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Microsoft on the Sherman Act

``` [Forwarded with permission. Rule represents Microsoft and is a former DoJ antitrust chief.]

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April 29, 1998

OVERVIEW OF SECTION 2 OF THE SHERMAN ACT AND ITS APPLICATION TO MICROSOFT

By Charles F. (Rick) Rule

A great deal of the public discussion concerning Microsoft seems to assume that, because Microsoft has been highly profitable and has engaged in various practices that have placed a number of rivals under intense competitive pressure, the company is fair game for whatever "remedies" the Department of Justice might choose to impose. In fact, however, the Department's power to impose remedies on Microsoft is dependent on its ability to establish in court that Microsoft has violated section 2 of the Sherman Act. Specifically, the Department must prove not only that Microsoft has monopoly power but also that Microsoft has acquired or maintained that power through "exclusionary" or "predatory" acts.

In light of those legal requirements, there simply is no sound basis for a section 2 suit against Microsoft. The various theories that have been advanced by Microsoft's detractors as grounds for a section 2 suit would require a radical departure from existing case law. In effect, the law's current focus on consumers and innovation would have to be diverted to protection of competitors at the expense of consumers. Moreover, those theories would require courts to second-guess Microsoft's product design and distribution efforts - a task that the courts are simply not equipped to perform. And, even if the Department could persuade the courts to transform the antitrust laws so radically, any remedy that the Department might seek to impose would inevitably be highly regulatory and would almost certainly reduce consumer welfare and impede innovation. I. Section 2 of the Sherman Act and "Monopolization"

As the Supreme Court has stated, "Congress designed the Sherman Act as a 'consumer welfare prescription.'" Reiter v. Sonotone Corp., 442 U.S. 330, 343 (1979), quoting R. Bork, The Antitrust Paradox 66 (1978). In other words, the law protects the marketplace from private conduct that interferes with the competitive process. Or stated differently, the antitrust laws protect "competition, not competitors." Brown Shoe Co. v. United States, 370 U.S. 294, 320 (1962).

Antitrust law as a general matter does not attempt to regulate the unilateral activities of a person or firm. In addition, the law does not condemn commercial success achieved through competition on the merits, even when it results in the competitive triumph of a single firm. Rather, the law - section 2 of the Sherman Act specifically - only condemns "monopolization" (or attempts to "monopolize"). 15 U.S.C. =A7 2. As interpreted by the courts, "monopolization" has two elements: (A) the possession of monopoly power in a relevant market and (B) the "willful" acquisition or maintenance of that power "as distinguished from growth or development as a consequence of a superior product, business acumen, or historic accident." United States v. Grinnell Corp., 384 U.S. 563, 570-71 (1966).

A. Monopoly Power (1) The Law

* - A necessary, though not sufficient, prerequisite for a violation of section 2 of the Sherman Act is a showing that the defendant has "monopoly power." The Supreme Court has defined such power as "the power to control market prices or exclude competition." United States v. E.I. du Pont de Nemours & Co., 351 U.S. 377, 391 (1956). While a very large market share may raise an inference of monopoly power, "[w]hen there are better ways to estimate market power, the court should use them." Ball Memorial Hosp. v. Mutual Hosp. Ins., 784 F.2d 1325, 1336 (7th Cir. 1986). For example, a large market share is only indicative of monopoly power if it is durable and persistent. If there are low barriers to entry or to expansion by fringe firms or if the market is highly dynamic, then a firm's current market position is likely to be fragile and any hope of exercising market power will be futile. See, e.g., Los Angeles Land Co. v. Brunswick Corp., 6 F.3d 1422 (9th Cir. 1993) (holding that the defendant did not possess monopoly power despite the fact that it had a 100 percent share of the relevant market). (2) Application to Microsoft* - Microsoft's critics claim that, because Microsoft's operating systems are installed on a large percentage of the PCs being shipped today, Microsoft has monopoly power. That claim, however, is extremely misleading for several reasons. First, a "market" limited to operating systems installed by computer manufacturers on Intel-compatible PCs is unduly circumscribed. Not only can a computer manufacturer choose among various PC operating systems, including IBM's OS/2, Solaris x86 from Sun Microsystems, UnixWare from Santa Cruz Operation, and Linux (the "open" operating system based on Unix), but consumers and businesses can choose systems other than a PC, such as an Apple Macintosh, a so-called Net Computer ("NC"), or even bigger systems such as mini-computers. In addition, any market definition that ignores the fact that Microsoft must compete against its own installed base fails to take account of an important competitive dynamic. Computer software does not wear out. A current computer owner will switch to a new operating system (whether Microsoft's or anyone else's) only if he or she perceives the incremental value of the new operating system to be worth its price. And, one cannot ignore so-called "middleware" layers, such as Netscape's browsing software or Lotus Notes, that provide independent software vendors or developers ("ISVs") with platforms complete with their own application programming interfaces ("APIs") that are being touted as substitutes for Windows. Indeed, powerful competitors such as IBM and Sun Microsystems are investing hundreds of millions of dollars to develop and market new technologies that they hope will replace Windows. Second, the "market share" of a software product is much less significant than the typical market share possessed by a manufacturer of a producer of physical goods. Once written, a piece of software can be copied an infinite number of times at virtually zero marginal cost. In other words, the productive "capacity" of every piece of software, once written, is virtually infinite, even if its current sales are de minimis. If the owner of the "dominant" software tries to reduce output, the fringe firms can costlessly increase the output of their software, completely replace the output withheld by the dominant software publisher, and thus thwart any effort to raise price. Therefore, any effort by Microsoft to raise prices (without providing commensurate value) would be doomed to failure because consumers are able to switch to competing operating systems or simply continue using the operating system they currently own. The price Microsoft charges and the market share it achieves are nothing more than a reflection of the inherent value (or superior efficiency) of Microsoft's operating systems as compared to the available alternatives. Third, because of the rapid change in technology in the computer market, there are always new opportunities for start-up firms or established players (such as IBM, Oracle, or Sun) to introduce new operating systems or to enhance existing ones. And, if those new or improved operating systems indeed represent the proverbial "better mousetrap," then they have a real chance to supplant the existing market leader. These opportunities are driven by changes, inter alia, in software, in hardware, in communications technology, and in consumer preferences. Microsoft has only succeeded by constantly bringing new technologies to consumers more efficiently, more attractively, and at lower prices than the competition. Some of Microsoft's critics claim that, because of so-called "network externalities," it is virtually impossible for anyone to challenge Microsoft's "dominance" on the PC desktop. Certainly, Windows is very popular, in part, because it provides for literally thousands of ISVs a valuable platform that simplifies the task of creating compatible applications and because millions of consumers have become familiar with the "look and feel" of Windows and have assembled libraries of Windows applications. Nevertheless, the notion that these "externalities" insulate Microsoft from competition is simply wrong. The same "lock-in" story was being told just a few short years ago about Nintendo's "monopoly" position in video games. Yet, in the intervening years, Sega and now Sony have overtaken Nintendo. The same thing will happen to Microsoft if it does not continue to innovate at a rapid pace and continue to offer its operating system at competitive prices. In short, notwithstanding the percentage of PCs currently being shipped with Windows, Microsoft has no power to suppress the changes that almost daily create opportunities for those hoping to supplant Microsoft. The company's only hope of sustaining its success is to continue to do the best, most efficient job of making each technological advance available to the consumer. That technological treadmill is hardly the quiet life and "deaden[ing] of initiative" experienced by a true monopolist. United States v. Aluminum Co. of America, 148 F.2d 416, 427 (2d Cir. 1945).

B. "Willful" Acquisition or Maintenance

(1) The Law

* - Even if Microsoft did have (or were ever found by a court to have) monopoly power, possession of such power alone would not constitute a violation of section 2 of the Sherman Act. The acquisition, maintenance or extension of monopoly power by virtue of foresight, skill, industry, or even luck is not unlawful. See, e.g., United States v. Grinnell Corp., 384 U.S. at 570-71.

Section 2 of the Sherman Act does not condemn a firm with lawfully obtained monopoly power from competing vigorously on the merits; rather, the law prohibits such a firm from engaging in "exclusionary" or "predatory" acts that lead to monopoly or that maintain an existing monopoly. According to the Supreme Court, "[i]f a firm has been 'attempting to exclude rivals on some basis other than efficiency,' it is fair to characterize its behavior as predatory." Aspen Skiing Co. v. Aspen Highlands Skiing Corp., 472 U.S. 585, 605 (1985), quoting R. Bork, The Antitrust Paradox 138 (1978). For example, in United States v. Lorain Journal Co., 342 U.S. 143 (1951), the Court found that the only local newspaper in Lorain, Ohio, had monopoly power over the sale of local advertising and had engaged in illegal exclusionary conduct. That conduct was blatant - the Journal flatly refused to accept any advertisements from companies also advertising on a new radio station that broadcast into Lorain and provided the only competing medium for local advertising. According to the Supreme Court, advertising in the Journal was "essential" for local advertisers, and the evidence was clear that the Journal engaged in the conduct to drive its only competitor out of business. The Journal, moreover, offered no efficiency rationale or other legitimate business justification for its conduct.

On the other hand, conduct for which there is a legitimate business justification (i.e., conduct designed to lower the cost of production, distribution or marketing or to increase demand for the product or service) is not exclusionary or predatory even if the conduct disadvantages competitors. See, e.g., Multistate Legal Studies, Inc. v. Harcourt Brace Jovanovich Legal and Prof'l Publics., 63 F.3d 1540, 1550 (10th Cir. 1995) ("A defendant may avoid liability by showing a legitimate business justification for the conduct"). In addition, so long as the justification is "asserted in good faith and not as a pretext, the defense does not require any kind of 'balancing' of social gains against competitive harms, except in the gross sense that trivial justifications should be disregarded." 3 P. Areeda & H. Hovenkamp, Antitrust Law =B6 658f, at 127 (Rev. ed. 1996).

Moreover, section 2 proscribes conduct, not intent, and illegality ultimately turns on objective evidence of anticompetitive effect, not on subjective evidence of intent. See, e.g., Ocean State Physicians Health Plan v. Blue Cross & Blue Shield, 883 F.2d 1101, 1113 (1st Cir. 1989) (a "desire to crush a competitor, standing alone, is insufficient to make out a violation of the antitrust laws"), cert. denied, 494 U.S. 1027 (1990). Statements by an alleged monopolist's officers - no matter how aggressive or colorful the rhetoric - cannot substitute for objective evidence that the alleged monopolist has actually engaged in exclusionary or predatory conduct. See, e.g., 3 P. Areeda & H. Hovenkamp, Antitrust Law =B6 651a, at 74 (Rev. ed. 1996).

(2) Application to Microsoft - When evaluating all the allegations concerning exclusionary conduct by Microsoft, it is useful to recall the outcome of the first wave of investigations of Microsoft in the first half of this decade. Notwithstanding careful examination (by both the Federal Trade Commission and the Antitrust Division of the U.S. Department of Justice) of numerous allegations, the Department found only a single practice - the so-called per processor license - to be worthy of challenge. And, even then, the Department stated on the record that the practice did not account for Microsoft's success in licensing operating systems to computer manufacturers but that the practice represented only a future threat to competition. According to the Department, Microsoft's position in the market was obtained by lawful means.

Microsoft's rivals, of course, did not stop making allegations when the court entered the consent decree preventing Microsoft from continuing to offer the option of a per-processor license. Indeed, not long after it agreed to the consent decree, the Department declared itself to be the "Microsoft complaint department." Now, the critics are alleging that Microsoft has engaged in various exclusionary practices in order to maintain its "monopoly" or to extend that monopoly into new markets, primarily the Internet. Nevertheless, most of the recent allegations are similar if not identical to those investigated and rejected by the Department during its original investigation. And, with respect to the current allegations that reflect actual (as opposed to confabulated) Microsoft practices, the conduct represents vigorous competition on the merits, not unlawful exclusion.

* o Integrating Internet Functionality into Windows -The current allegations focus largely on Microsoft's decision to integrate support for open Internet standards into Windows 95. However, the business justifications for that integration are numerous and manifest, while the adverse effect on rivals is nothing more than the inevitable impact of competition on the merits.

Quite simply, the principal reason Microsoft has integrated Internet functionality into its operating systems is that ISVs have demanded it. For example, ISVs are increasingly writing their applications to display information, whether stored locally (e.g., on a PC's hard drive) or downloaded from the Internet, in the common language of the Internet - so-called, hypertext mark-up language ("HTML"). Putting that functionality in the operating system allows the thousands of ISVs to call on the same HTML "shared library" in the operating system and to avoid the need for each ISV to write its own version of HTML rendering in its application. Having integrated HTML rendering and other Internet functionality into the operating system in order to satisfy the demands of ISVs, it is logical (and efficient) for Microsoft to provide a means (for example, the Internet Explorer ("IE") icon on the desktop) to enable consumers to launch that functionality to "browse" the Internet.

While the efficiencies of integrating Internet functionality into Microsoft's operating systems seem clear, the exclusionary effect of that integration is difficult to discern - except to the extent that such integration is so technologically superior that it diverts demand from web browsing software such as Netscape's Navigator and Communicator. Indeed, some level of Internet functionality has been integrated into Windows 95 from the time it was first shipped to computer manufacturers; however, it was not until IE's functionality (embodied in versions 3.0 and 4.0) surpassed that of Netscape's products that consumers in large numbers started choosing IE instead of those products.

Moreover, in its consent decree case against Microsoft, the Department has pointed to no evidence that Microsoft attempted to prevent any computer manufacturer from installing Netscape's web browsing software. Rather, Microsoft simply requires computer manufacturers to install Windows as shipped, thereby precluding them from deleting features, including Internet functionality and the IE icon. Ironically, Microsoft's enforcement of this license provision prevents Netscape - whose web browsing software is still used by more than 50 percent of Internet surfers - from obtaining exclusives with computer manufacturers; yet, the critics suggest it is Microsoft's conduct that is exclusionary!

* o "Giving Away" Internet Explorer - Similarly, the claim that Microsoft's policy of "giving away" IE amounts to predatory pricing is specious. In light of the fact that IE is integrated into Windows, it would be odd if Microsoft were to charge a separate, positive price for that one feature out of the scores of Windows features. And, no one disputes that Microsoft makes a profit on its sales of Windows.

Of course, Microsoft also allows existing owners of Windows to download the latest version of IE off the Internet at no charge and gives away to the users of non-Microsoft operating systems, such as Apple's Macintosh, the web browsing software that Microsoft has written for those other operating systems. However, those "give aways" are also not predatory. The Supreme Court has indicated that an alleged monopolist's pricing is not "predatory" unless its prices are "below an appropriate measure of [that firm's] costs." Brooke Group v. Brown & Williamson Tobacco Co., 509 U.S. 209, 222 (1993). Once a piece of software is written, the cost of copying it is essentially zero. Thus, even giving away copies of software would not be "predatory," as the Supreme Court has defined the term. Also, it was Netscape, not Microsoft, that began the practice of giving away web browsing software. Moreover, like Microsoft, Netscape gives away its web browsing software in the expectation of earning revenues elsewhere - for example, by stimulating sales of related software and services.

* o Manipulation of APIs to Disadvantage Competing Browsers - One of the favorite excuses of companies that have been unsuccessful in selling applications in competition with Microsoft has been the allegation that Microsoft has taken unfair advantage of undisclosed APIs in its operating systems in order to make Microsoft's applications work better than those of its rivals. The Department of Justice thoroughly investigated those allegations and rejected them before the original consent decree was negotiated in 1994. Nonetheless, based on published reports, Netscape is now trying to resurrect this canard as an excuse for its declining market share in web browsing software.

As with the past allegations, there is simply no substance to the claim that Microsoft has manipulated APIs in Windows to harm Netscape or anyone else. First, based on both Microsoft's own tests of its operating systems (both Windows 95 and Windows 98) and the observations of unbiased third parties (such as journalists), Netscape's browser products and related software install and function well on Windows - there is no evidence that Netscape's products routinely crash or that their performance is degraded. Second, Microsoft treats Netscape no differently from any of the other thousands and thousands of ISVs that successfully and profitably write applications for Windows. Netscape has full access to Windows APIs, and Microsoft's large software-developer relations group has always been available to work with Netscape to ensure that Netscape's browsing software functions to its maximum capabilities on Windows. Third, as even Microsoft's severest critics note, a central reason for Microsoft's commercial success has been the support Microsoft provides to ISVs writing applications for Microsoft's operating systems. That strategy, which Microsoft has traditionally and consistently followed, is fundamentally at odds with the allegations being resurrected by Netscape.

In short, there is no evidence that Microsoft has done anything to make Windows incompatible with Netscape's products. It would make no sense to do so given the popularity of those products among Windows users. Moreover, given the importance that Microsoft attaches to good relations with software developers, it is in Microsoft's interest to avoid even the appearance of treating one of those software developers unfairly by depriving it of information needed to develop applications that are compatible with Windows.

Nevertheless (and somewhat ironically), it is not unlawful for even a monopolist to make improvements in its products in such a way as to give its own related products (such as applications in the case of an operating system) a competitive advantage over competing products sold by rivals. And the law imposes no obligation on a monopolist to reveal proprietary information (such as APIs) to rivals simply because they are competitively disadvantaged without that information. A fortiori, if a company such as Microsoft systematically discloses large amounts of information about its new operating systems well in advance of commercial release to facilitate the development of compatible products, the fact that a feature of an operating system works better than a substitute stand-alone application would certainly not violate the antitrust laws.

* o Promotion of Microsoft's Web Browsing Software -Microsoft includes as part of Windows a so-called "wizard" that makes it easy for consumers to sign up for Internet access from a select group of Internet Service Providers ("ISPs"). Under their previous agreements with Microsoft, the few ISPs participating in the wizard-referral service agreed to promote Microsoft's web browsing software and not to promote (or otherwise try to switch consumers referred by the wizard to) competing web browsing software.

The provision reflected nothing more than a normal and legitimate understanding in a cross-marketing initiative, and it was not exclusionary. The provision appeared in Microsoft's agreements with only twelve ISPs in the United States, and those agreements did not prohibit the affected ISPs from distributing the web browsing software of Microsoft's rivals. The ISPs also were free to offer other Internet services (not participating in the referral program) that promoted competing web browsing software. In short, the provision was no more restrictive than similar provisions typically found in cross-marketing arrangements. Regardless of the industry, few if any firms (including those without the slightest hint of monopoly power) are willing to refer customers to third parties without some assurance that those customers will not be switched to the competition.

While the provision was hardly remarkable and clearly justified, it proved to be not very important to Microsoft's business. As a result, earlier this year when Microsoft was reviewing its agreements with participating ISPs, it modified the contracts to require merely that an ISP promote Microsoft's web browsing software no less favorably than the ISP promotes competing web browsing software. (Microsoft subsequently made essentially the same change to similar promotional limitations that appeared in its contracts with a few Internet content providers that participate in Microsoft's Channel Bar, a feature of Windows by which Internet content is automatically downloaded to a user's PC.)

o The "First Screen" Provision - Microsoft's critics also argue that it is "exclusionary" for Microsoft to ensure, through a provision in its licenses with computer manufacturers that, when a new PC is turned on ("booted up") for the very first time, the Windows user interface with all its features intact will appear. That provision of the Windows license reflects a key element of Microsoft's business formula for success, namely its guarantee to consumers and ISVs that the "look, feel, and functionality" of Windows will be consistent. When the consumer buys a PC that has Windows preinstalled, the provision ensures that the features a consumer associates with, and expects to see on, Windows will in fact be on the screen. Having allowed a computer manufacturer to install Windows and to use the Windows names and marks to sell the PC, Microsoft has a legitimate interest in preserving its goodwill by ensuring that its product reaches the consumer intact and not degraded. Indeed, in a few instances in the past when computer manufacturers shipped machines that initially booted to a first screen other than Microsoft's, some of the Windows' functionality was impaired and irate consumers blamed Microsoft.

While the "first screen" provision generates significant efficiencies, it is also crucial to keep in mind that it is in no legal sense exclusionary. Under the terms of Microsoft's license, a computer manufacturer is free to install on its PCs additional, non-Microsoft user interfaces to which the consumer can switch with a single "click of the mouse." After a new PC's very first "boot up" is complete, the machine's owner can configure the machine to boot to a different first screen thereafter. Similarly, computer manufacturers are free to load other third party applications and utilities - the icons for which computer manufacturers are free to place on the first screen of Windows - even if those applications and utilities compete with features of Windows. Indeed, if, as Microsoft's critics claim, the Windows first screen is the world's most valuable commercial real estate, more than three-quarters of that screen is "vacant" and freely available to a PC manufacturer to accommodate the icons of applications and utilities provided by the manufacturer and third parties.

* o "Tipping" - Some critics have claimed that because the operating system market is subject to "network externalities," practices that ordinarily might seem benign or that have only a slight exclusionary effect can "tip" markets in favor of a given operating system platform. It is claimed that such tipping can have a dramatic long-term anticompetitive impact, perhaps even enabling Microsoft to suffocate a paradigm shift (for example, to NCs) that threatens to make Windows obsolete. According to these critics, any of the foregoing practices (as well as others) alone or together may tip the market in Microsoft's favor. As a result, they argue that small threats of tipping warrant government intervention even when Microsoft has a valid business justification for the practices being challenged. In effect, they argue that the theoretical threat to competition outweighs even very substantial efficiencies that benefit consumers.

In order to succeed, an antitrust challenge based on such an argument would require a dramatic change in the way the courts have

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historically interpreted section 2 of the Sherman Act. As explained above, in section 2 cases, the courts historically have avoided even trying to balance legitimate business justifications against perceived anticompetitive effects - antitrust courts are simply not capable of engaging in such complex and subjective balancing. Moreover, Microsoft's conduct that some have characterized as "tipping" can just as easily and more accurately be characterized as competition on the merits. Microsoft, no less than Netscape, Sun, IBM, or any other competitor, should be free to convince consumers that its vision of computing after the next paradigm shift is the most desirable. Microsoft should also be free to bring that vision to market as quickly and efficiently as possible.

II. Remedies and The Inescapable Threat of Regulation

If Microsoft has not violated the law, then - no matter how much the lawyers at the Department would like to change or restrict Microsoft's behavior - they have no power to impose any remedy. Thus, unless and until there is some indication that the Department has meritorious claims against Microsoft, it is inappropriate for the Department even to contemplate remedies.

Nevertheless, if and when the Department (appropriately or not) reaches the issue of remedies, it is a virtual certainty that any remedy the Department might consider would enmesh the Department in broad regulation of the software industry. Even in the best of circumstances when it has explicitly tried to avoid regulation, the Department has almost always found itself acting as a regulator under section 2 decrees. The examples of regulatory decrees abound. However, one need go no further back than 1982 and the AT&T decree to find a striking example of how difficult it is to fashion a non-regulatory remedy when the Government seeks to constrain or manipulate the ability of a company or companies to compete.

The AT&T consent decree (also referred to as the "Modified Final Judgment" or "MFJ") marked the end of the Department's section 2 case against the nation's telephone monopoly. In addition to breaking up "Ma Bell," the decree also restricted the ability of the divested local telephone companies (the Regional Bell Operating Companies or "RBOCs") to enter competitive, non-regulated businesses. Though the Department believed that it had crafted decree restrictions that were simple, self-enforcing, and non-regulatory, those restrictions very quickly mired the Department in a regulatory quagmire that was only eliminated with the enactment of the Telecommunications Act of 1996. Within a year of the break-up of AT&T, there was a small staff of Department lawyers doing nothing but applying the decree restrictions to the day-to-day operations of the RBOCs. Decisions that most businesses make in a matter of days or weeks took the RBOCs months or years because they had to be cleared with the Department and, in some cases, even the decree court. Moreover, because of the evolution of technology, definitions that made sense in 1982 mandated inefficient conduct only a few years later.

The Department's experience with the AT&T decree bodes ill for any effort to find "non-regulatory" remedies to impose on Microsoft, particularly if the concern is "tipping." Remember the AT&T experience is not ancient history; it is recent and this Administration was every bit as responsible as its predecessors were for implementing the decree in a regulatory manner. Moreover, no one can doubt that Bill Baxter, who authored the decree, was sincere in his search for a non-regulatory solution to the competitive problems posed by the AT&T monopoly.

While reports indicate that the Department recognizes that a "break-up" of Microsoft would not be warranted (and would make no sense in any event), the Department might fool itself into believing that it can devise modest but effective "remedies" that are non-regulatory. It has been suggested, for example, that one such remedy could be found in a decree provision that simply requires Microsoft to make any new operating system feature optional to computer manufacturers. Though it may sound modest, such a remedy would in fact be highly regulatory.

First, such a provision would require Microsoft to consult with and defer to the Department in designing its operating systems, complicating and slowing the process to an intolerable extent.

Second, giving each computer manufacturer the option of picking and choosing features of the operating system would defeat the efficiencies and consumer benefits associated with ensuring that Microsoft's operating systems are consistent throughout the market. Currently, that consistency ensures software developers that, if they write their applications in a way that uses (and depends upon) certain functionality in (i.e., system services provided by) Windows, such functionality will be present in every copy of Windows that is installed on a PC. That consistency also ensures consumers that the features they associate with and expect from Windows will be present on any PC with Windows, regardless of the manufacturer of the PC. Not only is it more efficient to market Windows nationally and internationally if it has a consistent feature-set, but it is also makes using computers easier (i.e., consumers don't have to relearn how to use a computer's features every time they move from one brand of PC to another).

Third, because of the integrated nature of the various functionalities in an operating system, it is no simple matter to determine the impact that removing a given function will have on the rest of the operating system. The cost and delay associated with testing and "de-bugging" the numerous resulting varieties of Windows would be huge. Moreover, if any new feature of Windows must be made optional to computer manufacturers, the number of potential varieties of Windows that Microsoft would have to support (for example, by providing customer service) would be virtually infinite. The enormous cost and confusion would largely be borne by unhappy consumers.

Finally, such a regulatory remedy would undoubtedly beget even more regulation. For example, the Department might decide that such an option would only be meaningful if Microsoft charged more for a fully functional operating system than for an operating system from which certain features had been removed. That step, however, would inevitably involve the Department in regulating Microsoft's pricing decisions, a truly radical interference with the operation of the free market.

*

Based on the available information, it would appear that there is simply no viable section 2 case against Microsoft. That should be the end of matter - there is no need to consider remedies. However, if the Department launches a quixotic campaign to persuade the courts to overturn the accumulated lessons of over one hundred years of section 2 case law, the cost to innovation and consumers will be enormous.

=A91998 Microsoft Corporation. All rights reserved. Terms of Use

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IN THE

United States Court of Appeals

FOR THE DISTRICT OF COLUMBIA CIRCUIT

____________

No. 97-5343

____________

MICROSOFT CORPORATION,

Respondent-Appellant,

v.

UNITED STATES OF AMERICA,

Petitioner-Appellee.

____________

MOTION OF RESPONDENT-APPELLANT MICROSOFT CORPORATION FOR A STAY OF THE PRELIMINARY INJUNCTION INSOFAR AS IT RELATES TO WINDOWS 98

1. Pursuant to Rule 8 of the Federal Rules of Appellate Procedure, respondent-appellant Microsoft Corporation ("Microsoft") hereby moves for a stay of the District Court's December 11, 1997 preliminary injunction to the extent it relates to Windows 98, a new operating system Microsoft plans to make available to computer manufacturers on May 15, 1998 and release to the general public on June 25, 1998.

BACKGROUND

2. On October 20, 1997, the Antitrust Division of the U.S. Department of Justice ("DOJ") filed a petition for an order to show cause why Microsoft should not be found in civil contempt of a consent decree entered on August 21, 1995. See United States v. Microsoft Corp., 1995-2 Trade Cas. (CCH) =B6 71,096 (D.D.C. 1995). The DOJ argued that Microsoft's inclusion of certain Internet-related technologies (referred to under the rubric Internet Explorer) as an integral part of Windows 95 violated Section IV(E)(i) of the Consent Decree. Although the DOJ was aware of the forthcoming release of Windows 98, the DOJ's petition and supporting memorandum did not mention Windows 98 and did not allege any facts concerning the new operating system. Nor was Windows 98 mentioned by name or otherwise in any of the many declarations and memoranda subsequently submitted by the DOJ.

3. On December 11, 1997, the District Court denied the DOJ's request for a finding that Microsoft was in contempt of the Consent Decree. (J.A. 1289-90.) Even though the District Court denied the only relief requested by the DOJand expressly held that disputed issues of fact "abound as the record presently stands" (J.A. 1294)the District Court proceeded to enter a sua sponte preliminary injunction prohibiting Microsoft from "licensing the use of any Microsoft personal computer operating system software (including Windows 95 or any successor version thereof) on the condition, express or implied, that the licensee also license and preinstall any Microsoft Internet browser software (including Internet Explorer 3.0, 4.0, or any successor versions thereof) pending further order of Court" (J.A. 1300 (emphasis added)).

4. By including in its order the phrase "any Microsoft personal operating system software"as well as the phrase "any successor version" of Windows 95the District Court prima facie included Windows 98 within the scope of its preliminary injunction. That was plainly improper given that the DOJ (i) had not sought any relief with respect to Windows 98 and (ii) did not submit any evidence or make any argument concerning Windows 98 or any other successor version of Windows 95. Given the complete absence of evidence in the record regarding Windows 98, the District Court had no basis for awarding any relief with regard to that new operating system, which is different from Windows 95 in material respects, particularly with regard to the central role played by Internet-related technologies.

5. Upon entry of the District Court's sua sponte preliminary injunction, Microsoft immediately filed a notice of appeal and moved for expedited consideration. This Court granted Microsoft's motion, and the appeal was argued on April 21, 1998. When counsel for the DOJ was asked at oral argument what basis there was for applying the preliminary injunction to Windows 98, he responded:

There may be no basis, Your Honor. Now we don't know what Windows 98 is going to look like precisely because we haven't seen the released version. But we have offered to join Microsoft in a motion to the District Court to clarify this matter. We're not here to tell you that Windows 98 is prohibited by the preliminary injunction.

(Tr. at 46-47.) In fact, the DOJ has the latest build of Windows 98. With the exception of any changes required to remedy serious bugs identified during final testing, that build is identical to the operating system as it will be commercially released. Nevertheless, both before and after the oral argumentdespite repeated requests from Microsoftthe DOJ has refused to enter a definitive agreement immunizing Windows 98 under the preliminary injunction.

6. When Microsoft filed its notice of appeal, it was too early to predict with reasonable certainty when Microsoft would make Windows 98 available to computer manufacturers. Microsoft also did not know whether this Court would expedite the appeal and, if so, the extent to which the Court's consideration of the appeal would be expedited. Lastly, Microsoft wanted to give the DOJ sufficient time to conduct an investigation and formulate its position on whether the design of Windows 98 could raise an issue under the Consent Decree or the antitrust laws. (As noted in paragraph 14 below, the DOJ did not begin requesting information from Microsoft about Windows 98 until January 16, 1998more than a month after the preliminary injunction was entered.)

7. Microsoft concluded that it would have been premature at that time to seek a stay of the preliminary injunction to the extent it relates to Windows 98 because the injury to Microsoft was not sufficiently immediate to constitute irreparable injury. Since noticing this appeal, however, Microsoft has completed the development and nearly completed the testing of Windows 98, and it now appears that Microsoft will be in a position to make Windows 98 available to computer manufacturers on May 15, 1998 and release the product to the public on June 25, 1998.

8. Windows 98 differs from Windows 95 in several significant respects. Of particular importance to the instant motion, the Internet-related technologies in Windows 98 are even more deeply integrated into the operating system than they were in Windows 95. For example, the Windows 98 user interface is generated by the same modules of software code that enable end users to browse for information on the Internet. Those modules of software code cannot be removed from Windows 98 without rendering the operating system inoperable. What is more, because Internet-related technologies pervade virtually every aspect of Windows 98, the many visible means of accessing the web browsing functionality provided by those technologies cannot be facilely "hidden" from end-users (for example, by deleting icons from the Windows desktop) as they could in Windows 95. As a result, the convenient fiction that deleting the Internet Explorer icons from the Windows desktop is equivalent to "removing" Internet Explorer technologies from the operating system is not available in the case of Windows 98.

9. In order to comply with the preliminary injunction insofar as it relates to Windows 98, Microsoft would have to create a whole new operating system that did not provide support for Internet standards. Given the centrality of Internet-related technologies to Windows 98they underlie most of the major improvements in the operating system, including the new user interfacethe product that Microsoft would be forced to produce would bear little, if any, resemblance to Windows 98. Further, requiring Microsoft to design, develop and test such a new operating systeman extremely time-consuming and expensive undertakingwould represent an unprecedented governmental intrusion into unilateral product design decisions.

10. With this appeal fully briefed and arguedand with Windows 98 scheduled to be made available to computer manufacturers on May 15, 1998it is not practical for Microsoft to seek a stay in the first instance in the District Court. Indeed, this case is, for all practical purposes, in this Court, which has before it the full record of proceedings that have occurred below. Moreover, having granted the preliminary injunction, it is improbable that the District Court would reconsider its decision to make that order applicable to Windows 98. Microsoft therefore respectfully requests that this Court issue a stay of the December 11, 1997 preliminary injunction to the extent it relates to Windows 98 until the propriety of that order has been resolved. In light of the impending release of Windows 98, Microsoft respectfully requests that this Court set an expedited briefing schedule (if further briefing is deemed necessary) and issue its decision on this motion before May 15, 1998.

ARGUMENT

11. The factors to be considered in determining whether a stay is warranted are (i) the likelihood that the moving party will prevail on the merits, (ii) the likelihood that the moving party will be irreparably injured absent a stay, (iii) the prospect that other parties interested in the proceeding will be harmed if the court grants the stay, and (iv) the public interest in granting the stay. See Hilton v. Braunskill, 481 U.S. 770, 776 (1987); see also D.C. Cir. R. 8(a)(1). In ruling on a motion for a stay, a court must balance the strengths of the moving party's arguments on each of these four factors. See CityFed Fin. Corp. v. Office of Thrift Supervision, 58 F.3d 738, 747 (D.C. Cir. 1995) ("If the arguments for one factor are particularly strong, an injunction may issue even if the arguments in other areas are rather weak."). As a result, "[a] stay may be granted with either a high probability of success and some injury, or vice versa." Cuomo v. United States Nuclear Regulatory Comm'n, 772 F.2d 972, 974 (D.C. Cir. 1985) (per curiam). Taken together, the four factors strongly favor issuance of a stay in these circumstances.

I. Likelihood of Success on the Merits

12. Microsoft has already demonstrated a likelihood of success on the merits of its appeal. In its motion for expedited consideration and an expedited briefing scheduleas well as in its two briefs on the merits and at oral argumentMicrosoft set out in detail the numerous procedural and substantive errors committed by the District Court in entering its sua sponte preliminary injunction. At oral argument, the DOJ effectively conceded that the preliminary injunction was indefensible because there had been no showing that anyone would suffer irreparable injury in the absence of the order entered (Tr. at 60-61), which the District Court itself identified as a prerequisite to granting preliminary injunctive relief (J.A. 1295).

13. Microsoft's challenge to the preliminary injunction is even stronger with respect to Windows 98, an operating system that is significantly different from Windows 95. The DOJ's original petition did not mention Windows 98, nor did the DOJ seek any relief with respect to Windows 98 in any of its briefs. More importantly, the DOJ submitted no evidence or argument concerning Windows 98 at any time before (or, for that matter, after) the District Court entered its sua sponte preliminary injunction. The DOJ's petition was not silent about Windows 98 because the DOJ was unaware that Microsoft planned to release such a new operating system. Windows 98 has been under development by Microsoft for several years, and that fact has been widely reported in the industry trade press and was undeniably known to the DOJ before it commenced this action.

14. The DOJ has acted in a manner consistent with the notion that Windows 98 is not covered by its petition or properly encompassed by the District Court's preliminary injunction. On January 16, 1998more than a month after the District Court entered its orderthe DOJ served Microsoft with its first Civil Investigative Demand ("CID") seeking information related to "the licensing, marketing and distribution of Windows 98, including possible tying of Windows 98 and Internet Explorer." (See CID No. 17516, dated January 12, 1998 (a copy of which is annexed hereto as Exhibit A).) The word "design" is notably missing from the DOJ's description of the scope of its investigation, although the design of Windows 98principally the integration of Internet-related technologies into the operating systemhas been the central focus of discovery conducted thus far by the DOJ. The mere fact that the DOJ is still seeking information about the design of Windows 98it issued a second CID on that subject to Microsoft last Friday, May 1, 1998undermines the notion that the DOJ knew enough about the new operating system to include it in the DOJ's October 27, 1997 petition.

15. Moreover, the DOJ made clear in the cover letter accompanying its first Windows 98 CID that the DOJ views the litigation before this Court as limited to Windows 95, expressly stating that the CID "does not relate to, and does not seek documents or information for, the current Consent Decree litigation regarding Microsoft's conditioning of Windows 95 licenses on OEMs licensing Internet Explorer." (A copy of that letter, dated January 16, 1998, is annexed hereto as Exhibit B.) It therefore would be disingenuous for the DOJ to contend at this late stage that it now regards Windows 98 to be properly part of this case. Finally, the DOJ is permitted to issue CIDs only at the pre-complaint stage of a civil investigation; CIDs may not be used as a discovery tool in an ongoing litigation such as this. See 15 U.S.C. =A7 1311(a), =A7 1312(a); Department of Justice, Antitrust Division Manual III-33 (2d ed. 1987), reprinted in 6A Department of Justice Manual 7-703 (1997) ("Use of CIDs is restricted to the pre-complaint stage of civil investigations."). That is further evidence that Windows 98 is outside the scope of this litigation.

II. Irreparable Injury

16. Microsoft will be irreparably injured in the absence of the requested stay. To the extent it relates to Windows 98, the preliminary injunction on its face requires Microsoft to make available to computer manufacturers a version of the operating system from which all "Microsoft Internet browser software" has been removed. (J.A. 1300.) As an initial matter, it is not clear what that means. The DOJ has never identified what "Internet browser software" Microsoft is supposed to remove from Windows 95 (see J.A. 1462-73.), much less from Windows 98. In any case, a version of Windows 98 devoid of "Internet browser software" is not currently under development, and if Microsoft were to create such a non-existent product, it would necessarily lack much of the increased functionality provided by Windows 98. Internet-related technologies pervade virtually every aspect of Windows 98, and removing those technologies would require the design, development and testing of an entirely new operating system, one that did not provide support for Internet standards. Because every other modern operating system does provide support for such Internet standards, the end result of this substantial engineering effort would be a hobbled operating system with little or no commercial value.

17. Quite apart from issues of delay, expense and futility, Microsoft should not be required to offer to the public a product that Microsoft did not design of its own volition or to have such a plainly inferior product associated with its valuable "Windows" trademark. This is especially true where, as here, the DOJ adduced absolutely no evidence that Microsoft's development and marketing of Windows 98 violates the Consent Decree.

III. Harm to Other Parties

18. No other party to this proceeding will sustain injury as a result of the issuance of a stay, much less injury that would outweigh the irreparable injury that Microsoft will sustain in the absence of a stay. Having failed to seek any relief against Windows 98, or present any evidence or argument to the District Court concerning Windows 98, the DOJ cannot belatedly claim that it (or whoever's interest it is purporting to represent) will be seriously injured if the preliminary injunction is stayed with respect to Windows 98.

IV. The Public Interest

19. The public interest weighs strongly in favor of granting a stay. Windows 98, including its Internet Explorer technologies, represents a dramatic improvement over products currently available in the marketplace, and consumers will plainly benefit from the increased functionality and ease of use it provides. Moreover, numerous businesses in the high-technology and other industries are counting on the timely release of Windows 98. Software developers are planning to release updated versions of their products that take advantage of new features of Windows 98. Similarly, computer manufacturers are expecting the release of Windows 98 to stimulate consumer demand for their products, including a variety of new peripheral hardware devices that are supported by the operating system. Computer manufacturers also anticipate that the increased reliability of Windows 98 will significantly decrease their product support costs. Such businesses, together with the computer-using public, will be seriously injured if the DOJ does anything to hinder the commercial release of Windows 98.

20. In sum, the public has a strong interest in the prompt delivery of innovative technology to the marketplace, in aid of science, industry and the broad dissemination of information. That interest would be served by staying the preliminary injunction insofar as it relates to Windows 98.

CONCLUSION

21. For the foregoing reasons, Microsoft respectfully requests that this Court stay the preliminary injunction insofar as it relates to Windows 98 until the propriety of that preliminary injunction has been resolved. In view of the impending release of Windows 98, Microsoft also respectfully requests that this Court issue its decision on this motion before May 15, 1998.

Dated: New York, New York May 5, 1998

Respectfully submitted,

______________________________ John L. Warden Richard J. Urowsky Steven L. Holley Richard C. Pepperman, II Stephanie G. Wheeler SULLIVAN & CROMWELL 125 Broad Street New York, New York 10004 (212) 558-4000

James R. Weiss PRESTON GATES ELLIS & ROUVELAS MEEDS 1735 New York Avenue, N.W. Washington, D.C. 20006 (202) 628-1700

William H. Neukom Thomas W. Burt David A. Heiner, Jr. Steven J. Aeschbacher MICROSOFT CORPORATION One Microsoft Way Redmond, Washington 98052 (425) 936-8080

Counsel for Respondent-Appellant Microsoft Corporation

VERIFICATION

I, William H. Neukom, Senior Vice President, Law and Corporate Affairs of Microsoft Corporation, state that I have read the foregoing Motion of Respondent-Appellant Microsoft Corporation for a Stay of the Preliminary Injunction Insofar as It Relates to Windows 98, that I know the contents thereof, and that the statements contained in the motion are true of my own knowledge.

I declare under penalty of perjury under 28 U.S.C. =A7 1746 that the foregoing is true and correct.

Executed at Bothell, Washington this 4th day of May, 1998.

__________________________

William H. Neukom

CERTIFICATE OF SERVICE

I hereby certify that on this 5th day of May, 1998, I caused a true and correct copy of the foregoing Motion of Respondent-Appellant Microsoft Corporation for a Stay of the Preliminary Injunction Insofar as It Relates to Windows 98 to be served by hand upon: A. Douglas Melamed, Esq. Principal Deputy Assistant Attorney General Antitrust Division U.S. Department of Justice 10th Street & Constitution Avenue, N.W. Washington, D.C. 20530

Catherine G. O'Sullivan, Esq. Chief, Appellate Section Antitrust Division U.S. Department of Justice 601 D Street, N.W. Washington, D.C. 20530

_________________________

Christopher J. Meyers

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