The CFI Microsoft Judgment: Abuse 1 - Interoperability Dr Amelia Fletcher Chief Economist Office of Fair Trading NB The views expressed here are my own, and not necessarily those of the OFT

Refusal to Supply by Microsoft: The basic economic story I ● Microsoft Windows has a ‘quasi-monopolistic’ position in the supply of PC operating systems ● For non-Microsoft servers to work effectively with client PCs (and servers) running on Windows, interoperability with the ‘Windows domain architecture’ is required ● This is not being provided (and previously was) ● As a result, Microsoft has quickly gained a dominant position on the server market, and its position continues to strengthen

● Microsoft’s share of work group server OS market had experienced rapid and significant growth:  25% in 1996 to  61% in 2002 (by turnover) ● Substantial and continuing decline in market shares of Sun, Novell and Linux ● Competitors not eliminated but non-Windows servers restricted to certain tasks such as print servers or based on legacy installations Facts of the case: The foreclosing effects of the refusal to supply

Refusal to Supply by Microsoft: The basic economic story II ● Microsoft has an incentive to foreclose the server market:  A key exception to the Chicago School ‘one monopoly profit’ argument relates to the situation where, by foreclosing market B, the monopolist can prolong its own monopoly over market A.  Here, by gaining and strengthening a dominant position in servers, Microsoft can (1) reinforce barriers to entry into client PC operating systems, and (2) prevent (or control) any paradigm shift towards server-centric IT solutions

Refusal to Supply: Pro-competitive benefits ● It is typically pro-competitive for firms to be able to choose their trading partners (or deny supply):  The threat to refuse to supply plays a key role in competitive commercial negotiations  Exclusive relationships can be crucial for incentivising relationship-specific investments  Firms compete partly on the basis of the strength of their trading relationships (or ability to self-supply)  In the case of IPRs: IPRs are specifically designed to provide ex post exclusivity following innovation, in order ex ante to incentivise such innovation

Suggests a high hurdle for Refusal to Supply IPRs cases ● Only intervene if:  Likely effect on competition is substantial  There is a clear story on the incentive for abuse  The abuse harms dynamic competition, and therefore innovation, not just static competition  The intervention (or threat of such interventions in the future) does not harm innovation indirectly (by altering innovation incentives) by more than the abuse harms it directly.

Refusal to Supply IPRs: Economic enforcement policy I ● Does Firm X have the ability to foreclose?  Is the refused product ‘necessary’ for others firms to compete effectively in market B? ● Has it foreclosed all effective competition?  Have all competitors been refused supply? ● Does the firm have the incentive to foreclose?  Does Firm X also compete in market B?  Does the ‘one monopoly profit’ argument hold? ● On balance, is innovation likely to be harmed?

Refusal to Supply IPRs: Economic enforcement policy II ● On balance, is innovation likely to be harmed?  Is there likely harm to dynamic competition from the refusal to supply in this case?  How high is the risk to ex ante innovation from (the threat of) interventions such as this?  Does the former effect exceed the latter?

Refusal to Supply by Microsoft: The Commission’s Approach ● “The case-law of the European Courts suggests that the Commission must analyse the entirety of the circumstances surrounding a specific instance of a refusal to supply and must take its decision based on the results of such a comprehensive examination” ● “There is no persuasiveness to an approach that would advocate the existence of an exhaustive checklist of “exceptional circumstances”… [for finding abuse]”

Refusal to Supply by Microsoft: The Commission’s Key Findings Ability to foreclose ● Interoperability necessary for server OS vendors to be effective competitors. There are no substitutes. Substantial Foreclosure Effect ● All competitors refused interoperability ● Microsoft’s share in server market rising fast and indeed now dominant Incentive to foreclose ● The ‘one monopoly profit’ argument fails on the facts Harm to innovation ● Risk of harm to innovation from abuse that outweighs potential harm to innovation incentives from intervention

● Not made explicit, but question should be whether supply of the relevant info would have harmed Microsoft’s innovation incentives, had it known ex ante the supply would be required ● Commission found no significant negative effect:  Supply of relevant info would not enable ‘cloning’ of Microsoft’s servers  Such disclosure is normal practice in this industry  Other disclosures have been required, and these do not seem to have harmed innovation No significant harm to innovation incentives from intervention

Refusal to supply by Microsoft: The CFI’s Approach ● Treated as IPR (although not clear), as did EC ● Case law says refusal to supply will be abusive only in exceptional circumstances, including:  Indispensability  Exclusion of any effective competition  Prevents appearance of a new product  No objective justification ● The Court carried out only a ‘limited review’ of the Commission’s ‘complex economic assessments’

Ability to foreclose ● Interoperability necessary for server OS vendors to be effective competitors. There are no substitutes. Substantial Foreclosure Effect ● All competitors refused interoperability ● Microsoft’s share in server market rising fast and indeed now dominant Incentive to foreclose ● The ‘one monopoly profit’ argument fails on the facts Harm to innovation ● Risk of harm to innovation from abuse that outweighs potential harm to innovation incentives from intervention Refusal to Supply: The Commission’s Key Findings Indispensability Exclusion of any effective competition Prevents appearance of new product AND No objective justification No objective justification

A reaction to the CFI judgment “the standard applied to unilateral conduct by the CFI, rather than helping consumers, may have the unfortunate consequence of harming consumers by chilling innovation and discouraging competition.” Thomas Barnett US DOJ

● The CFI test for effect is ‘risk of elimination of any effective competition’, but in market B ● What if the real motivation for Firm X’s refusal is to protect its monopoly position in market A ● Now, what if Firm X did supply some competitors in market B – enough for effective competition – but none who might pose a threat in market A? ● Clear incentive and effect, but how would this case be run legally? No rounded story on effect

● The Commission appears to recognise the need for balancing up positive and negative effects ● Microsoft challenges this ‘new evaluation test’ as legally defective, vague and impossible to apply ● CFI opines: Balancing is not appropriate but is a misreading of the Commission’s Decision  Rather, Commission finds no significant negative effect on Microsoft’s incentives to innovate from intervention that would offset the harm to technical development from the refusal to supply No role for balancing in assessing harm to innovation

● The Commission examined carefully Microsoft’s ‘one monopoly profit’ argument for why it had no incentive to foreclose ● No CFI discussion of this. Why?  Because fully dispensed at Commission stage?  Or because irrelevant under EC case law? ● Sadly, probably the latter ● But should be one of first things to think about! No analysis of incentive to foreclose

● Commission tell a story of anti-competitive incentive and effect, and why refusal is not justified by innovation incentives ● CFI follows a checklist approach (and does not reopen any ‘complex economic assessment’) ● Pro: The CFI needed to do this to avoid appeal, so shouldn’t read as negative about the ‘more economic approach’ ● Con: Possibly dangerous. Rough congruence here, but not necessarily In summary

● Microsoft required to provide interoperability information to Windows domain architecture, i.e:  Provide interoperability information to allow non- Microsoft servers to interact with Microsoft client PCs  Provide interface information to allow non-Microsoft servers to interact with Microsoft servers ● Why the latter?  Would this remedy have been imposed if Microsoft had not been dominant in server market?  Yes, due to the technical nature of this product. But otherwise? Does the remedy reflect the abuse?