Expert economists Joe Perkins and Gabriele Corbetta co-authored an article for the for the Network Law Review on the frameworks for dynamic competition. The authors recast the OFT's assessment of Facebook's 2012 acquisition of Instagram under the Competition Appeal Tribunal's framework.

Abstract

Concerns around dynamic competition are increasingly featuring in merger control, particularly in the UK. Such concerns have been an important factor in the CMA’s decisions to prohibit the mergers between Microsoft and Activision and between Meta and Giphy. Other mergers that might have raised dynamic competition concerns have been abandoned by the parties, facing the prospect of an exacting review. This was an expected development following the CMA’s adoption of revised Merger Assessment Guidelines in 2021. But what framework should authorities adopt in assessing dynamic theories of harm? The guidelines provide some indications but leave the issue largely open. The Competition Appeal Tribunal did however elaborate a framework for assessing dynamic competition in its 2022 judgment on Meta’s appeal against the CMA on Meta/Giphy. We recast the OFT’s assessment of Facebook’s 2012 acquisition of Instagram under the Competition Appeal Tribunal’s framework and comment, with the benefit of hindsight, on which aspects of the framework are helpful and where it could be supplemented.

Introduction

If the UK Competition and Markets Authority (CMA)’s 2021 revised Merger Assessment Guidelines (MAGs) left any doubts about its enforcement posture on mergers in dynamic markets, recent high-profile prohibitions (Microsoft/Activision in 2023; Meta/Giphy in 2022) should clear up any doubts. The life sciences merger between Illumina and Pacific Biosciences was recently abandoned by the parties, who cited the “lengthy regulatory approval process the transaction has already been subject to and continued uncertainty of the ultimate outcome”.¹

The CMA’s findings in Microsoft/Activision illustrate this posture. The CMA was concerned that Microsoft would, as a result of the merger, withhold Activision games from cloud gaming platforms rivalling Microsoft’s. Given Microsoft’s strong position and limited competition from current and potential rivals, the CMA worried that the merger could alter the dynamics of cloud gaming for the worse: “By stifling competition in the growing and dynamic market for cloud gaming services, the Merger could alter the future of gaming”.²

Dynamic issues were key to the CMA’s decision to reject the behavioural remedies proposed by Microsoft and prohibit the merger. The CMA’s decision in this case suggests that proposing adequate behavioural remedies will be particularly difficult in “early-stage, growing, and dynamic” markets. First, the risk of not capturing future market developments is higher. There is a risk of introducing distortions and limiting innovation, for example by excluding alternative business models. Second, enforcing a complex and long-lasting remedy in a changing environment is challenging for the authority, and the risk of circumvention is higher.³

In this case, the CMA decided that the proposed remedies would not “restore the competitive dynamism that would be lost as a result of the Merger”, while a prohibition could “preserve the competitive dynamism and level of innovation that exists in the growing cloud gaming market”.⁴

In this context, it is important to scrutinise the analytical framework for dynamic theories of harm in mergers. In this piece, we describe the approach set out in the CMA’s MAGs, and the framework put forward by the Competition Appeal Tribunal (CAT) in its review of Meta/Giphy. We then recast the assessment of Facebook’s 2012 acquisition of Instagram under the CAT’s framework. We consider what applying the CAT’s approach to this case, with the benefit of hindsight, reveals about the key factors to analyse in dynamic competition cases, and what else might be needed beyond an analytical framework.

2. Mergers and dynamic competition: the UK MAGs and the CAT’s framework

2.1. The UK Merger Assessment Guidelines

The CMA’s new MAGs, published in 2021,⁵ are a major update over the 2010 guidelines⁶ in various areas, including dynamic competition.

The previous guidelines made no explicit reference to ‘loss of dynamic competition’ as a theory of harm.⁷ They (briefly) referred to a related concept, ‘perceived potential competition’: that is, the concern that the merger would remove a firm that, despite not being active in a market, imposes a constraint because of the threat of entry. This threat may exist even if actual entry is not likely to occur. A firm is more likely to be a ‘perceived potential competitor’ if it can enter cheaply, and fast: “without incurring any substantial sunk costs, […] within a year”.⁸

The CMA’s 2021 guidelines demonstrate an increased focus on the loss of dynamic competition:⁹ a merger could decrease incentives (of the merging parties and of their competitors) to innovate and enter new areas, and to invest in providing better goods and services in their existing areas of activity. The process of dynamic competition may relate to specific products, or “a broader pattern of dynamic competition in which the specific overlaps may not be identified easily at the point in time of the CMA’s assessment”, for example digital platforms with a pattern of launching similar new services. Here, what matters is “the merger firms’ incentives to continue investing in these competing programmes or strategies”.¹⁰ While the guidelines do not specify timeframes or sunk costs, their tenor suggests a wider net compared to the 2010 guidelines, taking into account longer-term market dynamics, and ones that may involve substantial investment by competitors.

The 2021 guidelines give some indications of what the CMA may look at in its assessment of dynamic competition . These include “evidence on any direct response of an incumbent merger firm to the threat of entry or expansion by the other merger firm or […] evidence on the incumbent’s incentive to respond to any such threat”, and “the likelihood of successful entry by a dynamic competitor and the expected closeness of competition between a dynamic competitor and other firms”.¹¹

The guidelines, however, fall short of providing any more concrete framework or indication of the types of evidence the CMA will look at.

2.2. Meta/Giphy: the CAT’s framework on dynamic competition

In 2021, the CMA required Meta (known as Facebook in the early stages of the merger) to unwind its acquisition of Giphy.¹² The CMA found that the merger would lead to a substantial lessening of competition due to horizontal unilateral effects in the supply of display advertising from a loss of dynamic competition and due to the potential of Meta foreclosing access to Giphy’s GIFs to its competitors.

Meta appealed against the CMA’s decision to the CAT. The CAT largely rejected Meta’s appeal in its judgment of 14 June 2022.¹³ In doing so, it discussed the concept of dynamic competition in detail and presented a framework for its assessment, particularly in the context of the CMA’s finding that the merger would lead to horizontal unilateral effects in the supply of display advertising.

In the CAT’s framework,¹⁴ before moving to the dynamic aspects, static and potential competition need to be assessed. This involves a well-rehearsed analysis: identifying the relevant markets and assessing the position of the merger parties and competition in each market.

Static competition, the CAT stated, “involves consideration of the market as it is”.¹⁵ Potential competition “focuses on the potentialities that exist in or arise out of the static case”, considering the prospects of entry and expansion of firms in the market. For example, if each of the merging firms has a market share of 10%, but is expanding rapidly, this might lead the authority to consider it carefully through the lens of potential competition (even if the transaction does not appear problematic in terms of static competition).¹⁶

Dynamic competition, instead, is “a much more fluid form of competition between innovating firms”, which “involves a far greater consideration of innovation and invention – in short, potentiality – rather than analysis of an existing market or an assessment of the future trends that lie within it”. The CAT acknowledged challenges in identifying whether a state of dynamic competition exists: for instance, “the temporal aspect that differentiates static from potential competition is an unhelpful one to draw in the case of dynamic competition”. With the benefit of hindsight, “one knows [dynamic competition] when one sees it”, which however will be “of scant comfort to the competition authority who must consider the issue in advance, without the benefit of hindsight”.¹⁷

The CAT noted that the traditional tools for competition analysis for static or potential competition cases (such as market definition and the analysis of market shares and concentration)” are “less likely to be determinative” in dynamic competition cases. In such cases, the CAT’s proposed framework proceeds as follows.

First, the authority should set out “the broad nature of the dynamic”: what makes the case ‘dynamic’?¹⁸

Second, ‘duds’ should be differentiated from the ‘genuinely dynamic’; duds are cases where the dynamic element is not likely to materialise. The CAT enumerates some factors to consider (stressing that the list is indicative, not exhaustive):¹⁹

Monetisation: is there a great potential to monetise the dynamic element, or is that unlikely?

In case of competition concerns, in its decision to unwind a merger the CMA must conclude that a substantial lessening of competition (SLC) has either taken place, or there is an ‘expectation’ (i.e., more than 50% chance) that it will. If effects are not expected to materialise for five years or more, the CAT expresses scepticism that they can be considered an ‘expectation’.²⁰ The issue of the standard of proof in cases having to do with potential and dynamic competition merits further examination, which is beyond the scope of this note.

The CAT also encouraged the CMA to consider explicitly, as a cross-check, the ”disbenefits of intervention”.²¹ Prohibiting or unwinding a merger may have benefits if it prevents a reduction in competition, but it can also have costs: for the merger parties; for consumers who may not enjoy any potential efficiencies; and possibly on the wider innovation environment, for instance if it discourages entrepreneurial activity.

3. Applying the CAT’s framework to Facebook/Instagram

Facebook’s 2012 acquisition of Instagram was reviewed by the US Federal Trade Commission (FTC)²² and the UK Office of Fair Trading (OFT).²³

However, it has often been cited as an example of a case where competition authorities ‘got it wrong’. In an ex-post assessment of mergers in digital markets, commissioned by the CMA, the economic consultancy Lear identified various gaps in the OFT’s assessment. Some of these gaps related to the metrics used in the assessment (e.g., looking at downloads, instead of usage, to assess user engagement). Other gaps related to the framework adopted for the theories of harm (e.g., a more dynamic perspective may have been adopted in evaluating Facebook’s incentives to foreclose rival social networks) and to the conclusions drawn from the available evidence (e.g., whether Instagram would be well-placed to monetise its services, or to compete against Facebook in the supply of social network services). Other commentators have argued that the transaction contributed significantly to entrenching Facebook’s position in social media, and that competition authorities did not look sufficiently closely at the potential competitive harms of the merger.²⁴

To understand the strengths and weaknesses of the CAT’s framework for assessing dynamic competition, we have tried to apply the framework to the Facebook/Instagram merger retrospectively. Were there aspects of the framework which, if applied, would be likely to have led the OFT to review the transaction more closely? We have drawn particularly on the OFT’s published decision, but have also considered later testimony on the merger, for instance the 2020 hearings of the US House Judiciary Subcommittee on Antitrust, Commercial, and Administrative Law.

3.1. Motives and thinking of the merging firms

The OFT decision mentions the possibility that “Given that Instagram’s user base was growing rapidly it may have been the case that Facebook perceived that Instagram would grow to be a credible social network competitor”.²⁵ The OFT’s decision also includes some redacted findings from a review of the parties’ internal documents.

Other sources can shed more light on Facebook’s motives. Facebook’s press release on the acquisition cites an improved photo sharing experience: “work[ing] even more closely with the Instagram team to also offer the best experiences for sharing beautiful mobile photos with people based on your interests”.²⁶

Facebook’s internal e-mails at the time suggest some other motivations. On the day of Facebook’s announcement of the acquisition, Facebook’s founder Mark Zuckerberg wrote to a senior engineer that: “I remember your internal post about how Instagram was our threat and not Google+. You were basically right. One thing about startups though is you can often acquire them”.²⁷

In an earlier exchange with Facebook’s then-CFO, David Ebersman, Zuckerberg described the transaction as trying to achieve a combination of neutralising a potential competitor and integrating Facebook’s and Instagram’s respective products to improve their services. He then summarised: “one way of looking at this is that what we’re really buying is time. Even if some new competitors springs up, buying Instagram, Path, Foursquare, etc now will give us a year or more to integrate their dynamics before anyone can get close to their scale again. Within that time, if we incorporate the social mechanics they were using, those new products won’t get much traction since we’ll already have their mechanics deployed at scale”.

The Verge reports dryly that “Forty-five minutes later, Zuckerberg sent a carefully worded clarification to his earlier, looser remarks. “I didn’t mean to imply that we’d be buying them to prevent them from competing with us in any way,” he wrote.” Zuckerberg stated at the 2020 US House Judiciary antitrust hearings that the FTC had reviewed all of these documents at the time of the acquisition; we have no reason to think the OFT was not aware of the same documents.²⁸

3.2. The market value attached to the dynamic element

We can read in the OFT’s decision that Instagram’s purchase value was $300 million in cash, plus shares of Facebook stock.²⁹ This amounted to a purchase value of $1 billion,³⁰ a significant amount for a company with 13 employees and no revenues.³¹

The OFT decision does not make much of the high value of the acquisition: the fact is stated in the section of the decision that describes the Parties and their activities, but not in the sections containing the competitive assessment.

Various commentators at the time perceived the value to be high, suggesting that Facebook may have overpaid – a possible explanation may have been rival bids for Instagram.³² Under the CAT’s Meta/Giphy framework, the high acquisition value might have indicated “a valuable dynamic potential”. Under that framework, the high value could have prompted an examination of whether the acquirer was aiming to strengthen or augment its market power.³³

3.3. Contestability

The OFT considered contestability in its assessment. Looking at Instagram’s rapid growth, from 1.4 million users in January 2011 to over 15 times that amount in February 2012, the OFT said that this was indicative of “relatively low” barriers to expansion and that “the attractiveness of apps can be ‘faddish’”.³⁴ Barriers to entry are otherwise not addressed.

Zuckerberg seemed to take a different view of contestability from the OFT in internal Facebook e-mails: “there are network effects around social products and a finite number of different social mechanics to invent. Once someone wins at a specific mechanic, it’s difficult for others to supplant them without doing something different. It’s possible someone beats Instagram by building something that is better to the point that they get network migration, but this is hard as long as Instagram keeps running as a product”.³⁵ Zuckerberg’s words indicate that, in his view, this particular market was subject to ‘tipping’: once a network wins, supplanting it is difficult.

3.4. Monetisation

The OFT discussed monetisation at considerable length (at least, in the context of a decision that covers only ten pages in total). At the time, Instagram was not generating any revenues, from advertising or any other sources.³⁶ ‘Few’ of the third parties consulted believed that Instagram presented immediate monetisation opportunities. One third party thought the merger could improve monetisation opportunities, but only in an indirect way: by better engaging consumers with Facebook and thereby increasing its usage.³⁷

Photo apps were not seen as attractive to advertisers in themselves, but only when complemented with a social network.³⁸ Instagram users, third parties said, spent little time on the app and little data on users was captured.³⁹

Some more prescient third parties thought it normal that social apps do not have monetisation opportunities at the outset; these would come after the user base had sufficiently grown.⁴⁰ Instagram was clearly on a high growth trajectory but the OFT decision does not make much of Instagram’s monetisation potential beyond the short term.

In addition, as mentioned by Lear, Instagram exhibited distinct features that could have been identified at the time, but were not mentioned by the OFT. In particular, it generated “significant user engagement compared to other photo apps and to other social networks. In September 2012, on average, Instagram’s users spent over three times more time on the app than Photobucket’s users”. Lear concluded that this set Instagram apart from other photo apps, making Instagram potentially more appealing to advertisers.⁴¹

3.5. Cross-check: the costs of intervention

The final step in the CAT’s framework is looking at the costs of intervention, as a cross-check on the authority’s conclusions if it decides to intervene in the case. That did not come up in this case: the OFT opted for no intervention and did not refer the merger for a more detailed review. We can, however, briefly consider two types of cost from prohibiting the transaction.

First, stopping the merger could have prevented merger-specific benefits from flowing to consumers. For instance, Lear concluded that one benefit from the transaction may have been to reduce inefficient duplication of ads, which customers tend to see as a nuisance.⁴²

Second, a prohibition could have had broader negative effects on the market. For example, it may have reduced the prospects for innovative entrants to get acquired and “cash out”. Ex-ante, this may have reduced their incentives to develop new products and business models.⁴³

3.6. Conclusions: do regulators need crystal balls?

With the benefit of more than a decade of hindsight, and the evidence of the great commercial success of Instagram under Facebook ownership, we can see that the OFT made several incorrect judgements in its decision. The rapid recent success of TikTok at the expense of Instagram, inter alia, provides some support that demand for social media is ‘faddish’⁴⁴ – but not to the extent that the OFT seemed to think. And opportunities for monetisation of Instagram’s popularity, at least under Facebook ownership, were clearly very substantial.

However, we cannot expect competition authorities to be soothsayers. While some market participants predicted that Instagram would be very successful, others thought that Facebook had seriously overpaid for a firm that would never contribute much to its bottom line. It is unreasonable to think that civil servants (or anyone else) will be able to make consistently better commercial judgements than people who are actually running merging firms or their competitors.

Moreover, even with the old guidelines, and in a context where most decisions were very short, we can see that the OFT examined a lot of what the CAT would expect an authority to look at in considering dynamic competition. We can identify at least some discussion of motives and thinking (with more likely to be hidden behind the redactions) alongside fairly substantial discussion of contestability and monetisation. There is admittedly little discussion of the implications of Instagram’s high market value, but it seems unlikely that any merger could be blocked primarily on the basis that the sales price is too high.

4. Conclusion

Why do we develop frameworks? There can be various reasons, such as enabling decision-makers to be held to account and providing greater confidence about likely decisions among market participants. But, from an analytical perspective, the key reason is because the framework helps to identify systematically factors that are good proxies for what we ultimately care about – in the CMA’s case, whether a transaction promotes competition, to the benefit of consumers.

On this criterion, the CAT’s framework is in our view insufficient. While the factors it raises will often be relevant to an assessment of the likely impacts of a merger involving dynamic competition, the link between these factors and consumer outcomes is currently insufficiently well-evidenced to place significant weight on them. Moreover, the example of the OFT’s assessment of Facebook/Instagram suggests that even that poster child for alleged detrimental impacts on dynamic competition may well not have been prohibited under the CAT’s framework.

So, we need an alternative approach. A full discussion of what alternative approaches are possible is beyond the scope of this note. But we would make three initial comments:

Third, we need more work to understand empirically how information available at the time of a merger correlates with its impacts on competition. The CMA and EC have made valuable strides in this direction by commissioning more evaluations, but there are still significant gaps in ourunderstanding of, for instance, how significant the potential gains are from merging complementary tech firms, and when markets are likely to reach ‘tipping points’ where one firm becomes dominant.

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This paper was originally published on the Social Science Research Network here. The views expressed are those of the authors only and do not necessarily represent the views of Compass Lexecon, its management, its subsidiaries, its affiliates, its employees, or clients.

Gabriele Corbetta & Joe Perkins, “Frameworks for Dynamic Competition”, Network Law Review, 6 July 2023.

[1] Pacific Biosciences (2020), press release, “Illumina and Pacific Biosciences Announce Termination of Merger Agreement”, 2 January.

[2] CMA (2023), Microsoft/Activision, final report, para 72.

[3] CMA (2023), Microsoft/Activision, final report, paras 11.128-11.132.

[4] CMA (2023), Microsoft/Activision, “Overview of our conclusions”.

[5] CMA (2021), Merger Assessment Guidelines.

[6] Office for Fair Trading (OFT) and Competition Commission (CC) (2010), Merger Assessment Guidelines.

[7] They refer to ‘dynamic competition’ only once, as a factor to consider when interpreting market shares (para 5.3.2).

[8] OFT and CC (2010), Merger Assessment Guidelines, paras 5.4.16-5.4.18.

[9] CMA (2021), Merger Assessment Guidelines, paras 5.17-5.24.

[10] CMA (2021), Merger Assessment Guidelines, para 5.21.

[11] CMA (2021), Merger Assessment Guidelines, para 5.23.

[12] CMA (2021), Meta/Giphy, final report.

[13] The exception was that the CAT agreed with Meta that the CMA failed to consult properly and wrongly excised part of its decision. The CMA published its final report at remittal in October 2022.

[14] CAT (2022), Meta/Giphy judgment, para 100.

[15] CAT (2022), Meta/Giphy judgment, para 30.

[16] CAT (2022), Meta/Giphy judgment, paras 31-33 and 93.

[17] CAT (2022), Meta/Giphy judgment, paras 34-37.

[18] CAT (2022), Meta/Giphy judgment, para 107.

[19] CAT (2022), Meta/Giphy judgment, para 109.

[20] CAT (2022), Meta/Giphy judgment, para 105.

[21] CAT (2022), Meta/Giphy judgment, para 110.

[22] FTC (2021), “FTC Closes Its Investigation Into Facebook’s Proposed Acquisition of Instagram Photo Sharing Program”.

[23] OFT (2012), Facebook/Instagram, decision. The European Commission did not review the merger, as it did not meet the “EU dimension” thresholds for EC review.

[24] See Lear (2019), “Ex-post Assessment of Merger Control Decisions in Digital Markets”, pp. 51-71; Tim Wu (2018), “The case for breaking up Facebook and Instagram”.

[25] OFT (2012), Facebook/Instagram, decision, paras 25 and 26.

[26] Meta (then Facebook) (2012), “Facebook to acquire Instagram”.

[27] See reporting from Casey Newton and Nilay Patel (2020), “‘Instagram can hurt us’: Mark Zuckerberg emails outline plan to neutralize competitors”, The Verge, 29 July, and US House Judiciary.

[28] See reporting from Casey Newton and Nilay Patel (2020), “‘Instagram can hurt us’: Mark Zuckerberg emails outline plan to neutralize competitors”, The Verge, 29 July, and US House Judiciary.

[29] OFT (2012), Facebook/Instagram, decision, para 2.

[30] Kara Swisher (2012), “Clicking on a Fortune: Facebook to Acquire Photo-Sharing Start-Up Instagram for $1 Billion”, All Things D, 9 April.

[31] OFT (2012), Facebook/Instagram, decision, para 3.

[32] See for example BBC (2012), “Facebook buys Instagram photo sharing network for $1bn”, 10 April, quoting commentator Paul Kedrosky.

[33] CAT (2022), Meta/Giphy judgment, para 109.

[34] OFT (2012), Facebook/Instagram, decision, para 36.

[35] US House Judiciary Subcommittee on Antitrust, Commercial, and Administrative Law (2020).

[36] OFT (2012), Facebook/Instagram, decision, paras 2 and 24.

[37] OFT (2012), Facebook/Instagram, decision, para 20.

[38] OFT (2012), Facebook/Instagram, decision, paras 19-21.

[39] OFT (2012), Facebook/Instagram, decision, para 19.

[40] OFT (2012), Facebook/Instagram, decision, para 19.