in professionally licensed football games before EA had an exclusive agreement with the NFL (when we had Madden NFL vs. NFL 2K sports), and after the exclusive agreement (Madden only). If EA has been able to slow the price decline in Madden after its exclusive agreement with the NFL, one presumes they could do the same in basketball/hockey games as well. I don't have that data in front of me, but it strikes me as a relatively straightforward analysis and an apples to apples comparison.
I say all of this, of course, with the caveat that I have no idea what the government is doing, or what it may do if and when this merger gets far enough along to be reviewed. What I've given you a synopsis of how I would have approached the analysis if I were still at the FTC.
Do I think this is a deal that the government would sue to block? Not really. But I wouldn't be at all surprised if they required EA to divest its license agreements with certain sports leagues, and maybe spin off some of the talent behind those games to a competitor. And if that happens, does this deal still have the appeal to EA? Not if what Mr. Pachter said was true and EA's offer is based on the realization of monopoly profits from its sports division. Furthermore, if you see the government give this deal a hard look--beyond the normal 30 days normally allocated--you could possibly see the deal delayed long enough by the review process to adversely affect financing arrangements, potentially derailing the whole affair.
In other words, I wouldn't consider this deal inevitable quite yet. Although you've yet to see antitrust law rear its head in a videogame merger, this is the best case I've seen where it could happen. Don't be surprised if this gets more interesting than anyone expects.
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