Court Rejects FTC’s Bid to Block Meta’s Proposed Acquisition of VR Fitness App Developer

On January 31, 2023, U.S. District Court Judge Edward Davila (N.D.Cal.) denied the request of the Federal Trade Commission (FTC) for a preliminary injunction to halt Meta’s acquisition of virtual reality (VR) fitness app developer Within.  Because Meta does not compete in the VR dedicated fitness app business, the litigation was a rare example of how a court assesses the “actual” and “perceived” potential competition theories of harm.  Although the court upheld the FTC’s market definition, claims of a highly concentrated market, and the validity of these potential competition theories, the court ultimately held that the FTC failed to demonstrate it was “reasonably probable” Meta would have entered the VR dedicated fitness app business without the Within acquisition, or that VR dedicated fitness app developers’ perception of Meta as a potential entrant had a direct effect on tempering anticompetitive conduct in that market. 

The FTC announced that it would not appeal the decision, although it has not clarified whether it will continue to pursue its administrative trial process, scheduled for hearing beginning February 13, even though the parties may have closed the transaction by then.  Although the FTC succeeded in reaffirming, and potentially advancing, the case law around potential competition theories of harm, this is the first litigated decision in the Biden Administration’s effort to reign in “big tech,” and represents a setback in that effort and yet another failure in the past several months to block mergers and acquisitions across a variety of industries.

Background

According to the court’s decision, Meta is investing heavily in the VR space, has an 80% worldwide share of VR headsets and operates a VR app store called the Quest Store.  In addition to offering VR apps developed by third parties, Meta develops its own VR apps (in part through acquired VR app studios) and funds development of VR apps by other parties.

In 2019, Meta acquired the developer of Beat Saber, a VR rhythm game that is the most popular VR app of all time and is viewed as a VR incidental fitness app.  Within’s key product is Supernatural, a VR dedicated fitness app available through the Quest Store, which has more than an 80% share of revenue among existing VR dedicated fitness apps. 

On October 22, 2021, Meta agreed to acquire Within for an undisclosed amount.  Following an investigation, on July 27, 2022 the FTC filed a complaint in federal court along with a motion for a temporary restraining order and preliminary injunction to block Meta’s acquisition, later amending its complaint to remove an allegation that Beat Saber and Supernatural are competing VR apps.  Meta filed a motion to dismiss on October 13, 2022.  Judge Davila held a seven-day evidentiary hearing on the parties’ respective motions, which ended on December 20, 2022.

Product Market

With respect to market definition, the FTC asserted that the relevant market is “VR dedicated fitness apps,” meaning VR apps “designed so users can exercise through a structured physical workout in a virtual setting.”  The defendants argued for a broader market to include other non-dedicated fitness VR apps and non-VR connected fitness products and services.  

Judge Davila utilized the Brown Shoe factors in assessing the proposed market definition, ultimately agreeing with the FTC’s narrower definition.  The court found that while VR dedicated fitness apps compete for consumers with other types of exercise products and apps, the evidence showed that VR dedicated fitness apps are a distinct economic submarket.  The court noted that the industry recognizes VR dedicated fitness apps as a distinct submarket; the VR dedicated fitness apps market has several peculiar characteristics and uses in comparison to other VR apps or forms of exercise, including being specifically marketed for fitness (e.g., trainer-led workouts, trackable progress), and providing the VR experience itself (e.g., transporting the user to a virtual 360-degree environment for the workout, being fully portable and taking up little space); and VR dedicated fitness apps have distinct customers from other products and apps.

Notably, the court also found that it was of no importance to its conclusion that the quantitative analysis by the FTC’s economic expert, carried out in the form of the hypothetical monopolist test (HMT), was faulty.  The court said that a relevant product market need not be proved through the HMT and that the Brown Shoe factors alone sufficed.

Theories of Harm

The FTC relied on two sparingly-used legal doctrines that prohibit mergers that reduce “actual potential competition” and “perceived potential competition.”  The court noted that both theories require proof that the relevant market is “substantially concentrated,” and found the FTC met its prima facie burden based on various measures of concentration. 

Having done so, the court shifted the burden to defendants to undermine that showing of market concentration, and it rejected the defendants’ argument that the FTC was required to plead oligopolistic, interdependent, or parallel behavior.  Rather, it was defendants’ burden to rebut the prima facie case by showing that the market was not subject to oligopolistic, interdependent, or parallel behavior, which the court found defendants failed to do.

Defendants also presented evidence of market nascency (all firms in the market entered within the last five years), volatility of market shares, new entry (a doubling of VR dedicated fitness apps), and low barriers to entry.  The court was “inclined” to find that such evidence did not sufficiently rebut the FTC’s prima facie case of substantial concentration, but the court did not decide the issue because the FTC did not satisfy the other elements of its potential competition theories.

Actual Potential Competition

Judge Davila first addressed the argument that the acquisition would substantially lessen competition because it deprives the VR dedicated fitness app market of the potential competition that would result from Meta’s independent entry.  Noting that the Ninth Circuit has not yet addressed the actual potential competition theory, the court declined defendants’ request to reject the theory outright as a “dead-letter doctrine.”  Judge Davila determined that he would apply the Fifth Circuit’s “reasonable probability” standard, pursuant to which the FTC must prove a “likelihood [of entry] noticeably greater than fifty percent,” rather than defendants’ proposed “clear proof” standard, which the FTC itself had adopted in a prior case. 

In assessing the FTC’s proof that Meta must have “available feasible means for entering” the market other than through the acquisition, the court held that there was no doubt Meta had the financial and VR engineering resources to undertake de novo entry.  However, it found that Meta lacked certain capabilities that are unique and critical to entry into the VR dedicated fitness app market, such as fitness content creation and studio production facilities.  The court also found that the record was “inconclusive as to Meta’s incentives to enter the relevant market,” noting that Meta can enjoy the benefits of VR fitness growth without directly entering the VR fitness app market.  Finally, Judge Davila assessed the actual means of entry Meta considered, including by repositioning its Beat Saber VR app to be a dedicated fitness app, and found that the FTC did not meet its burden of showing it was reasonably probable that Meta would have entered the market without the acquisition.   

Perceived Potential Competition

The FTC also argued that the acquisition would substantially lessen competition by eliminating the competitive influence Meta exerts on firms by virtue of its presence on the fringes of the market.  On this theory, the court said that the FTC needed to show that Meta (1) possessed the characteristics, capabilities, and economic incentive to render it a perceived potential de novo entrant, and (2) Meta’s premerger presence on the fringe of the target market in fact tempered oligopolistic behavior by existing participants.

The court found that the objective and subjective evidence did not show that Meta was perceived as a potential competitor by in-market firms, and that there was insufficient evidence that it was reasonably probable that Meta’s presence as a potential competitive had a “direct effect” on the competitive behavior of those firms.  However, even though the court found that the FTC failed to provide evidence sufficient on the second element, it held that the FTC’s complaint – alleging that Within was “concerned about making any moves that would hurt its ability to compete against Meta as a potential entrant” and providing an example – was sufficient to satisfy the FTC’s pleading burden, and on that basis denied defendants’ motion to dismiss the perceived potential competition claim.

Accordingly, the court held that the FTC did not demonstrate the likelihood of ultimate success on the merits of the perceived potential competition claim, nor the actual potential competition claim, needed to warrant a preliminary injunction.