Maintenance of Monopoly U.S. v. Microsoft (2001)

Introduction In May of 1998, the US Department of Justice, twenty individual states, and DC filed suit against Microsoft Claimed Microsoft had monopolized the market for PC OSs Also that it had used its monopoly to engage in a wide range of antitrust violations

Introduction Cased was tried in federal court starting in October of 1998 The court determined its legal conclusions on April 3, 2000 After appeals, settlement discussions, and a remedy trial period, Microsoft eventually settled at the end of 2002

Introduction Considered the antitrust case of the 1990s. Arguably one of the most significant of the 20th century Problems for Microsoft beyond this case: Class actions on behalf of consumers The EU begins increased enforcement Focused more on the media player packaged into Microsoft’s operating systems

Claims by Both Sides The Government claimed that Microsoft had engaged in multiple anticompetitive acts to protect its OS monopoly Consumers were being harmed by higher prices Microsoft’s actions had reduced innovation Microsoft argued it was not a monopoly Highly dynamic industry Microsoft also claimed to be procompetitive since consumers benefited Access to high quality, innovative software

Background Microsoft a relatively young corporation Began its existence in the mid 70s Since then, has exploded growth-wise and made many of its employees millionaires With success comes (antitrust) scrutiny Questions about whether or not Microsoft has restrained competition, excluded competitors, or expanded its market power through noncompetitive means

Background (Earlier Cases Against MS) In 1990 the FTC investigated Microsoft Involved software licensing practices Was voted to bring no suit against the company Immediately after that investigation ended the DOJ started its own In 1994, the DOJ filed a complaint saying that Microsoft’s contracts with OEMs were anticompetitive/exclusionary Case did not go to trial. Microsoft settled with the Government Signed a consent decree which limited Microsoft but still explicitly allowed the development of “integrated” products

Background (How it Got Started) The battle of the browsers Netscape Navigator was first successful internet browser To catch up Microsoft forced OEMs to license and install their browser (Internet Explorer) The Government sued Microsoft for this and was initially successful On appeal, however, it was ruled that the combination of Internet Explorer and the OS offered functionality not available without product “integration.

Background (How it Got Started) DOJ, 20 states, and The District of Columbia brought suit against MS claiming: That Microsoft had engaged in a range of practices in violation of Section 1 of the Sherman Act OS Licenses with OEMs Contracts with ISPs Ties between its OS and Internet Explorer That Microsoft had attempted to monopolize the market for internet browsers (Violated Section 2 of the Sherman Act)

Why Java/Netscape Was a Threat High “applications barrier to entry” Operating Systems depend on a wide range of applications to be successful These are typically sunk costs once you’ve spent time developing them Java could potentially lower the barrier Cross-platform language Netscape could potentially distribute Java to independent developers They could choose to write programs for another OS (OS/2 or Linux), putting Microsoft’s monopoly at risk

An Overview of the Economic Issues Did the Microsoft Corporation possess monopoly power in the market for personal computer operating systems? Did Microsoft maintain its monopoly power by a series of anticompetitive actions that unreasonably restrained trade?

Claim #1 Government's View: Microsoft's View: Microsoft did possess monopoly power in the market for operating systems for Intel-compatible desktop personal computers Microsoft's View: The relevant market for antitrust purposes is substantially broader than Intel-based PC OSs; it includes hand-held computer operated systems and servers Also, it faces threats from other non-OS platforms that can support applications and threats from yet unknown innovations The very fact that Microsoft found it necessary to take action against Netscape and Java shows that those companies and their products are in the market. Thus, Microsoft does not have monopoly power.

Claim #2 Government's View: Microsoft's View: They claimed Microsoft foresaw the possibility that the dominant position of its Windows OS would be eroded by Internet browsers and by cross-platform Java. Microsoft engaged in a series of anticompetitive practices in order to protect the monopoly power of its Windows OS Microsoft's View: It did perceive a competitive threat from Java and responded in a number of ways to combat that competitive threat However, those responses were the reasonable and appropriate responses of a competitor and cannot be appropriately characterized as an attempt by Microsoft to maintain its OS monopoly.

Debating the Economic Issues Did Microsoft have monopoly power? The Government’s Perspective Yes, according to market share data Microsoft’s share of PC operating systems was very high and had remained stable over time. During the 1990s, Microsoft’s worldwide share of shipments of Intel- based operating systems had been approx. 90 percent or more

Debating the Economic Issues Microsoft’s Response Microsoft denied it had market power, claiming that the government’s market definition was invalid It argued that it competed vigorously to remain a provider of the leading software platform. Any market power it enjoyed was temporary, thus could not be characterized as monopoly power

Debating the Economic Issues The Court’s Perspective The court supported the Government’s position on the market definition and monopoly power issues They also affirmed that there were significant barriers to entry in the market

Did Microsoft Maintain Its Operating System Monopoly by Thwarting the Threat Posed by Netscape’s Browser? The Government’s Case The government stressed that by bundling its free browser with its OS, Microsoft prevented browser companies from entering the browser market unless they entered the OS market as well

Did Microsoft Maintain Its Operating System Monopoly by Thwarting the Threat Posed by Netscape’s Browser? Market Allocation Microsoft took part in a number of market allocation efforts with Netscape, Apple, and Intel in an effort to minimize the competitive threat to its OS monopoly Netscape-Microsoft attempted to limit Netscape to the server market, so Microsoft could dominate the PC browser market Intel- Microsoft threatened to deny support for Intel’s new generation of processors Apple-Microsoft required Apple to make Internet Explorer the default browser on all Macintosh operating systems

Did Microsoft Maintain Its Operating System Monopoly by Thwarting the Threat Posed by Netscape’s Browser? Predatory Pricing Microsoft devoted $100 million per year to develop Internet Explorer which it distributed at a negative price Predatory Pricing Strategy Definition: A strategy in which the predator forgoes current profits in order to eliminate or cripple the competition, with the expectation of recouping those forgone profits at some point in the future.

Bundling and OEM Restrictions Microsoft bundled IE with Windows 95 and with Windows 98 The Government stated that there was separate demand for browsers and for operating systems 1996: Microsoft imposed screen and start-up restrictions on OEMs The Government argued that Microsoft viewed Netscape as a platform to support substitute OSs Because of bundling, OEMs and users were forced to take IE along with Windows if they did not wish to do so Harmful to consumers: limited browser choice Harmful to those who preferred not to use a browser Restrictions on OEMs keep them from developing better browsers Restrictions included: preinstallation of IE when Windows 95 or 98 installed, limited ability of OEMs to promote other browsers, agreements to not modify or delete IE Government stated that restrictions caused “significant exclusionary effect that ensured that IE was the only browser on most PCs shipped by OEMs”

Exclusionary Agreements with ISPs Microsoft drew up contracts with ISPs to limit the number of customers to whom ISPs could distribute other browsers Microsoft created a desktop folder for “favored ISPs” Government stated that Microsoft extracted promises from those ISPs ISPs = Internet Service Providers Largest distributors of browsers after OEMS Microsoft identifies companies that distribute IE and Netscape without preference as “IE Parity”

Exclusionary Agreements with ISPs (cont’d) ISP restrictive provisions: 75% or more ISP shipments must only have IE and only include a competing browser when requested Restricted total shipments of non-Microsoft browsers Government saw provisions as anticompetitive Provisions decreased competing browser manufacturers’ ability to distribute and promote their browsers

Microsoft’s Response “Browser battle” was really part of larger effort to be leading PC provider of Microsoft Windows Actions were not predatory improving its own browser and OS not eliminating Netscape Efficiencies in integrating browser into OS Microsoft saw Netscape’s Navigator as a competing software platform, and that it “had every right to compete aggressively with its most serious platform competitor” Microsoft stated that it had decided in 1993 to incorporate browser into OS

Microsoft’s Response (cont’d) Discussions with Netscape, Apple, and Intel did not alter their behavior Offering free browser was “natural step” toward integrating the browser into Windows 95 and 98 Government did not provide evidence that integrating the browser into its OS was “not profit-maximizing apart from any predatory motives” Microsoft pointed out that Apple continued to develop its QuickTime software and Intel’s software development was simply delayed, not eliminated Free browser did not heart Netscape because it could garner revenue from selling advertising on Netcenter (its web portal)

Microsoft’s Response OEM restrictions justified in order to “preserve the quality and speed of the start-up process” Bundling is not anticompetitive if firm does not have market power In fact, efficiencies would be lost if Microsoft had to separate its browser from the OS Government’s view that there were ways to remove IE from Windows 95 and that it was therefore not essential to Windows was irrelevant because Microsoft regarded Windows 95 and 98 as different Government’s claim that there was no decline in quality of Windows 98 when IE was misleading because the Government only removed “the visible means of accessing the browser and not the browser functionality itself”

Microsoft’s Response (cont’d) Justified in competing aggressively for the distribution of its browser Hence, ISP agreements were necessary OEM and ISP agreements = “no harm, no foul” Netscape could distribute its browser through the mail or encourage downloads from the web

The Court’s View Judge Jackson supported the Government’s claims of anticompetitive acts Sided with the Government on: Market allocation Predatory pricing Bundling Exclusionary agreement “Tying” the browser to OS was anticompetitive Judge Jackson only sided with Microsoft on claim that the Government did not have sufficient evidence that OEM and ISP restrictions eliminated competition Circuit court of appeals affirmed that OEM and ISP restrictions were anticompetitive and that Microsoft’s tying of its browser to its OS was anticompetitive

Was Microsoft’s Alleged Anticompetitive Behavior Harmful to Competition?

The Government’s View Microsoft succeeded in excluding Netscape from OEM distribution Relevant measure = Microsoft’s share of browser usage Contract restriction responsible for decline in Netscape’s share Microsoft’s browser share reached over 85% by mid-2000 The Government compared ISPs that made IE their default browser with ISPs that did not make IE their default browser 1997: Microsoft had a 94% weighted average share of browser shipments by ISPs that made IE their default browser vs. 14:5 weighted average share of browser shipments by ISPs that did not make IE their default browser 60% weighted average share of browser usage by subscribers to ISPs who made IE their default browser vs. 20% weighted average share of browser usage by subscribers to ISPs who did not make IE their default browser

Microsoft’s Response Wide distribution of browser = more people buy PCs to browse the Internet Planned to improve the quality of its browser None of its actions had or would harm consumers AOL could distribute Netscape if it so chose Microsoft’s share of the browser market would diminish Microsoft sold more copies of Windows OS, so browsers are a complement to Oss

Microsoft’s Response (cont’d) Disputed Government’s measure of browser market share Numbers offered that the market for browsers had not tipped in Microsoft’s favor Netscape failed to market its browser more effectively Microsoft had a better product Microsoft had a better product because: Invested $100 million annually in its browser Invested heavily in the distribution of IE Integrated its browser in Windows Reached a contract with AOL to have AOL use IE technologies for its own subscribers All of the above were pro-competitive from Microsoft’s point of view

The Court’s Perspective Findings of Fact supported the Government’s view “To the detriment of consumers,…Microsoft also engaged in a concerted series of actions designed to protect the applications barrier to entry, and hence its monopoly power from a variety of middleware threats…” –Judge Jackson Judge Jackson found that Microsoft’s refusal to give OEMs Windows without IE, forced them to ignore consumer demand Gave consumers PC systems that ran slower and had less memory space available Those who wanted Navigator had to pay the price in the form of downloading, installation, and confusion as well

The Court’s Perspective (cont’d) Microsoft kept Navigator from becoming an innovation that could enable other firms to compete effectively in the OS market Microsoft’s actions deterred investment in technologies and businesses that could threaten Microsoft Competition is necessary for consumer welfare and innovation

Resolution? The U.S. v. Microsoft case has now been resolved, and a remedy chosen Path to remedy circuitous The appellate court made clear it’s dislike of a structural remedy Easier to enforce than behavioral remedies, but also riskier as far as creating inefficiency Proposed settlement contained 3 components

Proposed Settlement First, attempted to prohibit Microsoft from foreclosing the OEM channel by eliminating restrictive licensing agreements and outlawing retaliatory measures. Second, it attempted to keep the ISP distribution channel open by placing limits on Microsoft’s ability to discourage companies from promotion of other middleware. Third, the settlement offered a series of compliance measures whose goal is to enforce the terms of the settlement agreement.

Opposition to the Proposal 9 States Opposed the Initial Proposal The proposal didn’t prohibit Microsoft from illegally bundling it’s middleware with its OS Claimed that the proposal wouldn’t effectively prohibit retaliatory conduct or open the ISP channel of distribution Were worried Microsoft could still withhold vital technical information from developers of rival middleware Enforcement mechanism won’t be effective

The Result? Judge Kollar Kelly was generally supportive of the initial settlement between the DOJ and Microsoft The court did offer more aggressive compliance procedures sympathetic to the issues raised by the litigating states

Where are We Now? Almost a decade later, the government’s predictions about browser competition have turned out to be correct. IE’s share of the market grew to over 90% Microsoft’s OS monopoly continues today New challenges for Microsoft A rise in browser competition from Firefox, etc. Power has shifted to web based companies Linux based operating systems gaining traction