Discussion on Microsoft’s Market Position

Microsoft’s Market Position

 

The government’s approach to the structural aspects of the Microsoft case was straightforward. The primary focus was personal computer operating systems, for which, at least

 

5 US Department of Justice, Merger Guidelines (Washington: June 14, 1982). 6 US v. Standard Oil Company of New Jersey, et al., 221 US 1, 76 (1911). 7 US v. Grinnell Corp., 384 US 563 (1966). 8 US v. Aluminum Co. of America, et al., 148 F. 2d 416, 430 (1945).

For the exclusive use of Y. Gao, 2017.

This document is authorized for use only by Yuanyuan Gao in Industrial Organization II: Spring 2017 taught by Erich Muehlegger, University of California – Davis from April 2017 to June 2017.

 

 

Microsoft on Trial ___________________________________________________________ CR14-99-1522.0

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with the technologies available in 1998, there were no obvious substitutes. Given “network effects” and the substantial costs consumers had incurred for complementary applications software and learning how to use it, consumers were unlikely to substitute away from accepted operating systems even if their prices were elevated substantially above competitive levels. Within the PC operating systems market, Microsoft had maintained since the early 1980s a dominant position. Indeed, during the late 1990s, its share of the PC operating system installed base and also its share of new PC operating systems was on the order of 90 percent—at the upper bound of the range identified by Judge Hand in the Alcoa decision.

Microsoft challenged these allegations on several grounds. Its principal economic expert witness, Professor Richard Schmalensee of the Massachusetts Institute of Technology, observed that the boundaries between operating systems and other software were fluid and constantly changing. Functions that were once sold separately had frequently been “bundled” into the operating system, and since this could continue, a much more expansive view should be taken of the relevant market—one that encompassed many if not all personal computer software packages. In such a broadly defined market, Microsoft’s share was much less than the 65 percent threshold identified by Judge Hand.

Furthermore, even though Microsoft’s share in supplying the functions traditionally performed by PC operating systems might have been high in 1998, it was by no means clear that the same would be true in the future. Given the rapid pace of change in connection with Internet technologies, Microsoft’s operating system might be displaced by alternative technologies—e.g., as indicated earlier, some combination of simplified operating systems and browsers used on television receivers or cellular telephones. Government witnesses argued in reply that although such changes were possible, there was no evidence that they were actually happening, and indeed, Microsoft was striving vigorously to prevent them from happening. And even if completely new ways of interacting with the Internet came into vogue, personal computers configured to use operating systems in accepted ways would continue to enjoy substantial market acceptance, especially for office-based word processing and number-crunching applications.

Microsoft’s economic expert argued in addition that the government had overlooked a crucial source of competition to Microsoft—the competition from Windows packages that had already been sold and installed, and hence over which Microsoft had no effective control. This “installed base” competition inhibited Microsoft from charging monopolistic prices. Had Microsoft tried to obtain monopoly prices on Windows 98, for example, competition from the tens of millions of copies of Windows 95 already installed would have allowed it to sell few Windows 98 packages.

Professor Schmalensee admitted that the prices of Windows 98 were well above marginal cost—a condition viewed by economists as symptomatic of monopoly power. But software was different, he continued. Most of the relevant cost is incurred in a front-end lump sum for development; once the software is written and debugged, the marginal costs of reproduction are

For the exclusive use of Y. Gao, 2017.

This document is authorized for use only by Yuanyuan Gao in Industrial Organization II: Spring 2017 taught by Erich Muehlegger, University of California – Davis from April 2017 to June 2017.

 

 

Microsoft on Trial ___________________________________________________________ CR14-99-1522.0

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trivial, i.e., a dollar or two per installation. If prices did not exceed marginal costs, development costs could not be recouped and progress in software development would grind to a halt. There was disagreement between Schmalensee and the government’s economic witnesses, Professor Franklin Fisher (like Schmalensee, from the MIT faculty) and Frederick Warren-Boulton concerning the level and trend of Windows operating system prices. Schmalensee portrayed them as modest and essentially stable despite continuing increases in functionality. He argued further that if Microsoft really attempted to maximize its short-run profits on Windows 98, an econometric study suggested, it would charge 16 times more than the average price of roughly $65 paid by computer makers. Government witnesses observed in reply that more than half the personal computers sold in the consumer market during 1998 bore prices of less than $1,000, and if Windows 98 were priced at the levels implied, many or most of those sales would not have been occurred. Warren-Boulton presented evidence suggesting that Windows prices had risen over time, in sharp contrast to the history of personal computer prices generally and the prices of most computer components. This he viewed as indicative of monopoly power.

Microsoft’s Conduct

In attempting to prove that Microsoft’s conduct exhibited intent to acquire and maintain a monopoly position, the government placed strong emphasis on how Microsoft positioned its Internet Explorer browser software relative to the Windows operating system. Key antitrust issues here involved the concepts of “tying” and “bundling.” Tying occurs when a firm says in effect to its customers, “If you buy product A from us, you must also buy from us product B.” Tying by firms with monopoly power had been viewed as an antitrust violation ever since it was singled out as illegal under the Clayton Antitrust Act of 1914, where “the effect … may be to substantially lessen competition or tend to create a monopoly.” Court interpretations of these provisions took a generally tough line, but by 1984 had evolved to require a three-pronged test. Tying was illegal if (1) the tying and tied products were distinct; (2) the firm tying a product had sufficient power in the tying good market to force the purchase of the tied good; and (3) the tying agreement foreclosed or threatened to foreclose a substantial volume of trade.9

 

9 Jefferson Parish Hospital District No. 2, et al., v. Hyde, 466 US 2, 15-18 (1984).

Complications arise under the first of these criteria when products are bundled, that is, sold as an integrated package with a single price rather than separately. When products are sold in bundled form it can be hard to tell whether or not they are distinct. Bundling was ruled illegal in certain prior monopolization cases, but the precedents evolved to require a finding that the relevant conduct was unreasonable in view of the specific case facts.

For the exclusive use of Y. Gao, 2017.

This document is authorized for use only by Yuanyuan Gao in Industrial Organization II: Spring 2017 taught by Erich Muehlegger, University of California – Davis from April 2017 to June 2017.

 

 

Microsoft on Trial ___________________________________________________________ CR14-99-1522.0


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