The Transition to Windows 98

The Transition to Windows 98

An early antitrust skirmish between Microsoft and the federal government ended with a negotiated consent decree in July 1994. The focus then was Microsoft operating system price terms that in effect established a zero price against which other operating systems had to compete. The terms of the decree were vague on questions of tying and bundling complementary products.

When Microsoft introduced the Windows 98 operating system in 1998, Internet Explorer was physically integrated into the new operating system so that file access within the user’s internal computer memory could be accomplished using Explorer in the same way that one would search for information externally on the World Wide Web. Needless to say, no separate and additional price was charged Windows 98 purchasers for the physically bundled browser feature, so again, independent browser vendors had to compete against what was essentially a zero price.

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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.



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Forewarned by a Microsoft advance product announcement, the Department of Justice brought suit to enjoin the bundling of Internet Explorer with Windows 98. A preliminary injunction was issued by Judge Jackson, but it was overturned on appeal to the Federal Appellate Court for the District of Columbia in 1998. The ruling by two Appellate Court judges (with a third dissenting) stressed two points: first, that the courts had little competence in judging such product design questions, and so it was undesirable for them to intervene; and second, that integration of features by a monopolist should not be viewed as anticompetitive as long as there was some technological justification for the integration.10

The 1998 bundling action continued to receive attention, however. Computer experts called as government witnesses testified that it was neither necessary nor, given the already great complexity of Windows operating systems, desirable from a reliability standpoint to bundle the browser with the operating system. One expert demonstrated in the courtroom that removing Internet Explorer from Windows 98, or at least, removing its icons from PC desktop screens, was feasible. Microsoft witnesses asserted in rebuttal that only a small fraction of the integrated Explorer code had been removed. Their attempt to show that even such a modest change impaired other Windows 98 functions precipitated a widely publicized comedy of errors. It became known that the demonstration computer operating system had been altered from the configuration used by the government witness and then, when a supposedly identical system was used, the demonstration failed. Microsoft continued to insist that bundling benefited consumers and complementary software writers.

This view surprised antitrust scholars who accepted a weighing of benefits against costs as a routine part of monopolization proceedings, but it could be rationalized on the premise that the courts are not adept at performing such balancing exercises. Stung by the Appellate Court’s decision, the Department of Justice converted its ongoing antitrust action against Microsoft (the second in five years), which was originally to be focused narrowly on Microsoft’s Internet Explorer strategy, into a more broad-ranging attack on Microsoft’s business policies.

From extensive testimony, it was clear that Microsoft had exerted strenuous efforts to win market share for Internet Explorer, as Microsoft representatives stressed, or to impair Netscape’s Navigator from becoming an industry standard outside Microsoft’s control—the interpretation emphasized by government advocates. Evaluation of these strategies was complicated by the acquisition in 1999 of Netscape Communications by network service provider AOL. Microsoft counsel insisted that the $10 billion acquisition price showed that Microsoft’s actions had not undermined Netscape’s viability and that the AOL-Netscape merger, with additional joint venture linkages to Sun Microsystems concerning its Java language, made the competitive threat of alternative Internet access technologies to Microsoft all the more potent. Government counsel argued in reply that Microsoft had already won the key battle, preventing Navigator from acquiring


10 Anne Gearan, “Federal Appeals Court Overturns Microsoft Injunction,” Chicago Daily Law Bulletin, vol. 144, June 23, 1998, p. 1.

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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.



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such a large browser market share that it became a standard through which competing operating systems could gain a defensible foothold.

Other Conduct

Government prosecutors broadened their attack to include other Microsoft conduct allegedly aimed at maintaining its dominance and frustrating threats to its Windows operating system monopoly.

In March 1996, Microsoft signed a licensing agreement with Sun Microsystems under which it agreed to implement the Java language in Microsoft software in a way that maintained cross-platform compatibility. In fact, Microsoft’s implementations left out or changed key Java components permitting Java programs to run well on operating systems other than Windows. Sun sued for breach of contract in 1997, and the government included the Microsoft Java story in its antitrust case, alleging that it represented yet another attempt by Microsoft to thwart the ascendance of web-based systems threatening Windows’ dominance. Microsoft defended its actions by insisting that it was merely remedying flaws in the basic Java language and improving it so that it worked better in the Windows environment. The credibility of this defense was impaired, however, by an internal Microsoft memorandum stating that a “strategic objective” of Microsoft was to “kill cross-platform Java by growing the polluted Java market.”

Other testimony and documents focused on the relationships between Microsoft and Intel, whose complementary operating system and microprocessor positions were described in computer industry colloquy as “the Wintel duopoly.” The two companies had a history dating back to 1982 of cooperating to maintain their common platform standard. In 1995, however, Intel responded to new opportunities opened up by the Internet by developing microprocessor chips that would deliver audio and video signals in a stream of digital bits. Learning of Intel’s plans, Microsoft executives, according to an Intel witness, threatened that they would withhold software development support for future versions of Intel’s microprocessors unless Intel cancelled its audio- video chip plans, which were perceived to intrude onto Microsoft turf. Microsoft also urged Intel to scale back its technical collaboration with Sun Microsystems in fine-tuning the performance of Java on Intel chips. Microsoft counsel insisted that its discussions with Intel on these matters were not really threats but only efforts to ascertain whether Microsoft’s symbiotic relationship with Intel was about to become more rivalrous.

Injury to Competition?

In the extensive body of case precedents accumulated under the Sherman Act’s monopolization doctrine, considerable attention was paid to the language of the complementary Clayton Antitrust Act, which declared various questionable business practices to be illegal only

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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.



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when their effect was “to substantially lessen competition or tend to create a monopoly.” An even longer line of scholarly discourse asked whether conduct that injured competitors was a violation of the antitrust laws, or whether the requisite proof of anticompetitive effect was injury to the quality of competition. This debate resurfaced in the context of the Microsoft case. Critics of the government’s approach urged that Microsoft’s conduct may have been disadvantageous to rivals such as Netscape, AOL, Spyglass, Sun, and the providers of such popular applications software as WordPerfect and Lotus 123, but that consumers were the net beneficiaries after unsuccessful competitors’ bodies were removed from the battlefield. Microsoft insisted through the 1998-99 trial before Judge Jackson that its principal motivation was simply, in the words of Bill Gates, to provide “great software.” Microsoft’s principal economic witness asserted that consumers benefited also from greatly increased functionality during a period when the prices of MS/DOS or Windows, even without an adjustment for general inflation, did not increase.

Although a government witness provided evidence of upward price creep, the government’s main rebuttal was both subtler and more speculative. The really serious threat to consumer welfare, the government claimed, came from Microsoft’s ability to thwart the emergence of superior alternative applications software packages because would-be developers have inferior access to Windows APIs. Even more importantly, consumers would be the losers if Microsoft were successful in its strategy, proclaimed in many internal decision-making memoranda, of impeding the emergence of Internet computing modes not dependent upon the Windows gateway. Whether it would in fact be able to defend Windows from nascent threats necessarily remained speculative at the time of the trial before Judge Jackson. The government could bolster its case only by arguing that the stakes involved in keeping access to the Internet as open as possible were huge, and therefore that the benefit of the doubt should be resolved against access-blocking strategies by a monopolist.

Noblesse Oblige?

Not directly incorporated by the Justice Department’s legal theories, but lurking in the background, was another doctrine with strong roots in US antitrust precedents—the notion that under certain circumstances, firms with a monopoly position in the ownership of some “essential facility” achieved by fully legitimate means nevertheless have an obligation to serve all would-be clients in an even-handed manner. In an early precedent, the US Supreme Court ruled that several railroads owning the only railroad bridge across the Mississippi River into the St. Louis area had to let other (competing) railroads use the bridge on non-discriminatory terms.11 In another case, an Ohio newspaper with a local monopoly was found to violate the Sherman Act when it refused to accept advertisements from businesses that also advertised on a new local radio station.12


11 US v. Terminal Railroad Association, 224 US 383 (1912).


12 Lorain Journal Co. v. United States, 343 US 143 (1951).

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


Witness after witness for the government described Microsoft’s industry-standard Windows operating systems as the essential utility of modern personal computing and a key gateway to the Internet. A possible implication was that Microsoft as a near monopolist carried an obligation to deal with other computer hardware producers, software vendors, and service providers in an especially open and even-handed way. Conditioning the provision of information on Windows APIs upon compliance with other Microsoft wishes, or denying preferential computer screen icons to firms that competed with Microsoft, could be seen as stepping beyond the bounds of the “essential facility” precedents.


If Judge Jackson concluded that Microsoft violated Sherman Act Section 2 because of its dominant position and business practices that unreasonably secured that position, remedies would have to be imposed. The usual remedies in monopolization cases are of two main types—conduct and/or structural. With a conduct remedy, the court orders the defendant to change its business practices in prescribed ways, monitors compliance with the order, and imposes fines or other remedies in cases of non-compliance. With a structural remedy, the court mandates changes in the market’s structure that are expected to compel desirable conduct more or less automatically through the impersonal play of structurally invigorated competition—e.g., by forcing the monopolizing firm to shed some assets. The differences in the two remedial approaches are sometimes compared to differences between surgery, with one-time-only intervention, and sustained drug therapy in medicine. The choice of remedies entails in part a question of which approaches are likely to be most effective, but the severity of the remedy imposed is normally graduated to the egregiousness of the antitrust violations found.

The Department of Justice and the 19 collaborating state attorneys general did not propose specific remedies at the time they concluded their prosecutorial case, preferring, as is not uncommon, to leave the question of remedies open until Judge Jackson issued his findings on whether and to what degree Microsoft had violated the antitrust laws. However, extensive discussions at public forum and in the press had identified an array of possible approaches.

On the conduct side, the principal alternatives were as follows:


Unbundling Internet Explorer: Microsoft would be required to develop unintegrated versions of Explorer and Windows and to market them at separate and remunerative prices.

Bundling a rival web browser: Microsoft would be required to include in its standard Windows packages one or more alternative browsers, any of which could be removed or included by computer makers in response to specific customer

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


demands. The most obvious candidate for mandated inclusion would be Netscape’s Navigator.

Creating a “Chinese Wall” within Microsoft: Microsoft would be required to enforce strict segregation of the groups that develop applications software (such as word processing and spreadsheet programs) and browsers from the group developing operating systems. Applications software writers would receive information about new APIs on schedules and to an extent identical to those enjoyed by outside software vendors.

Non-Discriminatory API Release: With or without a Chinese wall, Microsoft would be required to release full information on operating system APIs to all interested parties a specified number of months before commercial product release. After those preliminary disclosures, periodic revisions to document “bug fixes” would have to be disclosed equally widely and expeditiously. Provisions like this were imposed upon IBM in 1984 to settle a European Commission complaint against IBM’s market dominance and practices in Europe.

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