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E308 Gilbert and Katz.docx

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McGill University
Economics (Arts)
ECON 308
Christopher Green

Gilbert and Katz- An Economist’s Guide to US v Microsoft - Antitrust critics claim that the 19 century Sherman Act is ill-suited for the high- technology markets of the 21 century - In the Microsoft case, the government asserted that Microsoft engaged in anticompetitive conduct designed to maintain its operating system monopoly to the detriment of consumers. - According to the government, antitrust enforcement would rein in the Microsoft monopoly and result in more competition and innovation in the software industry. In its defense, Microsoft contended that the company is a vigorous competitor that benefited consumers by supplying high quality, innovative products. According to Microsoft, antitrust action against it would dampen incentives for competition and slow software innovation Early Skirmishes - Microsoft’s antitrust woes began in 1990 when the FTC launched an investigation of the company. After 3 years, the FTC’s legal staff recommended that the Commission bring a case focusing on Microsoft’s licensing practices with personal computer manufacturers - The US Department of Justice continued the investigation of Microsoft’s conduct and in July 1994 brought a complaint alleging that Microsoft used exclusionary and anticompetitive contracts with PC manufacturers to maintain an unlawful monopoly of PC operating systems. Simultaneous with the filing of the complaint, Microsoft and the DOJ entered into a consent decree in which Microsoft agreed to abide by certain restrictions on its licensing agreements - The consent decree stipulated that Microsoft won’t enter into any License Agreement in which the terms of that agreement are expressly or impliedly conditioned upon the licensing of any other Covered Product, Operating System Software Product or other product (provided, however, that this provision in and of itself doesn’t prohibit Microsoft from developing integrated products) - Not long after Microsoft and the DOJ signed the consent decree, Microsoft began requiring computer manufacturers to license and install Microsoft’s Internet Explorer (IE) browser as a condition for being able to obtain a license for the Windows 95 operating system. Microsoft argued that the IE browser was part of the operating system, not a separate product. The DOJ disagreed and sought an injunction against Microsoft. - In Dec 1997, Judge Jackson ordered Microsoft to offer its Windows 95 operating system and IE as separate products. Microsoft appealed the ruling. The appeals court reversed Jackson’s order, ruling that Windows 95 and IE provided computer users with functionality that didn’t exist with separate programs and this passed the integrated product provision of the consent decree The Battle is Joined - In May 1998, the government brought an antitrust case against Microsoft alleging that the company had monopolized the markets for PC operating systems and browsers. This rested on allegations that Microsoft compelled computer manufacturers to license and install IE, entered into contracts that tended to exclude rivals, and engaged in various forms of predatory conduct - The government alleged that Microsoft sought to eliminate the competitive threat posed by Java and Netscape in 2 ways: 1) To eliminate Netscape’s browser as a commercially viable product through an offer of market division and-after that offer was rejected- a combination of predatory and exclusionary actions 2) Undermine Java as an operating system independent platform by promoting a Windows-specific version of Java Assessment of Market Power - A firm’s conduct is unlikely to have significant adverse consequences for economic welfare if the firm lacks sig. market power. Therefore, the assessment of market power is the initial step in a typical economic antitrust analysis - The courts commonly assess market power by first defining the relevant markets affected by the firm’s conduct. A relevant market is a set of products that consumers consider to be reasonably close substitutes for each other. Once a relevant market has been defined, the assessment of market power move to the calculation of market share, examination of competitive interactions, determination of the conditions of entry, and analysis of other structural features of the market. - The government alleged that Microsoft was a monopolist in the relevant market. The government reasoned that buyers of Intel-compatible PCs have no substitutes for operating systems designed to work on those systems. Microsoft’s share of shipments of Intel-based PC operating systems has been 0- percent or more in recent years - Government also argued that another OS would be hard-pressed to displace Windows directly. Because of switching costs and consumers’ desire for a variety of application programs, an operating system cannot gain widespread acceptance until it has a large set of available applications. But because of economies of scale and sunk costs in software development, applications programmers don’t want to write an operating system unless there is a large base of users. The government labeled this problem as the applications barrier to entry - Microsoft countered that competition in the PC software markets was among platforms, not OS. A platform is a set of software interfaces to which programmers can write application such as spreadsheets (i.e. Mac OS, Linux) - Microsoft also asserted that in high-technology markets traditional measures of market share provide misleading assessments of the degree of competition. Markets with sig network effects, technological progress, and production economies of scale can exhibit catastrophic entry, whereby one product dominates the market until another product is sufficiently superior that it becomes the new network bandwagon. Rivalry in such markets can take the form of competition to become a dominant firm- competition for the market, rather than competition within the market. This, computer software markets may be characterized by a succession of temporary monopolies. - However, the government asserted that Microsoft preserved its monopoly by using exclusionary and predatory tactics to block catastrophic entry - Another argument raised by Microsoft was that it didn’t behave like a firm with monopoly power. Working backward from an estimate of the elasticity of demand for PCs, they calculated that the monopoly price of Windows should have been at least 16 times the price charged - The DOJ argued that Microsoft’s prices were consistent with long-run monopoly pricing once one takes into account factors that encourage Microsoft to restrain its prices, such as the value of growing its installed base, raising demand for complementary products, and discouraging software pirating. - The difference between the government’s characterization of Microsoft’s market power and Microsoft’s position is that the government considered Microsoft a monopolist that faced limited potential competition from other platforms, whereas Microsoft saw the market as already invigorated with significant actual platform competition - Microsoft possessed the ability to raise prices sig above long-run average costs, as suggested by the large multiple of Microsoft’s market value to the cost of its asset base. - This does not prove that Microsoft used its market power to disadvantage consumers. The possession of market power is in itself not objectionable under antitrust policy - The applications barrier to entry was central to the government’s theory of why Microsoft took the actions it did with respect to browsers and Java. According to the government, Microsoft had incentives to work hard to protect that barrier by ensuring that other OS could not share a common set of applications through middleware A Closer Look at Allegedly Harmful Conduct - The government alleged 2 sets of closely related mechanisms by which Microsoft’s practices weakened competition and harmed consumers: exclusionary behaviour and predatory behaviour Exclusionary Behaviour - This entails denying rivals access to some resource or set of consumers in order to raise the rival’s costs and weaken their ability to compete. - The government charged that Microsoft used several types of contractual arrangements that tended to exclude competitors - One set of arrangements was with online and Internet service providers, such as America Online and AT&T, in which Microsoft agreed to include a feature in its OS that made it easy for a user to establish an account with the service provider, but only if the service provider agreed to deny most or all of its subscribers a choice of Internet browser. - The traditional Chicago view of exclusionary contracts and exclusive dealing arrangements is that they must promote efficiency because the buyers in these transactions would not agree to contracts that made themselves worse off. The fundamental flaw in this argument is that a buyer may agree to an exclusive contract without taking into account harm to third parties - In many cases, exclusionary practices that raise rivals’ costs will lower economic welfare. However, there are circumstances under which such practices can increase efficiency and consumer welfare. For example, raising an inefficient supplier’s costs can increase total surplus by shifting share to more efficient producers. And elimination of a rival may promote innovation in some circumstances. - Microsoft defended its contracts on the grounds that they were in force when IE (Internet Explorer) accounted for only a small share of browser usage and that the contracts enabled Microsoft to build share rapidly to become a more formidable competitor to Netscape - This defense sidesteps the fact that Microsoft possessed considerable market power in PC operating systems. The question is whether Microsoft used this market power, in combination
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