Last Friday, Judge Jackson anounced his decision on the "findings of fact" in the Microsoft case. An expert on Industrial Organization and the Microsoft case, Professor Economides of the Stern School of Business at NYU has again agreed to answer some questions on the trial and the findings.

Links:

• Full text of Judge Jackson's findings.
• February 26 Trial Update from the Online NewsHour.
• The Economist coverage of the Micrsoft case.
• Microsoft | Netscape

Economides has published extensively on networks, network pricing, market structure and other topics. He has edited a special issue of the International Journal of Industrial Organization on Network Economics and is currently working on a book entitled The Impact of the 1996 Telecommunications Act to be published by the American Enterprise Institute and MIT Press.

He also maintains web sites on the Economics of Networks and on the current Microsoft Legal Battle.

Photo courtesy N. Economides

What were the expectations for the judge’s decision?

Let me first note that I am not now and have never been involved in any litigation involving Microsoft.

When Judge Jackson announced some time ago that he would release his decision on findings of fact before his decision on the findings of law (which are typically released together), many thought that the judge's decision on the “findings of fact” would be moderate, and the two parties would be urged to settle the case before the release of the “findings of law.” The incentive for Microsoft to settle before the findings of law are released would have been to reduce the probability of civil antitrust suits that would be based on a decision by the judge that found Microsoft guilty of monopolization and other wrongdoings. (Remember the judge's findings of fact do not constitute a conviction.) There are two incentives for settling by the plaintiffs. First, there does not seem to be a remedy that would take care of the antitrust problems without creating possibly bigger efficiency losses (see further analysis below). Second, it is desirable to reduce the expenditure of the public's money. Thus, on the eve of the judge's decision on findings of fact, the expectation was that the decision would be moderate, so the parties would settle. The decision was expected to be adverse for Microsoft because the judge had let it be known that the decision would be announced on a Friday at 6:30, after the close of the main US financial markets. Hence, the judge was expected to rule moderately for the plaintiffs.
 

What were your initial reactions to the judge’s findings of fact?

The “findings of fact” as decided by the judge on November 5, in almost all points, are favorable to the plaintiffs. In fact, it is hard to find even one major allegation for which the judge did not decide on facts that directly support the plaintiffs' positions. The judge was unusually harsh to Microsoft.
 

What were your subsequent reactions to the judge’s findings of fact?

In closer examination, the “findings of fact” are weak and not very well justified.  The judge fails to argue convincingly about:

1. The “fact” that consumers were harmed by Microsoft’s actions;
2. The “fact” that Netscape posed a real threat to Microsoft’s operating system, and that therefore that the browser integration in Windows was done to thwart such competition.

Were consumers harmed by Microsoft?

The judge finds the “fact” that consumers were harmed.  The plaintiffs' lawyers (including the US Attorney General) hailed the judge’s findings of fact as "a great victory for American consumers."  But is it really?  Microsoft gave away the browser.  Before Microsoft pursued this policy, Netscape was a monopolist in the browser market charging $40-50 per unit.  Consumers have directly saved about $2 billion by Microsoft’s free browser distribution and bundling policy that the judge found to be anti-competitive!  Why does this benefit to consumers escape Judge Jackson’s notice?

Moreover, consumers have directly benefited from the relatively low price of Windows ($40-50 to computer manufacturers) compared to historical prices of operating systems and current prices of other operating systems. For example, IBM was selling OS/2 (which ran much fewer applications than Windows) for hundreds of dollars. Some Linux packages (that are essentially add-ons to the free Linux source code) that run very few applications (compared to Windows) sell for $150. If Microsoft can exercise all this monopoly power as the judge finds, why is Microsoft so benevolent and does not charge more?

The judge found that Microsoft had the ability to exercise pricing power but does not fully do so.  This is very hard to believe.  Presently Microsoft is worth $400 billion, with the Windows division and the applications division worth each about half of that.  So, the Windows division of Microsoft is worth about $200 billion with Microsoft charging $50 per Windows 98 unit.  The same division would be worth at least $400 billion if MS charged $130 per Windows 98 unit.  The judge’s findings of fact imply that Microsoft forgoes an increase of its market value by $200 billion so that it can act anti-competitive and extend its monopoly power in other markets.  This is almost mathematically impossible because the value of MS from all the other markets (including markets with no allegations of anti-competitive acts) is $200 billion. So, Microsoft charges way below the monopoly price and consumers benefit from it.  Before DOJ splits Microsoft into three parts, it better make sure that the triopoly price with each baby MS having only one third compatible applications is in fact lower than what MS charges now.
 

Was Netscape a serious threat to Windows?

I seriously doubt it.  Netscape had not even taken the preliminary steps to create a rudimentary operating system that would run on top of its browser.  Although a possibility of the creation of such system existed (based on Java or otherwise) in principle, there was no evidence that Netscape was on its way to doing so.
 

Do you think a settlement is now more likely?

No.  Given the across-the-board siding of the judge with the plaintiffs, a negotiated settlement seems extremely unlikely in the short run. The terms of a settlement would be based on the “findings of fact” that are very adverse to Microsoft. Microsoft is unlikely to settle on terms implied by such adverse findings. Moreover, in a similar case about 15 months ago, the Appeals Court ruled that Microsoft had the right to include whatever it wanted in the PC Operating System, including its browser. So, Microsoft can reasonably expect that the same Appeals Court will rule similarly on appeal, reversing a significant part of the findings of fact of Judge Jackson. On the other side, there are 20 plaintiffs (USDOJ and 19 States). It would be hard for all 20 to agree on major concessions in settlement talks given the very favorable findings of fact. Thus, Microsoft is likely to wait for the final ruling on liability, fight the remedies battle, and keep appealing.
 

Are there any additional factors that are likely to weigh in the probability of settlement?

There are two additional factors that make it more likely that Microsoft would prefer to wait. First, Microsoft has argued in court that the landscape changes quickly and radically in the software industry, citing the Netscape buyout by AOL and Sun. The longer the duration of the case, the more likely it is that more such radical changes will happen before the final decision is made. Second, it is likely that the final appeal will end during the next US Administration. This may be beneficial to Microsoft, since a different Administration may be much softer on antitrust issues.
 

Is there any factor that may increase the incentive of Microsoft to settle?

A conviction of Microsoft on monopolization will open the doors to private antitrust suits against Microsoft.  This could be costly to Microsoft, but, in my opinion, it is not of critical importance to Microsoft.  The most crucial issue for Microsoft is how to make sure it preserves and appropriately utilizes its management.  Federal litigation has imposed on Microsoft the threat of a breakup that could cripple Microsoft’s ability to manage itself efficiently.  Microsoft clearly sees this as a threat and will fight it.  At the same time, Microsoft should guard against paying too much attention to private litigation rather than to the software business.
 

How damaging is the report to MS's legal case?

The judge finds solidly for the plaintiffs.  However, the judge’s argumentation is weak and may be reversed on appeal.  The lack of a clear identification of victims of Microsoft’s actions, and the lack of presentation of convincing evidence that consumers were harmed are key weaknesses of the report.  Microsoft may have a good chance of a wide reversal.

What criteria should be applied in determining remedies?

In defining remedies, the following criteria should apply. First, appropriate remedies have to be proportionate to whatever liability is finally established. Second, remedies also must be consistent with a strategy that prevents Microsoft from repeating whatever activity is found to be illegal in the case. Third, remedies have to be in the public interest and should help rather than harm consumers. In other words, the treatment should heal rather than kill the patient. Fourth, remedies should minimize other interference in Microsoft's business, and in the business of the rest of the computer industry. Thus, when defining remedies one has to consider:

1. What specifically Microsoft is convicted of doing illegally;
2. Which specific remedies would prevent Microsoft from committing the same crime or crimes again in the future;
3. Which remedies help consumers; in discussing whether or not a remedy helps consumers, one has to consider its effects on prices, on compatibility, on variety and quality, and on the speed of innovation;
4. Which of these remedies creates the least interference in the legitimate business of Microsoft and the rest of the computer industry;
5. Which remedies preserve and enhance incentives for innovation and technological progress.

Long before the present antitrust suit took shape, a loose coalition of IBM, Sun, Oracle, and Netscape was formed to fight Microsoft. This coalition has played a very significant role in bringing antitrust issues involving Microsoft to the attention of Congress and DOJ. In many ways, this coalition helped DOJ create and fight the case against Microsoft, even providing the idea of the Boies-Fisher team that had fought for IBM in DOJ’s antitrust suit against IBM in the 70s. At the time of the remedies determination, it is crucially important that remedies are not imposed for the benefit of competitors (including those of this coalition) but rather for the benefit of the consumers and competition.
 

What remedies have been proposed and how do you evaluate them?

A number of remedies have been informally proposed by sources close to DOJ. These remedies range from mild to very severe. The various remedies also differ to the extent that each deals with horizontal (within the same market) or vertical (across complementary markets) issues.

Two remedies on business conduct have been proposed.

Conduct remedy 1: Impose various restrictions on the contracts that Microsoft can write with sellers of complementary goods and with competitors. This is a likely remedy that is easy to tailor according to the violation.

Conduct remedy 2: Force Microsoft to disclose the APIs (definitions of the interface) that allow it to include Internet Explorer in the operating system. Microsoft routinely discloses APIs that hook applications to the operating system and allow for interoperability. Currently, Microsoft does not disclose the APIs that tie together parts of the Windows operating system, which includes Internet Explorer. If the APIs that hook Internet Explorer to other parts of the operating system are disclosed, Netscape (and any other browser) can get the same interoperability with Windows as Internet Explorer. Such disclosure would solve all technological bundling problems.

Four structural remedies have been proposed.

Structural Remedy 1: Force Microsoft to give away the Windows source code, or license it to successful bidders in an auction imposed by the government on Microsoft. Windows code may be worth as much as $200 billion. No company can bid that much. Practically speaking, only a handful of foreign governments can bid that much. This implies that the source code of Windows will be sold forcibly at a small fraction of its worth. Thus, this is a severe remedy that takes away the intellectual property of Microsoft. It will severely reduce the incentive for innovation, since dominant firms will no longer be guaranteed with certainty the value of their intellectual property. Moreover, source code evolves in time. Over time, different firms will add to and alter the Windows code. Soon, incompatibilities will arise. Applications vendors will have to write different applications for each version of the evolving version of Windows. It was exactly this problem that made Unix a failure in the individual consumer market. It is unlikely that all applications will be written for each of the incompatible versions of Windows. If, when there are three incompatible versions of Windows, each version has 1/3 of the applications, the benefits to a consumer from using a PC are reduced by 66%! By no means would this be a victory for the American consumer! In summary, auctioning the Windows code will result in incompatibilities that harm consumers and increase the cost of applications.

Structural Remedy 2: Break up Microsoft according to lines of business. This remedy is favored by the software association. Remedies that break up a company in any form are very severe. They are likely to severely damage the company, and they usually accomplish little or no more than alternative remedies. Microsoft is an entrepreneurial company that is run by very few top executives (about twenty). This makes it flexible and efficient, qualities that the DOJ should try to preserve, although Microsoft's competitors would probably like to extinguish. Breakup along lines of business is a very severe remedy. Its function can be accomplished by disclosure of APIs instead.

Structural Remedy 3: Break up Microsoft in three equal parts, with each part containing an equal amount of each business. Like other breakup proposals, this proposal may kill the managerial flexibility and efficiency of the company. Moreover, as with the auctioning the code proposal, one expects that significant incompatibilities will result within a short period of time. Incompatibilities harm consumers by significantly reducing the benefits that consumers get from applications, as explained above and by increasing the cost of applications. Finally, it is unlikely that this industry structure will result in significantly lower prices, since Windows prices are presently low, and each of the resulting three companies will have a much smaller scale of production. From a legal standpoint, this proposal has the weakness of also breaking up the applications division of Microsoft, although monopolization has not been established in applications.

Structural Remedy 4: Break up Microsoft along lines of business (operating systems and applications) and then break the operating systems division in three equal parts. Like other breakup proposals, this proposal may kill the managerial flexibility and efficiency of the company. It is also likely to result in incompatibilities, as explained above, with significant reduction of benefits to consumers, and increases in the costs of application development.
 

What do you think is the most likely outcome?

DOJ proposes structural remedies in an attempt to force Microsoft to settle.  But the game is more complicated.  And, DOJ lawyers are amateurs in games of strategy while Gates and his top executives are professionals.  Microsoft has managed over the years to snooker practically all the major players in the computer industry, including IBM, Apple, and Compaq.  If history is any guide, Microsoft will wait until the present US Administration fades into history, and will try to cut a deal with the next Administration.  I believe that a conduct remedy, such as contract restrictions possibly enhanced with API disclosures, is the most likely outcome.

Interview with Nicholas Economides. | Posted November 9, 1999 02:42 PM by John Irons