In advance of the 2021 OECD Competition Open Day, Cristina Caffarra argues that concerns about the impact on potential future competition of mergers between acquisitive platforms and small players are broader than ‘killer acquisitions’; they include ‘reverse killer acquisitions’ as well. This is an edited version of an article she wrote together with Greg Crawford and Tommaso Valletti first posted in VoxEU on 11 May 2020.
Beyond ‘killer acquisitions’
Agencies are paying more attention than ever to mergers where there is no loss of immediate competition, but the concern is the loss of future competition. ‘Potential competition’ theories are increasingly focused on the notion that, ‘but for the transaction’, parties engaged in complementary activities would have eventually come to expand and compete in each other’s domain; and the deal entails the loss of that future competition and the dampening of overall innovation relative to an independent counterfactual. This is coming up particularly in deals involving tech platforms buying up (or building stakes in) younger/innovative specialists in areas they are not currently in, but where they want to expand.
Greater attention to potential competition is indeed overdue, especially in deals involving tech platforms with enormous capabilities to expand into multiple adjacent markets through the ‘roll up’ of smaller or nascent firms. This is ‘the way tech rolls’: frequent relatively small acquisitions of complementary functionalities to be integrated into the platform – sometimes cannibalised, sometimes bolted on, but essentially no longer separate efforts. The traditional antitrust posture in these cases has been ‘Mergers of complements? No issue. In fact, great! Integration is efficient. Potential entry is too speculative to worry about.’ And indeed, integration into a platform that can provide execution and funding to a nascent firm could be a good thing. But this is only one side of the story. Suppose the target indeed offered a platform a ‘way to market’ in a service or functionality where it is lacking, but also suppose the platform would have otherwise strived to build its own offering in that space organically. A deal then eliminates a future competitor in that functionality – the acquirer itself.
Note that this is not just about whether there are ‘killer acquisitions’ in tech that we failed to catch, i.e. acquisitions for the purpose of killing or taming a potential future threat to the acquirer’s core business. A much more common possibility are ‘reverse’ killer acquisitions, where the question is what innovation by the buyer is being foregone as a result of it buying a business it could have built organically instead? Looking just for the possibly elusive ‘future replacement’ to a core business misses out on multiple cases where the buyer discontinues or foregoes its own effort because it has appropriated the ‘next best thing’.
Why do we care? Because what we should care about is the overall intensity of innovation effort in the economy and the impact this ultimately has on consumers. We want as much rival innovation effort as possible. A buyout of a promising nascent/small innovator deprives the world of that innovator’s contribution in an alternative scenario – an IPO, a sale to another buyer, or some other version of the future – in which it would have competed with an innovation developed and implemented by the buyer. This is what we are missing with ‘reverse’ killer acquisitions: social welfare is enhanced when the would-be buyer also develops a service or a product, with head-to-head competition in the final product market.
‘Killer acquisitions’ in digital are an important but narrow field
This debate on digital deals has sought to transpose the logic and insights of the seminal article of the same name by Cunningham, Ederer, and Ma, which used careful data analysis in pharma to identify deals involving the discontinuation (‘killing’) of competing innovation projects by an incumbent. The transposition to tech has been motivated by the idea that – while there is no similarly direct empirical evidence (antitrust markets are not so easily defined as in pharma, nor are outcomes of historical innovation projects) – there is a plausible concern that acquisitions by an incumbent can be motivated by a design to kill a potential future competitor.
Of course, testing for ‘killer acquisitions’, even ex post, remains difficult. Even careful studies such as the one done by Lear for the CMA do not provide a clear roadmap. There are some filters one can perhaps apply to spot ex ante deals where the target has the potential for being a replacement to the acquirer in the future, and agencies should remain on the lookout. But even so, ex ante and true ‘killer acquisitions’ certainly do not account for most of the deals that digital platforms have consummated in the past decade. But there is more to the story.
‘Reverse’ killer acquisitions
What seems empirically more prevalent are cases where we are not necessarily worried about the buyer acquiring and then neutering a future threat (either directly, or by making them unavailable to others); but where the acquisition may effectively extinguish the standalone effort of the buyer to expand in a particular space because the target immediately provides it with those capabilities. This covers a broader set of possibilities as platforms continue to expand into adjacent fields by buying functionalities, capabilities, even whole businesses. To date, this has been regarded as only benign: no overlap, no obvious foreclosure of existing competitors, quick time to market, and bonanza for the target. But wait. What is in fact often apparent (particularly when one looks at internal documents) is that these acquisitions are often evaluated internally in terms of ‘buy vs build.’ That is, there is often an alternative path to expanding into a particular space through the acquisition: with sprawling capabilities, competences, and limitless internal funding, buyers are often already on the way to building a functionality themselves. Internal documents often show the incumbent making (or thinking about making) an organic foray into this new market. The opportunity to buy instead then comes along. Once bought, the target may be cannibalised for certain assets to power the incumbent’s own effort. Or the incumbent’s own project may be quietly shelved. Either way, the buyer’s innovative effort in the target’s market has been extinguished. What may be of significance here is the killing of one of the two efforts – but not the target’s – the buyer’s. Hence a ‘reverse’ killer acquisition. There was some of this flavour indeed in the CMA’s reviews of Paypal/iZettle, Sabre/Farelogix, Amazon/Deliveroo, Visa/Plaid and others (where concerns included whether the acquisition allowed the buyer to forego its own efforts in the target’s area).
What enforcement posture do we want for these deals?
We want to preserve innovation efforts of both current and future competitors, even if duplicative, as much as possible. Consumers always like more competition in product and service markets, including through entry by large platforms.
The first question is then what would an agency need to show in order to conclude that the acquisition of a nascent/small player creates concerns? Agencies will not be able to know with a high degree of likelihood whether both innovation efforts (the buyer’s and the target’s) will lead to competing products or services in the counterfactual. There is judgement involved, as buyers will always insist they were never ever going to make it in that space on a standalone basis, nor invest in that innovation effort themselves. But in principle this is doable: every merger assessment involves constructing and analysing future counterfactuals, and those counterfactuals should be rich and imaginative.
While the CMA is a trail blazer, it is clear that going down that route (which involves implicitly embracing ‘expected consumer surplus’ in their toolkit) is ambitious for many – in terms of resources. Multiple experts (Valletti, Peitz, Motta, as well as various reports) have advocated in the past year or so the need to reverse instead the burden of proof and create a rebuttable presumption. Ultimately, the kind of policy we want needs to reflect our views – as a society – on what type of enforcement errors we think matter most. We have proceeded for years on grounds that ‘Type 1 errors’ (the risk of overenforcement) are the most pernicious as they would ‘chill innovation’ stone dead, while ‘Type 2 errors’ (the risk of underenforcement) will quickly be corrected by the growth of rivals or new entrants. But the recent track record in tech put that argument in the ground: hundreds of acquisitions not investigated, failures to diagnose potential ‘killer’ acquisitions, multiple ‘reverse’ cases where the buyer turns off its own effort, and fewer incentives to invest in challengers ‘under the shadow’ of giants.
There is therefore a strong case for agencies to ‘lean in’ and aggressively protect innovation in a huge and growing sector of the economy. Yes, enforcers cannot be all-knowing, especially given their limited resources and the huge asymmetry of information. This would militate in favour of super-dominant firms being required to proactively show what they want to do and why consumers would necessarily benefit. It is time to have some false positives after twenty years of false negatives, and to see more innovation competition instead of ‘rollups’ and shopping sprees.
Cristina Caffarra is an invited speaker at the 2021 OECD Competition Open Day’s panel which will discuss this topic on the 24 February 2021. Please follow the LinkedIn event for more information and join us for the discussion.
2022 OECD Competition Open Day Blog Series