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Google, Inc. & Motorola Mobility Holdings, Inc.

A Non-Horizontal Merger & Acquisition Case

Maastricht University School of Business and Economics Maastricht, 04 April 2012 Name: Gregor Hohls ID: i6001867 Study: International Business Economics Course: International Competition Policy Course Code: EBC2093 Group Number: 02 Tutor Name: G. Valletta Writing Assignment: Final Case Study

Table of Contents
1. Introduction ................................................................................................................... 1 2. The Case ........................................................................................................................ 1 2.1 Google, Inc. .......................................................................................................................... 2 2.2 Motorola Mobility Holdings, Inc. .......................................................................................... 2 2.3 Reasons for a Merger ........................................................................................................... 2 2.4 The EU Decision .................................................................................................................... 3 2.5 The US Decision .................................................................................................................... 4 2.6 Intermediate Summary ........................................................................................................ 5 3. Economic Analysis .......................................................................................................... 5 3.1 Antitrust Guideline ............................................................................................................... 5 3.1.1 Product Market Definition ................................................................................................... 6 3.1.2 Foreclosure or Harm on Consumers .................................................................................... 9 3.1.3 Efficiency Gains .................................................................................................................. 10 3.1.4 Results ................................................................................................................................ 11 3.2 Outlook and Other Issues ................................................................................................... 11 4. Conclusions .................................................................................................................. 12 Bibliography .................................................................................................................... 13

1. Introduction
On August 15th in 2011, Google, Inc. announces that it has agreed on acquiring Motorola Mobility, Inc. by means of share purchase. This $12.5 billion deal is Googles first step into the mobile device hardware market and can therefore be seen as a non-horizontal or vertical merger, as Google has been active in the market at a different stage of the supply chain through the development of one of the major mobile device operating systems (OSs): Android OS. This merger will strengthen Googles stance in the market for mobile devices and will mainly boost Googles patent portfolio. Nearly one third of all mobile device sales in 2011 were smartphones with a growth rate of 58 percent from 2010. In this rapidly developing market with such a high number of consumers, it is of great importance that there is high competition in order to keep the prices low and to drive innovation. As this market is also very global, antitrust organisations all over the world, for example the United States Department of Justice or the European Commission need to check, whether a merger like the one that is presented in the following could harm competition or increase a firms market power in a market above an acceptable level. Additionally, this paper will face the question, whether the sinergies of this merger are big enough to influence the competition commissions decisions. In order to answer these questions, this paper will firstly present the case and the decisions from both the European and the US point of view. Secondly, it will show an analysis of the economic background of the case to trace the steps of the two antitrust commissions and then, thirdly it will conclude with a competition analysis and a search for efficiency gains that justify the commissions decisions, followed by a short outlook.

2. The Case
As an introductory part to this paper, I will give some general information about the firms, their operations prior to the merger and a projection of their combined future. I will also present the notifying partys (i.e. Googles) reasons for why they would like to acquire Motorola. Following this are the EU and U.S. decisions and a short abstract on the differences in their approaches.

2.1 Google, Inc.

Google is mainly known as a provider of its internet search platform and online advertising services. Founded by Larry Page and Sergey Brin in 1998, it became a publically traded company in 2004 and since then it has become one of the biggest players in web-based enterprises around the world. Its broad range of products goes from web search tools, via advertising services like AdSense or AdWords, communication and publishing services, development resources, map-related products, statistical tools and desktop applications to mobile applications and the operating systems Android for mobile devices and ChromeOS for personal computers. (Google, Inc., 2012a)

2.2 Motorola Mobility Holdings, Inc.

MMI, formerly the mobile devices division of Motorola Inc., became its own publically traded company in January 2011. In the 1990s it was the pioneer of the flip phone, the StarTac. With this and through its focus on this market segment it was able to develop its hit product, the super-thin flip phone: Motorola RAZR. While these boosted its position in the analogue mobile phone market for a while, MMIs slow adaption to digital technology made it lose the race to its rivals, e.g. Sony Ericsson or Nokia, in the beginning of the 21st century (Motorola Mobility Holdings, Inc. , 2010). Its market share began to drop with a record $1.2 billion loss in 2007 and continued to drop in the years thereafter towards 2.7 percent in 2010. This, amongst other issues, has led some people to believe that Motorola was nearing bankruptcy. (Gartner, Inc., 2011)

2.3 Reasons for a Merger

In its own press release, Google Inc. (2012) states the main benefits of the deal to be: 1. An acceleration of innovation and choice in mobile computing through which consumers will get better phones at lower prices and 2. A protection of the Android Ecosystem through Motorolas patent portfolio, which guarantees Android to stay open-source software, which is vital to completion in the mobile device space, as it is ensuring hardware manufacturers, application developers, mobile phone carriers and consumers all to have choice. Since 2008 Motorola has fully implemented the Android operating system for their

smartphones, which creates a natural fit between [the two] companies (Google, Inc., 2012b, p. 1). This, as well as Motorola being a member of the Open Handset Alliance (OHA), a consortium to create open standards for mobile devices, which now includes 84 firms from every part of the supply chain, will enable faster innovation. Another point that Google stresses in their facts about the acquisition is the long history of innovation in communications technology at Motorola Mobility and additionally the development of intellectual property. The latter is very important to Google as it will support their own, so far very small, patent portfolio to defend Android OS against the strong competition from Apple and Microsoft, which is well explained in an extra paragraph in their press release. It is very important to Google to support the constant competition it has injected into the smartphone market since the introduction of the first Android phone in 2008. They are trying to give consumers, application developers, and mobile carriers high-quality alternatives to products like Apples iPhone and iPad and RIMs BlackBerry (Google, Inc., 2012b, p. 2). Google especially highlights what they will not be trying to do with the merger, in order to keep competitors and consumers calm. They do not want to close the Android ecosystem and favour Motorola over other hardware manufactures. The Android OS will stay available to everyone on an open source basis. Google will also not force their partners to use Google search (in order to boost their own advertising revenues).

2.4 The EU Decision

The European Commission (EC) was notified of the proposed merger in late November 2011. Since Google and Motorola Mobility have a combined world-wide turnover exceeding 5 billion and each have an EU-wide turnover of more than 250 million, as well as neither one company is achieving more than two-thirds of its EU-wide turnover within one European country, the merger has an EU dimension and has therefore to be allowed by the EC. In their analysis of whether the merger would bring about competition issues, the EC concluded to focus on the vertical relationships between Google as the supplier of the open source Android OS and online services on the one hand and Motorola Mobility as a supplier of mobile devices and holder of important Intellectual Property Rights for mobile devices on the other hand (European Commission, 2012, p. 4). The EC splits its initial market analysis into three parts: Firstly it focusses on the market for operating systems, secondly it analyses the market for mobile devices and thirdly it discusses the Standard Essential Patents (SEPs) 3

Google acquires from MMI. With their market analysis they conduct a competition analysis and conclude in all areas that the merger does not raise any competition issues, which can also be seen in the economic analysis that follows later. Their decision therefore is to drop the investigation and allow the deal to go through without any remedies or changes to be made.

2.5 The US Decision

The United States Department of Justice (DOJ) has approached the case in a similar, however, slightly different way. It combined the investigations of the merger case with acquisitions of certain patents by Apple Inc., Microsoft Corporation and Research In Motion Ltd., as all of these were linked to each other. In their analysis, the DOJ followed a similar approach to the EU, checking, whether the proposed acquisitions would create incentives and abilities for the acquiring firms to exploit ambiguities in the SSOs F/RAND [fair/ reasonable and non-discriminatory terms] licensing commitments to hold up rivals, this preventing or inhibiting innovation and competition (U.S. Department of Justice, 2012, p. 2). In terms of Microsoft Corp.s and Apples acquisition of Nortel patents, the divisions concerns were lessened by the clear commitments by Apple And Microsoft to license SEPs (U.S. Department of Justice, 2012, p. 1) on FRAND terms, as well as their commitments not to seek injunctions in disputes involving SEPs. However, the Department of Justice identifies Googles commitments to be less clear. The Department refers to Googles open letter to all Standard Setting Organizations (SSOs) and argues that Googles statement does not directly provide the same assurance, as for example the other companies mentioned before. Google for example mentions in their letter that it will not seek injunctions for the infringement of SEPs against a competitor, however only for disputes involving future license revenues, and only if the counterparty forgoes certain defenses such as challenging the validity of the patent; pays the full disputed amount into escrow; and agrees to a reciprocal assurance as the other companies statements concerning the exercise of its newly acquired patent rights (Lo, 2012, p. 3). These are, however, only reasons for the Department to decide on further monitoring of how competitors are exercising their patents, in order to identify potential misuses of the SEPs and not to prohibit the merger. It therefore concludes to allow all three transactions and highlights that each of them incurs a complex intersection of intellectual property right ans antitrust law (U.S. Department of Justice, 2012, p. 5), which 4

need to be balanced out correctly.

2.6 Intermediate Summary

After introducing the companies and their personal reasons for a merger, I have presented the antitrust commissions decisions and their general view of the proposed transaction. I did this in order to give a basic overview of the case surroundings for a better understanding of the now following economic analysis of the case, which will be based on an own antitrust guideline, supported by data from the companies themselves and the EU commissions detailed analysis of the markets.

3. Economic Analysis
Following the preceding description of the case is a detailed analysis of the market for the proposed transaction as well as a competition analysis to identify and explain the risk of anti-competitive behaviour post-merger. I will also present the potential benefits for consumers that may result because of this transaction. I will begin by explaining the method of analysis: my antitrust guideline.

3.1 Antitrust Guideline

In a vertical merger case it is important to follow certain steps in the analysis to identify whether a merger could be harmful for consumers or not. In his book about competition policies, Massimo Motto (2004, p. 377) concludes his chapter on vertical restraints and vertical mergers by saying: a per se prohibition rule [for vertical mergers] would clearly be inappropriate, since it would forego efficiency effects which are likely to dominate in most cases. These efficiency gains are to be found through the analysis below, in order to justify the competition policy makers decisions. The following Figure 1 shows the steps of such an analysis. A first step in every antitrust investigation is the definition of the relevant market. Through an analysis of the pre- and post-transaction market shares the analyst ends up with a verdict on dominance. If the merged entity will not be dominant, no further investigation is necessary, although the transaction might still be questionable. If dominance results from the transaction, it needs to be assessed, whether there is the possibility of foreclosure and potential harm on consumers. If this is the case then we need to see, if the before-

mentioned efficiency gains outweigh the losses on consumer welfare and foreclosure of the market.
Product Market DeniEon

Dominant

Not Dominant

Is there Foreclosure?

Will it hurt Consumers?

Are there Eciency Gains?

No further InvesEgaEon - although quesEonable Decision

Figure 1: Antitrust Guideline 3.1.1 Product Market Definition With regards to the definition of the relevant product markets, the European Commission has split up the analysis three-fold. First, it analyses the relevant market for operating systems: the market Google is active in. Operating systems are system software products that are designed to support the functioning of the mobile device and the corresponding applications (European Commission, 2012, p. 5). Googles OS, Android, is free to use, edit, and further develop under an open source licence. Google states that Motorola is not active in this market, as well as proposes to expand the market for mobile software platforms for smartphones to include mobile software platforms for tablets, as they are very similar to each other (arguing that for example Apples iOS is running on both the iPhone and the iPad). Additionally, Google sees Android as a direct substitute to other software platforms such as iOS (Apple) or BlackBerry OS (Research in Motion), which are not available for third- party Original Equipment Manufacturers (OEMs): From a demand side perspective [...] users can substitute between devices using licensable and non-licensable mobile software platforms(European Commission, 2012, p.5) and on the supply-side, OEMs can switch between mobile operating systems or start producing their own. In the view of the EU 6

Commission (2012), which is in line with Googles proposal, it can be concluded that: 1. Mobile OSs are different from PC OSs 2. Mobile OSs for smartphones are different from basic mobile phones 3. Mobile OSs for smartphones and tablets are part of the same market. Figure 2 shows the percentage of each operating systems market share for every quarter in 2010 and 2011. The trend lines I have added clearly show the constant increase of Android OSs usage in those two years, whereas the Symbian operating system faces a strong decrease. Apples iOS market share is increasing at a much slower rate, which is probably due to the fact that Android is available for a lot more mobile devices.
60,00 50,00 40,00 30,00 20,00 10,00 0,00 2010 2010 2010 2010 2011 2011 2011 2011 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Android iOS Symbian RIM Microsoft Bada Other Linear (Android) Linear (iOS) Linear (Symbian)

Figure 2: Mobile OS Market Shares % 2010 and 2011 by quarter (Gartner, Inc., 2011) The market for mobile devices, the Comissions second analysis part, is much easier to identify, as decisions from earlier EU Antitrust cases can be adopted. The commission decides that it separates the smartphone market from the market for other mobile devices (basic and feature phones) as the difference in functionalities and distribution channels majorly affects the consumers choice. Figure 3 on the next page shows the market shares of the smartphone manufacturers for the final quarters of 2010 and 2011. Apple and Samsung are the two big winners in the year 2011, whereas Nokias market share drops by almost a half. Motorola Mobilitys market share is negligible and gets lost as part of others. The market for Standard Essential Patents is very complex and therefore hard to generalise. Google, Inc. will acquire about 7000 to 8000 patents, of which 6000 7000 are US and 500

30 25 20 15 10 5 0 2010 Q4 2011 Q4 Apple Samsung Nokia Research in Motion HTC Others

Figure 3: Market Shares of Smartphone Manufacturers (Gartner, Inc., 2011) 1000 are EU patents. Motorola Mobilitys patent portfolio focuses mainly on wireless communication hardware and to some extent high-definition television (HDTV) (European Commission, 2012, p.2). This quote shows that the patents Google will acquire are part of many different product markets and therefore the commission defines that each SEP can be considered as a separate market in itself as it is necessary to comply with a standard and thus cannot be designed around (European Commission, 2012, p.12), meaning that there are no perfect substitutes or many alternatives for each patent. In terms of geographical boundaries the markets are said to be at least covering the European Economic Area, if they cannot even be considered worldwide and therefore very large in size. The product market analysis shows firstly, that although Android OS is by far the leader in the mobile OS market it does not change its position through the acquisition of Motorola Mobility, Inc.,; the success of Android is fully dependent on the smartphone manufacturers decision to choose it as their OS. Therefore, secondly, we notice that Motorolas market share in the market for mobile devices is negligibly low and will not create any dominant position in that market. Thirdly, Google states openly that it will not be favouring Motorola handsets and we can see that if it would do so, Androids market share and therefore a lot of advertising revenues would be lost. Lastly, because every SEP is seen as a separate market

and Google is committing openly to license all acquired patents under FRAND terms, there are no concerns for competition raised here as well. 3.1.2 Foreclosure or Harm on Consumers Although the preceding analysis has shown that there is no dominant position post-merger, meaning that no further investigation is necessary, I will continue with a competition analysis to see possible effects of foreclosure or harm on consumers. This will lead us to possible efficiency gains that result from the merger. Foreclosure is the behaviour of a firm to engage in many different practices aimed at deterring entrants (Motta, 2004, p. 88). These include, amongst others: investing in extra capacity, setting prices below cost, flooding a market wth many different product specifications, [...], bundling, price discriminating (Motta, 2004, p. 88). These activities can eventually force competitors out of a market and will keep possible competitors from entering. As mentioned earlier, it is very important to keep the market for mobile devices highly competitive as it affects an incredible amount of consumers. Subsequent to the merger Google will have access to all three key elements that are needed for a mobile device to work: (i) technology that allows the device to operate over mobile networks; (ii) a mobile OS; and (iii) the remaining device hardware (European Commission, 2012, p. 12). The first it will get through the acquisition of patents, the second Google already posesses and the third comes from Motorola. Therefore there are two vertical relationships that are created between those three points: the OS as a key ingredient into smartphones and the Standard Essential Patents as key ingredients into the smartphone industry. Next to these, the merger also presents some conglomerate relationship in the connection between smartphones on the one hand and Googles online services on the other hand. An analysis of the vertical relationship delivers the following results. Although Google states that it does not control Android and therefore Androids market share [] should not be attributed to Google but to each of the various OEMs building Android based phones (European Cmmission, 2012, p.13), the manufacturers state something different. Since Google is responsible for each new release of the Android OS and has to approve each tablet or smartphone that wants to run it, the Commission finds that all market share should be attributed to Google on the OS level. With this significant market share, Google would have enough power to exert some of the practices mentioned before. Through choosing a lead manufacturer for each new version of 9

the Android OS, it could significantly impede competition especially by favouring Motorola irrespective of its performance. Google could also downgrade versions of Android it offers to other OEMs than Motorola and therefore make their own handsets more attractive. Although the possibilities are great for Google to use these methods to foreclose the market, the revenue loss for Google from restricting access to Android is more likely to be far greater than the potential gain from Motorola Mobility smart mobile device sales (European Commission, 2012, p. 16). This is the main reason why it will be very likely that Google will try to ensure that Android is distributed as widely as possible amongst several OEMs and that it will not close the market, trying to boost only the Motorola smartphone sales. The topic of foreclosure does not seem to be an issue in this case. The question remains, whether the transaction will hurt consumers or not. Those using Motorola smartphones up until know will not be harmed by the transaction as Motorola Mobility is already using Android as the exclusive operating system for its smartphones. Other consumers using Android on other manufacturers devices might only benefit from Google having their own in-house hardware production, because the creation of new Android versions might improve through the cooperation of software and hardware development. 3.1.3 Efficiency Gains The large amount of patents Google buys from Motorola will bring some stronger competition to the smartphone market. As a lot of the patents are essential to every producer of smartphones, they will need to license them from Google from now on. Of course, they will be faced with the same terms and conditions as before with Motorola, however the power in Googles hands can bring about some difficulties for Apple or Samsung for example. HTC Corp., the second-biggest Asian smartphone producer for example has bought nine patents from Google that were part of the Motorola deal, with which it is now able to defend itself against a law suit by Apple. Apple was suing HTC for copying certain features of the iPhone. Google knows that HTC is under tremendous legal pressure from Apple and clearly on the losing track (Milford & Decker, 2011, p.1). By selling the patents to HTC, Google is clearly supporting one of its major OEMs to be able to stick up against one of its major competitors. By strengthening its OEMs, Google can further expand 10

its Android ecosystem and create a powerful counterpart to its competitors. As David Balto, senior fellow at the Center for American Progress and a former antitrust official at the Federal Trade Comission says: If anything, antitrust regulators may see the deal as a boost to competition. Android is such a crucial competitor to the iPhone in particular, that allowing Google to buy Motorola Mobility will likely produce even more innovation in smartphones and other devices (Tessler, 2011, p.1). 3.1.4 Results The economic analysis of this merger has shown that in terms of product market definition there are no issues of dominance. Whereas Android might be seen as dominant in the market for operating systems there will be no intentions for Google to foreclose any part of the market for new entrants. Google will also not be able to force any competitors out of the market by favouring solely Motorola smartphones, because of its small market share. Additionally, there are some efficiency gains through the acquistion of patents in terms of creating strong competition against Apple. Yves Maitre, senior vice president of France Telecom Orange gives the deal his blessing by saying: I believe it is always good to have very strong players and very integrated ones. We welcome strong competitors to Apple, and Motorola and Google will be this type of very strong competitor (Fried, 2011, p.2).

3.2 Outlook and Other Issues

An interesting issue to have a short look at is where Google will go from here. As mentioned earlier it has already used the purchased patents to support HTC in fighting one of Apple Inc.s lawsuits. Through the transaction Google gains the power to pull off some more moves like this. The patent portfolio also offers Google the opportunity to get further involved in the media market as it includes patents for high definition television, as mentioned in the beginning. These will provide the basis for the development of TV set-top boxes and other home entertainment devices; another sector in which there will be more competition (Higginbotham & Fehrenbacher, 2011). Tim Worstall (2011), author for The Register, claims that there is much more to the deal than patents and competition issues. He raises the issue that together with the company, its equity, employees, etc., Google has also bought a series of tax losses, which will reduce the cost of buying Motorola Mobilty from $12.5 billion to $3.8 billion. This is due to the fact that Motorla Mobility has been losing a shed-load of

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cash in recent years. It has lots of [] tax losses, which can now be offset against Googles future profits (Worstall, 2011, p.2). Google will be taxed on cumulative profits over a longer period of time and bringing in these losses will reduce the amount of money Google will have to pay taxes on. The tax benefits of the deal make what was a good deal into a great deal (Browning & Byrnes, 2011, p.1) said Robert Willens, a New York accounting and tax expert.

4. Conclusions
A great deal that is the general perception of this acquisition case. The preceding analysis has confirmed the public view of this merger as it has first presented the two companies and the reasons why Google would like to acquire Motorola. The short description of the European Commssions as well as of the United States Department of Justices decision have presented the legal background to the case. The following economic analysis gave answer to the questions stated in the introduction: The merged entity will not be able or more precisely it will not be willing to foreclose any of the markets it is active in. This would only harm its own operations and profits and it will have great influences on customer satisfaction. The efficiency gains analysed afterwards show that Google will create even more competition subseding the transaction, rather than destroy it. Furthermore, the acquired patents will stabilise Googles position as a competitor to Apple Inc. and other companies with great market shares. In conclusion, I can only agree with the European Commission and the US Department of Justice in saying that this acquisition of Motorola Mobility, Inc. by Google, Inc. should not be prohibited, as it will create a strong market player that is not dominant and will therefore increase innovation in the industry.

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Lo, A. (2012, February 8). Letter to Standard Setting Organizations. Retrieved March 20, 2012 from Google, Inc.: http://www.google.de/press/motorola/pdf/sso-letter.pdf McCarthy, J., & Golvin, C. S. (2011, August 15). Analysis: Google's Acquisition of Motorola Mobility. Retrieved March 19, 2012 from Forbes: http://www.forbes.com/sites/forrester/2011/08/15/analysis-googles-acquisition-of- motorola-mobility/ Milford, P., & Decker, S. (2011, September 8). HTC Sues Apple Using Google Patents Bought Last Week as Battle Escalates . Retrieved March 30, 2012 from Bloomberg: http://www.bloomberg.com/news/2011-09-07/htc-sues-apple-alleging-infringement-of- four-u-s-patents.html Motorola Mobility Holdings, Inc. (2010). ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. Washington, D.C.: United States Securities and Exchange Comission. Motta, M. (2004). Competition Policy Theory and Practice. New York, NY: Cambridge University Press. Tessler, J. (2011, August 16). Feds Likely to Let Google Buy Motorola Mobility . Retrieved March 30, 2012 from Associated Press: http://abcnews.go.com/Technology/wireStory?id=14311422 U.S. Department of Justice. (2012). Statement of the Department of Justices Antitrust Division on Its Decision to Close Its Investigations of Google Inc.s Acquisition of Motorola Mobility Holdings Inc. and the Acquisitions of Certain Patents by Apple Inc., Microsoft Corp. and Research in Motion Ltd. Washington, DC: Author. Worstall, T. (2011, September 1). The real reason Google bought Motorola. Retrieved March 22, 2012 from The Register: http://www.theregister.co.uk/2011/09/01/google_buys_tax_breaks_along_with_mobility/ 14