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Microsoft case: the defence

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by

Luca Pelliccioni

on 28 October 2014

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Transcript of Microsoft case: the defence

1)
For example, on December 7th 1993, Steve Ballmer, Microsoft's executive vice president for sales and support, sent email suggesting that it "
could really help popularise
" the forthcoming Windows 95
if the operating system could be positioned as "the greatest front-end to the Internet

2)
In an email dated on December 16th 1993, a Microsoft technologist noted that "
Internet connectivity . . . should be an integral part of the operating system
," adding that "
customers will love us for providing this facilities


3)

Several sources show how Microsoft's strategy has been developed before the Netscape's appearance on the market, so they can't say that Microsoft acted in an anti-competitive way.
1. Internet Explorer Development


2.TYING
a) Distribution Agreements
b) Predatory Pricing

3. Regaining the Technological Gap

Defense steps
Is it predatory to give away Internet Explorer
?

NO

Microsoft's revenues from Windows 98 are $3 billion annually

To recover its annual investment of roughly $100 million in Internet Explorer technologies,
Microsoft needs to license only 3.5% more units of Windows 98 than would have been the case if it had not improved the operating system with such technologies

1) Microsoft doesn’t have the control on the
whole production capacity: creativity is everywhere

2) A firm that exercises its monopoly power could actually have a smaller market share measured in unit sales, dollar sales, or both, than a firm that acts competitively

Example:
$45 per copy of Windows 95
80%

$1,000 per copy of Windows 95
2 - consumers may be hurt because these actions increase prices
3 - these actions may limit innovative activity, thereby hurting future consumers
1 - consumers may be hurt because these actions may limit their choices in terms of variety and quality
A consumer
can be harmed
in 3 different ways
Microsoft case: the defendant

Does Microsoft have monopoly in the OS market?

Have consumers been harmed?
Are Microsoft actions anticompetitive?
Luca Pelliccioni 818091
Andrea Perbellini 817987
Stefania Siro 800731

History of the company
Ability to increase price above competitive level

High entry barriers

Most of market share

Definition of monopoly power

Definition:
The market in which one or more goods compete
Includes all products ”reasonably interchangeable by consumers for the same purposes”

Relevant product market


Steve Ballmer
: ”Is the future of windows windows or is the future of windows Navigator? Windows number one competitor today is Netscape much more than it is OS/2”

In which market Microsoft compete?
Market actors:
- Intel based OS (Unix, Linux, OS/2)
- Apple
- Middleware (Java, Navigator)

Market share
Market share is not significant

Es: software applications
loop

INDIRECT

DIRECT

Es: file exchange
NETWORK EFFECTS

Entry barriers: network effects

Ipothesis
pH= PC hardware price
pW= Windows price
FW= Fixed cost of developing Windows
e= market elasticity
Marginal cost is negligible
Windows is installed on all PCs




Demand of a Windows PC:
D(pH + pW)

Windows profit:
profitW=pW*D(pH +pW)-FW

LET' S MAXIMIZE THE PROFIT!

D(pH +pW)+pW*dD/dpW = 0
1+[pW /(pH +pW)]*[(pH +pW)/D]*[dD/dpW]=0
pW /(pH +pW)=1/|e|,

Windows monopoly price: pW = pH/(|e| - 1)
where |e| = -[(pH + pW)/D]/[dD/dpW]

If one assumes that:
The average price of PC hardware is $1,800
|e| = 2
The monopoly price of Windows is pW = $1,800
Does Microsoft charge a monopoly price?
Does Microsoft beahave like a monopolist?

Microsoft is the “dominant seller” beacuse it acts competitively

"
The potential financial reward for building the "next Windows" is so great that there will never be a shortage of new technologies seeking to challenge it. Powerful competitors such as IBM, Sun Microsystems and Oracle are spending hundreds of millions of dollars annually to develop new software aimed squarely at replacing Windows. That is one reason why we price Windows so low. If we increased prices, failed to innovate, or stopped incorporating the features consumers want (such as support for the Internet), we would rapidly lose market share
" (Bill Gates)


DOES MICROSOFT HAVE MONOPOLY POWER?
Mails and documents

The incorporation of IE in the OS was due to consumer expectation to have a browser packaged with the operating system (Ex: NetPositive for BeOS)

Providing such access is just the latest step in the evolution of operating systems to keep pace with the changing nature of personal computing (media player, calculator)

If the software that provides Web-browsing functionality were removed from Windows 98, the operating system would fail to function in many ways
2. Tying
These contracts do not require "exclusive" distribution of Internet Explorer and have not prevented any competitor's products from coming to market

Microsoft entered into challenged contracts with only 11 of the more than 4,500 Internet service providers and only 24 of the thousands of Internet content providers that operate significant sites on the Web

These contracts are normal cross-promotional agreements that are commonplace in business


a) Distribution Agreements


3. Regaining the technological gap
"Our browsing technology has won 19 out of 20 head-to-head reviews against Netscape's, which is why we have seen more and more consumers using it.
Fortune, for example, wrote that version 4.0 of Internet Explorer "
beats Navigator hands down
." " (Bill Gates, 11 May 1998)

100 million each year for developing IE

"This time, Microsoft has the technology to compete on quality. They probably don't even have to bundle Explorer with the operating systems to compete” (Steve Jobs, 1996)
b) Predatory Pricing

In U.S. law, the standard requirements for a tying violation are as follows:20
(1) two separate product markets exist, based on distinct demands;
(2) the defendant has market power in the tying product market;
and (3) consumers are forced to buy a product or service they might not otherwise purchase.
No inquiry into impacts on consumers is required.



Free presence by default of Internet Explorer can only increase the value of the SO.

Social Welfare improve thanks a supplementary product , without
an adjustment of price.

From the welfare perspective, tying is preferred to no-tying.

The Internet-related tasks of operating systems are in very high demand as the Internet is presently in an exponential expansion path. The number of consumers who have been harmed in the way suggested by the Judge is likely to be very small.
1 – Better product, same price
The presence of I.E. can’t be seen as damage for consumers!

possibililty of downloading Netscape freely…and also other ones as:
IBM web explorer
MacWeb (Apple)
NaviPress (AOL)

Windows-based computers can run both IE and Navigator simultaneously, and users are not forced to choose one to the exclusion of the other.


2 – Free to choose
5 – Internet diffusion
The District Court judge ruled that Microsoft’s action of distributing Internet Explorer at no charge “increased the general familiarity with the Internet and reduced the cost to the public of gaining access to it".

So Internet Explorer inclusion in Windows 98 helped global spread of internet.
3 – More competiton
Not only Intel based operating system
Netscape (before entrance of I.E.) charged non-academic users $40-50 to use its browser.

Microsoft, by contrast, gave its Internet browser away. Netscape responded to the introduction of IE version giving its browser away as well.

So all users (not only I.E. users) benefit from this competition.

All browsers became free with an improvement of consumers saving.
If a firm comes out with a very better product consumers will switch to the new tecnology
The debut of Internet Explorer and its rapid improvement gave Netscape an incentive to improve Navigator’s quality.

In a sector where browsers price is null, the only way to make grow own market share is increase quality of browser.

since Microsoft’s actions intensified competition, which in turn produced higher quality browsers, they provided further benefits to consumers.

4 - More innovation
Consumer saving
With at least 100 million browsers installed in the United States, Microsoft’s actions have created a benefit of at least $4 to $5 billion to American consumers
NETWORK EFFECTS OF INTERNET:
More users lead to more informations on the net, that rise Internet value and utility.
Only 16 million people used Internet in 1995
2,76 billion worldwide internet users in 2013
Initially, there were few users of the internet and it was of relatively little value.
As more users gained access to the internet, there were more and more websites to visit and more people to communicate with.
The internet became extremely valuable to its users.
Success factors for a browser:
Installation and updates
Interface and simplicity
Speed
Security and privacy
Expandability

So browser companies have to offer a high level of quality in order to obtain market share and response to requests of consumers.


In dynamic industries, antitrust restrictions on “tying” inhibit competition in product design.

dynamic competition often involves creating new products by combining features
This pro-competitors situation could halt the evolutionary process of SO development.

The marketplace – not DOJ – should determine how operating system are designed.

The resrtictions may decrease the benefit of consumers.
Negative implication
The possible next step

Most U.S. economists who study antitrust policy favor substantially weakening or even abolishing standard tying law on the grounds that it does not reliably promote consumer welfare.
Are Microsoft's actions anticompetitive?
At first, because Microsoft did't constrain any retail to install Explorer, but

it was a free choice of them.
CRUX of the MATTER:

Internet Explorer is a separate product or an integrated part of the operating system?
Higher costs of entry but higher rewards ("Winner takes most")
1. IE development
A sixth implication of network effects is that, because inequality is natural in the market structure of network industries,
there should be no presumption that anti- competitive actions are responsible for the creation of market share inequality

or very high profitability of a top firm. Thus, no anti-competitive acts are necessary to create this inequality.
Firms do not reach their high output and market domination by exclusion, coercion, tying, erecting barriers to entry, or any other anti-competitive behavior.
The extreme inequality is a natural feature of the market equilibrium.
Integrating Internet Explorer with Windows was not a move designed with the aim to eliminate Netscape from the market. Just take a look at the history linked to the early stages of project development:
Microsoft's integration project was outlined long before Netscape was formed (October 1994).
Why is it important to define whether Microsoft is a monopolist or not?
Including Apple in the relevant market the share decreases until
80%
Monopoly is not illegal itself
Abuse of monopoly power is illegal under the section 2 of the "Sherman Act"
Accusal
"Anticompetitive  and Exclusive 
Behavior, with the purpose to
consolidate its monopoly on the
management of personal computers
and to extend that monopoly to the
navigation software on Internet. "
"Netscape was not obstructed"

The plaintiff proposal
Remedies
Breakup of Microsoft into two “Baby Bills,”
1)An operating systems company which would inherit all the operating systems software
2)An “applications” company with all the remaining software assets
The reasons why
The government put forward a number of reasons as:

telecommunications industry benefited from AT&T’s breakup, and so should Microsoft and the software industry

The breakup eliminates the incentive for vertical foreclosure;

The breakup reduces the “applications barrier to entry” since now the applicationscompany might write popular Microsoft applications for other platforms.

Cash and securities holdings of other companies held by Microsoft would be split between the resulting entities
Bill Gates and other officers / shareholders of the company would not be allowed to hold executive and ownership positions in both of the resulting companies
Possible detrimental effects
many layers of managment
few managers
AT&T and Microsoft:
key differences
100 years old regulated utility
23 years old enerpreneurial company
divisional structure
organic structure
248 milion users in 1999
Compatibility and its benefits could be quickly eliminated or significantly reduced if Microsoft is broken into competing pieces.

The breakup is likely to result in higher prices

The breakup is likely to eliminate the efficiencies that make Microsoft a flexible and formidable competitor

Without permanent restrictions on the post-breakup functions of the companies, the OS and the applications Baby Bills may enter into each other’s business and one of the resulting companies will dominate both markets.
16 firms already operates in the market
Low price of SO
to keep monopoly
Trasfering monopoly in software market
SO baby bill don't have incentive now to keep low price, so consumers would be damaged
DOJ opinion
After break up situation
Does Micosoft charge a monopoly price?
Profit per unit Microsoft looses = 1800-45 = $1755

Total profit Microsoft looses = 1755*40Mil =
$70,2B
Why should a monopolist give up all this money?
If Microsoft tries to reduce output and increase price the unmade sales would be left for other software firms
Browsers and operating systems are different products, this is no doubt, but it is also true that users benefit from the application software that continuously is distributed by Microsoft (regardless of whether it is bundled or tying) with Windows. Application software that ranges from the calculator, to the music CD player.
In conclusion....
Each business software company may be damaged from Microsoft's actions, but more than an appeal to free competition, we believe that in such cases we have to give priority to the common sense and especially to the benefits for users from such supplements.
BIBLIOGRAPHY
"Declaration of David S.Sibley" (15 May 1998)
"Lessons from the Microsoft Case", (26 March 2002) Richard Schmalensee, Massachusetts Institute of Technology
Nicholas Economides (2001) "The Microsoft Antitrust Case"
Nicholas Economides (2001), "United States v. Microsoft: A Failure of Antitrust in the New Economy,"
Nicholas Economides, (Revised June 2004), "Competition Policy in Network Industries: An Introduction", Stern School of Business, New York University
Compete, Don't Delete - Article by Bill Gates, Printed in the Economist (June 13, 1998)

ONLINE
https://www.microsoft.com/en-us/news/press/1998/aug98/8-10summarypr.aspx
http://www.microsoft.com/en-us/news/press/1997/nov97/dojpetpr.aspx
http://www.crn.com/news/channel-programs/18804541/microsoft-poses-no-barrier-to-entry-expert-says.htm
http://www.microsoft.com/en-us/news/press/1998/may98/doj5-18pr.aspx?mstLocPickShow=True
http://www.stern.nyu.edu/networks/UWLA.pdf
http://www.consumerfed.org/pdfs/jeclet.pdf
http://www.istitutomajorana.it/scarica2/monopolio_microsoft.pdf
http://www.jstor.org/stable/795848
http://stlr.stanford.edu/STLR/Articles/02_STLR_4
http://money.cnn.com/magazines/fortune/fortune_archive/1996/09/30/217424/index.htm
https://www.microsoft.com/presspass/legal/06-28opinion.mspx
NO
An example:
video games market in 90's

Nintendo has 80% of the market
High barriers to entry (externalities)
1994: Sony enters the market with his "PlayStation" and broke Nintendo dominance
Full transcript