The Case against Microsoft

© 2004 Pearson Addison-Wesley. All rights reserved12-2

© 2004 Pearson Addison-Wesley. All rights reserved12-3 The case against Microsoft Microsoft is often accused of exploiting its dominant position How does it do this? Is it guilty? Are consumers worse off? Are there remedies?

© 2004 Pearson Addison-Wesley. All rights reserved12-4 The charges FTC and DoJ (US) –1994: restrictive licensing agreements with OEMs. Settled by consent decree –1998: broke consent decree by bundling Internet Explorer with Windows EU Commission –MS abusing dominant position, 500m Euro fine

© 2004 Pearson Addison-Wesley. All rights reserved12-5 What does MS do? Restrictive licenses – e.g. a site license for a university for Windows, the price dependent upon the number of employees, not the number of users Restrictions on OEMs – e.g. not allowing Dell to install other software as standard (e.g. Netscape, Real Player). Users have to install these themselves

© 2004 Pearson Addison-Wesley. All rights reserved12-6 What MS does (cont) Bundling programmes with Windows – e.g. Internet Explorer, Media Player, often added free. Undermining (‘enhancing’ say MS) industry standards – e.g. Java language

© 2004 Pearson Addison-Wesley. All rights reserved12-7 Against Microsoft It is a monopolist It abuses that position It erects barriers to entry Used its position to enter and dominate other markets (browsers) It keeps parts of Windows secret, aiding its own software (e.g. Office)

© 2004 Pearson Addison-Wesley. All rights reserved12-8 In defence of Microsoft Monopoly ensures common standards There is a threat of entry Price of Windows is not excessive MS has the right to enhance Windows MS innovates

© 2004 Pearson Addison-Wesley. All rights reserved12-9 How to we analyse this? Useful bits of economics: –Monopoly theory –Barriers to entry –Bundling/tie-in sales –Networks

© 2004 Pearson Addison-Wesley. All rights reserved12-10 The monopoly price of Windows Windows is bundled with a PC, so we must consider the joint product MC PC = $500, MC W = $20, e = -1.5 Recall RHS = 3, so monopoly price of PC is $1560 Who gets the monopoly rent?

© 2004 Pearson Addison-Wesley. All rights reserved12-11 Microsoft! Microsoft is a monopolist, PC manufacture is highly competitive. Hence MS could sell Windows for $1060 to PC manufacturers, a 50-fold mark-up over MC! But actually, it sells Windows for around $40… Why is Windows so cheap?

© 2004 Pearson Addison-Wesley. All rights reserved12-12 Why is Windows so cheap? Threat of piracy Allows a higher price for Office, etc. Network effects – to encourage adoption Threat of entry

© 2004 Pearson Addison-Wesley. All rights reserved12-13 Why so cheap? Piracy - a threat in the early days and in some parts of the world, but main market is OEM and businesses, where the problem is less. Office price - can only extract consumer surplus once. Better to do it with Windows than Office. Low price of Windows benefits all writers of software, not just MS

© 2004 Pearson Addison-Wesley. All rights reserved12-14 Economics of networks Some goods have network effects (telephones, TVs) The benefit you get from a good depends upon how many others also have the good Part of the benefit of MS Word is that everyone has it, hence can exchange documents easily

© 2004 Pearson Addison-Wesley. All rights reserved12-15 Network effects Race for market share Winner takes most Profits unequally distributed, monopoly Possible consumer benefits of common standards Can be intense competition to become the market leader Costs of entry high, but leader can be overturned (e.g. Sega/Nintendo by Playstation)

© 2004 Pearson Addison-Wesley. All rights reserved12-16 Threat of entry Difficult, with network effects, but possible IBM tried, with OS/2 in 1990s, but failed Apple is not a significant competitor Linux is biggest current threat Browser + Java language also a threat

© 2004 Pearson Addison-Wesley. All rights reserved12-17 Barriers to entry and anti-competitive behaviour Widespread adoption of Windows creates an ‘applications barrier to entry’ to OS market Browser + Java provided a way around this MS ‘hijacked’ Java by adding extensions that only worked with Windows. Sneaky!

© 2004 Pearson Addison-Wesley. All rights reserved12-18 Bundling MS bundled IE with Windows, effectively killing off Netscape Bundling several programs together (MS Office) creates a barrier to entry Why bundle goods together?

© 2004 Pearson Addison-Wesley. All rights reserved12-19 The Economics of bundling Willingness to pay for Word and Excel: Strategies: –Price both at 60: revenue = 120 (1 sale of each) –P W = 30, P X = 20: revenue = 100 (2 sales) –Sell bundle for 80: revenue = 160! WordExcelTotal User User

© 2004 Pearson Addison-Wesley. All rights reserved12-20 Why bundling works Demands are uncorrelated Can get both users to buy both products without lowering the price of either too far Makes entry more difficult Next time you go to the restaurant, think about why there is both a set menu and à la carte menu… Bundling has benefits too - who would want to buy a car without tyres?

© 2004 Pearson Addison-Wesley. All rights reserved12-21 Why bundle with Windows? Since MS can obtain all the monopoly rent via Windows alone, why does it need to bundle other products with it (e.g. IE) for free? Perhaps to fight off the threat from alternative operating systems MS controls the desktop

© 2004 Pearson Addison-Wesley. All rights reserved12-22 Implications for policy Structure vs conduct remedies –Break up MS –Regulate its conduct

© 2004 Pearson Addison-Wesley. All rights reserved12-23 Structural remedies OS company and applications company (Judge Jackson) Still would not have competition Risks losing benefits of common standards

© 2004 Pearson Addison-Wesley. All rights reserved12-24 Conduct remedies Stop MS bundling products with Windows: –Web browser –Media player –Video players –What is the ‘operating system’? Danger of over-regulating a dynamic industry Does MS really innovate?

© 2004 Pearson Addison-Wesley. All rights reserved12-25 Summary and conclusion MS provides some benefits, in terms of common standards It seems to have restricted competition in a variety of ways Remedies are not easy to impose