High Technology Industries:
Competitive Issues and the
Microsoft Case
Salient structural features of
high technology industries
•Product and price differentiation
•Bundling
•Switching costs and lock-in
•Supply-side economies of scale
•Demand-side economies of scale
•Standards
The practice of selling two or more distinct
goods together for a single price.
•You cannot purchase Excel or PowerPoint as stand alone
applications—you must purchase Microsoft Office.
•Operating systems bundled with internet browser
software.
Switching costs and “lock-in”
Switching from Windows to
Linux means changing
document formats and
software applications. We
will have to train employees
to use the new platform.
Economies of scale
€
Manufacture of
software involves
substantial
development costs
but negligible
marginal cost
Average Cost
0
Quantity/time
Network effects
A good exhibits network effects if the demand for
the goods depends on how many other people
purchase it.
Examples: fax machines,
picture phones, e-mail.
Network Effects and Demand
Willingness
to pay
Demand curve
Willingness to
pay begins to
diminish at
network size N*
due to “network
congestion”
effects.
“Critical mass”
area
Supply curve
0
N*
Size of network
The Microsoft case
Microsoft Corporation v. U.S. 530 U.S. 1301 (2000)
The Antitrust Division of
the DOJ won Sherman
section 1 and section 2
convictions against the
software giant.
Acronyms and definitions
•OS: Operating system (e.g., Windows)
•OEM’s: Original equipment manufacturers (e.g., Dell, Compaq,
Gateway).
•IAP’s: Internet access providers (e.g., Yahoo, AOL).
•ISV’s : Independent software vendors. Software vendors not affiliated
with Microsoft or Apple.
•API’s: Application programming interfaces. “These are synapses at
which the developer of an application can connect to invoke prefabricated blocks of code in the operating system. These blocks of code
in turn perform crucial tasks, such as displaying text on the computer
screen. Because it supports applications while interacting more closely
with the PC system's hardware, the operating system is said to serve as a
‘platform.’” Judge Jackson’s Finding of Fact
Case Background
Microsoft’s antitrust troubles
began in 1990. Mr. Gates signed
a consent decree in 1994 to
settle an earlier filing by the
DOJ. This suit targeted
operating system licensing
policies that rivals claimed
blocked entry into the market.
Terms of the 1995 consent decree 1
1. Per-processor licenses. PC makers previously paid Microsoft
royalties for every PC shipped, regardless of whether they sell it
with Microsoft software. This arrangement meant PC makers paid
double to install a rival operating system. Microsoft agreed to
discontinue this practice.
2. Long term licenses. Licenses that lasted three to five years made
it tough for for rivals to get PC makers to use a new operating
system. Microsoft agreed that licenses should be one year with an
option to extend for an additional year.
3. Minimum commitments. Microsoft offered incentives to PC
makers to commit to purchase a fixed number of systems in
advance, crediting any shortfall to actual sales in the next year. The
arrangement effectively lengthens contracts and excludes rivals.
1
Federal Judge Sporkin rejected the decree but he was overturned by
the Federal Court of Appeals in 1995. Hear Audio explanation (wav)
DOJ Antitrust chief Joel Klein felt
that Microsoft violated the 1995
agreement by bundling its browser
software with its Windows
operating system. This provided the
impetus for the later filings.
The DOJ Complaint
1. Microsoft violated section 1 of the Sherman
Act by bundling it browser software with its
Windows operating system.
2. Microsoft illegally monopolized the market
for desktop operating systems, in violation
of section 2 of the Sherman Act
2-part test for illegal monopoly
The Supreme Court of the United States set forth two-part
test in the Grinnell decision The offense of monopoly
under section 2 of the Sherman Act has 2 elements:
1. The possession of monopoly power in the relevant
market;
2. The willful acquisition and maintenance of that power
as distinguished from growth or development as a
consequence of a superior product, business acumen,
or superior product.
Market definition
Judge Jackson agreed the
DOJ market definition—
”Worldwide licensing of
Intel-compatible operating
systems.” Microsoft had “at
at least a 95 percent” share
for this definition.
Merely showing monopoly
power in the relevant market
is not sufficient. The
government must give
evidence of “willful
acquisition and maintenance”
of monopoly power.
The applications barrier
Hear audio explanation (wav)
Judge Jackson stated in his Finding of Fact:
“[T]he applications barrier would prevent an
aspiring entrant into the relevant market from
drawing a significant number of customers away
from a dominant incumbent even if the
incumbent priced its products substantially
above competitive levels for a significant period
of time.”
The middleware threat
Mr. Gates viewed middleware (the
Java programming language and
Netscape browser software) as rival
platforms for ISV’s. Gates feared
middleware would bring down the
applications barrier.
Hear Brown’s comments (wav)
Evidence of ‘willful acquisition and
maintenance . . . “
The government alleged that Microsoft designed
its licensing agreements with OEM’s and IAP’s
so as to preserve the applications barrier. This
was also its objective in giving away Internet
Explorer for free.
The OEM Channel
•Licensing agreements with OEM’s stipulated preinstallation of Internet explorer.
• Internet Explorer icon must appear on the desktop after the
initial boot-up sequence.
•OEM’s prohibited from pre-installing Netscape browser
software.
The IAP Channel
•
Microsoft offered IAP’s valuable “real estate” on the Windows
desktop in exchange for their agreement to distribute Internet
Explorer exclusively. Hear audio explanation (wav)
•
If an IAP was already under contract to pay Netscape a certain
amount for browser licenses, Microsoft offered to compensate
the IAP the amount it owed Netscape.
•
Microsoft also reduced the referral fees that IAPs paid when
users signed up for their services using the Internet Referral
Server in Windows in exchange for the IAPs' efforts to convert
their installed bases of subscribers from Navigator to Internet
Explorer.
3-part test for illegal tying
a
1.
“The seller must possess power in the tying product market."
Effective tying entails leveraging a dominant position in the tying
product market to achieve a dominant position in the tied product
market.
2.
“There must be a substantial threat that the tying seller will acquire
market power in the tied-product market. If . . . the tying
arrangement is likely to erect significant barriers to entry into the tied
product market, the tie remains suspect.“
3.
"There must be a coherent basis for treating the tying and tied
product as distinct."
a Jefferson Parish Hospital District et al. v. Hyde [466 U.S. 2 (1984)].
Certainly Microsoft had monopoly
power in the tying product market
(test 1). Also, it threatened to close
off a substantial share of the browser
segment (test 2). So the remaining
issue was : were Windows and
Internet Explore “distinct products.”
Microsoft’s attorneys claimed that
Windows and Explorer were
“functionally integrated.” In fact,
they shared files so that if you
uninstalled Explorer, Windows would
not function properly. But Princeton
computer scientist William Felton (a
prosecution witness) showed this
problem could be easily corrected.
He demonstrated Windows would
run just fine without Explorer
The November 2, 2001 Settlement.
Click here to view the terms of the settlement
reached between the Justice Department and
Microsoft.
The election of George W.
Bush was lucky for
Microsoft. The new regime
at Justice was prepared to
reach a settlement that most
observers believe is
favorable to Microsoft.