by Jeffrey A. Eisenach and Thomas M. Lenard

Progress On Point
Periodic Commentaries on the Policy Debate
Release 7.4 n April 2000

The Microsoft case is a legitimate and important topic for political debate. Have the antitrust laws outlived their usefulness? Should they be enforced in the high-tech sector of the economy? Is Microsoft a good candidate for such enforcement? Have Microsoft’s actions violated the law and/or harmed consumers? Most importantly, if Microsoft has violated the law, what can or should be done about it?

In our view, it is quite clear that Microsoft has violated the law and harmed consumers. Further, we believe that one type of remedy -- a "competitive" structural remedy that would create four companies from the current one and so restore competition to the market for operating systems -- is clearly preferable to other alternatives. In this paper, we summarize the factual evidence and legal analysis that lead us to conclude a remedy is desirable, and describe briefly the remedy we have concluded would best serve consumers.

While we believe these issues are all worthy of debate and discussion, such discussion can only be constructive if it acknowledges the voluminous factual and legal record that has already been established during the course of the trial. Some of Microsoft’s defenders apparently view the trial record as unimportant -- or even biased. Rather than argue the facts, or the law, they have cast aspersions on the ideological leanings (too liberal?) or even the ethical standards (politically motivated?) of those involved in prosecuting the case.

For those who might be inclined to accept such arguments, it is important to remember that the Microsoft case has been prosecuted by an Assistant Attorney General for Antitrust, Joel Klein, who was confirmed by the Senate on a vote of 88-12 -- with all 12 of those opposing his nomination being liberal Democrats concerned that he would be too "pro-market" in his approach. Speaking in favor of Klein's nomination, former Judiciary Committee Chairman Senator Strom Thurmond (R-SC) defended his pro-market approach, calling him "within the mainstream of antitrust law and doctrine."

Further, the trial has been presided over by a Reagan-appointed judge, Thomas Penfield Jackson, who is not known for having anti-business views. Even as staunch a critic of the Microsoft case as The Wall Street Journal’s editorial page said "it was hard to find much wrong with Judge Jackson’s rendition of the ‘facts’."¹

Rather than casting about for conspiracy theories, everyone interested in this matter would do well to focus on the facts, the law -- and the choice now before the courts, which is not whether, but how, to remedy the damage being caused by the Microsoft monopoly.

The Facts

Judge Jackson’s 205-page "Findings of Fact"² convincingly establishes three facts that are crucial to understanding this case:

First, Microsoft possesses monopoly power in the market for Personal Computer (PC) operating systems;

Second, Microsoft engaged in a wide-ranging effort to protect its operating system monopoly, utilizing a full array of exclusionary practices; and

Third, Microsoft’s actions were harmful to innovation and to consumers.

The Microsoft Monopoly: Judge Jackson’s Findings leave no serious doubt that Microsoft is a monopoly -- that is, that it possesses market power in the market for Intel-compatible operating systems. Judge Jackson bases this conclusion on three factors:

Viewed together, three main facts indicate that Microsoft enjoys monopoly power. First, Microsoft’s share of the market for Intel-compatible PC operating systems is extremely large and stable. Second, Microsoft’s dominant market share is protected by a high entry barrier. Third, and largely as a result of that barrier, Microsoft’s customers lack a commercially viable alternative to Windows. Findings ¶¶34.

While some Microsoft defenders have argued that new developments in the computer marketplace have eroded Microsoft's monopoly power, they fail to acknowledge that Judge Jackson specifically addressed such developments, including the Linux operating system; the growing popularity of hand-held information appliances, such as Palm computers; and the growth of Web-based applications, but found no evidence to indicate that any of them would erode Microsoft’s market dominance for the foreseeable future. Findings ¶¶ 48-50, 22-26.

On the question of monopoly power, Jackson's finding is consistent with virtually all the available data, as well as the public and private statements of such industry leaders as Microsoft's own chairman, Bill Gates. To be credible, contrary arguments should either provide new information or suggest some flaw in Judge Jackson's reasoning. All of the arguments we have seen, however, do nothing more than repeat speculation about how technological change will soon make Microsoft's monopoly irrelevant -- speculation conclusively and persuasively rejected by the Court.

Microsoft's Conduct: T he fact of Microsoft's monopoly is important not because having a monopoly is in and of itself illegal, but because only firms that possess such power are able to engage in certain activities that are harmful to consumers. Since Microsoft has been established to have market power, the next question is whether Microsoft actually engaged in such behaviors. Judge Jackson finds that it did.

Judge Jackson finds that Microsoft was especially concerned about technologies, such as Netscape’s Navigator browser, that could support platform-independent computing and thereby erode Microsoft’s position. In response to the Netscape threat, Microsoft undertook a broad array of anticompetitive practices to increase the market share of its Internet Explorer.

Microsoft…paid huge sums of money, and sacrificed many millions more in lost revenue every year, in order to induce firms to take actions that would help increase Internet Explorer’s share of browser usage at Navigator’s expense. Findings ¶ ¶139.

Note that Judge Jackson's finding with respect to Microsoft and Netscape is not limited to the question of "technological tying" -- i.e. whether Microsoft could legally bundle its browser with its operating system. Instead, Jackson identifies a broad pattern of activities for which Microsoft advanced no credible efficiency rationale, but which can easily be understood as being designed to harm competition. For example, Judge Jackson found that Microsoft was able to use its Windows license as leverage in disputes with original equipment manufacturers (OEMs), such as Compaq, over which browser would be featured on their products.

Microsoft sent Compaq a letter. . . stating its intention to terminate Compaq's license for Windows 95 if Compaq did not restore the MSN and Internet Explorer icons to their original positions. Compaq's executives opined that their firm could not continue in business for long without a license for Windows, so in June Compaq restored the MSN and IE icons to the Presario desktop. Findings ¶ 206.

The Findings of Fact also establish that Microsoft's anticompetitive conduct was not limited to its battle with Netscape, but instead went well beyond the so-called "browser wars." When Intel, for example, began developing software that would go directly to the equipment manufacturers and bypass Windows, Microsoft Chairman Bill Gates went straight to the top.

Gates told Grove that he had a fundamental problem with Intel using revenues from its microprocessor business to fund the development and distribution of free platform level software. . . . Faced with Gates' threat, Intel agreed to stop. . . . Findings ¶ 102.

Similarly, Microsoft attempted to use the leverage provided by the Windows monopoly to persuade IBM to stop competing in the market for applications software.

When IBM refused to abate the promotion of those of its own products that competed with Windows and Office, Microsoft punished the IBM PC Company with higher prices, a late license for Windows 95, and the withholding of technical and marketing support. Findings ¶ 116.

In addition to these examples, the Findings of Fact also establish that Microsoft threatened or otherwise engaged in anticompetitive conduct on numerous other occasions, involving such major companies as Apple, AOL, Intuit, Real Networks and Sun Microsystems.

In summary, far from the cry of Microsoft's defenders that the company is being punished for being more efficient than its competitors, or for "building a better mousetrap," the facts establish that it engaged in a broad, persistent pattern of behavior for which there is no plausible explanation other than an intention to deprive consumers of the benefits of competition. Ignoring these facts, as Microsoft's defenders consistently do, cannot make them go away.

Microsoft and Consumers: Microsoft's defenders are also wont to suggest that Judge Jackson has ignored the issue of consumer harm. To the contrary, the Findings of Fact identify numerous instances in which Microsoft’s anticompetitive conduct had restricted consumer choice, deterred innovation and had a chilling effect on the entire industry.

Although Microsoft's campaign to capture the OEM channel succeeded, it required a massive and multifarious investment by Microsoft; it also stifled innovation by OEMs that might have made Windows PC operating systems easier to use and more attractive to consumers. Findings ¶ 241.

Microsoft also engaged in a concerted series of actions designed to protect the applications barrier to entry, and hence its monopoly power, from a variety of middleware threats, including Netscape's Web browser and Sun's implementation of Java. Many of these actions have harmed consumers in ways that are immediate and easily discernible. They have also caused less direct, but nevertheless serious and far-reaching, consumer harm by distorting competition. Findings ¶ 409.

Through its conduct toward Netscape, IBM, Compaq, Intel, and others, Microsoft has demonstrated that it will use its prodigious market power and immense profits to harm any firm that insists on pursuing initiatives that could intensify competition against one of Microsoft's core products. . . . The ultimate result is that some innovations that would truly benefit consumers never occur for the sole reason that they do not coincide with Microsoft's self-interest. Findings ¶ 412.

The Findings of Fact demonstrate beyond any doubt that Microsoft's conduct had its intended effect of raising the costs to consumers of using products that Microsoft deemed dangerous to its monopoly, and of reducing the benefits to consumers of the innovation that would have taken place in the absence of Microsoft's illegal conduct. This is precisely the sort of consumer harm the antitrust laws seek to mitigate.

The Law

The Sherman Antitrust Act is the cornerstone of antitrust policy in the United States. Based on his Findings of Fact, Judge Jackson issued "Conclusions of Law"³ in which he determined that:

Microsoft maintained its monopoly power by anticompetitive means and attempted to monopolize the Web browser market, both in violation of section 2. Microsoft also violated section 1 of the Sherman Act by unlawfully tying its Web browser to its operating system. The facts found do not support the conclusion, however, that the effect of Microsoft’s marketing arrangements with other companies constituted unlawful exclusive dealing under criteria established by leading decisions under section 1. Conclusions p. 2.

In other words, Judge Jackson found Microsoft guilty of monopolization under Section 2 of the Sherman Act, both because it used illegal means to maintain its operating system monopoly and because it used illegal means to attempt to establish a monopoly in the market for Web browsers. He also found Microsoft guilty under Section 1 of the Act for illegally tying the Internet Explorer browser to the Windows operating system. However, he exonerated Microsoft on the charge of exclusive dealing under Section 1.

Jackson's Conclusions of Law detail the basis for each conclusion. On the charge of illegally maintaining its operating system monopoly, he finds that:

Microsoft strove over a period of approximately four years to prevent middleware technologies from fostering the development of enough full-featured cross-platform applications to erode the applications barrier. . . . . Microsoft succeeded . . . . Because Microsoft achieved this goal through exclusionary acts that lacked procompetitive justification, the Court deems Microsoft's conduct the maintenance of monopoly power by anticompetitive means. Conclusions p. 9.

Jackson specifically finds that there was no legitimate economic purpose for Microsoft's illegal conduct.

Microsoft fails to advance any legitimate business objectives that actually explain the full extent of this significant exclusionary conduct. Conclusions p. 11.

Because the full extent of Microsoft's exclusionary initiatives in the [Internet Access Provider] channel can only be explained by the desire to hinder competition on the merits in the relevant market, those initiatives must be labeled anticompetitive. Conclusions p. 16.

There are no valid reasons to justify the full extent of Microsoft's exclusionary behavior in the [Internet Access Provider] channel. Conclusions p. 15.

He also considers and specifically rejects Microsoft's contention that its activities were nothing more than the rough and tumble of the competitive process, redounding ultimately to the benefit of consumers:

These actions cannot be described as competition on the merits, and they did not benefit consumers. Conclusions p. 19.

To the contrary, Jackson concludes that Microsoft's actions were the antithesis of competition on the merits and, in the broadest sense, constitute predatory behavior that is illegal under Section 2 of the Sherman Act.

Microsoft placed an oppressive thumb on the scale of competitive fortune, thereby effectively guaranteeing its continued dominance in the relevant market. More broadly, Microsoft's anticompetitive actions trammeled the competitive process through which the computer software industry generally stimulates innovation and conduces to the optimum benefit of consumers. Conclusions p. 20.

Microsoft's campaign must be termed predatory. Since the Court has already found that Microsoft possesses monopoly power . . . the predatory nature of the firm's conduct compels the Court to hold Microsoft liable under Section 2 of the Sherman Act. Conclusions p. 21.

In sum, Judge Jackson's Conclusions of Law are damning to Microsoft and its conduct. After considering each of Microsoft's arguments to the contrary, he demonstrates that Microsoft's conduct, taken as a whole and in its entirety, is both illegal under the Sherman Act and harmful to consumers, whom the Act is designed to protect.

The Remedy

Given the Court's Findings and Conclusions of Law, it is a virtual certainty that Microsoft will be subject to remedial action of some form. The available remedies fall into two broad categories, conduct remedies and structural remedies.

Microsoft's defenders have generally focused their commentary on the prospect of conduct remedies, which would place restrictions on Microsoft's future behavior. While we are not prepared to exclude the possibility that some form of conduct remedy could be beneficial, the ones proposed thus far would appear to do more harm than good.

Given the range of illegitimate behavior documented by the court, and the complexity of the software industry, a meaningful conduct remedy would require a lengthy list of conduct restrictions and requirements. The imposition of such a remedy on Microsoft would be burdensome for the company and difficult, if not impossible, for the government to enforce. The real danger, however, is that a conduct remedy would lead the decree court and the Department of Justice to function as de facto regulatory agencies, monitoring the operations of a firm with 30,000 employees producing dozens of technologically sophisticated products. Because enforcement of conduct restrictions would involve ongoing oversight of virtually all of Microsoft’s operations, including new product introductions, it could interfere with Microsoft’s ability to develop new products and compete. And, because Microsoft has dealings throughout the software industry, oversight of Microsoft by the decree court might well lead to indirect oversight of other firms as well. In sum, there are legitimate concerns about conduct remedies in the Microsoft case.

A well-designed structural remedy, on the other hand, is subject to none of the concerns described above. We have proposed a "competitive remedy" that would replace the current monopoly with a competitive market structure. Specifically, it would separate Microsoft’s operating system products from the rest of the company’s product lines, and then create three equivalent "Windows companies."⁴ Each of the new Windows companies would have full ownership over all the relevant intellectual property, and would be allocated an equal share of employees, contracts and other resources to go with the intellectual property.

The competitive remedy we propose would immediately replace the existing operating system monopoly with a competitive market. In so doing, it would eliminate the need for ongoing regulation and dramatically reduce the potential for subsequent litigation.

Furthermore, we believe it is highly likely that the competitive remedy would result in far more rapid innovation in computer operating systems than we have witnessed over the course of the past decade, for the simplest of reasons: Competitive firms have an incentive to innovate in order to win business away from their competitors; monopolists do not.

Microsoft's defenders have offered several arguments in opposition to such a remedy, two of which are worthy of rebuttal. The first is that this solution is unworkable because the task of dividing up a complex firm like Microsoft is too difficult, or the costs too great. We disagree. Indeed, the task of dividing up a firm like Microsoft, which has virtually no tangible assets and whose 30,000 employees are mostly young, mobile and well-off, is vastly easier and less costly than dividing up a firm like, say, AT&T circa 1984. We believe the breakup we propose could be carried out quickly and with relatively minimal costs, and have seen no plausible evidence to the contrary.

The second argument has to do with standardization. The idea is that we need a monopoly like Microsoft to provide a standard for operating systems and, in the absence of such a monopoly, we would have "fragmentation" and resulting incompatibility. In Dr. Lenard's longer paper on the remedies issue he shows that this argument fails at several levels. Specifically, all of the new firms would have extremely strong incentives to maintain compatibility with the existing Windows installed base and with each other on a going forward basis. Moreover, those who advance this thesis have the burden of showing why in this particular instance economic efficiency can only be obtained through a monopoly, whereas in all other markets competition produces an efficient balance between standardization, on the one hand, and specialization/diversity on the other. We have not seen such a showing made, nor do we believe one is possible.

Conclusion

The Findings of Fact and Conclusions of Law handed down by Judge Jackson address each significant argument Microsoft has made in its own defense -- and find them wanting. Microsoft has a monopoly, has engaged in anticompetitive behaviors, has harmed consumers and has violated the law. Those who would argue otherwise have an obligation to rebut Jackson's factual and legal conclusions on their substance. We have yet to see such a rebuttal. The conspiracy theories that have been offered in place of substantive argument are unsupported by any evidence, and seem incredible on their face.

The danger that a conduct remedy in the Microsoft case could lead to increased government involvement in the software marketplace is not without merit. A structural remedy, on the other hand, would end the Microsoft monopoly, end the threat of government regulation and obviate the need for further litigation now and for many years to come.

Endnotes

¹The Wall Street Journal, November 23, 1999, p. A22.
²Findings of Fact in U.S. v. Microsoft Corporation, Civil Action No. 98-1232 (TPJ) and State of New York, ex re. Attorney General Eliot Spitzer et al., v. Microsoft Corporation, Civil Action No. 98-1233 (TPJ), November 5, 1999 (hereafter, "Findings of Fact" or "Findings").
³Conclusions of Law in U.S. v. Microsoft Corporation, Civil Action No. 98-1232 (TPJ) and State of New York, ex. re. Attorney General Eliot Spitzer et al., v. Microsoft Corporation, Civil Action No. 98-1233 (TPJ), April 3, 2000 (hereafter, "Conclusions of Law" or "Conclusions").
⁴Thomas M. Lenard, Creating Competition in the Market for Operating Systems: A Structural Remedy for Microsoft, The Progress & Freedom Foundation, January 2000.

Jeffrey A. Eisenach is President and Cofounder of the Progress & Freedom Foundation. Thomas M. Lenard is Vice President for Research. The views expressed here are the authors and do not necessarily reflect those of The Progress & Freedom Foundation, its Board, Officers or Staff.