University of Southern California Dissertations and Theses

Compatibility standards, market power, and antitrust policy: Proprietary interfaces and their alternatives

(USC Thesis Other)

Compatibility standards, market power, and antitrust policy: Proprietary interfaces and their alternatives

PDF

Download a page range

Download transcript

Copy asset link

Request this asset

Transcript (if available)

Content INFORM ATION TO USERS
This manuscript has been reproduced from the microfilm master. UMI
films the text directly from the original or copy submitted. Thus, some
thesis and dissertation copies are in typewriter face, while others may be
from any type of computer printer.
The quality of this reproduction is dependent upon the quality of the
copy submitted. Broken or indistinct print, colored or poor quality
illustrations and photographs, print bleedthrough, substandard margins,
and improper alignment can adversely affect reproduction.
In the unlikely event that the author did not send UMI a complete
manuscript and there are missing pages, these will be noted. Also, if
unauthorized copyright material had to be removed, a note will indicate
the deletion.
Oversize materials (e.g., maps, drawings, charts) are reproduced by
sectioning the original, beginning at the upper left-hand comer and
continuing from left to right in equal sections with small overlaps. Each
original is also photographed in one exposure and is included in reduced
form at the back of the book.
Photographs included in the original manuscript have been reproduced
xerographically in this copy. Higher quality 6” x 9” black and white
photographic prints are available for any photographs or illustrations
appearing in this copy for an additional charge. Contact UMI directly to
order.
UMI
A Bell & Howell Information Company
300 North Zeeb Road, Ann Arbor MI 48106-1346 USA
313/761-4700 800/521-0600
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.
COMPATIBILITY STANDARDS, MARKET POWER, AND ANTITRUST
POLICY: PROPRIETARY INTERFACES AND THEIR ALTERNATIVES
By
Ian Patrick Maclnnes
A Dissertation
Presented to the
Faculty of The Graduate School
University of Southern California
In Partial Fulfillment of the
Requirem ents for the Degree of
Doctor of Philosophy
(Political Economy and Public Policy)
December 1998
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
ÜMI N u m b er: 9 9 3 1 8 4 7
mVH Microform 9931847
Copyright 1999, by UMI Company. All rights reserved.
This microform edition is protected against unauthorized
copying under Title 17, United States Code.
UMI
300 North Zeeb Road
Ann Arbor, MI 48103
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
UNIVERSITY OF SOUTHERN CALIFORNIA
TH E G RA D UA TE SCHOOL
UNIVERSITY PARK
LOS ANGELES. CALIFORNIA 90007
This dissertation, w ritten by
J.aB.,...MacIniie_s................
under the direction of f c .is Dissertation
Committee, and approved by all its members,
has been presented to and accepted by The
Graduate School, in partial fulfillment of re
quirements for the degree of
DOCTOR O F PHILOSOPHY
Dean ite Studies
DISSERTATION COM M ITTEE
Chai rperson
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Table of Contents
CHAPTER 1 ................................................................................................................1
OVERVIEW AND SUMMARY........................................................................................................ 1
Introduction...........................................................................................................1
Literature Review.................................................................................................5
CHAPTER 2 ..............................................................................................................33
C a s e S t u d y : T h e M ic r o so f t M o n o p o l y .......................................................................... 33
The Case Against Microsoft.............................................................................. 34
Innovation............................................................................................................43
Pricing.................................................................................................................56
Threat o f Entry................................................................................................... 61
Compatibility.......................................................................................................69
Conclusion...........................................................................................................71
CH A PTERS..............................................................................................................84
A n t it r u s t a n d t h e L e v e r a g in g o f S t a n d a r d s ..........................................................84
Leveraging o f Architecture................................................................................ 84
Bundling o f Products..........................................................................................99
Degree of Openness o f Monopoly Platforms.................................................106
Cultural Markets and Content........................................................................114
Analysis o f Acquisitions and Alliances....................................!.....................120
CHAPTER 4 ............................................................................................................146
A n t it r u s t a n d t h e M a r k e t in g o f S t a n d a r d s .........................................................146
Predatory Pricing.............................................................................................146
Preannouncements.......................................................................... 151
CH A PTERS............................................................................................................197
C a s e S t u d y : T h e IBM M o n o p o l y .......................................................................................197
Similarities........................................................................................................197
Differences....................................................................................................... 202
Comparison o f Antitrust Issues.......................................................................204
Licensing Rules................................................................................................208
Conclusion........................................................................................................ 209
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
CHAPTER 6 ..........................................................................................................215
T h e N o n -pr o p r ie t a r y A l t e r n a t iv e to M o n o p o l iz a t io n ................................. 2 1 5
Unix.................................................................................................................216
HTML..............................................................................................................217
Microsoft and Standards Bodies...................................................................220
Sun’ s Leadership o f Java...............................................................................2 2 2
Closed vs. Open Proprietary Standards........................................................223
Netscape and Open Source........................................................................... 226
Analysis of Non-proprietary Standards........................................................2 2 7
Conclusion.......................................................................................................230
C H A PT E R ?......................................................................................................... 235
E x p l a n a t o r y F r a m e w o r k ...................................................................................................2 3 5
A New Type o f Monopoly...............................................................................235
The Incentive System......................................................................................238
Adoption Model for an Upgrade to a Monopoly Standard..........................246
Competitive Analysis to Explain Monopolist Incentives..............................251
C H A PTERS..........................................................................................................258
C o n c l u s io n s..................................................................................................................................2 5 8
Competitive Strategy for Compatibility Standards...................................... 258
Applications to New Developments in the Microsoft Case..........................262
Policy Implications......................................................................................... 267
Conclusion.......................................................................................................281
APPENDIX............................................................................................................285
BIBLIOGRAPHY................................................................................................ 294
lU
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
List of Figures
Figure 1-1
Network Externalities.................................................................................................. 8
Figure 2-1
Customer Satisfaction...............................................................................................48
Figure 2-2
Pricing of Office Suite Applications........................................................................57
Figure 7-1
Sales Revenue for a Non-innovative Multi-generation Standards Monopoly .... 243
Figure 7-2
Sales Revenue for an Innovative Multi-generation Standards Monopoly.......... 244
Figure 7-3
The Impact of Reward and Security on
the Innovation and Pricing of a Monopoly............................................................ 246
Figure 8-1
Sales Revenue for a Multi-generation Standards
Monopoly Under the Recommended Licensing Rule...........................................271
IV
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
List of Tables
Table 1-1
Terminology.................................................................................................................5
Table 1-2
Sources of Network Externalities............................................................................. 10
Table 2-1
Technical Excellence Awards for Microsoft (PC Magazine)................................ 47
Table 2-2
Market Share in Office Suites.................................................................................. 58
Table 2-3
Strategic Partnerships Among Microsoft Competitors...........................................67
Table A-1
Upgrades to Microsoft’s Operating Systems........................................................ 285
Table A-2
Unix Upgrades Based on System V from AT&T.................................................286
Table A-3
Unix Upgrades Based on the Berkeley Software Distribution Version.............. 287
Table A-4
Unix Upgrades Based on the Open Software Foundation (OSF) Version.......... 287
Table A-5
Macintosh Operating System Upgrades................................................................ 288
Table A-6
Pricing of Microsoft Applications..........................................................................289
Table A-7
Pricing of Applications by Microsoft Competitors...............................................290
Table A-8
Pricing of Microsoft and Lotus Office Suites....................................................... 291
Table A-9
Prices of Microsoft Office and its Competitors....................................................292
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Abstract
Compatibility Standards, Market Power, and Antitrust Policy:
Proprietary Interfaces and their Alternatives
This theory-building study answers the following question: “why do
multi-generation standards-based monopolies not seem to have the typical anti-
consumer effects that economic theory predicts?” The author argues that
innovation, competitive pricing, entry of new competitors, and compatibility can
be maintained, in spite of a de facto monopoly, due to the special conditions that
often characterize compatibility standards. The competitive conditions include the
existence of substitutes in the form of prior versions, commoditization of the
interface, uncertainty resulting from rapid technological advance, and licensing
agreements that ensure compatibility. The study also evaluates antitrust issues
including product preannouncements, bundling, leveraging, mergers, and pricing.
The primary case study is Microsoft’s dominance in personal computer operating
systems.
The research proposes that a new type of monopoly should be identified in
the economic literature. This compatibility standards monopoly appears to be less
damaging to the interests of end users than other intellectual property-based
monopolies. Security of position tends to be low, due to threat of entry, while
potential rewards from iimovation are high, as a result of the need to differentiate
new products from previous versions that serve as substitutes. Nonetheless,
certain rules can foster innovation and pricing incentives.
Governments can implement several policies for antitrust enforcement of
compatibility standards-based monopolies. For example, they can reduce the
probability of market failure due to information asymmetry by establishing rules
to diminish the number of inaccurate product preannouncements. Competitive
behaviour can be encouraged by restricting time or usage-based licensing in
software and by ensuring that users can buy licenses for prior versions of
products. Constraints on pricing and the mandated break-up of standards-based
monopolies on the basis of architecture and applications would, however, be
counterproductive because they would reduce the incentive to innovate and the
ability to add value through superior integration. In general, governments should
encourage the use of proprietary interfaces for the global information
infrastructure because they are likely to be more innovative and compatible than
non-proprietary ones.
VI
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Chapter 1
Overview and Summary
Introduction
Common belief, supported by microeconomic theory, holds that the
dominance of a single company in a market is likely to lead to higher prices for
end users, lower quality products due to a lack of incentive for innovation, and
reduced probability of entry by potential competitors. It is surprising, therefore, to
find an example of a monopoly that does not seem to exhibit these characteristics.
Microsoft has introduced new products and upgraded old ones at a remarkable
rate in spite of the fact that it has a 90% share in its market segment. It is also
surprising that in spite of its reasonable record with respect to innovation and
pricing, Microsoft is faced with ongoing battles in the courts and investigations by
the U.S. Department of Justice (DOJ) to maintain its position.
Another monopoly in the information industry, Intel, has also not behaved
as economic theory predicts. One aspect that Intel and Microsoft have in common
is that their market power is based on the increasing returns effects resulting from
compatibility that cause a single product to dominate a particular segment. They
1
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
both have been able to consolidate their dominance because rivals cannot copy
their proprietary standards. Their competitors and some theorists claim that
proprietary standards wül negatively affect the industry by creating
incompatibility and giving excessive control to a single company. Non-
proprietary standards are considered superior because if all companies have an
equal stake in the standard, compatibility and adoption should result. This,
however, has not generally occurred in practice. Non-proprietary standards have
often led to incompatibilities, such as in the case of Unix.
The purpose of this research is to determine why multi-generation
standards based monopolies do not exhibit the typical anti-consumer effects that
economic theory predicts. It is a theory-building exercise that uses an inductive
method. The principal research question does not lend itself to quantitative
analysis because there are relatively few compatibility standards based
monopolies. For this reason, it is appropriate to make a detailed examination of a
single case. Microsoft is the most appropriate because it is the quintessential
example of a standards based monopoly. Furthermore, its competitive behaviour
seems to contradict economic theory. It has been under investigation for issues
related to antitrust violations throughout the current decade. The control of its
power has become a major public policy issue.
Some findings of the Microsoft case study are that it maintains its
incentive to innovate and price competitively because its old products are
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
substitutes for its new products, a high degree of uncertainty prevails regarding
future technologies, technological advance has lowered switching costs related to
learning, and compatibility adds such value that it does not make sense to impose
incompatibility on customers. There are caveats to the general conclusion that a
company with a dominant standard will not tend to behave as a monopoly
normally would. For example, an increasing returns monopoly may circumvent
the most important constraint on its activity by pricing on the basis of time or
usage so that products sold previously are no longer substitutes for new ones.
This study also determines why proprietary standards often result in
greater compatibility than non-proprietary ones. It is commonly believed that the
desire for control wül cause a company to exclude its competitors from a standard
whQe a consensus process wül lead to the inclusion of aU developers. Microsoft
has not, however, excluded personal computer (PC) software competitors and has
brought compatibiUty to PC applications. Consensus processes have also included
all competitors but this has often led to incompatibüity. This is due to lack of
control. The research further finds that although the imposition of strict
specifications by a committee results in compatibüity, this comes at the expense
of innovation.
The sources for this research include legislation, laws, regulations,
hearings, court cases, press releases, and news firom trade journals. The purpose is
to buüd a theory of compatibüity standards monopoly using a case study and
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
contrast this with some related cases. Further research will be required to test the
hypotheses that this study identifies. The key definitions used in this work are
provided in Table 1-1.
There are eight chapters in this dissertation. The current chapter introduces
the research questions and reviews the related literature. After determining that
Microsoft does not, in fact, behave as a monopoly would, the second chapter
establishes the reasons why this is so. Chapters three and four analyze many of
the antitrust issues that have been raised with respect to Microsoft. The purpose of
this analysis is to determine what legal constraints should be placed on a multi
generation compatibility standards monopoly given that it does not exhibit the
typical behaviour of other monopolies. The fifth chapter provides a contrast to the
Microsoft case by examining the parallels with IBM, a standards monopolist that
previously faced antitrust scratiny. Chapter six provides an answer to the research
question related to the relative incompatibility of non-proprietary standards. In
chapter seven, the answers to the research questions are brought together in an
explanatory firamework. The eighth and final chapter provides general
conclusions, applications of the theory to recent developments, and policy
implications.
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Table 1-1
Terminology
Term Definition
Applications The complementary products which connect to an architecture
Architecture The main part of the system which allows the connection of
complementary products
Closed A system for which it is necessary to pay a licensing fee to
make a complementary product
Compatibility The ability of one product to work in the same system as
another
Generation A stage in the evolution of a product
Innovation An improvement in a technology or process
Market power The ability of a rirm to increase profits by reducing output and
charging a higher price than it could with greater competition
Monopoly A company with a dominant position in terms of market share
and market power
Non-proprietary An unowned technology that is administered by a committee of
interested producers and/or users or is in the public domain
Open A system for which any firm can make complementary
products without paying a licensing fee
Proprietary A technology owned by a firm and protected by intellectual
property and licensing rules
Standard The rules which are established for a system
Literature Review
In the 1980s some new theories of economics became highly debated.
They focused on the differences between technological products and the more
common products that were the basis of traditional economic theories. The new
theorists focused on the tendency for monopolies to form in some industries.
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Proprietary standards and the monopoly status that companies can attain
are sources of controversy among scholars and government officials. There is no
unified view on the treatment of technological monopolies. According to Jonathan
Band, some government officials believe that proprietary technology provides
incentives for continuous innovation. They want companies to be able to recover
their investments and they also want to reduce the likelihood of other countries
free riding on American technology. They nonetheless believe that ownership of
critical technologies could give a company control over access.* There is also a
fear that technology wül result in what Martin Lebicki caUs “islands of
connectivity”: expensive systems that are incompatible, inflexible, and difficult to
use.^
A simUar controversy exists among scholars. Economists in general
believe that allowing firms to have ownership over their technologies should
foster innovation. They argue that in the tradeoff between low prices and
innovation, the preference should be for encouraging innovation.^ In contrast,
most standards theorists believe that proprietary standards and technological
monopolies are not beneficial to society. FarreU and Saloner, for example, state
that proprietary standards are anti-competitive.'* They identify five processes to
achieve standardization. Two of them—standardization by internal decision and
standardization from foUowing a leader—are accomplished because of the
existence of a company which, due to its market share and resources, is able to
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
impose a standard on the rest of the industry. Farrell and Saloner believe that,
even though compatibility could be more easily achieved, this type of company
wül have an incentive problem. It could, for example, engage in predatory pricing
to drive new entrants out of the market. In another article, Saloner argues that
proprietary standards have resulted in incompatibility among different computer
systems.^
Scholars in the standards literature argue against proprietary monopolies
primarily for two reasons: (1) they believe that like any other monopoly they wül
lack incentives to innovate, and (2) decreased competition will lead to higher
prices. There are four factors that contribute to the emergence, reinforcement and
possible abuse of monopolies from proprietary standards: network externalities,
the lock-in effect, switching costs, and lack of compatibility. These are addressed
below.
Network Externalities
The tendency toward monopoly in some of these industries can be
explained by the phenomenon of network extemahties, which has recently come
to prominence in economic theory. Nicholas Economides’ paper on the
economics of networks presents a description of this concept. He defines this as
the fact that “the value of a unit of the good increases with the expected number
of units sold.”® This concept is key in the information industry because an
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
additional connection to the network affects all users. Figure 1-1 illustrates this
aspect of network externalities. The dotted lines represent the new connections
that are possible when person E connects to this network.
Figure 1 -1
Network Externalities
B
E
Network externalities in an information network arise not only because
there are more people with whom to connect but also because the more people
there are in a network, the more applications, software, and support that is
developed for that network. In a network such as the Internet, for example, the
existence of an additional computer connecting to the network also implies one
more person to be targeted with information or the possibility that more
transactions will happen. Economides refers to this degree of complementarity as
a composite good.
The existence of network externalities causes concern in the standards
literature because it is the cause of the tendency toward monopoly. Larger
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
networks attract more users while smaller ones eventually disappear. Studies that
support this argument nonetheless assume that consumers are homogeneous and
that the market is small. A monopoly outcome wül indeed arise if everybody in a
geographic area has a strong preference for the attributes of that network. This is
not always the case, however, because peoples’ hkes and dislikes vary greatly. A
monopoly outcome is nonetheless more likely in a smaller market where
preferences play a secondary role. In a small market it would be difficult for two
or more standards to survive economically. Table 1-2 summarizes eleven sources
of network externalities identified by Owen and Wüdman.^
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Table 1-2
Sources of Network Externalities
Source of Network Externalities Reason
Number of users orphans: no replacement parts, repair
services, or technical advice
System economies components of a greater system
availability and quality of components
depends on the size of the user base
Economies of scale lower production costs help producers in the
short mn and consumers in the long run
growth of a complementary product industry
Benefits of experience as growth occurs experience is gained, costs
decrease, quality increases, and late adopters
benefit
Benefits of communication (e.g. telephone network size, VHS,
screwdrivers, light bulbs, right side driving)
markets can lock in to a technology that is
already inferior
Differences among users bandwagon effect: early adopters determine
the effect
movement to a new standard requires a large
user to adopt before others wül foUow
if everyone is smaH no one is likely to adopt
differences in uses of the technologies can
cause differences of opinion about the value
of a new standard
Influential adopters (often large users)
firms with a proprietary interest may profit
from subsidizing a technology early
Sponsorship a user or a producer might subsidize early
adoption
10
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Expectations
Suppliers of complete systems
Standards compatibility
people may adopt because of a perception
that a technology is ahead or supported by
others
can cause a bandwagon
can be created by mass media (e.g.
advertising)
if there are many component suppliers each
may want others to supply the first
components (chicken and egg problem)
two or more standards frequently coexist
can occur if network externalities are
exhausted at much less than the full market
or if subsets of users are significantly
different and each prefers a different
technology___________________________
The Lock-in Effect and Switching Costs
According to Brian Arthur many technological products are subject to
increasing returns, rather than the diminishing returns assumed by traditional
economic theory.® This means that technological markets tend toward
concentration. Nonetheless, antitrust laws were developed in the 19th century
context of diminishing returns. For this reason, Arthur suggests that they should
be updated to account for the phenomenon of increasing returns, which affects
industries such as pharmaceuticals, computer hardware, software,
telecommunications, aircraft, missiles, and bioengineered drugs.
One of the major implications of the theory of increasing returns is that
early events are more influential than later ones. The reason for this, according
1 1
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Katz and Shapiro, is that expectations are important.^ When a small and
seemingly unimportant event causes a user to choose a particular product, it may
create the impression that the product is more likely to win the standards battle.
This impression can create a bandwagon effect that results in a self-fuLBlling
prophecy.
The tendency for lock-in to an inferior standard can be caused by what
Farrell and Saloner have called excess inertia. When an older standard has a
large installed base, the early adopters of a replacement standard have to bear a
large share of the costs of incompatibility over a period of transition. This force,
caused by switching costs, slows the adoption of the superior standard.
The user of a product incurs switching costs when changing to a different
product. Switching costs include the price to be paid to replace the physical
capital, the time that it takes to learn to operate the new product, and the
translation necessary from the old to the new format. For products that have large
switching costs there is a tendency to not move away from the standard. Farrell
and Saloner explain how switching costs prevent users from moving to a new
technology even if it is better. This is principally due to the cost of
incompatibility. They argue that without early adopters the new standard will not
be chosen. Katz and Shapiro make a similar argument, pointing out that due to
differences in the preferences of users, a switch to a new standard would be made
sequentially and nobody would be willing to suffer the forgone benefits of
12
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
compatibility.*^ Users therefore become locked in to a standard and to the
company that produces it. Saloner points out that in the computer industry lock-in
occurs because the switching costs are extremely high not just for the replacement
of the equipment but more importantly for the rewriting of stored data that were
initially designed for that system.*^ The existence of switching costs together with
the presence of network externalities can potentially give a dominant monopoly a
lasting competitive advantage.
Compatibility
The issue of compatibility has become more prominent as a result of
discussions about the future shape of the global information infrastructure.
Compatibility is controversial because it raises the questions of proprietariness of
technology. The particular circumstances of firms ultimately determine their
compatibility choices. In the standards literature scholars have identified several
factors that may lead a company to be compatible or not. Two significant factors
are the size of the company and installed base. Being large may allow a company
to introduce an incompatible standard and have the resources necessary to
develop credibility among users and achieve implementation. Smaller companies
with fewer resources are therefore more likely to make compatible technology
because it increases the likelihood of adoption. A similar argument is made
regarding the installed base. The larger it is the more likely that a company will
13
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
opt for an incompatible standard. Peter Grindley, whose work on standards has
concentrated on gathering empirical evidence, has also suggested that adoption
and success in the implementation of a standard is related to the degree of
openness of the standard. This means that the more open the standard is, the easier
its adoption will be. Openness, in this case, could mean either giving ownership of
the technology or freely licensing it. Unix is an example of the former and VHS
of the later. There are two scenarios in which compatibility will be achieved. The
first is when the choice over a standard is primarily a coordination problem. This
is when no player prefers a particular standard but wishes to have only one. The
other case in which compatibility wül be achieved is when the costs of
incompatibility are high. There is disagreement on the issue of compatibility.
Some authors argue that compatibility wül never be perfect because there wül
always be incompatibility when there is technological progress. Later generations
that introduce more advanced features cannot be fiiüy compatible with the
existing version. The same is true for completely new products that make a
technological breakthrough over the existing product that they are replacing.
Other scholars argue that from a societal standpoint, compatibüity provides
sUghtly higher welfare than incompatibitity. They argue that competition over
compatible products will result in lower prices. They also argue in its favour due
to network extemahties, which are better exploited when compatibüity exists
14
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
rather than with isolated fragmented standards. Users wül also suffer from less
complementary products.
In the light o f the arguments presented above, it is possible to see that
large companies that already have a large installed base wül opt for incompatible
standards. Strategic moves from then on would be aimed at strengthening
monopoüstic status. Microsoft is a paradoxical case because in spite of its large
installed base and its access to vast resources, it has not opted for incompatibility,
high prices, or lack of innovation. In fact the company has revolutionized the
software industry by offering a large variety of user friendly and frequently
updated products. Standards theorists such as Brian Arthur and Garth Saloner
have argued in favour of limiting Microsoft’s monopoly because it should lead to
lower consumer welfare. One goal of this study is to show why this has not yet
occurred.
Methods o f Standard Setting
There are three potential methods that can be used to set standards:
governments can officiaUy endorse them; markets can determine them; or
committees involving industry sponsors and engineers can debate them. These
roughly correspond with Oliver Wüiiamson’s major categories of organization:
hierarchies, markets, and networks.*®
15
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
With respect to the first category, Paul David has pointed out that
governments are handicapped when they become involved in the standard setting
p ro c e ss.In particular he identifies the problem of narrow policy windows. This
arises from the importance of early events in determining which way the market
will tip. A critical mass in favour of one standard is often achieved so early that
governments have a very limited time to intervene in the process. In the early
stages of a standards battle it is usually difficult to determine which option is
superior. Governments normally do not have the personnel expertise to make a
correct decision with respect to complex technological choices. For this reason,
David refers to them as blind giants: players with the power to change the
outcome but not qualified to do so. David suggests that the best that a government
can do is to use its power of choice in procurement to favour the standard that has
the lower adoption rate to prolong the standards battle until the future evolution
can be better understood.
Besen and Johnson have similarly found that formal standards should be
avoided in times of rapid technological advance. For this reason, they suggest that
government action should simply serve as a focal point to bring together the
different protagonists in the standards battle. Governments are most effective
when users lack knowledge of the preferences of others and where no technology
is clearly preferred.
16
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
As a result of analyzing a specific case, the Telepoint mobile
communications standard, Grindley and Toker support the idea of the government
as a focal point but are more pessimistic about direct involvement. They find that
the government authority should facilitate coordination and not make decisions.
Standards decisions should not be mixed with industrial policy goals.
Owen and Wüdman have a more optimistic outlook on government
involvement. They feel that governments are needed when there is extreme inertia
in adopting a new standard. Government decrees are justified when narrow
interests are likely to win over broader social interests. They agree with David
that governments should slow the early selection process. They can also ensure
that information is widely disseminated and choose an appropriate time to endorse
a standard. An endorsement should occur if industry participants want a new
standard, the competing standards are similar, or risks to adopters are too high.“°
Many writers in this literature have addressed the second category: market
based standards. In a book entitled Computer Wars, Charles Ferguson and Charles
Morris argue persuasively that the control of proprietary architecture is a key to
success in the computer industry.^^ General purpose technologies wül normally
win over special purpose ones. For example, personal computers that could run
spreadsheets and databases in addition to word processors quickly overwhelmed
the market for stand-alone word processors. Ferguson and Morris also cite
examples that show that non-proprietary standards, especially those made by
17
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
committee, are technologically inferior. For example, there has been little
evolution in fax technology since non-proprietary standards were established.
These authors find that the keys to victory in a standards battle are to ensure
maximum diffusion of the architecture at the begiiming, cannibalize
enthusiastically, and ensure that the architecture remains dynamic. This book was
the first in the standards literature to make the distinction between architecture
and applications. The authors believe that control of an architecture provides a
major advantage in corresponding applications markets—an idea highly relevant
to the Microsoft case.
Several of the key conclusions of the study by Cusumano and Selby of
Microsoft are in accord with the assessment of Ferguson and Morris: markets
should be entered early; cannibalization of products is essential; and the
architecture owner should also make applications.^^ They add two other winning
strategies based on observations of Microsoft: first, companies should integrate,
extend and simplify products, which is similar to the Ferguson and Morris view
on general purpose technologies; second, firms should aim for volume sales and
exclusive contracts.
According to Peter Grindley, compatibility standards require a different
type of corporate strategy than firms have normally adopted. Compared to
traditional approaches, such as those of Michael Porter,^ standards strategies are
unconventional and counter-intuitive. To be successful companies have to share
18
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
proprietary technology, encourage competition, and adopt technically unexciting
designs to increase the total size of the market.^'^ They must sacrifice early profits
and subsidize partners who could potentially become competitors. Grindley
identifies several strategies that can assist a firm in winning a standards battle
such as timing, sponsorslnp, alliances, penetration pricing, and
preannouncements. There are two sets of basic strategy options: lead or follow
and open or proprietary. In this firamework Microsoft would be a leader using an
open strategy because it developed a standard and encouraged competitors to use
it without restrictions.
Paul David believes that one of the biggest problems with market based
standards is that they can strand the users of poorly supported minority
standards.^ He calls these unfortunates “angry orphans.”^ ^ The fear of becoming
an orphan may cause some users to postpone decisions and thus slow the adoption
process. The problem may not be as significant as David indicates. Usually these
people are early adopters that often have more resources and are less risk averse
than later adopters are. For this reason, the losses that they bear are more heavily
discounted. They are likely to continue to participate in the early adoption process
in spite of the obvious costs. Although there is a risk of fragmentation with
market based standard setting, it is becomes smaller the more important that
compatibility is. Furthermore, Farrell and Saloner point out that connectors can be
used to make two differing standards compatible.^^
19
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Committees, the third category, are an alternative to market based standard
setting. According to Farrell and Saloner, committees can outperform market
processes through giving firms the opportunity to negotiate prior to making
irreversible investments.^* They suggest that the most effective standard setting
method may be a hybrid whereby the commitment of firms to negotiated
standards is strengthened by market investments. Georges Feme, however, points
out that standards organizations are considered slow, bureaucratic and costly
Jack Brown addresses an alternative to committee standards; technology
joint ventures.H e believes that there is Little danger of these becoming an anti
competitive threat. In particular consortia may counteract the influence of other
competitors, add to innovation, and have legitimate goals. Their main purpose is
usually product innovation.
Garud and Kumaraswamy address strategy for non-proprietary standards
using a case study of Sun Microsystems. Its unconventional open systems strategy
entices competitors to adopt its technology by giving it away. It is able to
maintain a degree of competitive advantage by introducing its products ahead of
rivals. Thus, there is a time lag before other companies implement the new
technology. It maintains its development lead through learning by doing and
preserves the investments of its users by modular upgradability. The Sun strategy,
however, is quite distinct from committee standards because it is unilateral. In this
20
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
way it is similar to other market based standards, which are usually sponsored by
their developer.
Standards and Market Power
One of the potential solutions offered for reducing the market power of a
compatibility standards monopolist is to oblige it to license its technology. Some
writers have correctly pointed out that this is unfair under norms of intellectual
property. For example, WUliam EUis criticizes the compulsory licensing
procedures of the European Technical Standards Institute (ETSI).^^ First, it does
not provide equal access to non-member countries. More importantly, companies
forced to license do not receive a return on the technological investment that they
made due to the commoditization of the standard. This is even more problematic
for small companies and universities, which rely on revenue from licensing rather
than scale manufacturing. Although Ellis does not mention software, his argument
also applies to it because economies of scale in manufacturing are not the source
of competitive advantage in that industry. Shurmer and Lea also address the
conflict between standards and intellectual property and the issue of how far
intellectual property rights should be overridden to serve the public interest.^^
They point out that the standards process is becoming more important and
difficult than ever. Although monopoly leads to higher prices and lower quantities
21
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
sold, intellectual property rights are a special case due to the need for incentives
to undertake risky activity.
The issue of innovation is a common theme of the standards literature.
Farrell and Saloner believe that network effects and lock-in are likely to result in
reduced innovation.^^ A large installed base for an older product wül limit the
desirabüity of a new product due to its lack of compatibility. Although this
observation appears to make sense, the history of technological advance in the
information industry since the Second World War, and particularly in the past
decade, seems to contradict this view. Compatibility has become more important
but innovation rates have nonetheless been high. The paradox of the FarreU and
Saloner view of innovation and compatibility forms part of the basis of this study.
Joel Mokyr provides an alternative view of innovation. He argues that
random factors are one of the key determinants of technological success. For this
reason, technological and political diversity is b e tter.M o k y r, thus, would
approve of multiple efforts to develop technologies in different countries. He
would likely agree with Paul David that governments should use their power of
procurement to perpetuate standards battles until it is clearer which technology is
superior.
Several writers address the tendency toward monopoly when standard
setting is left to the market. Feme agrees with the common view in the industry
that monopolies wül lead to incompatibility. This view is contradicted by
22
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
evidence presented later in this study. Models presented by Carmen Matutes and
Pierre Regibeau show that compatibility will lead to higher prices and profits.^^
Nicholas Economides makes similar findings based on his models Although
these conclusions make sense in terms of the models provided, the prediction that
compatibility wül lead to higher prices is questionable given the experience of the
computer industry, where the prices of compatible systems, such as the IBM PC
architecture and Microsoft operating systems, have led to lower prices in both
software and hardware.
To encourage adoption of its technology a company may use marketing
techniques such as product preannouncements and penetration pricing. G.M.P.
Swann points out the possibility that preannouncements could be used
strategicaUy to manipulate expectations of which new standard wül be
successful.^^ This can benefit the preannouncing firm because people are more
likely to buy a technology that is likely to win. Katz and Shapiro further show that
a firm can increase the expectation that its standard wiU win by subsidizing early
adopters through the use of penetration pricing.^^ David Gabel and David
Rosenbaum take this argument farther, stating that network extemahties can
enable a predatory pricing strategy to be successful, thus violating antitrust laws.
These topics are addressed in the chapter on marketing and antitrust.
23
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Weaknesses in the Standards Literature
This study draws on much of the standards literature but addresses the
issues from a different perspective. Perhaps the most important problem with the
standards literature is that it bases its policy reconunendations on abstract and
static models which, though useful for illustration, are dependent on many
assumptions that do not hold in the world of public policy. In particular, network
externalities models can be used to predict both the tendency for inertia, causing
lock-in, and excess momentum, causing a new standard to supersede a superior
older one.^® The problem is that the theory cannot predict which of these opposite
results will prevail. Some critics of the standards literature, such as Liebowitz and
Margohs, make worthwhile observations but then carry their analysis too far by
claiming that lock-in does not occur.'*° The tendency to have increasing returns
when compatibility is important is undeniable. Surprisingly, these authors
contradict themselves when they acknowledge that users continued to use
programs such as Lotus 1-2-3 and WordPerfect long after Microsoft Excel and
Word were acknowledged to be superior.'^ ^ Liebowitz and Margolis choose to
ignore the tendency toward path dependence as a result of network externalities
when they write that: “[t]he current attempt to claim that Microsoft’s market
success is due to its control of the operating system, and not the creation of better
products at lower prices, is merely an attempt to rewrite history to promulgate
antitrust theories that might be used to erase the errors o f Microsoft’s
24
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
competitors.”" ^ ^ Although there is some validity in this statement, these writers too
easily dismiss the possibility that an inferior product can win a standards battle.
This study, however, argues that the tendency toward lock-in is not infinite and in
fact can lead to more radical irmovation due to the need to produce a far superior
product to overcome the installed base advantage.
Brian Arthur’s theoretical explanation of increasing returns emphasizes
the importance of small and random events in determining the outcome of a
standards battle. He suggests that if history were replayed entirely different results
could occur."*^ This assertion ignores the importance of strategy in deterrniriing the
result of a standards battle. For example, if the VHS vs. Betamax battle were
replayed 100 times with both JVC and Sony adopting the same strategies as they
did, VHS would likely win every time. Strategy is far more important than
random events in determining the victor of a standards battle. Arthur’s theory
predicts that inferior technologies will become locked in but he and his colleagues
offer few historical examples. Paul David, for example, states that the Dvorak
keyboard was superior to the dominant QWERTY o n e ,"* "* but this claim is disputed
elsewhere."*^
Given the lack of empirical evidence in support of their hypotheses and
the speed of technological advance that society has experienced over the past few
decades, it seems likely that lock-in does not slow technological advance
significantly. Inferior products are replaced much more often than the theory
25
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
predicts. Furthermore, the fear of standards monopolies may not be justified given
the mitigating features illustrated in later chapters. This study offers a more robust
policy analysis than the standards literature has been able to provide by focusing
on strategic issues and developing theoretical conclusions based on the analysis of
evidence from industry sources.
26
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Notes
^ Jonathan Band, “Competing Definitions of ‘Openness’ on the NH,” in Brian
Kahin and Janet Abbate, eds.. Standards Policy and the National Information
Infrastructure (Cambridge, MA: MIT Press, 1995), pp 378-404.
^ Martin Lebicki, “Standards: The Rough Road to the Common Byte,” in Kahin
and Abbate, 1995, op.cit., pp. 35-78.
^ Joseph Farrell, “Arguments for Weaker Intellectual Property Protection in
Network Industries,” in Kahin and Abbate, 1995, op.cit., pp. 368-377.
^ Joseph Farrell and Garth Saloner, “Competition, Compatibility, and Standards:
the Economics of Horses, Penguins and Lemmings,” in H. Landis Gabel, ed..
Product Standardization and Competitive Strategy (New York: North Holland,
1987), pp. 1-21.
^ Garth Saloner, “Economic Issues in Computer Interface Standardization: The
Case of UNIX,” Economics o f Innovation and New Technology, 1, 1990, pp. 135-
156.
^ Nicholas Economides, “The Economics of Networks,” International Journal o f
Industrial Organization, 14 (6), 1996, pp. 673-700.
^ Bmce M. Owen and Steven S. Wildman, Video Economics (Cambridge, MA:
Harvard University Press, 1992).
27
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
* W. Brian Arthur, “Increasing Returns and the New World of Business,”
Harvard Business Review, July-August 1996, pp. 100-109.
^ Michael Katz and Carl Shapiro, “Product Introduction with Network
Externalities,” Journal o f Industrial Economics, 40 (1), 1992, pp. 55-84.
Joseph Farrell and Garth Saloner, “Installed Base and Compatibility:
Innovation, Product Preannouncement, and Predation,” American Economic
Review, 76, 1986, pp. 940-955.
Farrell and Saloner, 1987, op.cit.
Michael Katz and Carl Shapiro, “Product Compatibihty Choice in a Market
with Technological Progress,” Oxford £'c(?nom/c Papers, 38, 1986, pp. 146-165.
Saloner, 1990, op.cit.
Farrell and Saloner, 1987, op.cit.
Peter Grindley, Standards, Strategy, and Policy: Cases and Stories (Oxford:
Oxford University Press, 1995).
Oliver Williamson, The Economic Institutions o f Capitalism (New York: Free
Press, 1985).
Paul A. David, “Some New Standards for the Economics of Standardization in
the Information Age,” in Partha Dasgupta and Paul Stoneman, eds.. Economic
Policy and Technological Performance (Cambridge: Cambridge University Press,
1987), pp. 206-239.
28
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Stanley M. Besen and Leland Johnson, Compatibility Standards, Competition,
and Innovation in the Broadcasting Industry (Santa Monica: Rand Corporation,
1986).
Peter Grindley and Saadet Toker, “Establishing standards for Telepoint:
problems of fragmentation and commitment,” in G. Pogorel, ed.. Global
Telecommunications Strategies and Technological Changes (Amsterdam:
Elsevier Science, 1994), pp. 201-225.
Owen and Wildman, 1992, op.cit.
Charles H. Ferguson and Charles R. Morris, Computer Wars: How the West
Can Win in a Post-IBM World (New York: Times Books, 1993).
Michael A. Cusumano and Richard W. Selby, Microsoft Secrets: How the
World's Most Powerful Software Company Creates Technology, Shapes Markets,
and Manages People (New York: Free Press, 1995).
^ Michael Porter, Competitive Strategy: Techniques for Analyzing Industries and
Competitors (New York: Free Press, 1980).
Grindley, 1995, op.cit., p. 8.
^ Paul A. David, “Understanding the Economics of QWERTY: The Necessity of
ffistory,” in W.N. Parker, ed.. Economic History and the Modem Economist
(Oxford: Basil Blackwell, 1986).
David, 1987, op.cit.
29
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Joseph Farrell and Garth Saloner, “Converters, Compatibility, and the Control
of Interfaces,” Journal of Industrial Economics, 40 (1), 1992, pp. 9-36.
Joseph Farrell and Garth Saloner, “Coordination Through Committees and
Markets,” Rand Journal o f Economics 19 (2), 1988, pp. 235-252.
Georges Feme “Information Technology Standardization and Users:
International Challenges Move the Process Forward,” in Kahin and Abbate, 1995,
op.cit., pp. 455-465.
Jack E. Brown, “Technology Joint Ventures to Set Standards or Define
Interfaces,” AnftYrwsr Law Journal, 61, 1993, pp. 921-936.
William Ellis, “Intellectual Property Rights and High Technology Standards,”
in Kahin and Abbate, 1995, op.cit., pp. 450-454.
Mark Shurmer and Gary Lea, “Telecommunications Standardization and
Intellectual Property Rights: A Fundamental Dilemma?” in Kahin and Abbate,
1995, op.cit., pp. 378-402.
Joseph Farrell and Garth Saloner, “Installed Base and Compatibility:
Innovation, Product Preannouncement, and Predation,” American Economic
Review, 76, 1986, pp. 940-955.
Joel Mokyr, “Is Economic Change Optimal?” Australian Economic History
Review, 32, March 1992, pp. 3-23.
30
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Carmen Matutes and Pierre Regibeau, “‘Mix emd Match’: Product
Compatibility without Network Externalities,” Rand Journal o f Economics, 19
(2), 1988, pp. 219-234.
Nicholas Economides, “Desirability of Compatibility in the Absence of
Network Externalities,” American Economic Review, 79 (5), 1989, pp. 1165 -
1181.
G.M.P. Swann, “Industry Standard Microprocessors and the Strategy of
Second-source Production,” in Gabel, 1987, op.cit., pp. 239-262.
Michael Katz and Carl Shapiro, “Network Externalities, Competition and
Compatibility,” American Economic Review, 75 (3), 1985, pp. 424-440; Michael
Katz and Carl Shapiro, “Technology Adoption in the Presence of Network
Externalities,” Journal o f Political Economy, 94, 1986, pp. 822-841.
Farrell and Saloner, 1987, op.cit.
S.J. Liebowitz and Stephen E. Margolis, “Network Externality: An Uncommon
Tragedy,” Journal of Economic Perspectives, 8 (2), Spring 1994, pp. 133-150.
Stan Liebowitz and Stephen Margolis, “Don’t Handcuff Technology,” Upside,
September 1995.
Liebowitz and Margolis, 1995, op.cit.
W. Brian Arthur, “Competing Technologies, Increasing Returns, and Lock-in
by Historical Events,” The Economic Journal, March 1989, pp. 116-131.
31
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Paul David, “Clio and the Economics of QWERTY,” American Economic
Review, 75, May 1985, pp. 332-337.
Liebowitz and Margolis, 1994, op.cit.
32
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Chapter 2
Case Study: The Microsoft Monopoly
In its relatively short twenty year history Microsoft has grown into a
dominant position in the enormous business of PC software. The company was
still small fifteen years ago and most of its progress came after the introduction of
Windows 3.0 at the beginning of this decade. In 1990 Microsoft’s ownership of
MS-DOS software did not seem to translate into correspondingly large positions
in applications. A different firm dominated each of the major business software
categories: WordPerfect in word processing, Lotus in spreadsheets. Harvard
Graphics in presentations, and Ashton-Tate in databases. Since then, these
products have been taken over by different companies as Microsoft swept away
their seemingly solid leads by integrating their functions into a suite called
Microsoft Office which had a common interface based on the Windows standard.
Now Microsoft seems intent on fiirther leveraging its monopoly in
operating systems to set standards for Internet publishing, commerce, and
security. Its competitors have requested government intervention to prevent
Microsoft from exercising the advantages of its monopoly. This section assesses
the validity of the arguments made against Microsoft and evaluates the company
33
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
in terms of innovation, pricing, threat of entry, compatibility, and the linkage
between architecture and applications. This permits a reassessment of the antitrust
issue in the context of the entire body of evidence.
The Case Against Microsoft
The most persistent critics of Microsoft’s proprietary monopoly are its
competitors. Many of them use arguments from the theoretical literature to justify
their positions. The main arguments are as follows.
Microsoft used anti-competitive actions to gain its position. The specific
actions were outUned in the Consent Decree of 1994. For example, Microsoft
required long term agreements with original equipment manufacturers (OEMs)
and tied its licensing fee to the total number of microprocessors shipped rather
than the number of Microsoft products.* Although Microsoft claimed this was for
ease of monitoring, competitors pointed out that the policy worked to shut out
rival operating systems. If a customer of an OEM wanted a competing operating
system such as DR DOS, PC-DOS, or OS/2, the OEM would still have to pay
Microsoft the same licensing fee even though its product was not shipped. This
made the use of non-Microsoft systems more expensive to OEMs.
The currently enforced rules restricting Microsoft apply only to MS-DOS,
Windows, and their successors. The Consent Decree did not restrict Microsoft
from using the same licensing practices with other products such as Windows NT
34
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
and Internet Explorer. In the past Microsoft has not been strong in enterprise-wide
computing but Windows NT may enable it to eventually dominate the client-
server area as weU. The same economics of increasing returns apply here and thus
Microsoft could use similar tactics to establish a monopoly in this area. Michael
Morris of Sun believed that the Consent Decree rules, if applied to Windows NT,
could forestall Microsoft dominance: .. since Microsoft has not yet established
dominance in this type of computing, the kind of remedies contained in the Justice
Department settlement might actually be effective in preventing Microsoft from
bootstrapping its PC monopoly to dominate the commercial computing world. But
wouldn’t you know that the only kind of Microsoft operating system product to
which last week’s settlement does not apply is—Windows NT.”"
The reason why Microsoft’s position seems unchallengeable is due to the
phenomenon of increasing returns explained in the previous section. The amici,
an anonymous group of companies that expressed dissatisfaction with the 1994
Consent Decree, put the argument as follows: “... in ‘increasing returns’
industries, there is every reason to believe that consumers wül get ‘locked into’
the first product that appears on a new platform, even if the product is
technologically inferior.”^ The reason for this is that the size of the network itself
brings great value to the end user. The benefits of network size are likely to
outweigh the advantages that a moderately superior technology would bring.
Furthermore, people develop specific assets, such as learning, as a result of their
35
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
adoption of a technology. For example, a set of Windows applications can only be
used with Windows and with no other operating system unless a converter is
developed. Lock-in is further increased by the development of complex user files
that can only be used with their corresponding program. Once users are locked in
to a particular technology little can be done to weaken the hold of the monopolist.
For this reason the “ties that bind are not contractual, they are technical, which is
why the Justice Department settlement will be ineffective,” according to Morris.'*
Owning the standard for the PC operating system is what guarantees Microsoft’s
position of power. The company no longer needs to use the practices that were
forbidden in the Consent Decree. According to Microsoft’s competitors, theories
of increasing returns must now be considered in public policy. For example, Scott
McNealy of Sun makes this argument: “U.S. law simply has not kept up with the
pace of technology. In the wake of this settlement, it is time for Congress to take a
fresh look at whether our antitrust laws are adequate to meet the novel challenges
of the information age.”^
Competitors of Microsoft further argue that monopolies have frequently
hurt consumer interests in the past and that society has benefited from their break
up. The CEO of Netscape, Jim Barksdale, compares Microsoft’s monopoly to that
of AT&T: “Theodore Vail was an honorable man who built this marvelous
monopoly called AT&T. He was a terrific businessman. Was AT&T a monopoly?
36
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
You’re damn right it was. Did it need to be changed? Of course. And look what’s
happened since it divested itself. A huge industry has blossomed.”®
There is broad agreement that Microsoft fits the common definition of a
monopoly—a company with a dominant market share and market power as a
result. Several sources have reported a worldwide market share of 80 percent in
operating systems.^ The 1995 Consent Decree also claimed that Microsoft had
held monopoly power in the market for PCs using Intel processors since “at least
the mid-1980s” and held “an extremely high market share” of above 70% for
nearly a decade.* It reports that in 1993 the market share in PC operating systems
was MS-DOS 79%, IBM PC-DOS 13%, IBM OS/2 4%, DR DOS 3%, and Unix
1%.^ Its dominance had increased since the end of 1990 when the shares were:
MS-DOS 70%, IBM PC-DOS 18%, and DR DOS 10%.^°
Another problem with Microsoft is that its software is not open. Scott
McNealy goes as far as to compare Microsoft’s products to those of Nintendo,
which has a strict licensing policy. The vice-president of marketing of Netscape,
Mike Homer, rejects its competitor’s claims of pursuing open standards for the
Internet: “... Microsoft has no interest in supporting open standards, except to the
extent that they grease the skids for them co-opting the standard and making
applications proprietary. It’s how they’ve always been, it’s their whole economic
model.” A recent supporter of this view is MasterCard, which abandoned its
alliance with Visa to establish a common standard for credit card processing on
37
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
the Internet. Together with Netscape and IBM, MasterCard claimed that “the
standard, created by Microsoft and published as an “open” set of specifications,
was actually proprietary, designed to give Microsoft a powerful advantage,
perhaps enabling it to take a slice of every transaction.”^ ^ This is because the
Windows implementation of the freely available specifications requires the
payment of a license that can be charged on a per transaction basis. It has become
common for competitors to charge that Microsoft keeps important details of a
supposedly open architecture secret.
Perhaps the most effective critique of Microsoft power has concerned the
linkage between system architectures and their applications. For example,
Microsoft Office is a suite of applications mnning under the dominant Windows
architecture that has achieved a market share estimated at 90%.^^ The ability of a
company to increase profits by leveraging architectural control was brought
forward in the book Computer Wars by Charles Ferguson and Charles Morris.*^
One way of doing so is by making the “system calls,” which interface between the
Windows operating system and its applications, obscure. For this reason,
according to McNealy, “Microsoft’s applications programmers, who just happen
to have a product that competes with that spreadsheet product you’ve bought,
have an unfair time advantage, enjoying access to information about changes in
the interface weU before the competing programmers.” McNealy believes that
this is analogous to charging a user fee for the right to speak or write in the
38
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
English language because “[s]witching to a different technology now is at least as
difficult as learning a new spoken language.” Companies such as Lotus,
WordPerfect, and Ashton-Tate are said to have had little chance to become
dominant in writing programs for Windows 3.0 because they did not have the
same access to the irmer-workings of the platform that Microsoft did. The amici,
in fact, argue that “a company with a large installed base in one market can give
its inferior product in a second market an insurmountable advantage over
competitors in the second market by integrating the products from the two
markets together technologically.” ^ ^ A potential solution to this problem is that a
“Chinese wall” be built between Microsoft’s applications and operating systems
division to ensure that they do not communicate with each other. Microsoft,
however, claims that this already exists.
The linkage between architectural ownership and success in applications
does not in itself justify the severing of linkages between the two divisions unless
the architecture constitutes an “essential facility,” a tool that must be used for
anybody to have access to the nation’s infrastructure.’^ Both Jim Barksdale and
Scott McNealy believe that the Microsoft operating system is essential. The latter,
for example argues that “[t]he operating system to 100 million desktop computers
is now a critical interface, an ‘essential facility’ to our economy, like the
telephone. And a single entity controls that infrastructure, that alphabet.”^ ®
39
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Another argument made to justify government intervention against
Microsoft is that if the company is not stopped it will dominate information
infrastructure content and everything else related to the global information
industry. Jim Barksdale is a proponent of this view: . I don’t know that
Microsoft necessarily needs to own the Internet. Because the logical extension is
that then they wiU control the telephone systems and all manner of
communications, be it voice or data. They’ll control the cable TV industry, they’ll
control all manner of content—I mean, where does it stop? Suppose that every
time you bought a phone it just automatically dialed AT&T? I would say that’s
not fair competition.”^ ^ Equally worried is Eric Schmidt, former CTO of Sun and
current CEO of Novell, who believes that “Microsoft is the most powerful
economic force in the United States in the second half of the 20th cenmry.”^
Presumably the breadth of this control hurts society as a whole. Bill Gates himself
has claimed to want “a computer on every desk and in every home, all mnning
Microsoft software.”^ The critics of Microsoft believe that this is not in the
public interest.
An argument that seems logical enough is that if Microsoft is allowed to
steamroller over its competitors now who wUl be willing to risk challenging the
company in the future? A former Apple executive puts it this way: “[i]f they blow
away Netscape, what venture capitalist is going to have an interest in funding the
next interesting project?” Barksdale concurs: .. it will stifle smaller companies
40
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
like ours.”“'^ Microsoft critic James Gleick argues that the changing boundaries of
what Windows can do forces other companies to abandon efforts to offer products
that may later be incorporated into the operating system. He then states that “[n]o
quantity can be harder to perceive and harder to measure than innovation that
never occurs—the absent pioneers, the fading of vitality in a still-comfortable
industry.”^ This view begs an intriguing question. The power of Microsoft has
been clear for many years already. Why is it that there are so many companies
willing to challenge it now?
Critics of Microsoft also offer some of the standard disadvantages of
monopoly: higher price, reduced variety, and lack of innovation. McNealy says
that “[w]ithout competition, there is no choice on price, no choice on products, no
choice on service.”^ ^ He believes that non-proprietary interfaces are critical “to
guaranteeing that the information superhighway allows competition, innovation
and choice.”^^ A seemingly contradictory argument is later offered by McNealy:
“... a monopoly gives Microsoft the power to impose a regime of planned
obsolescence on consumers: you may not care to replace your Windows with its
follow-on, Chicago, but Microsoft will give you little choice.”"^ An advantage of
planned obsolescence may at first seem to be innovation but McNealy is arguing
that end users would be forced to pay for marginal improvements to maintain
compatibility.
41
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
The arguments against monopolies usually focus on issues of consumer
welfare and fairness to competitors but Sun executives go even farther, stating
that United States industrial competitiveness is at stake. Michael Morris sees
difficulties for the country from the behemoth’s move into client-server systems
because these are at the heart of firm competitiveness: “Microsoft’s practices of
keeping these specifications closely held becomes an issue of national economic
importance as the company makes a serious foray into the commercial arena, or
what’s known as enterprise-wide computing.”^ ^ McNealy agrees: “[t]he
company’s control has frozen this critical market, affecting the competitiveness of
the United States.”^°
Microsoft competitors suggest several policy options. McNealy and
Morris both state that the operating system be put in the public domain and under
the direction of a standards group. Any changes would be negotiated: “[a] multi-
organizational group, including representatives of government, consumer groups,
academia and business, could establish policy guidelines on publishing the
specifications to interfaces, ensuring that they are free for all to use, changed with
timely notice, and that the changes conform to established industry standards.”^ ^
The government could lend support to this group simply by insisting on these
particular standards in procurement. McNealy rejects the possibility of a
Microsoft break-up or regulation of the industry: the latter because it is
42
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
undesirable, the former because the government is unlikely to take such a
significant step.
Innovation
One of the central tenets of increasing returns theorists is that new
innovations wül not be adopted and may not even be attempted due to lock-in to
older technologies with large installed bases. Many of Microsoft’s competitors
claim that proprietary standards reduce innovation. Alex Morrow, general
manager of architecture and technology at Lotus has a typical view: “[wje’ve lost
this notion of a public standard as good... Instead we have this new thing, a
quasi-open private standard that’s controlled by one company. That’s where
innovation is going to suffer.”^^ Sun’s Michael Morris provides evidence in
favour of this view, citing the example of Apple’s Macintosh.^^ It took Microsoft
six years to develop an alternative graphical user interface that was good enough
for a critical mass of users to adopt. In the meantime Microsoft was still able to
prosper with a clearly inferior DOS product due to its installed base of users with
DOS applications who faced large switching costs. According to Morris “one
would think that if genuine competition existed in PC operating systems, this five-
year gap would have been exploited by one or more competitors of Microsoft.
Indeed, it’s hard to conceive that any company could have taken as long as
Microsoft did to get a basic technology right and still survive.”^ '^ Brian Arthur
43
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
agrees with this assessment: “[w]e had 10 years’ worth of DOS even though
Apple had a better operating system available back in 1984.”^^ Another common
view is that dominant companies will eventually stop improving their products.
As a white paper prepared by Wüson-Sonsini puts it: “once Microsoft achieves
dominance in a market, it has little incentive to innovate.”^ ^ This is an assumption
unsupported by the evidence of this case. Although it seems plausible, there are
several mitigating factors in the case of this industry which foster innovation by
the dominant firm.
The fact that Microsoft’s products have been rated consistently behind
those of Apple in terms of ease of use is often cited as evidence of a lack of
innovation. This, however, is an unfair assessment because Microsoft introduced
the text-based MS-DOS prior to the graphical Macintosh. The desire by end users
to maintain backward compatibility obliged Microsoft to work within the confines
of the original DOS specifications. The company produced six successively
improved versions of DOS.Even after introducing Windows 95, however, it stiU
maintained backward compatibility to DOS. The original limitations of DOS,
combined with the desire for backward compatibility, remain a key barrier to
radical improvement in Microsoft products.
Some observers claim that Microsoft is not innovative because its products
are not entirely original and are often based on the ideas of earlier developers.
This critique is somewhat unfair because innovations generally follow a path of
44
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
development that can be traced over many different inventors. For example,
Excel’s design was based on that of Lotus but 1-2-3 was based on Visicalc, which
bad been developed from the method that corporations were using to track
income. Bringing a product to market and making it usable for consumers is at
least as important as an initial invention. For example, the Palo Alto Research
Center invented the first graphical user interface but Xerox did not bring it to
market. Apple and Microsoft deserve much of the credit for developing the
product into the dominant standard that it has become.
One can argue that the frequent upgrades that Microsoft provides are
evidence of innovation but Brian Arthur disagrees: “when a high-tech market is
dominated by a single company, you end up with fewer new technologies, since
competitors with smart new ideas have to battle against the huge advantages of
increasing returns. So competitors, by and large, step back and don’t upgrade the
technology. You get these itty-bitty upgrades, and the upgrades have to be
backward-compatible with your own product.”^ ^ According to Sten Thore,
however, small upgrades are not necessarily indicative of a lack of innovation:
. . . the majority of changes of technology and of products occur as
the cumulative sum of a large number of small changes of product
design rather than big discrete jumps. Most innovations are no
longer the result of one inspired genius (an Edison or a Nobel) or a
farsighted entrepreneur (Ford) but are planned and subject to
management and control. In the intensely competitive climate of
the 1990s, a firm needs to bring to the marketplace a continuous
stream of new product designs, each generation being superior to
the preceding one. Consider the cases of the modem kitchen
machine, or the garment industry, or even the automobile. New
45
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
designs hit the market every month. But the change from one
“vintage” to the next is minute.^^
Notwithstanding this interpretation, the evidence does not support Arthur’s
contention that Microsoft’s upgrades have not been substantial. Consistently
positive reviews from industry magazines do not indicate dissatisfaction with the
rate of technological advance. Many publications provide annual articles that
evaluate software on the basis of innovation and superiority of features. Table 2-1
lists awards for “Technical Excellence” that Microsoft has received. Each year PC
Magazine gives an award to the highest quality new product release in one of
approximately ten categories of PC hardware and software.*^ Microsoft won some
of the early awards for its initial releases for the Windows graphical user interface
but had a drought of four years without an award. Since it established a large
installed base in the early 1990s, however, it has consistently brought out
improved releases of its software that exceed the quality and features of rival
products. This is reflected in five consecutive years of at least one award.
46
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Table 2-1
Technical Excellence Awards for Microsoft (PC Magazine)
Year Product
1996 Point-to-Point Tunnelling Software'^*
1995 Microsoft Access for Windows 95
1995 Microsoft Windows 95
1994 Microsoft Office 4.2
1994 Microsoft Windows NT Workstation 3.5
1993 Microsoft Windows NT Advanced Server
1993 Microsoft OLE 2.0
1992 Microsoft Windows for Workgroups
1987 Microsoft Excel for Windows
1987 Microsoft Windows 386
1986 Microsoft Windows 1.03
The quality of Microsoft software is widely acknowledged. PC Magazine,
for example, has consistently given its products a much greater share of “Editor’s
Choice” awards than to its rivals. These are usually bestowed on the top one or
two products evaluated for a given article. Of 20 Microsoft business software
titles evaluated in comparison to others since 1991, 15 have received awards. In
contrast only 13 of 90 products from its competitors received accolades The
same magazine also publishes an annual survey of end users. It asks them to give
a rating of their satisfaction with the product on a ten point scale. For each of the
past five years Microsoft has scored higher in terms of overall customer
satisfaction than its rivals in PC applications. The average for Microsoft products
over the five year period is 8.36 while that of competing products is 8.10. The
results for each year are provided in Figure 2-1/^ Microsoft’s relative advantage
47
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
narrowed between 1992 and 1994 but has grown since. The large improvement in
customer satisfaction for both Microsoft and its competitors in 1993 can be
attributed in part to the general price declines in the industry shown in Figure 2-2.
Figure 2-1
Customer Satisfaction
1992 1993 1994 1995
I Com petitors I Microsoft
1996
The Chicago School approach to antitrust asserts that monopoly power in
the marketplace can be eroded by the technological advance of those seeking
monopoly profits. Gary Reback, a lawyer who has battled Microsoft in the courts,
feels that this erosion takes far too long. Just as IBM held a monopoly for a
quarter century, Microsoft could do so as weU and “[w]hen there’s a monopoly,
people suffer. Consumers don’t get the benefit of the best products. I don’t think
48
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
that it would be fair for us to think that we should just wait and let the free market
take care of this problem when it would take a long time to do it.”” * ^ Reback,
however, seems to neglect that in economic theory monopolies, even those
bestowed by the government, are not always bad for consumers or society.
For centuries governments have recognized that certain innovations are
worthy of a patent which prohibits competition for a certain length of time in the
production of the specific good that has been invented. Microsoft has an
intellectual property monopoly. As with any other intellectual property monopoly,
Microsoft’s products may not continue to be chosen in the market if another
company’s are deemed to be significantly better. Of course the issue of installed
base gives the incumbent a built-in advantage but this advantage is not infinite. It
would be difficult to move to a moderately better technology even if the
incumbent were non-proprietary. In fact, it is easier for sponsored technologies to
overcome technological lock-in. Furthermore, monopolies can be useful in
bringing innovations quickly to market, particularly when there are issues of
compatibUity as was the case with Edison’s light bulb and the early AT&T
telephone system.
To evaluate the arguments of critics it is necessary to look at the evidence
for irmovation by the monopolist Microsoft and its competitors as well as its
incentives. However small the company’s upgrades may seem to its critics, they
do constitute a degree of innovation. One of the tests is whether users adopt them.
49
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Relatively few people are now using software from the 1980s because upgrades
since then have significantly improved ease of use and features. PC users are not
generally compelled to upgrade their software. The reason they change computers
and software is that they see some benefit from doing so. It is true that part of the
decision to upgrade is based on the desire for compatibility with purchases for
new computers but the speed of adoption of improved programs suggests that the
additional features are important to the decision.
There were several upgrades to DOS after its release in 1981. Windows
eventually became good enough for widespread adoption in 1990. In the five
ensuing years there were two upgrades that increased the stability of the program
and one major modification of the interface. Appendix Tables A-1 through A-5
provide Usts of upgrades by Microsoft and its competitors. Its inability to match
Macintosh features quickly has more to do with an early lack of resources and an
inferior starting point than a lack of effort.
Microsoft originated one of the most successful innovations in the history
of PC software after the introduction of Windows 3.0. It was able to develop an
integrated suite of previously separate programs that many users can benefit from
linking together. Its release of Microsoft Office enabled users to embed
spreadsheets, presentation graphics, and database information in word processing
documents and in each other. This set of programs has received three major
updates since its initial bundling.
50
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Debate and argument are common in the upper management of the
company. This has fostered the flexibility required to make radical changes in
strategy, such as adopting the open standards of the Internet instead of pursuing
the proprietary online model that the firm had previously developed for The
Microsoft Network. Perhaps the strongest evidence for the ability and willingness
of Microsoft to innovate has been the company’s transformation as a standard
setter for the Internet and its integration of Internet tools onto the desktop.
Industry observer Mike Elgan points out that “[vjarious software development,
product cycle, distribution and use models underwent a paradigm shift that
deviated sharply from the PC “Wintel” universe, proving Microsoft is powerless
to stop software innovation to protect its franchise. Microsoft responded by
turning the company around as if it were a small mom-and-pop shop,
transforming itself into a killer Internet company.”'* ®
The competitive fervor of the company’s leaders is reflected throughout
Microsoft. This excerpt from the Seybold Report on Internet Publishing illustrates
the marketing ability of the company:
Every Microsoft representative we met at Seybold was well-
briefed and focused on one task: telling the Seybold audience what
his company could do to make their lives easier. The company’s
developers and technical evangelists knew how to pitch their
products to a publishing crowd, and they did so with the help of a
small army of third-party developers and vendors. While leaping
from one industry sore spot to another—color management,
Windows NT device drivers, technical support, even the dreaded
Font Wars—Microsoft’s representatives apologized for past
mistakes and swore to deliver the goods the next time around. This
51
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
was PR jujitsu, turning every hostile remark and pointed question
into another opportunity to spread the gospel and make more
money/^
This degree of customer responsiveness is highly unusual for a monopoly and is
consistent with the evidence on innovation. It shows that the statements of the
company’s leaders have substance and are not merely attempts to mask the
deficiencies of a monopoly.
The evidence of the past ten years does not seem to support the argument
that Microsoft has innovated less as a result of its monopoly. Bill Gates points out
that users wUl not pay for an upgrade unless it provides something of significant
value, not just a few minor features. He states the company’s motivation for
innovation: “[i]t takes . . . guts to bet on the Sea Change when you are the market
leader but it is the only way to position yourself for massive upgrades.” The
importance of upgrades appears to be the major reason why Microsoft has
remained innovative in spite of its strong position.
One of the key differences between this and other forms of intellectual
property monopoly is that the incentive for innovation is clear not only before the
introduction of a new product but also afterward. Some intellectual property
monopolists can continue selling the same product to previous customers. For
example, pharmaceutical companies can profit firom an earlier investment for the
entire length of the patent. They can sell the same drug over and over again to
patients who can benefit firom it. Software makers do not have this luxury. Once
52
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
the product is sold the same person wül never buy it again. A previous customer
is, however, a prime candidate for future sales of a significantly improved
product. For this reason, lock-in can act-uaUy result in greater innovation than may
otherwise occur. A monopolist will not generally succeed in selling anything to a
locked-in customer unless it provides value.
Another question worth asking is whether Microsoft displays motivation
for innovation. This can be represented by both expenditures on research and the
attitudes of company leaders. The company claims to spend $1 billion per year on
research and development. According to an observer “[i]t spends much of that
research on usability studies—finding out what real users want rather than what
software developers think users want.”'* * Nathan Myhrvold claims that Microsoft
has “one of the leading research groups in computer science.” Although IBM has
more researchers overaU than Microsoft’s 170, it dedicates much of its effort to
hardware and physics. Thus, Microsoft is among the leaders in software research
and is now in the process of tripling in size.'*^
The anticipation of new rivals is part of the Microsoft culture. The tone is
set by Bill Gates who points to once monopolists such as IBM which later fell;
“[i]n this business, by the time you realize you’re in trouble, it’s too late to save
yourself. Unless you’re running scared aU the time, you’re gone. IBM could
recover, but in terms of what it was, it’ll never have a position like that again. It
was during the glory years, its years of greatest profit and greatest admiration, that
53
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
it was making the mistakes that sowed the billions of dollars of losses that came
later.”^° In spite of the company’s high degree of market power. Gates is
convinced that his firm is not far away from failure: “[t]he only key to success is
developing and shipping products that customers want. If we start to lose sight of
that fundamental fact, it is certain that our business will decline r a p i d l y H e
keeps a picture of Henry Ford in his office as a reminder of how a company that
dominates an industry can quickly lose its leadership to a rival as Ford did to
Alfred Sloan’s General Motors in 1927.^^ In The Road Ahead Gates writes that,
“[s]uccess is a lousy teacher. It seduces smart people into thinking they can’t lose.
And it’s an unreliable guide to the future. What seems the perfect business plan or
latest technology today may soon be as out-of-date as the eight-track tape player,
the vacuum-tube television, or the mainframe computer.Thus, there is much
evidence that Bül Gates is motivated to innovate by his own fear of being left
behind technologically.
The fear of potential competitors stated by Gates permeates Microsoft,
making it unlike other companies with high degrees of market power. According
to Myhrvold, “[w]e’re in a technology industry—the fundamental driving force
behind our products is technology. If we fail to innovate, if we fall to keep up and
deploy new things, we will be cmshed. The wave of technology that we surf on is
so much bigger than us that you ignore it at your peril. Therefore, in our industry,
the most successful companies are those driven by technologists, by product
54
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
people.”^ " ^ The fundamental understanding of technology by the firm’s leaders
makes it more inclined to innovate than other monopolies would. Myhrvold
claims that Microsoft researchers are encouraged to interact professionally at
conferences with those of rival firms.^^ Although discussing ideas publicly may
inspire a new product from a competitor, it is just as likely to benefit Microsoft.
The willingness to share ideas in this way fosters innovation in the industry as a
whole. Another argument for innovation mentioned by Myhrvold is the
company’s willingness to cannibalize sales of successful products: “Windows was
intended to replace DOS. That was its reason for existence. Excel replaced
Multiplan. You don’t blithely replace a giant business, but if there’s someone
who’s going to threaten it, by God, I want it to be somebody here on campus, not
somebody outside the company.”^ ® Thus fear of rivals, leadership by
technologists, industry level peer review, and willingness to cannibalize are all
factors that explain why Microsoft innovates in spite of its monopoly.
Microsoft is an innovative company and PC software is a highly
innovative industry. It is hard to imagine, in fact, how it could be much more
innovative. There is a limit to the number of times that users will want to upgrade
their systems. The claim that innovation now is lower than it would be if there
were no monopoly is an easy one to make because it is entirely untestable. In fact
any measurement of innovation is suspect because of endogeneity of independent
variables. It is also difficult to know whether Microsoft is responding to
55
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
innovations by its competitors or vice versa. The only thing that is clear is that in
spite of an extremely strong position, Microsoft still produces new products and
improves its older products. Even Jim Barksdale, one of those calling for
government constraints on Microsoft, agrees that it has been an innovative
company, stating that it has “good people who try hard and create great
products.”^^ Given the evidence it is pmdent to ask those who request government
intervention on the basis of innovation to show that it is slowing as a direct result
of the standards monopoly.
Pricing
One of the common concerns about a monopoly is that it will set prices
higher than the socially optimal level. One of the criteria for antitrust action is
therefore pricing. Market power increases may not be of great concern to the
consumer if prices do not also rise.
In the case of pricing there is no question that software prices have
declined at the same time that Microsoft increased its market share of PC desktop
software sales to 70%.^^ For example, in 1990 the prices of the leading word
processor, spreadsheet, presentation graphics, and database programs were
approximately $350 each. Now all four of these programs are bundled for about
$500. This represents a 60% reduction in price. The pricing trends for office
suites are shown in Figure 2-2 as well as in Appendix Tables A-6 through A-9.^^
56
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Although it indicates that rivals are now undercutting Microsoft’s price, which
has increased slightly in the last two years, this is not surprising given the near
unanimity in the trade press that Microsoft applications are superior. It is also
worth noting that an aggressive pricing strategy by Corel increased its market
share in office suites from 12% in 1995 to 35% in 1996 (see Table 2-2).®° This
shows that the lock-in effect in this software category is relatively mild thus
reducing the market power of the leading firm.
Figure 2-2
Pricing of Office Suite Applications
Competitors
Microsoft
1995
1996
Several factors can explain the surprising decline of prices as monopoly
power has increased. Perhaps the most important is the standard setting role
57
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
played by Microsoft Windows, which causes PC software to adopt a similar
interface and features and thus becomes less differentiable. According to Andrew
Schulman: “[t]his makes software packages fungible commodities that shoppers
differentiate primarily by price.”^ * Furthermore, the Microsoft irmovation of
software suites has pushed down prices. As well, the price war related to
competitive upgrades is another factor as is the corresponding fall in hardware
prices
62
Table 2-2
Market Share in Office Suites
1995 1996
Publisher
Market
Share
(Revenue)
Market
Share
(Units)
Market
Share
(Revenue)
Market
Share
(Units)
Microsoft 88.26% 82.8% 79.46% 58.97%
Corel 7.07% 11.98% 16.26% 35.39%
Lotus 4.65% 5.2% 4.28% 5.65%
In spite of the evidence in opposition to pricing concerns, Arthur remains
skeptical: “[t]he real question is whether prices are higher than they otherwise
would be . . . We end up with bad, cheap products that are priced higher than they
should be. Is Microsoft charging more than they would if they had real
competition in many of their markets? The answer is probably yes.”* ^ ^ This is an
entirely theoretical argument, based on his belief that increasing returns
monopolies significantly reduce the probability that new and radical innovations
will be introduced. As stated above there is no method of testing whether prices
58
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
are really higher than they would be if Microsoft did not have such a dominant
position. It is, however, just as easy to argue that if it had not standardized the
marketplace and offered integrated Windows applications, prices would be
considerably higher now. Interface and feature similarities as a result of the
Windows interface have led to a degree of commoditization. One can also argue
that Microsoft cannot risk taking advantage of customer lock-in through
monopoly pricing because it is such a high profile company and it must be careful
to maintain a positive public image.
The most basic economic argument against a monopoly is that it sets its
price well above cost. As a result it will receive a portion of what would be
consumer surplus and many potential buyers wül not be served resulting in an
overall “deadweight” loss of surplus to the society. Rent-seeking theory identifies,
however, that this loss is of relatively minor significance compared to potential
losses caused by the pursuit of the above normal profit that the monopolist
receives.^ If the monopoly is estabhshed by fiat through a bureaucratic decision,
this pursuit wül likely encompass activities that are directly unproductive, such as
lobbying and bribery. If, on the other hand, this excess profit is not legislated but
must be fought for in the marketplace, the tools for its pursuit are likely to be
productive, such as innovation and cost reduction. Monopohes conferred through
increasing returns faU into the latter category and are therefore far less
problematic than regulated monopolies.
59
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
There is a fundamental difference about software that disciplines
monopolies and prevents them from charging higher prices. There are few
substitutes, for example, for oil and steel if these industries become monopolized.
Either the higher price is paid or production and transport stop. This was the
reason why antitrust laws were established in the first place. They were intended
for industries with unappealing short-term substitutes. In the software industry the
number of substitutes is large. In particular, Microsoft carmot sell the same
product to the same customers twice. If the price of its new product is much above
that of its old product, customers wiU choose not to upgrade unless they can
receive benefits in new features that outweigh the higher cost. A software
monopoly is therefore unlike others in the sense that it has a good substitute that
limits its market power: previous versions of its own software. If users feel that
the price is too steep they may not upgrade. This disciplines the standards
monopolist in the same way that the McDonald’s monopoly on Big Macs does not
result in excessive prices charged to buyers. Competition from close substitutes
such as Burger King’s Whopper prevents McDonald’s from charging significantly
above cost.
This turns the argument of some increasing returns theorists on its head.
Antitrust enforcement may need to be modified as a result of network externalities
but for some products, such as software, the movement may well be toward
weakening it. In this way, the standards monopoly is not treated differently from
60
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
other monopolies based on intellectual property. In fact patent monopolies are
often viewed positively even though consumers pay much higher prices than
software users do. Pharmaceutical companies resell the same product to their
customers and there are few substitutes for them. Thus, unlike Microsoft, they
have an enormous degree of market power for the entire duration of their patent.
Economic theory justifies this as the price of maintaining the motive for
innovation. Microsoft’s position is even more justifiable if end users are not
paying higher prices in spite of its copyright monopoly.
Threat of Entry
According to economic theory, the greater the amount of power
concentrated m the hands of a single firm the lower the threat of entry that the
dominant firm will face. Nonetheless, the computer software industry seems to
have many new entrants in spite of Microsoft’s dominance. This view of the
industry, does not, however, have universal support.
The Software Publishers Association (SPA) commissioned a survey of its
membership by Public Opinion Strategies. There were 13 questions dealing with
competition in the industry. 80 percent of firms felt that anti-competitive and
monopolistic practices had increased over the previous ten years. 56 percent of
respondents said that there was “over-concentration of market power in the hands
of one company.” Most accepted the hypothesis that a firm could use dominance
61
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
in one segment to control others. With respect to threat of entry, 75% of SPA
members agreed that “the emergence of dominant players in key segments of the
software industry increases barriers to entry for new software companies.”^^
These findings confirm what is expected by economic theory but they are
controversial. Microsoft questioned the survey’s methodology and SPA board
members voted against issuing a press release about the survey
There is, however, a great deal of evidence that refutes the belief that
entry barriers are high in the industry. Through most of the history of the
computer industry there has been a dominant player at the systems level.
Recent history suggests that unforeseen competitors can cause serious
damage to monopolists in technological industries. For example, little more than a
decade ago IBM’s position in the computer industry looked impregnable. Many
felt that it could use the power of its proprietary lock-in to perpetually maintain its
mainframe and minicomputer customers. The networking of personal computers
has provided a more powerful and cost effective solution for enterprises. When a
viable substitute became available, IBM’s monopoly established due to the power
of increasing returns was eroded. The decade long antitmst battle against IBM
proved unnecessary because entry occurred as a result of rapid technological
advance. Jim Barksdale provides an example of another company that faced
unexpected competition: “Apple was railing against IBM, but their real
competitors were Intel and Microsoft. They never saw them coming.”^^
62
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Furthermore, unlike AT&T prior to its break-up, Microsoft’s dominance is
not enshrined in law. It has to work to maintain its position because its source of
competitive advantage is the protection of its intellectual property. Most patents
last twenty years. It seems unlikely that a standards based information technology
monopoly could last that long. Such a lengthy monopoly could only be
maintained if the monopohst were innovative over multiple generations or if it
were able to force previous customers to buy new versions of its software.
Microsoft leaders often state their belief that they can be and are faced
with strong new entrants at any time. According to Bill Gates: “Microsoft does
not dominate the software industry by any stretch of the imagination... We have
lots of very able competitors who keep us constantly vigilant, and sometimes they
beat us to the punch. Microsoft’s success to date is based solely on the fact that
people like our software . . . The notion that if you’re doing well today you will
necessarily do well tomorrow just isn’t true.”^^ This may sound self-serving for a
company under constant antitmst surveillance but many observers share his
opinion. For example, Mike Elgan states that “[t]he history of the microcomputer
industry has demonstrated that the potential for anything from minor application-
level innovation to a massive paradigm shift is always just around the comer. And
when paradigms shift, companies fail—if they don’t keep up.”^ ^
The rapid growth of the Internet was also not foreseen only three years
ago. Netscape and many other start-ups came out of nowhere to challenge
63
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Microsoft. If it were not for a rapid reinvention of the latter ±ey might have
succeeded in reducing the Microsoft power base in the same way that IBM lost its
monopoly. The speed of change can be illustrated from the fact that in the first
half of 1996 some industry observers predicted the end of Microsoft dominance as
a result of the Internet while in the last half they predicted that it would take over
the Internet entirely.^® Both claims were exaggerated.
Tim Bemers-Lee, founder of the World Wide Web and now in charge of
the W3 Consortium, explains why the very existence of the Internet wül reduce
switching costs further and permit new entry: “[i]f you have a browser you can
install another browser in about three clicks. That’s a fairly short time cost for the
market to be able to change. When you have agents on your machine, then the
time cost wiU be even smaller because the agents wül download the software onto
your machine to prepare for your next day without you having to do anything.
When that happens we’re going to see technological revolutions happen
extremely rapidly.Microsoft competitor Scott McNealy agrees that “[tjhere
wiU be radical change.Barksdale also supports this view: "[t]he main reason
[the software business] is very competitive is its extremely fast pace. Software
can be created and implemented almost overnight now. So you don’t have big,
long, competitive product advantages. You’re orüy as good as yesterday’s product
release.”^ ^ It is hard to reconcüe these opinions with the claim that industry
innovation is in danger of being stifled by Microsoft’s market power.
64
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
It is certainly true that it is difficult for a start-up Srm to enter and succeed
in the software market but this is also true of other industries. As industries
mature they tend to consolidate. To succeed new entrants must be innovative.
Nonetheless, many independent observers believe that this can happen. According
to Anderson, “[t]he history of this industry has shown that all companies have
some weaknesses, and these vulnerabilities can and w LU be exploited. On a
superficial level, Microsoft looks unbeatable, but 1 once thought IBM was
invincible, too.”^ " * ^ Marshall notes that “[m]any experts are skeptical that
Microsoft’s dominance of PC operating systems makes it invincible in other
fields, since new technology is making old standards obsolete at a record pace.”^^
Gifford agrees: “[o]perating systems are continually in process. At the stage of
each new move to a higher-level technology, the market carries a potential for
opening wider to new entrants and for presenting new opportunities to existing
players. If Microsoft has been the leader during the era of the 16-bit platform,
perhaps IBM will be the leader during the era of the 32-bit platform. We have no
idea who wUl lead in the era of the 64-bit platform.”^ ®
One of the most important factors fostering entry in the software industry
is the commoditization caused by the success of Microsoft Windows in the first
place. According to Leibowitz and Margolis, “[b]efore Windows, software
producers had to design their own printer drivers, video drivers, menuing systems
and so forth. This provided large software producers, such as Lotus Development
65
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Corp. and WordPerfect Corp., with a major advantage over smaller rivals. It was
costly to write hundreds of drivers for every printer, video card and so forth.
Windows allowed software authors to dispense with these efforts and concentrate
on the program itself.”^^
Companies such as Sun, Oracle, IBM, Netscape, and Apple are willing to
dedicate resources to battling Microsoft directly. Although these firms and other
observers request that the government restrict Microsoft’s ability to compete on
the grounds of its market power, this raises a question. If Microsoft’s position is
so unchallengeable why are there so many companies willing to try? Put another
way, if Microsoft were allowed to defeat Netscape why would any other company
be willing to take the risk to challenge Microsoft? One potential answer is that by
uniting, challengers may be strong enough to counter-balance Microsoft power.
This was the motivation behind the PowerPC chip coaUtion of Apple, IBM, and
Motorola, which wanted to provide a viable alternative for Wintel PCs. The
companies mentioned above are also in an informal “anybody but Microsoft”
coalition to provide a new direction for the future of computing. Some examples
of partnerships by Microsoft’s competitors are provided in Table 2-3.
66
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Table 2-3
Strategic Partnerships Among Microsoft Com petitors
Companies Livolved Reason for the Alliance Type of Alliance
Sun Microsystems Inc.,
Netscape
Communications Corp.,
Apple Computer Inc.,
and International
Business Machines
Corp., Austin’s SunRiver
Data Systems Inc.,
Taiwan’s Acer Inc. and
Tatung Co. and Italy’s
Olivetti SpA
Develop a set of technical
specifications for making
network computers that can
all run the same software
Product Development
Oracle and Sun
Microsystems Inc.
Develop software for the
network PC
Product Development
Apple, Novell, IBM,
Adobe, Lotus
Develop Component
Integration Laboratories (Cl
Labs) to rival Microsoft’s
Object Linking and
Embedding (OLE) standard
for interapplication
communications
Product Development
Informix, Illustra
Information
Technologies Inc.,
Spider Technologies
Genesis Inc., VPE Inc.
Bluestone Inc.
Combination of Informix
Dynamic Scalable
Architecture
with the niustra Server for
the development of a new
Universal Server
Acquisition of
niustra Information
by Informix and
partnership for
product enhancement
67
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Table 2-3
Strategic Partnerships among Microsoft Competitors
(continued)
Companies Involved Reason for the Alliance Type of Alliance
Informix, Netscape
Communications Corp.
Netscape wiU bundle the
Workgroup version of the
Informix DBMS server into
its LiveWire Pro
development environment.
Netscape also bundles the
Informix-On-Line Dynamic
Server in its Internet
Applications such as IStore,
online merchandising
system, and the Netscape
Publishing System
Partnership for
product
complementarity
Computer Associates,
Fujitsu Ltd.
Development of Jasmine a
program that facilitates
development of Intranet and
Internet applications.
Product
development
Corel, NoveU Development of World
Wide Web products
Acquisition by Corel
Adobe, Frame
Technology, Aldus Corp.
Publishing software for the
World Wide Web
Acquisition by
Adobe of both
companies
Corel, WordPerfect Productivity software to
create a suite of products to
compete against Microsoft
Office
Acquisition by Corel
Lotus Development
Corp., Fujitsu
Distribution of Lotus’s
SmartSuite into Fujitsu
Personal Systems
Distribution
Partnership
Source: AFX News, May 20, 1996; Times Newspaper Limited, June 16, 1996;
DBMS, May 1996; Computer Reseller News, November 6, 1995; PC Week,
February 5, 1996, August 12, 1996; Government Computer News, August 5,
1996.
68
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Furthermore, Microsoft has hundreds of potential competitors. According
to Anderson there were 1,500 current and future rivals last year and 600 new ones
launching this year. Many of these are funded by one of the 250 first-tier venture
capital firms in the United States.^* This is the same pool from which Netscape
and Cisco Systems came. Microsoft currently faces challenges from several rivals.
Intel’s microchips, for example, include software instructions and this relationship
between software and hardware could put these two companies in direct
competition. Intuit has dominated Microsoft in the personal finance market and
has better relationships with banks.According to Anderson, Cisco Systems is
strategically placed to battle WindowsNT with its Internetwork Operating
System.^° Netscape has distributed 55 million copies of Navigator, which is
second only to Windows in number of users Netscape and Lotus are strong
competitors in the groupware / e-mail segment which is highly important for
communications within and between companies. In industrial strength databases
Oracle provides strong competition. Thus, Microsoft’s position is much more
precarious than its market share indicates.
Compatibility
One of the most common claims of the open systems movement is that
proprietary technologies fostered by particular firms wtU lead to incompatibility
while open systems not only reduce the control of any single firm over the
69
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
industry but also result in order and compatibility. The latter claim is examined
below but the former can be addressed in the context of Microsoft. Although it is
true that some standards battles lead to incompatibility, this possibility decreases
as the importance of network externalities grows. If users view compatibility as
essential, the increasing returns effect is extremely strong and the length of the
battle will be short. One of the competing technologies wül be adopted quickly
while those who have adopted the losing technology are likely to convert quickly.
The very nature of the increasing returns argument therefore suggests that
compatibility will happen quickly if markets are left alone and proprietary
technologies battle for superiority. Microsoft’s competitors often complain that its
solutions are not portable and that this hurts compatibility. This, however, is not
surprising given the company’s position in the marketplace. As Schuhnan notes
.. with 80% or more market share, they don’t need to be any more portable
than they are. By relying on the Windows API, you have the vast majority of
machines taken care of.”® " The personal computer market is far more compatible
than the Unix market ever became and this is due to the ability of the leading firm
to provide a single compatible product. Chapter 7 elaborates on this point.
The DOS/Windows standard was adopted quickly. It was not possible for
any firm but Microsoft to modify the operating system and this ensured that
compatibility would be maintained. Firms that standardized on Unix are now
abandoning that decision because they prefer the compatibility that they can
70
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
expect from Microsoft. Financial trading firms provide a specific example. They
have been using Unix for more than a decade but have tired of its
incompatibilities.^^ The lock-in effect forces users to choose a standard. This will
tend to occur more quickly when a company exercises control over the standard
because there is less uncertainty.
Given that network externalities are high in the PC software industry,
increasing returns theory predicts that a single firm is likely to become dominant.
Consumers strongly value compatibility and are unwilling to adopt a technology
with a smaller installed base unless the benefits of superior performance exceed
the cost of incompatibility. Kenneth Arrow, arguing on behalf of the government
in the judicial review of the 1994 Consent Decree, reaches the following
conclusion: “[i]f monopolization is inevitable, as the amici’s argument implies,
then the outcome can only be criticized on the basis that the wrong monopolist
survived.”* " ^ Some firm was likely to achieve the position that Microsoft now
holds. If the government were to punish Microsoft simply for achieving its strong
position, this may provide a disincentive to future entrepreneurial firms in search
of above normal profits.
Conclusion
This chapter has shown that the PC software market is innovative, has
competitive pricing, experiences entry by new competitors, and delivers
71
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
compatibility. All of this occurs in spite of strong market power by Microsoft.
Nonetheless, the company is still perceived in many quarters as a deserving target
for antitrust enforcement. A brief review of antitrust law can be useful as a
transition to a more detailed treatment in the next chapter.
Antitrust laws were established and have been enforced with the goal of
promoting the competitive process. They were not intended to protect specific
competitors from an attack by a more well endowed firm.*^ It is in the interests of
a competitor to make an antitrust complaint against a powerful rival that is
reducing its market share or profits. Fierce competition may not benefit some
companies but consumers do benefit. In its decision in Berkey Photo, Inc. v.
Eastman Kodak Co., the Court stated that “[w]e must always be mindful lest the
Sherman Act be invoked perversely in favor of those who seek protection against
the rigors of competition.”* ^ The Court has also held that even a 100% market
share does not justify the enforcement of antitrust laws unless its existence harms
consumers. This is implicit in the comment by Judge Learned Hand that “[t]he
successful competitor, having been urged to compete, must not be turned upon
when he wins.”* ^
Another aspect of antitrust laws is that in general they are not invoked
when a monopoly over a product is enforced by intellectual property laws.
According to the U.S. Constitution, “[t]he Congress shall have Power . . . To
promote the Progress of Science and useful Arts, by securing for limited Times to
72
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Authors and Inventors the exclusive Right to their respective Writings and
Discoveries .. The ability of Microsoft or any other company to establish a
monopoly based on irmovative products is thus protected constitutionally.
Perhaps the reason why there have not been many antitrust lawsuits by
Microsoft’s competitors is that the potential plaintiffs realize that they do not have
a strong legal case and have opted for political pressure instead. This chapter has
shown that there is little evidence that consumers have been hurt by Microsoft’s
position. Several observers agree that this is the case.^^ Marketing Week, for
example, noted that stock markets were not concerned by an antitrust
investigation of Microsoft because “in a matter of months, Microsoft has taken on
its rival Netscape in this market, struck innovative alliances with Internet service
providers and given introductory software away free. And the winner? The
consumer, of course.”^°
There is much evidence that mistakes by the company’s competitors were
a factor in the monopoly position. The most obvious example is their slow
introduction of products for the Windows 3.0 operating system. This mistake was
repeated by WordPerfect, for example, when it was slow to introduce products for
Windows 95. Although it is true that Microsoft products may not be the most
technologically advanced in the industry, the market rewards companies such as
Microsoft that are successful at distributing and marketing their products.
73
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Given what seems to be overwhelming evidence favouring the company,
why is it that the general perception of illegal monopoly remains? Mike Elgan
points out that it may be related to a public image problem. The company is
perceived as withholding information regarding new operating systems and not
having a good relationship with OEMs.^* This perception is not entirely self-
inflicted though. Competitors may use antitrust as a weapon against a dominant
firm regardless of the merit of the case. Judge Sporkin was strongly influenced by
the arguments of the amici, believed in the industry to be Sybase, Sun
Microsystems, and Borland International.®^ Richard Rule, an antitrust lawyer and
Microsoft consultant, states that “[a]n attorney general’s office can start an
investigation without a complaint, but it is unusual. Often these people (state
attorneys general) are on their way to higher office and it has been said some of
them look for high profile cases such as the one with Microsoft.”® ^ It is thus not
surprising that a dominant company such as Microsoft can get a monopolistic
reputation due to its market position rather than through significant anti-consumer
activity.
74
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Notes
* The amici brief from the challenge to the 1994 Consent Decree disapprove of
this as does Michael Morris of Sun in “Microsoft Settlement is Too Little Too
Late,” Sunday San Francisco Examiner, July 24, 1994.
^ Morris, 1994, op.cit.
^ John E. Lopatka and William H. Page, “Microsoft, monopolization, and network
externalities: some uses and abuses of economic theory in antitrust decision
making,” The Antitrust Bulletin, Summer 1995, p. 336.
^ Morris, 1994, op.cit.
^ Scott McNealy, “Window(s) on Monopoly,” The Wall Street Journal, July 27,
1994.
^ Esther Dyson, “Netscape's Secret Weapon,” Wired, 4.03, March 1996.
^ Claudia MacLachlan, “Microsoft Investigators Press Ahead,” National Law
Journal, Aug. 21, 1995, pp. A l, A21; Louise Kehoe, “Microsoft Attacks Probe,”
Financial Times, June 27, 1995, p. 4; Jim Carlton, “Motorola’s New Computer
Line to Run Multiple Systems, Relying on Windows,” Wall Street Journal,
December 13, 1995, p. B6.
® Federal Register, 59, 1994, p. 42,847.
^ Federal Register, 1994, op.cit., pp. 42,845, 42,850.
75
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Kenneth C. Baseman, Frederick R. Warren-Boulton, and Glenn Woroch,
“Microsoft Plays Hardball: The Use of Exclusionary Pricing and Technical
Incompatibility to Maintain Monopoly Power in Markets for Operating System
Software,” Antitrust Bulletin. 4, 1995, pp. 265, 272.
McNealy, 1994, op.cit.
Mike Homer, “Will Open Standards Win the Web?” Communications Week,
621, July 29, 1996.
“Microsoft VP Steve Ballmer Speaks,” CNETNews, May 10, 1996. Available
(online): http://www.news.com/SpeciaIFeatures/0,5,1300,00.html.
CNET News, 1996, op.cit.
James Gleick, “Making Microsoft Safe for Capitalism,” The New York Times
Magazine, November 5, 1995, p. 57.
Charles Ferguson and Charles Morris, Computer Wars (New York: Times
Books, 1993).
McNealy, 1994, op.cit.
Lopatka, 1995, op.cit., p. 336.
This term originates in Section 2 of the Sherman Act and is defined as
“reasonable, non-discriminatory access to some ‘facility’ that is essential to
effective competition.” Amy C. Page, “Microsoft: A Case Study in International
76
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Competitiveness, High Technology, and the Future of Antitrust Law,” Federal
Communications Law Journal, 47 (1).
McNealy, 1994, op.cit. Jim Barksdale makes a similar argument in Dyson,
1996, op.cit.
Dyson, 1996, op.cit.
^ Gleick, 1995, op cit.
^ Gleick, 1995, op cit.
^ Dyson, 1996, op.cit.
^ Gleick, 1995, op.cit.
McNealy, 1994, op.cit.
McNealy, 1994, op.cit.
McNealy, 1994, op.cit.
Morris, 1994, op.cit.
McNealy, 1994, op.cit.
McNealy, 1994, op.cit.
Gleick, 1995, op.cit.
Morris, 1994, op.cit.
Morris, 1994, op.cit.
Paul Kedrosky, “The More You Sell, the More You Sell,” Wired, 3.10, October
1995.
77
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Gary Reback, Susan Creighton, David Killam, and Neil Nathanson,
‘Technological, Economic and Legal Perspectives Regarding Microsoft’s
Business Strategy in Light of the Proposed Acquisition of Intuit, Inc.,” Upside,
February 1995.
Daniel J. Gifford, “Software: Microsoft Corporation, the Justice Department,
and Antitrust Theory,” Southwestern University Law Review, 25, 1996.
Kedrosky, 1995, op.cit.
Sten Thore, The Diversity, Complexity, and Evolution of High Tech Capitalism
(Boston: Klewer Academic, 1995), p. 8.
Over the past 15 years PC Magazine has developed a consistent methodology
for evaluating products for end users.
Point-to-Point Tunnelling Software was jointly developed by Microsoft and
U.S. Robotics.
This data was compiled from twelve major review articles published in PC
Magazine between 1991 and 1997.
“Software Support and Satisfaction,” PC Magazine, July 1992, July 1993, July
1994, July 1995, and July 1996.
Nick Wingfield, “Microsoft Menace,” CNET News, 1996. Available (online):
http://www.news.com/Newsmakers/Reback/reback.html.
78
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Walter Isaacson, “In Search of the Real Bill Gates,” Time, 149 (2), January 13,
1997.
^ Mike Elgan, “Justice Department: Hands Off Microsoft!—Splitting Microsoft
into Two Companies would be Disastrous for the Industry—and for Users,”
Windows Magazine, 801, January 1, 1997.
Matt McKenzie, “Seybold Shoot-Out: A Deep Six for Big N?” Seybold Report
on Internet Publishing, 1 (2), October 1996, p. 3.
^ Elgan, 1997, op.cit.
Eric Nee, “One on One with Eric Nee,” Upside, March 20, 1997.
“The Bill Gates Interview,” Playboy, 1994. Available (online):
http://ei.cs.vt.edu/~history/Bill.Gates.html.
Upside, April 1995, op.cit., p. 66.
52
Isaacson, 1997, op.cit.
Isaacson, 1997, op.cit.
Nee, 1997, op.cit.
Nee, 1997, op.cit.
Nee, 1997, op.cit.
Dyson, 1996, op.cit.
58
Kedrosky, 1996, op.cit.
79
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Sources for this figure are advertisements in PC Magazine from mail order
companies in the first issue of each year. The Microsoft products were not
bundled until 1990 while the first competing bundle became available in 1992.
Prior to these dates the competing products generally represent the most popular
application in each category (e.g. WordPerfect, Lotus 1-2-3, Freelance Graphics,
dBase). While these represent different pricing strategies for different companies
the true price to end users is of greatest importance for this analysis.
Jeff Moad, "Rolling Out Microsoft’s Office 97,” PC Week, Febmary 24, 1997,
p. 122.
Andrew Schulman, “Consolidation of the PC Software Industry,” The O ’ Reilly
Windows Center, 1995. Available (online):
ftp://ftp.ora.com/pub/examples/windows/win95.update/consolid.html.
Schulman, 1995, op.cit.
Kedrosky, 1995, op.cit.
^ James M. Buchanan, “Rent Seeking and Profit Seeking,” in James M.
Buchanan, Robert D. Tollison, and Gordon Tullock, eds., Toward a Theory o f the
Rent Seeking Society (College Station: Texas A&M University Press, 1980).
Darryl K. Taft, “FTC probes need for antitrust enforcement changes,”
Computer Reseller News, January 1, 1996, p. 16.
80
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
^ Jack Sweeney, “Software trade groups tangle in turf war—It’s Software
Publishers Association vs. Business Software Alliance,” Computer Reseller News,
February 12, 1996.
Dyson, 1996, op.cit.
Upside, 1995, op.cit.
Elgan, 1997, op.cit.
Elgan, 1997, op.cit.
“Interview,” The World Wide Web Journal, I (3), 1996. Available (online):
http://www.ora.com/catalog/wj3/.
Scott McNealy, “Positioned for growth: Resellers and the intranet,” Computer
Reseller News, 677, April 1, 1996.
Eric Nee, “One on One with Jim Barksdale,” Upside, November 1996.
Howard Anderson, “Target: Microsoft,” Upside, March 18, 1997.
Jonathan Marshall, “Antitrust Punishes Market Winners,” San Francisco
Chronicle, July 24, 1995, p. E7.
Gifford, 1996, op.cit., p. 639.
Stan Liebowitz and Stephen Margolis, “Don’t Handcuff Technology,” Upside,
September 1995.
Anderson, 1997, op.cit.
Anderson, 1997, op.cit.
81
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Anderson, 1997, op.cit.
Anderson, 1997, op.cit.
Andrew Schulman, “Can Microsoft Catch Up to the Internet: A Software
Developer’s Perspective,” The O ’ Reilly 'Windows Center, March 21, 1996.
Available (online):
ftp://ftp .ora.com/pub/examples/windows/win95 .update/msinet.html.
Dean Tomasula, “NT’s Momentum Nudges at Unix; Windows NT Operating
System,” Wall Street & Technology, 14 (3), March, 1996, p. 46.
Lopatka, 1995, p. 336.
Samuel R. Miller, “Does Netscape Really Have Antitrust Claims Against
Microsoft?” The Computer Lawyer, 13 (11), November 1996, p. 7.
Miller, 1996, op.cit.
Miller, 1996, op.cit.
U.S. Constitution, I, 8.
Elgan, 1997, op.cit.; Patrick McKenna, “Texas Attorney General Requests
Information From Microsoft,” Newsbytes, February 12, 1997; “Monopolies in
Cyberspace,” The Economist, September 7, 1996, p. 18.
George Pitcher, “Qne20ne to Face UK Regulation with US-style Marketing
Plans,” Marketing Week, 19 (27), September 27, 1996, p. 22.
Elgan, 1997, op.cit.
82
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Jeff O'Heir, “Gary Reback—Wilson, Sonsini, Goodrich & Rosati,” Computer
Reseller News, November II, 1996, p. 148.
McKenna, 1997, op.cit.
83
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Chapter 3
Antitrust and the Leveraging of Standards
One of the most common arguments by those who fear that Microsoft’s
market power is not in society’s best interests is that it will be able to leverage its
control in architecture to gain monopolies in the applications market. This is a
vertical competitive action as distinct from a horizontal one, such as those used to
foster adoption of the operating system. ^ Horizontal actions were the only ones
covered in the 1994 Consent Decree.
To understand the issues discussed in this section it is necessary to define
the key terms. This paper follows the definition of architecture provided by
Morris and Ferguson: a set of rules that defines how commands work and how
data moves in a system." Applications function within an architecture to
accomplish specific tasks. Leverage is the extension of a strong position in one
market to foster a position in a new market.
Leveraging of A rchitecture
Monopoly leveraging has been addressed in court rulings. For example, in
Eastman Kodak Co. v. Image Technical Services, the Supreme Court commented
that a seller can be held liable if he “exploits his dominant position in one market
84
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
to expand his empire into the next.”^ There are three different types of monopoly
leveraging claims. First, the monopolist could force customers to purchase its
product from a new market. Second, the seller could use its monopoly power in a
market to raise the costs or reduce the quality of rival products in a second
market. Third, the monopolist could use its position to gain a competitive
advantage in the new market unrelated to the price or quality of rivals.'* The U.S.
Federal Trade Commission (FTC) has concluded that markets for complementary
products, such as those of computer interfaces, are particularly susceptible to
monopoly leveraging.^
The use of the term leveraging can be misleading considering that its legal
context is sometimes different from common usage. The usual legal usage
involves a buyer that is obliged to purchase an undesirable or expensive product
in a second market in order to obtain a product from a monopolized market. In
this context leveraging is closely related to tying.^ For the purpose of this study
the broader definition of leveraging provided in the Kodak case will be
emphasized.
Several court cases have addressed the issue of leveraging. For example,
in 1973 the Court found that an electric company violated the Sherman Act by
attempting to leverage its transmission monopoly into generation and
distribution.’ In 1979 Kodak was unsuccessfully accused by a competitor of
attempting to gain a competitive advantage by not selling film for use in a
85
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
competitor’s cameras. Recent plaintiffs have had little success in proving that a
monopolist used anti-competitive leveraging.® Many Justice Department consent
decrees have acted against leveraging. The amici brief cites the 1956 IBM decree
and the 1982 AT&T decree as prominent examples.
There are two reasons why a monopoly may be able to leverage its
control. First, it could use profits obtained from the monopolized market to cross-
subsidize projects in other markets. Second, it could benefit from advantages
conferred by the monopoly in a complementary area. Many economists discount
the possibility of leveraging.John Lopatka and William Page, for example,
argue that “Microsoft would seem to have an incentive to enhance demand for its
operating systems by encouraging development of the best applications. It would
have to discount the price of operating systems enough to compensate users who
would have preferred the non-Microsoft product.”’" However, this is not
convincing. If Microsoft dominates operating systems there would be no
alternative that Microsoft would be afraid of losing to. It would thus concentrate
on conquering new markets because it is better to have control of 50 markets than
just one. Architectural control does seem to give Microsoft a technical advantage
in the other markets. If the quality of an application is affected by its degree of
integration with the architecture, the platform owner can exploit a competitive
advantage over its rivals in applications. David Gabel and David Rosenbaum
point out that a firm can benefit from predatory pricing when it leverages
86
Reproduced with permission
of the copyright owner. Further reproduction prohibited without permission.
advantages in one market to defeat a rival in another. This is likely when a new
entrant is particularly skilled because there are limits to the number of firms with
skilled managers.*^ The most important linkage between operating systems and
apphcations is their interdependence. A caveat to this interdependence is that the
relationship is asymmetric. Michael Morris of Sun puts it this way: “[ojperating
systems are useless without application programs and vice versa. Neither has
discrete, stand-alone value. But of the two, operating systems software must come
first and clearly provides the most potential for leverage.” Microsoft is able to
exploit its ownership of the architecture by providing its applications earlier
notice than any of its competitors of any changes in the operating system
specifications. Microsoft’s competitors have made this claim for years.
According to Barksdale, ownership of the platform also gives a company the
ability to choose which competitors can produce for the system .Specifically, the
monopolist can use predatory pricing: “[t]hat’s why you have to watch bundling.
Monopolists can always give away or include for free until their market share is
regained and maintained. And then they have the power to set prices
unilaterally.”* ^ In Netscape’s case, this means that Microsoft can bundle Internet
Explorer for free with its operating system while Netscape has to charge for its
browser because it does not have the luxury of bundling with a necessary
complement.
87
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
A software monopolist such as Microsoft may be able to use its leverage
to gain a strong position in hardware, a necessary complement. Microsoft has not
traditionally offered many hardware products. Although co-founder Paul Allen
initially wanted the company to produce both hardware and software, BUI Gates
insisted on a software focus because that was what he knew best. As well, he
believed that software would be a scarcer good due to the rapid improvement in
processing power. He reiterated his emphasis on software after IBM bought
Lotus in 1995: “it’s nice for hardware companies to be independent of software
companies.” Over many years the company has developed strong relationships
with hardware vendors, which would be severely strained if Microsoft made itself
a direct competitor.
The company has, however, developed several successful hardware
products and may see some potential leveraging possibilities arising from its
control over standards. While the Microsoft Mouse was not its first hardware
product, it quickly became successful. Microsoft brought its own mouse to market
because it was a necessary complement to Windows, which did not receive strong
third party hardware support. Microsoft maintains its focus by outsourcing the
manufacture of the hardware products that it designs and markets. Microsoft has
also benefited from leverage by modifying keyboard design for Windows 95.
Several competitors in this low margin business were forced to redevelop their
products at great expense. For example, Sejin America spent $3.5 million dollars
88
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
to modify its manufacturing process with little corresponding pricing advantage.
The only advantage to Microsoft competitors was an increase in the after-market
sales price. The movement to Windows 95 considerably improved Microsoft’s
position in the keyboard market, thus illustrating that a software monopoly can
have strategic benefits in the hardware market."®
The most likely area of leveraging for a software monopoly such as
Microsoft is with the applications that interface with its architecture. The logic of
this is that presumably no company can know the intricacies of Microsoft’s
operating system better than Microsoft itself. One of the chief proponents of this
view is Novell. Its former chief executive, Ray Noorda, complained about
Microsoft’s leveraging ability to the FTC and he and Bill Gates have had public
battles over the issue."^ Novell was the strongest competitor to Microsoft in the
area of networking operating systems but was not as successful in linking its
product to other layers of computing and software.""
Ownership of the operating system does not, however, guarantee
dominance in apphcations. Apple Computer, for example, owns and controls the
Macintosh OS but it is nowhere near as dominant as Microsoft in applications for
its operating system. In fact, Microsoft itself has provided many of the best
selling programs for the Macintosh. Lack of advance notice of changes does not
seem to have affected Microsoft at all. Rather, it seems more likely that its
success in apphcations is due to the perception that they are of superior quahty.
89
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Furthermore, Microsoft’s dominance in operating systems has not always led to
the success of particular applications. For example, it has been unable to defeat
Intuit’s Quicken with its similar Money program. As well, in spite of the
resources dedicated to the development and promotion of BOB, this simplified
interface did not sell very well.^
Even if one does accept the linkage between operating systems and
applications it does not necessarily follow that consumers are made worse off than
they would have been if the OS company did not make applications. It may well
be that integration of the operating system with applications results in superior
applications. Preventing Microsoft from taking advantage of the linkage may
result in inferior applications than would be possible under integration.
Some critics argue that Microsoft’s market power in operating systems
could also lead to dominance in areas not directly related to PC software such as
multimedia, electronic commerce, interactive television, and online services. For
example, Gleick states that “[w]ith its new Microsoft Network, providing both an
online service and Internet access, it is focusing on electronic financial-
transaction processing—which is to say, all electronic commerce; which is to say,
at least in some visions of the future, pretty much all commerce.”" '^ A senior
executive for a Microsoft competitor puts it as follows: “[bJasicaUy what
Microsoft is trying to do is tax every bit transaction in the whole world. When a
bit flips, they will charge you.”^ It is too early to know whether Microsoft will be
90
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
able to leverage its dominance in operating systems elsewhere. Currently,
however, its dominance is restricted to PC software. The potential for synergy
with other areas remains highly debatable. In this context it seems unreasonable
for the government to punish Microsoft for something it might be able to achieve
in the future. Antitrust action is easier justified when it repairs damage done by
monopolies rather than preventing a company that does not have a monopoly
from obtaining one.
One of Microsoft’s key advantages is its strong financial position. It is
much easier for it to cross-subsidize and heavily market new products using
penetration pricing than it is for other firms. This factor, however, is ururelated to
the linkage between operating systems and applications. If another firm with
similar resources wants to promote a new product that competes with one by
Microsoft, it may well succeed. Resources, however, are not everything. IBM, for
example, was by far the largest company in the computer industry and also had an
architectural monopoly but these advantages did not lead to long term dominance.
Those urging antitrust vigilance often point to the example of AT&T as a
monopoly that was rightfully broken up and that the result has been greatly
beneficial for the industry and for consumers. Competition from AT&T was
considered unfair because of its ability to cross-subsidize activities in unregulated
markets with profits received under regulation. Steve Case of America Online, for
example, sent a message to the Department of Justice arguing that the operating
91
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
system relates to the computer in the same way that dial tone relates to the
telephone and that Microsoft should not be allowed to use its operating systems
monopoly to enter new markets such as the Internet and online services."^
Timothy Brennan points out, however, that a firm’s ability to cross-subsidize a
new market with revenues from a monopolized one is not damaging to
competitors in the same way that AT&T’s cross-subsidies were if no aspect of its
operations is under rate of return regulation."^ Cross-subsidy is a common practice
by virtually all firms. For example, many restaurants provide a morning
newspaper for free to entice customers. Retail companies advertise loss leaders
and hope that new customers buy products that have not been discounted below
cost. Unregulated long distance companies are able to charge more to business
customers who are willing to pay more than households. Some types of cross
subsidy may be more problematic than others though. The difference in
Microsoft’s case is the strong position that it holds in an essential complementary
product.
A compatibility standards monopoly has a greater ability to leverage its
monopoly compared to a more conventional firm. Actions that would seem
normal and pro-competitive in the majority of circumstances appear anti
competitive in the context of a compatibility standards monopoly. The difference
is that an architectural firm such as Microsoft has a dual relationship with its
competitors in applications. Paradoxically, cooperation among firms in this
92
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
industry fosters competition.^* Competitors need cooperation from the standards
monopoly to make products that conform to the specifications. When the
dominant company protects a trade secret it may be denying information that
would be essential to competition in the industry. Competition can also be
impeded by the monopolist’s decision to introduce a new technology. Non
cooperation, trade secret protection, and the introduction of new technologies are
considered normal business activities in most industries. According to Chris
Weare, they can seriously constrain competition, however, when interoperability
is required to enable competition."^
Microsoft has also been accused of building incompatibilities into its
operating system with the intention of putting its competitors at a disadvantage.
According to Zachmamn, there have been numerous occasions when Microsoft
modified its software and as a result made the software of its rivals less
compatible. He believes that “it is such a pervasive pattern that it is hard to
believe that somebody wasn’t consciously motivated. Microsoft intentionally uses
its powerful position in operating systems to the disadvantage of competitors.”^”
Furthermore, industry observer Mike Elgan claims that it is obvious that the
company has withheld information about its operating system to give its own
applications an advantage over those of its competitors.^'
A compatibility standards monopoly also has a great deal of negotiating
power with other firms wishing to provide interoperable products. The
93
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
concessions extracted by Microsoft over its competitors are further evidence of its
ability to leverage its dominant position. For example, according to the amici
brief, Apple made five declarations of anti-competitive conduct against Microsoft.
This came about because Apple realized the importance of enabling its users to
run Microsoft Windows applications. Apple claimed that Microsoft’s top officer
attempted to extract concessions from it based on its need for compatibility.^"
One of the central aspects of Microsoft’s advantage is its ability to control
the specifications of the application program interface (API). The power of its
operating system dominance gives it a strong position in negotiations for APIs for
particular types of applications. It is often impossible for other companies to
estabhsh an API that competitors will agree to. This allows Microsoft to gain
valuable knowledge about new program areas. For example, new applications are
being developed in speech recognition. Microsoft was the only company powerful
enough to establish an API for this new industry. This enabled it to receive much
knowledge of its competitors’ activities at little cost to itself. Gleick explains the
Faustian bargain that Microsoft’s competitors are forced to accept: “in the course
of the meetings, Microsoft received and filed away an enormous body of
intelligence on the speech-software state of the art and even the specific product
plans of your company. That’s a risk you had to take.”^ ^ This example shows the
clear competitive advantage that architecture confers on its owner. In the midst of
this evidence, however, it is important to reiterate that the mere existence of a
94
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
competitive advantage does not imply that consumers are hurt by Microsoft’s
position.
Microsoft’s dominant position in operating systems has also given it
advantages in establishing an online service. It was able to ensure that every new
computer sold had an icon on its desktop advertising the Microsoft Network and
providing a wizard that enabled a user to easily establish an account. In this case
Microsoft cannot be accused of tying because the icon and online software are
free to end users by general industry practice. In determining whether this is truly
a case of leveraging, however, the product used must be defined as a monopoly.
When Windows 95 was introduced it was not a monopoly because it had no
market share at all. This definition of monopoly shows why multi-generation
compatibility standards should be treated differently by antitrust laws than more
traditional products. Since Windows 95 was a successor to and backward
compatible with Windows 3.1, a monopoly product, it should have been treated as
a monopoly. Windows 95 could also be classified as part of a monopoly using
traditional definitions if the product is defined broadly enough. Windows 95 could
have been considered part of Microsoft’s monopoly over the general operating
systems market.
It can also be argued that Windows 95 does not provide an advantage that
its online rivals cannot replicate. Prior to the introduction of Windows 95, leading
companies such as America Online, CompuServe, and Prodigy each promoted
95
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
their services by embedding icons into the operating systems of newly shipped
computers. Microsoft’s introduction of an icon could thus put it at no greater
advantage than the three largest online services had over their smaller rivals.
Considering this, the advantage conferred to the Microsoft Network is neither
critical nor unique and would not qualify for antitrust action. Furthermore, MSN
provided new competition in a market by only three companies.^"^ Another
argument in Microsoft’s favour is that the online market already faced
competition from large rich companies such as IBM and Sears Roebuck of
Prodigy, AT&T’s Interchange, and General Electric’s Genie. As weU, these
companies were doing relatively poorly compared to America Online and
CompuServe, which were not as rich.^^ The history of online services suggests
that powerful and rich companies such as Microsoft are not guaranteed to
dominate smaller rivals.
There are, however, good arguments in favour of restricting Microsoft’s
ability to use its operating system to promote MSN. The ability to use its own
product guaranteed it access to the vast majority of new computer system
desktops at no cost to itself. The transaction cost for online rivals of replicating
this access would have been prohibitive. They would have had to negotiate
individually with every reseller large and small to have equal visibility on
desktops. The impossibility of achieving this paved the way for later agreements
with Microsoft to trade space on the Windows desktop for the support of Internet
96
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Explorer as the principle browser for an online service. The free joint marketing
of Internet Explorer would not have been possible for Microsoft without its
control over the desktop. It seems unfair for Microsoft to have the ability to
receive costless promotion of its product on its own desktop while its rivals either
have to pay enormous distribution costs or give Microsoft something of great
value by marketing one of its most important architectural products. Nonetheless,
Microsoft’s ability to promote its online service does little if any harm to
consumers. Gifford points out that it benefits them by providing information.^^
Two of the alternatives for dealing with Microsoft’s ability to leverage an
operating systems monopoly in applications are either divestiture or the
establishment of a “Chinese wall.” The first of these options receives some
support from Microsoft’s competitors but little otherwise. It is a risky action that
could easily make end users worse off. Some customers have expressed this view
in interviews. Some comments from professionals in information systems include
the following: “[Microsoft] is one of the few companies that can execute on a
cohesive vision for the future,” the size of Microsoft provides “a comfort level in
terms of service, support and longevity.” Another belief is that communication
between operating system and application developers makes Microsoft’s products
more tightly integrated than those of its competitors.^^ It also would be extremely
costly to attempt such a major restructuring. The move would be hard to justify
using antitrust laws because the monopoly came into being not as a direct result of
97
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
anti-competitive actions but due to the unique economic characteristics of
increasing returns markets. The Chinese wall idea is less costly to implement and
is more politically realistic for competitors of Microsoft to achieve. The Wilson-
Sonsini white paper suggests that it is practical to force Microsoft by court decree
to open meetings between the company’s applications and systems employees to
its competitors. This could be achieved by placing the burden of proof on
Microsoft.^®
In summary, it is clear that there are several features of a compatibility
standards market that make it more susceptible to monopoly leveraging. The
advantage to a monopolist in new markets emanates from the need for integration
between the system architecture and its applications. Rivals have little choice but
to cooperate with the monopolist but this dependence is not entirely reciprocated.
There have, however, been many competitors to the dominant company and there
is no sign that this is about to change soon. It is also clear that end users, whose
welfare is the main purpose of antitrust laws, have little to complain about from
the advantages conferred to Microsoft. Architectural leaders have a strong
incentive for innovation because they can sell new products to old customers.
This explains the many improvements in software usability in spite of the
dominance of Microsoft. Anybody who has bought software for computers over
the past ten years can attest to these enhancements. The dates of upgrades by
Microsoft, Apple, and non-proprietary Unix are provided in Appendix Tables A-6
98
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
through A-9. Microsoft’s number of new versions compares favourably with that
of its rivals. Furthermore prices fell considerably in the early 1990s. Over the past
couple of years, prices of business software have remained stable, as is shown in
Appendix Table A-9. Critics of Microsoft counter that what matters is not
whether consumers are better off but whether they are better off than they would
have been if its monopoly did not exist. This is an easy justification to make but is
unconvincing. It is entirely untestable to say that software would be of even
higher quality and lower price if Microsoft’s market power did not exist.
Thus, although architectural leaders may have some advantages over
potential rivals in producing applications, this does not imply that consumers are
worse off. Vertical integration may result in a superior product and even
architectural monopolies have incentives to innovate. The justification for much
antitrust action, therefore, would be based on fairness to competitors rather than
public welfare.
Bundling of Products
One of the issues facing antitrust authorities is whether to regulate the
extent to which a standards monopolist is able to bundle products. Competitors
claim that bundling allows a monopolist the ability to use an advantage in a strong
product to improve a position in a relatively weak area. A form of bundling
known as tying is already covered under U.S. antitrust law. An indicator of its
99
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
importance is its mention in both the Sherman and the Clayton Acts.^^ According
to a Court decision: “[a] tying arrangement is ‘an agreement by a party to sell one
product but only on the condition that the buyer also purchases a different (or
tied) product, or at least agrees that he will not purchase that product from any
other suppUer.”’" ^ ® For this to be considered illegal, there must be two products
involved, each with separate consumer demand,"^ ‘ and proof that the customer is
obliged to buy a tied product that the buyer either does not want or could obtain
from another source/"
The issue of bundling or tying is of great importance in the history of the
software industry. Prior to 1969 IBM charged a single price for a computer
system, software, and support. The threat of antitrust litigation caused IT to
voluntarily price software separately from hardware. The result of this unbundling
was the creation of what would become the software industryThe vibrancy of
this industry is one of the best examples pointing to the value of keeping products
unbundled.
As shown in the preceding chapter Microsoft brought software prices
down considerably in 1990 by bundling the major business applications into a
suite. This sort of inducement is a gray area of the law. It may be considered
coercive if “it is the only viable option” that “all rational buyers” would choose.'*^
Although the discount was significant it was still possible for a customer that only
wanted one of the programs to pay significantly less than the price of the package.
100
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Thus it would seem that the requirement of coercion was not met for this to be
considered tying.
Another controversial case of bundling is the inclusion of software for the
Microsoft Network in Windows 95. This gave Microsoft an advantage over
competing online services in the form of lower software distribution and
promotion costs. Steve Case, CEO of competitor America Online, has complained
that “Windows is the dial tone of the digital age[.] They shouldn’t be allowed to
do this.”" ’^ The bundling of MSN with Windows 95 cannot, however, be
considered a true case of tying because all of Microsoft’s competitors also
distribute their software for free. Users are charged on a monthly basis for online
services and the price is entirely unrelated to the software loaded on the computer.
Thus the relative cost to consumers of bundling is no different than that of an
unbundled Microsoft Network.
Microsoft has also chosen to bundle its browser Internet Explorer with
Windows 95. Microsoft claims that the web browser should be considered part of
an operating system. Bill Gates argues that “[a]ny operating system without a
browser is going to be f—ing out of business. Should we improve our product, or
go out of business?”^^ An alternative interpretation of the browser and the
operating system is that it is analogous to the relationship between hardware and
software before IBM unbundled them in 1969.'^^ Browsers, however, have usually
been given away since NCSA and later Netscape brought them to market. The
101
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
pricing of browsers by Netscape began only after it had a strong position in the
market and did not apply to many of its customers. The key question is whether
consumers are better off in the long run with the ease of use provided by having
an integrated browser or with the potential for increased innovation due to
competition between multiple browsers. If, as would be expected, there are strong
network externalities in browsers, the length of time that competition would
continue would be relatively short. For this reason, if the products are bundled,
innovation is unlikely to be reduced significantly over the long run and ease of
use is likely to be higher. Thus consumers would likely be better off as a result of
bundling the browser with the operating system. One method of implementing a
non-bundling policy that would cause the least inconvenience to users would be to
include a basic browser with every new computer that would simply direct users
to a location where they could choose and download a browser that would
automatically install on the computer. This might provide the best balance
between ease of use and competition.
Another area of contention is the bundling of server applications. For
example, the Back Office suite could reduce competition.'*^ As well, Microsoft
has two major products with similar technical specifications but different bundled
products and licensing terms. Microsoft charges much more for Windows NT
Server than it does for NT Workstation due to its network support utilities, which
include the Internet Information Server. The problem is that licensing terms
102
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
essentially forbid the use of NT Workstation as a web server. Thus the only web
server option for NT is NT Server which already includes the Internet Information
Server.'*^ It would make little sense for a company to purchase an alternative
Internet server when it already has a competitive product. It can be argued
therefore that Microsoft has in this case coerced users into buying Internet
Information Server if they choose Windows NT as the basis for a web server. This
seems to fit the definition of illegal tying. If Microsoft changed its licensing terms
to permit the use of NT Workstation as the basis for a web server, coercion would
no longer be evident and thus the case for tying would no longer be valid. One
potential difficulty with enforcing antitrust law in the case of NT and Internet
Information Server is that it has a very small market share: about 4% in a market
of web servers dominated by Unix.^° Another issue, therefore, is whether the
dynamic nature of these markets should be examined instead of a static market
share such as this. It is clear that Unix is in a major decline compared to Windows
NT and the position of the latter could soon provide leverage for the Internet
Information Server.
There are other examples of potential stand-alone products that have been
bundled with Microsoft operating systems. Windows 95, for example, shipped
with a number of programs including a word processor, modem and fax software,
games, screen savers, a telephone dialer, a paint program, back-up software, and
disk utilities, in addition to the Internet browser and online software mentioned
103
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
above.^* This type of bundling could be considered tying if Windows 95 is
considered a monopoly. The problem is that when the product was introduced it
was considered part of a new market segment: 32 bit operating systems. If it is
considered distinct from prior Windows versions it could not be considered to
have a monopoly. Windows 95 gained a strong position within four months of
introduction, when it had 18 million u sers,a considerable share of the 120
million personal computers that existed at the time of its launch.^^ This immediate
adoption, which Microsoft claims is “a record for any new computer product,”^ '^
lends support to the product’s classification as a monopoly given that it was
marketed as the successor of Windows 3.1 and that it was expected that new
system purchases would generally not ship with the earlier product.
The bundling that Microsoft does has a strong impact on competitors. For
example, including a built-in back-up program essentially eliminated the market
for these utilities.^^ Companies can attempt to use patent protection to prevent the
incorporation of their segments into the Microsoft operating system but the only
notable success so far is the disk compression software developed by Stac
Electronics. Stac was able to negotiate favourable terms for the inclusion of its
software after being awarded $ 120 million in a patent infringement lawsuit.^^
Microsoft could severely constrain competitors in any product segment
through bundling of applications with an operating system. Since every computer
needs an operating system and users perceive great value in the compatibility of
104
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
operating systems, they will tend to choose the dominant operating system even if
its price is considerably higher than that of competitors. The inelasticity of
demand for this product can enable Microsoft to raise its price while including,
say, a full word processor such as Microsoft Word. It is highly unlikely that a user
would be willing to pay for WordPerfect if he already owns the most recent
version of Word. Microsoft has already attempted this sort of bundling in
Amsterdam. WordPerfect launched a complaint with the European Union when
Microsoft provided a Windows for Workgroups/Word bundle at a reduced price.^^
One of the key arguments in favour of forced unbundling is that it does
little if any harm in the market. If a consumer receives value from the product he
wül purchase it even if it is not bundled. Thus forced unbundling wiU have little
effect on an innovative standards monopolist. The only potential harm could come
from the treble damages that a competitor could receive.^^ Furthermore, it is hard
to see economic value in the bundling of applications with an operating system.
Although it provides some ease of use this may be outweighed by other factors.
For example, it can increase the complexity and size of the architecture. This
makes it more difficult to bring an operating system to market. It can also lock in
the technology to an early level because it is hard to modify a complex
architecture.^^ It also uses computing resources and storage space.
Tying cases tend to be easy for a government to succeed in as can be seen
by the IBM case relative to other unsuccessful antitrust actions against the
105
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
company. As well, they require little o f the intervention that would be necessary
in other antitrust actions. There is no need to set prices, product features, or
marketing terms.All that is required is the relatively easy separation of the
bundled products. Unbundling allows the marketplace to determine whether it is
most efficient for the architecture holder or one of its competitors to provide a
product.
This discussion of bundling results in implications for antitrust. A
company may be allowed to bundle an application with its architectural monopoly
when the price charged in the marketplace for competing products is generally
zero. This is the case with the software required to connect to online services and
may also be true for web browsers. This is not so for word processors, web
servers, or many utilities however. A bundle of applications sold separately from
the operating system can be discounted as long as buying a single application
remains a viable option for the customer. Otherwise coercion would be evident.
Degree of Openness of Monopoly Platforms
One of the implications of lock-in for competitive strategy in multi
generation compatibility standards is that the dominant architecture owner may
have an incentive to reduce the opermess of its product in moving from one
generation to another. If, for example, it could keep information about a new
version secret from other developers until it can release simultaneously the
106
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
architecture and many applications, it could gain a critical mass for its new
releases that would enable it to dominate the complementary parts of its system.
Users would quickly realize that if they did not use the products of the
architectural monopolist they would be behind in features as they waited for third
party developers to catch up. This type of strategy represents the closing of a once
open standard. Architectural openness has its main benefits to the innovator early
in the standardization process. Once the architecture is established there are
incentives to close it. An architectural monopolist could even decide which types
of applications it would license away to third party producers. Presumably it
would continue to produce mass market products while leaving marginal niches to
other companies. The monopolist would still have to manage prices and
innovation carefully because competing architectures that are radically superior
could provide advantages that outweigh their incompatibility with the dominant
standard. Regardless, there may be a significant advantage to closing a once open
architecture. Some examples can illustrate this idea.
The introduction of Windows 3.0 provides an example of how a head-start
can give an architectural monopolist an advantage that would be hard for once
dominant applications providers to overcome. In this case, Microsoft’s advantage
in applications was achieved unintentionally. The company was more interested
in the long term advantages provided by establishing the Windows graphical user
interface than achieving domination in the major applications markets. Companies
107
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
such as Lotus and WordPerfect chose not to develop Windows versions of their
applications until after the success of the GUI became clear. Bill Gates describes
the advantage given by the company’s unintended head-start: “[w]e take lots of
affirmative steps to help other companies. Naturally, our applications group is the
most committed to Windows. In the early days they didn’t hesitate when I said.
Hey, we’re going to do Windows. Other companies did, even though we begged
them to write for Windows. That gave us a leadership position, which we’ve
continued to increase over the years.”^’ Unlike its PC rivals, Microsoft had much
experience in developing GUI applications for the Macintosh. This was another
factor in its ability to release strong Windows applications.
Lotus and WordPerfect compounded their error when Windows 95 was
introduced. They were again late to release versions for the new operating system.
This occurred in spite of the fact that Windows 95 was “one of the most
thoroughly beta-tested products in the history of the software industry.’’® ” There
were several hundred thousand pre-release copies, 400,000 paid for preview
copies, and 50,000 preview copies given to developers and hardware companies.®^
Bül Gates claims that Microsoft has provided pre-release information to many of
the companies that have battled it in Washington and the courts: “[i]f your
question is, does Microsoft know how to turn the other cheek when we get
slapped, the answer is yeah, just look at the track record. And look at today. Ask
anybody who says the various unfounded things they’ve been saying. Are they
108
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
getting Windows 95 betas? Have we been great about how’ve treated the
industry? The answer’s yes.”^ Microsoft did, however, impose non-disclosure
agreements on beta testers who were independent software vendors (ISVs).
According to the U.S. Department of Justice (DOJ), these discouraged ISVs
“from working with operating system companies, other competitors of Microsoft,
and competing technologies for an unreasonably long period of time.”^^ The
company would not have been able to force such restrictions if it did not have the
power provided by its dominance in operating systems. With future versions,
Microsoft may be able to extract even more concessions from ISVs or increase
the proprietariness of the system.
Many competitors already claim that Microsoft has taken advantage of its
monopoly position to make its operating system more proprietary. According to
the amici memorandum of February 1, 1995, they had a document in which
Microsoft warned a company that it would retaliate if it made a version of its
product to run on a competing operating system. It would “ensure that third party
products would not work with any of the company’s products in the future.
Further, Microsoft changed one of its products solely to create an incompatibility
with the company’s products. Microsoft did so, it is reported, so that the company
would ‘understand the atmosphere at Microsoft.’”^ ®
Another claim is that Microsoft gave information about Windows object
linking and embedding (OLE) to its own applications developers prior to ISVs.
109
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
This apparently gave the company a significant lead over competitors in
providing applications integration.^’
The Wilson Sonsini white paper mentions that Microsoft tells customers
that Windows NT and SQL Server have the advantage of being able to
communicate better with home customers because they also use Windows. Its
own engineers know Windows better than any competitor can because they have
better access to information.^^
Microsoft has also been able to use hardware to make its own operating
system more proprietary. It was able to oblige keyboard makers to incorporate
operating system specific keys with Windows logos. Microsoft defended the
move by pointing out that Apple has its own keys for its computers.^® This could
foreshadow a strategy whereby Microsoft closes its standard to competitors just as
Apple did. The difference is that Apple did not have a personal computer
monopoly while Microsoft does.
Microsoft has also been accused of putting hidden bugs into its software
with the purpose of making competing applications seem less compatible. The
most celebrated case is that of Caldera, which claims that “beginning in
December, 1991, Microsoft released beta versions of Windows 3.1 containing
code that generated error messages when Windows 3.1 ran on top of DR DOS
rather than MS-DOS. Microsoft created these error messages solely for the
purpose of creating the impression that DR DOS would be incompatible with
110
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Windows in order to dissuade customers from purchasing DRDOS.”’° The
company further complained that Microsoft declared incorrectly that DR DOS
would be incompatible with Windows 3.17' This hurt the sales of DR DOS
Microsoft also did not provide a copy of the Windows 3.1 beta to Novell, which
then owned DR DOS.
The error messages may not, however, have been intended to help MS-
DOS against its rivals. Microsoft provided a special module in its Windows 3.1
beta test that would detect whether non-Microsoft memory management software
was running. According to Dratler, “the fact that a non-Microsoft pedigree
triggered the error message had a valid business reason. It is far easier to write a
software routine to check the origin of a program than to write one that checks
whether the program is doing its job properly. Indeed, writing the latter routine
would be comparable in difficulty to writing the program its e lf!A lth o u g h
Windows generated an error message when operating under DR DOS, which had
its own memory management system, the combination continued to run. This
error message had an important technical purpose during the beta test. Since
memory management software is especially sensitive and prone to error it would
enable trouble-shooters to quickly determine the source of a problem rather than
search through millions of lines of code. The purpose of the beta test was to
determine if the operating system would work with the thousands of programs
being designed for it. For this reason, it seems unlikely that the error message was
111
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
targeted at DR DOS. The case of the DR DOS error message shows how hard it is
to determine whether a standards monopolist is intentionally trying to shut down
competitors.
Standards monopolists have the incentive and the ability to make their
products less open as they change generations. The question is: what if anything
should be done to prevent this from occurring? Several cases have addressed the
failure to predisclose changes in product design and interfaces. Courts have
established that monopolists are permitted to improve their products.W hen an
innovation in a monopolized market affects complementary products, however, a
claim of leverage may be made.
Microsoft clearly has the ability to hurt rivals for complementary products
when it makes changes to the operating system. Minor changes in the architecture
could, for example, render parts of a program such as WordPerfect inoperable.
The ability to change generations at wiU gives the company a competitive
advantage.
Another advantage is that it is able to change the structure of the desktop
in a way that can hurt competitors attempting to estabhsh their own place on the
desktop. Industry pioneer Bob Metcalfe explains a potential solution to this
problem: “[i]f Microsoft can replace the desktop module of Windows to produce a
unified desktop and browser, then so can Netscape. Justice should insist that
Microsoft further enhance, document, support—and not abruptly change—its
112
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
desktop programming interfaces in Windows (among others) so that other
software companies can use those interfaces to compete by offering integrated
desktops, browsers, and who knows what exciting else.”’^ The problem with this
idea is that the underlying operating system would essentially be cemented in
place. Once rivals had competing unified desktops and browsers Microsoft could
not make any change without causing damage to its rivals. Such a policy would
be equivalent to confiscating Microsoft’s operating system and putting it in the
public domain. This would likely end innovation in operating systems. This
example shows how comphcated it is to set policies that promote competition and
innovation.
Predisclosure of changes in the operating system to competitors in
applications markets is an alternative. The problem with this is in defining what
types of changes have to be predisclosed. This would create a great deal of
uncertainty because the definition of a significant change is highly subjective.
Otherwise the monopolist would be required to submit every minor modification
to the entire industry. As well a specific length of time would have to be defined.
There may also be circumstances under which the monopolist may wish to
withdraw the change.^^ It could then be held liable for damages arising from the
mistaken disclosure. The courts would be forced to arbitrate in the complex
intricacies of technologies, certainly not their strength. Innovation would surely
suffer as a result of this uncertainty and the inevitable litigation that would follow.
113
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Perhaps the optimal solution can be found in the beta testing process.
According to Dratler, “beta tests provide, among other things, critical information
about the interfaces in the operating system that connect with applications—
information which the ISVs need to write applications that run on the operating
system.”^^ The experience of beta tests shows that information is key to preparing
for new generations of standards. Rather than require predisclosure, the
monopolist can be forced to provide a pre-release version that will enable users to
test the product for stability. In this way, the monopolist and its competitors both
gain. For the former, the new product is tested and improved prior to general
release. The latter gain access to the new interface so that they can prepare
changes to their products. The key rule would be this: a company would not be
able to release any new version beta of a monopoly architecture to its own
applications developers prior to its release to the rest of the industry. It would
make sense to put the burden of proof for this rule on the monopolist. To comply
with this alternative, a monopolist would have to maintain the openness of an
architecture in the sense that it could not force other companies to pay for the
right to develop applications for it.
Cultural Markets and Content
One controversial issue about market power based on ownership of a
network is that the standards monopolist may be able to leverage its position to
114
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
control access to content. Microsoft, thus, could become a gatekeeper for cultural
markets and reduce the number of opinions heard. It would presumably use its
control to foster opinions that it approves of and muzzle its critics. Although these
fears are generally overstated it is worthwhile to examine the ability of a network
monopolist to leverage control of content.
Gary Reback has been one of the most outspoken Microsoft critics on the
issue of content control. He beheves that its market position has already enabled it
to gain control over some content markets. The clearest example is the fact that
Encarta outsells every other encyclopedia, whether in print or multimedia,
including the Britannica.^® Ownership of network architecture could enable
Microsoft to demand a degree of content control in exchange for distribution. It
can use its bargaining power to put rival publications out of business.
As evidence of modified content, Reback claims that Microsoft changed
the biographical description for Bill Gates when it took over the text of Funk and
Wagnall’s encyclopedia for Encarta. Encarta made no unfavourable commentary
and replaced a statement about Gates placing value on “winning in a competitive
environment over money”’^ with one stating that he is well known for his
charitable contributions.®^ Microsoft placed an angry rebuttal on its web site,
stating that the original encyclopedia had little content on computer-related topics
and none at all on BiU Gates. The company thus wrote both profiles of Gates,
making reference to charitable donations in an update after he had given $500
115
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
million away. The company claims that profiles of Microsoft competitors such as
Netscape, Oracle, and Sun are positive and accurate.** The case of the Encarta
references does not provide enough evidence to show that Microsoft has used
control over content to bend the truth in its favour. Although the company owns
other sources of content, it does not seem to have manipulated its editorial
control. For example, Reback and other critics have not cited any evidence that
the MS-NBC news channel has modified its message to suit the interests of one of
the parent companies. Likewise, the company has given editorial freedom over
Slate to a respected journalist, Michael Kinsley. The web magazine provided a
platform for Ralph Nader to criticize the parent company. These examples do not
prove that Microsoft will not use its position to control content in the future but
other powerful corporations, such as Disney and General Electric are permitted to
own large broadcast facilities. There does not seem to be a reason to expect that
Microsoft would be more damaging to free speech. It is unlikely that rules, such
as those of the Federal Communications Commission, would permit it to own
enough content to have a significant negative effect.
The dynamics of marketing content are different from those of system
software. Microsoft’s brand name may benefit it in selling business and personal
productivity software that faces competing substitutes whose superiority and
inferiority can be measured using feature sets. The lock-in effect is significant in
this type of software because there are benefits to consistency in moving from one
116
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
generation to another. The same cannot be said of consumer entertainment
content. The only movie studio that benefits significantly from its brand is
Disney. This is because people know prior to entering a theater what type of
movie they can expect from the company.®" Most entertainment content is,
however, driven by titles because media companies tend not to focus on a single
segment of the market. Purchasers of entertainment software do consider brands
but, as with movies and television, they carry less weight than the subject matter
that the software covers as well as reviews by independent observers.
Content does, however, have a feedback effect but it occurs in the opposite
direction to the one theorized by observers such as Reback. Rather than
leveraging control of an architecture to gain customers for entertainment services,
the popularity of certain titles can be used to improve the market share of an
architecture. For example, Nintendo marketed an already popular arcade
character, Mario, to make its hardware the most popular of its generation.
Microsoft is in the process of leveraging popular entertainment software to
build market share for its browser. The company established a free online game
service called the Internet Gaming Zone. It has used its service to promote its own
branded games such as Close Combat and Age of Empires. The latter of these has
sold nearly one million copies in less than half a year. Its multiplayer component
is particularly popular and this is shown by its position as the second most played
game on the Zone. The current incarnation of the Zone began in May 1997 and
117
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
for the first year Microsoft claimed to have worked to make it compatible with
Netscape Navigator. Anybody who tried to access the service using Navigator
received the following message: “[w]e are working hard to complete Netscape
Navigator support so that it will ship with the next major upgrade to the Zone. In
the meantime, if you’d like to join the multiplayer action and excitement of the
Zone, we invite you to download Microsoft Internet Explorer for free.”^ ^ It can
hardly be considered coincidental that a year of incompatibility occurred during a
period of great intensity in the browser market share war. Given the speed of
standards battles Microsoft seemed to be hoping that it can continue to avoid
compatibility until after the battle is already decided and Internet Explorer is
locked in.
Another difference in marketing for the entertainment industry is that price
is usually charged on the basis of usage (pay per view) or subscription rather than
a one time fee that gives unlimited usage for an unlimited time, which is the
normal way of paying for software. A major reason is that entertainment tends to
be consumed rather than applied.O nce a consumer has seen entertainment he is
unlikely to wish to see the same content again. Companies can make more money
from rentals of movies than through selling videos to consumers at ten times the
price of the rental. Payments on a per use basis can be permitted without reducing
innovation in the entertainment industry because the content has to be different
for a user to want to purchase again. If, however, Microsoft could charge on a per
118
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
use basis for access to its network system without having to produce the content
itself, this does not increase the company’s incentive for innovation.
One of the main reasons that Microsoft cannot dominate the entertainment
market is that brand name counts for little. Apparently the company has not
generally understood this in the past. Pete Higgins, who is in charge of
Microsoft’s content business, once said that he does not spend time networking
with executives and creators in the entertainment industry because “[w]e don’t
need other names. Microsoft will be the brand name.”^ ^ This attitude may work
for productivity and reference software but certainly not for content. Consumers
wül only spend money on titles that interest them. As well, content is not created
through brute force. Individuality and ownership of ideas are major determinants
of creativity and thus creators cannot be directed to produce whatever a parent
company thinks will sell for it at a given time.^®
One way that Microsoft could develop an advantage in the production of
multimedia content is that it could give access to early versions of new
generations of its technologies to its own developers. For example, it may
incorporate new tools into its media server software. This strategy could be
prevented if the company was required to give identical beta versions to both
internal and external developers at the same time.
In summary there appears to be little reason to fear that Microsoft’s
architectural power wUl impede the flow of independent content to consumers.
119
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Reback’s argument goes much too far because it would be impossible for a single
company to satiate all potential tastes of readers with its own publications. People
are far more diverse than this argument gives them credit for. Even if Microsoft
started to exercise such control it seems likely that readers in a free society would
demand action from governments to preserve the diversity that they are
accustomed to. Furthermore, the Internet is far from the only method of receiving
content. Newspapers and magazines remain widely read in their print versions in
spite of the possibility of receiving the same content via computer.
Microsoft may be able to use high quality content to help it win
architectural standards battles but this tool is limited and does not constitute
leveraging of a monopoly in one area to gain a monopoly in another. Thus, there
does not appear to be an economic justification to forbid such cross-promotion.
Microsoft should face the same regulations that other content providers do.
Further restraints based on the fear of architectural dominance are unnecessary.
One possible exception is that Microsoft’s content developers should not receive
access to architectural upgrades earlier than its competitors do. Beta versions
should be released simultaneously to external and internal makers of applications.
Analysis of Acquisitions and Alliances
One of the key questions for antitrust policy toward network.industries is
to determine when to permit mergers, acquisitions, and alliances. In some
120
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
circumstances these can entrench a monopoly position while in others they may
reduce market power. The existence of increasing returns results in different
conclusions than would be made in other industries. This section wül examine
mergers and alliances by rivals of Microsoft, speculate on the competitive effects
if the aborted merger with Intuit had occurred, and outhne some of the factors that
antitrust enforcers must consider in determining whether to challenge a merger.
Mergers and alliances are common in high technology industries such as
software. They are often regarded as a method by which less powerful companies
can compete with the dominant player. To understand the implications of a
relationship with a dominant company, it is worthwhüe to evaluate the
motivations of sirmlar arrangements by Microsoft’s rivals. After Microsoft
transformed the software industry by bundling business applications into Office,
its rivals eventually decided that they could not succeed on their own. The key
was to integrate a spreadsheet with a word processor. WordPerfect first
established an alliance with Borland to bundle its word processor with Quattro
Pro. Their development, however, remained uncoordinated and thus it was not a
strong competitor in document integration. The merger of Novell with
WordPerfect was a method by which the two products could provide stronger
competition for Microsoft. The addition of Novell was important because it then
had a strong position in networks through its NetWare product. The network had
great potential for the distribution of applications such as office suites. Ray
121
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Noorda of Novell initially wanted to add Lotus to the alliance so that 1-2-3 would
become the spreadsheet component. This potential alliance fell through though
because WordPerfect believed that Novell’s potential in operating systems would
be more important for the long term success of the product.^^ In the end Microsoft
proved too nimble for Novell and WordPerfect and the merged company sold off
its suite to Corel.
Netscape has established alliances with a number of companies. Corel
shipped Navigator with Corel Office Professional 7.0 and other products.
Netscape made agreements with Apple and Pacific Bell to bundle Macintosh
versions of Navigator with their products. Navio, the company’s network
computer spinoff, has been allied with IBM, Oracle, Sony, Nintendo, Sega, and
NEC. Netscape has engaged in international alliances as well, such as with
Elektroson of the Netherlands, which bundled Navigator 3.0 with its WebGrabber
software.*^ This sort of alliance, by smaller players in the software market, is one
of the methods available to challenge the Microsoft monopoly. Microsoft,
however, can be involved in alliances of its own. It has successfully promoted its
Internet Explorer through agreements with Internet access providers. An
agreement with the MCI / News Corp. venture at the end of 1995, for example,
cost Netscape a licensee that had strong marketing abilities.A lliances against
Microsoft are also at a disadvantage because it is difficult for them to provide the
same level of integration that a single dominant company would. A single
122
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
provider also provides greater accountability to customers. As well, Microsoft’s
reputation for winning in increasing returns markets is hard for any alliance to
match.^°
The importance of reputation and size led IBM to ally with Apple in a
joint venture named Taligent. The goal of the venture was to develop and market
a new operating system that would provide compatibility between their systems.
The FTC approved Taligent because its independent management reduced the
probability of collusion on prices and output by the two large firms. They claimed
that they would “compete ferociously”^ ^ in hardware platforms for the new OS.
Taligent provides a good example to introduce the difficulties of market definition
faced by antitrust authorities, which wül be elaborated on later in this section. At
the beginning a joint venture such as Taligent starts with no market share. If its
product is defined as object oriented operating systems, however, it wül rapidly
achieve a large share because it is the main producer. If the market definition
consists of all operating systems the market share would be very low due to the
dominance of Microsoft. Autitrust decisions often rely on market concentration
ratios such as the Herfindahl-Hirschman Index (HHI). Simply defining the market
in a different manner, however, can radically alter this seemingly objective
figure.^" Thus, ± e arbitrary nature of market definition reduces the reliability of
concentration ratios.
123
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Microsoft’s attempted acquisition of Intuit failed due to opposition from
the Department of Justice, which based much of its claim on concentration ratios.
The high profile and importance of this case makes it a benchmark by which
antitrust policy is measured. Microsoft announced the acquisition in October 1994
and the DOJ launched its suit the following April. Within a month Microsoft and
Intuit terminated the deal. The DOJ defined the industry as personal finance /
checkbook and determined that Intuit had 69% of the market compared to 22%
for Microsoft.^^ The rationale for prohibiting the merger was that “[a] Ho wing
Microsoft to buy a dominant position in this highly concentrated market would
likely result in higher prices for consumers who want to buy personal finance
software and would cause those buyers to miss out on the huge benefits from
innovation.”® '^ This research, however, shows that this particular concern is
unwarranted as long as old versions of Quicken serve as substitutes for new
products. As well, the effect of competition on the banking industry may have
reduced prices and increased innovation for financial products as a whole. For this
reason banks opposed the merger.®^
Although the rationale that the Department of Justice used may have been
inappropriate, there was certainly a danger that the narrowly defined sector would
become more monopolized as a result of the merger. The lock-in effects related to
personal finance software are among the strongest of any type of application.
Some observers have claimed that there is little if any effect of increasing returns
124
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
in personal finance software. They base this view on the observation that people
do not share files with other people because financial information is generally
kept private. Compatibility is essential, however, to move files to new generations
of programs and between programs that can manipulate the data in other ways.
Historical information is important in personal finance and users will generally
not want to re-enter old transactions every time that they upgrade the program.
Personal finance programs can also benefit from compatibility with taxation
applications. For example, users can import their financial data from Quicken into
TurboTax. Changing to a new personal finance program would likely result in
having to re-input data as well as leara the new software and switch to a different
taxation program. If a standard open file format for translation to different
programs were developed the most serious lock-in effects would be eliminated.
Until this occurs users will be inclined to choose the leading program.
Customers also wül purchase forms and cheques for use with the program.
This purchase is usage-based and ensures a recurring revenue stream regardless of
whether the company upgrades its product. This “extremely profitable” segment
constitutes 18% of Intuit's annual revenues.^® The strong lock-in effect is likely to
lead to monopolization in this industry and this is what consumers want. They
want to be assured when they purchase a personal finance program that it will
continue to be supported as far into the future as possible. The problem is that
there is less incentive to improve the product and price it competitively because of
125
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
the complementary market for forms and cheques. The acquisition of Intuit would
have been somewhat less dangerous to consumers if Microsoft were forced to
allow any firm to produce the paper firee of licensing fees.
The personal finance software market is likely to become monopolized
due to the increasing returns effect. If Microsoft happens to be the monopolist it
could receive benefits that other companies could not. It could, for example,
choose not to produce versions of Quicken for competing operating systems, thus
reinforcing its monopoly over the entire PC architecture. If bundling were
permitted, Microsoft could leverage monopoly power from one product category
to another. Quicken could conceivably become the basis for all consumer
electronic commerce and this could reinforce Microsoft’s position in enterprise
computing because retailers could better integrate these transactions using
Windows NT.^^ Although this scenario could happen it is not necessarily going to
hurt consumers or society as a whole. It may result in enhanced product
functionality or increased competition in the financial services industry. Even a
critic of monopolization in the software industry sees this benefit. According to
David Coursey, “.. . the leveraged environment I so decry on monopoly grounds
is probably just the sort of thing which wUl get online financial services off the
ground. And that, I believe, really is good for customers, at least until the lack of
competition keeps prices high and services limited.”^ ^ Microsoft’s power over
126
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
these markets could be controlled ex post via antitrust laws if the company chose
to exploit its position to the detriment of society.
The decision by the Justice Department to challenge the Intuit takeover
seems inconsistent. The DOJ expressed no concern with Microsoft participating
in the personal finance / chequebook market in the first place. It is unlikely that
the DOJ would have challenged Microsoft if it had gained a dominant position
through market promotion of its Money software. The only difference with a
merger is that Microsoft would not have to spend resources defeating Quicken
through marketing and product development. As Scott Cook, CEO of Intuit, stated
it to his board members, the merger would eliminate “a bloody share war” with
“Godzilla.”^^ Microsoft told Intuit that it would more aggressively pursue the
market if the companies did not come to an agreement. According to Shapiro,
“... competition can be especially intense if rival brands are jockeying to take the
lead in terms of installed base, perhaps with the hope of tipping the market in their
favor. Competition of this type would be lost due to a merger of the competing
programs.” The problem with Shapiro’s statement is that this type of price
competition requires incompatibility, which consumers wish to avoid. Prohibiting
the merger could have a short-term benefit in innovation and competitive pricing
but this would be at the short-term cost of incompatibility and eventually would
cease due to the lock-in effect. If the problem is with the potential for leveraging,
then logically Microsoft should not be permitted to participate in the personal
127
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
finance / chequebook market at all. It is not reasonable to allow a company to
participate in an increasing returns market only to revoke its monopoly position
when it wins.
Microsoft attempted to deflect the traditional antitrust arguments that
would be used against it by divesting itself of Money, which held one-fifth of the
installed base in personal finance software. This decision did not win favour for
the company with the DOJ, which argued that the program would not be an
effective competitor after the merger took place. Microsoft provided its own
evidence in opposition to the merger in a memo from a senior official who wrote
that “[i]f we were to try to buy Intuit . . . I can’t imagine anyone would be stupid
enough to [purchase Money] . . . I think they would imagine that we’d never be
allowed to do it.” For this reason, Novell was able to negotiate a low price of no
more than $1 million. Microsoft would have to pay compensation of several
million dollars to Novell if it did not succeed.Money might have become
crippled because the personnel that developed it were to remain with Microsoft.
This is significant because Microsoft apparently viewed the employees of Intuit as
the most important asset in the acquisition."^ The transfer of Money to Novell
was, therefore, unlikely to maintain competition in the segment.
The merger would have resulted in a larger market share and dominance
for Quicken than would have occurred in its absence. Few new competitors could
be expected in a market that had such strong entry barriers. Even a company with
128
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
the resources and motivation of Microsoft required four years to develop a
competitive set of features and was unable to make the product profitable over the
period. Thus, monopolization was the clear result of the merger.
It is also true, however, that Intuit was already dominant in the market and
was likely to strengthen its monopoly position naturally due to the network
externalities effect. The merger essentially would replace Intuit with Microsoft as
the monopolist. If the market wül be monopolized anyway, what difference does
it make which company becomes dominant? Anne Bingaman is reported to have
said that the sale of Money to Novell would not maintain competition because
Microsoft was better endowed financially. According to Gifford this is
indicative of a return to the doctrine of entrenchment, which was abandoned in the
1982 antitrust guidelines. This doctrine arose from Supreme Court decisions in
the 1960s that held that the acquisition of a dominant firm by a wealthy
competitor would increase the probability that the firm would remain dominant.
The 1968 antitrust guidelines added entrenchment as a rationale. Several
problems with the theory were identified and as a result it was no longer used. For
example, why should a firm be permitted to use its wealth to develop products for
a market but not to acquire a firm that does the same th ing ?T h e same
monopoly position may result for the wealthy company m either case.
Furthermore, the supervisor of the 1968 guidelines that established entrenchment
later admitted that it was faulty.In the Microsoft case, the DOJ may have had a
129
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
more sophisticated version of entrenchment in mind. Perhaps Microsoft has other
resources aside from mere wealth that would give it an extra advantage in the
purchase of complementary resources owned by Intuit.
The distinction between internal expansion and acquisition is problematic.
The Clayton Act only addressed the anti-competitive results from acquisition. For
this reason, the profession decided that internal expansion was never anti
competitive. Gifford logically concludes that “an acquisition which does not
reduce competition between market participants and which produces results
equivalent to internal expansion cannot be anticompetitive either.”’" The DOJ
apparently does not see this logic and has decided that firms which have achieved
dominant positions will be restricted to the paths available to them from internally
available technologies and will be prohibited from seeking synergies with abilities
not available internally.
Mergers are common for fast growing companies for reasons aside from
increasing market share. Stock prices are often based on the ability of a company
to maintain a high growth rate in its revenues and profits. Such rates of growth are
impeded by the large cash reserves that can accrue to a highly profitable company
that does not offer dividends on its stock. This is the dilemma faced by Microsoft.
$9 billion, 70% of the company’s total assets, are in cash reserves, which have
earned 5.8% annual returns in treasury instruments.’’" This rate is significantly
below what is required to maintain its stock price growth. The reduction of cash
130
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
was a motivation in Microsoft’s $2.3 billion attempted merger with Intuit.* The
company’s monopoly position in operating systems has hampered its ability to
use its cash reserves for acquisitions. Any acquisition of a company earning over
$10 million in annual revenue must be filed with the Justice department. For this
reason, Microsoft has focused on purchases of small companies with growth
potential such as Vermeer Technologies, producer of Front Page, which creates
and manages web documents.**'* The DOJ requested information for even this
small acquisition. Microsoft wül tend to outbid most competitors because it can
afford to overpay when such purchases are so small relative to its cash position.
DOJ oversight and strategic relationships with customers restrict Microsoft’s
ability to use its cash reserves. This is unfortunate for the company because
acquisitions are natural in an industry with few capital requirements and where
inputs and outputs are both inteUectual in nature. The company has gained many
bright new employees in this way, such as Nathan Myhrvold, who joined as a
result of the acquisition of Dynamical Systems in 1986.**^ Restricting acquisitions
is one way of tying the hands behind the back of a monopoly.
The primary method used by U.S. antitrust enforcers to evaluate the
competitive effect of a merger is the market’s concentration ratio, as measured by
the HHI. The HHI is calculated by summing the squares of the market shares of
all firms in a sector. The score for a perfect monopoly would be 10,000 (100 x
100). The DOJ or FTC often challenge acquisitions that raise a market’s HHI
131
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
above 1800."^ The reliability of this method of evaluating market power is
dependent on the definition of the product market. The Supreme Court has
approved of the use of smaller market definitions. The rapid development,
unpredictability, and interrelatedness of the computer industry have made it
difficult to define markets. Small market definitions often find high degrees of
concentration in new products that nonetheless have many partial substitutes.
Many observers are concerned about the use of small market definitions.^^* The
ease of acquisitions, combined with small market definitions, has led to many
investigations and private antitrust lawsuits. An obvious solution to this problem
would be to first examine the broadest market in determining a definition.
Andrew Hruska suggests a three-part test: examine the entire industry; consider
partial substitutes and potential entrants over the long term; and estimate market
concentration for the product when it enters the market.’* ^ If the entire industry
were to include hardware, software, workstations, and mainframes, as Hruska
suggests, it would be hard to imagine many mergers being rejected. The HHI
appears precise but, according to Tom Smith, it is subject to assumptions that
often do not hold. Antitrust enforcers may not be able to satisfactorily define the
industry, or even determine the appropriate market shares. As well, concentration
may not distort competition because some companies may be failing or there
could be compensating efficiencies. Increasing returns industries provide
132
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
another special case: perhaps consumers receive greater benefits from
monopolization than costs.
The example of Taligent can Illustrate the difficulty of definition. If the
smallest market approach were used to determine whether Apple and IBM could
form the joint venture, for example, the HHI for object oriented operating systems
would be virtually 10,000. If, however, PC operating systems were used
Microsoft’s 80% share combined with Apple and IBM would result in an HHI
above 8,000. The problem in this case is that these two companies could provide
greater competition to the market if they joined together. If all computer software
including applications were defined as the relevant market, the HHI may fall
below the enforcement range.'"'
The appropriate market definition for Microsoft’s products may not be PC
operating systems or applications as a whole. The interaction of software with
hardware may imply that both should be considered as a single market.
Regardless, market definitions may be a moot point if the benefits of
concentration exceed the costs, as may well be the case when there is a strong
desire for compatibility.
The Intuit case illustrates clearly a serious problem with the application of
antitrust laws in markets with demand side economies of scale. Unlike more
traditional products, consumers receive benefits from monopoly that are
unavailable to them in competition. The rationale used by the DOJ for not
133
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
permitting the Intuit merger is that competition would be reduced. There is little
doubt that this is true but the desire for compatibility made this also the desirable
outcome. A superior approach would be to establish rules that reduce the
undesirable consequences of monopoly for consumers and maintain the positive
results.
The FTC and DOJ should not be preventing monopolies for products with
demand side economies of scale from being achieved through markets or mergers.
They should instead develop and enforce rules that wül ensure that consumers are
not damaged by the monopoly. For this reason, this study recommends that
mergers generaUy be approved subject to the following rules. The dominant
company should be forced to simultaneously release any feature upgrades for all
platforms supported by the acquired program. This should occur for at least five
years and continue afterward for a platform or its successor as long as it maintains
a 5% market share.’"" Furthermore, the dominant company should not be able to
bundle the acquired program with its architectural products. Applications
bundling should be permitted only if it significantly improves functionality that
would not occur in the absence of bundling. Any rule should be clear ex ante to
avoid confusion and resulting inefficiency.
134
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Notes
^ Kenneth C. Baseman, Frederick R. Warren-Boulton, and Glenn Woroch,
“Microsoft Plays Hardball: The Use of Exclusionary Pricing and Technical
Incompatibility to Maintain Monopoly Power in Markets for Operating System
Software,” Antitrust Bulletin. 4, 1995.
“ Charles R. Morris and Charles H. Ferguson. “How Architecture Wins
Technology Wars.” Harvard Business Review. March-April 1993, p. 88.
^ Samuel R. Miller, “Does Netscape Really Have Antitrust Claims Against
Microsoft?” The Computer Lawyer, 13 (11), November 1996, p. 7.
Miller, 1996, op.cit., p. 7.
^ Miller, 1996, op.cit., p. 7.
^ Daniel J. Gifford, “Software: Microsoft Corporation, the Justice Department,
and Antitrust Theory,” Southwestern University Law Review, 25, 1996, p. 560.
’ ’ Otter Tail Power Co. v. United States, 410 U.S. (1973), pp. 366, 377
* Berkey Photo, Inc. v. Eastman Kodak Co., 603 F.2d (2d Cir., 1979), pp. 263,
276.
^ Cases are cited in Gary Reback, Susan Creighton, David Killam, and Neil
Nathanson, “Technological, Economic and Legal Perspectives Regarding
Microsoft’s Business Strategy in Light of the Proposed Acquisition of Intuit,
Inc.,” Upside, February 1995. These include: Alaska Airlines, Inc. v. United
135
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Airlines, Inc., 948 F.2d (9th Cir., 1991), pp. 536, 546-549; Fineman v. Armstrong
World Industries, Inc., 980 F.2d (3d Cir. 1992), pp. 171, 206.
’° David Bender, “Microsoft and the Antitrust Wars,” Practising Law Institute,
Patents, Copyrights, Trademarks, and Literary Property Course Handbook Series,
September, 1995, p. 59.
’ * For example see Richard A. Posner, Antitrust Law, An Economic Perspective
(Chicago: University of Chicago Press, 1976), pp. 171-174; Ward S. Bowman,
Patent and Antitrust Law: A Legal and Economic Appraisal (Chicago, University
of Chicago Press, 1973), pp. 62, 65; Joseph G. Sidak, “Debunking Predatory
Innovation,” Columbia Law Review, 83, p. 1121; Joseph A. Franco, “Limiting the
Anticompetitive Prerogative of Patent Owners: Predatory Standards in Patent
Licensing,” Yale Law Journal, 92, 1983, p. 831.
John E. Lopatka and William H. Page, “Microsoft, monopolization, and
network externalities: some uses and abuses of economic theory in antitrust
decision making,” The Antitrust Bulletin, Summer 1995, p. 336.
David Gabel and David I. Rosenbaum, “Prices, costs, externalities and
entrepreneurial capital: lessons from Wisconsin,” The Antitrust Bulletin, Fall
1995, pp. 581-609.
Michael Morris, “Microsoft Settlement is Too Little Too Late,” Sunday San
Francisco Examiner, July 24, 1994.
136
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Morris, 1994, op.cit.
Eric Nee, “One on One with Eric Nee,” Upside, March 20, 1997.
16
Nee, 1996, op.cit.
“The Bill Gates Interview,” Playboy, 1994. Available (online):
http ://ei.cs. vt.edu/~history/B ill .Gates.html.
Geoffrey James, “Microsoft Goes Hardware,” Upside, March 17, 1997.
James, 1997, op.cit.
Playboy, 1994, op.cit.
Reback, 1995, op.cit.
Mike Elgan provides these examples in “Microsoft: Do not Pass Go, Do not
Collect $2,000,000,000.00,” Windows Magazine, October 1, 1995, p. 61.
James Gleick, “Making Microsoft Safe for Capitalism,” The New York Times
Magazine, November 5, 1995
^ Gleick, 1995, op.cit.
Gleick, 1995, op.cit.
Timothy J. Brennan, “Is the theory behind U.S. vs. AT&T applicable today?”
The Antitrust Bulletin, Fall 1995, pp. 455-482.
Chris Weare points out that the need to maintain a cooperative relationship may
explain why the “amici” companies wished to remain anonymous during the
Tunney Act review of the 1994 Consent Decree. Christopher Weare, “The
137
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Institutional Governance of Interoperability in the Computer and
Telecommunication Industries,” Annenberg School for Communication,
University of Southern California, August 4, 1995, photocopy.
Weare, 1995, op.cit.
“Microsoft will End Successful Year on High Note, Analysts Predict,” Report
on Microsoft, 4 (13), July 1, 1996.
Mike Elgan, “Justice Department: Hands Off Microsoft!—Splitting Microsoft
into two companies would be disastrous for the industry-and for users,” Windows
Magazine, Jan 1, 1997.
Bender, 1995, op.cit., p. 85.
Gleick, 1995, op.cit.
Gifford, 1996, op.cit., p. 665.
Stan Liebowitz and Stephen Margolis, “Don’t Handcuff Technology,” Upside,
September 1995.
Gifford, 1996, op.cit., p. 666.
Mitch Betts, Stuart J. Johnston, and Ed Scanned, “Users hold key to antitrust
battle,” Computerworld, April 18, 1994.
Reback, 1995, op.cit.
Jay Dratler, Jr., “Software: Microsoft as an Antitrust Target: IBM in Software?”
Southwestern University Law Review, 25, 1996, pp. 726-727.
138
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Eastman Kodak Co. v. Image Technical Servs., Inc., 504 U.S. (1992), pp. 451,
461, quoting Northern Pac. Ry. Co. v. United States, 356 U.S. (1958), pp. I, 5-6.
Dratler, 1996, op.cit., p. 727.
Miller, 1996, op.cit., p. 7.
Dratler, 1996, op.cit., pp. 730-31.
Miller, 1996, op.cit., p. 7.
Jonathan Marshall, “Antitrust Punishes Market Winners,” San Francisco
Chronicle, July 24, 1995, p. E l.
^ Walter Isaacson, “In Search of the Real BiU Gates,” Time, 149 (2), January 13,
1997.
Dratler, 1996, op.cit., p. 733.
Stuart J. Johnston and Ed Scannell, “Server Suite Could Squeeze Market,”
Computerworld, October 10, 1994, p. 4.
Diganta Majumder, “Justice Eyes MS . . . Again,” Windows Magazine,
December 1, 1996, p. 46.
Jessica Davis, “Justice asked to investigate Microsoft bundling plans,”
InfoWorld, February 19, 1996, p. 10.
Gleick, 1995, op.cit., p. 55.
139
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Charles McCoy and G. Christian Hill, ‘Tech Stocks’ Decline May Be
Overreaction, But Problems are Real,” Wall Street Journal, January 11, 1996,
p. AlO.
Federal Register, 59, 1994, pp. 42,845, 42,847.
McCoy, 1996, op.cit., p. AlO.
Gleick, 1995, op.cit., pp. 55-56.
Gleick, 1995, op.cit., pp. 55-56.
Wendy Goldman Rohm, “The Last Harpoon,” Upside, July 1994.
Dratler, 1996, op.cit., p. 683.
Dratler, 1996, op.cit., p. 737.
Dratler, 1996, op.cit., p. 742.
Playboy, 1994, op.cit.
Dratler, 1996, op.cit., p. 701.
Adrian King, “Inside Windows 95,” Computer Reseller News, September 11,
1995, p. 113.
^ “Bill Gates Uncensored,” Business Week, April 10, 1995, p. 132.
Federal Register, 59, 1994, pp. 42,845, 42,848.
Bender, 1995, op.cit., p. 68.
Brian Livingston, “Undocumented Windows Calls,” InfoWorld, Nov. 16, 1992,
p. 98.
140
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Reback, 1995, op.cit.
James, 1997, op.cit.
“Software Developer Caldera ® Sues Microsoft ® for Antitrust Practices,
Alleges Monopolistic Acts Shut its DR Dos ® Operating System Out of Market,”
PRNewswire, July 24, 1996.
PR Newswire, 1996, op.cit.
Reback, 1995, op.cit.
Dratler, 1996, op.cit., p. 701.
For example, in Berkey Photo, Inc. v. Eastman Kodak Co., 603 F.2d (2d Cir.
1979), pp. 263, 286, the court ruled that “any firm, even a monopolist, may
generally bring its products to market whenever and however it chooses.” In
United States v. Aluminum Co. of America, 148 F.2d (2d Cir. 1945), pp. 416,
435-36, Judge Learned Hand wrote that innovation and patenting by a monopohst
was not prohibited by Section 2 of the Sherman Act.
Bob Metcalfe, “Tying IE4 with Windows may be an incentive for Netscape,
other vendors,” InfoWorld, October 14, 1996, p. 46.
Dratler, 1996, op.cit., pp. 702-03.
Dratler, 1996, op.cit., p. 699.
Reback, 1995, op.cit.
Reback, 1995, op.cit.
141
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Margie Wylie, “Nader opens campaign against MS,” News.com, November 13,
1997. Available (online): http://www.news.com/News/Item/0,4,16340,00.html.
“Setting the Record Straight,” Microsoft, December 19, 1997. Available
(online): http://www.microsoft.com.
Gerry Khermouch, “Casebook 6: a brand past its prime? Microsoft’s Home
brand,” Marketing Computers, 16 (2), February, 1996, p. 47.
Available (online): http://www.zone.com/asp/default.asp.
Denise Caruso, “Capturing a Swarm o f New Money-Making Opportunities,”
Upside, April 1995.
Jeffrey Young, “You Call That Content?” Upside, March 19, 1997.
^ Young, 1997, op.cit.
The merger talks are described in Goldman Rohm, 1994, op.cit..
“Netscape Steps Up Partnerships,” DOT.COM, 3 (6), September 1996.
“MCI and Microsoft Ally to Cross-Market,” Interactive Home, January 1, 1996.
Reback, 1995, op.cit.
Quote from Michael Spindler in Peter H. Lewis, “Not Just Blue Sky: I.B.M.
and Apple Have a Product,” New York Times, Oct. 20, 1991, p. 8.
Andrew C. Hruska uses these examples to show this point in “A Broad Market
Approach to Antitrust Product Market Definition in Innovative Industries,” Yale
Law Journal, 102, October 1992, pp. 316-318.
142
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Bender, 1995, op.cit., p. 94.
“U.S. Department of Justice Challenges Planned Acquisition of Intuit Inc.,”
S&P Daily News, April 27, 1995.
Terence P. Pare, “Why the Banks Lined Up Against Gates,” Fortune, May 29,
1995, p. 18.
Reback, 1995, op.cit.
This point is outlined convincingly in Reback, 1995, op.cit.
David Coursey, “We Need a Microsoft Policy,” Red Herring, 15, November
1994. Available (online): http://www.redherring.com/mag/issuel5/david.html.
Mitch Betts and Stuart J. Johnston, “Microsoft, justice dance antitrust tango
again,” Computerworld, May 1, 1995.
Bender, 1995, op.cit., p. 99.
Carl Shapiro, “Antitrust in Network Industries,” U.S. Department of Justice,
Antitrust Division, address before the American Law Institute and American Bar
Association, January 25, 1996.
Bender, 1995, op.cit., p. 95.
Bender, 1995, op.cit., p. 98.
Bender, 1995, op.cit., p. 98.
Bender, 1995, op.cit., p. 97.
143
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Don Clark and Viveca Novak, “U.S. Files Antitrust Suit to Stop Microsoft
From its $ 2.1 Billion Acquisition of Intuit,” Wall Street Journal, April 28, 1995,
pp. A3, A6.
Gifford, 1996, op.cit., p. 659.
Gifford, 1996, op.cit., pp. 659-60.
Donald F. Turner, “Observations on the New Merger Guidelines and the 1968
Merger Guidelines,” Lûvv/oM A T za/, 51, 1982, p. 307.
Gifford, 1996, op.cit., p. 660.
Gifford, 1996, op.cit., p. 665.
James, 1997, op.cit.
James, 1997, op.cit.
James, 1997, op.cit.
Howard Anderson, “Target: Microsoft,” Upside, March 18, 1997.
Federal Register, 47, 1982, p. 28,497.
Eastman Kodak Co. v. Image Technical Servs., Inc., 504 U.S. (1992), p. 451.
Gregory J. Werden, “Market Delineation and the Justice Department’s Merger
Guidehnes,” Duke Law Journal, 514, 1983, pp. 550-551.
Hruska, 1992, op.cit., pp. 311-312.
Tom D. Smith, “Merger Counseling Checklist,” Antitrust Law Journal, 56,
1987, pp. 810-11.
144
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Hruska, 1992, op.cit., pp. 329-30.
The five year and 5% figures are arbitrary but reasonable.
145
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Chapter 4
Antitrust and the Marketing of Standards
Marketing is an essential determinant of success for technological
products. This is due to the fact that products are introduced rapidly. A strong
advertising and marketing effort is essential for a product to avoid being one of
the 80% of new products that fail. Companies such as Microsoft have even gone
as far as giving out free samples of a product as if it were a bar of soap. The
elements of marketing, particularly price and promotion, have been used by firms
to gain advantages over their rivals. Sometimes these methods have been anti
competitive in the sense that they destroyed the marketability of rival products
based not on the intrinsic value of the alternative provided but on dishonesty by
the seller. This chapter will first determine whether predatory pricing can be used
to gain and hold a compatibility standards monopoly. It will then examine the
issue of preannouncements.
Predatory Pricing
Predatory pricing has been one of the criteria used in antitrust
enforcement. The implications of compatibility standards on pricing are
significant and may give economic justification to a practice that might ordinarily
146
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
be considered as predatory pricing. A pricing policy is considered predatory if a
company is willing to endure a short-term loss to drive out current competitors
with the purpose of raising prices above competitive levels afterward. Entry
barriers would have to be high enough to prevent new competitors from
undercutting the new monopolistic price. In the case of setting standards, a
company may choose to price below cost or even give away a product until it
attains a sustainable critical mass of users. The perception that the product will
become dominant wiU cause new adopters to choose it even if the price later
becomes considerably higher than incompatible substitutes. In this way, a
company can become a monopolist and face little threat of entry for that
generation of products. A major difference between this and predatory pricing in
traditional industries is that there is economic value in the compatibility that
monopolization can bring. As well, a product with increasing returns wül have a
tendency toward a monopoly regardless of the actions of any firm.
U.S. courts have attempted to define predatory pricing. One definition is
“pricing below an appropriate measure of cost for the purpose of eliminating
competition in the short run and reducing competition in the long run."' Another
ruling states that “[a] firm engaged in predatory pricing bites the bullet and
forgoes present revenues to drive a competitor from the market. Its intent, of
course, is to recoup lost revenues through higher profits when it succeeds in
making the environment less competitive.”^ In a third case “[pjricing is predatory
147
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
when a seller forgoes short-term profits in order to develop a market position
from which it can later raise prices and recoup lost profits.”^ The key tests of
predatory pricing cases are whether the company is pricing below cost and
whether it has a reasonable expectation of offsetting its short-term losses with
profits later. This is based on the assumption that the monopolist is rational and
would not engage in such activity if it could not recover its losses.'^
Attempts at showing predatory pricing often focus on dramatic statements
by managers from the firm allegedly monopolizing. Examples include: “[w]e are
going to mn you out of .. . business. Your days are numbered[;]” “pound them
into the sand[;]” and “Do whatever it takes. Squish [competitor] like a bug.”^ As
Dratler points out, however, the issue of intent is of little use in determining the
validity of a predatory pricing claim because it is natural for a firm to want to
cmsh its competitors. The means of excluding rivals should be the focus of
attention rather than intent.^ According to Judge Learned Hand in the Aluminum
Company of America case of 1945, even a monopolist should be allowed to
destroy its competition as long as the means of doing so are “superior skill,
foresight and industry[,]” or even pure chance.^ For this reason, unfair prices are
defined as those below either marginal cost or, as a proxy, average variable cost.^
The difficulty of measuring these may, however, enable firms to avoid antitrust
sanctions in spite of pricing below cost.
148
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Courts have generally gravitated toward the view that “predatory pricing
schemes are rarely tried, and even more rarely successful.”^ However, a practice
resembling predatory pricing has proven successful with compatibility standards.
One of the reasons for this is that when standards compete, the winner is
able to amortize its development costs over a much larger number of users. In this
way, fixed costs play a much more important role in products where compatibility
matters. With some of these marginal cost is essentially zero, which could never
lead to predatory pricing using the normal definition. Given the relatively short
product cycles in this type of industry, it makes sense to incorporate some fixed
cost into a more realistic interpretation of cost for the purpose of determining
whether a price is predatory. The problem with this interpretation, however, is
that it will prevent firms firom lowering prices and thus benefiting consumers.
Since a monopoly will eventually occur regardless of whether predatory pricing
takes place, consumers receive a net benefit from the early lower pricing.
For example, Microsoft was able to attain a dominant position for DOS by
charging a lower price than its competitors in the first IBM personal computers. It
was able to charge more after it had obtained a monopoly position, particularly
after clones of the PC came to market. The desire for compatibility would have
made one of the original operating systems dominant regardless of the
“predatory” action but in the meantime consumers received lower prices.
149
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
The Internet has magnified the economics of compatibility because
incremental distribution costs are near zero. For this reason, there are many
companies that have given away products in the hope of establishing them as
standards. Some hope to “charge” their customers through selling advertising
space once their products are adopted as standards. Netscape did not charge the
users of its first browser products and was able to develop a dominant share. The
free browser fostered software designed for servers, which it charged for. Once
the company built a critical mass of users it started charging many of its users for
the browser as well. Microsoft copied the early Netscape pricing model for its
Internet Explorer browser, hoping to overcome the upstart’s position due to its
own lower price (free), strong reputation, and ability to integrate the browser with
its other dominant products. Microsoft, however, differs from Netscape because it
was already a monopolist in some areas of the industry prior to charging below its
cost.
It is not appropriate to use predatory pricing as a basis for antitrust
enforcement in industries where compatibility standards are important. There is a
tendency toward monopoly regardless of the pricing policies of any firm. The low
prices charged by firms wishing to establish this monopoly can only benefit
consumers in the short run. The long run result is equivalent with or without low
initial prices.
150
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Preannouncements
This section addresses the effects of product preannouncements on
competition. In the computer industry preannouncements are often referred to as
vapourware. Stewart Alsop defines the term as “computer products that exist
chiefly in the minds of the people who announce them.”" For the purpose of this
section vapourware is defined as a product that is declared to be in development
but which does not exist in its final form at the time of the announcement.
Antitrust Scrutiny of Microsoft Preannouncements
Judge Stanley Sporkin brought Vapourware into Microsoft’s official
antitrust proceedings in the Tunney Act hearing on the 1994 Consent Decree. The
government had not treated this issue in the Consent Decree but Sporkin’s interest
resulted in the filing of memos on the issue by the government and opponents of
the decree. This may not have occurred if Judge Sporkin had not taken an interest
the issue the summer prior to receiving the case. He read a book by James
Wallace and Jim Erickson entitled Hard Drive: Bill Gates and the Making o f the
Microsoft Empire, which alleged that Microsoft had used vapourware to hurt
competitors by freezing the marketplace.In a ruling Judge Sporkin
characterized the issue: “[b]y telling the pubüc, ‘we have developed a product that
we are just about to introduce into the market (when such is not the case) that is
just as good and is compatible with all your old applications,’ Microsoft can
151
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
discourage consumers and OEMs from considering switching to the new
product." The court defined vapourware in a competitive context: “the public
announcement of a computer product before it is ready for market for the sole
purpose of causing consumers not to purchase a competitor’s product that has
been developed and is either currently available for sale or momentarily about to
enter the market.”
The judge felt that a memo praising the preannouncement of Quick Basic
3.0 by Microsoft was a “smoking gun.”^ ^ Judge Sporkin may have felt that it was
relevant to the Tunney Act hearing because the DOJ had been aware of them
during its investigation and had deposed its author, the company’s Senior Vice
President for Advanced Technology.BUI Gates, however, claims that the judge
misunderstood the issue of preannouncements because nothing stated in the
announcement was false at the time it was made.^^ Regardless of the validity of
his mling, Sporkin’s opinion resulted in an intensified debate in the industry over
the issue.
Benefits of Preannouncements to the Incumbent Firm
There are many benefits of preannouncements. Many of these accrue to
the firm making the announcement. This has been particularly so in the computer
industry, mainly because of the tendency for a product to lock-in to a single
version due to the desire by users for compatibility. For this reason the industry
152
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
has been the primary developer of the vocabulary which describes it, including
terms such as “vapourware,” “paper tiger,” “ambush marketing,” and “FUD
[fear, uncertainty, d o u b t].T h e tactic is particularly effective for a firm that is
seen as a market leader. Buyers are usually willing to wait for a product from a
market leader such as IBM in the 1960s or Microsoft in the 1990s.
Evaluating the tactic is complicated by the fact that it seems legitimate to
inform customers of future competing products, particularly when they are likely
to be locked in to a single product for a significant period. Forbidding the
dissemination of information about future products could help result in premature
adoption of a product that consumers would not want if they had access to the
information. Furthermore, many other stakeholders also can benefit from early
knowledge of a product in development." ‘ In particular, a multi-generation
standards monopolist would have an enormous advantage over competing
applications providers if it could keep secret the pre-release versions of a
succeeding standard. Makers of complementary products thus need to know of
future developments as early as possible. Similarly computer systems consultants
require this information to make informed recommendations for their clients.
Government and regulatory agencies also require pre-release knowledge of a
product to assess any anti-competitive implications. For example, early
knowledge of the Microsoft Network icon on the Windows 95 desktop enabled
the Department of Justice to investigate whether the claims by competing online
153
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
services of its anti-competitive implications were justified. Financial analysts and
investors also demand knowledge of the future plans and strategies of publicly
traded companies.
Members of the computer media regard obtaining information about future
products as one of their primary functions. Their readers demand this. At the same
time, Microsoft has benefited greatly from the enormous amounts of publicity that
the trade press has given its products in development. Microsoft has been quite
skillful in its use of the free publicity that it is able to receive from product
preannouncements. With respect to Windows 95 one observer commented that
“Microsoft’s delays have had consumer PC publications hitching and starting,
running an endless series of big preview stories for an operating system that kept
teasing them with new release dates.”” This publicity is significant because
computer magazines have been an important factor in the computer industry’s
evolution.^
Preannouncements can be used in a strategic manner to benefit a firm and
may also serve the purpose of reducing competition. According to Rubino and
Moore, they can be used strategically in the following ways: “(1) to preempt the
competition by encouraging buyers to await the firm’s new product rather than
purchase a competitor’s; (2) communicate plans for a retaliatory move against a
competitor; (3) test a competitor’s reaction; or (4) redefine a competitive industry
position .. Thus a preannouncement is a competitive tool.
154
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Vapourware can be predatory in the sense that it can help eliminate the
viability of a competitor’s products. In this way it is similar to predatory pricing.
Unlike predatory pricing, however, preannouncements are not costly to make and
there are many real world examples of their success. Vapourware is not simply a
theory explaining exceptions rather than the rule that can be easily dismissed by
the opponents of antitrust enforcement. However, a company cannot fail to meet
expectations every time it makes a preannouncement. Eventually the tactic would
be rendered useless as the firm lost credibility. Nonetheless, if the tactic is used
only where it will matter most and not in less important markets, it can be an
effective tool against potential entrants. For example, Microsoft could use it
against architectural competitors, such as OS/2 and DR DOS, but avoid using it in
smaller, less important markets or where its competitive position is more secure,
such as with Microsoft Office. Another potential benefit of vapourware tactics is
the reputation that its successful use can gain with firms considering entry. The
use of this method sends a signal to potential competitors about the willingness of
an incumbent firm to seriously damage its rivals.^
One of the factors explaining the use of vapourware tactics is the
importance of critical mass in explaining how technical standards can become
locked in. As the number of adopters increases the network product becomes
more valuable. In more precise terms what matters is the perception that a product
is likely to become a standard. A product that has fewer adopters at a given time
155
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
can still be perceived as the eventual winner by enough people that this becomes a
self-fulfilling prophecy. Expectations are the key to determining the point of
critical mass in human activities.
For this reason, vapourware is related to the idea of “mind share,” which is
when consumers accept a product that either does not exist or has not been
introduced."^ This is particularly effective for an established firm intending to
bring a product to a market that has been entered by a smaller first mover.
Normally the first mover in an industry gains an advantage that its competitors are
unable to completely eliminate."^ A strategic vapourware announcement,
however, can quickly neutralize the first mover advantage. A firm with a well
known brand name, a large advertising budget, and better distribution channels
can achieve this."* Consumers expect such a company to win a market battle
against a small firm and this is why mind share and expectations can neutralize
the first mover advantage. It is thus possible to use marketing to create the
impression that a product will win a standards battle. This becomes a self-
fulfilling prophecy. For example, T.J. Rogers, CEO of Cypress Semiconductor,
once stated that “there’s enough ambiguity that it is really a marketing pitch that
will win or lose this war [in the RISC chip market].”"^
The effect of advertising has been a point of controversy among antitrust
scholars.The importance of marketing in this industry seems to support the
view that advertising raises entry barriers. Advertising heavily influences the
156
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
introduction of new computer products. Microsoft has recognized the importance
of advertising, as can be seen by its expenditure of approximately $200 million in
the introduction of Windows 95. The same product benefited from another $550
million of spending by makers of complementary goods.^* A good brand is
valuable in the high tech marketplace, as can be seen by the estimated valuation
of the Microsoft brand at $9.8 billion.^" The evidence from the industry supports a
significant body of thought in antitrust on advertising. According to Howard
Beales, consumers are risk averse and wül often choose an inferior product that
has a stronger reputation.^^ For this reason, policy makers and courts should not
discount the market power that can arise from a reputation. This can be used to
make the preannouncement of a competing product damaging to a first mover in a
new market. In contrast to the view of critics of intervention, the gains received
from a preannouncement can be preserved in the long term due to the critical
mass and lock-in effects.
Preannouncements also have some positive effects that carmot be regarded
as anti-competitive. The introduction of new products affects competitors,
suppliers, partners, customers, and investors. None of these wants products in
development to be kept secret. This is particularly true for architectural products
such as operating systems. If the developer of a monopoly architecture did not
inform the market of its new generation product in development, it could become
dominant in the markets for many applications as well. Microsoft’s competitors in
157
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Windows applications would not survive in the absence of predisclosure. In this
sense, the lack of a preannouncement can be anti-competitive. New architectural
products often need complementary software from independent companies to be
valuable to customers and this can be achieved most efficiently through
preannouncements. For example, in 1986 IBM preannounced a professional
workstation and said that there was limited software. This created an incentive for
ISVs to develop for the new market.^"* Hardware makers also want to be informed
of new products so that they can plan inventories and marketing campaigns.
Preannouncements enable customers to develop longer term plans for future
purchases.^^ Investors desire as much information about future plans as possible
and this includes specifics on where research and development money is spent.^^
Thus, there is clearly a degree of truth to Microsoft’s response to Judge Sporkin’s
concern about vapourware. In a white paper to the court the company wrote that
“[t]he widespread, market-driven practice the industry has been discussing is not
in fact vaporware, but predisclosure. Its purpose is to engage customers and the
industry in a useful dialogue about products that help customers make better
decisions and developers make better products.” This argument, however, tells
only part of the vapourware story. There are many reasons to believe that
vapourware can be used to reduce competition. The Software Publishers
Association has summarized the issue: “[p]re-announcements of specific products
or features are, at times, very relevant to a broad range of industry players in
158
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
terms of assisting them in determining technology trends. However, the
intentional preannouncement of products that do not yet exist can have the effect
of freezing the market. When a product pre-announcement is knowingly false, it
may harm competition and restrict the availability to the market of innovative
products from other vendors.The key goal for policymakers is to develop rules
that maintain the positive aspects of preannouncements while reducing their
potential for abuse.
Negative Effects of Preannouncements
Preannouncements have the potential to damage the market but can also
have negative repercussions for the perpetrator of the announcement. Opponents
of laws against vapourware often point out that an inaccurate announcement can
damage a company’s reputation. This is more likely to hurt a small company than
a larger one. Small companies have few products on which to build their
reputation. A single disappointment thus has a much greater impact on a small
company’s reputation. Several small companies have been destroyed by their own
vapourware. Two examples are VisiCorp and Gavilan Computer Corp.^^ Wang
Laboratories is a larger company which suffered a similar fate after it announced
14 products that did not then exist and of which most were never brought to
m arket."*® Investors have often reacted negatively to product delays. A clear
example is the immediate 4.5% drop in Microsoft’s stock price after it announced
159
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
that it could not meet a scheduled delivery date for Windows 95.“ ^ ^ Although this
has a greater effect on shareholders than the company itself, it provides a degree
of discipline. This will have a greater impact if employees and managers are
directly affected by the stock price. This is certainly the case for Microsoft.
Nonetheless, the reaction of investors is also a sign of marketplace irrationality
that indicates the effectiveness of vapourware. If investors can be fooled by a
company with a well-known reputation for inaccurate announcements surely
consumers cannot be expected to punish a company for past transgressions. As
will be pointed out below, however, the potential for damage to a company’s
reputation is not great enough to stop a large company from engaging in
preannouncements. The negative effect is not generally as large as the benefit that
can be gained from injuring a competitor in a strategic market.
There are two other negative effects that a firm can face by its own
preannouncement. First, it informs competitors of the plans that a company has
and gives them time to respond.'^" Second, an announcement of new product
versions can slow the sales of the prior versions. This has been cited as the cause
of the demise of Osborne Computer and has thus been referred to as the "Osborne
Effect.”'^ ^ This type of cannibalization without new revenues can be avoided with
appropriate tactics. Besen and Farrell point out that a firm can avoid the fate of
Osborne by providing discounts on the future version to consumers who buy the
current one.'^ Microsoft, for example, provided upgrade coupons to buyers of
160
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Office 95 for several months prior to the introduction of Office 97. The larger that
a company is and the more products that it has, the better able it is to absorb the
losses caused by cannibalization. If the company is facing a competitor in a new
market that it wants to enter, however, it can only freeze sales of the competitor’s
product, not its ow n."^^
The effects on the market and competitors seem to be much more
significant than the effects on the vapourware announcer itself. There is a general
consensus that vapourware is a common tactic. In an academic survey, many
companies even admitted to engaging in it.'*^ It is commonly believed that
preannouncements have damaged competition. In a different survey 68% of
managers in information systems agreed that Microsoft’s announcements have
been anti-competitive in the sense that they froze markets for the products of
smaller companies. Nonetheless, 80% of respondents still felt that the information
provided in the announcements was useful to IS managers.'*^ A large company is
also able to use vapourware to enter new markets that are led by small companies.
A historical example is the IBM preannouncement of a disk array drive system for
its mainframe computer. This caused a slump in the sales and stock price of the
small leading firm, E.M.C. C orp."*® There is also theoretical support for the idea
that the potential for competition from a large company can have a serious impact
on small markets."^® This would not be as problematic if the target of vapourware
were able to use a counter-strategy to protect itself. Unfortunately, however.
161
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
vapourware is much more effective for large firms than for small firms. Thus, a
competing announcement wül be relatively ineffective.
One of the key factors that makes vapourware so effective and common is
that it is virtually costless to the perpetrator. As mentioned above, the reputation
and cannibalization effects are relatively minor for large firms. The only cost is,
thus, for advertising the future product, which, given the importance of the trade
press in diffusing information, may consist of a single press release. Press releases
have been found to be an effective promotion method.^° At very little cost the
large company is able to raise the costs of a smaller company because it is more
costly to counter the false information that the larger company is spreading.^’
A serious effect of a fraudulent preannouncement is that it misleads
customers. Thus it can be equated to false advertising, which has been shown to
be damaging to markets. False information causes a misallocation of resources.
It can reduce the number of competitors and thus the choice that consumers face
as weU as increase the market power of a dominant firm.^^ According to Gerla,
“[fjalse or misleading information is a deadweight economic loss, causing injury
without any offsetting economic benefit.”^'’ ^ Similarly, BeVier notes that “[fjalse
advertising. . . is unequivocally bad. It increases uncertainty and impedes
informed decision making.”^^ Furthermore, false advertising has been condemned
by many as unethical. For example Rudolf Callman states that “[a] seller who, by
means of false advertising, obtains a business contact which he can exploit,
162
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
acquires an undeserved advantage over his more ethical competitors.”^ ^ Richard
Degeorge, an ethicist, writes that “[i]f an ad makes a false claim, which the
advertiser knows to be false, for the purpose of misleading, misinforming, or
deceiving potential customers, then the ad is immoral.”^^ Although some
supposedly anti-competitive activities such as aggressive pricing can be seen to
have benefits for consumers, this is not so for inaccurate announcements. An
intentional act can also be condemned on ethical grounds.
Inaccurate information can be damaging to markets because it can lead
buyers to choose the wrong product. Consumers will not buy the product of the
smaller company because they falsely believe that they will soon be able to judge
it next to a new alternative from a better known company. Buyers also want to
avoid becoming technologically orphaned, which they expect might occur due to
the likelihood that the larger company will defeat the smaller one, thus resulting
in lack of support for the currently available product. Inaccurate
preannouncements thus tend to have greater negative effect on competitors than
on announcers.
Examples of Preannouncements
There are many examples of the use of vapourware by computer
companies to impede the adoption of rival products. The tactic was not invented
by Microsoft and has been used by many firms. In response to the Sporkin ruling,
163
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
one observer pointed out that “N'licrosoft’s guilty of vaporware. So is half the
industry.”^ * There are many examples throughout the history of the industry. In
1978 Intel’s introduction of the first 16 bit microprocessor, the 8086, was met
with announcements of products that did not then exist by competitors Motorola
and Zilog.^^ Another example is an integrated software package by a company
called Ovation Technologies which was announced but never came to market.^°
Microsoft itself has been a victim of vapourware. After introducing a word
processor, the company was faced with an advertisement by Ann Arbor Softworks
that urged users to wait for its Full write program, which did not become available
for several months.^' Lotus also battled a Microsoft product through the
announcement of a Macintosh version of 1-2-3. The product took three years to
reach the market.^^ After Microsoft preannounced its Windows version code-
named Chicago, which became known as Windows 95, Apple offered its own
vapourware, its Copland operating system, which was at a minimum two years
away from commercial release. Apple admitted that the purpose of the
announcement was to “blunt Chicago’s momentum .. Apple continued with
this tactic in November 1995 months after the introduction of Windows 95, even
though Copland would require a year of further development.^ These examples
show that Microsoft may be able to develop a case against other firms if
vapourware is declared illegal.
164
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
There are, of course, many documented examples of Microsoft’s use of
vapourware. The term, in fact, was apparently coined in 1982 by Microsoft’s own
engineers John Ulett and Mark Ursino.^^ Microsoft used the tactic in the earliest
days of the company. BUI Gates promised the president of MITS, Ed Roberts, that
he and Paul Allen could provide him a working version of BASIC for the Altair
computer within three weeks.^^ Roberts was told that they already had h e
program available^^ but in fact they had not written it and eventually delivered it
in seven weeks. Similarly, when IBM made a contract for a BASIC program for
the 8086, Microsoft missed most of its production deadlines.^^ A Microsoft
employee named Steve Wood later explained that the company “would always
underestimate” the time to complete a project and that “deadlines were often
missed, products weren’t always well designed, and contracts had to be revised
due to unforeseen obstacles or delays.”^^ Another Microsoft employee, Scott Oki,
stated that the company had a similarly difficult time developing products for the
Japanese market in the early 1980s: “[t]he number of undeliverables to Japanese
customers in the early days—I mean, boy, that’s a real long list. The number of
missed product dates: It’s incredible. We missed everything.”^ ®
Microsoft was also a major vapourware practitioner during its
development of a graphical user interface. The company began working on the
GUI in 1982. Shortly after VisiCorp announced its work on a similar product
called VisiOn at Comdex in Fall 1982, Gates claimed that Microsoft would be
165
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
able to ship its GUI before VisiCorp even though it did not then have a
prototype/* In October 1983, two weeks after VisiCorp announced its plans to
ship the product, Microsoft announced the future availability of Windows, which
Gates predicted would be installed on 90% of IBM compatibles by the end of
1984/“ Another probable purpose of the announcement was to blunt the
introduction of the Macintosh that was to occur shortly afterward as weU as
impede IBM, which was working on a similar project/^ According to Microsoft
employee Scott McGregor, the company “basically announced the product when
we hadn’t even designed it yet.”’'* Microsoft continued promising and missing
release dates until Windows finally shipped on November 21, 1985.’^ These
announcements likely damaged competing products that had been released, such
as VisiOn and GEM.’^ The product manager for Windows, Leo Nikora, admitted
in a 1984 interview that his company’s software was almost always completed
behind schedule.”
The use of vapourware by Microsoft has also been frequent since the mid-
1980s. The company armounced a multitasking version of DOS, DOS 4.0, in early
1984 but were unable to ship it until late 1986.’^ In 1989, it announced that it
would work with Apple to produce a competitor to Adobe Postscript and then
clarified a year later that the product was still more than a year from completion.”
Competitors also complain that Microsoft has used public announcements
strategically to reduce the probability that a competitor’s product will be adopted.
166
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
For example. Caldera, which owns the rights to the defunct DR DOS operating
system claims in a 1996 antitrust lawsuit that Microsoft declared incorrectly that
DR DOS would be incompatible with Windows 3.1.^° The product had been a
market leader, with higher retail sales than MS-DOS, and had higher customer
satisfaction in a PC Magazine polL^* The Caldera complaint gives a specific
example of Microsoft’s use of vapourware:
Microsoft responded to DR DOS 5.0 by announcing, in May 1990,
that it intended to issue a new release of MS-DOS, to be called
MS-DOS 5.0, which would mirror the technical advantages already
present in DR DOS 5.0. Microsoft indicated that the new release of
MS-DOS would be available within a few months. Industry
experience indicates that it would have been near-impossible for
Microsoft to develop and release a commercial version of its
product matching the features of DR DOS 5.0 within that period.
Nonetheless, Microsoft repeated this vaporware announcement
throughout the summer and into the fall of 1990. In fact, MS-DOS
5.0 was not released until June 1991 and, when finally released, it
did not offer the features Microsoft had promised.^”
The preannouncements have continued as Microsoft grew in strength and began
to face antitrust scrutiny. In 1993 Microsoft shipped Windows NT six months late
and without several promised features^^ and using twice as much memory as had
been previously claimed.*'^ The company had already announced an upgrade to
NT code-named Cairo in 1992. It was promised for 1994^^ but did not ship until
1997. In 1994 Lotus and Microsoft engaged in what industry observer Jessie Berst
characterized as “dueling vaporware,” with announcements on client-server
systems. The Microsoft Exchange Server, a competitor to Lotus Notes, shipped
more than a year late.*^
167
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
The shipping date for Windows 95 was likewise pushed back several
times. The promise of this new operating system may have deterred some
purchases of IBM OS/2, which provided a 32 bit environment over a year before
Windows 95 became available. The announcement of a six month shipping delay
resulted in an example of the effect of “freezing the market.”® * It resulted in
slumping sales for the computer industry.®^ The company showed particular skill
in receiving help from Compaq to promote the plug-and-play features of
Windows 95 more than a year prior to the release of the program. According to
industry observer John Blackford, “Microsoft’s side benefit is that such deals
prevent its new partners from joining the ever-popular Microsoftbashing refrain
echoing around the industry.”^ ®
These vapourware tactics have extended into the Internet era. There were
many preannouncements of products in 1995 and 1996.^^ A particularly blatant
example was Blackbird, which, according to one observer, succeeded in its goal
of stopping “investors, the media and users from declaring Java the standard for
software of its kind.”^“ An Internet competitor, Netscape’s Mark Andreessen,
agrees that Microsoft is guilty of vapourware: “they are very good at using FUD
[fear, uncertainty, doubt] to attempt to paralyze the market.”^ ^ Similar opinions
abound. According to William Zachmann, president of Canopus Research,
“Microsoft routinely claims it is going to ship software when it knows the
software isn’t ready, to keep the market on tenterhooks waiting for Microsoft
168
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
products and therefore not buying competitors’ products.The publication PC
Letter regularly publishes a list of companies that engage in vapourware.
Microsoft is often at the top.^^
There is thus substantial evidence that Microsoft has used vapourware
tactics at least as much as its competitors. Furthermore, its size has helped it to be
more successful with the announcements than its rivals have been. The next
section outlines the reasons why this occurs.
Theoretical Explanations for Preannouncements
There are several potential explanations for the success of vapourware.
One possibility is that it raises the costs of rival firms. The antitrust theory of
raising rivals costs was developed relatively recently in the post-Chicago School
period. It was initially brought forward in the context of vertical integration by
Thomas Krattenmaker and Steven Salop.^^ A monopolist could put its rivals at a
long term disadvantage if it were able to secure exclusive use of the least
expensive input. The main criteria of raising rivals costs is that the firm takes an
action against a competitor rather than exercising market power with buyers or
suppliers.^^ Advertising is particularly effective. According to Harry Gerla, “the
nature of human information processing makes the dissemination of false
information an almost ideal strategic tool for raising rivals’ costs.”^ ® To battle the
false information provided by a competitor’s vapourware announcement, firms
169
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
have to raise their expenditure on advertising. Indirectly it can lower a firm’s
stock price, thus increasing the costs of finance.^^
Vapourware is thus a good example of a tactic that raises the costs of
rivals. This is more effective than price predation because it does not have short
term costs. The competitor has the higher costs and thus will either raise prices or
lower output, which may raise the short term profits of the firm using the tactic.
Furthermore, there is no need to force the competitor out of the market because it
is at a competitive disadvantage after its costs have increased."^ I^nlike,
predatory pricing, fraudulent announcements have no potential benefit for
consumers. As well, there are many real world examples of their successful anti
competitive use.
Another advantage of preannouncing products, is that it can gain the
company a reputation amongst potential competitors that it can cause great
damage to them at little harm to itself. This credible threat may prevent these
rivals from challenging the dominant company and thus preventing it from having
to engage in the practice. According to George Hay, to make the credible threat
model work “requires only good information (i.e., the story of the predation in the
first market has to be communicated to the future wouldbe entrants), and some
nontrivial costs of entry and exit (so that unsuccessful entry attempts are not
costless).”
170
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
The reputation gained with potential competitors can be offset by a
negative reputation perceived by consumers who have been disappointed by
inaccurate preannouncements. When IBM was faced with its antitrust case, it
hired an economist, Franklin Fisher, to address the issue of preannouncements. He
later stated that “a firm that practiced such tactics would acquire a tarnished
reputation that would ill serve it in the future.” Similarly Richard Posner has
argued that firms are deterred from false advertising due to the negative effect it
can have on a company’s reputation.
Although this makes sense in theory, Microsoft does not seem to have
been punished by consumers for its extensive use of vapourware. One of the
factors protecting the company is its monopoly position. If consumers have no
other choices they cannot punish the dishonest company. Monopoly has been
identified by Robert Reich as insulating the monopolist from such concerns: if
there is “excessive concentration, goodwill may cease to be an important factor,
since patronage can often be guaranteed without it.”* °^ Another factor is the view
that since the public has a positive view of Microsoft due to its strong position,
people may be more inclined to believe its announcements than those of its
com petitors.Several factors have been pointed out by Prentice. If the company
carefully chooses the markets in which it uses FUD tactics, it may be able to
offset the cases of inaccurate announcements with a majority of announcements
that are accurate. Furthermore, customers may never realize the degree of
171
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
inaccuracy of the preannouncement because they did not have the opportunity to
try the superior product that was first to market. As well, to the extent that the
product is technically complicated, users may come to the conclusion that
apparent problems are due to their lack of understanding. Consumers are also
limited in their ability to punish a company by the number of times that they buy
the product. Goods such as software packages are purchased infrequently and thus
memories of past difficulties may fade.'°^ Cognitive dissonance is another
potential explanation. Users who buy Windows may subconsciously search for
facts to support their purchase decision. They could convince themselves that they
made the right decision. Prentice further points out that there could be an
endowment effect. This would cause a user to value a product that he has higher
than one that he does not and lead him to continue purchasing from a company
due to habit or loyalty.Consumers may also wrongly assume that firms that
may engage in false advertising will be deterred by punishment under the law
even though this has not generally occurred in the computer industry. This
assumption could lead them to believe that the current aimouncement is truthful.
If they realize the laws are not being enforced they may choose to punish high
tech firms in general rather than those that are truly guilty of the practice.
According to one observer vapourware has “hurt the reputations of companies
with histories of on-time delivery as much as the tardy ones.”"° As well, the
effects of increasing returns and network externalities mean switching costs are
172
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
high once a consumer chooses a standard. This limits the ability to inflict
punishment and is due to the amount of time and money that a customer needs to
invest when he switches to a new standard. Furthermore, given that customers
tend to remain with one company due to the lock-in effect, the fraudulent
preannouncement cannot hurt the predator. Even if the preannouncer receives a
bad reputation it never would have received the business of the customer that it
fooled in the first place because he would have been locked into the competitor’s
product. ' ^ ^ There are thus, many reasons to believe that a vapourware marketer
need not fear the effect that dishonesty will have on its reputation.
Vapourware and reputation issues would not matter if advertising were not
a major determinant of success. However, it is particularly significant in the
computer industry, where economies of scale are important. According to Roger
McNamee, a general partner of Integral Capital Partners, “the critical success
factors in the software business are marketing, distribution and customer support,
all of which benefit from economies of scale.” Likewise, a commentator in
Advertising Age has pointed out that the software industry has changed from “one
solely based on innovation to one partly based on economies of scale, including
marketing mass.”"^ There is also a relationship between advertising and market
power. In a study of advertising and competition, William Comanor and Thomas
Wilson concluded that “heavy advertising does contribute to high levels of market
power in some industries.” "'* The courts have also accepted the importance of
173
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
advertising as an entry barrier. In Berkey Photo, Inc. v. Eastman Kodak Co., the
court ruled that: “[a] monopolist is not forbidden to publicize its product unless
the extent of this activity is so unwarranted by competitive exigencies as to
constitute an entry barrier.” In Phototron Corp. v. Eastman Kodak Co., it ruled
that some advertising can create barriers to entry and can thus be considered
predatory behaviour. ' Established brands are much cheaper to advertise than
new ones and this also favours the monopolist. The importance of advertising in
high tech industries is one of the reasons why vapourware is so successful.
Legal Interpretations and the Issue of Intent
There is some disagreement on the subject of whether an inaccurate
product preannouncement can constitute an antitrust violation. In the Tunney Act
proceeding following the 1994 Consent Decree, the amici brief argued that in the
U.S. V. AT&T (1981) the court ruled that a preannouncement had an anti
competitive effect. AT&T was found to have launched an aggressive marketing
campaign to discourage investors from financing a new network introduced by a
competitor using the rationale that it was developing its own system."^ However,
many legal scholars argue that preannouncements cannot be anti-competitive.
According to William Kovacic of American University, in the 1970s companies
such as IBM and Kodak won litigation against them for preannouncements that
they had made."^ Lopatka and Page state that fraudulent vapourware should be
174
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
treated under tort rather than antitrust law/^^ Prentice states that Microsoft
preannouncements do not seem to meet the Sherman Act section 2 sanction
against conspiracy to monopolize.Thus, it would be difficult to win an antitrust
case based purely on vapourware. One promising area would be if new post-
Chicago antitrust theories, such as raising rivals’ costs, were accepted by the
courts.
Another legal interpretation of interest is whether courts consider intent as
a decisive factor in determining whether a preannouncement is to be punished.
Intent refers to whether the vapourware marketer believed the statement to be true
at the time it was made. The distinction is important because accurate information
cannot be considered bad from the point of view of efficient markets. The more
information available to a consumer, assuming that it is accurate at the time it is
made, the easier it is for the consumer to make the decision that maximizes his
welfare. It is tme, however, that accurate announcements may prove false later
due to changes in circumstances. Products that are in development can mn into
many unexpected difficulties. Sometimes a feature that is promised may be more
complicated to deliver than at first thought. The complexity of technological
products is such that promises can be broken unintentionally.^"* Inaccurate
announcements do, however, have negative repercussions. Consumers find that
previous decisions were not optimal. Vendors may face inventory difficulties such
as an excess number of products for the targeted firms followed by the lack of
175
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
products from the announcer. Sellers, for example, were hurt in this way by
IBM’s preannouncement of the PC Jr. prior to Christmas 1983.’“ Given this
damage, it would seem unjust to allow a company to benefit from an intentionally
inaccurate announcement.
Courts have generally held that intent matters in issues of false
advertising. In MCI v. AT&T the court found that intentionally false statements
constitute an antitrust violation while ones that are truthful at the time they are
made do not.’^ There was a similar ruling in Berkey Photo v. Kodak that
advertising is not anti-competitive unless there is a knowing attempt at
deception.According to Prentice, the Lanham Act goes even farther:
“punishing false representations even in the absence of an intent to deceive or
knowledge of the falsity.”’^
With respect to compatibility standards, Farrell and Saloner point out that
accurate preannouncements may reduce welfare if they cause a later technology to
be adopted and impose greater costs on consumers orphaned by the first product
to market than benefits for the adopters of the new technology.’"^ This, however,
seems unlikely if the preannouncement is truly accurate. Consumers should be
able to gauge the advantages and disadvantages of each choice based on the
available information. In the absence of the announcement they could choose the
first technology, which could just as easily be the wrong choice.
176
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
The issue of intent is also controversial in the opposite way. Some courts
have held that neither an accurate nor a fraudulent announcement can be anti
competitive. This view is held by Judge Easterbrook.^"^ Some observers, such as
Harold Demsetz, believe that intent is impossible to determine and thus should
not be considered.
There are, however, many reasons to believe that intent should be
considered by the court. An announcement that is truthful at the time it is made
cannot be considered bad conduct. There are many legitimate motives for
outlining product plans in advance. Consumers, vendors, developers, and
investors want to plan for the future. Providing information may improve profits
for the firm due to the intrinsic benefit of the information. If the information were
false, profits would be achieved at the direct expense of the competitor. If a firm
were automatically held hable for statements made that later turned out to be
false, it would cease making any statements about future plans, whether they were
truthful or not.*“^ Furthermore, industry observer David Coursey has pointed out
that if a company were punished for failing to meet release dates that had been
promised, it would ship the software regardless of the number of bugs still to be
worked out.’^° Robin Landis and Ronald Rolfe make a convincing argument in
support of innocent preannouncements: “[t]he welfare of consumers can be
increased only by having additional correct information that is relevant to their
purchasing decisions. If competitors lose sales because consumers prefer to
177
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
postpone their purchases until the new (and presumably more desirable) product
becomes available, those lost sales are the result of competition . . . The practice
creates no entry barriers because it imposes no differential costs on would-be
entrants.” Given the benefits provided by information and the uncertain
environment surrounding technological products, consumers should be willing
and able to weigh in their purchase decision the probability that a preannounced
product might not ship exactly as expected.
It also should be pointed out that in the case of architectural monopolies,
predisclosure is absolutely essential to preserve openness and competition for
applications. In the past, companies such as IBM and Kodak have been sued for
not predisclosing products prior to their introduction.^^" Although the court found
in each case that the monopolist had no such duty, this is not a desirable ruling
from the point of view of preserving the openness of a proprietary standard. One
cannot expect a company to make the predisclosures so necessary for competition
if they are to be held liable if they cannot deliver everything promised.
Competition in applications would probably decline if such a strict law were
implemented. Companies making preannouncements should only be held
accountable if it can be shown that the statements were untruthful at the time they
were made.
The number of examples of inaccurate announcements involving
Microsoft seems to provide evidence that the company would be held liable under
178
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
the type of law that is proposed here. The purpose of the law, however, is to deter
and its absence was no doubt a reason for why there have been so many blatant
examples. The evidence, nonetheless, should be quite strong to convict a
vapourware marketer and many observers feel that the evidence against Microsoft
is insufficient. One aspect that any law regarding intent would have to address
is how to deal with a somewhat fraudulent announcement. For example, an
announcer might know that the release date is very uncertain but could offer a
date regardless. It seems likely that any successful litigation would require a
“smoking gun” such as an internal memo.
Toward a Law of Preannouncements
An appropriate law must take into account the views of the industry for
which it is aimed. In May 1995, Computerworld polled information systems
managers on the topic of vapourware. The four main findings were that: IS does
not want federal government involvement in vapourware regulation; Microsoft
uses the tactic to freeze the market; many firms in the industry do the same; and
vapourware provides useful information but IS does not need to know about
products more than three to six months prior to introduction. The problem with
this poll is that it is too narrowly focused on IS. There are other stakeholders such
as innovating companies and makers of complementary software. Since
fraudulent preannouncements can unfairly damage a company there is little
179
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
alternative to legal liability. Furthermore, three to six months is not enough to
ensure that complementary products can be brought to market in time for the
introduction if the product is architectural in nature.
It is quite possible that new laws do not need to be established to police
vapourware. The interpretation of existing ones can be used to find violations of
the Sherman Act provision against monopolizing behaviour. For example,
Prentice points out that fraudulent preannouncements can meet a traditional test
for anti-competitive activity. Since it is unnatural in the sense that it is unethical
and is directly aimed at competitors, it is thus unfair conduct for a monopoly.
Another important issue is how to differentiate fraudulent
preannouncements by a monopoly from similar behaviour by small firms. Both
are unethical but a key point is that the law sets different rules for monopolies
than it does for other firms. It does not seem fair, however, to permit some firms
to destroy the market position of a dominant firm that is not permitted to respond
using similar tactics. However, the tactics are much more likely to be successful
when used by a large firm. The best solution is to recognize this form of false
advertising as a potential method for anti-competitive conduct by a monopoly
while at the same time applying tort laws to small and large firms alike.
A potential application of the law that seems sensible is provided by
Prentice. He suggests that fraudulent preannouncements are similar to statements
made by publicly traded companies to their investors. It is thus possible to borrow
180
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
from regulations established by the Securities and Exchange Commission to deal
with false statements by companies. Prentice cites many examples of cases that
have been filed under SEC rules against high tech companies that failed to meet
the claims in their vapourware announcements. To be actionable under these rules
an announcement must meet the conditions “(a) that the statement is genuinely
believed, (b) that there is a reasonable basis for the belief, and (c) that the speaker
is not aware of any undisclosed facts tending to seriously undermine the accuracy
of the statement."This test has already been applied many times and represents
a high burden of proof. Its application in antitrust would provide a clear rule that
large firms could follow to avoid liability. It would give them a legal as well as a
moral incentive to avoid untrue statements that damage their rivals. The heavy
burden on plaintiffs is important because it will prevent mistakes that could
reduce the incentive for innovation and the provision of information to the
market.
Economists argue that consumers are well served by valid information that
enables them to evaluate options. To the extent that product preannouncements
are accurate, therefore, no harm can be said to be done to either the consumer or
competitors. If malicious intent can be proven, however, then competitors may be
entitled to seek damages. To avoid accusations of vapourware, firms may
voluntarily not provide shipping dates because it is difficult to know when a
product based on intellectual work will actually be ready if it does not already
181
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
exist. To avoid liability they could adopt a policy similar to the one proposed by
industry observer Stewart Alsop. The company could restrict information
provided on products in development to its developers and most important
customers. It could oblige them not to reveal the information to the industry press
or others through nondisclosure agreements. Thus the market would not be misled
but key players would be informed.Of course, for products that do not involve
the development of complements the market does not receive great benefits from
predisclosure and thus firms could follow the advice of the IS professionals and
not preannounce more than three to six months prior to the shipping date.
The most serious reason why vapourware should be addressed by the law
is that it distorts markets and causes consumers to choose products that do not
maximize their own or general welfare. Institutions are required to ensure that the
optimal choice is made. The reason for this is that vapourware is a clear case of
asymmetric information. High tech firms can easily conceal information about
their true product developments from consumers, who cannot normally evaluate
the veracity of product announcements. Since firms can gain from inaccurate
statements there wül be a tendency for these to drive accurate statements from the
market, thus increasing the difficulty of evaluating purchases. Although this can
be a severe problem in the absence of rules, it can be reduced considerably
through imposing disincentives on those who would engage in the practice. Firms
that can be shown to have knowingly made an inaccurate product announcement
182
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
should be held liable. If the perpetrator has monopoly power it should be charged
under antitrust laws. With a high burden of proof, this law could achieve a
reduction in false preannouncements while limiting any disincentive for releasing
accurate information.
Some observers, including Alsop, claim that the movement toward
Internet time has made the issue of vapourware increasingly irrelevant. New
versions of products seem to be released at an ever increasing speed. It is certainly
true that there is less of a buzz in the industry about the issue than there once was.
The movement toward faster product cycles may, however, be a short term
phenomenon. There is a limit to the number of times a user wants to upgrade to a
new software version. Customers may soon prefer to standardize on a single
version of an architecture for a longer period. This will reduce the incentive of
software makers to introduce new versions of their programs. There already
seems to be a decline in the frequency of major upgrades to the Netscape
Navigator and Internet Explorer browsers. At least a year will pass between
versions 4 and 5 of each program. The issue of vapourware has been a factor in
the industry since the dominance of IBM in mainframes and is not likely to go
away soon. For this reason, legal clarifications remain appropriate.
183
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Notes
‘ Cargill, Inc. v. Monfort of Colorado, Inc., 479 U.S. (1986), pp. 104, 117.
” Kelco Disposai, Inc. v. Browning-Ferris Indus, of Vermont, Inc., 845 F.2d (2d
Cir. 1988), pp. 404, 407.
^ D & S Redi-Mix v. Sierra Redi-Mix & Contracting Co., 692 F.2d (9th Cir.
1982), pp. 1245, 1249
lay Dratler, Jr., “Software: Microsoft as an Antitrust Target: IBM in Software?”
Southwestern University Law Review, 25, 1996, p. 720.
^ Respectively, A.A. Poultry Farms, Inc. v. Rose Acre Farms, Inc., 881 F.2d (7th
Cir. 1989), p. 1398; U.S. Philips Corp. v. Windmere Corp., 861 F.2d (Fed. Cir.
1988), p. 703; Kelco Disposal, Inc. v. Browning-Ferris Indus, of Vermont, Inc.,
845 F.2d (2d Cir. 1988), p. 406.
^ Dratler, 1996, op.cit., pp. 685-86.
^ United States v. Aluminum Co. of America, 148 F.2d (2nd Cir. 1945), pp. 416,
430.
^ Phillip E. Areeda and Donald Turner, “Predatory Pricing and Related Practices
Under Section 2 of the Sherman Act,” Harvard Law Review, 88, 1975, p. 716.
^ Matsushita Elec. Indus. Co. v. Zenith Radio Corp., 475 U.S. (1986), pp. 574,
589.
Dratler, 1996, op.cit., p. 723.
184
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
David Churbuck, " ‘Vapordisk,” Forbes, October 28, 1991, p. 188.
Mitch Betts, “Microsoft rivals seek to overturn antitrust deal,” Computerworld,
January 16, 1995.
United States v. Microsoft Corp., 159 F.R.D. (D.D.C. 1995), p. 335.
David Bender, “Microsoft and the Antitrust Wars,” Practising Law Institute,
Patents, Copyrights, Trademarks, and Literary Property Course Handbook Series,
September, 1995, p.73.
United States v. Microsoft Corp., 159 F.R.D. (D.D.C. 1995), p. 335.
Bender, 1995, op.cit., p. 63.
Mitch Betts and Stuart J. Johnston, “Judge probes deeper into Microsoft
antitrust case,” Computerworld, January 30, 1995.
Stuart J. Johnston and Mitch Betts, “Industry Debates U.S. Vaporware Probe,”
Computerworld, February 13, 1995.
William H. Davidow, Marketing High Technology: An Insider’ s View, New
York; Free Press, 1986, p. 3.
Wayne Eckerson, “Users Want Network Vendors to Stop Using ‘Vaporware’
Tactics,” Network World, July 10, 1989, p. 4
Jerry Wind and Vijay Mahajan, “Marketing Hype: A New Perspective for New
Product Research and Introduction,” Journal o f Product Innovation Management,
4, 1987, pp. 43,44.
185
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
“ Jayson Aycock, “Windows Development Saga: That Was Then, This Is 95,”
Austin American Statesman, August 19, 1995, p. D6.
^ Stan Veit, “Stan Veit’s History: Computer Magazines Created the Channels,”
Computer Shopper, October 1991, p. 693.
Samuel Rabino and Thomas E. Moore, “Managing New-Product
Announcements in the Computer Industry,” Industrial Marketing Management,
18, 1989, pp. 35, 36.
^ Robert Prentice, “Vaporware: Imaginary High-Tech Products and Real
Antitrust Liability in a Post-Chicago World,” Ohio State Law Journal, 57, 1996,
p. 1206.
Avery Jenkins, “Long Overdue: The Reasons Behind Vaporware,”
Computerworld Focus, October 5, 1988, p. 10.
Joseph E. Stiglitz, “Technological Change, Sunk Costs, and Competition,”
Brookings Papers on Economic Activity, 3, 1987, p. 910.
Prentice, 1996, op.cit., pp. 1198-99.
Michael R. Leibowitz, “The Microprocessor Marketing Wars,” Electronic
Business, July 10, 1989, p. 31.
Elizabeth Mensch and Alan Freeman, “Efficiency and Image: Advertising as an
Antitrust Issue,” Duke Law Journal, 1990, pp. 321, 341-53; William S. Comanor
186
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
and Thomas A. Wilson, “The Effect of Advertising on Competition: A Survey,”
Journal of Economic Literature, 17, 1979, p. 473.
Mike Langberg, “Microsoft to Unleash Hype to Open Windows 95,” Austin
American-Statesman, August 17, 1995, p. Cl.
“Coca-Cola Tops Magazine’s Rankings of Brands’ Value: IBM, Hit by PC
Clones, Shps to No. 290,” Washington Post, July 12, 1994, p. C4.
Howard Beales et al., “The Efficient Regulation of Consumer Information,”
Journal o f Law and Economics, 24, 1981, p. 510.
Rabino and Moore, 1989, op.cit., p. 40.
Mark Lacter, “Judge Went Beyond the Antitrust Spirit in His Microsoft
Ruling,” Sacramento Bee, February 21, 1995, p. B7.
Donald J. Boudreaux, “Microsoft’s Great Business Secret,” Washington Times,
March 3, 1995, p. A21.
Linda Bridges, “The Sweet SmeU of Vaporware Starts to Turn Sour for Many
Micro Managers,” PC Week, November 17, 1987, p. 19.
Software Publishers Association Europe, “SPA’s Competition Principles As
Adopted by the SPA Board of Directors, Jan. 30,1998,” February 3, 1998.
Available (online): http://www.spa-europe.org/press/Compprin2.HTM.
Lori Hawkins, “High-Tech Mirages,” Austin American-Statesman, March 6,
1995, p. Cl.
187
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Charles C. Kenney, Riding the Runaway Horse: The Rise and Decline o f Wang
Laboratories (Boston: Little, Brown, 1992), pp. 125-147.
Boudreaux, 1995, op.cit., A21
Grace Cassehnan, “Vaporware: Vüe or Valid?” Computing Canada, December
19, 1991, p. 1.
Casselman, 1991, op.cit., p. 1.
Stanley M. Besen and Joseph Farrell, “Choosing How to Compete: Strategies
and Tactics in Standardization,” Journal of Economic Perspectives, 8, 1994,
p. 124.
Prentice, 1996, op.cit., p. 1207.
Robert Smiley, “Empirical Evidence on Strategic Entry Deterrence,”
International Journal o f Industrial Organization, 6, 1988, p. 175.
Stuart J. Johnston, “Vaporware Tactics Elicit Mixed Views,” Computerworld,
May 1, 1995, p. 1.
Steve Lohr, “Product Prognostication, and Then ± e Unveiling,” New York
Times, June 19, 1994, p. F9.
William G. Shepherd, “Theories of Industrial Organization,” in Harry First
et al., eds.. Revitalizing Antitrust in its Second Century: essays on Legal,
Economic, and Political Policy (New York: Quorum Books, 1991), pp. 37-57.
188
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Jordan Goldman, Public Relations in the Marketing Mix: Introducing
Vulnerability Relations (Chicago: Crain Books, 1984), p. 225.
Harry S. Gerla, “Federal Antitrust Law and the Flow of Consumer
Information,” Syracuse Law Review, 42, 1991, p. 1063.
Roger Schechter, “Letting the Right Hand Know What the Left Hand’s Doing:
The Clash of the FTC’s False Advertising and Antitrust Policies,” Boston
University Law Review, 64, 1984, p. 323.
Richard Craswell, “Interpreting Deceptive Advertising,” Boston University Law
Review, 65, 1985, p. 686-687.
Gerla, 1991, op.cit., p. 1030.
Lillian R. BeVier, “Competitor Suits for False Advertising Under Section 43(a)
of the Lanham Act: A Puzzle in the Law of Deception,” Virginia Law Review, 78,
1992, p. 14.
Rudolf Callmann, Unfair Competition, Trademarks and Monopolies, 4th ed.
(Wilmette, DL: Callaghan, 1993), pp. 88-89.
Richard T. De George, Business Ethics, 2d ed. (New York: Macmillan, 1986),
p. 277.
Paul Somerson, “Spork You,” PC Computing, May 1995, p. 51.
Davidow, 1986, op.cit., p. 3.
Nico Krohn, “Not As Easy as 1-2-3,” InfoWorld, April 1, 1991, p. 41.
189
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Lindsay Van Gelder, “Vaporware for Sale,” Lotus, February 1988, p. 140.
Stephen Kreider Yoder, “Computer Makers Defend ‘Vaporware,’” Wall Street
Journal, February 16, 1995, p. BI.
G. Pascal Zachary and Jim Carlton, “Software Rivals Vying to Define How
PCs Work,” Wall Street Journal, Mar. 7, 1994, p. B l.
^ Peter Burrows, “Apple’s Copland: New! Improved! Not Here Yet!” Business
Week, December 18, 1995, p. 80.
Laurie Flynn, “The Executive Computer,” New York Times, April 24, 1995,
p. D4.
James Wallace and Jim Erickson, Hard Drive: Bill Gates and the Making o f the
Microsoft Empire, (New York: Wiley, 1992), p. 78.
Stephen Manes and Paul Andrews, Gates: How Microsoft’ s Mogul Reinvented
an Industry and Made Himself the Richest Man in America (New York :
Doubleday, 1994), p. 71.
Wallace and Erickson, 1992, op.cit., p. 192.
Wallace and Erickson, 1992, op.cit., pp. 120-21, 135-36, 152
Manes and Andrews, 1994, op.cit., p. 211
Wallace and Erickson, 1992, op.cit., pp. 251-52.
Wallace and Erickson, 1992, op.cit., pp. 256, 258.
Wallace and Erickson, 1992, op.cit., p. 257.
190
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Manes and Andrews, 1994, op.cit., p. 241.
Wallace and Erickson, 1992, op.cit., p. 313.
Manes and Andrews, 1994, op.cit., p. 421.
Tom Shea, “Developers Unveil ‘Vaporware,’” InfoWorld, May 7, 1986, p. 48.
Manes and Andrews, 1994, op.cit., p. 421.
James Daly, “Postscript Challenger Fades: Microsoft’s Page Description
Language Not Expected Until Mid-1991,” Computerworld, October 15, 1990,
p. 48.
“Software Developer Caldera ® Sues Microsoft ® for Antitrust Practices,
Alleges Monopolistic Acts Shut its DR Dos ® Operating System Out of Market,”
PR Newswire, July 24, 1996.
Prentice, 1996, op.cit., p. 1182.
PR Newswire, 1996, op.cit.
Richard Morochove, “Lies My Computer Maker Told Me,” Toronto Star, May
12, 1994, p. 02.
^ Manes and Andrews, 1994, op.cit., p. 461.
Amy Cortese, “Windows 95,” Business Week, July 10, 1995, pp. 94, 104.
^ Martin Wolk, “Microsoft to Outline Messaging Strategy,” Reuters Financial
Service, April 19, 1994.
191
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Don Clark, “Microsoft’s Windows 95 Is Just a Sideshow,” Wall Street Journal,
August 24, 1995, p. B8.
^ Charles Bruno, “Playing Fair,” Network World, July 25, 1994, p. 44.
Jeff Rose, “What’s on the Table When Shark is Finished Dining?” San Diego
Union-Tribune, November 8, 1994, p. 3.
John Blackford, “Microsoft Uber Allés? Software Titan’s Marketing Savvy
Overcomes Its Childish Posture,” Computer Shopper, July 1994, p. 62.
Thomas Mace and Ned J. Rubenking, “Inside the ActiveX Platform,” PC
Magazine, September 24, 1996, p. 207.
Dave McCombs, “The Emperor’s New Software,” Daily Yomiuri, April 8,
1996, p. 15.
Chip Bayers, “Why BiU Gates Wants to Be the Next Marc Andreessen,” Wired,
3.12, December 1995.
“Report Slams Microsoft Tactics,” Report on Microsoft, 3 (24), December 18,
1995.
“Vaporware Wins No Laughs at Microsoft Now,” San Diego Union-Tribune,
February 21, 1995, p. 1.
Thomas G. Krattenmaker and Steven C. Salop, “Anticompetitive Exclusion:
Raising Rivals’ Costs to Achieve Power over Price,” Yale Law Journal, 96, 1986,
p. 292.
192
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Prentice, 1996, op.cit., p. 1201.
Gerla, 1991, op.cit., p. 1063.
Kathy Rebello et al., “Is Microsoft Too Powerful?” Business Week, March 1,
1993, pp. 82, 86.
Prentice, 1996, op.cit., p. 1202.
George A. Hay, “A Confused Lawyer’s Guide to the Predatory Pricing
Literature,” in Stephen Salop, ed., Strategy, Predation, and Antitrust Analysis
(Washington, D.C.: Federal Trade Commission, Bureau of Economics, Bureau of
Competition, 1981), pp. 160-61.
Franklin M. Fisher et al.. Folded, Spindled, and Mutilated: Economic Analysis
and U.S. v. IBM (Cambridge, MA: MTT Press, 1983), pp. 289-90, 299.
Richard A. Posner, Regulation o f Advertising by the FTC (Washington DC.:
American Enterprise Institute for Public Pohcy Research, 1973), pp. 4-9.
Robert B. Reich, “Toward a New Consumer Protection,” University of
Pennsylvania Law Review, 128, 1979, p. 29.
James Coates, “Beware the Bearer of Hype,” Austin American-Statesman,
April 18, 1994, p. FI.
Prentice, 1996, op.cit., p. 1210.
Prentice, 1996, op.cit., p. 1211.
Prentice, 1996, op.cit., p. 1211.
193
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
109
Prentice, 1996, op.cit., p. 1211.
Joyce Lane, “Promotion Peddlers Tug on the Reins,” San Jose Business
Journal, Apr. 28, 1986, s. 2, p. 6.
Prentice, 1996, op.cit., p. 1215.
Barbara Darrow and Deborah Gage, “And Then There Were Three—Huge
Buyout Plan Pits Novell Against Microsoft, Lotus in the Applications Business,”
Computer Reseller News, March 28, 1994, p. 1.
Junu Bryan Kim, “Fighting Giants with ‘Sim’-pie Ideas,” Advertising Age,
May 16, 1994, p. 148.
Comanor, 1979, op.cit., p. 473.
Berkey Photo, Inc. v. Eastman Kodak Co., 603 F.2d (2d Cir. 1979), p. 287.
Phototron Corp. v. Eastman Kodak Co., 842 F.2d (5th Cir. 1988), p. 100.
Bender, 1995, op.cit., pp. 68-69.
Philip Elmer-DeWitt, “Tripping Up the Titan,” Time, February 27, 1995, p. 33.
* John E. Lopatka and William H. Page, “Microsoft, monopolization, and
network externalities: some uses and abuses of economic theory in antitrust
decision making,” The Antitrust Bulletin, Summer 1995, p. 356-61.
Prentice, 1996, op.cit., p. 1187.
Prentice, 1996, op.cit., p. 1175.
194
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Regis McKenna, Wlio’ s Afraid o f Big Blue? How Companies are Challenging
IBM—and Winning (Reading, MA: Addison-Wesley, 1989), pp. 118-19.
MCI Communications v. AT&T, 708 F.2d (7th Cir. 1983), p. 1128.
Berkey Photo, Inc. v. Eastman Kodak Co., 603 F.2d (2d Cir. 1979), pp. 287-
288.
Prentice, 1996, op.cit., p. 1244.
Joseph FarreU and Garth Saloner, “Installed Base and Compatibility:
Innovation, Product Preannouncements, and Predation,” American Economic
Review, 76, 1986, pp. 942-43.
A.A. Poultry Farms, Inc. v. Rose Acre Farms, 881 F.2d (7th Cir. 1989),
p. 1401.
Harold Demsetz, “Barriers to Entry,” American Economic Review, 72, 1982,
pp.54-55.
Prentice, 1996, op.cit., pp. 1244-1245.
Hawkins, 1995, op.cit., p. Cl
Robin C. Landis and Ronald S. Rolfe, “Market Conduct Under Section 2:
When is it Anticompetitive?” in Frankhn M. Fisher, ed.. Antitrust and Regulation:
Essays in Memory o f John J. McGowan (Cambridge, MA: MTT Press, 1985),
p. 140.
195
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
California Computer Prod., Inc. v. IBM Corp., 613 F.2d (9th Cir. 1979),
p. 744; Berkey Photo, Inc. v. Eastman Kodak Co., 603 F.2d (2d Cir. 1979),
p. 281.
Brit Hume, “The Flaw in Judge’s Rejection of Microsoft Settlement,”
Washington Post, February 27, 1995, p. F20.
Stuart J. Johnston, “Vaporware Tactics Elicit Mixed Views,” Computerworld,
May 1, 1995, pp. I, 47.
Prentice, 1996, op.cit., pp. 1-2-36-38.
Prentice, 1996, op.cit., p. 1253.
Flyim, 1995, op.cit., p. D4.
196
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Chapter 5
Case Study: The IBM Monopoly
It can be instructive to the case for antitrust policy to look at an earlier
example. There are many parallels between the case of Microsoft and that of
IBM. The IBM case shows that a seemingly unassailable position can unravel
quickly. It had virtually absolute control of the computer industry until the early
1980s but was the victim of technological advances that it could not control. Prior
to its relative decline, it too was the subject of great antitrust attention. Eventually
the case against it was dropped but its monopoly feU without the direct assistance
of the government. As Kenneth Arrow states: “[w]e are dealing with a complex
system in which the outcome is not easily predictable. Indeed, predictions in the
whole of modem history of the information business have been very poor.”'
Given that this view can apply to Microsoft, an examination of how these
circumstances affected IBM can be instructive.
Similarities
One of the parallels is the connection between the two companies.
Decisions made by IBM eventually led to Microsoft’s strong market position.
IBM was late to the personal computer market and already faced strong but small
197
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
competitors such as Apple and Commodore, which each had incompatible
proprietary operating systems. In 1980 the company started a one year project
with the goal of bringing a personal computer to market. Given the short time
specified, developers had little choice but to put a machine together with off-the-
shelf components owned .by other companies. The largest beneficiaries were Intel,
which supplied the microprocessor, and Microsoft, which purchased a clone of
the CP/M operating system named QDOS from Seattle Computer Works. The
open architecture of the PC led to supporting products from ISVs thus enabling it
to rapidly become a de facto standard. IBM hoped to maintain a degree of control
through ownership of the BIOS but this proved easy to replicate for potential
competitors. Intel and Microsoft were happy to sell their components to makers of
clones. The combination of these factors resulted in a highly competitive market
for personal computers that incorporated Intel processors and Microsoft operating
systems. IBM had lost its early market power and thus achieved much lower
profit margins than its two partners. Its market share fell below 50% in 1986 and
collapsed to 24.5% in 1988.“ IBM tried to regain the initiative by introducing its
proprietary micro channel architecture (MCA) in 1987. It later broke with
Microsoft and brought the first 32 bit operating system, OS/2, to market.
Microsoft overcame this challenge with the introduction and eventual success of
Windows NT and 95.
198
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
The loss of IBM’s computer monopoly can be attributed more to internal
decisions by the company than to the antitrust actions taken against it by the U.S.
and foreign governments. Nonetheless, these may have made IBM’s management
more tentative. The U.S. Department of Justice brought a case in 1969 that took
more than a decade to settle.
The European Commission also sued for “abuse of dominant position.” In
1984 IBM voluntarily agreed to modify its business practices. Specifically it
agreed not to bundle memory with CPUs and pledged to disclose interface
information for peripherals within 120 days of the announcement of a product. It
also agreed to provide information to competing makers of systems to enable
them to interconnect with the System 370.^ The antitrust scrutiny on both sides of
the Atlantic is thus a parallel between the cases of Microsoft and IBM. There are
many more.
Like Microsoft, IBM operated in a market where complementary products
were important. The plug compatible peripheral devices (PCPDs) of IBM’s
system were thus similar in function to applications software in Microsoft’s case.
IBM had a larger share of the complementary market than Microsoft has been
able to achieve. In 1970, its market shares were 90% for plug-compatible tape
drives, 68% for plug-compatible disk drives, 99.6% for compatible memory, and
92.3% for compatible communication controllers."^ Nonetheless, its share of the
market as a whole was declining, from 82.5% of revenues from the leasing of
199
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
general purpose computers in 1964 to 64.68% in 1970.^ IBM was, however, able
to maintain a dominant share of the mainframe industry well beyond this period.
The PCPD shares support the idea that IBM was able to leverage its mainframe
monopoly into complementary markets. Although antitrust law does not generally
restrict a company’s ability to innovate in its primary market, the effect of such
innovation on complementary markets requires greater attention. Both Microsoft
and IBM were accused of arranging innovation in the primary market to exclude
competition in secondary markets. Two separate lawsuits were brought against
IBM. Transamerica claimed that it had changed the interface between the
mainframe and peripherals.^ Calcomp attempted to prove that “IBM made design
changes on certain of its CPUs, disk drives and controllers of no technological
advantage and solely for the purpose of frustrating competition from plug-
compatible manufacturers.”’ These claims are similar to those frequently heard
about Microsoft’s manipulation of the interface between the operating system and
applications to put its competitors at a disadvantage.
Another similarity is that many observers believed that IBM remained
dominant in spite of producing products inferior to those of its competitors.
Although these observers suspected that the company’s control was due to
antitrust violations, the courts held that IBM was better at business strategy than
innovation. The company was known for a strong marketing and sales force,
speed, and high quality service. Its technical product design was not as strong but
200
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
this weakness was offset by the company’s other strengths/ Likewise, many have
declared Microsoft to be behind its competitors in terms of product design. The
company’s dominance could be explained by antitrust violations but good
business sense seems more probable.
Both companies faced much antitrust attention. The U.S. government
twice sued IBM for tying. The result was that IBM first unbundled punch cards
and later software. Other suits regarding the tying of services to parts are stiU
pending.^ Suits unrelated to tying have had little success. The general
monopohzation suit begun in 1969 which could have led to divestiture was
terminated by the DOJ in 1982 because it was “without merit” as a result of
changes in the in d u stry .T h e suit continued for four presidential administrations
and was described by Robert Bork as “the Antitrust Division’s Vietnam.”^ * IBM
also faced several private antitrust cases of which most failed.
The DOJ’s actions regarding Microsoft and IBM were both challenged by
district court judges under the Tunney Act. In the IBM case the judge criticized
the dismissal of the suit and refused to allow the parties “to dispose of billions of
pages of documents accumulated over the course of the litigation.”* " In both cases
the judges were later rebuked by the Court of Appeals, which, in IBM’s case,
ruled that the Tunney Act did not apply to voluntary dismissals.*^
In spite of their dominant positions, IBM and Microsoft have been able to
avoid most antitrust sanctions against them. The only successful charges against
201
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
IBM have been for tying, squeezing leasing companies, and attempting to
monopolize some services/'^ Microsoft has only had to modify practices related to
OEMs, although a tying case against it remains in process. Courts and the law in
general may already treat computer monopolies differently than they do
monopolies in other industries.
Differences
Although there are many similarities between the situations of IBM and
Microsoft, there are also some differences. For example, IBM emphasized
hardware, had a greater degree of control, did not face uncertainty at higher
computing layers, had less need for backward compatibility, and did not execute
strategy as well.
IBM’s emphasis of hardware means that it has had little incentive to
modify its operating system with the purpose of reducing its compatibility with
competing applications programs. If it did so, its customers would be less likely to
buy IBM m achines.Instead they would buy systems that ran the greatest
number of applications programs well.
IBM had a greater degree of control over the computer industry than
Microsoft currently does. If the market is defined as the entire computer industry,
Microsoft has less than 10% of the overall share of revenues. In contrast, IBM
202
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
controlled most of the world market/^ The computer market has therefore become
more diverse and competitive in the 1990s than it was previously.
An indicator of the greater threat facing Microsoft is that, unlike JBM, it
has not controlled the top layer of computer systems. Just as applications makers
have to react to changes in the operating system, so must Microsoft in response to
improvements in computer hardware.
Microsoft has also faced a greater need for compatibility between
operating systems versions than IBM did. The reason is that the degree of training
necessary to use the operating systems of mainframes is relatively small.
Personal computers are driven by applications programs. If a new operating
system does not run the installed base of programs it is unlikely to succeed.
A final difference between IBM and Microsoft is that the latter appears to
have adopted more successful business strategies. In 1982 the Yankee Group
argued that IBM was a non-threatened company because of its position as market
leader in storage, communications, mainframes, minicomputers, and
microcomputers as well as its enormous R&D budget, which was larger than that
of the next five companies together.*^ In spite of this dominance, it did not take
long for it to be out-maneuvered by many of its much smaller competitors.
According to Bill Gates, part of the reason is that IBM became complacent and
did not renew its vision.“° In contrast to IBM, Microsoft has been able to adopt
technologies that threaten its base.“' It has, for example, bought small companies
203
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
that have developed innovative technologies that are likely to succeed. This adds
value for customers by bringing new innovations to the mainstream much faster
than would occur otherwise.
Comparison of Antitrust Issues
The comparison of IBM with Microsoft can now shift to specific antitrust
issues such as pricing, licensing, and bundling. Although Microsoft has at times
been accused of giving away software that its competitors sell, this issue has not
been a focus of antitrust cases against it. Competitors of IBM did, however,
charge the company with predatory pricing. This episode began with the
development of new products of which many were based on IBM’s internal
secrets. Competitors then undercut the IBM price and began to gain market share.
When IBM responded with its own price cuts it was sued. The litigation was
unsuccessful because IBM’s costs were found to be 10-15% lower than those of
its rivals.” Although it could have driven them out of business entirely, it chose
simply to stop the erosion in its market share. In this way it avoided legal action
and maintained large profit margins. One of the problems with accusations of
predatory pricing in this industry is that economies of scale make the costs of the
dominant company lower than those of new competitors. Thus the potential
monopolist could drive out aU competitors without pricing below cost.
204
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
IBM and Microsoft have both been successfully charged with
implementing anti-competitive licensing agreements. IBM was shown to have
manipulated the terms and prices of its computer leases to reduce competition
firom companies specializing in leases. Licensing agreements with OEMs were the
primary target of the first major antitrust investigation by the DOJ against
Microsoft. The resulting consent decree forbade Microsoft from charging OEMs
based on computers shipped rather than the number of copies of its own programs
loaded. Thus, both companies have manipulated their distribution channels to
lessen competition. Given the willingness by monopolists to attempt this and the
success of legal action to date, governments should continue to examine
distribution agreements by standards monopolists.
BundUng represents another strong parallel between the two cases.
Peripheral devices can be bundled with mainframes just as operating systems can
incorporate applications. A company may violate antitrust laws if it markets
products together that can be priced separately. IBM faced two accusations of
illegal tying.
In 1936 the Supreme Court forced it to sell punch cards separately from
tabulating machines and thus created independent competition for paper supplies.
IBM claimed that it bundled for the purpose of quality control but the court ruled
that the company should simply provide specifications. IBM was permitted to
205
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
produce and promote its own cards as well as specify that warranties only apply to
cards that meet its specifications.^
On June 23, 1969, IBM made a decision with much more sweeping
implications. The company faced legal action on bundling from a competitor,
Advanced Digital Research, in addition to the five month old lawsuit from the
DOJ.""^ IBM’s legal team concluded that unbundling was inevitable.^ As a result,
the company abandoned the practice of packaging software and services together
with its mainframe. This created the vibrant new software industry consisting, for
the first time, of ISVs.“^ The resulting innovation is one of the best arguments for
using the threat of legal action to force a monopolist to sell its products
separately.
The only problem with this method is that if the monopolist unbundles
voluntarily, rather than signing a consent decree or being ordered by the court, it
may return to bundling at a later date. By the 1980s, for example, some observers
were claiming that IBM was trying to return to bundling. In particular, it was
feared that the company was trying to dominate the PC software industry through
“sales promotion” of software bundled with the XT."^ As well, the company once
tried to determine which software programs had the ability to “drag” hardware
sales so that it could bundle effectively."® ISVs fought the bundling by threatening
legal action. For example, one CEO stated that bundling IBM software with the
AS/400 was illegal and that he would encourage members of the industry trade
206
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
association ADAPSO to take action."^ ADAPSO later threatened to fight IBM
through the judicial, administrative, and legislative systems of Europe and the
U.S.^° IBM made many attempts after 1969 to fight ISVs but also made steps
toward accepting the industry, such as its formation of Information Programming
Services, which acquired and used independent software.^'
IBM’s unbundling did not stop other vendors from selhng hardware and
software together. According to Pallatto, “[vjirtually all microcomputer vendors
have offered free software with their microcomputers at one time or another.”^"
Although bundling has never been proven illegai,^^ IBM’s lawyers felt,
nonetheless, that it could not be continued in 1969. In the absence of the antitrust
threat, therefore, the computer industry may not have been nearly as competitive
as it turned out to be.
Like IBM once did, Microsoft currently faces legal action from the Justice
Department on bundling. At stake is Microsoft’s ability to incorporate into its
operating system new features that could be provided as separate products. This
case is more complicated than the previous one because the difference between an
operating system and an application is open to debate whereas the difference
between hardware and software is much clearer since the former is tangible while
the latter is not. At the same time, the current industry has many synergies that
can be exploited as a result of the convergence of computers and communications.
Microsoft may be able to use bundling to leverage its operating system monopoly
207
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
into networks and the information that flows within them. The increasing
complication of the industry makes antitrust action more difficult and riskier than
it was in the 1960s.
Licensing Rules
There is a final parallel between IBM’s monopoly and that of Microsoft
that has clear policy implications. IBM received large profits and was able to
moderate its level of innovation as a result of its ability to charge its customers on
a subscription basis. Many of its mainframes as well as related software and
services were sold on an annual basis. In this way the company was not forced to
improve its product regularly and was able to raise prices due to the fact that its
customers were locked in to the product. According to Walker, “IBM was not
forced to rush out the 7094 or 360 under the gun by competitive fears— they could
switch their rental base to a new generation at a time of IBM’s choosing, when the
technology was ripe to increase their revenues and earnings.The annuities
accruing from rental fees also enabled IBM to make investments that would
increase the research gap between the monopohst and potential competitors. The
use of rental or subscription fees also gave enormous advantages to AT&T and
Xerox. In the latter case it caused such complacency that the company failed to
maintain its product advantage.^^ Unfortunately the market is unlikely to
effectively discipline the monopolist in the computer industry, though, because of
208
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
the lock-in effect. Not only did IBM lack the incentive to innovate but it used its
lock-in of customers to raise prices significantly. IBM raised prices for its
mainframe operating system by 30% per year during the 1980s. The price for an
annual license at the end of the decade was 1,900% higher than at the beginning.
Large firms had to pay $20,000 per month per mainframe to have the right to use
software on it. The prices did not stabilize until 1990, as mainframes faced
increased competition firom PC networks.Currently, Microsoft has expressed an
interest in changing to a subscription based model. The lessons of the IBM case
indicate that governments should be wary of allowing this to occur. Otherwise,
Microsoft would have Little reason to price and innovate in a competitive manner
because of the lack of viable substitutes for its locked in customers.
Conclusion
The case of IBM shows that there are many useful historical parallels to
assist policy-makers and other observers in evaluating the factors affecting
competition in the computer industry. Both companies have had similar levels of
dominance based on the lock-in of their customers. They have each faced a great
deal of antitrust scrutiny, particularly in the areas of licensing practices and
bundling. There are also many lessons to be learned from the IBM case that can
assist policy-makers that have power over Microsoft. These are outlined below.
209
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
If IBM could not maintain its dominance in spite of a much greater overall
control of the industry, policy-makers have little to fear from Microsoft, which
receives less than 10% of industry revenues, compared to well over 50% for IBM
at the peak periods of its strength. Even though a company has what seems to be
an unassailable position, it can still be rapidly overtaken if it is not responsive to
customer needs and technological trends. Strong competitors can appear without
warning as they did in the cases of IBM and Microsoft.
As a court found in a judgement related to IBM, a company can be
effective in terms of bringing products to customers by having a broad business
strategy that adds value for customers rather than focusing simply on a narrow
engineering-oriented definition of innovation. Although claims that Microsoft has
a slower rate of innovation than its competitors are questionable, even if they
were shown to be true, the reduced rate of innovation might be offset by
responsiveness to customers in other areas.
The industry was well-served by the unbundling of software and services
from hardware in the IBM case. It would be tempting to conclude that this policy
should also be implemented in the current market. The problem with applying it
now, however, is that the issue has become much more complicated. The
distinction between tangible and intangible goods made in the IBM case is much
clearer than it would be for Microsoft. The definition of an operating system has
evolved and broadened. Customers expect considerably more functionahty from
210
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
one than they did in the early 1980s. Stand-alone products could have provided
these functions but this would have likely led to greater incompatibility and
steeper learning curves. For this reason, it is difficult and perhaps undesirable to
establish and maintain a legal distinction between architecture and applications.
Manipulation of distribution channels is a tactic used by both IBM and
Microsoft that should, however, receive antitrust scrutiny. There can be Uttle, if
any, benefit to consumers from policies by the monopolist that restrict leasing
companies from competing or that discourage OEMs from offering products that
compete with those of the monopolist. The IBM case illustrates the benefit of
implementing rules of behaviour that a dominant company should be required to
follow.
The IBM case also illustrates the danger of allowing Microsoft, or any
other multi-generation standards based monopoly, to price on the basis of time or
usage rather than outright purchase. This can cause the dominant company to
behave as more typical monopolists do, with low rates of innovation, and higher
levels of pricing than would occur in a competitive market. IBM mainframe
software received few upgrades in the 1980s even though the price for its annual
licenses increased by 1900% during the decade. This is perhaps the most
important conclusion, in the overall context of this research, which can be made
from the IBM case.
211
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Notes
* John E. Lopatka and William H. Page, “Microsoft, monopolization, and network
externalities: some uses and abuses of economic theory in antitrust decision
making,” The Antitrust Bulletin, Summer 1995, p. 336.
■ Richard N. Langlois, “External Economics and Economic Progress: The Case of
the Microcomputer Industry,” Rev/ew, 66, March 22, 1992, p. 1.
^ Eleanor M. Fox, “Monopolization and Dominance in the United States and the
European Community: Efficiency, Opportunity, and Fairness,” Notre Dame Law
Review, 61, 1986, pp. 1013-1014.
^ Telex Corp. v. IBM Corp., 510 F.2d (10th Cir. 1975), p. 900; 423 U.S. (1975), p.
802.
^ Greyhound Computer Corp. Inc. v. IBM Corp., 559 F.2d (9th Cir. 1977), p. 497;
496 U.S. (1978), p. 1040.
^ Transamerica Computer Co. v. IBM Corp., 698 F.2d (9th Cir.), p. 1380; 464
U.S. (1983), p. 955.
’ California Computer Prods, v. IBM Corp., 613 F.2d (9th Cir. 1979), p. 739.
^ Jay Dratler, Jr., “Software: Microsoft as an Antitrust Target: IBM in Software?”
Southwestern University Law Review, 25, 1996, pp. 715-716.
^ Dratler, 1996, op.cit., p. 679.
Fox, 1986, op.cit., pp. 1014-15.
212
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Donald Baker, “Government Enforcement of Section Two,” Notre Dame Law
Review, 61, 1986, pp. 898, 899.
In re IBM Corp., 45 F.3d (2d Cir. 1995), pp. 641, 642.
In re IBM Corp., 687 F.2d (2d Cir. 1982), pp. 603-04.
Dratler, 1996, op.cit., p. 681.
“IBM StiU unchaUenged mainframes giant,” The San Diego Union-Tribune,
December 24, 1996, s. Computer Link, p. 22.
Fred Davis, “Microsoft/Intuit: Justice Blew It,” Wired, 3.08, 1995.
Dratler, 1996, op.cit., pp. 705-6.
Dratler, 1996, op.cit., p. 706.
Howard Anderson, “Target: Microsoft,” Upside, March 18, 1997.
“The BUI Gates Interview,” Playboy, 1994. Available (online):
http://ei.cs.vt.edu/~history/BUl.Gates.html.
Anderson, 1997, op.cit.
~ Dratler, 1996, op.cit., p. 721.
^ IBM Corp. V. United States, 298 U.S. 1936, pp. 132, 139-40.
Bob Djurdjevic, “Up the Software Curve,” Datamation, May 1985, p. 98; Curt
Monash, “Software Strategies: Although IBM is Taking Steps to Strengthen Its
Position in the Mainframe Software Market, It’s StUl a Hardware Company at
Heart,” Datamation, February 1984, p. 171.
213
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
^ Martha Rounds, “IBM Saw ‘Limited’ Software Industry; 1969 Prediction:
‘Limited But Increasing Number of Enterprises Engaged in the Development of
Computer Programs for Sale,” ’ Software Magazine, 9, March 15, 1989, p. 37.
Dratler, 1996, op.cit., p. 730.
John Pallatto, “IBM Software Bundling: ‘Routine Sales Promotion’ or Unfair
Market Advantage?” PC Week, July 23, 1985, p. 43.
Rounds, 1989, op.cit., p. 37.
John Desmond, “Back to Bundling? Recombining Software with Hardware,”
Software Magazine, June 1989.
David R. Brousell, “Software Firms Plan Campaign to Obtain IBM Source
Code," Datamation, November 1, 1987, p. 19.
Rounds, 1989, op.cit., p. 37.
Pallatto, 1985, op.cit., p. 43
Stanley Gibson, “Bundle Up, Adapso,” Computerworld, September 11, 1989,
p. 25
John Walker, “Does This Sound Familiar? 2,” 1997. Available (online):
http://www.fourmilab.ch/autofile/www/section2_106_6.html.
Walker, 1997, op.cit.
The San Diego Union-Tribune, 1996, op.cit., s. Computer Link, p. 22.
214
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Chapter 6
The Non-proprietary Alternative to Monopolization
Although this study has shown that a multi-generation compatibility
standards monopoly can maintain an incentive to innovate and price
competitively, this must be weighed against the non-proprietary altemative to
determine which results in greater societal benefit.
It has become a point of seemingly universal agreement in the information
industry that non-proprietary systems will enable the industry and end users to
prosper while proprietary ones will reduce growth, result in incompatibility, and
create other problems. Several quotations from key industry participants can
illustrate the prevailing belief. According to Lewis Platt, CEO of Hewlett
Packard, “[gjaining the consensus required to create an open standard is an
arduous process. But the altemative—a proprietary environment—will stifle the
growth of our industry because it can’t lead to a widely accessible information
infrastructure.” ^ Scott McNealy of Sun similarly states that “[l]ike other
mainframe computing models, proprietary systems are giving way to standards-
based open systems. Open systems invite ingenuity, competition and
collaboration.”^ Jim Barksdale claims the high ground for Netscape: “[a] lot of
people talk about being open, but then are still proprietary. Our goal is to be
215
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
nonproprietary, open, and cross-platform.”^ Even Microsoft seems to support
these views. Brad Silverberg, a vice-president, states ± at “[t]he key to
Microsoft’s success on the Internet can be summed up thus: ‘Innovate based on
open standards.Furtherm ore, Charles Ferguson suggests four criteria for World
Wide Web architecture: “end user ease of use; compliance with nonproprietary
standards for basic communications protocols and data formats; maximum
interoperability; and vendor-independent, platform-independent, open APIs. If the
Web’s standardization and interoperability deteriorate, both users and vendors
will suffer.”^ This echoes the common refrain that proprietary standards will
result in incompatibility whereas non-proprietary ones will achieve
interoperability. There are, however, historical and current examples that indicate
that the opposite may be true.
Unix
Unix is a prime example of the incompatibility that can result from non
proprietary standards. In spite of the movement toward open systems and frequent
negotiations, approximately fifty incompatible versions of the operating system
were developed.^ Four factors can be identified to account for this surprising
result: the demand from scientific and academic users for more specialized
versions; the desire to differentiate products from those of competitors; the ability
of licensees to adapt Unix for their own needs and relicense their own proprietary
216
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
versions; and the goal of backward compatibility with older proprietary systems
to support locked-in customers and to prevent rivals from winning them over.
Unix was initially developed by AT&T but was released to the public
domain in part due to concerns that the company could face antitrust scrutiny. In
spite of its early development it failed to gain favour in business computing
because there were so many companies involved in its development that there was
a lack of leadership. According to King: “UNIX . . . in all its versions, has been
around even longer than MS-DOS, and each year brings a renewed pledge of
unity and coherence from the UNIX vendors. Usually the vendor infighting
reasserts itself about six months later, and UNIX returns to its status of technical
overachiever and commercial also-ran.”^ Manchester notes that “hardware
manufacturers found it difficult to break their proprietary technology habits. As a
result, they ‘enhanced’ their versions of Unix, making it difficult to move
applications from one version to another.”^ Modifying a public domain standard
in a proprietary way is natural for companies to do. If they were prohibited by
licensing rules from doing this the standard would probably stagnate. Committees
have a hard time anticipating customer requirements.
HTML
Hypertext Mark-up Language (HTML) is another example to illustrate the
problems that can arise with non-proprietary standards. The World Wide Web
217
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
was popularized by improvements to original HTML specifications made by a
group of students led by Marc Andreessen at the NCSA. Their product. Mosaic,
was distributed freely and the coding used to display documents could be adapted
by any user. The W3 Consortium currently administers modifications to the non
proprietary HTML standard. Even now many developers see HTML as inflexible
because it does not enable the same unlimited number of fonts and formatting that
are used in desktop publishing. The W3 Consortium is not able to keep up with
the demand for new HTML specifications. For this reason firms have had the
incentive to implement their modifications to HTML before they are submitted to
committee for approval. For example, Microsoft developed a method of animating
web pages that it called Dynamic HTML. It then submitted the extension to the
W3C for approval. It did not wait for approval before implementing it in its own
browser. This can be characterized as an “embrace and extend” strategy, a term
coined by Bill Gates when outlining Microsoft’s first major Internet strategy in
December 1995.
Microsoft did not, of course, originate the use of embrace and extend on
the Internet. Netscape owes much of its initial success to its ability to extend the
initial HTML specifications with its Navigator browser. In particular it specified
the order of appearance of text and graphics, provided blinking words, allowed
scaling of fonts and centering of text as well as caching to speed the transfer of
data.
218
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Currently there are some incompatibilities as a result of alternative
proprietary implementations of HTML. In particular, pages may not be formatted
correctly on some browsers. Design of web pages would be far more complicated
if there were more than two dominant browsers. Given that browsers are being
targeted for the mass market, however, there wül be a tendency toward a single
compatible standard due to the need for publishers to reach a mass audience. The
tendency toward increasing returns is evident in the decisions by America Online
and other service providers to support one of the dominant browsers rather than
develop their own proprietary implementations. A lesson of the HTML case is
that if the specification were left to a committee rather than open to proprietary
modification it would take much longer to implement new features. Furthermore,
compatibility would not be assured unless the committee could prevent end users
from making their own improvements. As well, companies would have little
incentive to improve the product if they could not implement innovations prior to
official approval.
Internet whiteboarding provides a similar example to HTML. In this case
the rrU developed a bare bones standard for transferring notes, but maintaining
compatibility means sacrificing features. The quality and utility of the product is
improved much faster if different implementations battle for dominance in the
marketplace.
219
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Microsoft and Standards Bodies
Microsoft claims that its method of embrace and extend supports the non-
proprietary standards of the Internet. Silverberg, for example, even states that the
firm offers “core Microsoft technologies as open standards to be owned by the
Internet community.”^ To bolster this claim, he points to the company’s decision
to give control over its ActiveX technology to a standards body known as The
Open Group. Although this action may have provided benefits to Microsoft in
terms of public relations, it may not be the ideal solution for web compatibility.
This depends on how The Open Group treats the standard. It is highly unlikely
that ActiveX was already mature enough that it would require no further
improvement to serve customer needs. If Microsoft truly maintained no further
control over the standard any company could embrace and extend it. The key
question is whether The Open Group must negotiate and approve changes before
they are implemented or simply rubber-stamp a change that has already been
introduced into the marketplace. The former is much more time-consuming in
terms of negotiation and tends to reduce the rate and incentive for innovation. The
latter makes more sense because customer demands can be met quickly. There
may be some danger of fragmentation of the standard but this can be prevented if
the standards body acts swiftly to approve standards that have been introduced
and then insists that firms licensing ActiveX conform to the newly approved
standard. Another important question from the point of view of firm strategy is
220
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
what, aside from improving public relations, would motivate a company to
relinquish ownership of its technology to a standards body. One major advantage
is that the company could increase the probability of adoption if potential
customers perceive less threat of becoming locked in to a monopoly provider. As
well, the “donating” company would have a head-start over rivals due to the
intimate knowledge of the new system attained through being its developer.
The Internet has experienced problems related to supply and demand of
new technologies far exceeding the ability of standards bodies to negotiate and
approve specifications. The Internet Engineering Task Force (IETF), for example,
is often unable to keep up with the proliferating technologies. Standards bodies
such as the IETF generally acknowledge that they have little power in the face of
market forces and competitive companies. Many interested parties agree. A
comment by Robert Gahl, chief operations officer of Sphere Information Services
Inc., is typical of this common view: “[sjtandards bodies take forever, and
sometimes you just need to move forward with a product.” ”
Vendors have been forced to choose between approved standards and
proprietary implementations. The latter typically provide more advanced
capabilities. One example is Microsoft’s introduction of Distributed Common
Object Model (DCOM) which allows communication between objects, but is not
compatible with the Common Object Request Broker Architecture (COREA)
221
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
which is administered by several firms belonging to the Object Management
Group (OMG).
Sun’s Leadership of Java
The Java programming language is another Internet standard that is
receiving a great deal of interest from developers. It is more open than the
Windows operating system in the sense that its owner. Sun, freely distributes the
source code. For this reason, some observers have interpreted it as a non
proprietary standard. For example, Irving Wladawsky-Berger IBM’s chief
strategist for Java, has said that “Sun is leading it, but by design nobody really
owns it.”'“ Sun, however, is careful to maintain a degree of ownership over Java.
It closely guards the specification. For this reason, it has been criticized by
competitors who see this as an attempt to obtain dominance over potential
applications providers through architectural control. This view, however, neglects
an essential advantage that vigilance by the owner provides. If Sun did not
provide leadership, Java could easily develop into several incompatible versions
due to modifications by end users and competitors. For example. Sun has accused
Microsoft of violating its licensing agreement by extending the Java language so
that it runs only in Windows, thus defeating the firm’s goal of a write once run
anywhere system. To achieve this end Sun has used litigation and a marketing
campaign that declares its version to be “ 100% Pure Java.” The company also set
222
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
up a new division, JavaSoft, to ensure that licensees do not introduce
incompatibilities. Sun’s approach to Java is superior to a public domain standard.
A major danger of unowned committee-administered standards is that they will
foUow the model of Unix: incompatibility in spite of the market’s preference for a
single standard.
Microsoft became a licensee of Java in March 1996. It had httle choice but
to adopt this technology that could undermine the position of Windows because
otherwise it would not be able to compete with Netscape’s browser. The
incorporation of Java into Navigator proved to developers that it was viable to use
the language to send applications across the Internet and run them on entirely
different systems. If Sun did not strictly enforce the compatibility aspect of its
licensing agreement, Microsoft or any other company would be able to modify it
and thus balkanize the language.
Closed vs. Open Proprietary Standards
The key to achieving compatibility in a system is control. This can, of
course, be achieved easily in a closed system. Apple, for example, maintained
tight licensing terms and this eased its ability to determine the specifications of
the system and compatibility with all of its component parts. It also used its
licensing system to restrict competition for Macintosh hardware. Although this
maintained the company’s high profit margins over the short term, it eliminated
223
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
the possibility that it could become a dominant long term standard. An open
approach with free licensing, such as that of Microsoft, provides a higher rate of
consumer adoption without sacrificing compatibility. It is true, however, that the
Macintosh had better compatibility within its system due to enhanced control.
This, however, was offset by a lack of compatibility with the overall body of
computer users due to its relatively low adoption rate. Therefore, compatibility
requires that computer makers balance the issue of control with that of overall
adoption of a consumer system. For this reason, the Microsoft open proprietary
strategy is nearly ideal if the goal is to maximize the degree of compatibility of
the entire market.
In contrast to Apple, Sun is commonly characterized as supporting non
proprietary standards. This view is, however, mistaken. Its competitive model is
based on developing a nev/ technology and permitting other companies free
access to the standard so that they can develop complementary products. It has
certainly been more open than Microsoft in the sense that it has published its
standards and generally allowed other companies to use them without paying fees.
For example, the company made the specifications for its Network File System
protocol freely available.'^ Scott McNealy once claimed that Sun would “continue
to create standards first and publish them before implementing them in Sun
products.”* '^ This, however, has not generally been the case. At best the company
has pubhshed the standards simultaneously with product introduction. The
224
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
company succeeds because it introduces products faster than its competitors and
then moves to new technologies when they begin to narrow the technological gap.
According to Bernard. Lacroute of Sun, “[c]opying something that moves faster
than you can copy isn’t a good business to be in.” ^ ^ The company is able to fund
its research in part through licensing fees that it charges companies for the use of
its technologies such as the SPARC microprocessor. Although these fees are not
exorbitant, because otherwise the adoption would be low, they nonetheless show
that Sun’s strategy is proprietary. It does not, however maintain a closed system
because it uses off-the-shelf components and ensures that its computers are able to
share data with systems from other manufacturers.^^ In this sense. Sun’s open
strategy is similar to Microsoft’s. The main distinction is its publication of its
standards. Although this can create more competitors, it also increases the rate of
adoption so that its technology wins. The workstation battle between Sun and
Apollo is analogous to the personal computer battle between Microsoft/Intel and
Apple. The former chose open standards while the latter tried to maintain high
profit margins through a closed system. Buyers felt more comfortable with open
systems and desired compatibility. Thus, the decisions by Apollo and Apple
eventually doomed their systems.
225
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Netscape and Open Source
Netscape has launched an experiment as an alternative to proprietary
standards. It was influenced by followers of “free software” to adopt a business
model which has been renamed “open source.” On March 31, 1998 the company
released the source code for Communicator to developers via its mozilla.org web
site. The advantage of this model is that a company with limited resources can
receive input and debugging assistance from thousands of programmers not
employed by the company. This is similar to peer review in academia only on a
grand scale with the potential for thousands of reviewers. Participants are obliged
to share their modifications to the code with Netscape, which may incorporate
them into future commercial releases of Communicator. The financial incentive
for independent programmers in the open source model is that they can provide
service to their modifications or be hired by companies that have seen their work.
It is difficult to know exactly how this experiment with the open source
model works out for both Netscape and other developers. There is certainly a
danger of fragmentation due to the large number of different developers making
modifications to the software. It could result in disaster for Netscape if it does not
carefully control how its source code is used and if it does not promptly
incorporate any desirable changes made by developers. There could be so many
groups working with radically different perspectives that it could be difficult to
develop a coherent strategy for the future of the code. Netscape has a relatively
226
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
limited set of resources and wül require significant assistance from people it does
not pay to ensure that the component parts work together. According to Benjamin
Nham “[t]he flood of developers and lack of adequate controls to control their
development of Netscape wül surely evolve into a final integrated program that
would be a compiling nightmare.”’^ The question is whether users wül prefer a
predictable program integrated with a single vision or a random and rapidly
evolving one that may give access to cutting edge features sooner at the expense
of coherence and perhaps compatibility. Netscape had to take action because it
was already behind Microsoft in allowing other companies to easüy integrate web
features into their programs. This hurt Netscape’s browser share because
independent developers such as Intuit made instaUation of Internet Explorer a
requirement for their own software to work. In this sense, Netscape finally out-
opened Microsoft though it may have occurred too late to win the standards war.
The key to recovery wül be Netscape’s ability to preserve compatibility in its
approach to HTML and the Web.
Analysis of Non-proprietary Standards
Sponsorship is often necessary for new technologies to diffuse. This is true
for many industries. The cinema business, for example, could never have grown
as quickly as it did if the Hollywood studios had not been vertically integrated,
owning the theaters in which their films were shown. It was not until the industry
227
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
was already established that the U.S. government forced studios to divest their
theaters.'* In this case, the distribution medium was key.
The evidence presented here leads to the conclusion that non-proprietary
standards are likely to have one of two results. The non-proprietary standard may
be embraced and extended with proprietary implementations in response to
potential benefits to end users of the change. In this way the unowned committee
standard is stolen by a company to make its own proprietary standard. The
alternative result assumes that the committee has placed licensing rules that
prevent standards stealing. In this case end users are likely to be inconvenienced
while negotiations slow the implementation of new innovations. The committee
process may also delay product introduction by freezing industry development
while negotiations occur.
Furthermore, committee standards will not necessarily prevail in the
marketplace. If they do, it may simply be that the committee adopted the
dominant company’s product. According to an empirical study by Martin Weiss
and Marvin Sirbu, the most important determinant in the decision of a voluntary
standards body is the size of the firms represented on the committee."” The largest
company usually sees its standard adopted. One of the possible reasons for this
outcome is that if the leading firm does not expect its standard to be adopted it
wiU simply take its product directly to market, superceding the standards
committee. It may do the same if it perceives a long time lag before the committee
228
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
will adopt the standard, because this would eliminate any time-based competitive
advantage that it may have over rivals."’ According to Tom Nolle, president of
CMI Corp., “Every business is faced with a choice—bring a product to market
when the user wants to buy it and have that product based on proprietary
technology, or wait for standards and tell the user nothing. No rational business is
ever going to make the second choice.”"
The costs of choosing non-proprietary standards appear to exceed the
benefits. The major benefit of non-proprietary standards is the lack of control by
any single firm in the industry. Empirical study has, however, shown that
committees may choose the dominant company’s standard in any case. Non-
proprietary standards are often thought to guarantee compatibility but this may
not occur, even when it is desired by end users, because of the potential for
fragmentation due to lack of control and licensing rules. If demand for the product
is high, a negotiated standard may be pre-empted in the market by proprietary
alternatives. Furthermore, a standards battle is likely to occur regardless as firms
either modify the non-proprietary standard in a proprietary way or introduce their
own alternatives. If the standard will eventually be proprietary regardless of the
negotiated process, it seems counterproductive to have the intermediate step of
analyzing the standards alternatives in a long committee process. One of the most
common complaints about non-proprietary standards is the glacial pace of
229
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
committees compared to immediacy of the market. When network externalities
are high, market standards are likely to achieve compatibility.
One option for the future of voluntary standards bodies is that they be used
to provide an official stamp of approval for a standard that has already been
adopted in the marketplace. This will require changes in attitude. On past
occasions when companies have submitted technologies for official approval after
they have been introduced to the market, there has been a tendency for standards
bodies to become annoyed because they feel that are being treated as puppets.^
To prevent fragmentation, however, a superior outcome would be to have a single
profit-seeking entity control the standard. The entity should be profit-seeking
because this provides the motivation to modify the product to meet customer
needs.
Conclusion
This chapter has pointed out flaws in the commonly held view that non
proprietary standards are superior for the end user. In theory they result in greater
competition but in practice the technologies are either delayed or fragmented.
Government documents have trumpeted the desirability of non-proprietary
standards for essential Global Information Infrastructure interfaces. As Denise
Caruso of Upside magazine points out, however, “hell will freeze over” before a
set of unowned standards for the GII can be agreed upon."'*
230
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
This chapter endorses the view that open systems are superior to closed
ones. However, compatibility and innovation are fostered when the standard is
owned and controlled by a single firm. Sun is a good example of this. It maintains
control over the evolution of the basic architecture of its system. It nonetheless
keeps the use of the system open. It sponsors the standard and provides easy
access to technical knowledge to its rivals. The strategy of Sun is thus similar to
that of Microsoft.
231
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Notes
* Lewis Platt, “N il Spells Opportunity for Computer Resellers,” Computer
Reseller News, 579, May 23, 1994.
“ Scott McNealy, “Positioned for growth: Resellers and the intranet,” Computer
Reseller News, 677, April 1, 1996.
^ Esther Dyson, “Netscape’s Secret Weapon,” Wired, 4.03, March 1996.
Brad Silverberg, “Start Reading,” 1997. Available (online):
http:www.microsoft.com.
^ Charles Ferguson, “Fertile Ground,” Upside, November 1995.
® K. Cook and H.L. Gabel, “Open Systems and the European Mainframe
Computer Industry,” Case Study, Insead Fontainebleau, 1991.
^ Adrian King, “Inside Windows 95,” Computer Reseller News, September 11,
1995, p. 113.
* Philip Manchester, “Survey of A-Z of Computing,” Financial Times, April 26,
1994, p. x m .
^ Silverberg, 1997, op.cit.
Michael Moeller and Norvin Leach, “Are proprietary technologies closing the
Net?” PC Week Online, April 8, 1996.
* * Moeller and Leach, 1996, op.cit.
232
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
* “ Brent Schlender, “Sun’s Java: The Threat to Microsoft is Real,” Fortune,
November 11, 1996.
Raghu Garud and Arun Kumaraswamy, “Changing Competitive Dynamics in
Network Industries: An Exploration of Sun Microsystems’ Open Systems
Strategy,” Strategic Management Journal, 14 (5), July 1993, pp. 351-369.
Art Wittmann “Technology And Chopsticks: What A Combo!” Network
Computing, 803, February 15, 1997. Available (online):
http://www.techweb.com/se/directlink.cgi7NWC1997Q215SGG38.
Garud and Kumaraswamy, 1993, op.cit.
Garud and Kumaraswamy, 1993, op.cit.
Benjamin Nham, “Desperate Defense,” Computers: News & Opinion, April 7,
1998. Available (online): http://www.suitelGl.com/articles/article.cfm/6632.
Denise Caruso, “Capturing a Swarm of New Money-Making Opportunities,”
Upside, April 1995.
“Gentle Giants,” The Economist, December 21, 1996, pp. 15-16.
Martin B.H. Weiss and Marvin Sirbu, “Technological Choice in Voluntary
Standards Committees: An Empirical Analysis,” Economics of Innovation and
New Technologies, I, 199G, pp. 111-133.
233
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Raphael Needleman, “Standard operating procedure,” CNETNews, March 24,
1997. Available (onhne):
http://www.cnet.coni/Content/Voices/Needleman/032497/index.html.
“ “Report Slams Microsoft Tactics,” Report on Microsoft, 3 (24), December 18,
1995.
^ Needleman, 1997, op.cit.
Caruso, 1995, op.cit..
234
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Chapter 7
Explanatory Framework
A New Type of Monopoly
The primary goal of this work is to show why a standards monopoly such
as that of Microsoft may not exhibit the characteristics typical of other firms with
dominant positions. This study has shown that there are different types of
monopolies and that the differences are due in part to the reason why they became
monopohes. Microeconomic theory has identified three different types of
monopolies according to the manner in which they achieve their status. This paper
proposes a fourth type of monopoly. The four categories are:
(a) Monopoly over inputs,
(b) Natural monopoly,
(c) Intellectual property monopoly,
(d) Multi-generation compatibility standards monopoly.
A monopoly over inputs occurs when a company gains market power
because of its ownership of most or aU of the sources of a particular input, usually
235
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
a natural resource. Monopolies over natural resources with inelastic demand will
result in prices far above average cost.
Natural monopolies exhibit a tendency toward the dominance of a single
firm as a result of extremely high fixed cost and very low marginal cost. Although
a standards monopoly develops naturally, it should not be classified as a “natural
monopoly.” Industrial organization theory explains natural monopoly through
supply side economies of scale caused when fixed costs are so high that the
average cost curve declines for aU portions of the demand curve. This can justify
rate of return regulation. Standards monopolies, in contrast, are caused by demand
side economies of scale, where the demand curve for each product in a standards
battle shifts out as it is adopted and the demand curve for competing products
shifts in. Rate of retum or price cap regulation would be inappropriate for most
standards monopolies because it would reduce the incentive for innovation. ^
Intellectual property monopolies are granted to companies that, as a result
of their research activities, have created a new product or process that qualifies for
copyright or patent protection. This protection has a dual purpose: to give these
companies an incentive to invest and innovate and to allow them to recover their
investment in research. This type of monopoly, although protected by law, does
not generally exhibit the same negative effects as those that have been granted
legal protection with the main objective of protecting them from competition.
Intellectual property monopolies can have some negative consequences on society
236
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
if high prices on products seen as essential make them inaccessible for a portion
of the population. Medicines and medical equipment are examples of this.
Companies that develop proprietary standards are also intellectual
property monopolies. In the information industry these have been criticized by
rival companies who do not have access to the copyrighted codes. This limits their
ability to compete by developing products that work with these systems. It also
makes compatibility with the leading standard more difficult to achieve.
Compatibility standards monopohes are unlike the previous two types of
monopolies in that they emerge from the customer’s desire to belong to a large
network. Larger networks have the advantage of allowing communication among
all of those that form a part of it and of providing more support and
complementary products. This type of monopoly is more evident in the
information industry where working within compatible systems for the sharing of
information is key to communication. A standards monopoly emerges because
more people wish to join a network as it gets bigger. Smaller networks are
abandoned and eventually disappear. This is a self-reinforcing mechanism that
gives the larger network an advantage over others so that it eventually dominates
the market. Telephone services, computer mediated communications, and
software are some examples of industries that experience these type of effects.
Economists in the network and standards literature, such as Brian Arthur and
Garth Saloner, consider this phenomenon to have a negative impact on innovation
237
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
because of the reluctance of users to switch to companies offering alternative
services. This, in their opinion, gives the monopoly an advantage that can
translate into reduced incentives for innovation, high prices, and little threat of
entry. This study has found that the particular circumstances of the industry will
determine if these companies have the incentive to innovate or not. In general,
market circumstances force multi-generation standards monopolies to innovate
and price competitively in spite of their market power.
The Incentive System
The effect of monopolies on the welfare of society depends primarily on
the incentive system within the industry. The Microsoft case illustrates two
conditions that influence the behaviour of a monopoly.
Security
Security is an important factor influencing whether a monopoly will
innovate and price near cost. A company will tend to be more innovative when it
is less secure about its position in the market and when being innovative is
necessary for survival. The contrary also applies: the more secure that its position
is the less likely it is to innovate. Its behavior with respect to prices is similar. A
monopoly that has a secure market where it is the only supplier will normally
238
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
charge prices that are significantly higher than average cost. Lack of security
causes companies to price nearer to cost.
The level of security depends on the regulatory environment and the
ability of other companies to enter the market. Companies that receive their
monopoly status through government regulation are considerably more secure
than those which received a dominant position as a result of an innovation. In the
latter case, other companies may develop rival products.
Security, nonetheless, is a static concept. Changes in environment can
force a company to move from a secure environment to a situation in which its
survival is at stake. Changes can result from modifications to the law, innovations
from outside and within the monopoly’s industry, as well as changes in the
economic environment such as booms or recessions. As security increases
innovation tends to decline.
Although the purpose of this study is not to determine the behavior of
monopolies in general but rather to explain the peculiar behavior of a multi
generation standards monopoly, an example from another sector can help to
illustrate the concept developed above. Local coaxial cable monopolies in the
United States are not considered to have a particularly strong record with respect
to innovation and pricing. The movement toward competition in
telecommunications and cable has, however, made companies in both industries
more innovative. The level of innovation by cable companies increased as their
239
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
industry became less secure as a result of new competitors such as direct
broadcast satellite and telephone companies offering programming.
The tendency toward short-term monopoly in industries subject to lock-in
may also be justified if it is caused by the creative destruction described by Joseph
Schumpeter. The failure of competitors as a result of the success of a dominant
innovator may be socially desirable because it results in the shift of resources
toward radically new areas that will lead to further innovation.”
Reward
Another factor that influences innovation and pricing is the reward system.
Reward in this context refers to the amount of revenue that the company can
obtain over time considering that it has a large share of the market. Here again
there are different types of monopolies. There are companies whose product can
be sold to the same customers several times. This is the case with
pharmaceuticals. Firms that have obtained a patent to cure a disease will be able
to sell the same medicine to the same person as long as he needs it. Their level of
sales is stable because they can sell exactly the same product to the same
customer. There is no need for improvement in the drug. Companies in this
industry will attempt to discover cures for other diseases but wUl tend not to
improve medicines that have already been released. Similarly, a monopoly by
Saran Wrap over the key technologies related to plastic wrap would be more
240
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
damaging to consumers than a software monopoly because Saran Wrap does not
need to be improved to be resold to the same customers. There are, nonetheless,
other products which, even though they dominate the market, have to renew the
quahty or design to resell them. This happens primarily with long lasting products
because customers will not buy them again until they break down. In such cases,
even though they dominate the market, their annual sales often fall because the
customers that already have the product do not need to buy again. Sales, therefore,
constitute only the portion of the market that corresponds to new users. For long
lasting products there is thus a tendency for sales to decline for a company, such
as a monopoly, reaching a stagnant market position.
Companies in this circumstance have an incentive to innovate often to
maintain their level of sales. It is therefore not surprising that some industries
introduce new designs and improvements on a regular basis, in spite of market
power. The purpose of this is to generate demand even when a user still has a
product that works properly. Frequent innovation will maintain and perhaps even
increase the level of sales.
Figures 7-1 and 7-2 provide a graphical contrast between a firm that
upgrades and one that does not. Figure 7-1 represents the sales of a monopoly that
chooses not to upgrade its product. At first it receives revenue for providing a
product that the market desires. Later, however, revenues decUne to a steady level
for as long as the monopoly is held by the dominant firm. The remaining sales are
241
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
made only to new buyers and not to the initial purchasers. Even in the absence of
competitors, however, the monopoly still has an incentive to upgrade its product.
If there were no new products then sales would at first decline and then level off
due to demand from new users. This is shown in Figure 7-1 with the horizontal
line that follows the curve. Figure 7-2 shows that sales for an innovative
monopoly are much higher than those for a non-iimovative one. At specified
intervals, the company introduces a new product or design. This happens
presumably when the sales from the previous product start to decline. When a
new product enters the market the previous version is no longer supported and its
supply and demand drop to zero. For multi-generation standards monopolies their
own products are close substitutes for new ones. Therefore newer products must
represent a significant enough advance to entice users to buy them. Monopolies
that can sell the same products several times to the same customer have less
incentive to innovate than those that sell more durable goods.
Continued innovation also affects prices because whenever a new product
enters the market, the older version drops in price. The newer version, although
more expensive, cannot be priced much higher than the older one because
otherwise demand for the more recent product would not be generated. This,
however, does not apply in the software industry because the marginal cost is
nearly zero. It is easy to pull the old products off the market. The incentives for
innovation and competitive pricing would thus be higher if these products could
242
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
not entirely be pulled from the market. Therefore it is necessary to make a caveat
to the assertion that monopolies with longer lasting products have a less negative
effect on society’s welfare. The act of upgrading does not necessarily ensure
innovation if the old product is not forward compatible with the new ones. In this
case the upgrade would be obhged by the desire to maintain compatibility rather
than due to superior product features. This problem can be dealt with through
licensing rules, such as the one provided in the public policy section below.
Figure 7-1
Sales Revenue for a Non-innovative
Multi-generation Standards Monopoly
Sales
Initial Demand New Furchases
Improved sales if
^ ^ 1
upgrades are made
t
Time
243
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Figure 7-2
S ales Revenue for an Innovative
Multi-generation Standards Monopoly
Sales
Total Saies for AU Versions
Time
Original Version New Versions
Rewards also play a role in compatibility. The emergence of a graphical
interface for the Internet gave rise to support for open standards. The primary
reason for this movement was the desire for compatible information systems.
Open standards, nonetheless, have a serious flaw, which is the lack of rewards for
the companies that develop them. Each company has an incentive to expand the
original specification and introduce proprietary aspects on top of the open
standard that could result in multiple incompatible versions. Technological
advance in this industry has occurred so rapidly that improvement over open
standards is not uncommon and companies that perceive higher rewards with
proprietary systems will steal the standard and develop a clearly superior product.
Compatibility therefore can be more easily achieved when property rights over a
244
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
technology are clearly specified. The incumbent has an incentive to keep
improving the product and can demand that the licensees fulfill requirements that
preserve compatibility. Jim Herman of Communications Week puts it this way:
“market leaders are solely motivated by the desire to grab the gold ring of a de
facto standard.”^
Security and Reward
Figure 7-3 represents the combination of the two main determinants of a
monopoly’s behaviour. Of the four possible combinations represented in the
matrix, monopolies generally fall into the first and second quadrants. They tend to
enjoy high security but, depending on the industry, have high or low rewards. A
company that has a secure environment and high annual sales is likely to be less
innovative and abuse its privileged position to charge higher prices. A small
change in the market’s conditions could also change a company’s overall strategy.
Assuming, for example, that the company faces lower rewards but the same level
of security, it would not be surprising for managers to attempt to improve sales by
introducing new products or expanding markets. This would depend on ambition
as well as the costs and benefits of doing so.
245
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Figure 7-3
The Impact of Reward and Security
on the Innovation and Pricing of a Monopoly
Reward
High Low
I n
High
Security
Low innovation
and highest prices
Lowest innovation
and low prices
IE IV
Low Highest innovation
and high prices
High innovation
and lowest prices
An environment with lower security implies that there is competition and
thus reduced market power. Less security may not necessarily mean that there are
already other competitors but that they could enter in the near future. This change
could force a company to change its strategies and become more innovative. It is
therefore not surprising that many governments have so strongly supported the
market as a force that enhances competition.
Adoption Model for an Upgrade to a Monopoly Standard
It is possible to represent the adoption decision of previous customers of a
multi-generation standards monopoly using a simple illustrative model. The
decision by previous customers is the principal determinant of revenue for the
246
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
monopolist because new customers are likely to enter the market at a constant rate
and wül be inclined to choose the dominant product because compatibility is the
single most important determinant of value.
There are six major factors determining whether a locked in customer will
adopt a new version of a product. These are represented as follows:
A = P a + F-3 + C%,
where 0 < A, P, a, F, p, C, x < 1,
anda + P + %= 1,
and where A is the adoption rate of old customers, P is the desirability of the price
of the upgrade, a is the relative importance of price in the adoption decision, F is
the desirability of the new features, p is the relative importance of new features in
the adoption decision, C is the desirability of the compatibility provided by the
upgrade, and % is the relative importance of maintaining compatibility in the
adoption decision.
Intrinsic benefit to users adopting the upgrade can be defined as P + F
because this represents the improvement of the product over the previous version
with the cost of the upgrade to the user factored in. The reason why a, p, and %
sum to one is that they are each judged by the customer relative to each other. The
247
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
firm decides through its licensing how important maintaining compatibihty will
be in the customer’s decision. To the extent that the monopolist is able to raise the
importance of compatibility, customers will be relatively less concerned with
whether the upgrade provides true value in terms of new features and attractive
pricing.
Case 1: License expiration
It is relatively easy for a standards monopohst to raise the importance of
maintaining compatibility in the mind of a previous customer. The simplest and
least costly way would be to make the prior license entirely invalid after a period
of time. In this way a truly locked in customer would be forced to upgrade
regardless of whether the new product provides any value at all in terms of price
or features. In the absence of public pressure and the interference of policy
makers, therefore, a rational compatibility standards monopolist would wish to
maximize the importance of compatibility, and minimize the importance of new
features and price from the point of view of the customer. The reason for this is
that it is costless for the firm to make compatibility the most important feature to
a prior customer. The monopolist could thus avoid having to spend any resources
at all improving the product and could set the price at a relatively high level that
maximizes revenue. This extreme case would have the monopolist choose the
following values for the six variables: P, F, a, and [ 3 would each equal 0 while C
248
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
and % would both equal 1. The arithmetic yields an adoption rate (A) of 1, or
100%. Every locked in user would adopt the upgrade in spite of the fact that the
price was highly undesirable and that there were no new features added at aU.
Since the addition of P and F is 0, users would receive no intrinsic benefit to
upgrading at all.
Case 2: Customers unable to buy previous versions
If a standards monopolist were unable to simply make the use of previous
versions of its products illegal its next best option would be to engage in a
strategy that might be classified as planned obsolescence. This requires the
implementation of two policies. First, the new version should be backward
compatible with older versions but the older versions cannot be forward
compatible with the new version. For example Windows 95 applications can read
Windows 3.1 files but Windows 3.1 applications cannot read Windows 95 files.
Second, a user with multiple systems cannot purchase a license for an old version
of the product for use on a newly purchased system. If this were the case, the
relative importance of compatibility to price and new features would be high. For
this reason, the monopohst would provide relatively few new features and
relatively unattractive pricing. Thus P, F, a, and [ 3 could each be 0.1 while C
could be 0.9 and % 0.8. This would yield an adoption rate of 74%. The intrinsic
249
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
benefit of upgrading to end users would be a relatively meagre 0.2 compared to
the maximum of 2.
Case 3: Laws prevent license expiration and enable
customers to purchase previous versions
Legal constraints can ensure that the old products of a standards
monopolist are strong substitutes for new versions. This can discipline the
dominant firm by giving it the incentive to improve its product and to price
competitively in spite of its strong position. Maintaining system compatibility
would no longer be the principal reason why a user might choose to upgrade. In
this case P and F could be 0.6; a, and P could be 0.4, and C and % could be 0.2.
The adoption rate would be 52%. The intrinsic benefit of upgrading would be 1.2,
much higher than before.
For the most part, Microsoft has voluntarily implemented the Case 3
policy during the transition period from Windows 3.1 to Windows 95. For this
reason, end users have not been seriously inconvenienced by its monopoly. There
are signs, however, that the company would like to stop issuing new licenses for
Windows 3.1 and, more ominously, hopes to shift to the time based licensing
illustrated in Case 1.
250
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Competitive Analysis to Explain Monopolist Incentives
This study establishes the factors that explain why Microsoft does not
engage in the monopolistic behaviour that economic theory predicts. A
competitive analysis of its market will provide a framework that can be used to
evaluate other potential monopolies and develop policy recommendations. This
analysis can be broken into three categories representing the major actors in an
industry; the dominant producer, users, and competitors. These are each examined
below.
Dominant Producer
There are three factors directly affecting the dominant producer that give it
the incentive to avoid monopolistic practices. These are the existence of strong
substitutes, the need for diffusion of technological advances, and the protection
provided for their intellectual property.
The ability of a monopolist to charge high prices or avoid costly
improvements to products is determined by the extent to which there are
competing substitutes available. Multi-generation standards monopolies face a
significant substitute: the similarity of older versions of products to current ones.
In order to sell to prior customers and maintain the stream of income shown in
Figure 7-2, it is necessary to bring improved products to market at prices that
make an upgrade worthwhile for existing users.
251
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Establishing and maintaining a compatibility standard also requires a
diffusion of technological advance that benefits society in general. This occurs
because the value of networks is higher the greater the number of complementary
goods available. This implies that the standards setter has a strong incentive to
ensure that other companies are able to produce goods that can be incorporated
into the system. For products with many potential uses, it is highly unlikely that
any single firm could provide all potential complementary goods. For example,
there are many customized programs for PCs that Microsoft would not want to
dedicate resources to providing because it focuses on mass markets. Diffusion,
and thus innovation, is likely to occur in this market even in the existence of a
monopoly.
The protection of intellectual property rights is another factor promoting
innovation by a monopolist. Economic theory suggests that producers wiU not
have the incentive to develop a new product unless they are convinced that they
will be able to recoup their development costs because they have the exclusive
right to produce it. If other firms were allowed to steal a new innovation when it
is first brought to market they could afford to undercut the innovator by a
significant margin and force it to accept a negative return on its investment.
Protection of proprietary standards gives the leading company the incentive to
develop a higher quality product.
252
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Users
Three factors affecting the purchasing behaviour of users also force a
standards monopolist to act in the interests of society. These are the durability of
the product, the fact that lock-in wül encourage competitors to develop more
radical innovations, and the heterogeneity of user preferences.
The more durable that a good is, the greater the power that a user has over
a producer that wants to seU a substitute product for one already bought. The
durability of software is long. It is stiU possible to use many of the early software
apphcations developed for the IBM PC XT on computers buüt today. It is also
possible to continue using an original XT and its software for as long as one
wishes, an entire lifetime perhaps. The reason why there is Little original PC
software in use today is that users have found that the benefits o f upgrading have
exceeded the costs. New innovations and reasonable pricing have enabled these
upgrades to occur.
This study does not dispute the idea that network externalities tend to
lock-in end users to a product with a large installed base. This certainly puts
competing companies at a disadvantage compared to the standards monopoly.
Nonetheless, the installed base advantage has limits. Some degree of technical
superiority from a competing product will outweigh the installed base effect that
benefits the monopolist. The lock-in effect can therefore benefit society by
encouraging potential competitors to develop radical innovations. Only an
253
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
enormous improvement can bring about the adoption of an incompatible
technology and the incentive of monopoly profits will encourage competitors to
work to establish their own proprietary standard.
The heterogeneous preferences of end users encourage the holder of a
software monopoly to continue improving its product to increase its ubiquity. For
example, one user may have chosen a particular word processor for its automatic
correction feature but does not use the workgroup features at aU. A different user
may have the opposite preference and chooses a competing product that performs
better in that area. Any given user may exploit a small portion of the total number
of features but since these preferences differ greatly, the leading product has to
incorporate a large number of features. To achieve the ubiquity of the standard,
the leading provider has to serve a wide range of user needs and must continually
improve the product until these customers are satisfied. Otherwise it runs the risk
of losing entire categories of users to niche products. The re-integration of users
into the leading product is costly.
Competitors
As with users and dominant producers, three factors can be identified with
respect to new competitors which forces the standards monopolist to behave in the
interests of end users. These are the commoditization of the applications market,
technological uncertainty, and the formation of alliances.
254
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Interface standards for an architecture normally commoditize the market
for applications. It becomes much more difficult for companies, including the
owner of the architecture, to differentiate their products from those of their
competitors. Ih the case of Windows, the common graphical user interface
combined with standard keyboard shortcuts significantly reduced switching costs
associated with learning a new program. The common set of drivers provided by
Windows reduced the costs of entry of small developers that never could have
battled WordPerfect and Lotus in the DOS market. Commoditization puts
downward pressure on prices through new entrants and reduced differentiation. It
also forces firms to differentiate by introducing new features before their
competitors can.
Compatibility standards issues apply increasingly to industries that are
undergoing rapid technological advance. It is not surprising, therefore, that
leaders of the industry are challenged periodically and cannot afford not to
innovate. DBM once had a seemingly invincible monopoly position little more
than a decade ago. Like Microsoft, it faced constant attention from the
Department of Justice, culminating in the 1982 decision to drop the antitrust case.
DBM did not, however, foresee the potential for the personal computer to
challenge its position in mainframes and minicomputers. Microsoft almost
suffered a similar fate by not recognizing the potential of the Internet until long
after new competitors such as Netscape had established strong positions.
255
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
New competitors can also challenge near monopolists by forming
alliances. The dominant company will not perpetually be able to defeat all of its
competitors. If its position is that strong, challengers are likely to band together.
Such defensive alliances have recently been formed by competitors to Microsoft
such as IBM, Apple, Sun, Netscape, and Oracle.
256
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Notes
^ It can be said that standards monopolies have similarities to the “contestable
markets” theory of natural monopoly. This theory suggests that regulation is often
not the best option for natural monopolies because they could be disciplined by
some competition. Policy makers would thus focus on reducing entry and exit
barriers. Standards monopolies are contestable enough that the damage that would
be caused by price regulation likely exceeds any potential benefit. For further
discussion of contestable markets, see William J. Baumol, “Contestable Markets:
An Uprising in the Theory of Industry Structure,” American Economic Review, 72
(1), 1982.
^ Joseph A. Schumpeter, Capitalism, Socialism, and Democracy (third ed. 1950),
pp. 83-84.
^ Jim Herman, “You Can’t Quit and You Can’t Get Out of the Game,”
Communications Week, October 7, 1996.
257
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Chapter 8
Conclusions
After having evaluated the motivations of Microsoft, the antitrust
imphcations of its actions, the non-proprietary alternative, and provided an
explanatory framework, it is now valuable to summarize these findings, apply
them to recent developments, and present policy imphcations.
Competitive Strategy for Compatibility Standards
The previous chapter provides an analytical framework that helps explain
the strategies of some monopoUes. The primary purpose is to explain Microsoft’s
competitive strategies. As a monopoly it faces low security because of the ease of
software development. In spite of the fact that the company has been able to attain
90% of the market, it achieved this by attracting customers from other firms that
had high market shares in their segments. Software development primarily
requires human capital in the form of programmers. Therefore it is possible for
companies in the industry to take away part of Microsoft’s market share with
superior products and marketing campaigns. Microsoft has dominated in part
because of its commitment to success. Its relatively secure environment can be
further eroded by regulatory changes that have allowed telephone and cable
258
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
companies to deliver information products as well. More importantly the Internet
poses a serious threat to this company given the fact that it does not require a PC
operating system to deliver programs. These two events have eroded its security.
Microsoft is also an ambitious company. This is shown by its ability to
change the focus of its core business to embrace the Internet's emerging
opportunities. The company is involved in numerous projects in different areas
that demonstrate its ability to survive regulatory and technological changes.
As well, software is a durable product that can be sold again to the same
customer only when there have been considerable improvements. Microsoft has
been committed to increasing sales by 20% every year. The company has been
able to do this by cannibalizing its own products, innovating, and expanding to
new markets.
Nonetheless, Microsoft’s products have often not been considered the best
in the marketplace or first with new features. It took ten years for it to release a
product that could favourably compare to Apple’s Macintosh. As well, IBM’s
OS/2 was considered by some observers to be better than Windows 95. Part of
Microsoft’s success is due to the desire of consumers to belong to the largest
network and to migrate to new platforms gradually. Remnants of the original
DOS constrain Microsoft’s operating systems today. Apparently, consumers are
willing to tolerate these disadvantages to maintain compatibility. Does this mean
that Microsoft’s platforms are an example of lock-in to an inferior standard by
259
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
small events? There is certainly some lock-in effect but this appears to be far less
than infinite if the history of the computer industry is any guide. Furthermore, this
lock-in was not caused by random events. DOS became dominant because IBM
chose to establish a largely open system and Microsoft continued to foster this
openness by encouraging independent developers for its operating system. This
open system assuaged the buyers’ fear of ex post opportunism. In contrast,
Apple’s closed strategy caused deep concerns that its superior technology could
not offset.
Some examples can show the importance of Microsoft’s management
strategy. Although being chosen by IBM to provide a PC operating system may
seem like a random event, Microsoft’s own actions played a far more important
role in establishing its monopoly than critics give it credit for. First, it was able to
deliver an operating system much faster than any of its rivals could. To do this it
had to locate a candidate system, buy it, and then adapt it for IBM’s computer.
Second, the company had early marketing savvy, as can be seen by its licensing of
DOS to IBM for a one time fee while PC rivals CP/M-86 and the USCD Pascal P-
System charged on a per copy basis. ^ Thus IBM was able to offer lower prices on
PCs with Microsoft’s OS. This was a deciding factor for many customers. Thus,
Microsoft strategies resulted in its strong position. The key lesson here is that
technological superiority is only one determinant of consumer welfare. The
outcome of standards battles is determined primarily by firm strategy and the
260
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
overall perceived value provided to customers. Random events may play a small
role but not a decisive one.
Given that network externalities are high in the PC software industry,
increasing returns theory suggests that a single firm is likely to become dominant.
Consumers strongly value compatibility and are unwilling to adopt a technology
with a smaller installed base unless the benefits of superior performance exceed
the cost of incompatibility. When compatibility matters to consumers, therefore,
monopolization is almost inevitable. Some firm was likely to achieve the position
that Microsoft now holds. If the government were to punish Microsoft simply for
achieving its strong position, this may provide a disincentive for future
entrepreneurial firms in search of above normal profits.
Furthermore, unlike AT&T prior to its break-up, Microsoft’s dominance is
not enshrined in law. It has to work to maintain its position because its source of
competitive advantage is the protection of its intellectual property. Most patents
last twenty years. It seems unlikely that a standards based information technology
monopoly could last that long. Such a lengthy monopoly could only be
maintained if the monopolist were so innovative that it did not damage
consumers.
It is important to acknowledge, however, that the winner of a standards
battle has a substantial advantage in succeeding generations. For example, IBM
was able to partially offset Microsoft’s advantage when it provided backward
261
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
compatibility with Windows 3.1 programs in OS/2. However, users wül be
inclined to believe that an incumbent can provide better compatibility in
succeeding versions. Another factor is speed because emulation tends to run
slower than native modes. IBM faüed to convince enough users that it could
provide backward compatibility at least as well as Microsoft. In addition,
Microsoft had a cost advantage over IBM because it had a higher volume of sales
in operating systems.
Applications to New Developments in the Microsoft Case
By the end of November 1998, there have been several important
developments with respect to Microsoft. The first, and most significant, is the
major antitrust case brought by the U.S. Department of Justice against the
company. In October 1997, the DOJ launched a suit that claimed that Microsoft
had violated the consent decree that it had signed in 1994 by bundhng its Internet
Explorer browser with the Windows operating system. This trial judge, Thomas
Penfield Jackson, ruled in favour of the DOJ on this issue but his injunction was
later overturned on appeal.
The antitrust principle that a monopolist should not be aUowed to tie a
monopoly product directly to a product in a non-monopoly market is a good one.
It is, however, inappropriate to apply it in the case of Internet Explorer and
Windows. The reason is that many observers, including Microsoft’s competitors,
262
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
believe that a browser integrated with the Java programming language can
represent an alternative platform to Windows. Browsers can thus be seen as an
extension of the market for operating systems and not a distinct market. Under
this interpretation, the integration of a browser with an operating system should
be permitted because they are in the same market. At a basic level the two types
of products have the same goal: to provide a user interface that enables access to
files and programs. For this reason, it seems illogical to claim that the integration
of the two products is equivalent to leveraging a monopoly in one market to gain
another monopoly in a second market.
In May 1998, the DOJ and twenty state Attorneys General launched a new
antitrust suit that was independent of the 1994 Consent Decree. This occurred
after negotiations to avert it failed. In them, Microsoft was given a choice of
either removing Internet Explorer components from Windows or bundling an
additional browser, Netscape’s, with the operating system. The key arguments of
the filing by the states were that Microsoft committed the following illegal
actions. First, it used monopoly power to maintain its monopoly in operating
systems. Second, it attempted to monopolize the Internet browser market. Third, it
leveraged its operating systems monopoly. Fourth, it tied the Internet browser to
its operating system. Fifth, it tied other applications, especially Outlook Express,
to its operating system. Sixth, it maintained its monopoly over Microsoft Office.
Seventh, it used licensing agreements to restrain trade.^ This filing encompassed
263
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
the same issues as presented by the DOJ although the fifth and sixth points were
unique to the case brought by the state attorneys general. The first and sixth
claims make little sense. If companies are prevented firom acting to maintain their
position in a monopoly market, their rate of innovation wül slow and consumers
wül be worse off. Since Microsoft did not attempt to close these platforms to
outside developers, it should not be held liable on these counts. The second, third,
and fourth claims are also questionable because an Internet browser can be
properly thought of as being in the same market as an operating system. The fifth
claim may, however, have merit because it is harder to see how an electronic mail
cHent can be considered as in the same market as an operating system. The
seventh claim, if proven, should indeed result in court sanctions.
The reason for this is that it is unreasonable for Microsoft to threaten to
withdraw an OEM license for Windows, simply because the OEM placed
additional icons on the desktop for products that competed with those of
Microsoft. There is, however, some justification for Microsoft to maintain some
control over how OEMs use Windows. In particular, Microsoft has the right and
duty to ensure that OEMs do not introduce incompatibilities into the operating
system through technological customization. A grayer area of licensing involves
the use by Microsoft of its desktop real estate to promote its own products and
those of partners. This revenue can be seen as one of the spoüs going to the
winner of a standards battle. Permitting such revenue can give competitors
264
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
wishing to overtake the monopolist an extra financial incentive to make the risky
investments necessary to develop an innovation radical enough to overcome the
installed base of the incumbent. A potential solution could be to guarantee a
certain portion of the desktop to Microsoft icons and the rest to those of the OEM.
To ensure compatibility, the standards monopohst should retain the right to
standardize the basic user interface at the time of purchase by the end user.
In October 1998 the antitrust trial against Microsoft began. Several
witnesses firom competitors claimed that the monopohst had tried to exploit its
market power through aggressive negotiation. One of the more damaging claims
was that Microsoft executives had tried to coUude with Netscape by suggesting
that the companies spht the Internet browser market between them with Microsoft
controlling ah users of the Windows platform.
The release of videotape and transcripts of the lengthy deposition of Bhl
Gates appeared to be a pubhc relations disaster. The CEO firequently denied or
claimed no knowledge of aggressive negotiation tactics that were well
documented by internal electronic mah. Several of the accusations, such as the
supposed “leveraging” of the Windows monopoly in the browser market, may not
have been upheld depending on the interpretation of markets. The vehement
denials by Gates in the face of convincing evidence, however, suggested that
company leaders themselves felt that the activities they were accused of indeed
were hlegal.
265
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Microsoft has also been faced with a private lawsuit by its competitor Sun
Microsystems. The plaintiff claimed that Microsoft had violated its licensing
agreement for use of Sun’s Java programming language by attempting to integrate
it with its Windows operating system in such a way that it would create
incompatibilities with other Java implementations. Essentially, Microsoft was said
to have attempted to steal the Java standard away from Sun by making a
customized version that would not run on other platforms. This would neutralize
the competitive threat to its operating system monopoly posed by the “write once,
run anywhere” principle that Sun promoted as a key advantage of Java. If this
claim is proven. Sun should indeed win its lawsuit. One of the key conclusions of
this research is that the owners of proprietary technologies should act aggressively
to ensure the compatibility of their standards. This means that Sun should be able
to force licensees, including Microsoft, to adhere to interface guidelines such as
the principle of “write once, run anywhere.”
Another recent development also underscores one of the key theoretical
conclusions of this research about the motivations of a standards monopolist to
behave as if it were in a competitive industry. Competitors can improve their
probability of overcoming the deep pockets of the monopolist through alliances or
mergers. The decision by America Online to abandon its support for Internet
Explorer and replace it with the acquisition of Netscape’s Navigator browser and
the Netcenter portal should improve the ability of competitors to provide a viable
266
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
alternative to Microsoft’s products. These negotiations also resulted in an alliance
between AOL and Sun to allow the latter to take over the enterprise server
software that Netscape was selling.
Policy implications
The general premise of this research is that compatibility standards
monopolies are different from traditional types of monopolies because they
maintain incentives for innovation and competitive pricing, and face a
considerable threat of entry. This study has found that some of the factors that
cause this unusual behaviour are within the realm of public policy. For this
reason, it is necessary to present the policy recommendations that are implicit in
the theoretical conclusions. The rationale for these recommendations has been
developed throughout the work and this represents a brief summary of the main
ideas. The normative assumption is that technological innovation, competitive
pricing, and compatibility are the principal goals of the policy maker. It is
important to note that these conclusions are based on the theory built in the study
as a whole. The implications that follow are based on an assumption that further
testing wül confirm the theories that have been developed. They are presented in
the order of the degree of activity required by the policy maker. The first five
require direct action while the last five involve letting market forces determine
outcomes.
267
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Areas for Active Government Involvement
End User Licenses
One of the most important factors limiting Microsoft’s ability to exploit
consumers through high prices and low rates of innovation is inherent in the
characteristics of software. Once a piece of software is sold it is impossible for the
producer to sell the same software to the same customer. Software companies
provide new innovations to continue selling to the same customers. This is
different from most other industries. For example, a pharmaceuticals company
can sell the same drug to the same customer for as long as the customer needs it.
The importance of reselling in the protection of consumers leads to an implication
for pubUc policy. If a software company is able to specify in its license that the
software can only be used until a certain date it is then able to resell the same
software to the same customers, thus reducing its incentive for innovation. A
simple solution for those still concerned about the potential for reduced
innovation is to make a law that prohibits software companies from engaging in
time or usage variable pricing.
Thus, governments should establish rules that ensure the substitutability of
older versions. Software companies should not be permitted to charge on the basis
of time or usage as this option becomes more technologically feasible. One of the
268
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
main factors that forces software monopolists to innovate and price competitively
is that they are forced to sell improved versions of products if they are to extract
revenues from prior customers. If they could price by usage or time, they would
have less incentive to irmovate because they could simply resell the same piece of
software to aU of their customers without improving it. This does not mean,
however, that aU innovation in the industry would stop. Other factors such as
technological uncertainty and reduced learning costs would also provide a degree
of discipline for the standards monopoly. Some scholars claim that time and usage
based pricing are beneficial to both customers and suppliers because they provide
flexibility. This argument makes sense when applied to a manufactured good with
extremely high production costs but it is much harder to see benefits to end users
in the software industry.
Another policy that would promote substitutes is to enable users to buy
licenses for old versions of software products. This would ensure that a firm is not
forced to upgrade to a new version simply to maintain compatibility of its
systems. Frequently the file formats of upgraded software cannot be read by
previous versions. This incompatibility can reduce productivity in a large
enterprise. For this reason, the choice to upgrade may have little to do with
improvements in the product. If firms are not allowed to buy licenses of older
software for their new machines this will virtually guarantee an upgrade revenue
stream for the standards monopolist regardless of its degree of innovation. It is
269
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
important to note that the marginal cost of these licenses to the producer is
virtually zero because the software product is simply copied to the new machine.
Beyond a certain number of years the support of older products could shift to the
licensee. To reduce uncertainty and ex post opportunism, however, the license for
the current version of a software product should specify a minimum number of
years that product support will be available after the product is discontinued. The
license for older versions should be priced at or below the price that prevailed
prior to being discontinued. This policy could conceivably reduce the diffusion of
new technologies by allowing large numbers of end users to avoid upgrades but
this will force software companies to add more value in their new products to
tmly make the upgrade worthwhile. This reduces the ability of a monopohst to
exploit its position. The impact of this policy on revenues for software
monopolies is shown in Figure 8 -1 . The decline in revenue for an earlier version
of the product is much slower under this rule. This decline wül only happen if the
new product is sufficiently better. Otherwise sales for the software monopolist
WÜ1 be much lower, resembling those of Figure 7 -1 . The more irmovative that the
firm is the higher its overall sales wiU be and the shorter the period that it wül
receive revenues for its older versions. The firm’s revenue stream wiü look
similar to that of Figure 7 -2 but lack of forward compatibility wiü no longer be
enough to guarantee this favourable outcome.
270
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Figure 8-1
Sales Revenue for a Multi-generation Standards
Monopoly Under the Recommended Licensing Rule
Sales
Time
Original Version New Versions
Microsoft has generally been willing to support its products after they
have been replaced by new versions. In 1997, however, they began encouraging
OEMs to cease offering Windows 3.11 as an option to their customers. They
requested an end to dual Windows 3.11/95 installations, publicly contemplated
charging higher fees for 3.11, and planned to terminate development of BIOS and
driver updates.^ The former two actions should be prohibited for the reasons
outlined above. The latter is more understandable. After a period of time it seems
unreasonable to request that a company support old products. This may not cause
much hardship to customers. For example, Glen Morley, a systems engineer at
Design Professional Insurance Co. said: “Fm familiar with idiosyncrasies of
Windows, so it doesn’t matter that they’ll not be supporting it . . . I never call
271
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
them for support anyway.”" ^ Regardless, customers should be informed in the
initial licensing agreement of the long term support policy.
D egree of O p en n ess of M onopoly Platform s
It is also important to ensure the openness of new versions of backward
compatible monopoly architectures. The introduction of a new version of an
architecture can give the monopolist a head-start over its rivals if it restricts
access to pre-release versions. Microsoft is often accused of withholding
information from its rivals but little concrete evidence has been provided of this.
The primary reason why Microsoft was able to develop such a strong position in
office applications is due to the choice by companies such as WordPerfect and
Lotus to not develop versions of their DOS products for Windows 3.0. This gave
Microsoft a lengthy head-start which its rivals were unable to recover from. The
importance of a head-start therefore should not be underestimated. The holder of
the monopoly may therefore choose to restrict access to a new version of its
backward compatible architecture so that it can gain this head-start. The existence
of such a de facto monopoly gives the government ample reason to use antitrust
enforcement to ensure openness of subsequent versions of the product. Openness
consists of equal access to beta versions and any information necessary to provide
fully compatible applications. The ownership and control of the architecture
should not, however, be challenged.
272
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Although the openness of the architecture should be preserved, it is
important not to eliminate the ability of the standards setter to make above normal
profits. The argument here is analogous to that of patent protection. To have
radical technological change there must be an incentive to gain monopoly profits.
If the government confiscates the monopoly once it is attained this wül düute the
property right and make aU firms less likely to take the risks inherent in an effort
to set a new standard.
A monopolist should not, however, be able to unüaterally make its
previously open standard closed. It should disclose any information necessary to
make the applications of rivals interoperate with new versions of the system. It
can maintain proprietary ownership while still publishing applications
programming interfaces. This rule can probably be enforced through existing
antitrust laws because acting otherwise would be monopolizing behaviour.
Product Preannouncem ents
In spite of faster product introductions as a result of the Internet, product
preannouncements remain problematic. Although there is little benefit to end
users of early announcements of non-architectural products, there are clear
benefits when the product can be used with complements. It is essential that new
versions of operating systems be preannounced in enough time for independent
producers to develop competitive applications. However, it is also possible for
273
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
firms to use a preannouncement to put a rival that has introduced a competing
product at a disadvantage. If this is intentionally inaccurate it is clearly unethical
and should be discouraged. If not, market failure could be caused by the
asymmetric information problem. If end users cannot determine the validity of
announcements, firaudulent vapourware will be the norm.
Governments can reduce this phenomenon if they ensure that fraudulent
announcements can be prosecuted under antitrust laws for monopolies and under
tort laws for large and small firms alike. It is, however, essential that these laws
not be overused because end users and independent developers alike desire the
information provided by preannouncements. For this reason, the burden of proof
should be high. To determine intent, access to internal communication may be
necessary. An architectural monopolist could reduce its exposure to liability by
restricting information about its upcoming product to independent developers and
its largest customers, under strict non-disclosure agreements. In this way the
societal benefits of preannouncing are realized while reducing the probability that
the market wiU be misled.
Bundling
It is important to establish a consistent rule for bundling so that firms with
established architectural standards know ex ante what they wiU be permitted to
do. Consumers have generally received benefits from bundling. It is much easier
274
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
to buy an integrated product rather than piece one together. As well, there may be
a compatibility benefit. Buyers of an integrated system will have all of the same
abilities built into their system so that independent developers can target a mass
market. In this way, more programs would become available to the user of an
integrated system. For this reason, the claim by Robert Prentice that forced
unbundling can cause little harm is too optimistic.^ Consumers often perceive
benefits from bundling.
It is true, however, that bundling can enable the owner of an architectural
standard to extend its monopoly into a new area. For this reason, some restrictions
are necessary. The following test would balance the two concerns related to
bundling. Four questions should be asked. First, at the time of bundling were the
functions of the two products distinct? Second, at the time of bundling did one of
the products have a monopoly share? Third, at the time of bundling would the
product(s) then facing competition have been protected by high barriers to entry
(i.e. customer lock-in) if they became monopolies? Fourth, are customers forced
to buy the products together either because there is no option to buy them
separately, or because there would be no financial advantage in doing so? If the
answers to aU four questions are true then bundling should not be permitted. For
example, if Microsoft Office were bundled into Windows and its components are
not available at a feasible price separately, aU four questions would be answered
affirmatively and the bundling would not be permitted. This test would also
275
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
resolve the controversy over the integration of Internet Explorer in Windows.
Although the last three questions can be answered affirmatively the first one
probably cannot. Like an operating system, a browser’s principle task is to access
files and programs whether they are on a network or a local drive. If Microsoft
were the only company forbidden from bundling a browser into its operating
system its monopoly would likely be replaced with a new monopoly from a
competing firm that was able to do so. This type of confiscation of a market
position might reduce the overall level of innovation. Potential challengers for an
architectural standard would not invest as heavily because if they happened to win
they would be prevented from defending their position.
R ules of B ehaviour
A basic guideline for any antitrust policy that the U.S. Supreme Court has
generally adopted is to apply the Hippocratic Oath used in medicine.^ The latin
phrase “primum no nocere” translates as “first do no harm.” An over-zealous
defense of competition in this industry could easily make the situation worse.
There is little if any evidence that the existence of a compatibility standards
monopoly has led to lower innovation or higher prices than would otherwise
prevail. William B. Kovacic, a law professor at George Mason University, puts it
weU: “[a]ntitrust intervention is a very clumsy tool for correcting perceived
problems in high-tech industries. By the time antitrust officials figure it out, the
276
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
industry has already changed.. This does not, however, mean that nothing
should be done. Establishing and enforcing simple and consistent rules is
desirable.
Antitrust sanctions should generally emphasize documented cases of
intentional sabotage of rival products. Some of the accusations outlined by the
Department of Justice in the 1994 Consent Decree with Microsoft, such as per
processor licenses for OEMs, qualify as sabotage. If they are proven in court
Microsoft can be forced to compensate rivals. The accusations have merit if
Microsoft deliberately intended to sabotage the products of its competitors. If the
claims are substantiated they may entitle a competitor to treble damages, as
specified in the Clayton Act. This, however, does not mean that consumers would
be made better off by the break-up of Microsoft into two companies, each
dedicated exclusively to either operating systems or applications. Nor does it
mean that Microsoft’s dominance of the PC software market hurts consumers.
Areas for Caution in Pubiic Policy
G lobal Inform ation Infrastructure
In the debate over rules for interfaces for the Global Information
Infrastructure, the demonstration that proprietary standards appear to be better for
end users than non-proprietary ones implies that governments should not insist on
277
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
the latter for essential GII interfaces. The profit motive will provide the incentive
to innovate that will ensure that these interfaces serve the needs of users.
Proprietary standards are also likely to be more compatible than non-proprietary
ones.
A cquisitions
It is possible to argue that acquisitions enable a monopolist to avoid
having to compete in a market. By taking over their major competitors, they
reduce the amount of effort they need to expend in market battles. This may mean
less innovation and higher prices over the period that would have been subject to
more intense competition. In the case of standards, however, this period of
competition comes at the cost of incompatibility. Thus mergers are not nearly as
damaging to consumers in this type of industry.
The tendency toward standards monopolization implies that market
concentration ratios such as the Herfindahl-Hirschman Index (HHI) are of little
public policy use in systems industries. Consumers clearly benefit when
compatibility is provided and this is far more likely when a standard is owned and
controlled by a single firm. The Wilson Sonsini white paper on Microsoft’s
attempted acquisition of Intuit stresses HHI ratios as its justification.® This
methodology may be appropriate for some industries but is inappropriate for
analysis when consumers derive benefits from compatibility.
278
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
P redatory Pricing
One of the traditional justifications for antitrust enforcement is the ability
of a company to undercut its rivals by charging below incremental cost. In the
case of software, some companies have clearly engaged in this practice. In
particular, Netscape and Microsoft have distributed their browsers for free. A
company may face antitrust liability if it uses this method to destroy competition
with an intent, and a reasonable probability of success, of raising the price later to
take advantage of the monopoly position. Given that entry barriers are high due to
the lock-in effect, it would seem that compatibility standards monopolies comply
with the conditions for liability under predatory pricing.
There are, however, significant problems with this conclusion. It is
common for firms introducing products for the first time to set introductory prices
lower to promote the product. Penetration pricing may thus be entirely justifiable
under non-predatory profit maximization. More importantly, a predatory pricing
claim should not succeed unless consumers are likely to be hurt as a direct result
of the strategy. In the case of compatibility standards, the phenomenon of lock-in
ensures that a monopoly will occur regardless. This is exactly what consumers
want to happen because the ability to interoperate is essential. Since monopoly is
inevitable and desirable, the low “predatory” prices benefit consumers. Long run
prices wül be the same regardless of the earlier pricing activity. Thus, companies
279
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
wishing to establish a compatibility standards monopoly should not be held liable
for predatory pricing.
C ro ss-su b sid y
Although this study concentrates on the software industry, there is also an
implication for telecommunications policy in the theoretical conclusions.
Monopolists are often feared for their ability to cross-subsidize goods in new
markets with those in the markets which they dominate. Cross-subsidy of
products is common to virtually all firms, not just to monopolies. It becomes
problematic when the monopoly is regulated to provide a guaranteed rate-of-
retum in one of its markets because it is difficult to prevent the use of creative
accounting to provide subsidized entry to the new market. This, however, does
not apply to Microsoft or other dominant companies that are not subject to rate-
of-retum regulation. The fear that a company may grow too big for the good of
society should not require pre-emptive action. It is often possible to use existing
laws to reduce market power after it is achieved if this is viewed as in the long
term interests of consumers.
D ivestiture
It is important to determine the extent to which Microsoft and other
compatibility standards monopolies should be permitted to leverage advantages in
280
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
architectures into applications. Part of this is achieved by implementing a test for
bundling such as the one above. It would be difficult, however, for a regulator to
determine what qualifies as an architecture and what is an application. For
example, there are arguments for and against including device drivers, DLLs, web
access, text editors, search engines, and file explorers as part of an operating
system. If Microsoft were split into two divisions, regulators would have to
redefine what constitutes an OS as computing evolves.^
Therefore, a recommendation for antitrust policy is that it is not desirable
to break up standards monopolies on the basis of architecture and applications.
The Microsoft case shows how dominant companies in the information industry
can maintain their incentive to innovate and price competitively. It is not clear
that Microsoft’s architectural control guarantees it a dominant position in
applications as weU. Although it may have an inherent advantage over some rivals
due to its vertical integration, this may benefit consumers in the long run because
the application will be better integrated and thus of higher quality. As well, a
small advantage to the architecture owner can give it a greater incentive to
improve the standard.
Conclusion
This study has shown why an architectural standards monopoly,
Microsoft, continues to innovate, price competitively, and face threat of entry, in
281
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
spite of its dominant position. The competitive environment includes the
existence of substitutes in the form of prior versions, commoditization of the
interface, uncertainty resulting from rapid technological advance, and Licensing
agreements that ensure compatibility. The smdy also evaluated competitive
strategies and antitrust enforcement for standards including the issues of product
preannouncements, bundling, leveraging, mergers, and pricing.
A compatibility standards monopoly is different from the traditional ones
in the economic literature. It is less damaging to end user interests than other
intellectual property-based monopolies. Security of position tends to be low, due
to threat of entry, while potential rewards from innovation are high, as a result of
the need to differentiate new products from previous versions that serve as
substitutes. Nonetheless, the rules outlined above can foster iimovation and
pricing incentives.
The theories developed in this work can be tested through in-depth study
of other cases of multi-generation compatibility standards monopolies. If enough
examples can be found, statistical analysis may be possible. This does not seem
likely, however. Thus, case analysis seems to be the most productive way of
moving forward with this research in the near future.
282
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Notes
^ Bill Gates, The Road Ahead (New York: Viking, 1995), p. 48-49.
^ State of New York, et al. v. Microsoft Corporation, Complaint, US District Court, District of
Columbia, May 18, 1998.
^ Lisa DiCarlo and Michael R. Zimmerman, “Microsoft pushing OEMs to move
to Windows 95,” PC Week, November 25, 1996.
^ DiCarlo and Zimmerman, 1996, op.cit.
^ Robert Prentice, “Vaporware: Imaginary High-Tech Products and Real Antitrust
Liability in a Post-Chicago World,” Ohio State Law Journal, 57, 1996, pp. 1163-
1262.
^ Jay Dratler, Jr., “Software: Microsoft as an Antitrust Target: IBM in Software?”
Southwestern University Law Review, 25, 1996, p. 689.
^ Mitch Betts, “Experts say DOJ made its best case,” Computerworld, August 1,
1994.
^ Gary Reback, Susan Creighton, David KiUam, and Neil Nathanson,
“Technological, Economic and Legal Perspectives Regarding Microsoft’s
Business Strategy in Light of the Proposed Acquisition of Intuit, Inc.,” Upside,
February 1995.
283
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
^ Mike Elgan, “Justice Department: Hands Off Microsoft!—Splitting Microsoft
into Two Companies would be Disastrous for the Industry—and for Users,”
Windows Magazine, 801, January 1, 1997.
284
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Appendix
Table A-1
Upgrades to Microsoft’s Operating System s
Product Date
DOS 1.0 for PC 1981
MS-DOS for IBM PC XT 1983
MS-DOS 3.0 for IBM PC AT 1984
MS-DOS 3.1 for networks 1984
Windows 1.03 1985
Windows 2.0 1987
Windows 386 1987
OS/2 1.0 1987
Windows 2.03
OS/2 LAN Manager 1988
Windows 3.0 1990
MS-DOS 5.5 1991
Windows 3.1 1992
Windows NT 1992
MS-DOS 6.0 1993
Windows 95 1995
Source: Michael A. Cusumano and Richard W. Selby, Microsoft Secrets: How the
World’s Most Powerful Software Company Creates Technology, Shapes Markets,
and Manages People (New York: Free Press, 1995), pp. 451-455.
285
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Table A-2
Unix Upgrades B ased on System V from AT&T
Product Date
System IH 1982
System V 1983
SVR2 1984
SVR3 1986
SVR3.2
SVR4 1988
SVR4.1
SVR4.2
Source: Pierre P. Lewis, “Unix FAQ,” (http://www.cis.ohio-
state.edu/hypertext/faq/usenet-faqs/htinI/uiiix-faq/faq/part6/faq-doc-3 .html).
286
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Table A-3
Unix Upgrades Based on the Berkeley Software Distribution Version
Product Date
2.XBSD 1978
3BSD 1978
4.0BSD 1980
4.1BSD
4.2BSD 1983
4.3BSD 1986
4.3 Tahoe 1988
4.3 Reno 1990
Net I and Net2 June 1991
4.4BSD (alpha) June 1992
Source: Pierre P. Lewis, “Unix FAQ,” (http://www.cis.ohio-
state.edu/hypertext/faq/usenet-faqs/htmI/unix-faq/faq/part6/faq-doc-3.html).
Table A-4
Unix Upgrades Based on the
Open Software Foundation (OSF) Version
Product Date
OSF/1 1991
Release 1.3 June 1994
Source: Pierre P. Lewis, “Unix FAQ,” (http://www.cis.ohio-
state.edu/hypertext/faq/usenet-faqs/htmI/unix-faq/faq/part6/faq-doc-3.htmI).
287
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Table A-5
Macintosh Operating System Upgrades
Product Date
Operating System for Lisa 1983
Introduction of QuickDraw graphics 1984
Mac Multitasking (MultiFmder) 1987
System 7.0 (32 bit OS) 1991
System 7.1 1992
System 7.1.2 (For RISC) 1994
System 7.5 1994
MAE 2.0 (Mac OS for Unix) 1995
Source: Apple, Inc.,
(http://www.macos.apple.com/macos/aboutmacos/roadl.html,
http://www.macos.apple.com/macos/aboutmacos/road2.html,
http://www.macos.apple.com/macos/aboutmacos/road3.html)
288
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Table A-G
Pricing of Microsoft Applications
Year Word Excel PowerPoint Access
1997 297/116 297 297/115 298
1996 293/93 293/95 293/93 293/93
1995 295/113 293/114 295/113 297/113
1994 297/114 297/97 297/114 299/19
1993 299 299 299 439
1992 292 292 290
439***
1991 299 297 299 427***
1990 209 274 452***
1989 185 247 225** 190***
1988 195 305 229**
1987 252 108* 164**
1986 225 115*
Sources: Advertisements in the first issue of each year in PC Magazine by the
following mail order firms: CDW (1994-1997), Software Add-ons (1991-1993),
and Warehouse Data (1986-1990).
Note: Where a second number is given it is the price for an upgrade. Prices are
rounded to the nearest U.S. dollar. *=Multiplan, **=Chart, ***=FoxPro/FoxBase.
289
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Table A-7
Pricing of Applications by Microsoft Competitors
Year WordPerfect Lotus 1-2-3 Lotus Freelance dBase
1997 377/142* 377/142* 320 271/113*****
1996 256/89 290/94 320 326
1995 274/82 303/95 324 326/190
1994 280/99 293/98 324/99 522/95
1993 255 337 335
249******
1992 238 395 309 465
1991 242 395 309 469
1990 229 339 309 469
1989 255 295 345 463
1988 195
229*** 325*******
1987 278** 310*******
1986 285**
299*******
Sources: Advertisements in the first issue of each year in PC Magazine by the
following mail order firms: CDW (1994-1997), Software Add-ons (1991-1993),
PC Connection (1989) and Warehouse Data (1986-1990).
Note: Where a second number is given it is the price for an upgrade. Prices are
rounded to the nearest U.S. dollar. *=SmartSuite96, **=WordStar 2000,
***=Harvard Graphics, ****=Chartmaster, *****=Visual DB Professional 5.5,
* * ** * *=Approach, *******=Condor lU.
290
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Table A-8
Pricing of Microsoft and Lotus Office Suites
Year Microsoft Office
Professional
Lotus SmartSuite
1997 544/314 377/142
1996 529/309 379/192
1995 533/350 452/271
1994 450/269 439/389
1993 465 453
1992 599
1991 629
Sources: Advertisements in the first issue of each year in PC Magazine by the
following mail order firms: CDW (1994-1997), Midwest (1994), and Software
Add-ons (1991-1993).
Note: Where a second number is given it is the price for an upgrade. Prices are
rounded to the nearest U.S. doUar.
291
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Table A-9
Prices of Microsoft Office and its Competitors
Product May-
June
1995
July-
Aug.
1995
Sept-
Oct
1995
Nov.
95
Dec.
95
Ian.
96
Feb.
96
May.
96
lune
96
Aug.
96
Sep.
96
Oct.
96
Nov.
96
Dec.
96
Jan.
97
Windows OS
Bundled
Products
MS Office
Standard
439
Win
95
439 439 439 439 439 439 439 439 439 439 478
MS Office
Standard *
259 259 189
Win
95
189 219 219 219 219 219 219 219 219 219 219 238
Lotus Smart
Suite 3.1
429
($40
re
bate)
429
(40)
389 389 389 389 389 389 389 389 399 399
Lotus Smart
Suite 3.1 *
199 199 199 199 199
(4.0)
149 149 149 149
**
149
**
Novell Perfect
Office*
189 189 Free
(Win
95)
Free
(Win
95)
95
Co
rel
99 95 95 95 95 95 89
Novell Perfect
Office
419 419 419 419 249
Co
rel
269 269 239 239 239 259 225
Claris Works 69
(4.0)
65 65 45 49 45 45 45 45
W ord
[Processors
W ord 299 299 299 299 299 299 299 316
Word * 115 115 89
(W in
95)
89 89 89 89 89 89 98
AmiPro 3.1
(Now
W ordPro)
79 79 99 95 95 95 95 65 65 65 65
WordPerfect
WordPerfect* 89 89 89 89 89
Spread-sheets
M S Excel 5.0 299 & 99 [299 299 299 299 316
MS Excel
5.0*
115 115 89 89 89 89 89 89 98
Lotus
1-2-3 5.0
289 289 299 ^95 289 289 289
292
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Product May-
lune
1995
luly-
A.ug.
1995
Sept-
Oct
1995
Nov.
95
Dec.
95
Ian.
96
Feb.
96
May.
96
lune
96
Aug.
96
Sep.
96
Oct.
96
Nov.
96
Dec.
96
Jan.
97
Lotus
1-2-3 5.0*
95 95 95 97 97
Novell
Quattro Pro
6.0
239
Novell
Quattro Pro
6.0*
49 49 49 49 49 69 69 69 65 65 65
Presentations
M S
PowerPoint
299 299 299 299 299 299 299 316
M S
PowerPoint *
89 89 89 89 89 89 89 98
Lotus
Freelance
Graphics
329 329 329 329 329 329 329 339 339
Lotus
Freelance
Graphics*
99 99 95 95 95 95
Novell
WordPerfect
Presentations
3.0
69
(Co
rel)
69 69 65 65 65
Novell
WordPerfect
Presentations
3.0*
119 119 119 119 119
Databases
M S Access 95 95 299 299 299 299 299 299 316
M S Access * 89 89 89 89 89 89 89 89 98
Lotus
Approach
95 95 99 95 95 95 95 95 99 99
Source: Insight Direct,
* = upgrade price, ** =
Inc. catalogs.
: competitive upgrade price
293
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Bibliography
“Bill Gates Uncensored.” Business Week. April 10, 1995, p. 132.
“Coca-Cola Tops Magazine’s Rankings of Brands’ Value: DBM, Hit by PC
Clones, Slips to No. 290.” Washington Post. July 12, 1994, p. C4.
“Gentle Giants.” The Economist. December 21, 1996, pp. 15-16.
“IBM still unchaUenged mainframes giant.” The San Diego Union-Tribune.
December 24, 1996, s. Computer Link, p. 22.
“Interview.” The World Wide Web Journal. I (3), 1996. Available (online):
http://www.ora.com/catalog/wj3/.
“MCI and Microsoft Ally to Cross-Market.” Interactive Home. January 1, 1996.
“Microsoft VP Steve Ballmer Speaks.” CNET News. May 10, 1996. Available
(online): http://www.news.com/SpecialFeatures/0,5,1300,00.html.
“Microsoft will End Successful Year on High Note, Analysts Predict.” Report on
Microsoft. 4 (13), July 1, 1996.
“MonopoDes in Cyberspace.” The Economist. September 7, 1996, p. 18.
“Netscape Steps Up Parmerships.” DOTCOM. 3 (6), September 1996.
“Report Slams Microsoft Tactics.” Report on Microsoft. 3 (24), December 18,
1995.
“Setting the Record Straight.” Microsoft. December 19, 1997. Available (online):
http://www.microsoft.com.
“Software Developer Caldera ® Sues Microsoft ® for Antitrust Practices, Alleges
Monopolistic Acts Shut its DR Dos ® Operating System Out of Market.”
PR Newswire. July 24, 1996.
“Software Support and Satisfaction.” PC Magazine. July 1992, July 1993, July
1994, July 1995, and July 1996.
294
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
“The Bill Gates Interview.” Playboy. 1994. Available (online):
http://ei.cs.vt.edu/-history/Bill.Gates.htnil.
“U.S. Department of Justice Challenges Planned Acquisition of Intuit Inc.” S&P
Daily News. April 27,1995.
“Vaporware Wins No Laughs at Microsoft Now.” San Diego Union-Tribune.
February 21, 1995, p. 1.
Anderson, Howard. ‘Target: Microsoft.” Upside. March 18, 1997.
Areeda, Phillip E., and Donald Turner. “Predatory Pricing and Related Practices
Under Section 2 of the Sherman Act.” Harvard Law Review. 88, 1975.
Arthur, W. Brian. “Competing Technologies, Increasing Returns, and Lock-in by
Historical Events.” The Economic Journal. March 1989, pp. 116-131.
Arthur, W. Brian. “Increasing Returns and the New World of Business.” Harvard
Business Review. July-August 1996, pp. 100-109.
Aycock, Jayson. “Windows Development Saga: That Was Then, This Is 95.”
Austin American Statesman. August 19, 1995, p. 06.
Baker, Donald. “Government Enforcement of Section Two.” Notre Dame Law
Review. 61, 1986.
Band, Jonathan. “Competing Definitions of ‘Openness’ on the NU.” In Standards
Policy and the National Information Infrastructure. Brian Kahin and Janet
Abbate, eds., pp 351-367. Cambridge, MA: MIT Press, 1995.
Baseman, Kermeth C., Frederick R. Warren-Boulton, and Glerm Woroch.
“Microsoft Plays Hardball: The Use of Exclusionary Pricing and
Technical Incompatibility to Maintain Monopoly Power in Markets for
Operating System Software.” Antitrust Bulletin. 4, 1995.
Baumol, William J. “Contestable Markets: An Uprising in the Theory of Industry
Structure.” American Economic Review. 72 (1), 1982.
Bayers, Chip. “Why Bril Gates Wants to Be the Next Marc Andreessen.” Wired.
3.12, December 1995.
Beales, Howard, et al. “The Efficient Regulation of Consumer Information.”
Journal of Law and Economics. 24, 1981.
295
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Bender, David. “Microsoft and the Antitrust Wars.” Practising Law Institute.
Patents, Copyrights, Trademarks, and Literary Property Course Handbook
Series. September, 1995.
Besen, Stanley M., and Joseph Farrell. “Choosing How to Compete: Strategies
and Tactics in Standardization.” Journal o f Economic Perspectives. 8,
1994.
Besen, Stanley M., and Leland Johnson. Compatibility Standards, Competition,
and Innovation in the Broadcasting Industry. Santa Monica: Rand
Corporation, 1986.
Betts, Mitch, and Stuart J. Johnston. “Judge probes deeper into Microsoft antitrust
case.” Computerworld. January 30, 1995.
Betts, Mitch, and Stuart J. Johnston. “Microsoft, justice dance antitrust tango
again.” Computerworld. May 1, 1995.
Betts, Mitch, Stuart J. Johnston, and Ed Scannell. “Users hold key to antitrust
battle.” Computerworld. April 18, 1994.
Betts, Mitch. “Experts say DOJ made its best case.” Computerworld. August 1,
1994.
Betts, Mitch. “Microsoft rivals seek to overturn antitrust deal.” Computerworld.
January 16, 1995.
BeVier, Lillian R. “Competitor Suits for False Advertising Under Section 43(a) of
the Lanham Act: A Puzzle in the Law of Deception.” Virginia Law
Review. 78, 1992, pp. 1-48.
Blackford, John. “Microsoft Uber Allés? Software Titan’s Marketing Savvy
Overcomes Its Childish Posture.” Computer Shopper. July 1994, p. 62.
Boudreaux, Donald J. “Microsoft’s Great Business Secret.” Washington Times.
March 3,1995, p. A21.
Bowman, Ward S. Patent and Antitrust Law: A Legal and Economic Appraisal.
Chicago, University of Chicago Press, 1973.
Brennan, Timothy J. “Is the theory behind U.S. vs. AT&T applicable today?” The
Antitrust Bulletin. Fall 1995, pp. 455-482.
296
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Bridges, Linda. ‘The Sweet Smell of Vaporware Starts to Turn Sour for Many
Micro Managers.” PC Week. November 17,1987, p. 19.
BrouseU, David R. “Software Firms Plan Campaign to Obtain IBM Source Code.”
Datamation. November 1, 1987, p. 19.
Brown, Jack E. “Technology Joint Ventures to Set Standards or Define
~hit& vîaceiS." Antitrust Law Journal. 61, 1993, pp. 921-936.
Bruno, Charles. “Playing Fair.” Network World. July 25, 1994, p. 44.
Buchanan, James M. “Rent Seeking and Profit Seeking.” In Toward a Theory of
the Rent Seeking Society, James M. Buchanan, Robert D. Tollison, and
Gordon TuUock, eds. College Station: Texas A&M University Press,
1980.
Burrows, Peter. “Apple’s Copland: New! Improved! Not Here Yet!” Business
Week. December 18, 1995, p. 80.
CaUmann, Rudolf. Unfair Competition, Trademarks and Monopolies. 4th ed.
Wilmette, HI.: Callaghan, 1993, pp. 88-89.
Carlton, Jim. “Motorola’s New Computer Line to Run Multiple Systems, Relying
on Windows.” Wall Street Journal. December 13, 1995, p. B6.
Caruso, Denise. “Capturing a Swarm of New Money-Making Opportunities.”
Upside. April 1995.
Casselman, Grace. “Vaporware: Vile or Valid?” Computing Canada. December
19, 1991, p. 1.
Churbuck, David. “Vapordisk.” Forbes. October 28, 1991, p. 188.
Clark, Don, and Viveca Novak. “U.S. Files Antitrust Suit to Stop Microsoft From
its $2.1 Billion Acquisition of Intuit.” Wall Street Journal. April 28,
1995, pp. A3, A6.
Clark, Don. “Mhcrosoft’s Windows 95 Is Just a Sideshow.” Wall Street Journal.
August 24, 1995, p. B8.
Coates, James. “Beware the Bearer of Hype.” Austin American-Statesman. April
18, 1994, p. FI.
297
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Comanor, William S., and Thomas A. Wilson. “The Effect of Advertising on
Covaç&tiûon: A. Journal o f Economic Literature. 17, 1979.
Cook, K., and H.L. Gabel. “Open Systems and the European Mainframe
Computer Industry.” Case Study, Insead Fontainebleau, 1991.
Cortese, Amy. “Windows 95.” Business Week. July 10, 1995.
Coursey, David. “We Need a Microsoft PoUcy.” Red Herring. 15, November
1994. Available (online):
bttp://www.redberring.com/mag/issuel5/david.html.
Craswell, Richard. “Interpreting Deceptive Advertising.” Boston University Law
Review. 65, 1985, pp. 657-732.
Cusumano, Michael A., and Richard W. Selby, Microsoft Secrets: How the
World’ s Most Powerful Software Company Creates Technology, Shapes
Markets, and Manages People. New York: Free Press, 1995.
Daly, James. “Postscript Challenger Fades: Microsoft’s Page Description
Language Not Expected Until Mid-1991.” Computerworld. October 15,
1990, p. 48.
Darrow, Barbara, and Deborah Gage. “And Then There Were Three—Huge
Buyout Plan Pits Novell Against Microsoft, Lotus in the Appbcations
Business.” Computer Reseller News. March 28, 1994, p. 1.
David, Paul A. “Clio and the Economics of QWERTY.” American Economic
Review. 75, May 1985, pp. 332-337.
David, Paul A. “Some New Standards for the Economics of Standardization in the
Information Age.” In Economic Policy and Technological Performance,
Partha Dasgupta and Paul Stoneman, eds., pp. 206-239. Cambridge:
Cambridge University Press, 1987.
David, Paul A. “Understanding the Economics of QWERTY: The Necessity of
History.” In Economic History and the Modem Economist, W.N. Parker,
ed., Oxford: Basil Blackwell, 1986).
Davidow, WiUiam H. Marketing High Technology: An Insider’ s View. New York:
Free Press, 1986.
Davis, Fred. “Microsoft/Intuit: Justice Blew It.” Wired. 3.08, 1995.
298
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Davis, Jessica. “Justice asked to investigate Microsoft bundling plans.”
InfoWorld. February 19, 1996, p. 10.
De George, Richard T. Business Ethics, 2d ed. New York: Macmillan, 1986.
Demsetz, Harold. “Barriers to Entry.” American Economic Review. 72, 1982.
Desmond, John. “Back to Bundling? Recombining Software with Hardware.”
Software Magazine. June 1989.
DiCarlo, Lisa, and Michael R. Zimmerman. “Microsoft pushing OEMs to move to
Windows 95.” PC Week, November 25, 1996.
Djurdjevic, Bob. “Up the Software Curve.” Datamation. May 1985, p. 98.
Dratler, Jr., Jay. “Software: Microsoft as an Antitrust Target: IBM in Software?”
Southwestern University Law Review. 25, 1996, pp. 671-744.
Dyson, Esther. “Netscape's Secret Weapon.” Wired. 4.03, March 1996.
Eckerson, Wayne. “Users Want Network Vendors to Stop Using ‘Vaporware’
Tactics.” Network World. July 10, 1989, p. 4
Economides, Nicholas. “Desirability of Compatibility in the Absence of Network
Externalities.” American Economic Review. 79 (5), 1989, pp. 1165-1181.
Economides, Nicholas. “The Economics of Networks.” International Journal of
Industrial Organization. 14 (6), 1996, pp. 673-700.
Elgan, Mike. “Justice Department: Hands Off Microsoft!— Splitting Microsoft
into Two Companies would be Disastrous for the Industry—and for
Users.” Windows Magazine. 801, January 1, 1997.
Elgan, Mike. “Microsoft: Do not Pass Go, Do not Collect $2,000,000,000.00.”
Windows Magazine. October 1, 1995.
EUis, William. “Intellectual Property Rights and High Technology Standards.” In
Standards Policy and the National Information Infrastructure. Brian
Kahin and Janet Abbate, eds., pp 450-454. Cambridge, MA: MIT Press,
1995.
Elmer-DeWitt, Philip. “Tripping Up the Titan.” Time. February 27, 1995, p. 33.
299
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Farrell, Joseph, and Garth Saloner. “Competition, Compatibility, and Standards:
the Economics of Horses, Penguins and Lemmings.” In Product
Standardization and Competitive Strategy. H. Landis Gabel, ed., pp. 1-21.
New York: North Holland, 1987.
Farrell, Joseph, and Garth Saloner. “Converters, Compatibility, and the Control of
Interfaces.” Journal of Industrial Economics. 40 (1), 1992, pp. 9-36.
Farrell, Joseph, and Garth Saloner. “Coordination Through Committees and
Markets.” Rand Journal o f Economics. 19 (2), 1988, pp. 235-252.
Farrell, Joseph, and Garth Saloner. “Installed Base and Compatibility: Innovation,
Product Preannouncement, and Predation.” American Economic Review.
76, 1986, pp. 940-955.
Farrell, Joseph. “Arguments for Weaker Intellectual Property Protection in
Network Industries.” In Standards Policy and the National Information
Infrastructure. Brian Kahin and Janet Abbate, eds., pp 368-377.
Cambridge, MA: MTT Press, 1995.
Ferguson, Charles H., and Charles R. Morris. Computer Wars: How the West Can
Win in a Post-IBM World. New York: Times Books, 1993.
Ferguson, Charles. “Fertile Ground.” Upside. November 1995. ’
Feme, Georges. “Information Technology Standardization and Users:
International Challenges Move the Process Forward.” In Standards Policy
and the National Information Infrastructure. Brian Kahin and Janet
Abbate, eds., pp. 455-465. Cambridge, MA: MTT Press, 1995.
Fisher, Franklin M., et al. Folded, Spindled, and Mutilated: Economic Analysis
and U.S. v. IBM. Cambridge, MA: MTT Press, 1983, pp. 289-90, 299.
Flynn, Laurie. “The Executive Computer.” New York Times. April 24, 1995,
p. D4.
Fox, Eleanor M. “Monopolization and Dominance in the United States and the
European Community: Efficiency, Opportunity, and Fairness.” Notre
Dame Law Review. 61, 1986.
Franco, Joseph A. “Limiting the Anticompetitive Prerogative of Patent Owners:
Predatory Standards in Patent Licensing.” Yale Law Journal. 92, 1983,
pp. 831-861.
300
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Gabel, David, and David I. Rosenbaum. “Prices, costs, externalities and
entrepreneurial capital: lessons from Wisconsin.” The Antitrust Bulletin.
FaU 1995, pp. 581-609.
Garud, Raghu, and Arun Kumaraswamy. “Changing Competitive Dynamics in
Network Industries: An Exploration of Sun Microsystems’ Open Systems
Strategy.” Strategic Management Journal. 14 (5), July 1993, pp. 351-369.
Gates, Bill. The Road Ahead. New York: Viking, 1995, p. 48-49.
Gerla, Harry S. “Federal Antitrust Law and the Flow of Consumer Information.”
Syracuse Law Review. 42, 1991.
Gibson, Stanley. “Bundle Up, Adapso.” Computerworld. September 11, 1989,
p. 25
Gifford, Daniel J. “Software: Microsoft Corporation, the Justice Department, and
Antitrust Theory.” Southwestern University Law Review. 25, 1996.
Gleick, James. “Making Microsoft Safe for Capitalism.” The New York Times
Magazine. November 5, 1995.
Goldman Rohm, Wendy. “The Last Harpoon.” Upside. July 1994.
Goldman, Jordan. Public Relations in the Marketing Mix: Introducing
Vulnerability Relations. Chicago: Crain Books, 1984, p. 225.
Grindley, Peter, and Saadet Toker. “Establishing standards for Telepoint:
problems of fragmentation and commitment.” In Global
Telecommunications Strategies and Technological Changes, G. Pogorel,
ed., pp. 201-225. Amsterdam: Elsevier Science, 1994.
Grindley, Peter. Standards, Strategy, and Policy: Cases and Stories. Oxford:
Oxford University Press, 1995.
Hawkins, Lori. “High-Tech Mirages.” Austin American-Statesman. March 6,
1995, p. Cl.
Hay, George A. “A Confused Lawyer’s Guide to the Predatory Pricing
Literature.” In Strategy, Predation, and Antitrust Analysis, Stephen Salop,
ed. Washington, D.C.: Federal Trade Commission, Bureau of Economics,
Bureau of Competition, 1981.
301
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Herman, Jim. “You Can’t Quit and You Can’t Get Out of the Game.”
Communications Week. October 7, 1996.
Homer, Mike. “WiU. Open Standards Win the Web?” Communications Week. 621,
July 29,1996.
Hruska, Andrew C. “A Broad Market Approach to Antitrust Product Market
Definition in Innovative Industries.” Yale Law Journal. 102, October
1992.
Hume, Brit. “The Flaw in Judge’s Rejection of Microsoft Settlement.”
Washington Post. February 27, 1995, p. F20.
Isaacson, Walter. “In Search of the Real Bill Gates.” Time. 149 (2), January 13,
1997.
James, Geoffrey. “Microsoft Goes Hardware.” Upside. March 17, 1997.
Jenkins, Avery. “Long Overdue: The Reasons Behind Vaporware.”
Computerworld Focus. October 5, 1988, p. 10.
Johnston, Stuart J. “Vaporware Tactics Elicit Mixed Views.” Computerworld.
May 1, 1995, pp. 1,47.
Johnston, Stuart J., and Ed Scaimell. “Server Suite Could Squeeze Market.”
Computerworld. October 10, 1994, p. 4.
Johnston, Stuart J., and Mitch Betts. “Industry Debates U.S. Vaporware Probe.”
Computerworld. February 13, 1995.
Katz, Michael, and Carl Shapiro. “Network Externalities, Competition and
Compatibility.” Amencan Economic Review. 75 (3), 1985, pp. 424-440.
Katz, Michael, and Carl Shapiro. “Product Compatibility Choice in a Market with
Technological Progress.” O ^ord Economic Papers. 38, 1986, pp. 146-
165.
Katz, Michael, and Carl Shapiro. “Product Introduction with Network
Externalities.” Journal o f Industrial Economics. 40 (1), 1992, pp. 55-84.
Katz, Michael, and Carl Shapiro. “Technology Adoption in the Presence of
Network Extemahties.” Journal o f Political Economy. 94, 1986, pp. 822-
841.
302
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Kedrosky, Paul. “The More You Sell, the More You Sell.” Wired, 3.10. October
1995.
Kehoe, Louise. “Microsoft Attacks Probe.” Financial Times. June 27, 1995, p. 4.
Kenney, Charles C. Riding the Runaway Horse: The Rise and Decline of Wang
Laboratories. Boston: Little, Brown, 1992, pp. 125-147.
Khennouch, Gerry. “Casebook 6: a brand past its prime? Microsoft’s Home
brand.” Marketing Computers. 16 (2), February, 1996, p. 47.
Kim, Junu Bryan. “Fighting Giants with ‘Sim’-pie IÛ & 3& ." Advertising Age. May
16, 1994, p. 14S.
King, Adrian. “Inside Windows 95.” Computer Reseller News. September 11,
1995, p. 113.
Krattenmaker, Thomas G., and Steven C. Salop. “Anticompetitive Exclusion:
Raising Rivals’ Costs to Achieve Power over Price.” Yale Law Journal.
96, 1986, pp. 209-293.
Krohn, Nico. “Not As Easy as 1-2-3.” InfoWorld. April 1, 1991, p. 41.
Lacter, Mark. “Judge Went Beyond the Antitrust Spirit in His Microsoft Ruling.”
Sacramento Bee. February 21, 1995, p. B7.
Landis, Robin C., and Ronald S. RoLfe. “Market Conduct Under Section 2: When
is it Anticompetitive?” In Antitrust and Regulation: Essays in Memory o f
John J. McGowan, Franklin M. Fisher, ed. Cambridge, MA: MTT Press,
1985.
Lane, Joyce. “Promotion Peddlers Tug on the Reins.” San Jose Business Journal.
Apr. 28, 1986, s. 2, p. 6.
Langberg, Mike. “Microsoft to Unleash Hype to Open Windows 95.” Austin
American-Statesman. August 17, 1995, p. Cl.
Langlois, Richard N. “External Economics and Economic Progress: The Case of
the Microcomputer Industry.” Business History Review. 66, March 22,
1992.
Lebicki, Martin. “Standards: The Rough Road to the Common Byte.” In
Standards Policy and the National Information Infrastructure. Brian
303
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Kahin and Janet Abbate, eds., pp. 35-78. Cambridge, MA: MTT Press,
1995.
Leibowitz, Michael R. “The Microprocessor Marketing Wars.” Electronic
Business. July 10,1989, p. 31.
Lewis, Peter H. “Not Just Blue Sky: I.B.M. and Apple Have a Product.” New York
Times. Oct. 20, 1991, p. 8.
Liebowitz, S.J., and Stephen E. Margolis. “Network Externality: An Uncommon
Tragedy.” Journal o f Economic Perspectives. 8 (2), Spring 1994, pp. 133-
150.
Liebowitz, Stan, and Stephen Margolis. “Don’t Handcuff Technology.” Upside.
September 1995.
Livingston, Brian. “Undocumented Windows CaHs.” InfoWorld. Nov. 16, 1992,
p. 98.
Lohr, Steve. “Product Prognostication, and Then the Unveiling.” New York Times.
June 19, 1994, p. F9.
Lopatka, John E., and William H. Page. “Microsoft, monopolization, and network
externalities: some uses and abuses of economic theory in antitrust
decision making.” The Antitrust Bulletin. Summer 1995.
Mace, Thomas, and Neil J. Rubenking, “Inside the ActiveX Platform.” PC
Magazine. September 24, 1996, p. 207.
MacLachlan, Claudia. “Microsoft Investigators Press Ahead.” National Law
Journal. Aug. 21, 1995, pp. Al, A21.
Majumder, Diganta. “Justice Eyes MS . . . Again.” Windows Magazine. December
1, 1996, p. 46.
Manchester, Philip. “Survey of A-Z of Computing.” Financial Times. April 26,
1994, p. x m .
Manes, Stephen, and Paul Andrews. Gates: How Microsoft’ s Mogul Reinvented
an Industry and Made Himself the Richest Man in America. New York :
Doubleday, 1994.
Marshall, Jonathan. “Antitrust Punishes Market Winners.” San Francisco
Chronicle. July 24, 1995, pp. El, E7.
304
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Matutes, Carmen, and Pierre Regibeau. “‘Mix and Match’: Product Compatibility
without Network Externalities.” Rand Journal o f Economics. 19 (2), 1988,
pp. 219-234.
McCombs, Dave. “The Emperor’s New Software.” Daily Yomiuri. April 8, 1996,
p. 15.
McCoy, Charles, & G. Christian Hül. “Tech Stocks’ Decline May Be
Overreaction, But Problems are Real.” Wall Street Journal. January 11,
1996, p. AlO.
McKenna, Patrick. “Texas Attorney General Requests Information From
Microsoft.” Newsbytes. Febmary 12, 1997
McKenna, Regis. Who’ s Afraid of Big Blue? How Companies are Challenging
IBM—and Winning. Reading, MA: Addison-Wesley, 1989.
McKenzie, Matt. “Seybold Shoot-Out: A Deep Six for Big N?” Seybold Report on
Internet Publishing. 1 (2), October 1996, p. 3.
McNealy, Scott. “Positioned for growth: Resellers and the intranet.” Computer
Reseller News. 677, April 1, 1996.
McNealy, Scott. “Window(s) on Monopoly.” The Wall Street Journal. July 27,
1994.
Mensch, Elizabeth, and Alan Freeman. “Efficiency and Image: Advertising as an
Antitrust Issue.” Duke Law Journal. 1990.
Metcalfe, Bob. “Tying IE4 with Windows may be an incentive for Netscape,
other vendors.” InfoWorld. October 14, 1996, p. 46.
Miller, Samuel R. “Does Netscape Really Have Antitrust Claims Against
Microsoft?” The Computer Lawyer. 13 (11), November 1996.
Moad, Jeff. “Rolling Out Microsoft’s Office 97.” PC Week. February 24, 1997,
p. 122.
Moeller, Michael, and Norvin Leach, “Are proprietary technologies closing the
Net?” PC Week Online. April 8, 1996.
Mokyr, Joel. “Is Economic Change Optimal?” Australian Economic History
Review. 32, March 1992, pp. 3-23.
305
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Monash, Curt. “Software Strategies: Although IBM is Taking Steps to Strengthen
Its Position in the Mainframe Software Market, It’s Still a Hardware
Company at Heart.” Datamation. February 1984, p. 171.
Morochove, Richard. “Lies My Computer Maker Told Me.” Toronto Star. May
12, 1994, p. G2.
Morris, Charles R., and Charles H. Ferguson. “How Architecture Wins
Technology Wars.” Harvard Business Review. March-April 1993, p. 88.
Morris, Michael. “Microsoft Settlement is Too Little Too Late.” Sunday San
Francisco Examiner. July 24, 1994.
Nee, Eric. “One on One with Eric Nee.” Upside. March 20, 1997.
Nee, Eric. “One on One with Jim Barksdale.” Upside. November 1996.
Needleman, Raphael. “Standard operating procedure.” CNET News. March 24,
1997. Available (online);
http://www.cnet.eom/Content/Voices/Needleman/032497/index.html.
Nham, Benjamin. “Desperate Defense.” Computers: News & Opinion, April 7,
1998. Available (online):
http://www.suite 101 .com/articles/article.cfm/6632.
O’Heir, Jeff. “Gary Reback—Wilson, Sonsini, Goodrich & Rosati.” Computer
Reseller News. November 11, 1996, p. 148.
Owen, Bruce M., and Steven S. Wildman. Video Economics. Cambridge, MA:
Harvard University Press, 1992.
Page, Amy C. “Microsoft: A Case Study in International Competitiveness, High
Technology, and the Future of Antitrust Law.” Federal Communications
Law Journal. 47 (1).
Pallatto, John. “IBM Software Bundling: ‘Routine Sales Promotion’ or Unfair
Market Advantage?” PC Week. July 23, 1985, p. 43.
Pare, Terence P. “Why the Banks Lined Up Against Gates.” Fortune. May 29,
1995, p. 18.
Pitcher, George. “0ne20ne to Face UK Regulation with US-style Marketing
Plans.” Marketing Week. 19 (27), September 27, 1996, p. 22.
306
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Platt, Lewis. “N il Spells Opportunity for Computer Resellers.” Computer Reseller
News. 579, May 23,1994.
Porter, Michael. Competitive Strategy: Techniques for Analyzing Industries and
Competitors. New York: Free Press, 1980.
Posner, Richard A. Antitrust Law, An Economic Perspective. Chicago: University
of Chicago Press, 1976.
Posner, Richard A. Regulation o f Advertising by the FTC. Washington D C.:
American Enterprise Institute for Public Policy Research, 1973.
Prentice, Robert. “Vaporware: Imaginary High-Tech Products and Real Antitrust
Liability in a Post-Chicago World.” Ohio State Law Journal. 57, 1996,
pp. 1163-1262.
Rabino, Samuel, and Thomas E. Moore. “Managing New-Product
Announcements in the Computer Industry.” Industrial Marketing
Management. 18, 1989.
Reback, Gary, Susan Creighton, David Killam, and Neil Nathanson.
“Technological, Economic and Legal Perspectives Regarding Microsoft’s
Business Strategy in Light of the Proposed Acquisition of Intuit, Inc.”
Upside. February 1995.
Rebello, Kathy, et al. “Is Microsoft Too Powerful?” Business Week. March 1,
1993, pp. 82, 86.
Reich, Robert B. “Toward a New Consumer Protection.” University o f
Pennsylvania Law Review. 128, 1979.
Rose, Jeff. “What’s on the Table When Shark is Finished Dining?” San Diego
Union-Tribune. November 8, 1994, p. 3.
Rounds, Martha. “IBM Saw ‘Limited’ Software Industry; 1969 Prediction:
‘Limited But Increasing Number of Enterprises Engaged in the
Development of Computer Programs for Sale.’” Software Magazine. 9,
March 15, 1989, p. 37.
Saloner, Garth. “Economic Issues in Computer Interface Standardization: The
CzscofUNTX..” Economics o f Innovation and New Technology. 1, 1990,
pp. 135-156.
307
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Schechter, Roger. “Letting the Right Hand Know What the Left Hand’s Doing:
The Clash of the FTC’s False Advertising and Antitrust Policies.” Boston
University Law Review. 64, 1984, pp. 265-323.
Schlender, Brent. “Sun’s Java: The Threat to Microsoft is Real.” Fortune.
November 11, 1996.
Schulman, Andrew. “Can Microsoft Catch Up to the Internet: A Software
Developer’s Perspective.” The O’ Reilly Windows Center. March 21, 1996.
Available (online):
ftp://ftp.ora.com/pub/examples/windows/win95.update/msinet.html.
Schulman, Andrew. “Consolidation of the PC Software Industry.” The O ’ Reilly
Windows Center, 1995. Available (online):
ftp://ftp.ora.com/pub/examples/windows/win95.update/consolid.html.
Schumpeter, Joseph A. Capitalism, Socialism, and Democracy. Third ed. 1950.
Shapiro, Carl. “Antitrust in Network Industries.” U.S. Department of Justice,
Antitrust Division. Address before the American Law Institute and
American Bar Association. January 25, 1996.
Shea, Tom. “Developers Unveil ‘Vaporware.’” InfoWorld. May 7, 1986, p. 48.
Shepherd, William G. “Theories of Industrial Organization.” In Revitalizing
Antitrust in its Second Century: essays on Legal, Economic, and Political
Policy Harry First et al., eds., pp. 37-57. New York: Quorum Books, 1991.
Shurmer, Mark, and Gary Lea, “Telecommunications Standardization and
Intellectual Property Rights: A Fundamental Dilemma?” In Standards
Policy and the National Information Infrastructure. Brian Kahin and Janet
Abbate, eds., pp. 378-402. Cambridge, MA: MTT Press, 1995.
Sidak, Joseph G. “Debunking Predatory Innovation.” Columbia Law Review. 83,
p p .1121-1149.
Silverberg, Brad. “Start Reading.” 1997. Available (online):
http ://www.microsoft.com.
Smiley, Robert. “Empirical Evidence on Strategic Entry Deterrence.”
International Journal of Industrial Organization. 6, 1988.
Smith, Tom D. “Merger Counseling Checklist.” Antitrust Law Journal. 56, 1987.
308
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Software Publishers Association Europe. "SPA's Competition Principles As
Adopted by the SPA Board of Directors, Jan. 30,1998.” February 3, 1998.
Available (online): http://www.spa-europe.org/press/Compprin2.HTM.
Somerson, Paul. “Spork You.” PC Computing. May 1995, p. 51.
Stiglitz, Joseph E. ‘Technological Change, Sunk Costs, and Competition.”
Brookings Papers on Economic Activity. 3, 1987.
Swarm, G.M.P. “Industry Standard Microprocessors and the Strategy of Second-
source Production.” In Product Standardization and Competitive Strategy.
H. Landis Gabel, ed., pp. 239-262. New York; North Holland, 1987.
Sweeney, Jack. “Software trade groups tangle in turf war—It's Software
Publishers Association vs. Business Software Alliance.” Computer
Reseller News. February 12, 1996.
Taft, Darryl K. “FTC probes need for antitrust enforcement changes.” Computer
Reseller News. January 1, 1996, p. 16.
Thore, Sten. The Diversity, Complexity, and Evolution of High Tech Capitalism.
Boston: Klewer Academic, 1995.
Tomasula, Dean. “NT's Momentum Nudges at Unix; Windows NT Operating
System.” Wall Street & Technology. 14 (3), March, 1996, p. 46.
Turner, Donald F. “Observations on the New Merger Guidelines and the 1968
M&tgei Antitrust Law Journal. 51, 1982.
Van Gelder, Lindsay. “Vaporware for Sale.” Lotus. February 1988, p. 140.
Veit, Stan. “Stan Veit's History: Computer Magazines Created the Channels.”
Computer Shopper. October 1991, p. 693.
Walker, John. “Does This Sound Familiar? 2.” 1997. Available (online):
http://www.fourmilab.ch/autofile/www/section2_106_6.html.
Wallace, James, and Jim Erickson. Hard Drive: Bill Gates and the Making o f the
Microsoft Empire. New York: Wiley, 1992.
Weare, Christopher. “The Institutional Governance of Interoperability in the
Computer and Telecommunication Industries.” Annenberg School for
Communication, University of Southern California, August 4, 1995,
photocopy.
309
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
Weiss, Martin B.H., and Marvin Sirbu. ‘Technological Choice in Voluntary
Standards Committees: An Empirical Analysis.” Economics o f Innovation
and New Technologies. I, 1990, pp. 111-133.
Werden, Gregory J. “Market Delineation and the Justice Department’s Merger
G\xid&]m!ts.” Duke Law Journal. 514, 1983.
Williamson, Oliver. The Economic Institutions o f Capitalism. New York: Free
Press, 1985.
Wind, Jerry, and Vijay Mahajan. “Marketing Hype: A New Perspective for New
Product Research and Introduction.” Journal o f Product Innovation
Management. 4, 1987.
Wingfield, Nick. “Microsoft Menace.” CNET News, 1996. Available (online):
http://www.news.com/Newsmakers/Reback/reback.html.
Wittmann, Art. ‘Technology And Chopsticks: What A Combo!” Network
Computing. 803, February 15, 1997. Available (online):
http://www.techweb.com/se/directlink.cgi7NWC19970215S0038.
Wolk, Martin. “Microsoft to Outline Messaging Strategy.” Reuters Financial
Service. April 19, 1994.
Wylie, Margie. “Nader opens campaign against MS.” News.com. November 13,
1997. Available (online):
http://www.news.com/News/Item/0,4,16340,00.html.
Yoder, Stephen Kreider. “Computer Makers Defend ‘Vaporware.’” Wall Street
Journal. February 16, 1995, p. Bl.
Young, Jeffrey. “You Call That Content?” Upside. March 19, 1997.
Zachary, G. Pascal, and Jim Carlton. “Software Rivals Vying to Define How PCs
Work.” Wall Street Journal. Mar. 7, 1994, p. Bl.
310
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.
IMAGE EVALUATION
TEST TARGET (Q A -3)
V ,
/
A MA.
%
1 . 0
l.l
1.25
w a
L 2 1 ^
C
1 5
1 .4
\15
12.2
2.0
.8
1 . 6
150mm
V
< P
7
/ ;
V
/
O
7
' / a
A P P L IE D A IIVL4GE . Inc
— — 1653 East Main Street
—— • Rochester. NY 14609 USA
Phone: 716/482-0300
- = ~ - ^ = Fax: 716/288-5989
0 1993. Applied Image. Inc.. Ail Rights Reserved
R eproduced with perm ission of the copyright owner. Further reproduction prohibited without perm ission.

Linked assets

University of Southern California Dissertations and Theses

Conceptually similar

PDF

A comparative examination of the impact of business -government relations on labor market reform in Egypt and Mexico, 1975--1995

PDF

Globalization and the decline of the welfare state in less developed countries

PDF

By sea: The port nexus in the global commodity network (the case of the West Coast ports)

PDF

Context is everything: An empirical study of institutions, instability and economic growth

PDF

The Role Of The State In The Development Of The Indonesian Textile And Garment Industries

PDF

The Interventionist State Revisited: The Political Economy Of State-Business Relations In India

PDF

Analysis of the role of government in Taiwan's industrialization and economic development

PDF

The drivers of economic change: Technology, globalization, and demography

PDF

Developing economies and outward foreign direct investments: The case of the South Korean electricity and electronics industry

PDF

Before and after reform: The effects of structural adjustment on women's employment in Latin America

PDF

An analysis of the developmental state: The case of the Vietnamese textile and garment industries

PDF

The political economy of the state and development strategies: A case study of Turkey, 1930-1980

PDF

Policy formulation for the politico-economy of Greece: A system dynamics simulation

PDF

The political economy of domestic airline mergers: The neglected international determinants

PDF

A multidimensional analysis of regional integration and cooperation: The case of the Economic Community of West African States

PDF

An empirical analysis of foreign aid and the provision of international public goods

PDF

Dialectical feminism and contradictory economic systems: Campesina daily life from Somoza to Aleman

PDF

International markets and interstate cooperation: united states-Japanese efforts to conserve ocean life, 1950-1995

PDF

After protection: The impact of import barriers on corporate equity values and profit expectations

PDF

The politico-economic determinants of ASEAN regional economic cooperation

Asset Metadata

Creator MacInnes, Ian Patrick (author)

Core Title Compatibility standards, market power, and antitrust policy: Proprietary interfaces and their alternatives

Degree Doctor of Philosophy

Degree Program Political Economy and Public Policy

Publisher University of Southern California (original), University of Southern California. Libraries (digital)

Tag Economics, Commerce-Business,information science,OAI-PMH Harvest

Language English

Contributor Digitized by ProQuest (provenance)

Advisor [illegible] (committee chair), [illegible] (committee member), Kalaba, Robert (committee member)

Permanent Link (DOI) https://doi.org/10.25549/usctheses-c17-416130

Unique identifier UC11353747

Identifier 9931847.pdf (filename),usctheses-c17-416130 (legacy record id)

Legacy Identifier 9931847.pdf

Dmrecord 416130

Document Type Dissertation

Rights MacInnes, Ian Patrick

Type texts

Source University of Southern California (contributing entity), University of Southern California Dissertations and Theses (collection)

Access Conditions The author retains rights to his/her dissertation, thesis or other graduate work according to U.S. copyright law. Electronic access is being provided by the USC Libraries in agreement with the au...

Repository Name University of Southern California Digital Library

Repository Location USC Digital Library, University of Southern California, University Park Campus, Los Angeles, California 90089, USA