Maintenance of Monopoly U.S. v. Microsoft

INDUSTRIAL ECONOMICS

Dulguun Ganbat (54356)Tomasz Piechula (53625)

CASE STUDY

• Brief Introduction• Background • Economic Issues

• Did Microsoft really possess a monopoly power?

OUTLINE

INTRODUCTION

The US Department of Justice and other 20 individual states filed suit against Microsoft Corporation in May of 1998.

1. Microsoft had a monopoly power over

both PC and OS’s markets

2. Misuse of monopoly power, and several antitrust violation

• Consumers were being harmed by high prices• Microsoft’s actions had reduced innovation

• Highly dynamic industry• Access to high quality and innovative software

Gov Microsoft

INTRODUCTION

The court determined its legal conclusions on April 3, 2000.

After appeals, settlement discussions, and a remedy trial period, Microsoft eventually settled at the end of 2002.

Background

Relatively young corporation

• Began its existence in the mid 70s• Since then, has exploded growth-

wise

Antitrust scrutiny• restrained competition • excluded competitors

• expanded its market power through noncompetitive means

In 1990 the FTC investigated Microsoft

• Involved software licensing practices

• Was voted to bring no suit against the company

DOJ started investigation• Microsoft’s contracts with OEM’s

were anticompetitive

DOJ – DEPARTMENT OF JUSTICEFTC – FEDERAL TRADE COMMISSIONOEM – ORIGINAL EQUIPMENT MANUFACTURER

The Battle of the browsers

• The Government sued Microsoft for this and was initially successful

• On appeal, however, it was ruled that the combination of Internet Explorer and the OS offered functionality not available without product integration.

Netscape Navigator was first successful INTERNET BROWSER

Microsoft forced OEM’s to license and install their INTERNET EXPLORER

Background (Suits)

That Microsoft had attempted to monopolize the market for internet browsers (Violated Section 2 of the Sherman Act)

OS licenses with OEMs

Contracts with ISPs

Ties between its OS and Internet Explorer

VIOLATION OF SECTION 1 OF THE SHERMAN ACT

THREATS OF JAVA/NETSCAPE

Operating systems depend on a wide range of applications

• These are typically sunk costs once you’ve spent time developing them

JAVA could potentially lower the barrier due to:• Cross-Platform language

THREATS

1. Netscape could potentially distribute Java to independent developers.

2. They could choose to write programs for another OS (OS/2 or Linux), putting Microsoft’s monopoly at risk

An overview of Economics Issues

Did Microsoft really possess a monopoly power?

CLAIM 1 Government's View:Microsoft did possess monopoly power in

the market for operating systems for Intel-compatible desktop personal computers

• Market share structure• Changes in purchases of Windows OS by personal computer manufacturers resulting from an increase in price of Windows OS• Network effects• Application barrier to entry

Supported by following analyses

An overview of Economics Issues

Did Microsoft really possess a monopoly power?

CLAIM 1 Microsoft's View:The relevant market for antitrust purposes is

substantially broader than Intel-based PC OSs; it includes hand-held computer operated systems and servers

Also, it faces threats from other non-OS platforms that can support applications and threats from yet unknown innovations

The very fact that Microsoft found it necessary to take action against Netscape and Java shows that those companies and their products are in the market. Thus, Microsoft does not have monopoly power.

An overview of Economics Issues

Did Microsoft really possess a monopoly power?

CLAIM 1 Microsoft's View:Microsoft has supported its claim by giving following arguments:

• The market definition developed by the Government was invalid

• The application barrier to entry was not significant

• Standard static model for short-run monopoly showed that its price was far below the price that a monopolist would charge

An overview of Economics Issues

Did Microsoft really possess a monopoly power?

CLAIM 2

Government's View: They claimed Microsoft foresaw the

possibility that the dominant position of its Windows OS would be eroded by Internet browsers and by cross-platform Java.

Microsoft engaged in a series of anticompetitive practices in order to protect the monopoly power of its Windows OS

An overview of Economics Issues

Did Microsoft really possess a monopoly power?

CLAIM 2

Microsoft's View:

It did perceive a competitive threat from Java and responded in a number of ways to combat that competitive threat

However, those responses were the reasonable and appropriate responses of a competitor and cannot be appropriately characterized as an attempt by Microsoft to maintain its OS monopoly.

DID MICROSOFT REALLY POSSESS A MONOPOLY POWER?

– The Government’s Perspective• Yes, according to market share data

Microsoft’s share of PC operating systems was very high and had remained stable over time.

• During the 1990s, Microsoft’s worldwide share of shipments of Intel-based operating systems had been approx. 90 percent or more

DID MICROSOFT REALLY POSSESS A MONOPOLY POWER?

• Microsoft’s Response

– Microsoft denied it had market power, claiming that the government’s market definition was invalid

– It argued that it competed vigorously to remain a provider of the leading software platform. Any market power it enjoyed was temporary, thus could not be characterized as monopoly power

DID MICROSOFT REALLY POSSESS A MONOPOLY POWER?

• The Court’s Perspective– The court supported the Government’s position

on the market definition and monopoly power issues

– They also affirmed that there were significant barriers to entry in the market (Windows had more than 70000 applications)

It admitted that Netscape Navigator and Java are rather complements to the OS and therefore they should not have been considered as products from the same market.

Were Microsoft’s actions against Netscape browser anticompetitive?

• Government’s claim:

„Microsoft engaged in a range of acts whose primary purpose was to protect its operating system monopoly (the key to maintaining the monopoly was to thwart the success of the Netscape Navigator browser).”

GOV: BROWSER ARGUMENT

Microsoft recognized that it could protect its dominant position by getting large share of the browser business and suport only MS technology.

Pogrammers have little incentive to write apps that are not Windows-based.

Evidence: Netscape’s market share has declined (from 70% - 1996) to the benefit of Microsoft (86% in June 2000)

GOV: MS’s ANTICOMPETITIVE ACTIONS

Government enlisted for types of anticompetitive actions:– Market allocation– Bundling and OEM restrictions– Predatory pricing– Exclusionary agreements with ISP

GOV: MARKET ALLOCATION

Microsoft engaged in a series of meetings with Netscape, Apple, Intel) in order to minimize threat from their side.

Offers browsers in the server market with no competition from MS – did not agree.

NETSCAPE

Agreed that Apple makes IE a default browser in their MAC Oss and encouraged Apple to abandon developing QuickTime streaming software – threat to MS.

APPLE

MS threatened to withhold support for Intel’s processors if they offer a competitive platform-level software

INTEL

GOV: MARKET ALLOCATION

•Microsoft was confronted with platform-level software to which app programs can be written

•Platform-level APIs could erode the applications barrier to entry by deliverig programs that could be used on multiple OSs

•MS forced suppliers of the potential platform-level competitive solutions to focus on products with no platform potential

•MS was ready to preclude competitors from successful offering of competitve product regardless of the standard economic goal – maximizing profits.

GOV: PREDATORY PRICING

$100 milion on developmentTens of millions of dollars on promotion

IE expenses per year

Zero or MS even paid to accept, distribute and promote IE

IE price

LOSS

Result

MS was ready to promote its IE, forgo profits with expectation of recouping them in the future and eliminate Netscape threat. IE was a „no-revenue” product.

As from 20% to 50% of the Netscape revenues came from browser licencing, this strategy eliminates Netscape from the market and saves MS monopolist position in the OS market.

DESIRED OUTCOME

GOV: BUNDLING - REASONING

Other browsers were not installed as the disk space was scarce and additional programs would slow down the computer.

The choice of products (browsers) was limited and the system was not effective (harm to consumers)

Before giving for free IE browser by Microsoft, ISPs and retailers distributed browsers separately from OSs. Now they were forced to use IE

Furthermore, in 1996 MS imposed screen and start-up restrictions on OEMs and prevented them from positioning other browsers before IE (browser as a complementary good to OS) or make any changes to MS apps

MS integrated IE in Windows 95 and 98 distributed via retail or OEM channels even if the demands for OS and IE were different (viewed other browsers as substitutes). By January 1999 IE was (by exclusionary effect) in most of the OS distributing via OEMs.

GOV: BUNDLING - RESULTS

Action

• Microsoft gives its IE for free

Result I

• Create additional barier to entry to OS market – a „two-level” barier emerges

Two-level entry barri

er

• You cannot successfully enter the browser market unless you successfully enter the OS market

• This increased MS’s monopoly in OS market

MS’s motiv

es

• Netscape Navigator was capable of supporting applications that were OS independent and hence could ultimately develop into alternate platforms thereatening Windows OS

GOV: BUNDLING – SOME TECH

Navigator browser runs on many different Oss:– Windows– Mac– UNIX, including Linux

Netscape’s browsers contain their own set of APIs (application programming interface)

Possibility to create apps that will run via browser, regardless of the underlying OS and to virtualization of the apps

GOV: EXCLUSIONARY AGREEMENTS WITH ISPs

ISPs – second largest distributors of browsers (after OEMs)

MS required the promotion and distribution of IE, and required that ISPs not do the same with competitive browsers to more than a small fraction of their clients in exchange for bounties and rebates

Some of ISPs were „IE Parity” – distribute browsers with no preferences

Microsoft entered in agreement with AOL, CompuService, Prodigy and AT&T to appear in a folder in desktop to ensure that Netscape will not be a good business partner

As a result, MS reduced the ability of the competitive browser manufacturers to distribute and promote their products via ISPs.

Microsoft’s response – Internet both threat and opportunity

Pricing

•Firms often give software for free in the „winner-takes-it-all” battle and Netscape had many other channels it could go•Integrating IE in Win 95 was a natural proces of raising the MS OS value•Not enough evidence from Gov

Bundlin

g

•Browser battle - appropriate behavior of a competitor. Netscape Navigator could become competing platform by adding certain APIs

•By bundling MS maintained the quiality of its system and had no monopoly power (integration value)

Not predatory

•Actions were taken to improve its own browser and the expenses made IE of better quality than that of Netscape. MS always planned to integrate MS OS with IE.

Market allocation

•MS had legitimate business reasons to meet with Netscape, Apple and Intel. Such meetings are valuable to the techology and procompetitive. Moreover, no agreements were reached and MS did not intimidate. Apple developed QuickTime and Intel its software.

Further argumen

ts

•Separating OS from browser would reduce usability and quality and would be impossible once combined•Removing the browser would reduce the quality seriuosly•Agreements with ISPs were the result of its competitive quality and comditions it offered

THE COURT’S VIEW

Judge Jackson:• Support for Gov’s claims (all four)• Tying OS with IE was anticompetitive• Gov should submit more evidence on harmful impact of OEMs

and ISPs agreements on competition

Circut court:Support for maintenence of monopoly arguments, however raised questions about bundling-tying benefits and costs.

WAS MS’s ALLEGED ANTICOMPETITIVE BEHAVIOUR HARMFUL TO COMPETITION?

MS excluded almost completely Netscape from IEM distribution channel.Evaluation of the MS actions:

94% wa share of browser shipments by ISP (IE default)

IE default (1997)

14% wa share of browser shipments

IE not default (1997)

60%

IE default subscribers (1997)

20%

IE not default subscribers (1997)

Contract restriction, not IE quality…

MICROSOFT’S RESPONSE

– OS and browsers – complementary products – wide use oe web browser – increased demand for OS.

– No harm to the customers (AOL acuired Netscape and could distribute both IE and Netscape Navigator)

– MS disputed the measure of the browser market share and pointed that Netscape failed to do a good marketing

The real source of Netscape decline was simply worse product.

THE COURT’S PERSPECTIVE

• MS’s actions cause immediate harm by distorting competition

• Obligatory IE caused the PCs to run slower

• Clients who wanted Netscape had to pay additional price

• Innovations that reduce application bariers to entry was stopped (middleware could have introduced more competition)

• MS’s actions conveyed to every enterprise that could innovate the computer industry. Moreover, these actions deterred investment- some of the innovations never occur

RESOLUTION OF THE CASE

Remedies hearing• Behavioral remedies are temporary• Structural – less regulatory but would be inefficient and

not 100% effective – appelate court and DOJ

9 states and District of Columbia pressed for stronger remedies

Government and 9 of 18 states agreed with MS on a range of behavioral remedies

RESOLUTION OF THE CASE

Proposition:• Eliminate restrictive licensing agreemenst• Outlaw retaliatory measures against OEMs• Limiting MS ability to discourge others from promoting

other middleware products• Establishing compliance measures to enforce the terms of

settlement agreement

DOJ and 9 states focused on conduct remedies and

RESOLUTION OF THE CASE

The court’s statement:The remedy is „carefully tailored to fit the wrong creating the ocasion for the remedy and is forward-looking in the parameters of relief provided and is crafted to Foster the competition in the monopolized market.”

The court rejected many of the more aggressive remedies, but overall it offered more aggressive and potentially more effective compliance procedures that were sympathetic to issues raised by the litigating states.

WHAT THEN?

The court’s statement:The remedy is „carefully tailored to fit the wrong creating the ocasion for the remedy and is forward-looking in the parameters of relief provided and is crafted to Foster the competition in the monopolized market.”

Most of the Gov’s predictions about the browser competition right: in the subsequent decade the IE market share was 90%.

QUESTIONS1. Choose the corresponding answer to a given definition. “The value of a product or service is dependent on the number of others using it” a. Cobra effectb. Network externalitiesc. Complex multiplierd. Sailing ship effect

2. Microsoft was accused of violating which act? a. Sherman Actb. Clayton Actc. Antitrust lawd. Posner Anticompetitive Regulation

3. Why Microsoft corporation forced its OEM’s to install INTERNET EXPLORER? a. Due to threats from JAVAb. To catch up with Netscapec. To keep their market shared. A&B

4. What markets were influenced by MS?a) The operating systems marketb) The web browsers marketc) The Internet providers and OEMs marketsd) All of them

5. What constitutes two-level barier to entry?a) You cannot successfully enter the browser market unless you successfully enter the OS marketb) You cannot successfully enter the OS market unless you successfully enter the web browser marketc) You have to have first new APIs for your web browserd) You have to have enough capital to fund no-revenue products

QUESTIONS

Thank you!