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Economists: Slice and dice Microsoft

Four economists weigh in on remedies -- and sound an awful lot like Sun CEO Scott McNealy in their conclusions.
Written by Mary Jo Foley, Senior Contributing Editor

Maybe Sun Microsystems Inc. CEO Scott McNealy's plan for restructuring Microsoft wasn't as half-baked as Microsoft claimed, after all.

A Brookings Institution economist and three other colleagues, in a filing on Thursday of an unsolicited friend of the court briefing regarding remedies in the Department of Justice vs. Microsoft Corp. (MSFT) antitrust case, called for a remedy that mimics closely the one McNealy suggested recently.

The economists are not in favor of the likely DOJ/state remedy, due to be filed late Friday, which would call for a so-called "functional breakup," slicing Microsoft into a Windows company and an Office-led "everything else" company.

Instead, the economists suggested "full divestiture" in their 72-page brief filed to Judge Jackson and posted on the Brookings Institution Web site. This would call for Microsoft to be split into three competing Windows companies and one Office-plus-everything-else company.

"The full divestiture would be the most effective way, in our view, of introducing real competition into the platform market, of reducing the applications barrier to entry, and of reducing or removing Microsoft's ability to project its operating systems monopoly into other markets," claimed the economists.

McNealy recently suggested that Microsoft be split into five companies: three competing Windows vendors, an Office company and an Internet company.

The four economists agree that breakup is not an extreme option.

"It is straightforward that the remedy should be proportional to the gravity of the offenses found by the court, the context in which they have occurred, and the behavior that Microsoft has displayed," the economists noted. "The conclusions of law makes clear that these offenses were severe, numerous, and committed as part of an overall pattern over an extended period of time."

While the economists acknowledged that a conduct, rather than a structural remedy would be the least disruptive to Microsoft and the economy, they claimed it would be the remedy the least likely to address the "core problem" which resulted in the antitrust suit in the first place.

"A conduct decree would be difficult to enforce, and Microsoft can be expected to take advantage of the 'enforcement lag' built into the post-decree process to tilt the market in its favor," the economists claimed.

"Moreover, a conduct order that requires continued judicial supervision of the content of Microsoft's future operating systems would run a risk of chilling innovation by involving the Courts on an ongoing basis in the design of computer software, against which the D.C. Circuit has already, and in our view correctly, warned."

The economists, likewise, warn that any attempt to force Microsoft to open source Windows would be overly complex. They claimed that, without access to Microsoft programmers and middle managers, potential OS competitors would find it difficult to continue to evolve Windows in a meaningful way.

Instead of dealing with these kinds of complexities, the Brookings economists push for breakup -- but not a breakup DOJ-style. "The major drawback of a functional [the rumored DOJ/states proposal] breakup is that it leaves the platform monopoly intact," wrote the economists. "If the Court does not limit the lines of business of this monopoly, it then runs the risk of having the Windows company leverage its desktop monopoly into adjacent markets. "On the other hand, if the court does impose line of business restrictions on the OS company, limiting it either to specific operating-systems markets in which it may currently be engaged, or even more restrictively, to just the Windows 98 and Windows 2000 versions, it runs the risk of chilling innovation. The experience of this district court in administering similar restrictions imposed on AT&T, turning the court into a judicial regulatory agency, should give this Court pause about the wisdom of such an approach," the economists continued.

One author of the brief is Robert Litan, vice president and director of the Economic Studies Program at the Brookings Institution and former deputy assistant attorney general of the U.S. Justice Department's Antitrust Division from September 1993 until March 1995. During that period, Litan helped supervise the first civil antitrust investigation of Microsoft, which resulted in the 1995 Consent Decree.

The other three authors are: Roger Noll, a professor of public policy in the Department of Economics at Stanford University; William Nordhaus is a professor of economics at Yale University; and Frederic Scherer a professor of public policy and corporate management at the John F. Kennedy School of Government at Harvard University.

After the stock market closes Friday, the DOJ and most, if not all, of the 19 state attorneys general engaged in the Microsoft case, are slated to release publicly their suggested remedy proposal. The DOJ and states are highly likely to suggest Microsoft be divided into a Windows company and Office company, according to numerous published reports. Such a remedy, if Judge Thomas Penfield Jackson decides to adopt it, would not be applied until Microsoft is allowed to appeal the case, which could take years.

But the DOJ and states also are likely to call for some less-drastic interim remedies, ranging from requiring Microsoft to make public its OEM (original equipment manufacturer) Windows pricing list, to publishing all Windows application programming interfaces, to agreeing not to engage in exclusive contracts at the expense of consumer choice, reports indicate. These remedies, if agreed to by the judge, could be applied immediately.

Microsoft has until May 10 to file its response to the DOJ/states' proposal. The DOJ and the states are slated to reply to Microsoft's reply by May 17. The judge has slated a remedies hearing for May 24.

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