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. ...