Category: Economics for Business: Ch 14

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Does profit maximisation lead to maximum profit? The case of Boeing

The traditional theory of the firm assumes that firms are profit maximisers. Although, in practice, decision-makers in firms are driven by a range of motives and objectives, profit remains a key objective for most firms – if not maximising profit, at least trying to achieve profit growth so as to satisfy shareholders, retain confidence in the company and prevent the share price from falling. After all, if the company is profitable, it is easier to fund investment, either from ploughed-back profit, borrowing or new share issue. And greater investment will help to drive profits in the future.

But does the pursuit of profit and shareholder value as the number-one objective actually lead to higher profit? It could be that a prime focus on other things such as consumer satisfaction, product design and value, innovation, safety, worker involvement and the local community could lead to greater long-term profit than an aggressive policy of marketing, cost cutting and financial rejigging – three of the commonest approaches to achieving greater profits.

Boeing disasters

In 2018 and 2019 there were two fatal crashes involving the new 737 MAX-8 aircraft. On 29 October 2018, Indonesia’s Lion Air Flight 610 crashed into the Java Sea; all 189 people on board died. On 10 March 2019, Ethiopian Airlines Flight 302 similarly crashed; all 157 people on board died. Both disasters were the result of a faulty automatic manoeuvring system. The company and its CEO, Dennis Muilenburg, knew about issues with the system, but preferred to keep planes flying while they sought to fix the issue. Grounding them would have cost the company money. But taking this gamble led to two fatal crashes. This damaged the company’s reputation and cost it billions of dollars.

The US Securities and Exchange Commission (SEC) investigated the cases and found that the company had made false statements about the plane’s safety and had put ‘profits before people’. But putting profits first ended up in a huge fall in profits, with the 737 MAX grounded for 20 months.

Since the crashes there have been several other issues with various critical systems, including stabilisation, engines, flight control systems, hydraulics and wiring. In December 2023, Boeing asked airlines to inspect its 737 MAX planes for a potential loose bolt in the rudder control system.

On 5 January 2024, Alaska Airlines Flight 1282 experienced an emergency. A window panel on the 737 MAX-9 aircraft, which replaced an unused emergency exit door, blew out and the cabin depressurised. Fortunately the plane was still climbing and had reached only just under 5000m – less than half of the cruising altitude of over 11 500m. The plane rapidly descended and safely returned to Portland International Airport without loss of life. Had the incident occurred at cruising altitude, the rush of air out of the plane would have been much greater. Passengers would be less likely to be wearing their seat belts and several people could have been sucked out.

The Federal Aviation Administration (FAA) temporarily grounded 171 MAX-9s for inspections. It found that several planes had loose bolts holding the panels in place and could potentially have suffered similar blow outs.

Profits rather than safety?

Critics have claimed that the corporate culture at Boeing prioritised profit over safety. This was made worse in 2001 when company headquarters moved from Seattle to Chicago but production remained at Seattle. The culture at headquarters became sharply focused on financial success. Boeing was under intense competition from Airbus, which announced its more fuel-efficient version of the A320, the A320neo, in 2010, with launch planned for 2015. Boeing’s more fuel-efficient version of the 737, the 737 MAX, was announced in 2011, scheduled for first delivery in 2017. Since then, Boeing has been keen to get the 737 MAX to customers as quickly as possible. Also, Boeing has sought to cut manufacturing costs to keep prices competitive with Airbus.

Despite warnings from some Boeing employees that this competition was leading to corners being cut that compromised safety, Boeing management continued to push for more rapid and cheaper production to fight the competition from Airbus.

The aircraft industry is regulated in the USA by the Federal Aviation Administration (FAA). In 2020, the House Committee on Transportation and Infrastructure produced a detailed report on the industry. It found that the FAA delegated too much safety certification work to Boeing. This was a case of regulatory capture. It was also accused of sharing the goal of promoting the production of US-based Boeing in its competition with European-based Airbus.

Effects on profits

But rather than a focus on profit leading to greater profits, safety issues have led to groundings of 737s, a fall in sales and a fall in profits. The first chart shows deliveries of 737s slightly lagging A320s from 2010 to 2018. Since then deliveries of 737s have fallen well behind A320s. In terms of orders for all planes, Boeing was ahead of Airbus in 2018 (893 compared with 747). Since then, Boeing has significantly lagged behind Airbus and in 2019 and 2020 cancellations exceeded new orders. The January 2024 incident and subsequent groundings are likely to erode confidence, orders and profits even further.

As you can see from the second chart, profits fell substantially in 2019, and with COVID fell again in 2020. They have not recovered to previous levels since. Depending on how the market responds to the issue of loose panel bolts on the MAX-9, profits could well fall again in 2024. There will almost certainly be a further erosion of confidence and probably of orders.

The Boeing story is a salutary lesson in how not to achieve long-term profit. A focus on design, quality and reliability may be a better means to achieving long-term profit growth than trying to appeal to shareholders by increasing short-term profits through aggressive cost cutting and hoping that this will not affect quality.

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Questions

  1. Why is the pursuit of long-run profit likely to result in different decisions from the pursuit of short-run profit?
  2. How has Airbus’s strategy differed from that of Boeing?
  3. How would you summarise Boeing management’s attitude towards risk?
  4. Is it important to locate senior management of a company at its manufacturing base?
  5. What is regulatory capture? Is it fair to say that the FAA was captured by Boeing?
  6. Should Boeing scrap the 737 MAX and design a new narrow-body plane?
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The AI revolution

Artificial intelligence is having a profound effect on economies and society. From production, to services, to healthcare, to pharmaceuticals; to education, to research, to data analysis; to software, to search engines; to planning, to communication, to legal services, to social media – to our everyday lives, AI is transforming the way humans interact. And that transformation is likely to accelerate. But what will be the effects on GDP, on consumption, on jobs, on the distribution of income, and human welfare in general? These are profound questions and ones that economists and other social scientists are pondering. Here we look at some of the issues and possible scenarios.

According to the Merrill/Bank of America article linked below, when asked about the potential for AI, ChatGPT replied:

AI holds immense potential to drive innovation, improve decision-making processes and tackle complex problems across various fields, positively impacting society.

But the magnitude and distribution of the effects on society and economic activity are hard to predict. Perhaps the easiest is the effect on GDP. AI can analyse and interpret data to meet economic goals. It can do this much more extensively and much quicker than using pre-AI software. This will enable higher productivity across a range of manufacturing and service industries. According to the Merrill/Bank of America article, ‘global revenue associated with AI software, hardware, service and sales will likely grow at 19% per year’. With productivity languishing in many countries as they struggle to recover from the pandemic, high inflation and high debt, this massive boost to productivity will be welcome.

But whilst AI may lead to productivity growth, its magnitude is very hard to predict. Both the ‘low-productivity future’ and the ‘high-productivity future’ described in the IMF article linked below are plausible. Productivity growth from AI may be confined to a few sectors, with many workers displaced into jobs where they are less productive. Or, the growth in productivity may affect many sectors, with ‘AI applied to a substantial share of the tasks done by most workers’.

Growing inequality?

Even if AI does massively boost the growth in world GDP, the distribution is likely to be highly uneven, both between countries and within countries. This could widen the gap between rich and poor and create a range of social tensions.

In terms of countries, the main beneficiaries will be developed countries in North America, Europe and Asia and rapidly developing countries, largely in Asia, such as China and India. Poorer developing countries’ access to the fruits of AI will be more limited and they could lose competitive advantage in a number of labour-intensive industries.

Then there is growing inequality between the companies controlling AI systems and other economic actors. Just as companies such as Microsoft, Apple, Google and Meta grew rich as computing, the Internet and social media grew and developed, so these and other companies at the forefront of AI development and supply will grow rich, along with their senior executives. The question then is how much will other companies and individuals benefit. Partly, it will depend on how much production can be adapted and developed in light of the possibilities that AI presents. Partly, it will depend on competition within the AI software market. There is, and will continue to be, a rush to develop and patent software so as to deliver and maintain monopoly profits. It is likely that only a few companies will emerge dominant – a natural oligopoly.

Then there is the likely growth of inequality between individuals. The reason is that AI will have different effects in different parts of the labour market.

The labour market

In some industries, AI will enhance labour productivity. It will be a tool that will be used by workers to improve the service they offer or the items they produce. In other cases, it will replace labour. It will not simply be a tool used by labour, but will do the job itself. Workers will be displaced and structural unemployment is likely to rise. The quicker the displacement process, the more will such unemployment rise. People may be forced to take more menial jobs in the service sector. This, in turn, will drive down the wages in such jobs and employers may find it more convenient to use gig workers than employ workers on full- or part-time contracts with holidays and other rights and benefits.

But the development of AI may also lead to the creation of other high-productivity jobs. As the Goldman Sachs article linked below states:

Jobs displaced by automation have historically been offset by the creation of new jobs, and the emergence of new occupations following technological innovations accounts for the vast majority of long-run employment growth… For example, information-technology innovations introduced new occupations such as webpage designers, software developers and digital marketing professionals. There were also follow-on effects of that job creation, as the boost to aggregate income indirectly drove demand for service sector workers in industries like healthcare, education and food services.

Nevertheless, people could still lose their jobs before being re-employed elsewhere.

The possible rise in structural unemployment raises the question of retraining provision and its funding and whether workers would be required to undertake such retraining. It also raises the question of whether there should be a universal basic income so that the additional income from AI can be spread more widely. This income would be paid in addition to any wages that people earn. But a universal basic income would require finance. How could AI be taxed? What would be the effects on incentives and investment in the AI industry? The Guardian article, linked below, explores some of these issues.

The increased GDP from AI will lead to higher levels of consumption. The resulting increase in demand for labour will go some way to offsetting the effects of workers being displaced by AI. There may be new employment opportunities in the service sector in areas such as sport and recreation, where there is an emphasis on human interaction and where, therefore, humans have an advantage over AI.

Another issue raised is whether people need to work so many hours. Is there an argument for a four-day or even three-day week? We explored these issues in a recent blog in the context of low productivity growth. The arguments become more compelling when productivity growth is high.

Other issues

AI users are not all benign. As we are beginning to see, AI opens the possibility for sophisticated crime, including cyberattacks, fraud and extortion as the technology makes the acquisition and misuse of data, and the development of malware and phishing much easier.

Another set of issues arises in education. What knowledge should students be expected to acquire? Should the focus of education continue to shift towards analytical skills and understanding away from the simple acquisition of knowledge and techniques. This has been a development in recent years and could accelerate. Then there is the question of assessment. Generative AI creates a range of possibilities for plagiarism and other forms of cheating. How should modes of assessment change to reflect this problem? Should there be a greater shift towards exams or towards project work that encourages the use of AI?

Finally, there is the issue of the sort of society we want to achieve. Work is not just about producing goods and services for us as consumers – work is an important part of life. To the extent that AI can enhance working life and take away a lot of routine and boring tasks, then society gains. To the extent, however, that it replaces work that involved judgement and human interaction, then society might lose. More might be produced, but we might be less fulfilled.

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Questions

  1. Which industries are most likely to benefit from the development of AI?
  2. Distinguish between labour-replacing and labour-augmenting technological progress in the context of AI.
  3. How could AI reduce the amount of labour per unit of output and yet result in an increase in employment?
  4. What people are most likely to (a) gain, (b) lose from the increasing use of AI?
  5. Is the distribution of income likely to become more equal or less equal with the development and adoption of AI? Explain.
  6. What policies could governments adopt to spread the gains from AI more equally?
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The increasing use of dynamic pricing strategies

In September 2023, the Stonegate Group, the largest pub company in the UK with around 4,500 premises, announced that it was going to start increasing the pint of beer by 20p during busy periods. There was an immediate backlash on social media with many customers calling on people to boycott Stonegate’s pubs such as the Slug & Lettuce and Yates.

This announcement is an example of dynamic pricing, where firms with market power adjust prices relatively quickly in response to changing market conditions: i.e. to changes in demand and supply.

Traditionally, prices set by firms in most retail markets have been less flexible. They may eventually adjust to changing market conditions, but this could take weeks or even months. If a product proves to be popular on a particular day or time, firms have typically left the price unchanged with the item selling out and customers facing empty shelves. If the product is unpopular, then the firm is left with unsold stock.

One business that makes extensive use of dynamic pricing is Amazon. Prices for popular items on Amazon Marketplace change every 10 minutes and can fluctuate by more than 20 per cent in just one hour.

Conditions for dynamic pricing to operate

The Amazon example helps to illustrate the conditions that must be in place for a firm to implement dynamic pricing successfully. These include:

  • The capacity to collect and process large amounts of accurate real-time data on the demand for and supply of particular items i.e. the number of sales or the interest in the product.
  • The ability to adjust prices in a timely manner in response to changing market conditions indicated by the data.
  • Effectively communicating the potential advantages of the pricing strategy to consumers.

Consumer attitudes

The last point is an interesting one. As the Stonegate example illustrates, consumers tend to dislike dynamic pricing, especially when price rises reflect increases in demand. A previous article on this website discussed the unpopularity of dynamic pricing amongst fans in the ticket market for live musical events.

The precise reason for the increase in demand, can also have an impact on consumer attitudes. For example, following a mass shooting at a subway station in New York in April 2022, the authorities shut down the underground system. This led to a surge in demand for taxis and this was picked up by the algorithm/software used by Uber’s dynamic pricing system. Fares for Uber cars began to rise rapidly, and people started to post complaints on social media. Uber responded by disabling the dynamic pricing system and capping prices across the city. It also announced that it would refund customers who were charged higher prices after the subway system shut down.

There is a danger for businesses that if they fail to communicate the policy effectively, annoyed customers may respond by shopping elsewhere. However, if it is implemented successfully then it can help businesses to increase their revenue and may also have some advantages for consumers.

The growing popularity of dynamic pricing

It has been widely used in airline and hotel industries for many years. Robert Cross, who chairs a revenue management company predicts that ‘It will eventually be everywhere’.

More businesses in the UK appear to be using dynamic pricing. In a consumer confidence survey undertaken for Barclays in September 2023, 47 per cent of the respondents had noticed more examples of companies raising prices for goods/services in response to higher demand at peak times.

It has traditionally been more difficult for bricks-and-mortar retailers to implement dynamic pricing because of the costs of continually changing prices (so-called ‘menu costs’). However, this might change with the increasing use of electronic shelf labels.

It will be interesting to see if dynamic pricing becomes more widespread in the future or whether opposition from consumers limits its use.

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Questions

  1. Explain the difference between surge and dynamic pricing.
  2. Using a diagram, explain how dynamic pricing can increase a firm’s revenue.
  3. Discuss both the advantages and disadvantages for consumers of firms using dynamic pricing.
  4. How might dynamic pricing influence consumer behaviour if it alters their expectations about future price changes.
  5. There is some evidence that the use of dynamic pricing is less unpopular amongst 18–24-year-olds than other age groups. Suggest some possible reasons why this might be the case.
  6. Using the concept of loss aversion, consider some different ways that a business could present a new dynamic pricing policy to its customers.
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Game over or game on? The Microsoft/Activision merger case concludes

In a recent blog post on this site about the Microsoft/ Activision Blizzard merger, the European Commission had just reached a decision to approve the merger subject to remedies, but the investigations in the USA and UK were still ongoing. Since then, the merger has been approved by competition authorities around the world, including in the USA and UK, and thus the merger has gone through.

However, there were some differences in the way the case unfolded under the regulation of these three competition authorities.

The European Commission’s (EC) decision

The European Commission (EC) was the first to give the merger the green light. The EC’s in-depth investigation revealed concerns about the market for the distribution of games via cloud game streaming services. In particular, the concern was related to the possibility that Microsoft might make Activision’s games exclusive to its own cloud game streaming service (Game Pass Ultimate) and restrict access from competing cloud game streaming providers.

The EC argued that this in turn could strengthen Microsoft’s position in the market for PC operating systems, as Microsoft may have an incentive to limit or reduce the quality of the streaming of Activision’s games on PC’s which do not use the Windows operating system.

Thus, while the merger was approved, this was subject to remedies. These remedies included 10-year licensing commitments from Microsoft, as outlined in the EC’s press release:

These licenses will ensure that gamers that have purchased one or more Activision games on a PC or console store, or that have subscribed to a multi-game subscription service that includes Activision games, have the right to stream those games with any cloud game streaming service of their choice and play them on any device using any operating system.

This type of remedy is called a behavioural remedy and often requires the merging firms to commit to taking particular actions post-merger. Unlike structural remedies (which may for example, require the merging firms to sell off an entire business unit), behavioural remedies often require monitoring and enforcement by competition authorities. The EC argued that the deal, with these behavioural remedies, could strengthen competition in the market for cloud gaming.

The Federal Trade Commission’s (FTC) decision

The FTC, in the USA, had similar concerns to those of the EC related to the cloud gaming market. These were outlined in the FTC’s press release:

[The deal] would enable Microsoft to suppress competitors to its Xbox gaming consoles and its rapidly growing subscription content and cloud-gaming business.

The FTC also argued that when Microsoft had previously acquired gaming content, it had made this content exclusive to Microsoft consoles. This could result in higher prices, and reduced quality, choice and innovation. To this end, the FTC appealed in an attempt to block the deal, but the Court ruled in favour of the deal going ahead.

During this time, Microsoft announced that it had committed to keeping Call of Duty on Sony’s PlayStation after the merger, and this likely contributed towards the court’s decision. Hence, the FTC was unsuccessful in its attempt to halt the merger.

The Competition and Markets Authority’s (CMA) decision

The final hurdle remaining for Microsoft, was the CMA’s approval. As outlined in a previous blog post on this site, the CMA’s phase 2 investigation revealed similar concerns about the supply of cloud gaming services (amongst concerns related to the market for the supply of console gaming services, which were later dispelled), and whilst Microsoft offered some commitments similar to those accepted by the EC, the CMA did not deem these to be sufficient to address its concerns and thus prohibited the merger.

The CMA’s published remedies guidance suggests that the regulator has a preference for structural remedies over behavioural remedies. One of the reasons for this is because of the requirement to monitor and enforce the commitments, and this therefore formed part of the CMA’s reasons for not accepting the remedies. Unsurprisingly, Microsoft appealed this decision to the UK’s Competition Appeals Tribunal (CAT), probably partly driven by the fact that the EC accepted similar remedies to those rejected by the CMA. However, Microsoft and the CMA agreed that if the appeal was paused, Microsoft could propose a new deal.

The new deal: did the CMA make a U-turn?

In August 2023, Microsoft submitted a new restructured deal for the CMA to review. As described by the Chief Executive of the CMA, this deal was “substantially different from what was put on the table previously” and was therefore investigated as a separate merger case under the CMA’s phase 1 processes.

The new deal meant that Microsoft would no longer be purchasing the cloud streaming rights held by Activision. Instead, the cloud streaming rights would be sold to an independent third-party game publisher – Ubisoft. This means that Microsoft will not be in control of the cloud gaming rights for Activision’s gaming content (outside of the EEA), and therefore will not be able to restrict its competitors’ access to Activision’s games, which was one of the main concerns outlined by the CMA based on the initial merger proposal. The new deal also opens up the possibility that Activision’s games will be made available on cloud gaming services that run on a non-Windows operating system.

On 13 October, the CMA approved this deal, subject to the cloud gaming rights being sold to Ubisoft, and some subsequent commitments from Microsoft in relation to its relationship with Ubisoft post-merger, as outlined in the CMA’s final report. However, the Chief Executive of the CMA has emphasised that they are unhappy with the way that Microsoft dealt with negotiating the approval of the merger:

But businesses and their advisors should be in no doubt that the tactics employed by Microsoft are no way to engage with the CMA. Microsoft had the chance to restructure during our initial investigation but instead continued to insist on a package of measures that we told them simply wouldn’t work. Dragging out proceedings in this way only wastes time and money.

What’s next in big tech?

While the merger deal has now gone through, the FTC has recently re-opened its case against Microsoft, which will continue to unfold over the next couple of months until December when the case will appear in Court. This means it is possible that the FTC could attempt to undo the merger, though this would be challenging.

In the tech market more broadly, the CMA has recently launched a market investigation into cloud services. While the focus of this blog post was on cloud gaming, cloud services are now increasingly being used by many businesses. The CMA’s issues statement suggests that a key focus of its investigation will be on the ability for customers to switch between cloud service providers. Microsoft is one of the largest providers of cloud services in the UK, and therefore it is inevitable that it will be under scrutiny. Given all three regulators’ recent efforts to ‘crackdown’ on big tech, this is just one of a series of cases that will be interesting to see unfold.

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Competition authorities documentation

Questions

  1. Discuss the effectiveness of behavioural remedies vs structural remedies for a merger.
  2. Why might the competition authorities have been concerned about the possibility of Microsoft making Activision’s games exclusive to its own cloud game streaming service? Is exclusive dealing always anti-competitive?
  3. Why was the transfer of the cloud game streaming rights to Ubisoft seen as a suitable remedy?
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Microsoft’s proposed takeover of Activision Blizzard: CMA’s final ruling.

Effects on competition in the console and cloud gaming markets

Many people in the games industry expected the Competition and Markets Authority (CMA) to approve Microsoft’s proposed takeover of the games business, Activision Blizzard. However, in its final report published on 26 April, the CMA stated that the takeover would result in a substantial lessening of competition (SLC) in the supply of cloud gaming services in the UK. It rejected a behavioural remedy proposed by Microsoft and concluded that the merger should be prohibited.

When analysing the potential impact of this merger, the CMA focused on the following three issues:

  1. How important is the availability of Activision Blizzard’s games for the competitiveness of Microsoft’s rivals in the console and cloud gaming market? If, following the merger, Microsoft used its control over Activision Blizzard to restrict the availability of the games, would this significantly harm the competitiveness of their rivals?
  2. If restricting the availability of the games did harm its rivals, would it be profitable for Microsoft to do so? Do the benefits outweigh the costs? The major benefit for Microsoft is the additional sales this generates as consumers switch to its products to gain access to Activision’s games. The major cost is the forgone sales of the games to their rivals in the console and cloud gaming market.
  3. If it is profitable for Microsoft to limit the availability of the games, would this policy lead to a substantial lessening of competition (SLC) in the console and cloud gaming market? To answer this question the CMA compared the level of competition that would be most likely to occur if the merger were to proceed with the level if the deal were prohibited? In other words, it needed to identify the counterfactual.

In response to the first issue, the CMA judged that restricting access to Activision Blizzard’s games post-merger would significantly harm the competitiveness of Microsoft’s rivals in both the console and cloud gaming markets. However, its judgment on the second issue differed between the two markets. Why was this? One key issue was the difference in the relative market power of Microsoft in cloud vs console gaming.

One common indicator used to analyse the market position of a business relative to its rivals is market share. Using data on revenues generated from the sales of hardware, associated games and subscription services, console gaming market shares in the UK for 2021 were as follows:

  • Sony (PlayStation): 40% – 50%
  • Microsoft (xBox): 30% – 40%
  • Nintendo (Switch): 10% – 20%

Given the important market position of the PlayStation, limiting the ability of its users to purchase Activision games would result in Microsoft forgoing significant sales and revenue. Detailed analysis of the data by the CMA, indicated that the costs outweighed the benefits and so Microsoft did not have a commercial incentive to limit the availability of the games in this market. Therefore, the CMA concluded that the merger would not result in a SLC in the console gaming market. This finding was discussed in more detail in a blog on this website in March 2023.

The CMA judged that Microsoft had a much stronger position in the market for cloud gaming.

Cloud gaming services

Cloud gaming offers consumers a new way of playing graphically complex games. In this sector of the market, the games run on remote servers/data centres and then stream over the internet to the user’s device. The great advantage with this approach is that it enables consumers to play games on less powerful hardware devices such as smartphones, tablets, smart televisions, and standard PCs. Although the market is currently quite small it, has grown significantly over the past couple of years. Some people argue that it has the potential to make a dramatic change to the gaming market in the same way that businesses such as Netflix and Spotify have transformed the film, TV, and music industries.

It is more difficult to judge the relative market position of firms in a new and dynamic market, where things can change very quickly. The use of market share data is less informative but can still offer some insights. To estimate market shares in cloud gaming, the CMA used data on the number of monthly active users (MAUs). The figures for paid services in the UK for 2022 were as follows:

  • xCloud (Microsoft): 70% – 80%
  • PlayStation Cloud Gaming (Sony): 20% – 30%
  • Boosteroid: 0 – 5%
  • Nvidia GFN: 0 – 5%

Data suggest that Microsoft has a much stronger position in this market than in console gaming. There is also evidence that its market position is becoming more dominant. The same market shares for xCloud and PlayStation Gaming in 2021 were 40% – 50% and 50% – 60% respectively.

Given some of the limitations of using market-share data in a new and dynamic market, the CMA analysed other information about the sector to assess Microsoft’s market position. The investigation identified three key factors that could give Microsoft a significant cost advantage over its rivals: cloud infrastructure, the Windows operating system and access to a wide variety of games.

  1. Infrastructure: Microsoft’s ownership of Azure, a major cloud computing platform, could give it a significant cost advantage over its rivals in the future. A rival firm would need to develop it own cloud infrastructure or purchase these services from a third-party supplier.
  2. The Windows operating system: Given that far more games are developed for Windows as opposed to other operating systems, using Windows on a cloud infrastructure system gives a supplier access to large number of games. As it already owns Windows, Microsoft will be able to supply the operating system to its own cloud gaming service at little additional cost whereas its rivals will have to pay a license fee.
  3. Access to a wide range of games: Microsoft already owns twenty-four development studios that produce some very successful games such as Minecraft and Halo. It also has commercial relationships with other third-party developers who produce games for the Xbox console. This gives Microsoft another advantage over many of its rivals.

Given this evidence on Microsoft’s strong market position, the CMA concluded that the benefits to the company of restricting the availability of the games in the cloud gaming market outweighed the costs.

If Microsoft has commercial incentives to restrict the availability of Activision’s games, would this strategy lead to a SLC in the market for cloud gaming? To answer this question, the CMA had to identify the counterfactual: i.e. the most likely outcome in the market if the merger did not proceed. Following detailed analysis of the evidence, the competition authority concluded that Activision was likely to make its games available to different cloud gaming services if the deal did not take place.

Given Microsoft’s (a) strong market position and (b) limited number of relatively small competitors in cloud gaming, the CMA concluded that Microsoft’s commercial incentive to restrict the availability games would lead to a SLC compared to the counterfactual.

Martin Coleman, the chair of the independent panel of experts who conducted the CMA’s investigation, stated that:

Microsoft already enjoys a powerful position and head start over other competitors in cloud gaming and this deal would strengthen that advantage giving it the ability to undermine new and innovative competitors.

In response to these competition concerns, Microsoft offered to supply Activision games to certain cloud gaming services for a 10-year period. However, the CMA concluded that this behavioural remedy was not enough to address the competition issues raised by the merger and recommended that the deal be prohibited.

Microsoft’s immediate response was to appeal the decision to the Competition Appeal Tribunal.

The Federal Trade Commission is currently investigating the impact of the deal in the USA while the European Commission has just completed its investigation in the European Union. On 15 May, the EC announced that Microsoft’s behavioural remedy did fully address the competition concerns identified during its investigation. Therefore, the merger was approved on condition that Microsoft fully implemented the actions outlined in the remedy.

It will be interesting to read the recommendations of the FTC when the final results of its investigation are published later this year.

Articles

CMA and EC press releases

Questions

  1. Discuss the barriers to entry that exist in both the console and cloud gaming markets.
  2. Outline some of the issues when trying to calculate market shares in cloud gaming.
  3. What is meaning of the term ‘input foreclosure’? How is this relevant to the Microsoft/Activision case?
  4. What is the difference between a behavioural and a structural remedy? In what circumstances is a behavioural remedy most likely to be effective?
  5. Discuss some of the potential limitations with the behavioural remedy proposed by Microsoft.
  6. Explain why Microsoft’s position in the downstream market for cloud gaming is likely to influence incentives it faces to restrict the availability of Activision’s games post-merger.