Microsoft is betting its future on cloud gaming — but that's what tripped up the Activision deal

Important Points

Cloud gaming is the one that Microsoft is betting on for its future in gaming. Microsoft's blockbuster Call of Duty Warcraft and Diablo titles could be withheld from cloud gaming platforms in the future, according to U.K. regulators.

Microsoft's offer to purchase Activision Blizzard at $68.7 Billion was one of the largest acquisitions ever in the history of video games -- and for the Redmond-based technology company.

Activision was purchased by the U.S. technology giant for many reasons. Activision is the owner of many popular video game franchises, including Call of Duty and World of Warcraft.

Microsoft would add a wealth of content to its Xbox gaming division. Microsoft would also add talent to its own game studios, which could be used for developing new games.

Cloud gaming was the one that Microsoft bet its gaming future on. That's why U.K. regulators decided to block Wednesday's deal.

What is cloud gaming?

Cloud gaming allows people to play games on any device that has an internet connection, whether it's a PC, console, smart TV or mobile phone, from a data center located far away.

In the past, to play a video game you would need dedicated hardware, such as a PC or console.

With the advancement of smartphones, things have improved over time. There are even studio-quality games like Call of Duty Mobile that you can play on your phone.

Cloud gaming is different because it allows you to stream titles from remote data centers of a company in real-time, much like you'd do with a Netflix movie or show.

Microsoft has spent a lot of time and money to make cloud gaming an integral part of its game offering. Cloud gaming is a perk that Microsoft has included in its Xbox Game Pass subscription service, which gives people access to many titles for a monthly charge.

Cloud gaming can be a great benefit to consumers in developing countries where consoles and computers are expensive.

Microsoft has been losing ground to rival consoles, particularly Sony, over the years. Sony's PlayStation 4 console won the "console Wars" in the last generation, surpassing Microsoft's Xbox One on lifetime sales.

The current console generation, which will be launched in November 2020 is more of the Same. According to the latest quarter's numbers, 32 million PS5 units have been sold.

Microsoft does not publish unit sales as part of its results. However, an estimate by the video game data site VGC puts lifetime sales for Xbox Series X and S consoles at just over 20 million units.

Microsoft CEO Satya Nadella explained the vision for cloud gaming in an interview Tanvir Gill conducted with CNBC in November.

"We want to make sure that people can play the games they enjoy on any platform they choose. "That's what we want," Nadella stated.

We love consoles, PCs, and mobile devices. "We love xCloud which is a streaming service so you can play on your TV and whatever else."

He added, "Activision has been a great partner for us today and we'd like to make all of the content available across every platform."

Why the CMA is worried

The CMA's merger review, published on Wednesday, expressed concern that Microsoft's dominance in cloud gaming could harm competition.

In a Wednesday press release, the CMA stated that allowing Microsoft to have such a dominant position in the cloud gaming sector at a time when it is growing rapidly could undermine the innovation necessary to develop these opportunities.

According to regulators, Microsoft accounts for 60-70% percent of the total cloud gaming market.

Microsoft, as well as other regulators and competitors like Sony, fear that Microsoft may in the future refuse to allow other cloud gaming platforms to offer Call of Duty Warcraft and Diablo.

Activision Blizzard’s crown jewel is Call of Duty, which sells huge numbers each year. In the first 24 hour period, more than 6,000,000 people played its Warzone multiplayer battle royale mode.

Microsoft can use this as a valuable asset. Imagine Nintendo buying Electronic Arts and offering a $10 monthly subscription to play all new FIFA soccer games the moment they were released.

Azure is Microsoft's cloud computing platform. It is used by many companies to store and process data.

The analyst firm Omdia told CNBC that while Microsoft has partnered with cloud gaming providers in order to bring selected ABK games to their services, it does not mean they will have unrestricted default access.

Microsoft has absorbed these fees in a different manner as part of its acquisition.

Omdia said that Microsoft also owns Azure infrastructure, which powers Xbox Cloud Gaming as well as other third-party cloud services. These companies will pay for each minute and user of the Azure backend.

Microsoft should be able to operate at lower costs in ten years, when the cloud gaming market is much bigger.

Cloud gaming is not perfect

Cloud gaming is in its infancy. For the technology to work properly, it needs a good internet connection. Otherwise, gamers will experience performance drops and latency problems.

Shooters and combat games require a high level of responsiveness.

Google Stadia was killed in September, only three years after it launched, due to the struggle of finding the right market for the service.

Cloud gaming is also not a big market. According to Omdia data, cloud-enabled services will generate $5.1 billion in revenue by 2022. This is less than 15% the $35 billion generated by console games.

The CMA is concerned that Microsoft's technology could stifle the gaming industry as it moves towards mass-market adoption. According to the CMA, cloud gaming revenues will triple in 2022.

Omdia stated that the CMA was taking a "forward-looking" view of the issue, taking into consideration concerns about where cloud gaming will be in the future relative to the small size it has today.

Our projections show that cloud gaming will grow rapidly with revenues more than doubling in 2026.