Microsoft, Markets and Monopolies

by Tom Painter

On April 28, 2000, the U.S. Justice Department and 17 states asked a federal judge to direct that the Microsoft Corporation be divided into two companies. Wow. Split Microsoft in two. It does sound radical, doesn't it? However, in asking that Microsoft be split up, the plaintiffs said, "unless effectively remedied Microsoft's actions threaten an enormous toll on competition and innovation".

Naturally, Microsoft opposes the idea, and lobbies congress and the public for support. In a full page New York Times advertisement, on May 1, 2000, top Microsoft officers, Bill Gates (Chairman) and Steve Balmer (CEO), said: "We believe the government's extreme regulations would be a major setback for consumers, the high technology industry and the American economy".

So what's this all about?

Two years ago, the U.S. Justice Department and 19 states filed an antitrust lawsuit against Microsoft. That was a collective result of years of investigations and litigation. The lawsuit was filed with federal judge Thomas Penfield Jackson, who has presided over the Microsoft cases since June 1995. The claim of the suit is that Microsoft "has engaged in a broad pattern of unlawful conduct with the purpose and effect of thwarting emerging threats to its powerful and well-entrenched operating system monopoly" (Windows). Microsoft tried, with it's own witnesses and experts, to counter the plaintiffs' claims. After all the evidence, testimony and arguments, Judge Jackson issued a ruling on November 5, 1999, which essentially agreed with the plaintiffs. He then appointed Judge Richard Posner, of the U.S. Court of Appeals in Chicago to mediate a settlement. Judge Posner was considered by many as one who could do that job with the least prejudice toward either side. Five months later, Judge Posner said his efforts had failed and on April 3rd Judge Jackson ruled that Microsoft was in violation of U.S. antitrust laws and asked the plaintiffs to propose remedies.

Three weeks later, the Justice Department and 17 states gave Judge Jackson their remedy proposal (two of the original 19 states declined to sign it). The division of Microsoft they requested would carve out one company to produce and market Microsoft's operating systems, like Windows and Microsoft NT, while a separate company would own the rest of Microsoft's operations, including the software applications like word processors, spreadsheets and Internet browsers.

In addition to breaking Microsoft up, the government's remedy would impose some restrictions on the new Microsoft companies for three years. On May 10, 2000, Microsoft gave Judge Jackson an alternative remedy; outlining restrictions it would voluntarily impose on itself. Many of those restrictions are similar to the government's, yet more narrowly focused. Also, the government's restrictions would require an internal compliance monitoring process in the two new companies, while Microsoft's would not.

Microsoft complained they did nothing wrong and that the government's remedy is too restrictive. Bill Gates has said, "Restrictions such as these would stifle innovation, and make computers less capable and more expensive". Then Microsoft's proposal agreed to impose many of the government's restrictions. If Microsoft's conduct was not wrong to begin with and the restrictions too much of an intrusion on how they do business, then why not leave it at that and say so.

There are two commonly accepted rumors about Microsoft's legal response in the case. One is that they will appeal any decision the judge makes. The other one is that Microsoft wants to delay final judgment until at least next year, when they hope a new administration might provide a more favorable situation. With that in mind, either Microsoft's lawyers do not believe their own case, or their remedy proposal is simply an insincere offer to Judge Jackson, who wants to conclude the remedy phase by the end of May 2000.

Does Microsoft have a Monopoly? There is not much question that a de-facto monopoly exists. Industry data cited in the case indicate Microsoft Windows is on 90% to 95% of all Intel-compatible personal computers, and nearly 85% of all personal computers. According to many economists, either of those percentages would constitute a monopoly by most standards.

If there is a monopoly, did Microsoft create it? The lawsuit never claimed that Microsoft created a monopoly, only that a de-facto monopoly exists. There were enough mistakes by IBM, Apple, Unix and others that contributed to Microsoft's success. Apple had its niche, wouldn't move out of it and often sold at a premium over Intel-compatible machines. IBM lacked the will and the vision, and Unix stayed in the technical background letting Microsoft flourish. Was that Microsoft's fault? - No, not by a long shot.

The more argumentative part of the story involves the question: If the Windows operating system constitutes a monopoly, did Microsoft behave illegally? After Windows became a de-facto monopoly, how was Microsoft's success built? Did their success come simply out of an ability to produce new, unique, creative and innovative software, better than anyone else, as Microsoft wants to claim?

In their May 1 advertisement, Bill Gates and Steve Balmer said, in reference to the achievements of the high-tech industries: "Continued healthy competition, innovation and consumer choice - not government intervention - are the most effective tools to ensure these benefits will continue for years to come".

In the Justice Department's report titled 'Plaintiffs Joint Proposed Finding of Fact', September 10, 1999, in a reference to Microsoft's view of Netscape Navigator, a Microsoft executive is quoted, saying: "we were very concerned that if the user saw Netscape Navigator side by side with Internet Explorer……we would lose." Clearly Netscape had jumped ahead of Microsoft and together with other Internet related technologies posed a competitive challenge to Windows' dominance. How did Microsoft respond to that threat?

Microsoft actions in response to Netscape and other previous competing innovations, are detailed in the lawsuit and challenge the "benign dominance" view which Microsoft projects for itself. While Microsoft has many successes to be proud of, the view presented by the antitrust case is that Microsoft's conduct often does not promote healthy competition, innovation and consumer choice. Where is the once healthy competition for Windows applications for file compression, word-processing, spreadsheets, desktop publishing, presentations, and most recently Internet browsers, just to name a few? Some might call it just sour grapes, but The Computer & Communications Industry Association (CCIA) and the Software and Information Industry Association (SIIA), two highly respected industry trade groups, filed friend of the court briefs supporting the government's remedy in the antitrust case. Microsoft was a member of the SIIA until the other members favored supporting the government's case.

The software industry is littered with remnants and more than a few carcasses, of companies that tried to compete head-on with Microsoft and lost. Did they always lose because their software was inferior, or because their products were less than what consumers wanted? No. They sometimes lost because of how Microsoft used its monopoly to manipulate whose products got to the Windows desktop and how they got there. Judge Jackson's rulings have repeatedly found that Microsoft's conduct violates U.S. antitrust laws.

Will our high-tech revolution whither if Microsoft is divided up?

Some recent Microsoft statements about the lawsuit are reminiscent of a phrase that was once used in reference to General Motors, at a time when it had maybe 60% or more of the U.S. automobile market. That phrase went something like "If it's good for General Motors, it's good for America". Bill Gates speaks of Microsoft allot like that lately. He has said, "The dismantling of Microsoft also would send a signal that companies in America that are too successful will be punished harshly - a signal that will be welcomed by foreign competitors seeking to overtake America's global leadership in technology". In spite of those words from Mr. Gates, those sentiments were untrue about General Motors in the past, and are equally false about Microsoft today.

If success and dominance alone were the features that brought the suit against Microsoft, then why didn't the government try to break up the Intel Corporation? If Windows is on 85% of the worlds personal computers, and every Windows PC is an Intel-compatible PC, and most of those PC's use Intel's computer chips then isn't Intel a de-facto monopoly and shouldn't they be broken up? The answer is no and the reason is because the real issue is not simply a matter of dominating success - it is how the dominant player operates in meeting the challenge of healthy competition. Intel has been both an industry team leader and an industry team player. Microsoft is seldom willing to take a role that is less than at least co-captain.

Microsoft markets the idea that it is being punished simply because it is successful, and the public is lulled into to not looking behind the scenes for the basis of some of that success. Meanwhile, it is not "foreign competitors" against "Americas global leadership" that Microsoft is really concerned about. The American economy hosts the largest contingent of competitors and entrepreneurs across every facet of the high-tech industry. Those are the competitors Microsoft worries about.

Microsoft's public relations campaign on the antitrust issue attempts to wrap the fate of the country in with it's own fate. And, with Windows on the vast majority of PCs, it's easy to see how that campaign makes people feel their technological security depends on Microsoft. Yet, that campaign also helps demonstrate one of the foundations of Microsoft's success: which is, that in many ways greater than their technological prowess, they have been great at marketing themselves and their products. That is maybe their best asset.

So, Bill Gates runs around the country sounding a lot like a character in an old children's' story. That character is 'Chicken Little' and in the story something falls on his head and he runs around yelling, "the sky is falling, the sky is falling". Yes, the government wants to hit Microsoft on the head pretty hard. However, even if the government's remedy is implemented in full, there are plenty of expert arguments that say the increased competition and innovations from that breakup will be greater than the disruptions it may cause. Chicken Little's friends learned he was paranoid about the sky falling; we don't need to let Mr. Gates get us paranoid about our technological futures.

If Microsoft is broken up will shareholders be damaged in the long run? Microsoft could become like AT&T, where the sum of the parts is greater than the whole. In a New York Times article dated April 29: Garth Saloner, an economist at Stanford University, is quoted saying, "This is the most conservative of the structural split-ups" that the government looked at. In that same article, two investment industry advisers, Robert F. Greenhill and Jeffrey P. Williams, are reported writing that the government proposal "will not result in a material decrease in market value over the intermediate to long term". Many industry analysts accept those views.

If a legal remedy is necessary, is the Justice Department's the right one? Some experts in management theory believe that a regulatory regime is a less disruptive measure for enforcing restrictions on a monopoly, than breaking it up. They fear the disruption of internal teams will spill over into current and future developments with a monopoly's business partners. Some of those developments may be in cutting edge technology that some companies are depending on for their business plans. Some would site disruptions in the internal dynamics at AT&T, when it was split up, as examples of conditions that delayed the public introduction of new technology that was on its way to production.

Many commentaries on the issue ignore the fact that a regime of restrictions was placed on Microsoft in 1995, following an earlier lawsuit. And, the current lawsuit resulted in part from the government's finding that Microsoft was not living up to earlier agreements. From its history of litigation with Microsoft, the government argues that the details in the self-imposed restrictions Microsoft suggests do not provide any assurance Microsoft will abide by them. The government position also fears that restrictions alone will not prevent the monopolistic conduct that stifles innovation and competition.

Paul Romer, another Stanford University economist, has made the most forceful argument for the government's view that their remedy matches their goal. He argues that tomorrow's upstart entrepreneurs should not be discouraged from competing against Microsoft. "This remedy" he wrote, "will significantly increase the returns that outside innovators…….can hope to earn if they develop and commercialize new technology like the browser."

So, there is a body of experts that acknowledge Microsoft's breakup will cause some disruptions, yet believe new forces of innovation and competition will also be released. Their view is that the long-term situation will be better than if the government did nothing.

There is another general view of monopolies. That is, that a monopoly always carries the seeds of its own undoing. A monopoly restricts innovation and competition. That produces needs that the monopoly does not meet. Entrepreneurs step in to exploit those needs. New innovations are created. Eventually, some new innovation begins to bypass the monopoly. The monopoly's vulnerability is exposed and more competition is created around those vulnerabilities.

Whether or not Microsoft is split in two, competitive forces may already be in play to undo its dominance in the not too distant future. For evidence of that, you might look at what is going on with the Linux operating system and Internet server operations, or the Palm digital personal assistant, or Nokia and AOL porting Instant Messenger into the cell phone or a raft of new wireless products to take you onto the Internet from a handheld device and perform everything you now do from your computer - without Windows.

Is the Justice Department's solution needed now? Even though Microsoft could be approaching a point in it's life that is similar to IBM's at the time the government sought to break it up, the antitrust issue is always one of concern for the harm the monopoly is doing now - how bad is it? The Justice Department and 17 states feel there is more harm in not doing something. If Microsoft is restricting too much competition now and the breakup will unleash innovation and competition with greater value than what is lost from disruptions, which the breakup may cause, then yes divide 'er up. If a standard of behavior to expect from the next potential technology monopolist is needed, and a breakup is less intrusive than an ongoing regime of regulations, then maybe a breakup will be a good warning. But didn't the IBM and AT&T cases provide a warning? Do monopolies pay attention to such warnings?

In the end, no matter what Judge Jackson decides, his decision alone (even if implemented), will not prevent Microsoft's employees and business partners from continuing to cooperate in an ongoing high-tech revolution, nor will America's technological superiority be seriously jeopardized and consumers will not be saddled with fewer choices and inferior products. The sky is not going to fall.

Besides, Microsoft has an equal chance of running out the clock on the antitrust litigation, without any final judgment. In the meantime, there is no reason to embrace Microsoft more than we already have. Microsoft makes wonderful software, but its dominance is not benevolence and it is not our technological messiah.

by Tom Painter

Editorial #22

May 25, 2000