IMAGINE A corporation whose ambitions are un­bounded and whose main product seems indispensable. Imagine that it has threatened to withhold this product in order to impose its will on competi­tors and manufacturers who require it. Imagine that it has in its coffers $30 billion in cash, and that its profits in one recent year came to almost $8 billion. And now imagine that this company has provoked so much hostility in its industry that it is regularly referred to as the “Evil Empire,” and that one com­petitor has spent $3 million lobbying the U.S. Department of Justice to take action against it.

The company, of course, is Microsoft, and in re­sponse to that lobbying, and other complaints, the Justice Department did indeed bring an antitrust suit against it in 1998. Last year, after a trial that lasted 76 days and generated 13,466 pages of transcript and 2,695 exhibits, the district court in Washington, D. C., presided over by Judge Thomas Penfield Jackson, ruled that Microsoft, with its Windows program, possessed monopoly power over a particu­lar kind of operating system. (An operating system is the crucial program that controls all a computer’s activities.) Indeed, so unshakably secure was Mi­crosoft’s position that, according to Judge Jackson, no competitors were likely to arise in the foreseeable future. In protecting and expanding this mo­nopoly, the company had been, he said, “untrustworthy,” “disingenuous,” “oppressive,” and “predacious,” and had done “violence” to the creative process. For thus violating the Sherman Antitrust Act, Microsoft would be broken up, split into two separate companies.

This past June, an appellate court reviewed Judge Jackson’s harsh conclusions. In a decision hailed by Microsoft and accepted by most of the news media as a setback for the Justice Depart­ment, the court rejected the proposed “remedy,” declared one of the major accusations unproved, and attacked Judge Jackson for holding confiden­tial press interviews during the trial in which he had likened Microsoft to drug traffickers and “gangland killers”; in so doing, the appellate court declared, the judge had violated the judicial code of conduct in ways that were “deliberate, repeated, egregious, and flagrant.”

Initial impressions notwithstanding, however, the appellate court’s decision was hardly good news for Microsoft. The court refrained from challeng­ing most of judge Jackson’s “findings of fact”; it found the company to be in possession of monop­oly power; and it declared Microsoft guilty of maintaining that power by anticompetitive means. As of now, it is unclear whether some settlement will be reached, or whether a lower court, in order to determine appropriate “remedies,” will conduct the full “evidentiary hearings” that Judge Jackson dispensed with, or whether the case will be decided by the Supreme Court. But neither a settlement nor any future judgment is likely to call into ques­tion the assertion that Microsoft is a monopoly or even remotely to challenge the findings of fact. Any compromises and penalties demanded of the company are bound to be substantial.

Have we, then, arrived at a just conclusion? Not in the least. Despite everything we have learned through two stages of adjudication, this case re­mains one that, in my view, should never have been brought at all. Moreover, I believe that the Justice Department and the eighteen state attorney gener­als who remain committed to the case seriously misjudged the nature of the technological land­scape and, in the name of protecting competition, acted to inhibit it.

Some of my objections have been raised by Microsoft in its own defense or have appeared in arti­cles or books; others have not. Under close scruti­ny, for example, many of the presumptions of the case seem very peculiar. Antitrust law in the United States, as the company itself has pointed out, is de­signed to protect consumers, not competitors, yet consumers did not seem eager for protection; be­fore the trial began, a New York Times/CBS News poll found that only 2 8 percent of computer users had an unfavorable opinion of Microsoft and a full 77 percent of all Americans believed it made qual­ity products. (Attorney General Janet Reno said at the time that part of the government’s job was to “convince people” it was acting in their interest in this case.)

As far as the consumer and the industry are con­cerned, moreover, market dominance is not neces­sarily a drawback. In creating a defacto standard, Microsoft has made computer use easier for con­sumers and more economical for software develop­ers. Then, too, while Windows is, without ques­tion, the most important piece of software in any computer, it accounts for less than 5 percent of the average computer’s cost; in fact, the price of Win­dows today is not significantly higher than the price of earlier versions a decade ago. In addition, the Windows operating system, whatever its flaws, is regularly improved, with new versions leading to faster speeds and more sophisticated applications. In pursuit of such improvements, Microsoft has spent over $5 .3 billion on research and develop­ment in the last year alone; its latest version, Win­dows 2000, required 5,000 workers, 500 many years of testing, and a $2 billion investment.

The polemical drift of these arguments is clear: what sort of monopoly can it be that does not dispense with, or whether the case will be decided by the Supreme Court. But neither a settlement nor any future judgment is likely to call into ques­tion the assertion that Microsoft is a monopoly or even remotely to challenge the findings of fact. Any compromises and penalties demanded of the company are bound to be substantial.
Have we, then, arrived at a just conclusion? Not in the least. Despite everything we have learned through two stages of adjudication, this case re­mains one that, in my view, should never have been brought at all. Moreover, I believe that the Justice Department and the eighteen state attorney gener­als who remain committed to the case seriously misjudged the nature of the technological land­scape and, in the name of protecting competition, acted to inhibit it.

The polemical drift of these arguments is clear: what sort of monopoly can it be that does not.

II

DOES, OR did, Microsoft hold monopoly pow­er? Unless it did, what seemed to the courts
like anticompetitive behavior was merely competi­tive behavior.

The courts considered three major issues in es­tablishing Microsoft’s monopoly power.

Defining the relevant market. The courts were very precise. Microsoft Windows was said to hold over 90 percent of one particular market, namely, the market for operating systems used in Intel­-compatible PC’s (personal desktop computers that evolved out of a design now nearly twenty years old). Other forms of operating systems such as those used in handheld computers, Apple Macin­toshes, network computers connected to other ma­chines, or “servers” for hosting Internet sites were judged by the courts to constitute separate markets and thus to offer no competition. This is a necessary distinction, for if the relevant market had been defined as operating systems for all comput­ing devices, Microsoft would be just another player in an actively competitive world.

Barriers to entry. According to Judge Jackson, Windows boasts some 70,000 “applications” programs, written specifically for it, ranging from word processors to video games. Any operating system is made stronger by the number of its applications the higher the number, said the courts, the more popular the system will become, and thus the more likely a system will be to preserve its strength by developing still more applications. And this constitutes a barrier to competitors trying to enter the market for who, in a short time, can match such a quantity of offerings? Thus, as the courts reasoned, IBM’s operating system, OS/2once a major competitor to Windows ended up failing because it could not match Win­dows’ number of applications.

“Switching costs” and “lock in.” Programs for one operating system will not run on another, which means that a consumer wishing to switch to a dif­ferent operating system will have to purchase all new software and perhaps even new hardware. Such “switching costs” are high, said the courts, with the consequence that consumers are effective­ly “locked in” to Windows.

In sum, Microsoft (in the courts’ view) domi­nates a market the boundaries of which prevent competition from entering and consumers from leaving. This in turn means that, unfettered by competition, Microsoft does not need to succeed on the merits; it can charge a price for Windows higher than if it had to respond to competition.

These contentions have a certain truth to them, but a much larger modicum of untruth. Nor, separately or together, do they establish monopoly power. As the history of operating systems shows, the relevant markets are permeable and promise to remain so; the success of an operating system is due not to the absolute number of applications it sup­ports but to the design of a handful of its essential applications; and consumers willingly undertake to pay “switching costs” when major improvements are offered.

A little over two decades ago, the entire computer arena was dominated by IBM and its “main­frames” large computers sold to institutions and corporations. No one in the mid-1970’s would have credited the possibility of a significant consumer market for operating systems alone. But then the world changed, desktop computers began to ap­pear, and IBM, in developing its own such “personal computer” (PC), needed an operating system. Acting on its old understanding, according to which operating systems were mere appendages to the more important hardware, it did not design its own such system but turned to a fledgling company called Microsoft, from which it licensed a program called MSDOS. IBM’s failure to purchase this program outright was perhaps the most significant economic blunder in the history of the industry. The market had shifted, and IBM was caught unaware.

A similar transformation occurred in 1984 when Apple created the Macintosh the first consumer this constitutes a barrier to competitors trying to enter the market for who, in a short time, can match such a quantity of offerings? Thus, as the courts reasoned, IBM’s operating system, OS/2once a major competitor to Windows ended up failing because it could not match Windows’ number of applications. computer displaying different typefaces on the screen and using images to represent programs. So dramatic were these improvements that they not only helped displace earlier, non-graphic Apple models but lured users away from MSDOS as well. Until 1990, even though Apple’s own market share was small, Microsoft struggled unsuccessful­ly to compete, its awkward and inadequate designs leading to continual failure.

Then, at last, Microsoft made a breakthrough with Windows 3 .0. Black and white monitors were junked, new computers were sold with ever faster processors, and individuals and corporations, far from being “locked in” by their investments in hardware and software, or being deterred by “switching costs,” eagerly welcomed the new tech­nology, spending millions of dollars in the process.

In today’s marketplace, the concepts of “lock in” and “switching costs” apply still less. Given the pace of technological change, computers hardly ever represent a onetime cost, but typically are re­placed or upgraded as prices drop and power continuously increases. Judge Jackson in his findings of fact acknowledged that “PC users buy new PC systems relatively frequently,” but failed to draw the proper conclusion. A superior piece of software or hardware can quickly displace its rivals; the critical factor is quality.

In 1979, for example, a program called VisiCalc was developed that helped businesses create “spreadsheets,” studies of revenues and expenses. It was so powerful that it spurred the sale of PC’s themselves, and it became so established that it cre­ated an industry of ancillary products. Then it gave way to a superior program, Lotus 123, which dis­placed VisiCalc until it, too, was displaced when Microsoft’s program, Excel, came on the market and was hailed by reviewers and consumers alike. This is but one example of many; over time, as Stan J. Liebowitz and Stephen E. Margolis show in their recent book, Winners, Losers, and Microsoft, Microsoft’s market share of products has been strongly correlated to positive reviews of their quality.

SO, WHAT about the sheer quantity of applica­tions? In the first place, as Richard B. McKenzie showed in a paper for the Cato Institute last year, the figure of 70,000 seems to refer not to Windows programs but to the total number of pro­grams written for IBM-compatible machines over the last two decades; about 3,000 such programs are currently listed for sale, and only a fraction of those is in use. In the second place, beyond a certain point it does not really matter. All that most people require is a basic handful, a selection of professional software and some amusing games. That was what it took to jumpstart the Macintosh, Windows 3.0, and even IBM’s OS/2. According to the courts, OS/2, which was meant to compete with Windows, failed because it offered only 2,500 applications; but 2,500 applications is more than enough to satisfy anyone but the most obsessive user. OS/2 really failed because of poor marketing, awkward design and installation, and inadequate courting of software developers.

If “switching costs” are unimportant, and the “ap­plications barrier to entry” is low and easily broken down, then there is nothing to prevent competition. As it happens, Microsoft has had quite a bit of it. Does the company possess the power, as the appel­late court stated, simply to “stave off even superior new rivals”? Every time Microsoft has had to com­pete against a superior consumer product, it has not fared well, which is why it must spend so much on research and development. This has happened with competitors in specific fields like America Online (AOL) for Internet service or Quicken for financial software and there is no reason to believe
things are otherwise with operating systems for the average consumer. If varieties of the operating system Linux became easier to install and more consumer oriented, its 15 million users would multiply significantly.

As Judge Jackson himself asserted, again without acknowledging the significance of what he was say­ing, “Signs do not indicate large demand for a new Intel-compatible PC operating system.” Quite so: Windows stands relatively unchallenged not be­cause of its ruthlessness but because it is both rea­sonably priced and, for consumer use, superior to anything else on offer.

Finally, Microsoft does not even have the ability, ascribed to it by Judge Jackson, to “set the price of Windows substantially higher than that which would be charged in a competitive market.” In the judge’s eyes, Microsoft was guilty of charging a “revenue-maximizing price” of $89 for a Windows 98 upgrade when a price of $49 would still have made money. A move like this, which failed to con­sider prices “charged by other firms in the mar­ket,” was itself “probative of monopoly power.”

How so? All companies are free to charge what they like for premium products, and Microsoft charged a price it believed would be paid. Besides, at the very time the trial was going on, a commer­cial Internet site was offering a Windows 98 up­grade for $82.95, Apple’s Mac OS 9.0 for $86.95, and a commercial version of Linux for up to $61.95. Does this suggest monopolistic pricing?

The truth is that Microsoft has had to constrain its pricing in view not just of immediate changes in the market but of future competition. If it charged $1,000 for Windows, there would be a stampede to Apple and systems like Linux. And this is a point with general significance: despite its undoubted power, Microsoft has had to improve and price its products as if it were beset by a large number of competitors; otherwise, it would be left behind just as IBM was left behind in the 1980’s. It must act, in other words, in constant awareness of its potential weakness, a weakness that is itself an inherent fea­ture of the unpredictable fluidity of technological innovation.

III

As I have already stipulated, it is unlikely that r1. any appeal to the Supreme Court or any set­tlement will alter the ruling that Microsoft does in­deed possess monopolistic power. Even so, howev­er, Microsoft would be in violation of antitrust law only if it misused that power, by engaging in an il­legal form of “exclusionary conduct” to protect or extend that monopoly. This, in fact, was the bur­den of the accusation that started the case in the first place, an accusation involving what was once called “the browser wars.”

A browser is a program used to “access” sites on the Internet. In the early 1990’s, there were as many as 50 such programs. Then, in 1994, a company called Netscape Communications developed a new browser, dubbed Navigator, that was substantially better than those previously available. Other companies: Microsoft, Apple, IBM, Sun Microsystems having already started to plan for the Inter­net, also soon began to package browsers with new versions of their operating systems.

Microsoft had been characteristically aggressive in developing its own browser, Internet Explorer, which it kept improving while weaving it more and more tightly into Windows. Finally, the two prod­ucts (as the company itself would assert) were made inseparable. This effectively created a massive dis­tribution network and seemed, indeed, a clear use of monopoly power to win the browser wars. In ad­dition, Microsoft sought to make deals both with computer manufacturers and with online services like AOL to offer Internet Explorer with their products, sometimes exclusively, and it prevented manufacturers from deleting Microsoft’s brows­er even when they also installed Netscape’s. In short, it threw its weight around, sometimes by threatening to withhold its products altogether.

Many of these kinds of dealings, involving dis­counts, incentives, and exclusive contracts, are common in every industry. In this indus¬try, the aggression is virulent, featuring regular commands to “kill” and “choke” competitors. But both before and during the case, Microsoft showed itself willing to compromise in its licensing and deal making and in law, as the courts themselves pointed out, these are inherently murky areas, full of counterfactual possibilities and subtle assess­ments. Still, that did not prevent the judges from reaching the remarkably straightforward conclu­sions that (a) the success of Internet Explorer had little to do with quality, and (b) Netscape was un­fairly prevented from competing.

In 1999, Judge Jackson insisted that there was no “best of breed” in browsers and none was likely to emerge “at any time in the immediate future.” As for Netscape’s failures, these were laid to the machina­tions of Microsoft, which hampered Netscape’s most economical method of distributing its product. In the unequivocal words of the findings of fact, “Mi­crosoft’s campaign succeeded in preventing” Netscape from developing its competitive potential “for several years and perhaps permanently.”

None of this is plausible. When Microsoft first introduced Internet Explorer, Navigator was clear­ly the better product, and the more successful. It was only in 1997, once its browser was widely judged by reviewers and users to equal or surpass Navigator’s in quality, that Microsoft began signif­icantly to improve its market share. By the time the judge was presenting his “review,” the superiority of Internet Explorer was unquestioned. The design of Internet Explorer also made it easy to be cus­tomized by applications companies and by Internet providers like AOL; Navigator was unable to match that flexibility.

Nor is it easy to see how Netscape failed because of Microsoft’s actions. Microsoft never even “suc­ceeded in preventing” the distribution of Netscape’s browser. In 1998, the year the trial began, 160 mil­lion copies of Navigator were downloaded from the Internet. The program was also available on 24 percent of all computers sold by manufacturers like Dell and Compaq the very distribution channel the courts believed Microsoft had closed off with its heavy-handed dealing. In their scrupulous study, Competing on Internet Time, Michael A. Cusumano and David B. Yoffie show that what “allowed Mi­crosoft to catch up” in the browser wars was not its misuse of monopoly power but Netscape’s incompetence and bad decisions: the company missed deadlines, alienated customers, and failed to create a compelling business model. Netscape’s successes were largely unaffected by Microsoft’s actions, and its failures were its own to achieve.

Besides, even if Microsoft had not been involved, it was clear to executives at Netscape that they could not rely on Navigator for long-term profits, certainly not in an industry where it was tradition­al to give browsers away. Long before the trial began, Netscape’s business plan had shifted several times; in the end, the company was dependent not on sales of the browser itself but on a website to which each new browser was directed, a site that in mid-1997 was receiving 100 million visits a day and bringing in tens of millions of dollars a year in ad­vertising. And while the trial was still going on, suf­ficient potential value remained in the company to inspire AOL to pay $4 billion for it.

BUT SUPPOSE I am wrong, and Netscape was in­deed pummeled by a monopolist with no
claims on product superiority. How was antitrust law violated?

The district court held that the violation lay in Micro­soft’s attempt to use one monopoly to create another er; that is, it tied Internet Explorer to its Windows operating system, and then leveraged Windows to take over the browser market. This was the conclu­sion the appellate court rejected as unproved. But it left standing the charge that Microsoft engaged in the browser wars in order to protect and maintain its Windows monopoly. Thus, according to the ap­peals court, the compulsory installation of its brows er with Windows “protect[ed] Microsoft’s monop­oly from the competition.” Or again: the integration of the browser into Windows meant that Microsoft was “protecting its operating-system monopoly.”

There is an elaborate theory behind this asser­tion, a theory invoked by the courts to justify many of their rulings in the Microsoft case. That theo­ry is now widely accepted, but deeply flawed. Ac­cording to it, Netscape was a threat to Windows be­cause its browser, Navigator, could have begun to function as a kind of operating system itself. Other applications would begin to be written for Net­scape’s program: there might be, say, a Navigator-­based word processor, a Navigator-based financial program, and Navigator-based video games. Devel­opers of such applications, moreover, would only need to write their programs once, completely ignor­ing the operating system underneath; the programs would run anywhere that Netscape was in use. feet of stripping away the advantage Microsoft en­joyed by virtue of the number of applications writ­ten specifically for Windows and would thus lower the “barrier to entry.” And therein lay the peril that Microsoft had to meet and crush. Netscape’s browser called a species of “middleware” because it sat between the operating system and scores of usable applications was, in Judge Jackson’s opinion, the “Trojan horse” that “threatened to demolish Microsoft’s monopoly power.”

Microsoft did not completely discourage the court’s theory. In May 1995, Bill Gates himself had described Netscape as a “competitor” pursuing a strategy that would weaken Windows, and in the trial Microsoft referred to that threat in order to demonstrate that it had significant competition. And there were some at Netscape who felt they had indeed zeroed in on Windows itself as a target. But in actuality, the chances of Navigator’s making good on this threat were minuscule.

There is still not a single example of an impor­tant application written for Navigator, and no evi­dence of one’s having been on the horizon. Even Judge Jackson said “it remain[ed] to be seen” whether major applications would develop. It is highly unlikely that any browser, even one signifi­cantly more sophisticated than Navigator, could easily support so many different applications and take on the many functions of an operating system, a significantly more complicated and demanding piece of software.

By focusing on this theory, in any case, both courts ignored the most important aspect of the browser wars and the real reason why Microsoft competed with Navigator so urgently and aggres­sively. That reason was the Internet. Although Judge Jackson did mention the “exponential growth of the Internet,” he asserted in 1999 that it would have no impact on consumers or operating systems for “the next few years,” and went so far as to argue that many consumers would not even want a browser on their computer. These statements were absurd in 1999 and are more absurd now.

Indeed, given the presence of the Internet, it would have been suicidal for Microsoft not to have been at work on a browser, and not to market it aggressively as part of its operating system. In 1995, Gates sent a memo to his managers: “In the next twenty years, the improvement in comput­er power will be outpaced by exponential im­provements in communications networks.” In the future, as he and every other manufacturer of computers and operating systems recognized, locating a document stored on the Internet, or on a server in Sri Lanka, would be no different from locating a document on one’s own hard drive. The computer would no longer stand alone; it would be a networked product, working with other PC’s and interacting with them on the Internet. This meant that the operating system would also have to evolve to be able to work within those net­works.
All this is already taking place. Companies that dominate the market for computer networks like Sun Microsystems and Oracle want to extend their dominance into the workings of the PC. So did Netscape, in its case by hoping (according to the courts) to combine a browser with the functionality of an operating system. Microsoft, mov­ing from the other direction, wants to do the same thing, and will do it more effectively in its forth­coming new operating system, Windows XP. If anything, and despite Judge Jackson’s odd assertion that there are “no plausible benefits” to such changes, this conjoining of the browser and the op­era ting system will become more complete over time, thereby providing a benefit to consumers that the courts were unable to see and tried to obstruct.

IV

OF COURSE, the courts could not help acknowl­edging that the technological marketplace is subject to constant disruption. Judge Jackson, referring to the “dynamic vigorous competition” in the software industry, admitted that “nascent paradigms could oust the PC operating system from its position.” The appellate court noted that “In technologically dynamic markets . . . entrenchment may be temporary.” Judge Richard A. Posner, who attempted to mediate a settlement of the Microsoft case before a final judgment was reached, went further, raising questions about the very applicability of antitrust law in an economy characterized by such continuous disruption. These observations follow the thinking of the economist Joseph Schumpeter, who in his theory of “creative destruction” argued that displace­ments of monopoly power are common in innova­tive industries.

But even as they recognized these key qualities of the technological marketplace, the courts de­clined to regard them as consequential or even rel­evant. Such considerations, they said, were for the long term, whereas their own focus was on price constraints in the “near future.” In so saying—and even putting aside the question of how they could arrive at the far-reaching decisions they did while admitting that the justifi­cations for them were temporary and limited-the judges revealed, again and again, their obtuseness about technological reality.

The Internet, whose power is here and now, they put off as an issue for the future. The near­-future prospect of merging handheld computers, game systems, and network computers they put off into the distant future. But the idea that Naviga­tor could threaten Windows as “middleware” a threat for the distant future if ever there was one, they treated as so imminent and perilous that Mi­crosoft, in their reading, violated the law in order to prevent it. Setting the real technological mar­ketplace in amber, the courts conjured up a false one in urgent need of their supervision and control.

Regardless of their decisions, the Internet will soon become even faster and more commonplace than it is now and will be transformed into a medi­um for television broadcasts, film, and telephone communications. AOL, after its merger with Time Warner, is already a cable and communications giant; telephone companies and cable television companies are becoming Internet providers; game systems are acting like computers and browsers. In ten years, both browsers and operating systems will be nothing like what they are today. But thanks to the grievously anticompetitive actions of the U.S. Department of Justice and two federal courts, it will take us longer to get there, the way will be strewn with more obstacles, and the cost to consumers and taxpayers will be much, much higher than was ever necessary.

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