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Press X to Kill: an IP-competition conversation on Microsoft’s game studio closures (part 2)

Posted on    by CREATe Team

Press X to Kill: an IP-competition conversation on Microsoft’s game studio closures (part 2)

By 13 June 2024June 21st, 2024No Comments

This is part 2 of a cross-disciplinary conversation about the recent, and controversial, mass closure of Microsoft-owned game development studios. The conversation shares perspectives from competition (Magali Eben and Dave Reader) and IP (Amy Thomas) lawyers, all of whom share a common interest in the creative economy. This is the latest addition to our CREATe project which encourages a multidisciplinary approach to studying developing legal issues in the games industry. Read part 1 here.

Q (Amy): Many gamers have been (rightly) upset about these significant closures, and instinctively feel that, coming from a large and powerful company like Microsoft, this is very unfair, or perhaps even illegal. What’s your take on this as competition lawyers – how would you conceptualise Microsoft’s behaviour? 

A (Magali and Dave): When we hear concerns about the closure of these studios – and thus of the IP going unused, – as opposed to selling them off to competitors, – I instinctively hear a ‘killer acquisition’ narrative. However, whether these are actually killer acquisitions in a strict sense is debatable. Some members of the gaming community are convinced that Microsoft is engaging in strategies to acquire and indefinitely shelve IP, and choosing to close—rather than sell-off—studios to avoid the risk of competitors benefiting from tried-and-tested development teams with a history of success. But we simply can’t be sure.

It may be insensitive to phrase it like this given the very real cuts and losses these closures will bring, but for competition academics this is an interesting discussion. We often debate so-called ‘killer acquisitions’ in competition law circles, but don’t get asked very often whether or not a real-life event is a killer acquisition. Scholars have ascribed different definitions to killer acquisitions in the literature, contributing to doubts around their prominence in practice (still a hotly debated topic). Simply put, a killer acquisition is one where a big firm (Firm A) acquires a relatively smaller firm (Firm B) with the purpose of removing a potential competitive threat. It might be that Firm A sees Firm B posing a threat in the future, so acquires Firm B with the intention of phasing out its operations. Or perhaps Firm B is in possession of a valuable asset—e.g. an innovative piece of IP—which, if it were to fall into the hands of one of Firm A’s rivals, could also pose a threat to Firm A’s market share. This too could be a reason for A to acquire B – to ‘kill-off’ rival innovations that may otherwise enter into its market.

Arkane Austin, developers of Prey – a game title that perhaps aptly foreshadows the studio’s fate  – were among the recent closures. Img source.

There is a distinct difference between, on the one hand, making it so that your competitors cannot access the same technology or content you do, but then using it yourself, and, on the other hand, completely killing things off. Microsoft could buy up important IP or studios with specific skillsets and capabilities to integrate them within their own development and distribution. Even if it makes games exclusive or stops other studios from hiring talent by retaining it, this is not truly a killer acquisition. We can only really talk about ‘killing’ here if the content disappears, and the rights and capabilities do not come back on the market. So with Microsoft, there are two things happening: first, its recent buying spree in games, and, second the closing of these studios. When Microsoft bought ZeniMax Media and, later, Activision Blizzard, there were some real concerns that it would make games exclusive or accumulate technology and IP which would give it an edge not just in console gaming but in cloud, streaming, and subscription gaming. The fear that Microsoft would actually kill things off seemed – at least as far as I can tell – a later development as, despite piquing the interest of competition authorities at the time, both mergers were ultimately waved through.

In fact, the risks envisaged and the remedies put forward during these queries were more clearly about Microsoft’s incentives to keep things for themselves, for their own use, rather than Microsoft buying studios and IP in order to kill them off entirely. Indeed, the authorities seemed mostly concerned with ‘iconic’ game franchises and AAA content, the ownership of which would allegedly give Microsoft an edge. The studios which are now being closed are not the ones creating AAA games. And so, what happened to them was not front and centre.

Microsoft aren’t necessarily alone in this behaviour (particularly where the human cost is concerned), and we have seen that, for example, Sony has also been closing game development studios and making staff redundant at scale. The word on the street after the acquisition of Activision Blizzard was that Microsoft would be focusing on increasing efficiencies and profitability, particularly given the alleged mixed success of its Game Pass. Journalists were quick to comment that the new streaming business models create new challenges for extracting value from games. Shutting down studios whose games generate less revenue may be part of this rationalisation. And yet, a question niggles at the back of my mind about the effect on competition of shutting such studios. If we consider that competition benefits from having a plurality of products – something which is debated in competition circles – then there may be a problem with killing off these games without the ability of competitors to acquire the rights to revive them.

Q (Amy): Your latest co-authored article describes killer acquisitions as ‘innovation-crushing’. Could you explain what impact you would expect these closures to have, particularly in the context of the games industry? Is it inherently a ‘bad thing’?

A (Magali and Dave): The idea that innovation is crushed is part and parcel of the killer acquisition theory. As a result of Firm A acquiring Firm B, we may miss out on the chance to buy/play/consume an innovative product that Firm B—or those it supplies—would otherwise have released. Having dealt with the potential threat of Firm B, Firm A may also have fewer incentives to invest in developing its own products. The result is a double whammy for consumers: fewer choices and less innovative products than might otherwise have come to fruition.

That all sounds very “doom and gloom”. It’s a discussion for another day, but there is plenty of scepticism around the true impact of killer acquisitions on innovation – venture capitalists, for example, will point to the short-term strategies of many start-up firms, who gear themselves towards innovating new products with the express intention of exiting the market by attracting a money-spinning takeover. Who’s to say whether these start-ups would innovate—or exist in the first place—if the prospect of a lucrative takeover were not available to them? And who’s to say if they would ever have released their innovative products, let alone nurtured them into a competitive force to be reckoned with? This harks back to the comment Amy made in [part 1], about the risks involved when investing in games.

When it comes to the games industry, I think we first have to take a step back and ask – fundamentally – what is the effect of acquisitions on innovation? It has been argued before (for example by Rietveld and Ishihara) that acquisitions in the games industry increase ‘product quality’ but reduce innovation. When a publisher with deep pockets buys a game studio, it can put a lot of resources into not just the creation of games but also their distribution and marketing. It may pour more resources into existing franchises or games being developed by the teams of creators within the acquired companies, and so increase their appeal to consumers. When Microsoft acquired Bethesda in 2020-2021, Bethesda’s Pete Hines expressed this view as well: that integrating into Microsoft would allow them to ‘make even better games going forward. Microsoft is an incredible partner and offers access to resources that will make us a better publisher and developer.’

However, the study by Rietveld and Ishihara showed that innovation tends not to come from big conglomerates but from indies. Thus, acquisitions can have a negative impact: whereas most novel games are developed by independent studios, acquired companies take fewer risks and focus less on innovative intellectual property.  This is an issue which arises generally when there is a trend of consolidation in the industry, as well explained by Van Dreunen. This negative effect on innovation seems to exist even in the absence of a clear ‘killer acquisition’ strategy.

Bethesda’s Pete Hines had seemed to reassure gamers that they would continue to ‘mak[e] great games’ and ‘tr[y] new things.’ The question, however, is what ‘new things’ look like and whether they are necessarily synonymous with the most profitable games.

Q (Amy): Many gamers and creators in the industry will feel that the damage has already been done here, and that prevention would have been preferable to cure. Could anything have been done by a competition regulator to prevent this? What ‘remedies’ are available for studios that have been acquired and subsequently closed?

A (Magali and Dave): When scholars and practitioners talk about killer acquisitions “falling through the cracks” or “flying under the radar”, they’re often referring to smaller mergers that don’t meet the thresholds to be reviewed by the competition regulator. This has been considered a weakness of merger control laws that determine jurisdiction entirely on turnover thresholds, the reason being that smaller start-ups—while tremendously valuable—are less likely to meet these thresholds, especially if they have yet to commercialise their innovations. It means the regulator never even has the chance to scrutinise the acquisition. Some regimes have sought to overcome this by adopting transaction value-based thresholds (e.g. Austria and Germany), by creatively applying market share thresholds (e.g. the UK), or—in the case of the EU—encouraging Member States to refer even the smallest deals to the European Commission for review, if harm is suspected (i.e. its Article 22 EUMR mechanism).

The – hotly debated – Microsoft/Activision Blizzard merger completed in 2023.  Img source.

But while Microsoft/ZeniMax did not meet the EU’s turnover thresholds, the fact that the merger was subject to review in 3-or-more Member States meant the parties themselves were able to request a single EU-level review by the Commission – so jurisdiction wasn’t a problem. Did the Commission do enough to evaluate the merger as a potential killer acquisition? As we mentioned earlier, the Commission considered whether the merger stood to enable and incentivise Microsoft to engage in input foreclosure, ultimately concluding that no such risk existed. That conclusion is perfectly plausible within the scope of the evaluation, but it’s worth considering the wider context at play. At the time, no vertical merger had ever been blocked by the Commission, let alone on the basis of an innovation theory of harm.

That all changed on 6 September 2022, with the landmark decision in Illumina/GRAIL. In what is unquestionably the most controversial EU merger decision of recent times, the Commission prohibited the vertical merger on the grounds that it enabled and incentivised the acquirer (Illumina) to engage in input foreclosure that would effectively kill-off innovation competition between downstream rivals. It’s difficult to overstate the significance of this decision, both as a demonstration of the Commission’s willingness to consider a merger’s impact on innovation, and the lengths it will go to preserve and protect it. A new era of innovation-centric merger control may have dawned. While there is no suggestion that the likes of Microsoft/ZeniMax would be prohibited outright in this new era—Microsoft faced healthy competition in its upstream market, whereas Illumina enjoyed monopolistic status—greater scrutiny of innovation effects may see conditional clearances become more routine, including the deployment of lesser-spotted behavioural remedies to ensure that key innovation efforts are preserved.

For studios that have been acquired and subsequently earmarked for closure, ex post recourse is possible – albeit, with no guarantee of a successful or speedy resolution. If Microsoft was to become dominant in the upstream market for game development (admittedly, a remote prospect), any anticompetitive conduct it engaged in would fall foul of the abuse of dominance provision under Article 102 TFEU. Such abuse would most likely arise from a direct refusal to supply to rival game publishers in the downstream market, but it is not out of the question that a similar form of input foreclosure could be facilitated through the strategic closure of studios in its portfolio – especially those that develop titles of particular significance to rival platforms/consoles.

On certain occasions, therefore, Article 102 may offer a last-ditch safeguard against killer acquisitions in the gaming industry, as well as a means of keeping dominant acquirers in check. If cases are successful, this presents an opportunity for behavioural remedies to be imposed on the dominant firm, obliging it to preserve innovation efforts. In extreme cases, it may even be appropriate for structural remedies to be issued, requiring the forced divestiture of operations and assets (e.g. intellectual property).