On June 19, 2017, the Trump Administration’s Federal Trade Commission (“FTC”) authorized the staff to file an antitrust complaint to block the merger of DraftKings and FanDuel, the two largest daily fantasy sports (“DFS”) sites. The state of California and the District of Columbia Attorneys General joined in the lawsuit. The FTC’s legal challenge is a huge win for DFS customers.
Merger to Monopoly Tests Trump’s Antitrust Enforcement Policy
On November 18, 2016, shortly after President Trump won the election, the two largest DFS firms announced their plans to merge into a single company that would control more than 90% of the DFS market. Regardless of the political backdrop, any merger that would result in a virtual monopoly was sure to be highly scrutinized.
What is daily fantasy sports?
DraftKings and FanDuel each offer customers a quality website platform to compete in daily fantasy sport contests. They both operate in a similar fashion. Customers who participate in DFS contests generally pay an entry fee to play. This fee is different depending on the contest. Entry fees can range from $1 to $1,000 or even higher. Typically, the DFS customer selects a roster of professional athletes, which is limited by a salary cap so a customer can’t pick all the best players. DFS customers are competing with each other by selecting his/her own individual lineups. Each lineup earns fantasy points based on the real-life performance of the selected athletes using a predetermined scoring system. The DFS customers whose lineups generate the most fantasy points based on their ranking versus the other contestants receive cash prizes directly from the DFS provider. DraftKings and FanDuel provide DFS customers access to a wide variety of contests at a variety of entry fee levels and at varying prize levels. Undoubtedly, the two firms compete on price, innovation, and quality of product.
Why Did DraftKings and FanDuel Believe They Could Obtain Regulatory Approval?
So why would DraftKings and FanDuel announce a merger that appears to be anticompetitive on its face?
First, the timing seemed right. The Obama administration had been tough on mergers in concentrated industries so hesitating to pull the trigger on a deal that would arguably result in a merger to monopoly was prudent. The timing of the merger announcement occurred during the transition period and a couple of months before the inauguration so the companies were clearly hoping for a pro-business review that would result in an approval of the transaction. The merger to monopoly presented a test for the new Trump administration.
Second, the merging parties contended that the relevant market was much broader than DFS contests for cash prizes. Indeed, they argued that by combining they would be able to compete in the seasonal market with media powerhouses, ESPN and Yahoo. Some 57 million people play traditional season-long fantasy football, where users draft one team at the beginning of the NFL season and stick with that team for the whole year. By arguing that they compete with seasonal long fantasy football, DraftKings and FanDuel were claiming that the relevant antitrust market was much broader and that their combined share was minuscule. Moreover, only an estimated 6 million people have tried the “daily” alternative that DraftKings, FanDuel, Yahoo, Fantasy Aces, and others offer. But there’s no question that DraftKings and FanDuel dominate DFS contests, where customers can win actual cash prizes. Indeed, unless you are not a sports fan at all, it would have been difficult not to have heard of DraftKings and FanDuel because they have been spending tons of cash on marketing and advertising to build their brands. Both even compete by offering cash awards as enticements to customers to open accounts.
Third, the merging parties likely argued that entry into the DFS market was relatively easy. After all, it is the internet and DraftKings and FanDuel probably pointed to Yahoo and Fantasy Aces as successful entrants into the DFS category.
Fourth, the parties argued that the merger would result in efficiencies and cost savings, which would allow the merged firm a better chance at profitability. These two companies have been spending so much money on marketing and advertising that neither one is currently profitable. In short, the parties are arguing that the merger is necessary to lower costs and generate efficiencies so they can provide a higher quality product at a reasonable price.
What is the FTC’s Case?
Clearly, the merging parties were unable to persuade the FTC that the relevant market was broader than DFS contests, that entry and expansion into the DFS market is easy, or that efficiencies would outweigh the competitive harms that would result from the combination of two close rivals that dominate the DFS market.
The FTC’s complaint alleges that the combined firm would control more than 90% of the U.S. market for paid DFS contests. According to the complaint, DraftKings and FanDuel are each other’s closest and most meaningful competitor. FTC alleges that the two firms view each other as close competitors and compete head-to-head to offer promotional enticements to customers, a range of entry fees, larger contests, the largest prize pools, greatest selection of sports and variety of daily contests. The FTC also alleges that the two firms aggressively compete with each other on price. Much of this portion of the complaint is redacted, but it appears that the FTC has some confidential information that the two firms have lower commission rates because of direct competition with each other. In short, the proposed merger would create a virtual monopoly in the paid DFS market and allow the parties to raise prices, reduce innovation, lower acquisition bonuses paid to new customers, and lower the quality of the product/service that is being provided.
According to the complaint, the FTC is alleging that DFS and season long fantasy sports contests are not in the same market. The FTC is contending that DFS consumers are unlikely to view season long fantasy sports contests as a meaningful substitute for paid DFS. This allegation appears to make sense given that DFS consumers are looking for a quick daily contest compared to a season long contest, which lasts many months.
The complaint also alleges that entry or expansion by other providers is not likely to provide timely or sufficient competition to offset the anticompetitive effects of the merger. The FTC alleges that it is difficult for new startups to enter the DFS market because it is difficult to acquire a critical mass of customers. While it may be relatively easy to create a website platform, the FTC alleges that new competitors would find it difficult to convince customers to use the new platform versus the more established platform of the combined firm. The other impediment is that a new entrant would need to make significant investments in information technology infrastructure and software development. The fact that Fantasy Aces, one of the smaller DFS competitors, filed for bankruptcy in the middle of the investigation did not help DraftKings and FanDuel’s cause. This likely generated some problems for the merging parties because it is difficult to argue that entry and expansion is easy if one of the few nascent competitors is not doing very well. While Yahoo, a major internet media company, is currently the number three player in the DFS market, and only entered the paid DFS market last year, the FTC likely found that Yahoo for whatever reason has not established a significant customer base despite its own advantages. So, the FTC without naming it, basically discounted Yahoo’s entry.
The complaint also asserts that purported efficiencies would not offset the likely competitive harm.
Both FTC commissioners voted to issue the administrative complaint and to authorize staff to seek a temporary restraining order and preliminary injunction in federal court. The administrative trial is scheduled to begin on November 21, 2017.
DraftKings and FanDuel are currently reviewing their options.
The FTC’s challenge of the merger of DraftKings and FanDuel demonstrates that President Trump’s FTC will take action to preserve competition and protect consumers when the facts support a lawsuit. The FTC’s lawsuit is a huge victory for DFS customers. The two DFS firms directly compete with each other and dominate the DFS market. Despite the presence of major media companies such as ESPN and Yahoo in the broader season long fantasy sports market and Yahoo in the DFS market, the FTC discounted their presence, defined a narrow product market, and found that entry and expansion into the DFS market is not necessarily easy. This FTC action shows that the Trump administration is not simply waving through all deals and just because the industry involves the Internet does not necessarily mean that entry and expansion is easy. Though the FTC lacks a full commission, the FTC is still doing its job to protect consumers by quickly making a decision on this merger. In fact, the investigation and the authorization to sue was completed within just eight months. The other lesson learned is that the FTC does not appear to be taking into consideration whether the two merging firms are actually profitable rather the FTC is focusing on the reduction of price and non-price competition. The next move is up to DraftKings and FanDuel and whether they want to litigate in front of a federal judge. While the odds are against them, they will have their opportunity to tell their side of the story to a judge.