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Robert Bork on DOJ vs Microsoft
``` [The enclosed statement by Robert Bork on the Microsoft antitrust case is an excellent survey of the issues. Robert Bork is most famous for being rejected by the Senate when he was nominated to serve on the Supreme Court, but he is most important for a 1978 book entitled "The Antitrust Paradox", in which he argued for a dramatic narrowing of antitrust policy. Bork's book applied the precepts of the "law and economics" movement to antitrust questions. The premise of "law and economics" is that legal conflicts should not be settled on the basis of right and wrong but on the basis of economic efficiency. Decisions, in other words, are supposed to maximize wealth, and justice is recategorized as a mere "distributive matter". This concept tends to amaze ordinary Americans when they hear about it, but it's true: the most prominent conservative legal movement in the United States has largely remade American law by eliminating all considerations of morality, and Robert Bork, who has more recently written a book that accuses Americans of a staggering range of moral deficiencies, is one of the most important founders of that movement. The principal intellectual attraction of law-and-economics theorizing is that it feels precise and technical and detailed. We don't have medieval dialectic any more, so we use economic analysis instead. The well-documented problem, aside from the straightforward amorality of it, is that the economic analysis is systematically skewed to favor the wealthy. For example, in a dispute between two people, one of them wealthy and the other destitute, law and economics will find in favor of whichever party would pay more money to secure a favorable outcome, without any regard for their relative ability to pay. This mode of reasoning has the consequence -- supposedly paradoxical but in fact perfectly straightforward -- that it becomes mysterious why theft is illegal: if you have a bicycle in your garden shed that you never use, and I could profitably use that bicycle to ride to work each day, then aggregate wealth will be maximized if I steal your bicycle. The law-and-economics refutation of this simple deduction is roundabout and artificial; roughly speaking, they reply that permitting me to steal your bicycle would set a precedent that would lead to conflicts whose resolution would create an excessive economic burden. Now, one of the most celebrated assertions in "The Antitrust Paradox" is that it is economically impossible for a firm that holds a monopoly in one market to leverage that monopoly into any other markets. Even though this assertion flouts both history and common sense, no particular argument is offered for it, because it is a natural consequence of the strange world imagined by the assumptions of classical economics: you can't leverage your way into a perfect market, because as soon as you stop subsidizing your products in that market and try to extract some profit from it, your competitors will come roaring back, thus reestablishing the status quo ante. The problem with this argument, of course, is that very few markets are perfect, for example because of the barriers to entry created by the costs of plant and equipment, the establishment of brand names, and so on. In the present case, all of this matters because most information technology markets are about as far from economically perfect as they could possibly be. It is in very many cases quite possible for an existing monopolist to leverage his or her way into a monopoly position in an adjoining market, and this is what both Microsoft and Intel have been very aggressively doing for some years now. Bork explains these things quite clearly, although not in a way that tends to embarrass either his past analyses or the overall conceptual basis within which he works. The DOJ should clearly prevail. But our natural bloodlust for Microsoft should not distract us from the much more fundamental issues here, which are two: (1) American law has already been largely eviscerated by an amoral philosophy that is totally alien to its traditions; and (2) the dominant school of economics offers virtually no guidance in understanding the institutional dynamics of the information technology industry. Until both of these grave facts are widely recognized, we haven't the slightest chance of comprehending our predicament. In any case, I have reformatted the enclosed text to 70 columns. Although the ZDNet web site claims a copyright on it, their article makes clear that it was circulated by Netscape, to whom Bork is a consultant.]
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Full text of Bork's 'white paper' on DOJ vs. MS
By Robert Bork, ZDNN July 29, 1998 1:48 PM PT
The text of Robert Bork's "white paper" in the DOJ vs. Microsoft case:
The antitrust case brought by the Department of Justice against Microsoft is rock solid. That is also true of the parallel antitrust action brought by twenty states.
The controlling legal precedent is Lorain Journal Co. v. United States, 343 U.S. 143 (1951). The Journal was a newspaper that, as the Supreme Court put it, "enjoyed a substantial monopoly in Lorain [Ohio] of the mass dissemination of news and advertising, both of a local and national character." It had a 99% coverage of Lorain families. "Those factors," the Supreme Court said, "made the Journal an indispensable medium of advertising for many Lorain concerns." A challenge to the Journal's monopoly arose, however, with the establishment of radio station WEOL in a town eight miles away. The newspaper responded by refusing to accept local advertising from any Lorain County business that advertised on WEOL. The Supreme Court held that this was an attempt to monopolize, illegal under '2 of the Sherman Act. There being no apparent efficiency justification for the Journal's action, it was deemed predatory and hence illegal.
The parallel between the Journal's action and Microsoft's behavior is exact. Microsoft has a similarly overwhelming market share of the market for personal computer operating systems and it imposes conditions on those with whom it deals that exclude rivals without any apparent efficiency justification for such behavior. When a monopolist behaves in this fashion, it violates '2 of the Sherman Act.
The case against Microsoft is not an attack on vertical integration; that is not the objection to the coupling of Microsoft's browser, the Internet Explorer, and its Windows operating system. Like Lorain Journal, the Microsoft case concerns a monopolist's horizontal attempt to preserve its monopoly by destroying a potential rival. An analogy would be the owner of a toll bridge, which is the only bridge across a river, paying the owner of land to deny access to a site where a competitive bridge is partly built. In Microsoft's case, as in Lorain Journal, the attack is largely carried out through vertical exclusionary contracts. The newspaper imposed a requirement that advertisers not deal with the radio station. Microsoft imposes multiple requirements on customers and suppliers that inhibit their dealings with Microsoft's rivals.
The government does not challenge Microsoft's size or its business success any more than it challenged the size or success of Lorain Journal. It seeks only to reestablish competition in the market by applying solidly established antitrust doctrines.
This exposition will take up the major topics relevant to the Microsoft case: (1) Microsoft's possession of monopoly power; (2) Microsoft's extensive use of exclusionary and predatory practices to protect and extend its monopoly power; and (3) the decision of the United States Court of Appeals for the District of Columbia Circuit in a related consent decree case.
1. Microsoft Possesses Monopoly Power
Microsoft's monopoly is in personal computer operating systems. A PC operating system controls the interaction of the different parts of the computer. It creates files, organizes the computer's memory, manages the interaction between the monitor and the keyboard, and creates a platform for applications.
The operating system is thus indispensable to the computer. That may change as technology evolves, but for now a computer without an operating system is simply a box of inert hardware. Microsoft today ships 97% of PC operating systems that are installed by computer manufacturers. Case law defines monopoly as beginning at about a 70% share of a market. See, e.g., United States v. E.I. du Pont de Nemours & Co, 351 U.S. 377, 379, 391 (1956) (75% market share sufficient to infer monopoly power); Heatransfer Corp. v. Volkswagenwerk, A.G., 553 F.2d 964, 981 (5th Cir. 1977) (71-76% market share sufficient to infer monopoly power), cert. denied, 434 U.S. 1087 (1978). Size, even if it confers monopoly power, is not illegal if it is achieved by superior products, service, business acumen, or mere luck. United States v. Grinnell Corp., 384 U.S. 563, 570-71 (1966). Nor does market share alone necessarily confer monopoly power. A manufacturer might make 100% of knickers on the market, but if there are two dozen pants manufacturers whose facilities could easily be converted to knickers production, the knickers producer would be unable to charge more than a competitive price or to exclude rivals from his market.
"Monopoly power is the power to control prices or exclude competition." du Pont, 351 U.S. at 391. Microsoft has, and exercises, both forms of monopoly power: the power to charge above competitive prices and to use tactics that eliminate or subdue rivals by means other than superior efficiency that is beneficial to consumers. The company's profits are among the highest of any American businesses. Its own financial statements show a profit margin of about 47%. Though profit levels are viewed by some as ambiguous indicators of monopoly power, this profit margin is so high that many commentators would think it raises a strong inference of monopolistic pricing. More important to the present case, however, Microsoft has, and exerts, the power to exclude rivals by predatory tactics that do not reflect superior efficiency, tactics whose sole purpose is the destruction of rivals. Microsoft's spokesmen have attempted to deny that the company possesses monopoly power, but their arguments are feeble and transparently inadequate. Thus, a Microsoft legal consultant has asserted: "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." While true in the abstract, this proposition lacks any relevance to this case. Barriers to entry into the PC operating system market are very high, and the most important barriers are created by Microsoft for the specific purpose of defeating entry and the expansion of what it calls "fringe firms." While the technology is "highly dynamic," moreover, competition in the market is not. Microsoft has seen to that. But for Microsoft's interference, the market would be much more dynamic as new technologies and fresh innovations challenged the company's present dominance.
To argue, as Microsoft does, that computer manufacturers have a choice from a wide array of competing operating systems is to ignore reality. Other systems have low market shares for a variety of reasons. Apple Computer made the commercial mistake of confining its Macintosh system to its own computers, refusing to license others. Other systems may have low market shares because consumers view Windows as superior, a fact the government does not deny. But it is precisely those technologies that promise effective competition to Windows that Microsoft's exclusionary tactics prevent from being among the choices available to computer manufacturers. The result is that Microsoft can charge higher-than-competitive prices without loss of market share.
Nor is there any substance to the assertion that Microsoft's monopoly power is defeated by its need to compete against its own installed base. A current computer owner, according to Microsoft, will change to a new operating system only if he perceives the additional value of the new system to be worth its price. That abstraction is largely irrelevant to the government's case. The installed base is not a competitive constraint when a business or an individual purchases additional computers or makes a first purchase. Not only is the use of computers spreading rapidly but new generations of consumers keep coming into the market.
Neither does Microsoft's installed base constrain monopoly pricing to persons wishing to upgrade their current PCs. Consumers buy new operating systems often because they buy a new computer with features older ones do not have. Advances in computer hardware, where competition thrives, occur so rapidly that a new machine may be obsolete within months of its purchase. For these reasons, Microsoft's claim that computer operating systems never wear out is beside the point. Aside from the degradation of data stored on hard drives and other such matters, computer hardware does wear out. Replacement is simpler than repair, and consumers expect that the replacement will come with an installed operating system.
Competition among operating systems, if it were allowed to exist, would be competition to have computer manufacturers install operating systems on new machines. Microsoft has 97% of that market and, consequently, it has the power to charge monopoly prices for Windows. The installed-base argument evaporates on examination. Microsoft plainly has monopoly power in the market for PC operating systems.
We may move on, therefore, to the real issue in the case: Microsoft's exclusionary practices.
2. Microsoft Employs Exclusionary Practices to Maintain Its Monopoly
Microsoft's exclusionary war proceeds along two lines. First, it has built its browser, the Internet Explorer, into its Windows operating systems, and will not allow computer manufacturers to remove it.
Second, Microsoft employs a complex web of restrictive agreements designed to block the entry or growth of rivals. The purpose of both these tactics is to prevent what is now an incipient threat of competition for Windows from becoming a full-blown reality.
The Browser War Netscape produced the first browser, the Netscape Navigator, which made searching the Internet practicable for the average computer user. The Navigator posed a serious threat to Microsoft's monopoly. Singly or in conjunction with other companies' technologies, Navigator created the possibility of a system that would bypass the Windows operating system. Software applications can be written for the Navigator as they can be for Windows. Navigator works on numerous operating systems, moreover, so that applications developers need not invest the time and expense to rewrite their applications for different systems.
A browser with a large number of users can become an alternate platform by, for example, combining with Sun Microsystems' cross- platform programming language, Java, which can run on any operating system. Together, the Navigator and Java could reduce Windows to just one operating system among several as well as provide a route to the Internet.
Microsoft recognized the danger at once. Bill Gates said Netscape's strategy was to "commoditize the underlying operating system," which means that operating systems would become commodities like wheat or oil, commanding only a competitive rate of return. Other Microsoft executives were equally explicit, making such comments as that the company's operating system was threatened at a "fundamental level," "Netscape/Java is using the browser to create a `virtual operating system,'" and that a competing browser could eventually "obsolete Windows." These were free market possibilities Microsoft was not prepared to accept.
Microsoft counterattacked. It developed its own browser, the Internet Explorer. When the Explorer failed to oust the Navigator from the market in open competition, Microsoft joined its browser with its monopoly operating system, first in Windows 95 and now in Windows 98, so that computer manufacturers are forced to take both in one package. Moreover, Microsoft makes no extra charge for the browser, pricing it at zero, thus selling it below cost. There is no doubt about this, for a Microsoft spokesman stated that if the company were forced to offer its operating system and its browser as separate products, the company would still charge nothing for the browser. This forced Netscape to stop charging for the Navigator and to give it away. The number two man at Microsoft, Steve Ballmer, stated, "We're giving away a pretty good browser as part of the operating system. How long can [Netscape] survive selling it." He said Microsoft had to expand into Netscape's territory lest Netscape encroach on his operating system territory. The clear intent was not to compete with Netscape on the respective values of the Explorer and the Navigator but to drive Netscape out of the browser market altogether. The effect upon the much smaller Netscape was devastating.
The purpose of attaching the Internet Explorer to the operating system is plain and was articulated in the company's internal memoranda. A senior Microsoft official wrote: "It seems clear that it will be very hard to increase browser market share on the merits of IE alone. It will be more important to leverage the OS [operating system] asset to make people use IE instead of Navigator." Another executive wrote: "I thought our #1 strategic imperative was to get IE share (they've been stalled and their best hope is tying tight to Windows, esp. on OEM machines)." Microsoft concluded in late March 1997 that if Windows and the Internet Explorer "are decoupled, then Navigator has a good chance of winning" and that "if we take away IE for the O/S, most nav users will never switch to us." Microsoft followed the strategy set forth in these recommendations, and its share of the browser market skyrocketed, propelled by the operating system monopoly.
Microsoft does not contest these internal statements of its intent to defeat Navigator not on the merits of its browser but by coupling the Explorer with the monopoly operating system of Windows. Instead, Microsoft has concocted a fictional version of historical reality. We are told that the principal reason Microsoft hooked the Explorer to the operating system is that Independent Software Vendors demanded it. That is not the truth, and it most certainly is not what Microsoft said when it planned its maneuver.
This latter-day rationale does not square with the Microsoft memoranda quoted above, nor can it be accommodated to the very explicit statements on January 2, 1997, of Microsoft Senior Vice President Allchin that Microsoft needed to begin "leveraging Windows from a marketing perspective" if it was to defeat Netscape. "I am convinced we have to use Windows -- this is the one thing they don't have . . . We have to be competitive with features, but we need something more -- Windows integration." Allchin further stated that "Memphis [the code name for Windows 98] must be a simple upgrade, but most importantly it must be a killer on OEM so that Netscape never gets a chance on these systems."
Microsoft rationalizes its merging of the Internet Explorer and Windows with the argument that any producer is entitled to define its own product. Should it be required to offer its browser separately or to incorporate the Navigator in Windows, the company claims that it would have to obtain Department of Justice approval for every function it adds to the operating system in the future. Neither of these propositions is true. That a monopolist or virtual monopolist is not free to define its product in ways that stifle competition is clear from Aspen Skiing Co. v. Aspen Highlands Skiing Corp., 472 U.S. 585 (1985). The defendant Skiing Co. owned and operated downhill skiing facilities on three mountains in Aspen; plaintiff Highlands operated on a fourth mountain. For years, the two companies offered a week-long pass, the "all-Aspen ticket," usable at any of the four mountains. The price was usually discounted from the price of daily tickets.
Skiing Co. then initiated various changes that ended its cooperative marketing with Highlands, effectively denying skiers the benefits of the four-mountain pass and diminishing substantially skiers' use of Highland's mountain. In successive ski seasons, from 1976 to 1981, Highlands' share of downhill skiing services in Aspen declined steadily: from 20.5% to 15.7% to 13.1% to 12.5% to 11%. Though it agreed that "even a firm with monopoly power has no general duty to engage in a joint marketing program with a competitor," the Supreme Court said that if the firm attempts to exclude rivals on some basis other than efficiency, its behavior is predatory. The record supported the jury's finding that Skiing Co.'s conduct lacked an efficiency justification. The Court therefore upheld the conclusion that Skiing Co. had monopolized the market for downhill skiing services in Aspen. Aspen Skiing is a direct holding that a monopolist is not free to define its product for the purpose and with the effect of excluding a competitor.
Applying Aspen Skiing to Microsoft will not require it to obtain Justice Department approval for every change in its operating system. The only changes that may not be made are those that both impair the opportunities of rivals and do not further competition on the merits, i.e., lack a legitimate efficiency justification. If Microsoft loses the antitrust case and absorbs the lesson, there will be few, if any, additions to its operating system that meet both of those criteria.
Microsoft's Agreements in Restraint of Trade Not content with excluding Netscape's Navigator from sales to computer manufacturers by uniting Windows and the Internet Explorer, Microsoft devised a Web of restrictive agreements to serve the same purpose and to foreclose other channels of distribution to Netscape. The aim, as always, was to eliminate Navigator as a potential rival to the Windows operating system.
(1) Microsoft's licenses for Windows 98 prohibit computer manufacturers from modifying the screen first seen when users turn on their personal computer. This enforced uniformity prevents computer manufacturers from offering customers a choice of first screens. But the restriction also has another anticompetitive result. The Windows first screen is a platform from which software applications, such as word processing programs, are launched. Netscape's Navigator can also serve as such a platform. If consumers prefer the Netscape platform to the Windows platform, computer manufacturers will configure their machines so that the first screen to appear is that generated by Netscape's browser. If a significant number of computers had the Netscape first screen, software developers would write programs for it, and competition would flourish in the operating system market. Microsoft's first screen restriction squelches that. This effectively blocks Netscape from the most important channel for getting its browser to consumers. The nascent threat that Netscape's browser poses to Microsoft's operating system monopoly is snuffed out.
Microsoft counts on the fact that the home user of the personal computer, which comes with the Internet Explorer already installed in the operating system, is highly unlikely to take the time and trouble to download Navigator from the Internet. As browsers increase in complexity and size, the downloading process, even with a very fast modem, takes at least two hours. With a slower modem, the process can take six or seven hours. There is, moreover, a high rate of failures in downloading. Microsoft does not believe consumers will go to the trouble of downloading a second browser when one is already installed, which is the reason for the importance the company places upon control of the first screen. Microsoft has once more made its intention explicit in internal memoranda. Bill Gates wrote of his concern that manufacturers were adding browsers not made by Microsoft and "coming up with offerings together with Internet Service Providers that get displayed on their machines in a FAR more prominent way than . . . our Internet browser" and such offerings were interfering with the "very very important goal" of "[w]inning Internet browser share." Steve Ballmer said that the Windows-on-boot-up rule was designed to block Netscape's use of new software to take command of the viewer's attention. Though Microsoft spokesmen now speak of the first screen restriction as a trivial matter, the fact is that the CEO and the executive vice president of sales and support of Microsoft thought it was an important weapon in the browser war. And so it has proved.
(2) Microsoft has entered into exclusionary contracts with the largest and most important Internet Access Providers and online services. These include such companies as America Online, CompuServe, Prodigy, and MCI. Companies must accept these agreements in order to get placement of access to their services in two places: (1) on Microsoft's mandatory first screen; and (2) the Internet Connection Wizard and the Online Services Folder.
Not only do these agreements explicitly restrict consumers' access to non-Microsoft browsers, they even restrict the Internet Access Providers' ability to tell consumers that non-Microsoft browsers exist. The Access Providers might otherwise promote and distribute non-Microsoft browsers such as the Netscape Navigator. Though there are a few other browsers, the Navigator is the only one that can match, and sometimes outdo, the Explorer.
So exclusionary are the Microsoft agreements that the Internet Access Providers in the Referral Server are required to ship the Internet Explorer as the sole browser in at least 75% to 85% of all their shipments. That is true even if customers specifically request a competing browser. Access Providers that regularly fall below the percentage demanded by Microsoft will be removed from the Referral Server. Many Internet Access Providers no longer mention, or provide users the ability to download, the Netscape Navigator. This is crucial, for, according to Microsoft, at least 31% of Internet users get their browsers from an Internet Access Provider.
(3) Microsoft has also extracted exclusionary contracts from Internet Content Providers and Independent Software Vendors. Placement of their branded icons on the Windows desktop screen requires the Content Providers to limit their promotion, distribution, and support of competitive browsers. Many of the agreements require that Content Providers design Web sites that cannot be viewed as well with Netscape Navigator as with Internet Explorer. Microsoft also requires that Content Providers adopt Microsoft technologies that are not accessible by other browsers and design a certain number of their Web sites with Windows-specific technologies that make those sites less attractive when viewed with competing browsers.
There is no doubt that these contracts do, in fact, exclude Netscape from markets it would otherwise serve. Intuit's Senior Vice President and Chief Technology Officer, for example, said that without the agreement, Intuit "would have already entered into an agreement with Netscape to provide financial content on Netscape Web Sites," would have continued to promote Netscape Navigator on its sites, and probably would have continued to distribute Navigator with Quicken, as it had done since 1995. Microsoft has once again been explicit in internal memoranda about the purpose of these tactics.
Executive John Ludwig wrote to Bill Gates in July 1997: We have seen very little adoption of the technology tho. [sic] Finally with ie4 we have our top tier of content partners using the technology (because we force them to in our contracts with them). Microsoft's exclusionary contracts with Internet Content Providers, like its first screen restriction and agreements with Internet Access Providers, are predatory tactics. They have no business justification other than the efficacy of coercion. There are, moreover, high artificial barriers to the entry of new competitors and the expansion of small existing rivals. These barriers are deliberately created by Microsoft. Among them is the network effect. The network effect is the advantage any firm has when its product becomes more valuable as more people use it. The familiar example is telephone service, which increases in value as more people acquire telephones. Similarly, Microsoft's operating system monopoly has more value as writers of applications design their products for its platform. Application writers naturally prefer to write for an operating system that has 97% of current shipments. It is not worth their time, effort, and expense to redesign their applications for 3% of the market. The more application writers write for Windows, the more powerful Windows becomes, and hence the more application writers will be drawn to it. Unlike local telephone service, however, the network effect in operating systems can be easily overcome and need not lead to monopoly. There is not with computers the impracticability of running multiple wires to each dwelling and business place. In operating systems, the same value can be achieved without monopoly by a uniform standard that all applications writers and computer manufacturers can use. Such a standard is now in existence. The Netscape Navigator and Sun Microsystems' Java can provide it and many operating systems would flourish. Application writers could write for all platforms, not just Microsoft's Windows. It is precisely to avoid that open standard that Microsoft requires the use of its technology by licensees and is attempting to convert Java into a language that will run only on Microsoft's operating system. Though the company extols the benefits of an open standard, that is little more than doublespeak. What it means by that is maintaining Microsoft's Windows and associated technology as the standard all must use. Microsoft thus artificially maintains a network effect that is a barrier to competition.
We have already analyzed the barriers imposed by Microsoft's exclusionary agreements. These, as has been noted, are virtually insurmountable. This pattern of exclusionary contracts could be analyzed one by one and each would be seen not only as an agreement in restraint of trade violative of '1 of the Sherman Act but also, viewed collectively, as a powerful means of monopolizing. As a network of restrictions on others' ability to obtain, sell, and use Netscape's browser, these agreements are devastating to competition -- as they are intended to be. By using its monopoly power to coerce agreements, Microsoft has denied Netscape the primary channels for the distribution of Navigator and has, for good measure, prevented or made far more difficult consumer awareness of the Navigator alternative to Explorer and the ability to download Navigator from the Internet. Microsoft is attempting to crush the competition of Netscape's browser and Sun's Java and hence to preclude the likelihood of an alternative technology for operating systems and for using the Internet.
Microsoft's defenders typically belittle these restrictive agreements as easy for consumers and competitors to evade. That defense is easily demolished. Quite aside from its factual assumption of the ease of overcoming these restrictions, which is erroneous as to the average PC user, the statements of Microsoft executives demonstrate the company's confidence that such restrictions will be effective. It is significant that Microsoft spokesmen began to give innocent, though clearly false, explanations for this behavior once the prospect of an antitrust suit appeared. One may ask, moreover, if these restrictive agreements do not exclude competition, why does Microsoft impose them? They create little or no efficiency gains. That being so, their purpose and effect can only be anticompetitive. Furthermore, the imposition of unwanted restrictions upon its customers and suppliers must impose costs on Microsoft.
There is simply no reason for Microsoft to incur those costs unless it believes that the benefits of continued monopoly will exceed them. This industry, unlike most, lends itself to predatory tactics.
Predation is feasible because Microsoft already has a monopoly. Were that not so, there would be no objection in law or economics to the practices and agreements Microsoft has deployed. If Microsoft had, say, 20% or 30% of the market for operating systems, computer manufacturers could license Windows and the Internet Explorer or any other system and browser, coupled or not, as their consumers preferred. Microsoft would have no power to force a bundled operating system and browser or exclusionary agreements on the market. In competitive markets, refusal to meet the demands of customers and suppliers does not lead to monopoly but to bankruptcy. Monopolization and restraint of trade in such a market would be impossible. Too many customers and suppliers would turn elsewhere. ...
... But a monopolist is different. There is nowhere for its customers and suppliers to turn in order to avoid the onerous terms.
A monopolist cannot, of course, demand both a full monopoly price and also impose unwelcome restrictions on those with whom it deals. That would entail charging more than the maximizing price and would result in lower sales and profits. Although the monopolist holds the whip hand, it must pay in lower prices for any additional restraints it demands. The war Microsoft wages here is a form of predatory pricing through the payments it gives up in return for its exclusionary practices.
Such payments, however, may be worth the cost in order to block competitors and thereby preserve the monopoly. The record shows numerous instances of Microsoft paying or offering discounts in return for exclusionary agreements.
In the usual case, predatory pricing is unlikely to be attempted or, if attempted, is unlikely to succeed. The primary reasons are that the predator and the intended victim often have roughly proportional reserves (liquid assets plus available lines of credit) and that losses during the price war will be proportionately higher for the predator than for the victim. These factors mean that the victim can usually outlast the predator in a price-cutting campaign.
These constraints on predation do not apply in this case.
Microsoft and Netscape do not have roughly proportional reserves or anything close to it. Microsoft's reserves dwarf Netscape's by many orders of magnitude. The market capitalization of Microsoft is approximately $250 billion; that of Netscape is $2.7 billion. Bill Gates' personal fortune alone, which came from Microsoft, far exceeds the capital value of Netscape. The upshot is that Microsoft can easily outlast Netscape in a price war.
Microsoft also makes enormous profits on its monopoly operating system licenses while Netscape has no comparable source of income. As Bill Gates put it, "Our business model works even if all Internet software is free . . . We are still selling operating systems. What does Netscape's business model look like? Not very good."
Price predation also rarely succeeds because the predator must operate at increasingly higher costs while the victim need not. It will often, in fact, be possible for the victim to lower its costs in response to the attack. Before the price war begins, both the predator and victim will produce at rates where their marginal costs are increasing. In order to drive prices down, the predator must increase its rate of output, thus operating at a still higher marginal cost. As market prices decline, costs rise, and the predator suffers losses. The victim labors under no such disadvantage. It may suffer losses, but those losses will not be nearly as large as the predator's because its costs will not have increased. The victim may, in fact, be able to decrease its rate of output, thus moving to a lower marginal cost. This means that the predator will exhaust its reserves not only faster but disproportionately faster than the victim. That is the reason price predation is usually a losing game.
This analysis does not apply to software, however. The major elements of cost there are the fixed costs of physical facilities and compensation of personnel. The costs of production and distribution, once the software is perfected, show little variation with respect to the rate of output. The marginal cost curve is either flat or very nearly so.
Thus, Microsoft need not bear significantly disproportionate costs when both it and Netscape price their browsers at zero. Microsoft, moreover, need not even greatly increase its rate of output in attacking Netscape's Navigator because Microsoft already ships 97% of all operating systems pre-installed on personal computers. The only expansion needed is the rate of browser output and the browser is now, in any event, tightly tied into the operating system. The marginal cost curve with respect to browser distribution is flat. This fact, plus the enormous disparity in reserves, makes the predatory exclusion of the Navigator from the market entirely feasible.
To preserve its monopoly in operating systems, moreover, Microsoft need not drive Navigator completely from the market. It need only reduce Navigator to a size at which most application writers find it unprofitable to write for the Navigator. That would guarantee that Netscape would indeed be a "fringe" firm with regard to browsers.
It is axiomatic that no firm attempts monopolizing unless it has a clear prospect of recouping the costs of its predatory tactics and enjoying a monopolistic return. Brooke Group, Ltd. v. Brown & Williamson Tobacco Corp., 509 U.S. 209, 224 (1993) ("` For the investment to be rational, the [predator] must have a reasonable expectation of recovering, in the form of monopoly profits, more than the losses suffered.'")(quoting Matsushita Elec. Indus. Co., Ltd. v. Zenity Radio Corp., 475 U.S. 574, 588-89 (1986)). Microsoft, however, enjoys a monopoly return even while engaged in exclusionary practices.
Its present market size requires little expansion of output and the concessions to customers and suppliers in return for restrictive agreements are relatively inexpensive. If the Navigator is destroyed or marginalized, and if Java is altered to work only on Microsoft technology, Microsoft will not even have to deduct these minimal amounts from its monopoly profit.
3. The Court of Appeals Consent Decree Decision In No Way Forecloses the Separate Government Suit Against Microsoft Under Sections 1 and 2 of the Sherman Act
The conclusions of this memorandum are not disturbed by the recent decision of the U.S. Court of Appeals for the D.C. Circuit.
In a decision concerning the meaning of a 1994 consent decree, a three-judge panel of the U.S. Court of Appeals for the D.C. Circuit on June 23, dividing two to one, reversed the District Court's grant of a preliminary injunction prohibiting Microsoft from tying its operating system and its browser in licenses to computer manufacturers. The preliminary injunction was vacated on procedural grounds: the injunction was entered without notice to Microsoft in violation of the Rules of Civil Procedure. A divided panel also said that the District Court misconstrued the consent decree. The procedural ruling obviously has no implications for the separate Sherman Act suit filed by the government in May. Many commentators, however, quickly concluded that the Court of Appeals' substantive discussion of the consent decree's meaning harms the prospects of the government's Sherman Act case.
That conclusion is not justified.
Both the decree and the Sherman Act suit involve, among other issues, the question of permissible and impermissible bundling, the tying of Microsoft's Internet Explorer and its Windows operating system. The decree forbade tying products together unless they add up to one "integrated product." "Integration" occurs, the majority said, when combining two products produces benefits greater than selling them separately and the producer can combine them though the purchaser cannot. The Court said that Microsoft had ascribed "facially plausible benefits to its integrated design." This facial plausibility was apparently enough, under the consent decree, to justify tying the browser and the operating system. That conclusion has less impact upon the government's separate Sherman Act suit than some commentary supposes.
In the first place, the discussion of this subject by the Court of Appeals majority was unnecessary to its decision about the preliminary injunction. The procedural ground was sufficient, and all three members of the panel agreed on that point. Furthermore, the District Court had not held hearings on or decided the bundling issue. Thus, there were no findings of fact, no record, and no briefing of the question. The panel majority's observations are, in the strictest sense, dicta. As such, they are not binding on any future court or even on the two judges who entertained the issue in the consent decree context.
The non-binding character of the panel majority's remarks is clear for a much more important reason: the decree litigation did not bring before the Court the many predatory contracts required by Microsoft or the internal documents that make clear the predatory intent underlying both those contracts and the bundling of the browser and the operating system. That evidence will be central in the upcoming Sherman Act litigation.
Indeed, the Court majority warned that its discussion of integration was not to be final even in the consent decree litigation, much less in the coming Sherman Act trial. The majority opinion makes that point repeatedly. The panel admonished, for example, that the consent decree "does not embody either the entirety of the Sherman Act or even all 'tying' law under the Act."
More important is its emphasis that, "The guidance this opinion seeks to provide is limited to setting out the legal framework for analysis. The ultimate sorting out of any factual disputes is a different question, and one we of course cannot resolve on the limited record before us"; and again, "The factual conclusion [about integration] is, of course, subject to reexamination on a more complete record." In a word, the discussion of integration is tentative and may be altered or abandoned after a trial of the facts.
Directly relevant to the proof the government will offer in the Sherman Act case are the Court majority's observations that, "Manufacturers can stick products together in ways that purchasers cannot without the link serving any purpose but an anticompetitive one. The concept of integration should exclude a case where the manufacturer has done nothing more than to metaphorically 'bolt' two products together." Again: "[T]he overwhelming of the separate market [for the product tied in] is precisely what is feared and may simply indicate anticompetitive practices."
The government will show that the compulsory combination of Microsoft's monopoly operating system and its browser in its licenses to manufacturers is not necessary to efficiency or intended to be. "Sticking" or "bolting" the browser onto the operating system serves no purpose but an anticompetitive one and is designed to overwhelm the market for browsers.
This concept of "sticking" or "bolting" products together highlights the weakness of the majority's discussion of "integration": [I]ntegration may be considered genuine if it is beneficial when compared to a purchaser combination. But we do not propose that in making this inquiry the court should embark on product design assessment. In antitrust law, from which this whole proceeding springs, the courts have recognized the limits of their institutional competence and have on that ground rejected theories of "technological tying."
A court's evaluation of a claim of integration must be narrow and deferential. (footnotes omitted) While this passage speaks in welcome tones of judicial restraint, that restraint is misplaced where, as here, it amounts to giving Microsoft a judicially created exemption from the antitrust laws. The majority thought its test was satisfied because the Internet Explorer adds features to the operating system that cannot be included without also including the browser functionally.
Judge Wald's dissent on this point seems a sufficient rebuttal: The majority's interpretation would not, for example, appear to prevent Microsoft from requiring OEMs to license the right to sell computer peripherals (e.g., mice) as a condition of licensing Windows 95 so long as Microsoft had the prescience to include code in Windows 95 that made the cursor more responsive to the end user's touch than it would be with other mice. . . . I fail to see why the analysis should be so different for software than for peripherals or why our "evaluation of a claim of integration must be [any more] narrow and deferential." (footnotes omitted)
Judge Wald summarized: Thus, antitrust law cannot avoid determining whether a particular technological development has occurred because it is efficient or merely because it permits a monopolist to extend its monopoly to a new market. Software code is a particularly stark example of why such analysis is essential if antitrust concepts are to survive at all. Here, the majority effectively exempts software products from antitrust analysis by stating that "[s]oftware code by its nature is susceptible to division and combination in a way that physical products are not." . . . But this to me is an argument for closer, rather than more relaxed, scrutiny of Microsoft's claims of integration. An operating-system designer who wished to turn two products into one could easily commingle the code of two formerly separate products, arranging it so that "Windows 95 without IE's code will not boot," . . . so that Windows 95 without Internet Explorer would "represent a disabled version of Windows 95 . . . ." This is not to say that commingling of code is per se pernicious or even suspicious. Rather, the point is that commingling alone is not sufficient evidence of true integration; the courts must consider whether the resulting product confers benefits on the consumer that justify a product's bridging two formerly separate markets. (page citations to majority opinion omitted)
Judge Wald supported her argument by citing Jefferson Parish Hospital District No. 2 v. Hyde, 466 U.S. 2 (1984), where the Supreme Court rejected the hospital's argument that it could require patients to use certain anesthesiologists because their services were part of a "functionally integrated package of services." The hospital cited benefits from joining the anesthesiologists to other hospital services: 24-hour coverage, flexible scheduling, and facilitation of work routine, professional standards, and equipment maintenance. But these benefits could be obtained by promoting the benefits of the hospital's anesthesiologists and setting standards of compatibility. The Court held that the question of whether one or two products were involved did not depend on the functional relation between them, but on the character of the demand for each product. There being a separate demand for the services of anesthesiologists, there were two products, not one, and the hospital's requirement was a tie-in rather than a true integration.
So it is in the Microsoft case. There is a demand and a separate market for browsers from the market for operating systems. If there are any benefits or efficiencies from bundling the browser and the operating system, such benefits can be obtained, if consumers want them, by promoting the combined product. Hence, there is a tie-in and not an integration. That is a particularly appropriate result because, in the case of software, two products may be put together merely by adding a few lines of code to one.
That fact means that accepting the "facial plausibility" argument results in a complete exemption from the antitrust laws of Microsoft's incorporation of any feature or product into its operating system by adding just a few lines of code. This is a license for unrestricted monopolization. It is not to be expected that the courts will ultimately grant such a license.
Even without access to the full evidence in the government's hands, it is clear that the incorporation of the Internet Explorer into the monopoly Windows operating system is predatory and anticompetitive as are the restrictive contracts Microsoft demands. The record before the Court of Appeals on the consent decree litigation did not contain most of this material. The government will present that evidence in the Sherman Act case.
Microsoft contends that no remedy can be devised that will not do more harm than good. That argument is both premature and disingenous. Appropriate remedies will become more apparent as the factual situation is more fully developed. It is unthinkable, however, that a firm in blatant violation of the Sherman Act's prohibitions of monopolizing and making agreements in restraint of trade should escape the consequences on the basis of a specious argument about remedies. Where there is a clear violation, as there is here, there is an appropriate remedy. To say otherwise is to say that the Sherman Act is a straw man.
The essence of the government's case against Microsoft is simply this:
Microsoft has a monopoly of personal computer operating systems, maintains that monopoly with a pattern of interlocking exclusionary practices and agreements, and has repeatedly admitted its intention to do just that in its own internal documents. The conclusion that Microsoft is violating ''1 and 2 of the Sherman Act is inescapable.
If Microsoft is successful in this predation, and in its attacks on Sun's Java, Microsoft will retain its operating system monopoly and be well on the way to achieving its goals of becoming the only gateway to the Internet and spreading its power to other markets. This is what is at stake in the government's antitrust case against Microsoft.
This is not a unique case. Well-settled and economically sensible antitrust jurisprudence has consistently been used to halt predatory conduct employed to maintain an existing monopoly. Devotion to the principles of a free market requires support of the Justice Department's case. The result for consumers will be lower prices and many more competitive sources of innovation.
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