Chillin'Competition

My “learned” co-blogger (and NY-Times interviewee of the week) initiated a very interesting debate yesterday with regard to the Microsoft/Skype clearance decision. I must confess that I read the decision last evening on the plane back fromFlorence (more on that tomorrow) and, to be frank, I was astonished. Let me briefly, and not exhaustively, explain to you why:

As our usual readers know, I’ve a particular interest in looking at how competition authorities appraise network effects in competition cases (it was the topic of my LL.M dissertation and it’s also supposed to be the topic of a pending PhD project). Since the Microsoft/Skype merger involves two entities benefitting from huge network effects I regarded this decision as a must read.

Well, I was wrong; the decision is a must RE-READ: I had to read certain paragraphs several times in order to make sure that it wasn’t just that I was tired and couldn’t make sense out of it. After several re-reads, I reached the conclusion that, actually, parts of it don’t make any sense.

Nicolas said yesterday that “the decision clearly shows that a merger involving a large monopoly can get Phase I clearance”. I was not involved in this case and therefore I may be missing something but, if you ask me, the decision reads as if the Commission already knew that it wanted to clear the decision in Phase I and then tried to construct an assessment that would fit its pre-determined conclusion. Arguing in a convincing manner that the creation of a “large monopoly” such as the one at issue does not raise competitive concerns and is suitable for Phase I clearance is practically impossible. Nonetheless, that is what the decision has tried to do. And, inevitably, that leads to serious logical problems.

Even from the perspective of an outsider [PS. see note at the end of the post]  it’s easy to detect many defects, but for the sake of brevity (notably because I have only allocated one hour of today’s afternoon to write down my notes about this) let’s focus just on one of the Commission’s errors. I have chosen to present you with an error concerning the market for consumer communications because it involves network effects (which is what initially got me interested) and horizontal effects, and because all of us as consumers are able to understand it better. The decision is equally, perhaps even more, questionable with respect to the assessment of vertical and conglomerate effects in the market for enterprise communications, but that part is harder to explain in a brief post; I might develop my views on this in a later post.

In what follows I´ll explain what the decision says in this regards and I will provide you with my very personal views on the Commission´s reasoning. I might be right, but I certainly may as well be wrong. If interested in taking a look at the substantive stuff in other to arrive to your own conclusions, click here:

Substantive assessment

The decision acknowledges that the merged entity would have a market share of 80-90% in the segment for video calls on Windows-based PCs. The decision, however, states that the Commission doesn’t see how this could give rise to doubts as to the compatibility of the merger with the internal market for the following reasons (contained in paras. 120 and ff. of the decision):

– First, the Commission states that video call services are provided free of charge, and that in the event that a company started charging for its services or that innovation was slowed down consumers would switch to an alternative provider. This argument ignores that this is a two-sided market and that market power of course leads to monetization in one way or the other (why on earth would Microsoft otherwise have paid $ 8.5 billion for Skype??); it also ignores that -as I will explain below- switching is far from obvious.

– Second, the Commission relies on the alleged “strong competitive pressure” exerted by numerous current players which is illustrated by “successful” entries of companies which have rapidly “gained traction”. The decision’s stance here is striking in light of the fact that altogether  these “numerous” and “successful” players with “strong consumer brands”, “rapid traction” and “robust monetization models” (including Google, Facebook, Bistri, IMO, Friendcaller, Paltak or VZOChat) don’t account for more than 10% of the market!

– Third, the Commission states that Windows Live Messenger (“WLM”) has lost some market share in the past months. A true example of forward looking post-merger assessment…

– Fourth, it is argued that WLM currently has no presence on smart phones and tablets. This is interesting, but clearly has nothing to do with the segment at issue, which is that of Windows-based PCs.

– Fifth, (and, pay attention, this is a true “jewel”) the Commission explains that there are no network effects and barriers to entry/expansion because of this most curious reasoning stated in para. 92:

“Most consumers of communications services make the majority of their voice and video calls to the small number of family and friends that make up their so called “inner circle”. According to Facebook data, users engage in regular two-way interaction with four to six people. Therefore, it is not difficult for these groups to move between communications services. Moreover the Commission observes that consumers multi-home to a certain degree among various providers of consumer communications services.

In other words, the decision says that consumers only interact in groups of six, and it is easy for a group of six to “switch” provider. This is nuts. The decision fails to see that each one of those “six” individuals is, in turn, connected to another group of other “six” individuals, and so on until, at the end of the day, all consumers are interconnected! It’s blatantly absurd to argue that the world is only interconnected in “closed” groups of six people.

This last error is particularly crucial for the outcome of the case. If the Commission is wrong in this regard (and, as you have just seen, it is) and respondents to the market test are right (see para. 91 for their apparently unanimous views), then the situation is a lot different from the one on which the Commission builds its conclusions. If there’s a player with 90% of the market who benefits from network effects on various markets and there are high barriers to expansion, how this does not raise doubts over the compatibility of the merger?  The economic importance of the case and the growth prospects for the relevant market make this outcome all the more surprising: keep in mind that according to the Commission´s own estimates “it is expected that the number of video calls will increase from 3.2 billion in 2011 to 29.6 billion in 2015“.

I haven´t thought through all these issues, so I won´t dare to firmly deny that perhaps there were reasons to clear the merger (at least in relation to consumer communications); the problem is that, even if there were such reasons, they are not explained in the decision. In its attempt to justify a swift unconditional clearance, the decision engages in absurd certainly questionable reasoning; it departs from what appear to be unsubstantiated assumptions; it incurs in key omissions; it fails to adequately respond to the parties concerns; it appears to be somehow biased (probably this has to do with other pending investigations) when it understates the position of Microsoft’s products as well as of Skype and at the same time exaggerates that of Google and others; it ignores its previous decisional practice (not only in the Microsoft’s 2004 and 2009 decisions, but also in Intel/McAffee, Sun/Oracle and Cisco/Tandberg) as well as the General Court’s Microsoft Judgment; and –in spite of the nice words on dynamic analysis to which Nicolas referred in yesterday’s post- it only adopts a prospective analysis where a forward-looking perspective could support its conclusion but not when it’s the other way around.

Even if, as I suspect, the European Commission’s interest on the ongoing Google investigation may be behind this surprising decision, then the Commission may have acted against its own interests. As Nicolas also noted yesterday, the Commission has in the past relied on network effects derived from so-called “end-users inertia” (see §870 of the 2004 Microsoft decision), and a similar theory seems to be underlying the Google investigation. The Commission’s position in Microsotf/Skype explicitly refutes the relevance of this inertia might complicate the Commission´s stance in the future: from now on with what legitimacy can it respond to Google´s argument that competition is just one click away?

P.S. By the way, pursuant to paragraph 88 of the decision barriers to entry in the consumer communication markets are extremely low. According to this recital, with a capital investment of between EUR 750.000 and EUR 9,7 million and a development period of 8 to 24 months a company would achieve within only one year a user base of between 2.4 million to 17 million. In order to find out if this passes the “laught test” I propose that you go to a bank, provide them with this “business plan” and ask for EUR 750.000 to undertake a venture in this market. Tell them that the Commission buys this plan. See what happens…