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Feb 24

FTC Drops Challenge To Meta’s Acquisition Of Virtual Reality … – Mondaq

Court found harm to potential competition a viableanti-merger legal theory, but required evidence FTC could notproduce.

The FTC has decided to abandon its challenge to Meta PlatformsInc.'s acquisition of virtual reality (VR) exercise appdeveloper, Within Unlimited, Inc., after U.S. District Judge EdwardJ. Davila from the Northern District of California rejected theFederal Trade Commission's bid for a preliminary injunctionblocking the deal. A setback for the Biden administration'scampaign to get tougher on anticompetitive mergers, the judge foundthat entry by acquiring Within was Meta's only option because despite its enormous resources the company did nothave the "available feasible means" and capabilities todevelop 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 thetransaction to close on Feb. 8. The Commission could have appealedthe court's ruling or commenced a proceeding before theagency's Administrative Law Judge. On Feb. 6, the FTC said thatit would not appeal the district court's refusal to pause themerger and on Feb. 10 it stayed the administrative lawproceedings.

The Commission had argued that the market consisted of VR appsthat are "dedicated" to fitness and does not include appsfor which fitness is "incidental," such as exercisevideos on YouTube. Products described as "VR dedicated fitnessapps" occupy their own relevant market, the FTC alleged,because these products have distinct customers and pricing schemesand provide an offering that differs from other apps on VRplatforms. The merging parties countered that the Commission'smarket definition was impermissibly narrow because it excluded toomany reasonably interchangeable products.

The court agreed with the FTC's market definition, notingthat despite the existence of "a broad fitness market thatincludes everything from VR apps to bicycles," it would"in no way preclude[ ] the existence of a submarketconstituting a relevant product market for antitrustpurposes." 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 astationary bike or mobile phone. Moreover, VR dedicated fitnessapps are more likely than other VR apps to besubscription-based.

The court also observed that "neither general fitness firmsnor general VR firms have the production facilities to readilyproduce a substitute VR dedicated fitness app product, even if VRdedicated fitness apps were to raise prices and make market entrymore attractive.... That existing companies are not easily able toalter their facilities to produce VR dedicated fitness apps isadditional evidence that such apps constitute a distinct productmarket."

Before ruling on the Commission's preliminary injunctionpetition, the court disposed of the defendants' motion todismiss the complaint, which was premised on a theory of potential,or anticipated, competition explored in a pair of cases from themid-1970s.1

The merging parties argued that the FTC "stumble[d] rightout of the block" because the complaint did not allege theprospect of "oligopolistic" or "interdependent orparallel behavior." Such an allegation is standard in mergercases in which the transaction is likely to reduce existingcompetition in the market by eliminating a competitor, therebyenhancing the likelihood of "coordinated effects" amongthe remaining market participants.

But the FTC's theory of the case was not premised on thethreat posed by the deal to existing competition in the VRdedicated fitness app market, but, rather, the FTC alleged a marketthat was highly concentrated and not competitive. The transactionthreatens the potential competition in the future fromMeta's entry as a competitor to Within. In order to prevail ona potential competition theory, therefore, the Commission first hadto establish that the relevant market was nota competitivemarket but could be, provided Meta is forced to compete with Withininstead of acquiring it. It makes little sense to defend againstthe FTC's potential competition theory on the grounds that thecomplaint failed to allege injury to existing competition in therelevant market due to coordinated effects.

The court denied the merging parties' motion to dismiss in aclearly stated decision that the Commission's complaintadequately alleged a violation of Section 7 of the Clayton Actbased on harm to potential competition. Although the FTC mayconsider the decision a victory for its program of identifying andprohibiting transactions that threaten future competition byconcentrating adjacent centers of innovation, the court'sapplication of the law to the facts of the Meta-Within deal wasnarrowly mechanical and threatens to establish an exceedingly highevidentiary bar.

The industrial logic for challenging the Meta-Within acquisitionis unassailable. Meta has invested heavily already to try topenetrate the relevant market in addition to the billions ofdollars it has spent on its VR Reality Labs division. Meta operatesthe Quest Store, formerly the Oculus Store (obtained through aprevious acquisition), a distribution platform for third-party appdevelopers, and App Lab, an app distribution service for VR apps.It also acquired Beat Games, developer of Beat Saber, a popularsword-fighting game that is the best-selling VR app of all time.Clearly, Meta is positioning the "Metaverse" to be thedominant VR platform.

Within Unlimited launched on Meta's Quest Store in April2020 with Supernatural, a subscription-based VR fitness servicethat dominates the VR dedicated fitness app market. The companiesagreed to merge in October 2021. Past experience withMicrosoft's dominance over the markets for PC applications, andApple and Google's dominance over iPhone and Android apps,respectively, offer reason to believe that the VR dedicated fitnessapp market is likely to emerge as a more competitive market wereMeta prohibited from acquiring Within, or to put it another way, byrequiring Within to remain a center of innovation decision-makingseparate and apart from the dominant platform operator.

The concern for the protection of nascent competition expectedto emerge in the future is precisely the focus of the potentialcompetition doctrine. The court identified two economic mechanismsfrom the case law which eliminate potential future competition andare cognizable as a Section 7 violation. First, a transaction mighteliminate the prospect of actual independent entry by the acquiringparty in the short run. Second, a transaction might eliminate thecompetitive discipline imposed by the perception that a party isprepared to enter.

The FTC argued that the deal would substantially lessencompetition by depriving the relevant market of the pro-competitiveeffect of Meta's independent entry. The court framed the issueas whether Meta had the "available feasible means" toenter the relevant market de novo, which the FTC wasrequired to prove by a "reasonable probability."

Although the Commission argued that its burden had been metthrough evidence of Meta's "overall size, resources,capability, and motivation," the parties insisted that Metahad no plan to enter the relevant market de novo and wouldnot 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 throughconsultations with kinesiology and biomechanical experts. Meta alsolacked the necessary studio production capabilities to create andfilm VR workouts. The court observed that its Armature Studio wasreally a gaming studio lacking the necessary productioncapabilities to develop a VR dedicated fitness app. The court alsofound the FTC's theory that Meta could morph Beat Saber into adedicated fitness app to be "neither supported by thecontemporaneous remarks regarding the Beat Saber proposal nor thetiming of the subsequent investigation into thisproposal."

The court performed a detailed analysis of the evidence ofMeta's incentive to enter the relevant market to compete withWithin. Although it recognized that entry with its own dedicatedfitness app would facilitate Meta's development offitness-related VR hardware, the court nonetheless concluded thatde novo entry was not necessary to develop fitnesshardware. The court also recognized the benefits of deepintegration between the VR fitness hardware and software, but thecourt concluded that Meta's apparent excitement about fitnessas a core VR use case would not necessarily translate to an intentto build its own dedicated fitness app if it could enter byacquisition.

The court ultimately decided that Meta did not qualify as anactual potential entrant into the relevant market. "There canbe no serious dispute that Meta possesses the financial resourcesto undertake a de novo entry," the court wrote,"but financial and engineering capabilities alone areinsufficient to conclude it was 'reasonably probable' thatMeta would enter the VR dedicated fitness app market." For thesame reasons, the court failed to find sufficient evidence thatMeta's perceived potential future entry temperedanticompetitive behavior in the market. In sum, the FTC'sposition that, with all its resources, Meta would have found a wayto enter the market was, in the court's view,"impermissibly speculative." Because the Commission hadnot demonstrated a likelihood of success on the merits of itsSection 7 claim, the preliminary injunction was denied.

Whatever satisfaction the Commission may feel that its legaltheory of potential competition survived the parties' motion todismiss, any such reaction surely must be tempered by thesteepnearly impossibleevidentiary burden to which thecourt held the FTC. It is hard to imagine a case in which aprospective acquirer will have the capacity to enter denovo required by the court to qualify as an actual potentialentrant and at the same time seek to enter throughacquisition. The court's presumed knowledge of the "butfor" world based on the evidence before him shows a certainlack of humility in the face of powerful but as yet unseen forcesin industrial innovation. From the counterfactual perspective thatMeta is prohibited from acquiring Within, the court imagines aworld in which Meta is consigned helplessly to the sidelines of aVR dedicated fitness app market dominated by Within into whichothers, but not Meta, might seek to enter, while at the same timestriving to be the dominantindeed, evendefiningplatform in the "Metaverse." Such inactionby Meta, either by de novo entry or through a toeholdacquisition, seems akin to Google leaving the development ofAndroid-based mapping or messaging apps entirely to independentthird parties.

The court's concern in this case should have been whetherrequiring Meta to innovate in the VR dedicated fitness app spaceindependently instead of acquiring Within would avoidanticompetitive condition likely to reduce competition in thefuture. As the operator of the dominant VR platform, Meta is in asuperior position to innovate in the markets complementary to itsplatform. By capturing the dominant innovator in a complementarymarket, Meta greatly strengthens its ability to fend off futurecompetition in that market. For this reason, the transaction islikely lessen competition.


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

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