Category: Economics for Business: Ch 14

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Microsoft’s proposed acquisition of Activision

Why did a competition authority change its mind on one aspect of this merger?

In January 2022, Microsoft announced its plan to acquire Activision Blizzard for $68.7 billion. Activision Blizzard is one of the largest games publishers in the world and famous for titles such as Call of Duty and World of Warcraft. Sales revenue from Call of Duty: Modern Warfare II was over $10 billion within ten days of its release in 2022. Given Microsoft’s ownership of the Xbox, one of the three devices that dominate the market for gaming consoles, the deal was always likely to raise competition concerns.

Potential competition issues

Following Phase 1 and 2 merger investigations by the Competition and Markets Authority (CMA) a number of competition issues were raised. One particular concern was in the market for gaming consoles and the potential impact of the merger on the future availability of Call of Duty (CoD). Some of the key findings of the initial research undertaken by the CMA were that:

  • Sony’s PlayStation was a much closer rival for the Xbox than the Nintendo Switch, which tends to offer more family-orientated games.
  • PlayStation users spend significant amounts of gametime playing CoD.
  • Game availability is a key factor that influences console purchase decisions.
  • Twenty-four percent of PlayStation users who play CoD stated that they would not purchase future versions of the console if CoD was unavailable on the platform.

These findings suggest that there are commercial incentives for Microsoft to limit the availability of CoD on the PlayStation. For example, the newly merged business could make future versions of the game exclusive to the Xbox – total exclusivity. Alternatively, it could adopt a policy of partial exclusivity. For example, it could only make versions of CoD available on the PlayStation that exclude some of its more popular features.

There are costs to Microsoft of implementing a policy of total or partial exclusivity. For example, 76% per cent of PlayStation users who play CoD stated that they would not switch consoles if future versions of the game were made unavailable. By making CoD exclusive to Xbox users, Microsoft would lose revenue from forgoing potential sales of the game to this group of users. The firm may also suffer reputational damage if there was a social media backlash against an exclusivity decision.

However, these costs of implementing a policy of exclusivity could be outweighed by the potential benefits. These include:

  • The additional sales of consoles as some users switch from the PlayStation to the Xbox to gain access to CoD.
  • the sale of CoD and other games to these additional Xbox users.

To quantify these costs and benefits, the CMA used a financial model that includes information on the amounts of money users typically spend on the Xbox platform and CoD over a five-year period. This ‘lifetime value of customers’ model found that it would be profitable for Microsoft to implement a policy of exclusivity post-merger.

The CMA also noted that in the majority of cases where Microsoft had previously acquired gaming studios, the subsequent release of games had been made exclusive to the Xbox.

CMA findings

Following its analysis of the case, the CMA published its provisional findings on the 8th February 2023. One key finding was that the merger would harm consumers, as it would lead to a substantial lessening of competition in the supply of console gaming services. The CMA argued that the acquisition should proceed only if Activision Blizzard sold off the parts of its business responsible for producing CoD. This is a structural remedy.

Microsoft rejected these findings and argued that the financial modelling used by the CMA was based on inaccurate data. In its formal written response to the competition authority the company argued that:

  • The potential gains from a policy of exclusivity had been calculated over a five-year period whereas the costs (i.e. the forgone sales of CoD) had only been calculated over a one-year period. More accurate analysis should compare both the potential gains and losses over a five-year period.
  • When more recent data are used to calculate the amounts of money users typically spend on the Xbox platform and CoD over a five-year period, the figure is lower than in the original work by the CMA.

Revised CMA findings

Having adjusted its analysis to take account of these criticisms, the CMA published an update to its Provisional Findings on 24th March 2023. In this update the competition authority stated that:

The analysis now shows that it would not be commercially beneficial to Microsoft to make CoD exclusive to Xbox following the deal, but that Microsoft will instead still have the incentive to continue to make the game available on PlayStation.

Therefore, just six weeks after publishing its Provisional Findings the CMA changed its conclusion and stated that the merger would not result in a substantial lessening of competition in the market for the supply of console gaming services in the UK.

In response to these changes an ex-CMA lawyer stated that:

This is extremely unusual. Restating your provisional findings is something ‘you would rather die than do’.
It is important to remember that the investigation by the CMA also raised concerns about the impact of the acquisition on competition in the cloud gaming market. These concerns remain unaffected by these updated findings and a final report will be published by the CMA at the end of April.

Competition authorities from 16 different countries/regions are also investigating the deal, including the Federal Trade Commission in the USA and the European Commission. It will be interesting to see if these authorities agree on the potential impact of the merger on competition.

Articles

CMA documentation

Questions

  1. Under what circumstances could a merger result in a substantial lessening of competition?
  2. Summarise the thresholds that have to be met by a potential merger before it is investigated by the Competition and Markets Authority.
  3. Explain the direct and indirect network effects that exist in the console gaming market. To what extent do they create barriers to entry?
  4. Outline some different ways that Microsoft could introduce a policy of partial exclusivity for the Call of Duty franchise of games.
  5. What would be the impact of a policy of exclusivity on the cross price elasticity of demand between Xbox and PlayStation consoles?
  6. Outline the difference between behavioural and structural remedies for merger.
  7. Discuss why the acquisition of Activision by Microsoft might reduce competition in the cloud gaming market.
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A four-day week – a solution to sluggish productivity growth?

In two previous posts, one at the end of 2019 and one in July 2021, we looked at moves around the world to introduce a four-day working week, with no increase in hours on the days worked and no reduction in weekly pay. Firms would gain if increased worker energy and motivation resulted in a gain in output. They would also gain if fewer hours resulted in lower costs.

Workers would be likely to gain from less stress and burnout and a better work–life balance. What is more, firms’ and workers’ carbon footprint could be reduced as less time was spent at work and in commuting.

If the same output could be produced with fewer hours worked, this would represent an increase in labour productivity measured in output per hour.

The UK’s poor productivity record since 2008

Since the financial crisis of 2007–8, the growth in UK productivity has been sluggish. This is illustrated in the chart, which looks at the production industries: i.e. it excludes services, where average productivity growth tends to be slower. (Click here for a PowerPoint of the chart.)

Prior to the crisis, from 1998 to 2007, UK productivity in the production industries grew at an annual rate of 6.1%. From 2007 to the start of the pandemic in 2020, the average annual productivity growth rate in these industries was a mere 0.5%.

It grew rapidly for a short time at the start of the pandemic, but this was because many businesses temporarily shut down or went to part-time working, and many of these temporary job cuts were low-wage/low productivity jobs. If you take services, the effect was even stronger as sectors such as hospitality, leisure and retail were particularly affected and labour productivity in these sectors tends to be low. As industries opened up and took on more workers, so average productivity fell back. In the four quarters to 2022 Q3 (the latest data available), productivity in the production industries fell by 6.8%.

If you project the average productivity growth rate from 1998 to 2007 of 6.1% forwards (see grey dashed line), then by 2022 Q3, output per hour in the production industries would have been 21/4 times (125%) higher than it actually was. This is a huge productivity gap.

Productivity in the UK is lower than in many other competitor countries. According to the ONS, output per hour in the UK in 2021 was $59.14 in the UK. This compares with an average of $64.93 for the G7 countries, $66.75 in France, £68.30 in Germany, $74.84 in the USA, $84.46 in Norway and $128.21 in Ireland. It is lower, however, in Italy ($54.59), Canada ($53.97) and Japan ($47.28).

As we saw in the blog, The UK’s poor productivity record, low UK productivity is caused by a number of factors, not least the lack of investment in physical capital, both by private companies and in public infrastructure, and the lack of investment in training. Other factors include short-termist attitudes of both politicians and management and generally poor management practices. But one cause is the poor motivation of many workers and the feeling of being overworked. One solution to this is the four-day week.

Latest evidence on the four-day week

Results have just been released of a pilot programme involving 61 companies and non-profit organisations in the UK and nearly 3000 workers. They took part in a six-month trial of a four-day week, with no increase in hours on the days worked and no loss in pay for employees – in other words, 100% of the pay for 80% of the time. The trial was a success, with 91% of organisations planning to continue with the four-day week and a further 4% leaning towards doing so.

The model adopted varied across companies, depending on what was seen as most suitable for them. Some gave everyone Friday off; others let staff choose which day to have off; others let staff work 80% of the hours on a flexible basis.

There was little difference in outcomes across different types of businesses. Compared with the same period last year, revenues rose by an average of 35%; sick days fell by two-thirds and 57% fewer staff left the firms. There were significant increases in well-being, with 39% saying they were less stressed, 40% that they were sleeping better; 75% that they had reduced levels of burnout and 54% that it was easier to achieve a good work–life balance. There were also positive environmental outcomes, with average commuting time falling by half an hour per week.

There is growing pressure around the world for employers to move to a four-day week and this pilot provides evidence that it significantly increases productivity and well-being.

Articles

Questions

  1. What are the possible advantages of moving to a four-day week?
  2. What are the possible disadvantages of moving to a four-day week?
  3. What types of companies or organisations are (a) most likely, (b) least likely to gain from a four-day week?
  4. Why has the UK’s productivity growth been lower than that of many of its major competitors?
  5. Why, if you use a log scale on the vertical axis, is a constant rate of growth shown as a straight line? What would a constant rate of growth line look like if you used a normal arithmetical scale for the vertical axis?
  6. Find out what is meant by the ‘fourth industrial revolution’. Does this hold out the hope of significant productivity improvements in the near future? (See, for example, last link above.)
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The future of shipping and trade

Shipping and supply chains generally have experienced major problems in 2021. The global pandemic disrupted the flow of trade, and the bounce-back in the summer of 2021 saw supply chains stretched as staff shortages and physical capacity limits hit the transport of freight. Ships were held up at ports waiting for unloading and onward transportation. The just-in-time methods of delivery and stock holding were put under considerable strain.

The problems were compounded by the blockage of the Suez canal in March 2021. As the blog, JIT or Illegit stated “When the large container ship, the Ever Given, en route from Malaysia to Felixtowe, was wedged in the Suez canal for six days in March this year, the blockage caused shipping to be backed up. By day six, 367 container ships were waiting to transit the canal. The disruption to supply cost some £730m.”

Another major event in 2021 was the Glasgow COP26 climate conference and the growing willingness of countries to commit to decarbonising their economies. But whereas electricity can be generated from renewable sources, and factories and land transport, such as cars, vans and trains, can run on electricity, it is not so easy to decarbonise shipping, especially for long journeys. They cannot plug in to the grid or draw down from overhead cables. They have to carry their own fuel sources with them.

So, have the pandemic and the Ever Given incident exposed weaknesses in the global supply chain and in shipping in particular? And, if so, in what ways is shipping likely to adapt? And will the pressure to decarbonise lead to a radical rethinking of shipping and long-distance trade?

These are some of the issues considered in the podcast linked below. In it, “Shipping strategist Mark Williams tells Helen Lewis how examining the challenge of decarbonising shipping reveals a future which looks radically different to today, in a world where population, oil extraction and economic growth have all peaked, and trade is transformed”.

Listen to the podcast and have a go at the questions below which are based directly on it.

Podcast

Articles

Questions

  1. Why should we care about the shipping industry?
  2. What lessons can be drawn from the Ever Given incident?
  3. What structural changes are needed to make shipping an industry fit for the long-term demands of the global economy?
  4. Distinguish between just-in-time supply chains and just-in-case supply chains.
  5. What are ‘reshoring’ and ‘nearshoring’? How have they been driven by a growth in trade barriers?
  6. What are the implications of reshoring and nearshoring for (a) globalisation and (b) the UK’s trading position post-Brexit?
  7. What is the contribution of shipping to global greenhouse gas emissions? What other pollutants are emitted from the burning of heavy fuel oil (or ‘bunker fuel’)?
  8. What levers exist to persuade shipping companies to decarbonise their vessels?
  9. What alternative ‘green’ fuels are available to power ships?
  10. What are the difficulties in switching to such fuels?
  11. What economies of scale are there in shipping?
  12. How do the ownership patterns in shipping benefit decision making and change in the industry?
  13. Are ammonia or nuclear power the answer to the decarbonisation of shipping? What are their advantages and disadvantages?
  14. Why are President Xi’s views on the future of shipping so important?
  15. How will the decarbonisation of economies affect the demand for shipping?
  16. What is likely to happen to Chinese demand for iron ore and coking coal over the coming years? What effect will it have on shipping?
  17. How and by how much is the European Emissions Trading System likely to contribute to the decarbonisation of shipping?
  18. What is the Sea Cargo Charter? What difference is it likely to make to the decarbonisation of shipping?
  19. In what ways do cargo ships optimise productivity?
  20. What impact is slowing population growth, or even no population growth, likely to have on shipping?
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Hacking capitalism

The development of open-source software and blockchain technology has enabled people to ‘hack’ capitalism – to present and provide alternatives to traditional modes of production, consumption and exchange. This has enabled more effective markets in second-hand products, new environmentally-friendly technologies and by-products that otherwise would have been negative externalities. Cryptocurrencies are increasingly providing the medium of exchange in such markets.

In a BBC podcast, Hacking Capitalism, Leo Johnson, head of PwC’s Disruption Practice and younger brother of Boris Johnson, argues that various changes to the way capitalism operates can make it much more effective in improving the lives of everyone, including those left behind in the current world. The changes can help address the failings of capitalism, such as climate change, environmental destruction, poverty and inequality, corruption, a reinforcement of economic and political power and the lack of general access to capital. And these changes are already taking place around the world and could lead to a new ‘golden age’ for capitalism.

The changes are built on new attitudes and new technologies. New attitudes include regarding nature and the land as living resources that need respect. This would involve moving away from monocultures and deforestation and, with appropriate technologies (old and new), could lead to greater output, greater equality within agriculture and increased carbon absorption. The podcast gives examples from the developing and developed world of successful moves towards smaller-scale and more diversified agriculture that are much more sustainable. The rise in farmers’ markets provides an important mechanism to drive both demand and supply.

In the current model of capitalism there are many barriers to prevent the poor from benefiting from the system. As the podcast states, there are some 2 billion people across the world with no access to finance, 2.6 billion without access to sanitation, 1.2 billion without access to power – a set of barriers that stops capitalism from unlocking the skills and productivity of the many.

These problems were made worse by the response to the financial crisis of 2007–8, when governments chose to save the existing model of capitalism by propping up financial markets through quantitative easing, which massively inflated asset prices and aggravated the problem of inequality. They missed the opportunity of creating money to invest in alternative technologies and infrastructure.

New technology is the key to developing this new fairer, more sustainable model of capitalism. Such technologies could be developed (and are being in many cases) by co-operative, open-source methods. Many people, through these methods, could contribute to the development of products and their adaptation to meet different needs. The barriers of intellectual property rights are by-passed.

New technologies that allow easy rental or sharing of equipment (such as tractors) by poor farmers can transform lives and massively increase productivity. So too can the development of cryptocurrencies to allow access to finance for small farmers and businesses. This is particularly important in countries where access to traditional finance is restricted and/or where the currency is not stable with high inflation rates.

Blockchain technology can also help to drive second-hand markets by providing greater transparency and thereby cut waste. Manufacturers could take a stake in such markets through a process of certification or transfer.

A final hack is one that can directly tackle the problem of externalities – one of the greatest weaknesses of conventional capitalism. New technologies can support ways of rewarding people for reducing external costs, such as paying indigenous people for protecting the land or forests. Carbon markets have been developed in recent years. Perhaps the best example is the European Emissions Trading Scheme (EMS). But so far they have been developed in isolation. If the revenues generated could go directly to those involved in environmental protection, this would help further to internalise the externalities. The podcasts gives an example of a technology used in the Amazon to identify the environmental benefits of protecting rain forests that can then be used to allow reliable payments to the indigenous people though blockchain currencies.

Podcast

Questions

  1. What are the main reasons why capitalism has led to such great inequality?
  2. What do you understand by ‘hacking’ capitalism?
  3. How is open-source software relevant to the development of technology that can have broad benefits across society?
  4. Does the current model of capitalism encourage a self-centred approach to life?
  5. How might blockchain technology help in the development of a more inclusive and fairer form of capitalism?
  6. How might farmers’ co-operatives encourage rural development?
  7. What are the political obstacles to the developments considered in the podcast?
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The energy crisis

The global battle for fuel is expected to peak this winter. The combination of rising demand and a tightening of supply has sparked concerns of shortages in the market. Some people are worried about another ‘winter of discontent’. Gas prices have risen fivefold in Europe as a whole.

In the UK, consumers are likely to find that the natural gas needed to heat their homes this October will cost at least five times more than it did a year ago. This surge in wholesale gas prices has seen several UK energy suppliers stop trading as they are unable to make a profit. This is because of an energy price cap for some consumers and various fixed price deals they had signed with their customers.

There are thus fears of an energy crisis in the UK, especially if there is a cold winter. There are even warnings that during a cold snap, gas supply to various energy-intensive firms may be cut off. This comes at a time when some of these industries are struggling to make a profit.

Demand and supply

The current situation is a combination of long- and short-term factors. In spring 2020, the demand for gas actually decreased due to the pandemic. This resulted in low gas prices, reduced UK production and delayed maintenance work and investment along global supply chains. However, since early 2021, consumer demand for gas has soared. First, there was an increased demand due to the Artic weather conditions last winter. This was then followed by heatwaves in the USA and Europe over the summer, which saw an increase in the use of air conditioning units. With the increased demand combined with calm weather conditions, wind turbines couldn’t supply enough power to meet demand.

There has also been a longer-term impact on demand throughout the industry due to the move to cleaner energy. The transitioning to wind and solar has seen a medium-term increase in the demand for gas. There is also a long-term impact of the target for net zero economies in the UK and Europe. This has hindered investors’ willingness to invest in developing supplies of fossil fuels due the fact they could become obsolete over the next few decades.

Nations have also been unable to build up enough supplies for winter. This is partly due to Europe’s domestic gas stocks having declined by 30% per cent in the past decade. This heightened situation is leading to concerns that there will be black-outs or cut-offs in gas this winter.

Importation of gas

A concern for the UK is that it has scant storage facilities with no long-term storage. The UK currently has very modest amounts of storage – less than 6% of annual demand and some five times less than the average in the rest of Europe. It has been increasingly operating a ‘just-in-time model’, which is more affected by short-term price fluctuations in the wholesale gas market. With wind power generation remaining lower than average during summer 2021, more gas than usual has been used to generate electricity, leaving less gas to go into storage.

However, some argue that the problem is not just the UK’s physical supply of gas but demand for gas from elsewhere. Around half of the UK’s supply comes from its own production sites, while the rest is piped in from Europe or shipped in as liquefied natural gas (LNG) from the USA, Qatar and Russia. In 2019, the UK imported almost 20% of its gas through LNG shipments. However, Asian gas demand has grown rapidly, expanding by 50% over the past decade. This has meant that LNG has now become much harder to secure.

The issue is the price the UK has to pay to continue receiving these supplies. Some in the gas industry believe the price surge is only temporary, caused by economic disruptions, while many others say it highlights a structural weakness in a continent that has become too reliant on imported gas. It can be argued that the gas crisis has highlighted the lack of a coherent strategy to manage the gas industry as the UK transitions to a net zero economy. The lack of any industry investment in new capacity suggests that there is currently no business case for new long-term storage in the UK, especially as gas demand is expected to continue falling over the longer term.

Impact on consumers and industry

Gas prices for suppliers have increased fivefold over the past year. Therefore, many companies face a considerable rise in their bills. MSome may need to reduce or pause production – or even cease trading – which could cause job losses. Alternatively, they could pass on their increased costs to customers by charging them higher prices. Although energy-intensive industries are particularly exposed, every company that has to pay energy bills will be affected. Due to the growing concerns about the security of winter gas supplies those industries reliant on gas, such as the fertiliser industry, are restricting production, threatening various supply chains.

Most big domestic gas suppliers buy their gas months in advance, meaning they will most likely pass on the higher price rises they have experienced in the past few months. The increased demand and decreased supply has already meant meant that customers have faced higher prices for their energy. The UK has been badly hit because it’s one of Europe’s biggest users of natural gas – 85% of homes use gas central heating – and it also generates a third of the country’s electricity.

The rising bills are particularly an issue for those customers on a variable tariff. About 15 million households have seen their energy bills rise by 12% since the beginning of October due to the rise in the government’s energy price cap calculated by the regulator, Ofgem. A major concern is that this increase in bills comes at a time when the need to use more heating and lighting is approaching. It also coincides with other price rises hitting family budgets and the withdrawal of COVID support schemes.

Government intervention – maximum pricing

If the government feels that the equilibrium price in a particular market is too high, it can intervene in the market and set a maximum price. When the government intervenes in this way, it sets a price ceiling on certain basic goods or services and does not permit the price to go above that set limit. A maximum price is normally set for reasons of fairness and to benefit consumers on low incomes. Examples include energy price caps to order to control fuel bills, rent controls in order to improve affordability of housing, a cap on mobile roaming charges within the EU and price capping for regional monopoly water companies.

The energy price cap

Even without the prospect of a colder than normal winter, bills are still increasing. October’s increase in the fuel cap means that many annual household fuel bills will rise by £135 or more. The price cap sets the maximum price that suppliers in England, Wales and Scotland can charge domestic customers on a standard, or default tariff. The cap has come under the spotlight owing to the crisis among suppliers, which has seen eleven firms fold, with more expected.

The regulator Ofgem sets a price cap for domestic energy twice a year. The latest level came into place on 1 October. It is a cap on the price of energy that suppliers can charge. The price cap is based on a broad estimate of how much it costs a supplier to provide gas and electricity services to a customer. The calculation is mainly made up of wholesale energy costs, network costs such as maintaining pipes and wires, policy costs including Government social and environmental schemes, operating costs such as billing and metering services and VAT. Therefore, suppliers can only pass on legitimate costs of supplying energy and cannot charge more than the level of the price cap, although they can charge less. A household’s total bill is still determined by how much gas and electricity is used.

  • Those on standard tariffs, with typical household levels of energy use, will see an increase of £139.
  • People with prepayment meters, with average energy use, will see an annual increase of £153.
  • Households on fixed tariffs will be unaffected. However, those coming to the end of a contract are automatically moved to a default tariff set at the new level.

Ordinarily, customers are able to shop around for cheaper deals, but currently, the high wholesale prices of gas means that cheaper deals are not available.

Despite the cap limiting how much providers can raise prices, the current increase is the biggest (and to the highest amount) since the cap was introduced in January 2019. As providers are scarcely making a profit on gas, there are concerns that a further increase in wholesale prices will cause more suppliers to be forced out of business. Ofgem said that the cap is likely to go up again in April, the next time it is reviewed.

Conclusion

The record prices being paid by suppliers and deficits in gas supply across the world have stoked fears that the energy crisis will get worse. It comes at a time when households are already facing rising bills, while some energy-intensive industries have started to slow production. This has started to dent optimism around the post-pandemic economic recovery.

Historically, UK governments have trusted market mechanisms to deliver UK gas security. However, consumers are having to pay the cost of such an approach. The price cap has meant the UK’s gas bills have until now been typically lower than the EU average. However, the rise in prices comes on top of other economic problems such as labour shortages and increasing food prices, adding up to an unwelcome rise in the cost of living.

Video

Articles

UK government/Ofgem

Questions

  1. Using a supply and demand diagram, illustrate what has happened in the energy market over the past year.
  2. What are the advantages and disadvantages of government intervention in a free market?
  3. Explain why it is necessary for the regulator to intervene in the energy market.
  4. Using the concept of maximum pricing, illustrate how the price cap works.