Why Does the FTC Care Now: Getting Ready for a Democratic FTC Edition

No stranger to investigative pressure from every acronym associated with the US Government, Take Two is once again embroiled in controversy. Only this time, they really, really didn't do it. The FTC is trying to force Take Two to surrender reams of information, some of it confidential business information to determine whether the business combination the company does not want to be a part of will harm consumers. 

The FTC's action is not unprecedented, nor is it unique under the new FTC chairman, but it seems to upset fundamental rules of fairness. We like to think our government acts logically, this would not be the case here. EA instigated a takeover attempt and was rebuffed by Take Two. EA lowered its per share purchase price of its tender offer, which was already lower than the current trading price of the stock.  Now, before the tender offer is accepted, Take Two is being asked to show why it is ok for the merger to proceed.   Personally, if I were Take Two, I would be providing lots of information, with different color highlights for the parts constituting monopoly positions. Before I get to there, I have to wonder why the FTC is not investigating EA's position in sports without the business combination.

For some reason the FTC feels the need to protect a specific subcategory of games.  I don't know why, but let's go with it.  Most publishers operate successfully without sports titles. For years, hardly any publisher would touch sports because EA's position is so solidly entrenched. When they tried, bad things happened.  If a publishers started to make a market in a new sport, EA would step in and bid up the license. When Sega published ESPN football, EA bought the commercials and the name of the ESPN NFL broadcast, and ultimately an exclusive license. EA and the NFL said it was the NFL's decision to go exclusive, but was it the Arena Football league's decision too? Worldwide, soccer titles are the best selling sports titles, but in the world's largest homogenous market, Madden is the sports leader. Madden is the cornerstone of EA Sports, and its major lever.  EA will fight to protect its market share for this title, but it wasn't always like this. There as a time when EA cared about market size of market share.

When Sega was launching the Genesis in 1989 they didn't have a football game. They were building Joe Montana to compete with Madden, but the development was not going well. Trip Hawkins, who created Madden so his friends could play fantasy football with him, knew the market would suffer with only one football game. Worse yet, Sega would not survive without a Madden fighter and Hawkins needed two consoles to play off each other. Hawkins convinced the Madden developer to take new plays he had written and use the Madden code to make Joe Montana football. They were basically the same game with different plays and graphics. He laughed at reviews favoring one over the other, but the market grew and consumers benefitted. Years later, EA behaved differently when it was confronted with Take Two's bargain entry into the market.

In 2004, EA put out a full price Madden and Take Two put out a bargain priced ESPN 2K5. The games were comparable in scope and most felt they were comparable in quality, some even favored the ESPN game.  Before the next games could be built, EA entered into an exclusive agreement with the NFL.  EA says it was the NFL's request, but whoever drove the decision was thinking more about market share than market expansion. That year Madden sold about six million units, and ESPN had sold about 3 million. The interesting thing, according to a former EA senior executive, is 60% of the consumers purchased both skus and Madden sales were up from the previous year. Since the ESPN controls were basically the same as Madden, Take Two was subsidizing the entry of new consumers into the football market for EA. They expanded the market by millions of consumers and unit sales of Madden have not reached the aggregate sales of the two titles since ESPN left the market. All EA had to do to compete, is make a better game. EA did lower the price of Madden earlier than ever before and if Take Two continued to sell at a lower price, they may have had to lower launch prices in the future, but if they did, the consumer would benefit.  They could not shirk quality, because there would be a competitor in the market.  The only pain would be in margins.  Realistically, even margin pain would be alleviated when Take Two inevitably decided to raise prices.   When the license went exclusive, it was consumers who were hurt.

Aside from NFL, EA Sports has exclusive relationships with FIFA, NASCAR, Arena Football, The NCAA College Football and the PGA. The MLB is exclusive to Take Two, but does anyone really care about baseball games? I still don't get why they bought it. It is almost like EA needs Take Two to hold the license like Microsoft needs Apple to hold on to its 3% market share. They can say there is a competitor in the market, but not really. The real questions for all of this is why now, and does the addition of Take Two to the mix really make a difference?  If the FTC cares about this subsection of the video game market, shouldn't they have investigated years ago?

Getting back to the point . . . While the FTC's action is consistent with the new regime, it is unusual in the circumstances. The agency made a second request for information a few weeks back.  This is somewhat typical, and expected by more than a few people in this situation. It then went on to issue a civil investigative demand, or the equivalent of a subpoena, to provide additional information. In its affidavit the FTC says the action is necessary because Take Two is not complying with the original request, a charge Take Two denies, but why should they? They didn't ask for this deal. 

Imagine someone walks up to you and offers you money for your car. You don't want to sell your car, but they make an offer for what they believe it is worth. The DMV looks at their driving record and realizes the potential buyer has been in a lot of accidents, so they ask you to prove why selling the car to them will not be a danger to the community. But wait a second. You didn't want to sell the car. The DMV should not get involved until you try to sell the car. The FTC is getting involved before the car is sold.

If the FTC is concerned about whether Take Two's management is acting in the best interest of the shareholders, the extraordinary action may make sense. But the FTC is not responsible for shareholders, the SEC is. The FTC is responsible to consumers, who will only be harmed, if the shareholders accept the tender offer. In the case of a friendly merger, like Activision/Vivendi this type of investigation did not occur until after the parties agreed on terms and it looked like, absent shareholder objection, the deal would go through. We are not there yet with EA/Take Two. As far as the shareholders, if they feel they are harmed, they can bring their own action, as can the SEC.

Emotionally and morally, Take Two should not have to comply. They will find out if they legally have to comply after the hearing on June 24th. Practically, maybe they should. The FTC is obviously concerned about EA's ability to exert monopolistic control over the market. Take Two could probably present evidence of exertion of control today, and could probably easily present evidence indicating the combination of Take Two and EA would make the ability a certainty. In fact, they may even be able to prevent evidence of harm they incurred from EA's exertion of monopolistic pressure as the company stands today.  Such a showing may trigger FTC action against EA absent a merger.  

While the ability to exert control may only support separation of 2K Sports from the transaction and not compel blocking the acquisition, we must consider whether the acquisition will still be as appealing to EA. If they don't get sports and the majority of the GTA IV revenue is already booked, is Take Two still a compelling acquisition?  The very fact the FTC is investigating shows the interest this young regime has in making a mark and its suspicion the deal will harm consumers. Perhaps Take Two should work with the FTC to prove their concerns are justified.