Faceblocked

Finally antitrust enforcers act against a big tech merger. The Federal Trade Commission filed suit to stop Facebook from buying a popular VR app maker and thus dominating the virtual reality space.

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Today I’m writing about the first attempt in the U.S. to stop a big tech merger.

Facebook CEO Mark Zuckerberg needs something else to ruin.

Today, the big news in antitrust world is that the Federal Trade Commission, led by Chair Lina Khan, filed suit to stop Facebook, aka ‘Meta,’ from buying virtual reality app maker Within. The vote was 3-2, with the three Democrats voting to file a challenge, and two Republicans voting against bringing it. While not a large acquisition by dollar amount - the deal is just $400 million - there are a number of reasons why this merger challenge is historic.

First, let’s go over the deal, and the FTC’s action to block it. In October of last year, Facebook changed its name to Meta, signaling that Mark Zuckerberg did not see much more growth in the social networking space that his firm had heretofore controlled. He is seeking a new set of markets to dominate, which he calls ‘the Metaverse,’ a term he borrowed from science fiction denoting a set of immersive digital worlds.

The reason for this shift is simple. Mark Zuckerberg is stuck. Meta earnings came out today, and while still massive, the firm’s revenue declined for the first time ever. There are a few reasons for this drop. Meta’s existing monopoly over social networking is still solid - indeed the firm is still growing its user base - but there’s little more to squeeze out that he isn’t already harvesting.

Meta, unlike the other big tech giants, does not control its access to users. It’s not a computing platform, it’s a set of apps on which Zuckerberg sells targeted advertising. The firm’s products have to go through Apple’s app store and Google’s app store, and be subjected to privacy rules those firms impose. Apple has blocked Facebook’s ability to collect key types of data, which means ad revenue from targeting users has declined. In addition, Zuckerberg faces the looming antitrust case from the FTC, in which the commission is trying to undo his power over social media.

If this were the early 2010s, his strategy to get out of this morass would be simple. He would pay massively for TikTok, which is clearly the missed product opportunity for Meta. “It’s better to buy than compete,” Zuckerberg once said in email. But due to regulatory pressure and Chinese power, he cannot get control over TikTok.

Zuckerberg is not a great product guy, but he is good at monopolizing markets, particularly at technological pivot points. In the 2000s, he was able to vanquish MySpace by promising privacy and safety to users, and then bought Instagram and WhatsApp when the new computing platform turned out to be mobile. But he can’t do that today, with TikTok or any other large firm. (Indeed there’s a good argument that Zuckerberg’s monopolistic behavior is the reason that TikTok emerged in China, and not in the U.S. But that’s a digression.)

So where’s the new area of growth?

The answer, Zuckerberg hopes, is virtual reality, aka the Metaverse. He has a massive cash gusher in the form of targeted ads, so he’s using that to finance the commercialization of this nascent and immature technology. In 2014, Facebook bought VR headset maker Oculus, and in the last year or so has invested roughly $10 billion annually to build it out, which includes subsidizing the sale of headsets below cost. In other words, Zuckerberg is trying escape his social media constraints by creating a technological pivot point, a computing platform he can control. While it’s good he’s investing in a new technology, the business goal is simple. Control. The FTC cites Zuckerberg stating this explicitly.

As early as 2015, Mr. Zuckerberg instructed key Facebook executives that his vision for “the next wave of computing” was control of apps and the platform on which those apps were distributed, making clear in an internal email to key Facebook executives that a key part of this strategy was for his company to be “completely ubiquitous in killer apps.”

So far, the plan seems to be working. Meta had 62% of the VR headset market in 2020, and 78% in 2021. It doubled its revenue in 2019 and then again in 2020, so that Meta’s Reality Labs segment has $2.274 billion in 2021. That’s about 2% of the firm’s total revenue, so it’s not large, but it is what Zuckerberg thinks is the future, which is why he renamed the firm Meta. Moreover, Meta has a dominant app store, and in the last few years, the corporation has also gone on an acquisition spree, buying up VR firms Sanzaru, Dawn Studios, Beat Games, Echo RV, Downpour Interactive, Onward, BigBox, Unit 2 Games, Crayta, and Twisted Pixel. These are game makers and tool makers for ‘the Metaverse,’ and Meta wants to own it all.

Meta will soon likely face competition in this space. Apple may enter the virtual reality headset market, but right now, Meta is the king, and Zuckerberg is rapidly trying to tip the market in his favor by rolling up much of the ecosystem.

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Such a vertically integrated strategy is really no different than what any would-be tech monopolist has pursued over the years. In the 1960s, IBM controlled the computer industry with its IBM 360, and used its power over that platform to foster dominance in software, networking, memory and printing. In the 1980s and 1990s, Microsoft owned the PC operating system and used its power to sideswipe rivals and control killer apps for the PC, most notably the Office suit of products. (It also tried to buy Intuit, but the Antitrust Division blocked it in 1995 just before filing a major antitrust suit.) And in the 2000s and 2010s, Apple and Google emerged as a duopoly with control over the smartphone operating system, mobile app stores, and key apps.

So that’s Meta’s strategy. What about the case?

The argument from the FTC is fairly straightforward. The firm Meta bought - Within - produces the most popular VR workout app, which is named Supernatural. According to Within’s co-founder and CEO, “Fitness is the killer use case for VR.” Meta already has a game called Beat Saber, where users slice musical notes as they come at you, and people often use it for exercise. (Meta bought Beat Saber’s parent company, Beat Games, in 2019).

The FTC is making two claims about why this acquisition is illegal, but also implying a few others. First, “letting Meta acquire Supernatural would combine the makers of two of the most significant VR fitness apps, thereby eliminating beneficial rivalry between Meta’s Beat Saber app and Within’s Supernatural app.” That’s a straightforward structural argument. And second, if Facebook weren’t allowed to buy Within, it would produce its own direct fitness app. So this merger is eliminating potential competition. Such an argument about eliminating potential competition is something we haven’t seen for decades; this is Khan and the FTC pushing the bounds of law, which is something that is risky but ultimately necessary.

The commission also added, towards the end of its complaint, an observation that Meta could block new app producers from getting onto its platform. “To be sold on the Quest store,” it reads, “Meta itself must decide to approve an app through a technical review and a curation process by Meta that examines “quality, polish, entertainment, value, and utility.” This can be a lengthy process and there is no guarantee any third-party app will ultimately be approved.” In other words, Meta will have the ability and incentive to block competitive fitness apps from getting access on equal terms on the key distributional channels it provides. I would also add that Meta could withhold good VR content, tools, and talent from competitive platforms, such as the one Apple is rumored to be producing.

There are a number of risks in this challenge. The virtual reality space isn’t mature, so a lot of people will argue it is a small and irrelevant market. Why can’t the FTC focus on more important things than a niche video game? Isn’t Microsoft buying Activision more significant? (I would say yes, but it’s also a harder case.) There are disputes over market definition. Is Beat Saber really a fitness app? Does Beat Saber and Supernatural really compete? Are there really market power issues at play here?

Another argument here is that Meta is subsidizing the creation of virtual reality through its acquisitions, so blocking this purchase will chill investment. Here’s Benedict Evans making that point.

Benedict Evans @benedictevans

The interesting problem with the FTC’s thesis here is that FB is trying desperately to get a competitive VR ecosystem going. Blocking investment and indeed buyouts might not be the best regulatory response

Indeed, that is exactly Meta’s claim in response to this suit. The firm said that the FTC is “sending a chilling message to anyone who wishes to innovate.” The idea that people only build companies to get acquired by a monopolist is fairly powerful, so we’ll see how much sway courts give it. I don’t agree, people build products for a lot of reasons, not just to get acquired. In fact monopolization usually hinders more investment. Remember, one of the reasons that Meta is even trying to build out virtual reality is because regulatory pressure is forcing the corporation to invest in product design and not just monopolization. But that’s the argument.

Ok, so that’s the merger and the case. What about the broader implications?

This particular merger challenge matters for a number of reasons, most obviously because it’s the first merger challenge to a big tech firm, at least since Microsoft-Intuit in 1995. The FTC is using a creative legal theory, in an attempt to expand the bounds of antitrust law in a way that opens more space for enforcers. This is also a nascent technology space, which means that the FTC is trying to get ahead of problems in new markets rather than wait for monopolies to develop and then try and deal with mature concentrated industries.

Finally, the merger challenge is part of a historic revival of antitrust and competition policy, and that resurrection is finally beginning to have impacts on market participants.

• Today, the Spirit-Frontier airline merger proposal fell apart, in part because of heightened scrutiny over mergers from the Department of Justice Antitrust Division.

• Amazon, similarly due to regulatory pressure, is rolling back some of its private label products that compete with its third party sellers.

• Yesterday, enforcers from different parts of government actually dealt with corrosive practices in the poultry industry, which is the first time that has happened in decades.

• Today, Rohit Chopra at the Consumer Financial Protection Bureau publicly warned Apple about getting too far into the payments system.

• Gary Gensler at the Securities and Exchange Commission is finally cracking down on the crypto space by going after insider trading at Coinbase.

The FTC could lose this challenge, and it is a risky legal move to go after an acquisition like this. But whether the commission prevails is far less important than the cultural change among enforcers that is happening. Turning on enforcement isn’t like flicking a switch, it takes time, patience, a willingness to contest over bureaucratic turf, and institutional changes. But the change is starting to gather momentum.

For instance, the Antitrust Division has lost several important cases at trial recently, and yet, paradoxically that is a very good sign, because it shows they are actually trying to push the boundaries of the law. A contact told me he thinks that enforcers might lose cases for the next five to ten years, but then, the dam will break in the courts. I’m not that pessimistic on the outcomes. But the point stands that enforcers have been a huge problem in antitrust for a long time, because they narrowed the law by refusing to bring risky cases.

While we do face a hostile judiciary, at least our public servants are finally back in the game. And case by case, using the law to contest concentrated power is how we remember what it is to be a free people.

Thanks for reading. Send me tips on weird monopolies, stories I’ve missed, or comments by clicking on the title of this newsletter. And if you liked this issue of BIG, you can sign up here for more issues of BIG, a newsletter on how to restore fair commerce, innovation and democracy. If you really liked it, read my book, Goliath: The 100-Year War Between Monopoly Power and Democracy.

cheers,

Matt Stoller