Microsoft Case Poses Crucial Test for FTC’s Fight Against ‘Vertical’ Mergers

In the typical antitrust case, the government challenges a horizontal merger, or one involving rivals that compete head-to-head. Such mergers, by removing a competitor from the marketplace, can increase concentration, a factor that can be used to infer harmful future effects such as higher prices.

The government has struggled to win cases on vertical mergers because making claims about the potential future harms posed by such deals is less straightforward and can require complex speculation about how market forces might play out. U.S. District Judge

Richard Leon,

presiding in 2018 over the Justice Department’s landmark—and unsuccessful—challenge to

AT&T

‘s proposed vertical acquisition of

Time Warner,

described one of the government’s central legal theories as a “Rube Goldberg contraption.”

In a biting 172-page opinion, the judge said the government’s “generic” claims that vertical integration can give a company an unfair advantage “do not come close to answering the question before the Court.” 

Government agencies have historically policed vertical mergers less forcefully than horizontal ones, under the theory that vertically integrated companies can offer lower prices or better products, including through increased efficiency. Microsoft could, for instance, lower the price for its Xbox gaming console because it profits from selling Activision’s games.  

Still, antitrust officials under both Democratic and Republican administrations have recognized that some vertical transactions may unlawfully suppress competition. Such harms could come if a merged firm deters the rest of the industry from innovating or denies resources needed by rivals. 

Predicting a vertical deal’s effects is tricky, and antitrust authorities don’t have the analytical tools to reliably do it, said Michael Salinger, a professor at Boston University and a former FTC chief economist. 

“The models are not precise enough to nail down which way the effects go,” Dr. Salinger said. “I think they are going to have a tough time in court.”

Microsoft, which values the deal at $68.7 billion after adjusting for Activision’s net cash, has said it would give Sony and others access to Activision games, including the popular “Call of Duty” franchise.

Court challenges to vertical mergers have become more likely as antitrust agencies have grown less willing to accept upfront settlements that permit deals to close but put limits on the merged company’s future behavior, said Barry Nigro, a partner at Fried, Frank, Harris, Shriver & Jacobson LLP.  

There is less case law to support vertical-merger challenges, but the FTC and Justice Department can only change that by taking more cases to court, said Mr. Nigro, who worked as the Justice Department’s second-ranking antitrust official from 2019 to 2020.

“I don’t think the agencies are going to be discouraged from bringing vertical cases,” he said.

The FTC’s move under Ms. Khan to block the deal isn’t surprising, given her history of criticizing what she views as worrisome levels of dominance by a handful of giant technology companies. A divided FTC under Ms. Khan last year withdrew previous guidelines on how antitrust enforcers should view vertical mergers, believing they weren’t tough enough. Republican commissioners dissented.

Yet the FTC’s arguments against the Microsoft deal in many ways resemble those made by the Trump-era Justice Department when it sued to block the AT&T-Time Warner deal in 2017. The department argued the merger would give AT&T the power to suppress competition because it would be a top distributor of pay-TV service as well as the owner of top content. 

Under the Justice Department’s theory, AT&T would have the ability to hobble cable-TV rivals by charging higher prices to carry programming from Time Warner’s networks, or withhold it from the networks altogether.

The AT&T case was the first litigated vertical merger challenge in 40 years—and the Justice Department’s loss before Judge Leon was lopsided.

A handful of other vertical challenges brought since then have met a similar fate. The FTC last year sued to block Illumina Inc.’s planned $7.1 billion acquisition of Grail Inc., a company developing an early stage cancer-detection test, arguing the vertical deal would diminish innovation in the market for such tests.

That lawsuit drew unanimous bipartisan support at the commission but the FTC lost the case in its own in-house court. 

An administrative law judge ruled the FTC hadn’t shown Illumina would likely cut off Grail’s rivals from using technology that Illumina supplies. Illumina had agreed to continue supplying those competing firms and to not raise prices beyond inflation for 12 years. The FTC’s staff appealed the ruling to the agency’s commissioners, who act as an appellate body in matters litigated through the in-house court, and the case remains pending.

The Justice Department also lost one of the early merger challenges of the Biden era when a federal judge rejected its bid to block

UnitedHealth Group Inc.’s

$13 billion acquisition of health-technology firm Change Healthcare Inc., a case that rested heavily on vertical theories of harm. 

The government has prevailed in some investigations of vertical deals after showing the muscle and will to bring the cases to court. Lockheed Martin Corp. and Nvidia Corp. both abandoned planned acquisitions of suppliers this year after the FTC filed suit to block their deals.

The FTC is also seeking to prevent

Meta Platforms Inc.

from buying virtual reality startup Within Unlimited, Inc., with proceedings kicking off this week in a California federal court. 

In other cases, antitrust enforcers have used their concerns about vertical mergers to secure settlements that allowed the deals to move forward, but with conditions attached that were designed to alleviate any potential harms to consumers.  

Ms. Khan, both before and after she came to the FTC, has criticized the effectiveness of such settlements, and the Microsoft lawsuit is the latest signal of her unwillingness to accept them.

One such vertical-merger settlement that has come under intense criticism recently is the consent decree that allowed the combination of Ticketmaster and Live Nation, which the Justice Department approved in 2010. Last month’s debacle over ticket sales to Taylor Swift’s tour has led to fan lawsuits, a Justice Department investigation and calls in Congress for a breakup of the merged company,

Live Nation Entertainment,

Inc. 

Live Nation has said it hasn’t engaged in behavior that warranted litigation and that Ticketmaster has invested $900 million in digital infrastructure over the past five years. 

For her part, Ms. Khan suggested earlier this week that the ticket-sales fiasco illustrated that when “firms become dominant, they become too big to care.” 

Write to Brent Kendall at [email protected] and Dave Michaels at [email protected]