Court found harm to potential competition a viable anti-merger legal theory, but required evidence FTC could not produce.

The FTC has decided to abandon its challenge to Meta Platforms Inc.’s acquisition of virtual reality (VR) exercise app developer, Within Unlimited, Inc., after U.S. District Judge Edward J. Davila from the Northern District of California rejected the Federal Trade Commission’s bid for a preliminary injunction blocking the deal. A setback for the Biden administration’s campaign to get tougher on anticompetitive mergers, the judge found that entry by acquiring Within was Meta’s only option because – despite its enormous resources – the company did not have the “available feasible means” and capabilities to develop its own VR exercise app business on its own.

The order denying the preliminary injunction, entered Jan. 31, 2023 in FTC v. Meta Platforms Inc., et al., No. 5:22-cv-04325-EJD (N.D.Ca., filed Jul. 27, 2022), allowed the transaction to close on Feb. 8. The Commission could have appealed the court’s ruling or commenced a proceeding before the agency’s Administrative Law Judge. On Feb. 6, the FTC said that it would not appeal the district court’s refusal to pause the merger and on Feb. 10 it stayed the administrative law proceedings.

Definition of the Relevant Market

The Commission had argued that the market consisted of VR apps that are “dedicated” to fitness and does not include apps for which fitness is “incidental,” such as exercise videos on YouTube. Products described as “VR dedicated fitness apps” occupy their own relevant market, the FTC alleged, because these products have distinct customers and pricing schemes and provide an offering that differs from other apps on VR platforms. The merging parties countered that the Commission’s market definition was impermissibly narrow because it excluded too many reasonably interchangeable products.

The court agreed with the FTC’s market definition, noting that despite the existence of “a broad fitness market that includes everything from VR apps to bicycles,” it would “in no way preclude[ ] the existence of a submarket constituting a relevant product market for antitrust purposes.” The way the user of a VR dedicated fitness app is “embodied” in a virtual environment, the court said, is “vastly different” from what can be offered on a stationary bike or mobile phone. Moreover, VR dedicated fitness apps are more likely than other VR apps to be subscription-based.

The court also observed that “neither general fitness firms nor general VR firms have the production facilities to readily produce a substitute VR dedicated fitness app product, even if VR dedicated fitness apps were to raise prices and make market entry more attractive.... That existing companies are not easily able to alter their facilities to produce VR dedicated fitness apps is additional evidence that such apps constitute a distinct product market.”

The Complaint Survives the Motion to Dismiss

Before ruling on the Commission’s preliminary injunction petition, the court disposed of the defendants’ motion to dismiss the complaint, which was premised on a theory of potential, or anticipated, competition explored in a pair of cases from the mid-1970s.^[i]

The merging parties argued that the FTC “stumble[d] right out of the block” because the complaint did not allege the prospect of “oligopolistic” or “interdependent or parallel behavior.” Such an allegation is standard in merger cases in which the transaction is likely to reduce existing competition in the market by eliminating a competitor, thereby enhancing the likelihood of “coordinated effects” among the remaining market participants.

But the FTC’s theory of the case was not premised on the threat posed by the deal to existing competition in the VR dedicated fitness app market, but, rather, the FTC alleged a market that was highly concentrated and not competitive. The transaction threatens the potential competition in the future from Meta’s entry as a competitor to Within. In order to prevail on a potential competition theory, therefore, the Commission first had to establish that the relevant market was nota competitive market but could be, provided Meta is forced to compete with Within instead of acquiring it. It makes little sense to defend against the FTC’s potential competition theory on the grounds that the complaint failed to allege injury to existing competition in the relevant market due to coordinated effects.

The court denied the merging parties’ motion to dismiss in a clearly stated decision that the Commission’s complaint adequately alleged a violation of Section 7 of the Clayton Act based on harm to potential competition. Although the FTC may consider the decision a victory for its program of identifying and prohibiting transactions that threaten future competition by concentrating adjacent centers of innovation, the court’s application of the law to the facts of the Meta-Within deal was narrowly mechanical and threatens to establish an exceedingly high evidentiary bar.

The Commission’s Theory of Harm to Potential Competition

The industrial logic for challenging the Meta-Within acquisition is unassailable. Meta has invested heavily already to try to penetrate the relevant market in addition to the billions of dollars it has spent on its VR Reality Labs division. Meta operates the Quest Store, formerly the Oculus Store (obtained through a previous acquisition), a distribution platform for third-party app developers, and App Lab, an app distribution service for VR apps. It also acquired Beat Games, developer of Beat Saber, a popular sword-fighting game that is the best-selling VR app of all time. Clearly, Meta is positioning the “Metaverse” to be the dominant VR platform.

Within Unlimited launched on Meta’s Quest Store in April 2020 with Supernatural, a subscription-based VR fitness service that dominates the VR dedicated fitness app market. The companies agreed to merge in October 2021. Past experience with Microsoft’s dominance over the markets for PC applications, and Apple and Google’s dominance over iPhone and Android apps, respectively, offer reason to believe that the VR dedicated fitness app market is likely to emerge as a more competitive market were Meta prohibited from acquiring Within, or to put it another way, by requiring Within to remain a center of innovation decision-making separate and apart from the dominant platform operator.

The concern for the protection of nascent competition expected to emerge in the future is precisely the focus of the potential competition doctrine. The court identified two economic mechanisms from the case law which eliminate potential future competition and are cognizable as a Section 7 violation. First, a transaction might eliminate the prospect of actual independent entry by the acquiring party in the short run. Second, a transaction might eliminate the competitive discipline imposed by the perception that a party is prepared to enter.   

The Potential Competition Theory Is Unlikely to Succeed on the Merits

The FTC argued that the deal would substantially lessen competition by depriving the relevant market of the pro-competitive effect of Meta’s independent entry. The court framed the issue as whether Meta had the “available feasible means” to enter the relevant market de novo, which the FTC was required to prove by a “reasonable probability.”

Although the Commission argued that its burden had been met through evidence of Meta’s “overall size, resources, capability, and motivation,” the parties insisted that Meta had no plan to enter the relevant market de novo and would not enter it without acquiring Within.

The court found that Meta lacked certain capabilities that were “unique and critical” to success in the relevant market, such as personal trainers optimized for VR activity through consultations with kinesiology and biomechanical experts. Meta also lacked the necessary studio production capabilities to create and film VR workouts. The court observed that its Armature Studio was really a gaming studio lacking the necessary production capabilities to develop a VR dedicated fitness app. The court also found the FTC’s theory that Meta could morph Beat Saber into a dedicated fitness app to be “neither supported by the contemporaneous remarks regarding the Beat Saber proposal nor the timing of the subsequent investigation into this proposal.”

The court performed a detailed analysis of the evidence of Meta’s incentive to enter the relevant market to compete with Within. Although it recognized that entry with its own dedicated fitness app would facilitate Meta’s development of fitness-related VR hardware, the court nonetheless concluded that de novo entry was not necessary to develop fitness hardware. The court also recognized the benefits of deep integration between the VR fitness hardware and software, but the court concluded that Meta’s apparent excitement about fitness as a core VR use case would not necessarily translate to an intent to build its own dedicated fitness app if it could enter by acquisition.

The court ultimately decided that Meta did not qualify as an actual potential entrant into the relevant market. “There can be no serious dispute that Meta possesses the financial resources to undertake a de novo entry,” the court wrote, “but financial and engineering capabilities alone are insufficient to conclude it was ‘reasonably probable’ that Meta would enter the VR dedicated fitness app market.” For the same reasons, the court failed to find sufficient evidence that Meta’s perceived potential future entry tempered anticompetitive behavior in the market. In sum, the FTC’s position that, with all its resources, Meta would have found a way to enter the market was, in the court’s view, “impermissibly speculative.” Because the Commission had not demonstrated a likelihood of success on the merits of its Section 7 claim, the preliminary injunction was denied.

A Pyrrhic Victory

Whatever satisfaction the Commission may feel that its legal theory of potential competition survived the parties’ motion to dismiss, any such reaction surely must be tempered by the steep—nearly impossible—evidentiary burden to which the court held the FTC. It is hard to imagine a case in which a prospective acquirer will have the capacity to enter de novo required by the court to qualify as an actual potential entrant and at the same time seek to enter through acquisition. The court’s presumed knowledge of the “but for” world based on the evidence before him shows a certain lack of humility in the face of powerful but as yet unseen forces in industrial innovation. From the counterfactual perspective that Meta is prohibited from acquiring Within, the court imagines a world in which Meta is consigned helplessly to the sidelines of a VR dedicated fitness app market dominated by Within into which others, but not Meta, might seek to enter, while at the same time striving to be the dominant—indeed, even defining—platform in the “Metaverse.” Such inaction by Meta, either by de novo entry or through a toehold acquisition, seems akin to Google leaving the development of Android-based mapping or messaging apps entirely to independent third parties.

The court’s concern in this case should have been whether requiring Meta to innovate in the VR dedicated fitness app space independently instead of acquiring Within would avoid anticompetitive condition likely to reduce competition in the future. As the operator of the dominant VR platform, Meta is in a superior position to innovate in the markets complementary to its platform. By capturing the dominant innovator in a complementary market, Meta greatly strengthens its ability to fend off future competition in that market. For this reason, the transaction is likely lessen competition.

FOOTNOTES

^[i] United States v. Falstaff Brewing Corp., 410 U.S. 526 (1973); United States v. Marine Bancorporation, Inc., 418 U.S. 602 (1974).