Merger Control in Dynamic Markets – MANNE – December 2019 OECD discussion

OECD Global Forum
on Competition
Merger Control in Dynamic
Markets
What, If Anything, Should We
Do About “Kill Zones” and
“Killer Acquisitions”?
December 2019
Geoffrey A. Manne

Kill Zones & Killer Acquisitions
Some commentators have expressed concern that large incumbents in the technology industry
are behaving anticompetitively by serving as an innovation bottleneck.
 Two of the most prominent examples were an article in the Economist and a piece by
Bloomberg opinion writer Noah Smith.
These concerns boil down to three distinct forms of alleged anticompetitive behavior (even
though they are often conflated in public debate):
1. Large incumbents have become so dominant in their primary markets that venture
capitalists decline to fund startups that compete head-on, reducing potential
competition.
2. Large incumbents acquire potential competitors and shut down their businesses.
3. Large incumbents, particularly those that operate platforms used by third parties,
leverage their existing networks to facilitate “spying” on potential competitors through
data surveillance and “appropriate” the most profitable verticals, either through
internal development (copying) or external acquisition (merger).

Timeline
 April 20th, 2018: Albert Wenger, the managing partner of Union Square Ventures,
introduces the term at an antitrust conference at the Stigler Center.
 June 2nd, 2018: An article in the Economist cites Wenger approvingly and discusses the
details of this potential phenomenon.
 July 11th, 2018: Oliver Wyman, in partnership with Facebook, releases a skeptical report on
the idea that there is a ”kill zone” in tech, citing increased startup investments.
 September 12th, 2018: Cunningham, Ederer, and Ma publish “Killer Acquisitions” as a
working paper.
 October 12th, 2018: A study using data from PitchBook pushes back on the Oliver Wyman
report, arguing that while there has been an increase in aggregate venture capital
investment, three narrow industry categories — internet retail, internet software, and
social/platform software — have seen comparable declines.
 November 18th, 2019: Sai Krishna Kamepalli, Raghuram Rajan, and Luigi Zingales publish
“Kill Zone” as a working paper.

Kill Zones – Albert Wenger Introduces a New Theory
At the Stigler Center’s Antitrust and Competition Conference in 2018, Albert Wenger, the
managing director of Union Square Ventures, said:
 “Without a doubt, there's too much power… The scale of these companies and their impact
on what can be funded and what can succeed is massive… We have an annual summit
where we bring our portfolio company founders and CEOs together… This didn't come
from us, this came from one the entrepreneurs we were talking about, you know, ‘What
kind of things do you see?’… So the CEO said, ’I'm only investing in things that are not in
the Facebook, Apple, Amazon, Google kill zone.’ So I mean, that's the word this founder
used and that's a real thing. You know, unless you want to conclude that Facebook is
somehow the end state of how we communicate online and share socially, I think that’s
kind of a bad thing.”
 “The kill zone isn't a new thing. Microsoft had that when it had its platform monopoly. You
know, and it's a similar playbook where, you know, Microsoft would see what kind of
things are doing well on my platform, and then they would just absorb those into the
platform itself. And you know, that is a playbook that's being exercised by Amazon, by
Google, by Facebook, by all the big digital platforms.”

Kill Zones – The Economist Popularizes the Idea
Economist (6/2/18): “American tech
giants are making life tough for
startups”
 “Venture capitalists, such as Albert
Wenger of Union Square Ventures,
who was an early investor in Twitter,
now talk of a ‘kill-zone’ around the
giants. Once a young firm enters, it
can be extremely difficult to survive.
Tech giants try to squash startups by
copying them, or they pay to scoop
them up early to eliminate a threat.”

Potential Competition
If we think there is a systematic problem with large tech firms routinely purchasing future
rivals, then we also must think there is routine entry in these digital markets — thus
undermining a durable market power assumption.
 If Instagram’s product in 2012 represented a future/potential constraint on Facebook, then
LinkedIn, Pinterest, Snapchat, Twitter, TikTok, YouTube, et al. must also be considered
actual, potential, or nascent competitors to Facebook.
But not symmetrical: For threat of competition to restrain incumbent, not even a single
actual firm is required. For removal of potential competition to enable incumbent, removal
of a single firm is not enough.
John Kwoka in recent Senate testimony:
 “All twelve studies [of airline markets] find that potential competition results in lower
prices by incumbent carriers, in ten cases by statistically significant amounts.”
 “Except as noted below, the amounts range between one quarter of one percent to about
two percent, and in all cases are less than the amount of the price decline from one
additional actual competitor, specifically, from one eighth to one third as large.”
 Statistical significance does not equal economic significance.

Killer Acquisitions – Cunningham, Ederer, and Ma
(2019)
Some findings seem alarming: “[W]e find projects acquired by an incumbent with an
overlapping drug are 28.6% less likely to be continued in the development process compared
to drugs that are not acquired.”
However, the study’s industry-specific methodology means it is not a useful guide to
understand tech platforms.
 Drug development is highly regulated, standardized, documented, and contains set
milestones. It is often straightforward to identify market substitutes. Not so for digital
markets where products are highly differentiated. Thus, neither acquirers nor regulators
can be as readily presumed to know who is a potential threat
Also, these “killer acquisitions” represent only a small fraction — six percent — of the
pharmaceutical acquisitions studied.
 And which companies are in that six percent, ex ante?
And we don’t know direction of causation:
 Was R&D discontinued because a more knowledgeable purchaser made a more accurate
prediction?

Killer Acquisitions – Cunningham, Ederer, and Ma
(2019)
No efficiencies in the model, as John Yun pointed out in recent Senate testimony:
 Acquiring firm never has a positive incentive to acquire another firm unless there is a
“reduce competition” rationale.
 Some assumptions seem implausible: “If there is no product market overlap, the acquirer is
always indifferent between acquiring and not acquiring the entrepreneur.”
 Thus there is no positive incentive to acquire complementary assets.
Yet the authors’ own data disproves this assumption: Four-fifths of the acquisitions in their
data set involve non-overlapping products.
 Is it reasonable to assume the purposeful action behind these acquisitions represents
nothing more than a coin flip?
As for public policy implications, even the authors are reticent to draw any firm
conclusions:
 “[T]he overall effect on social welfare is ambiguous because these acquisitions may also
increase ex-ante incentives for the creation of new drug projects.”

Crémer Report on Killer Acquisitions:
Acknowledging Efficiencies
The Crémer Report also included a discussion of killer acquisitions:
 “[T]he Commission should explore whether the merger brings about a risk of a
‘cannibalisation effect’: is there a plausible scenario in which the target, using its
innovation, could ‘eat into the market of the acquirer’? If yes, would the acquirer then have
an incentive to delay or cancel potential innovation?”
But as the report goes on to note, this is “not the typical scenario” in the digital realm:
 ”Frequently, the project of the bought-up start-up is integrated into the ‘ecosystem’ of the
acquirer or into one of their existing products. Such acquisitions are different from killer
acquisitions as the integration of innovative complementary services often has a plausible
efficiency rationale. In these cases, the theory of harm becomes more complex.”
Thus, although some of the innovative developments that originate from outside of a
dominant firm are brought within that firm, it is typically not done to kill those
innovations but to integrate them into existing service offerings.
 These efficiencies are routinely ignored.

What Do Other Venture Capitalists Say About Kill
Zones?: Entry Undermines Market Power
Fred Wilson, co-founder of Union Square Ventures, said the following about kill zones in
October 2018:
 “I would venture, that big tech is increasingly vulnerable to a number of attack vectors,
many of them self-induced, which should be attracting entrepreneurs to more directly go
after the core franchises of big tech.
 “Whether those courageous entrepreneurs will attract the capital they need to launch those
attacks is an open question. But I have a fundamental belief in capital markets to do the
right thing over the long term and I also have a fundamental belief that entrepreneurs,
software engineers, and new innovations will undo these increasingly dominant
franchises in ways that regulators will never be able to.”
Error costs:
• Even assuming there are kill zones, it is entirely unclear if regulators can deliver superior
outcomes to the market:
• Will they correctly identify anticompetitive behavior?
• Will they implement effective/better remedies?

Zones?: Pathway - not Barrier - to Entry
Scott Kupor, managing partner at Andreesen Horowitz, argued at recent FTC Hearings that
incumbent advertising platforms can enable startups to break into a new market:
 “It’s the existence of these platforms that in many ways explains the significant growth
we’ve seen in the last seven to ten years in consumer startup and VC financing activity.
Simply put, the math works. Companies can experiment with customer acquisition via
these channels and fund their marketing companies iteratively based on which yields the
highest return on capital.
 “Without these platforms, I would venture that the economics of customer acquisition
might be cost prohibitive for most startups and, thus, that the venture capital economy
would shift its investment into other more cost-effective areas.”
Was Microsoft’s “applications barrier to entry” actually a pathway to entry? As I’ve written
elsewhere:
• “Microsoft created a huge positive externality for new entrants: existing knowledge and
organizations devoted to development, industry knowledge, reputation, awareness,
incentive for schools to offer courses, etc. It could well be that new entrants in fact faced
lower barriers with respect to app developers than did Microsoft when it entered.”

Zones?: Increased Venture Capital
Fred Wilson also said:
 “[W]e don’t really know because the analyses done to date are not conclusive.
 “But as a market participant, I can certainly say that we shy away from funding startups
that are going up directly against the large tech incumbents.
 “But we also are attracted to startups that are competing against the big incumbents with
a fundamentally different model, like DuckDuckGo in search, or ShopShops in commerce.
 “So, anecdotally, based on our activity and other venture capital activity that I have
observed, I would say that the big tech incumbents have most definitely shaped where
venture capital is going and where it is not going.
“That does not mean it has decreased the overall supply of venture capital. It most
certainly has not.”

Zones?: Liquidity Zones
Scott Kupor also said:
 “[T]hese large players play a significant role as acquirers of venture-backed startup
companies, which is an important part of the overall health of the venture ecosystem.
 “We know and understand this risk, of course, but nonetheless require that a small
number of companies have to yield high returns on capital to make the ultimate venture
business succeed. To that end, about 15 to 20 years ago, the venture in business enjoyed
what we called liquidity events, which is basically the ability to convert an investment into
a real economic return, in the form of about 50 percent IPOs and 50 percent M&A activity.
Today that math is closer to about 80 percent M&A and about 20 percent IPOs. The
reasons for this are beyond the scope of this hearing, but this trend plays a very important
role in the potential actions that the Commission might be considering with respect to the
large platform players in this industry.”

Zones?: Liquidity Zones

Kill Zone or Liquidity Zone?
Acquisitions by large firms are, in general, not problematic. They provide a crucial channel
for liquidity in the venture capital and startup communities (the other channel being IPOs).
According to the latest data from Orrick and Crunchbase:
 Between 2010 and 2018, there were 21,844 acquisitions of tech startups for a total deal
value of $1.193 trillion.
By comparison, according to data compiled by Jay R. Ritter, a professor at the University of
Florida:
 Between 2010 and 2018, there were 331 tech IPOs for a total market capitalization of
$649.6 billion.
Making it harder for a startup to be acquired would not obviously result in more
venture capital investment (and therefore not in more IPOs).
 Regulatory intervention that reduces the likelihood of reaching a profitable exit could
reduce the incentive for venture capitalists to invest in startups and may inhibit new
business formation.

Phillips & Zhdanov (2019)
Research by Gordon Phillips and Alexei Zhdanov on venture capital investments and M&A
activity found:
 Across 48 countries, “Our evidence shows increases in VC activity after pro-takeover laws.
VC activity grows by about 40-50% more from pre-law periods to post-law periods in
countries that enact pro-takeover laws versus those that do not.”
“This evidence provides support for our hypothesis that M&A and VC markets are
connected and improvements in M&A legislation spill over to VC markets by creating more
viable exit opportunities for VC firms.”
 Across 50 US States and DC, “[T]he number of [VC] deals scaled by the number of public
firms in the state declines by about 27% in post antitakeover years in states that enact an
antitakeover law relative to those that do not enact such a law.”
“Overall, our results highlight the importance of M&A markets for the incentives to engage
in VC.”
 “As many start-ups rely on VC funding and venture capitalists rely on acquisitions for
subsequent exits, our results suggest that an active M&A market is important for
encouraging venture capital investments, entrepreneurship and growth.”

Some Change in Type of Funding, Not Level of
Funding

The Furman Report: Recommending the
Precautionary Principle…

The Furman Report: Recommending the
Precautionary Principle…
The Furman Report advocates following the precautionary principle for digital mergers:
 “For example, take a large platform seeking to acquire a smaller tech company based on an
attractive innovation that gives it a real chance of competing for consumers. For the sake of
the example, assume that if the companies merge, there would only be a modest
efficiency benefit.
 “But if the smaller company would otherwise have become a serious and innovative
competitor, the resulting competition would have generated far greater consumer benefits.
 “The Panel is concerned that, under the system as it stands, the CMA could only block the
merger if it considered the smaller company more likely than not to be able to succeed as a
competitor. This is unduly cautious.
 “The report recommends that assessment should be able to test whether a merger is
expected to be on balance beneficial or harmful, taking into account the scale of impacts
as well as their likelihood.”

The Furman Report: …Unsupported by Evidence
In the face of uncertainty — why pursue precautionary principle instead of permissionless
innovation?
 Not based on data. For example, the Furman Report cites to Cunningham, et al. (2019)
without noting the study’s severe limitations.
 Crucially, the Report ignores innovation and other benefits from implementation by a
larger network of users in acquiring firm.
“The Panel recognises that the large majority of the acquisitions by large digital companies
in recent years have likely been benign or beneficial for consumers.
 “However… it appears that some of these acquisitions have been of platforms and other
companies that could have provided much-needed competition in these concentrated
markets.
 “Some also appear to have been companies up or downstream, whose products have
helped to cement platforms’ positions in their core market, increasing their power over
their users.”
Simplistic conclusion: More aggressive merger enforcement

The Furman Report: Error Costs? What Error Costs?
Some relevant context for the Furman Report’s recommendation for more aggressive
merger enforcement in digital markets:
 Google has acquired 270 companies in the last twenty years.
 Facebook has acquired 92 companies since 2007.
But this is common practice for large companies in general, including ones rarely mentioned
anymore in the context of antitrust:
 Microsoft has acquired 200 companies since 1994 (but almost no one mentions them
anymore in antitrust discussions).
The real test for regulators is whether they could identify the, say, 6% (16) potentially
anticompetitive mergers out of Google’s 270 acquisitions and, under an error cost analysis,
do less harm to consumers with false positives than false negatives.
 If anticompetitive mergers are such a tiny percentage of the total mergers, and identifying
them a priori is difficult, then a precautionary principle that results in many false
positives for enforcement would likely not merit the benefits from even correctly
blocking 16 anticompetitive mergers.

Public policy should focus on maximizing total
innovation, not innovation within small firms
The original formulation of the kill zone thesis myopically focused on the likelihood that
startups would enter markets dominated by Google, Facebook, Amazon, and Apple.
 As I have shown earlier, it is not clear these kill zones exist.
 But even if they do, that does not mean they are necessarily a problem from a public policy
perspective.
If incumbents continue to innovate and compete, then consumers are no worse off.

Stylized Facts in Conflict with Kill Zone Thesis

Public policy should focus on maximizing total
innovation, not innovation within small firms
And if incumbents implement “edge” innovations, at least in short run (which may be
quite long), many more consumers benefit.
 E.g., Instagram —> 30 million users; Facebook —> 2 billion users
The firm size/industry structure associated with innovation isn’t determinative (as far as we
know).
What matters are the rate and level of innovation, not its source.
And it’s always more complex than we think….

“there’s another reason this acquisition
was so valuable: It proved that Facebook
could build multiple products at the
same time.”
“the Instagram acquisition is the reason
Facebook ultimately landed WhatsApp…
and was able to acquire Oculus.”
“it helped Zuckerberg recruit big-name
executives to lead units outside of
Facebook’s core business.”
Is this addressed in any economic model or case? How would we assess whether it is
relevant & good/bad — in general or in any particular case?

Kamepalli, Rajan & Zingales (2019)
Tradeoffs:
 “From a welfare point of view… restrictions on mergers will have costs: if the market
remains segmented, network externalities will be lower than achievable, and some
customers will not enjoy a superior technology…. [T]he social optimum will not be
an outright prohibition or complete laissez faire, but some middle-of-the road
policy.”
Evidence of reduced investment:
 “We find that VC investments in start-ups in the same space as the company
acquired by Google and Facebook drop by 46% and the number of deals by 42% in
the three years following an acquisition.” Looking at neighboring companies, “our
results are if anything stronger.”
Indeterminate policy implications:
 “It would be premature to draw any policy conclusion on antitrust enforcement
based solely on our model and our limited evidence.”

Kamepalli, Rajan & Zingales (2019) — Maybe the
right solution is stronger IP
The problem is incentives to innovate:
 “[T]he more an incumbent can freely copy the technological innovations of new
entrants, the worse the incentives of early adopters to switch to a new entrant will be.
These reduced incentives will lower the stand-alone valuation of new entrants and
thus lower the return to innovation…. [T]he ability to copy freely an innovation
always reduces the incentives to invest.”
So, perhaps what we should be focused on is better patent/copyright system design
 “Note, however, that a very strong patent protection system can be a double-edged
sword, because it protects incumbents’ property rights too, possibly creating an
insurmountable advantage over potential entrants. To properly derive the optimal
degree of patent protection, we would need to model the incumbent’s incentives to
innovate. This is outside the scope of this paper.”
Institutional design matters; it’s not just “strong” or “weak” patent protection…

Geoffrey A. Manne
Founder & President
gmanne@laweconcenter.org

Merger Control in Dynamic Markets – MANNE – December 2019 OECD discussion

Recommended

Recommended

More Related Content

Similar to Merger Control in Dynamic Markets – MANNE – December 2019 OECD discussion

Similar to Merger Control in Dynamic Markets – MANNE – December 2019 OECD discussion (20)

More from OECD Directorate for Financial and Enterprise Affairs

More from OECD Directorate for Financial and Enterprise Affairs (20)

Recently uploaded

Recently uploaded (17)

Merger Control in Dynamic Markets – MANNE – December 2019 OECD discussion