Some may refer to this as the Roundup Formerly Known as the FTC Roundup. If you recorded yourself while reading out loud, and your name is Dove, that is what it sounds like when doves sigh.
Maybe He Never Said ‘Never’
The U.S. Justice Department’s (DOJ) Antitrust Division recently agreed to settle its challenge of Swedish conglomerate Assa Abloy’s proposed acquisition of the hardware and home-improvement division of Spectrum Brands.Assa Abloy will divest certain assets as a condition of settling the case and consummating the merger.
That’s of interest to those following residential-door-hardware markets—about which I know very little, although I have purchased such hardware on occasion—but it’s also of interest because Assistant Attorney General Jonathan Kanter, who heads the division, has (like Federal Trade Commission Chair Lina Khan) repeatedly decried settling merger cases. He has said he is “concerned that merger remedies short of blocking a transaction too often miss the mark” and that he believes “[o]ur goal is simple: we must be prepared to try cases to a verdict when we think a violation has taken place.”
More colorfully: “I’m here to declare that we’re not part of the chickenshit club.” À la Groucho Marx, he doesn’t want to belong to any club that will accept him as a member.
There has, at least sometimes, been a caveat: “[o]ur duty is to litigate, not settle, unless a remedy fully prevents or restrains the violation.” So maybe it was a line in the sand, but not cast in stone. Or maybe it wasn’t exactly a line.
And while I never really followed the “losing is winning” rhetoric (never uttered by a high school coach in any sport anywhere), I do understand that a tie is often preferable to a loss, and that settling can even be a win-win. Perhaps even when you (say, the DOJ, for example) basically agree to the settlement proposed by the other side.
Of Orphans and Potential Competition
All this reminds me of the “open offer” in the Illumina/Grail matter over at the FTC, whichwaspuzzledoverhere, there, and nearly everywhere. More recently, the FTC has filed suit to block Amgen’s acquisition of Horizon Therapeutics, which the commission announced with a press release bearing the headline: “FTC Sues to Block Biopharmaceutical Giant Amgen from Acquisition that Would Entrench Monopoly Drugs Used to Treat Two Serious Illnesses.”
Or, as others might call it, “if you think the complaint in Illumina/Grail was speculative, take a look at this.”
At stake are Horizon’s drugs Tepezza (used to treat thyroid eye disease) and Krystexxa (used to treat chronic refractory gout). Both are designated as “orphan drugs,” which means they treat rare conditions and enjoy various tax and regulatory benefits as a result. And as the FTC correctly notes: “[n]either of these treatments have any competition in the pharmaceutical marketplace.” That is, the patient population for each drug is fairly small, but for those who have thyroid eye disease or chronic refractory gout, there are no substitutes. Patients might well benefit from greater competition.
Given that these are currently monopoly products, the FTC cannot worry about future harm to an otherwise competitive market. Amgen has no drugs in head-to-head competition with either Tepezza or Krystexxa, and neither does any other biologics or pharmaceutical firm. And there’s no allegation of unearned market power—Tepezza and Krystexxa are approved products, and there’s no allegation that their approval or marketing has been anything other than lawful. Market power is not supposed to change with the acquisition. Certainly not on day one, or on any day soon.
Rather, there’s a concern that Amgen will (allegedly) be likely to engage in conduct that harms competition that’s expected to develop, at some time or other. The complaint alleges that Amgen will be likely to leverage its other products in such a way as to “raise… [their] rivals’ barriers to entry or dissuade them from competing as aggressively if and when they gain FDA approval.” The most likely route to this, according to the FTC complaint, would be to exploit bargaining leverage with pharmacy benefit managers (PBMs) to secure favorable placement in the formularies that PBMs design for various health plans.
Perhaps. The evidence suggests that most vertical mergers are procompetitive, but a vertically integrated firm can have an incentive to foreclose rivals, which may or may not lead to a net loss to competition and consumers, depending on the facts and circumstances.
But then there’s the “if and when” part. We don’t really know what the relevant facts and circumstances are—not from the public documents, at any rate. We are told that the Tepezza and Krystexxa monopolies will “not last forever,” but we’re not told who will enter when. There’s also no clear suggestion as to how a combined Amgen/Horizon could foreclose the development of a would-be competitor. Neither firm controls a critical input, would-be rivals’ clinical trials, or the Food and Drug Administration’s (FDA) approval process.
As for potential future competition, the large PBMs are not unsophisticated bargainers or lacking in leverage of their own. Hence, the FTC’s much-ballyhooed PBM investigations. On the one hand, there’s typically some forward-looking aspect to merger analysis: what would competition look like, but for the merger? On the other hand, as Niels Bohr and Yogi Berra have variously observed: “It is hard to make predictions, especially about the future.” Some predictions are harder than others, and some are just shots in the dark. As former FTC Commissioner Joshua Wright observed in his dissent in Nielsen Holdings, grounded…
…predictions about the evolution of a market [are] based upon a fact-intensive analysis …. when assessing whether future entry would counteract a proposed transaction’s competitive concerns, the agencies evaluate a number of facts—such as the history of entry in the relevant market and the costs a future entrant would need to incur to be able to compete effectively—to determine whether entry is “timely, likely, and sufficient.”
That was hard to do in Nielsen. It was hard to do (and the commission failed to do it) in the Meta/Within case. And it’s hard to do when we’re dealing with complex molecule products, when entry must clear significant regulatory hurdles, and when we have no clinical data establishing (or even, based on which, we might estimate) the approval and entry of any particular competing product in some specified timeframe.
Drugs in late-stage development may be far enough along in the approval process that one can reasonably predict approval and entry in a year or two. Not with any certainty, of course. Things happen. But predictions can be made with some confidence, at least when it comes to simple molecule pharmaceutical drugs (as opposed to biologics) and perhaps with drugs already approved by foreign regulators based on substantial clinical trials. But this is not that. There are potential rivals in the developmental pathway, but there seem to be zero reported results. None. That is, none reported by the FDA, where it reports such things and none mentioned in the FTC’s complaint. So we seem to lack the sort of data that might facilitate a reasonable prediction about the particulars of future entry, should it occur.
Nobody is poised to enter the market and there is no clear near-term entrant, but for one. As the complaint explains:
Horizon is currently developing a subcutaneously administered version of Tepezza, which it estimates will receive FDA approval. … The planned introduction of this subcutaneous Tepezza formulation promises to further lower Amgen’s logistical and economic barriers to establishing multi-product contracts between its pharmacy benefit products, like Enbrel, and Tepezza.
Perhaps, but surely that’s a double-edged sword for the FTC’s complaint, at best. Amgen’s stock of blockbusters—the alleged source of their leverage, should push come to shove—would not be affected. And there’s no reason to think (and no allegation) that Amgen would not continue the development of a new form of delivery for Tepezza.
The complaint maintains that “[t]here are no countervailing factors sufficient to offset the likelihood of competitive harm from the Proposed Acquisition.” But we have no idea how to estimate the risk that’s supposed to be offset. Certainly, the complaint doesn’t tell us and the complaint itself hinted at potentially offsetting factors in the very same paragraph: research, development, and marketing efficiencies, as well as the possibility of lower regulatory costs, courtesy of Amgen’s pockets, sophistication, and experience. If the subcutaneous Tepezza product could be brought to market sooner, and/or marketed more effectively, consumers wouldn’t be harmed. They would benefit.
It seems we really have no idea what future competition might or might not look like two or three years down the road, or four or five. Indeed, it’s not clear when or whether a rival to either drug will be approved for marketing in the United States, whether Amgen (or Horizon) attempts to erect barriers to entry or not. Moreover, there’s no obvious route by which Amgen can impede the development of rival products. Is the FTC estimating a risk of harm to competition or guessing?
Statisticians (and economists) distinguish between Type 1 and Type 2 errors, false positives and false negatives respectively. There’s ongoing debate over the question whether the current state of the law pays too much attention to the risk of false positives, and not enough to the risk of false negatives. Be that as it may, there are very real costs when procompetitive mergers are wrongly identified as anticompetitive and blocked accordingly.
The perfect no-false-negatives strategy of “block all mergers” (or all where there’s a non-zero risk of competitive harm) cannot be adopted for free. That ought to be plain in the case of drug development (and, say, the type of cancer tests at issue in Illumina/Grail). The population of consumers comprises patients and payers; delay the benefits of efficient mergers, and patients are harmed. A complaint is just that, but does the FTC’s complaint show that harm is likely on any particular time frame, or simply possible at some point?
Looking back at the past 25 years, one might view the FTC’s attention to mergers in the health-care sector as a model of research-based enforcement, with important contributions from the Bureau of Economics and the policy shop, in addition to those of enforcers in the Bureau of Competition. That was a nice view; I miss it.
In recent years, a growing chorus of voices has argued that existing merger rules fail to apprehend competitively significant mergers, either because they fall below existing merger-filing thresholds or because they affect innovation in ways that are purportedly ignored.
These fears are particularly acute in the pharmaceutical and tech industries, where several high-profile academic articles and reports claim to have identified important gaps in current merger-enforcement rules, particularly with respect to acquisitions involving nascent and potential competitors (here, here, and here, among many others).
Such fears have led activists, lawmakers, and enforcers to call for tougher rules, including the introduction of more stringent merger-filing thresholds and other substantive changes, such as the inversion of the burden of proof when authorities review mergers and acquisitions involving digital platforms.
However, as we discuss in a recent working paper—forthcoming in the Missouri Law Review and available on SSRN—these proposals tend to overlook the important tradeoffs that would ensue from attempts to decrease the number of false positives under existing merger rules and thresholds.
The paper draws from two key strands of economic literature that are routinely overlooked (or summarily dismissed) by critics of the status quo.
For a start, antitrust enforcement is not costless. In the case of merger enforcement, not only is it expensive for agencies to detect anticompetitive deals but, more importantly, overbearing rules may deter beneficial merger activity that creates value for consumers.
Second, critics tend to overlook the possibility that incumbents’ superior managerial or other capabilities (i.e., what made them successful in the first place) makes them the ideal acquisition partners for entrepreneurs and startup investors looking to sell.
The result is a body of economic literature that focuses almost entirely on hypothetical social costs, while ignoring the redeeming benefits of corporate acquisitions, as well as the social cost of enforcement.
Kill Zones
One of the most significant allegations leveled against large tech firms is that their very presence in a market may hinder investments, entry, and innovation, creating what some have called a “kill zone.” The strongest expression in the economic literature of this idea of a kill zone stems from a working paper by Sai Krishna Kamepalli, Raghuram Rajan, and Luigi Zingales.
The paper makes two important claims, one theoretical and one empirical. From a theoretical standpoint, the authors argue that the prospect of an acquisition by a dominant platform deters consumers from joining rival platforms, and that this, in turn, hampers the growth of these rivals. The authors then test a similar hypothesis empirically. They find that acquisitions by a dominant platform—such as Google or Facebook—decrease investment levels and venture capital deals in markets that are “similar” to that of the target firm.
But both findings are problematic. For a start, Zingales and his co-authors’ theoretical model is premised on questionable assumptions about the way in which competition develops in the digital space. The first is that early adopters of new platforms—called “techies” in the authors’ parlance—face high switching costs because of their desire to learn these platforms in detail. As an initial matter, it would appear facially contradictory that “techies” both are the group with the highest switching costs and that they switch the most. The authors further assume that “techies” would incur lower adoption costs if they remained on the incumbent platform and waited for the rival platform to be acquired.
Unfortunately, while these key behavioral assumptions drive the results of the theoretical model, the paper presents no evidence to support their presence in real-world settings. In that sense, the authors commit the same error as previous theoretical work concerning externalities, which have tended to overestimate their frequency.
Second, the empirical analysis put forward in the paper is unreliable for policymaking purposes. The authors notably find that:
[N]ormalized VC investments in start-ups in the same space as the company acquired by Google and Facebook drop by over 40% and the number of deals falls by over 20% in the three years following an acquisition.
However, the results of this study are derived from the analysis of only nine transactions. The study also fails to clearly show that firms in the treatment and controls are qualitatively similar. In a nutshell, the study compares industry acquisitions exceeding $500 million to Facebook and Google’s acquisitions that exceed that amount. This does not tell us whether the mergers in both groups involved target companies with similar valuations or similar levels of maturity. This does not necessarily invalidate the results, but it does suggest that policymakers should be circumspect in interpreting those results.
Finally, the paper fails to demonstrate evidence that existing antitrust regimes fail to achieve an optimal error-cost balance. The central problem is that the paper has indeterminate welfare implications. For instance, as the authors note, the declines in investment in spaces adjacent to the incumbent platforms occurred during a time of rapidly rising venture capital investment, both in terms of the number of deals and dollars invested. It is entirely plausible that venture capital merely shifted to other sectors.
Put differently, on its own terms, the evidence merely suggests that acquisitions by Google and Facebook affected the direction of innovation, not its overall rate. And there is little to suggest that this shift was suboptimal, from a welfare standpoint.
In short, as the authors themselves conclude: “[i]t would be premature to draw any policy conclusion on antitrust enforcement based solely on our model and our limited evidence.”
Mergers and Potential Competition
Scholars have also posited more direct effects from acquisitions of startups or nascent companies by incumbent technology market firms.
Acquisitions of potential or nascent competitors by a dominant firm raise inherent anticompetitive concerns. By eliminating the procompetitive impact of the entry, an acquisition can allow the dominant firm to continue to exercise monopoly power and earn monopoly profits. The dominant firm also can neutralize the potential innovation competition that the entrant would provide.
However, these antitrust theories of harm suffer from several important flaws. They rest upon several restrictive assumptions that are not certain to occur in real-world settings. Most are premised on the notion that, in a given market, monopoly profits generally exceed joint duopoly profits. This allegedly makes it profitable, and mutually advantageous, for an incumbent to protect its monopoly position by preemptively acquiring potential rivals.
Accordingly, under these theories, anticompetitive mergers are only possible when the acquired rival could effectively challenge the incumbent. But these are, of course, only potential challengers; there is no guarantee that any one of them could or would mount a viable competitive threat.
Less obviously, it must be the case that the rival can hope to share only duopoly profits, as opposed to completely overthrowing the incumbent or surpassing them with a significantly larger share of the market. Where competition is “for the market” itself, monopoly maintenance would fail to explain a rival’s decision to sell. Because there would be no asymmetry between the expected profits of the incumbent and the rival, monopoly maintenance alone would not give rise to mutually advantageous deals.
Second, potential competition does not always increase consumer welfare. Indeed, while the presence of potential competitors might increase price competition, it can also have supply-side effects that cut in the opposite direction.
For example, as Nobel laureate Joseph Stiglitz observed, a monopolist threatened by potential competition may invest in socially wasteful R&D efforts or entry-deterrence mechanisms, and it may operate at below-optimal scale in anticipation of future competitive entry.
There are also pragmatic objections. Analyzing a merger’s effect on potential competition would compel antitrust authorities and courts to make increasingly speculative assessments concerning the counterfactual setting of proposed acquisitions.
In simple terms, it is far easier to determine whether a merger between McDonald’s and Burger King would lead to increased hamburger prices in the short run than it is to determine whether a gaming platform like Steam or the Epic Games Store might someday compete with video-streaming or music-subscription platforms like Netflix or Spotify. It is not that the above models are necessarily wrong, but rather that applying them to practical cases would require antitrust enforcers to estimate mostly unknowable factors.
Finally, the real test for regulators is not just whether they can identify possibly anticompetitive mergers, but whether they can do so in a cost-effective manner. Whether it is desirable to implement a given legal test is not simply a function of its accuracy, the cost to administer it, and the respective costs of false positives and false negatives. It also critically depends on how prevalent the conduct is that adjudicators would be seeking to foreclose.
Consider two hypothetical settings. Imagine there are 10,000 tech mergers in a given year, of which either 1,000 or 2,500 are anticompetitive (the remainder are procompetitive or competitively neutral). Suppose that authorities can either attempt to identify anticompetitive mergers with 75% accuracy, or perform no test at all—i.e., letting all mergers go through unchallenged.
If there are 1,000 anticompetitive mergers, applying the test would result in 7,500 correct decisions and 2,500 incorrect ones (2,250 false positives and 250 false negatives). Doing nothing would lead to 9,000 correct decisions and 1,000 false negatives. If the number of anticompetitive deals were 2,500, applying the test would lead to the same number of incorrect decisions as not applying it (1,875 false positives and 625 false negatives, versus 2,500 false negatives). The advantage would tilt toward applying the test if anticompetitive mergers were even more widespread.
This hypothetical example holds a simple lesson for policymakers: the rarer the conduct that they are attempting to identify, the more accurate their identification method must be, and the more costly false negatives must be relative to false positives.
As discussed below, current empirical evidence does not suggest that anticompetitive mergers of this sort are particularly widespread, nor does it offer accurate heuristics to detect the ones that are. Finally, there is little sense that the cost of false negatives significantly outweighs that of false positives. In short, there is currently little evidence to suggest that tougher enforcement would benefit consumers.
Killer Acquisitions
Killer acquisitions are, effectively, a subset of the “potential competitor” mergers discussed in the previous section. As defined by Colleen Cunningham, Florian Ederer, and Song Ma, they are those deals where “an incumbent firm may acquire an innovative target and terminate the development of the target’s innovations to preempt future competition.”
Cunningham, Ederer, and Ma’s highly influential paper on killer acquisitions has been responsible for much of the recent renewed interest in the effect that mergers exert on innovation. The authors studied thousands of pharmaceutical mergers and concluded that between 5.3% and 7.4% of them were killer acquisitions. As they write:
[W]e empirically compare development probabilities of overlapping acquisitions, which are, in our theory, motivated by a mix of killer and development intentions, and non-overlapping acquisitions, which are motivated only by development intentions. We find an increase in acquisition probability and a decrease in post-acquisition development for overlapping acquisitions and interpret that as evidence for killer acquisitions. […]
[W]e find that projects acquired by an incumbent with an overlapping drug are 23.4% less likely to have continued development activity compared to drugs acquired by non-overlapping incumbents.
From a policy standpoint, the question is what weight antitrust authorities, courts, and legislators should give to these findings. Stated differently, does the paper provide sufficient evidence to warrant reform of existing merger-filing thresholds and review standards? There are several factors counseling that policymakers should proceed with caution.
To start, the study’s industry-specific methodology means that it may not be a useful guide to understand acquisitions in other industries, like the tech sector, for example.
Second, even if one assumes that the findings of Cunningham, et al., are correct and apply with equal force in the tech sector (as some official reports have), it remains unclear whether the 5.3–7.4% of mergers they describe warrant a departure from the status quo.
Antitrust enforcers operate under uncertainty. The critical policy question is thus whether this subset of anticompetitive deals can be identified ex-ante. If not, is there a heuristic that would enable enforcers to identify more of these anticompetitive deals without producing excessive false positives?
The authors focus on the effect that overlapping R&D pipelines have on project discontinuations. In the case of non-overlapping mergers, acquired projects continue 17.5% of the time, while this number is 13.4% when there are overlapping pipelines. The authors argue that this gap is evidence of killer acquisitions. But it misses the bigger picture: under the authors’ own numbers and definition of a “killer acquisition,” a vast majority of overlapping acquisitions are perfectly benign; prohibiting them would thus have important social costs.
Third, there are several problems with describing this kind of behavior as harmful. Indeed, Cunningham, et al., acknowledge that this kind of behavior could increase innovation by boosting the returns to innovation.
And even if one ignores incentives to innovate, product discontinuations can improve consumer welfare. This question ultimately boils down to identifying the counterfactual to a merger. As John Yun writes:
For instance, an acquisition that results in a discontinued product is not per se evidence of either consumer harm or benefit. The answer involves comparing the counterfactual world without the acquisition with the world with the acquisition. The comparison includes potential efficiencies that were gained from the acquisition, including integration of intellectual property, the reduction of transaction costs, economies of scope, and better allocation of skilled labor.
One of the reasons R&D project discontinuation may be beneficial is simply cost savings. R&D is expensive. Pharmaceutical firms spend up to 27.8% of their annual revenue on R&D. Developing a new drug has an estimated median cost of $985.3 million. Cost-cutting—notably as it concerns R&D—is thus a critical part of pharmaceutical (as well as tech) companies’ businesses. As a report by McKinsey concludes:
The recent boom in M&A in the pharma industry is partly the result of attempts to address short-term productivity challenges. An acquiring or merging company typically designs organization-wide integration programs to capture synergies, especially in costs. Such programs usually take up to three years to complete and deliver results.
Maximizing the efficiency of production labor and equipment is one important way top-quartile drugmakers break out of the pack. Their rates of operational-equipment effectiveness are more than twice those of bottom-quartile companies (Exhibit 1), and when we looked closely we found that processes account for two-thirds of the difference.
In short, pharmaceutical companies do not just compete along innovation-related parameters, though these are obviously important, but also on more traditional grounds such as cost-rationalization. Accordingly, as the above reports suggest, pharmaceutical mergers are often about applying an incumbent’s superior managerial efficiency to the acquired firm’s assets through operation of the market for corporate control.
This cost-cutting (and superior project selection) ultimately enables companies to offer lower prices, thereby benefiting consumers and increasing their incentives to invest in R&D in the first place by making successfully developed drugs more profitable.
In that sense, Henry Manne’s seminal work relating to mergers and the market for corporate control sheds at least as much light on pharmaceutical (and tech) mergers as the killer acquisitions literature. And yet, it is hardly ever mentioned in modern economic literature on this topic.
While Colleen Cunningham and her co-authors do not entirely ignore these considerations, as we discuss in our paper, their arguments for dismissing them are far from watertight.
A natural extension of the killer acquisitions work is to question whether mergers of this sort also take place in the tech industry. Interest in this question is notably driven by the central role that digital markets currently occupy in competition-policy discussion, but also by the significant number of startup acquisitions that take place in the tech industry. However, existing studies provide scant evidence that killer acquisitions are a common occurrence in these markets.
This is not surprising. Unlike in the pharmaceutical industry—where drugs need to go through a lengthy and visible regulatory pipeline before they can be sold—incumbents in digital industries will likely struggle to identify their closest rivals and prevent firms from rapidly pivoting to seize new commercial opportunities. As a result, the basic conditions for killer acquisitions to take place (i.e., firms knowing they are in a position to share monopoly profits) are less likely to be present; it also would be harder to design research methods to detect these mergers.
The empirical literature on killer acquisitions in the tech sector is still in its infancy. But, as things stand, no study directly examines whether killer acquisitions actually take place in digital industries (i.e., whether post-merger project discontinuations are more common in overlapping than non-overlapping tech mergers). This is notably the case for studies by Axel Gautier & Joe Lamesch, and Elena Argentesi and her co-authors. Instead, these studies merely show that product discontinuations are common after an acquisition by a big tech company.
To summarize, while studies of this sort might suggest that the clearance of certain mergers might not have been optimal, it is hardly a sufficient basis on which to argue that enforcement should be tightened.
The reason for this is simple. The fact that some anticompetitive mergers may have escaped scrutiny and/or condemnation is never a sufficient basis to tighten rules. For that, it is also necessary to factor in the administrative costs of increased enforcement, as well as potential false convictions to which it might give rise. As things stand, economic research on killer acquisitions in the tech sector does not warrant tougher antitrust enforcement, though it does show the need for further empirical research on the topic.
Conclusion
Many proposed merger-enforcement reforms risk throwing the baby out with the bathwater. Mergers are largely beneficial to society (here, here and here); anticompetitive ones are rare; and there is little way, at the margin, to tell good from bad. To put it mildly, there is a precious baby that needs to be preserved and relatively little bathwater to throw out.
Take the fulcrum of policy debates that is the pharmaceutical industry. It is not hard to point to pharmaceutical mergers (or long-term agreements) that have revolutionized patient outcomes. Most recently, Pfizer and BioNTech’s efforts to successfully market an mRNA vaccine against COVID-19 offers a case in point.
The deal struck by both firms could naïvely be construed as bearing hallmarks of a killer acquisition or an anticompetitive agreement (long-term agreements can easily fall into either of these categories). Pfizer was a powerful incumbent in the vaccine industry; BioNTech threatened to disrupt the industry with new technology; and the deal likely caused Pfizer to forgo some independent R&D efforts. And yet, it also led to the first approved COVID-19 vaccine and groundbreaking advances in vaccine technology.
Of course, the counterfactual is unclear, and the market might be more competitive absent the deal, just as there might be only one approved mRNA vaccine today instead of two—we simply do not know. More importantly, this counterfactual was even less knowable at the time of the deal. And much the same could be said about countless other pharmaceutical mergers.
The key policy question is how authorities should handle this uncertainty. Critics of the status quo argue that current rules and thresholds leave certain anticompetitive deals unchallenged. But these calls for tougher enforcement fail to satisfy the requirements of the error-cost framework. Critics have so far failed to show that, on balance, mergers harm social welfare—even overlapping ones or mergers between potential competitors—just as they are yet to suggest alternative institutional arrangements that would improve social welfare.
In other words, they mistakenly analyze purported false negatives of merger-enforcement regimes in isolation. In doing so, they ignore how measures that aim to reduce such judicial errors may lead to other errors, as well as higher enforcement costs. In short, they paint a world where policy decisions involve facile tradeoffs, and this undermines their policy recommendations.
Given these significant limitations, this body of academic research should be met with an appropriate degree of caution. For all the criticism it has faced, the current merger-review system is mostly a resounding success. It is administrable, predictable, and timely. Yet it also eliminates a vast majority of judicial errors: even its critics concede that false negatives make up only a tiny fraction of decisions. Policymakers must decide whether the benefits from catching the very few arguably anticompetitive mergers that currently escape prosecution outweigh the significant costs that are required to achieve this goal. There is currently little evidence to suggest that this is, indeed, the case.
Recently-published emails from 2012 between Mark Zuckerberg and Facebook’s then-Chief Financial Officer David Ebersman, in which Zuckerberg lays out his rationale for buying Instagram, have prompted many to speculate that the deal may not have been cleared had antitrust agencies had had access to Facebook’s internal documents at the time.
The issue is Zuckerberg’s description of Instagram as a nascent competitor and potential threat to Facebook:
These businesses are nascent but the networks established, the brands are already meaningful, and if they grow to a large scale they could be very disruptive to us. Given that we think our own valuation is fairly aggressive and that we’re vulnerable in mobile, I’m curious if we should consider going after one or two of them.
Ebersman objects that a new rival would just enter the market if Facebook bought Instagram. In response, Zuckerberg wrote:
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.
These email exchanges may not paint a particularly positive picture of Zuckerberg’s intent in doing the merger, and it is possible that at the time they may have caused antitrust agencies to scrutinise the merger more carefully. But they do not tell us that the acquisition was ultimately harmful to consumers, or about the counterfactual of the merger being blocked. While we know that Instagram became enormously popular in the years following the merger, it is not clear that it would have been just as successful without the deal, or that Facebook and its other products would be less popular today.
Moreover, it fails to account for the fact that Facebook had the resources to quickly scale Instagram up to a level that provided immediate benefits to an enormous number of users, instead of waiting for the app to potentially grow to such scale organically.
The rationale
Writing for Pro Market, Randy Picker argued that these emails hint that the acquisition was essentially about taking out a nascent competitor:
Buying Instagram really was about controlling the window in which the Instagram social mechanic invention posed a risk to Facebook … Facebook well understood the competitive risk posed by Instagram and how purchasing it would control that risk.
This is a plausible interpretation of the internal emails, although there are others. For instance, Zuckerberg also seems to say that the purpose is to use Instagram to improve Facebook to make it good enough to fend off other entrants:
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.
If this was the rationale, rather than simply trying to kill a nascent competitor, it would be pro-competitive. It is good for consumers if a product makes itself better to beat its rivals by acquiring undervalued assets to deploy them at greater scale and with superior managerial efficiency, even if the acquirer hopes that in doing so it will prevent rivals from ever gaining significant market share.
Further, despite popular characterization, on its face the acquisition was not about trying to destroy a consumer option, but only to ensure that Facebook was competitively viable in providing that option. Another reasonable interpretation of the emails is that Facebook was wrestling with the age-old make-or-buy dilemma faced by every firm at some point or another.
Was the merger anticompetitive?
But let us assume that eliminating competition from Instagram was indeed the merger’s sole rationale. Would that necessarily make it anticompetitive?
Chief among the objections is that both Facebook and Instagram are networked goods. Their value to each user depends, to a significant extent, on the number (and quality) of other people using the same platform. Many scholars have argued that this can create self-reinforcing dynamics where the strong grow stronger – though such an outcome is certainly not a given, since other factors about the service matter too, and networks can suffer from diseconomies of scale as well, where new users reduce the quality of the network.
This network effects point is central to the reasoning of those who oppose the merger: Facebook purportedly acquired Instagram because Instagram’s network had grown large enough to be a threat. With Instagram out of the picture, Facebook could thus take on the remaining smaller rivals with the advantage of its own much larger installed base of users.
However, this network tipping argument could cut both ways. It is plausible that the proper counterfactual was not duopoly competition between Facebook and Instagram, but either Facebook or Instagram offering both firms’ features (only later). In other words, a possible framing of the merger is that it merely accelerated the cross-pollination of social mechanics between Facebook and Instagram. Something that would likely prove beneficial to consumers.
This finds some support in Mark Zuckerberg’s reply to David Ebersman:
Buying them would give us the people and time to integrate their innovations into our core products.
The exchange between Zuckerberg and Ebersman also suggests another pro-competitive justification: bringing Instagram’s “social mechanics” to Facebook’s much larger network of users. We can only speculate about what ‘social mechanics’ Zuckerberg actually had in mind, but at the time Facebook’s photo sharing functionality was largely based around albums of unedited photos, whereas Instagram’s core product was a stream of filtered, cropped single images.
Zuckerberg’s plan to gradually bring these features to Facebook’s users – as opposed to them having to familiarize themselves with an entirely different platform – would likely cut in favor of the deal being cleared by enforcers.
Another possibility is that it was Instagram’s network of creators – the people who had begun to use Instagram as a new medium, distinct from the generic photo albums Facebook had, and who would eventually grow to be known as ‘influencers’ – who were the valuable thing. Bringing them onto the Facebook platform would undoubtedly increase its value to regular users. For example, Kim Kardashian, one of Instagram’s most popular users, joined the service in February 2012, two months before the deal went through, and she was not the first such person to adopt Instagram in this way. We can see the importance of a service’s most creative users today, as Facebook is actually trying to pay TikTok creators to move to its TikTok clone Reels.
But if this was indeed the rationale, not only is this a sign of a company in the midst of fierce competition – rather than one on the cusp of acquiring a monopoly position – but, more fundamentally, it suggests that Facebook was always going to come out on top. Or at least it thought so.
The benefit of hindsight
Today’s commentators have the benefit of hindsight. This inherently biases contemporary takes on the Facebook/Instagram merger. For instance, it seems almost self-evident with hindsight that Facebook would succeed and that entry in the social media space would only occur at the fringes of existing platforms (the combined Facebook/Instagram platform) – think of the emergence of TikTok. However, at the time of the merger, such an outcome was anything but a foregone conclusion.
For instance, critics argue that Instagram no longer competes with Facebook because of the merger. However, it is equally plausible that Instagram only became so successful because of its combination with Facebook (notably thanks to the addition of Facebook’s advertising platform, and the rapid rollout of a stories feature in response to Snapchat’s rise). Indeed, Instagram grew from roughly 24 million at the time of the acquisition to over 1 Billion users in 2018. Likewise, it earned zero revenue at the time of the merger. This might explain why the acquisition was widely derided at the time.
This is critical from an antitrust perspective. Antitrust enforcers adjudicate merger proceedings in the face of extreme uncertainty. All possible outcomes, including the counterfactual setting, have certain probabilities of being true that enforcers and courts have to make educated guesses about, assigning probabilities to potential anticompetitive harms, merger efficiencies, and so on.
Authorities at the time of the merger could not ignore these uncertainties. What was the likelihood that a company with a fraction of Facebook’s users (24 million to Facebook’s 1 billion), and worth $1 billion, could grow to threaten Facebook’s market position? At the time, the answer seemed to be “very unlikely”. Moreover, how could authorities know that Google+ (Facebook’s strongest competitor at the time) would fail? These outcomes were not just hard to ascertain, they were simply unknowable.
Of course, this is preceisly what neo-Brandesian antitrust scholars object to today: among the many seemingly innocuous big tech acquisitions that are permitted each year, there is bound to be at least one acquired firm that might have been a future disruptor. True as this may be, identifying that one successful company among all the others is the antitrust equivalent of finding a needle in a haystack. Instagram simply did not fit that description at the time of the merger. Such a stance also ignores the very real benefits that may arise from such arrangements.
Closing remarks
While it is tempting to reassess the Facebook Instagram merger in light of new revelations, such an undertaking is not without pitfalls. Hindsight bias is perhaps the most obvious, but the difficulties run deeper.
If we think that the Facebook/Instagram merger has been and will continue to be good for consumers, it would be strange to think that we should nevertheless break them up because we discovered that Zuckerberg had intended to do things that would harm consumers. Conversely, if you think a breakup would be good for consumers today, would it change your mind if you discovered that Mark Zuckerberg had the intentions of an angel when he went ahead with the merger in 2012, or that he had angelic intent today?
Ultimately, merger review involves making predictions about the future. While it may be reasonable to take the intentions of the merging parties into consideration when making those predictions (although it’s not obvious that we should), these are not the only or best ways to determine what the future will hold. As Ebersman himself points out in the emails, history is filled with over-optimistic mergers that failed to deliver benefits to the merging parties. That this one succeeded beyond the wildest dreams of everyone involved – except maybe Mark Zuckerberg – does not tell us that competition agencies should have ruled on it differently.
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