I will review all pending and future lawsuits brought on behalf on North Carolina consumers. I will only move forward with litigation and continue with pending litigation if I am assured that such action would provide consumers with economic benefits that can be measured.
– Senator Roy Cooper, candidate for North Carolina Attorney General, 9/18/00.
The pending antitrust case against Microsoft Corporation arose as a result of the company’s success in the so-called “browser wars” of the mid-1990s.1 These marketplace battles had definite victors. The spoils of victory went to consumers in the form of improved software products at costs approaching zero while ease of accessibility increased.
The direct testimony of MIT Sloan School of Business Dean Dr. Richard Schmalensee summarizes the case well. He noted that, “There is overwhelming economic evidence that Microsoft’s actions have benefited and continue to benefit consumers. With no evidence of actual consumer harm, I do not believe that it is appropriate to second-guess, much less ascribe illicit motives to, business decisions that Microsoft and other companies made that have provided demonstrable consumer benefits.”2
Competition throughout the last decade has been fierce. The result is evidenced by the introduction of new products, new methods of distribution, and new players in the marketplace. This competition was driven by consumer demand and led by two leading manufacturers of browser applications – Netscape Communications Corp. and Microsoft Corp.
The prosecution contends that Microsoft engaged in anticompetitive behavior to increase its share of the browser market. Such behavior, according to the complaint, included “welding”3 the Microsoft Internet Explorer to its Windows operating system and engaging in agreements to illegally increase the distribution costs for Netscape’s competing product.
The prosecution demonstrated ample flexibility in their case and strategy in order to account for changes in market composition. Both contentions – “welding” and illegal behavior to increase distribution costs – are scaled down versions of the original case. Initially, the prosecution contended that Microsoft illegally “tied” the Internet Explorer to the Windows operating system and “foreclosed,” through licensing agreements, Netscape’s ability to distribute its product.
The Tenth Circuit Court of Appeals rejected the tying claim and thwarted the notion that Internet Explorer and Windows should be regarded as separate products. The court ruled that the appropriate test was not whether separate markets exist, but rather, “whether there is a plausible claim that (the integration) brings some advantage.”4
The antitrust standard of proven consumer harm is the most essential point at issue. While the prosecution failed to prove consumer harm, the ample trial record and findings of fact did provide a record of consumer benefits. Again, in the words of Dean Schmalensee, “Charging low prices, expanding the markets, spreading the use of new technology, bringing consumers into the computer age, is providing benefits to consumers.” Speaking of the effect on both the market segment in question as well as on consumers, presiding Judge Penfield Jackson wrote in the findings of fact:
“The debut of Internet Explorer and its rapid improvement gave Netscape an incentive to improve Navigator’s quality at a competitive rate. The inclusion of Internet Explorer with Windows at no separate charge increased general familiarity with the Internet and reduced the cost to the public of gaining access to it, at least in part because it compelled Netscape to stop charging for Navigator. These actions thus contributed to improving the quality of Web browsing software, lowering its cost, and increasing its availability, thereby benefitting (sic) consumers.” (Emphasis added)5
Additionally, the prosecution contends that Microsoft engaged in costly competition in the browser market to maintain the “applications barrier to entry” in the operating system market. This reasoning suggests that Microsoft’s sole rationale for investing in browser technology, and the Internet generally, was to secure its existing market share in operating systems.
It is clear that Microsoft perceived Netscape as a threat to its position in the market for Intel-compatible operating systems. But Microsoft defended its position through innovation that improved the quality of its own product and fueled demand for other products. The Internet’s meteoric rise in the 1990s can be attributed in large part to the increased Internet familiarity Microsoft’s innovations produced. The prosecution wishes to punish Microsoft for investment that improved its own product and increased demand for personal computers and Internet applications in general.
The time to end the lawsuit has come. The threshold harm was not proved; quite to the contrary, economic benefits were found.
In the findings of law, Judge Jackson ignored the appellate court: “The commercial reality is that consumers today perceive operating systems and browsers as separate ‘products,’ for which there is separate demand.”6 Instead of “tying,” the government, and Judge Jackson, contended that Microsoft “welded” its two products. A product “weld,” as opposed to integration, infers that the rationale for the product tie was anticompetitive and not driven by consumer demand.
The power of Microsoft to keep Netscape out of the market was diminished independently of the appellate court. During the course of the trial, the number of consumers using Netscape Navigator increased at a steady, almost geometric rate. On February 15th of 2000, Netscape announced that its Navigator browser surpassed 25 million users-more than double the 1999 figure.7 After the acquisition of Netscape by America Online, the combined company commands more than 60 percent of the browser market.
Nonetheless, the prosecution contended that although the licensing agreements did not “foreclose” on Netscape’s ability to distribute, they did raise its distribution costs. After Internet Explorer 3.0 was integrated into Windows, computer manufactures were no longer willing to pay Netscape to distribute Navigator. Consequently, Netscape’s distribution costs increased, while the number of computers pre-installed with Navigator decreased.
While there is little doubt that changes in marketplace helped to increase Microsoft’s share of the browser market, it is unclear how it harmed consumers. The government’s case tends to focus on software development and narrow, often circuitous, market definitions, but fails to explain how any of Microsoft’s actions caused any harm to consumers.
This is because Windows 95, and subsequent browser-integrated operating systems, serviced consumer demand in the most cost-efficient manner. The integration of browser technology into Windows improved the quality of Web browsing software, lowered the cost of such software and increased its accessibility. Close scrutiny of market developments from 1995-1998 affirms this analysis.
In 1995, Netscape was the unquestioned leader in Internet browsing software. By 1995 Netscape had formed relationships with all of the major Internet Service Providers (ISPs) and had become nearly “synonymous with the Web.”8 At this time, Microsoft was unable to persuade ISPs to distribute Internet Explorer because of existing ISP agreements with Netscape.
In response to this setback, Microsoft introduced the Internet Connection Wizard (ICW) in August 1996. The ICW takes new computer users through the Internet connection process step-by-step. By double-clicking the ICW icon on the Windows 95 desktop, a consumer could automatically dial into the Windows referral server-a Microsoft central computer that offers information about participating ISPs. The ICW also allows the Windows user to sign up for Internet access with any of the participating ISPs.
By September of 1996, Microsoft had reached agreement with 14 ISPs to appear on the referral server. The agreements were “typically two years or less with both parties having a right of early termination,” and “did not require ISPs to distribute Internet Explorer exclusively.”9 The ISPs that did not reach agreement with Microsoft were able to download the Internet Explorer Administration Kit (IEAK) to customize Internet Explorer to their service from Microsoft’s web site free of charge. Netscape’s “Mission Control” application served the same function, but cost $1,995 per copy.
The cost differential was not “predatory,” but intended to increase Internet Explorer’s visibility. As a browser insurgent, Microsoft judged that the increased visibility would be more valuable than any fees accumulated from the sale of IEAK.
More important than Microsoft’s relationship with ISPs, however, was its relationship with computer (hardware) manufacturers – often referred to as OEMs, or original equipment manufacturers. In early 1995, manufacturers regarded Internet Explorer 2.0 as inferior to Navigator 2.0. Thus, hardware manufacturers paid additional fees to Netscape to distribute Navigator.
This changed when Microsoft released Internet Explorer 3.0. According to analysts, Explorer 3.0 was “at least equal to Navigator 3.0” in terms of functionality.10 But more importantly, America Online (AOL) viewed Explorer 3.0 as far superior because of its “componentized design.” Such design allowed AOL to hide Explorer beneath AOL’s branding and connect “seamlessly” with AOL software. Such functionality caused AOL chief executive Steve Case to tell a number of AOL executives, “From a pure technology standpoint, it does look like Microsoft might win this one.”11
AOL’s decision to contract with Microsoft to provide its client browser proved to be the most significant moment of the so-called “browser wars.” Although originally intending to contract with Netscape, AOL found Navigator’s technical deficiency and the attitude of the Netscape technical team too much to overcome. Thus AOL and its users, which currently number over 26 million, were placed in the Explorer column.
In addition to being technically superior as a stand-alone product, Explorer 3.0 was also integrated into Windows 95. Government attorneys attacked this innovation as a violation of a 1995 consent degree that prevented Microsoft from forcing hardware manufactures to license another product in exchange for Windows. The consent degree did not, however, prevent Microsoft from integrating the two products. Microsoft contended that Internet Explorer 3.0 was, “Microsoft’s brand name for features provided by code woven into Windows 95,” and not an independent product.12 The D.C. Circuit Court of Appeals agreed and openly questioned the prudence of selectively judging when one market ends and another begins. Stephen Margolis, Professor of Economics at North Carolina State University, expounded on this line of logic: “Separate markets exist for shirts and buttons, cars and tires, cars and rustproofing, yet few people would object to these integrations.”13
The integration of browser functionality was not only logical, but also necessary. It is difficult to explain how Microsoft was to improve on its operating system without browser integration. Consider a review from The Chicago Tribune:
The only customers with reason to rush out and buy the upgrade are the minority with heavy Internet habits. If you’re any kind of Web wonk at all you’ve got to have Windows 98 right now. (emphasis added)
Fire up a machine on Windows 98 and the display is all but identical to what you get on Windows 95, but old Internet hands will see instantly that huge things are going on under the hood. (emphasis added)14
Clearly the reviewer appreciated the Internet functionality, but underestimated the number of consumers who would soon be self-described “web wonks.” The fantastic growth of Internet users-due in large part to Explorer’s integration- made appreciation for Windows 98 extend well beyond “old Internet hands.” In fact, another review seemed to predict that Microsoft’s easy-to-grasp technical improvements would increase Internet familiarity:
On a technical level, most of the improvements in Windows 98 seem substantial, but they’re hidden beneath the same Win 95 interface to which users are accustomed. We couldn’t ask for more.15
Such facile integration improved consumers’ entire computing experience. “Windows 98, with its rich set of convenience and Internet features,” another independent reviewer exclaimed, “is the most powerful and friendly environment ever invented for computing.”16
Sales volume indicated that consumers were as enamored of new features in Windows 98 as independent reviewers. This consumer satisfaction caused the foundation of the prosecution’s case to evaporate. The beauty of Windows 98 is encapsulated in three tiny icons sitting on the task bar next to Start. They serve as a master control board that lets you move back and forth across the invisible barrier between your local machine and the Internet. In an effort to manufacture some semblance of consumer harm, the government resorted to the absurd: In Windows 98 “browser-specific routines have been commingled with operating system routines to a greater degree than is necessary to provide consumer benefit.”17 Government attorneys further suggested that integration:
Increased the likelihood that “a browser crash will cause the entire system to crash;”
“Made it easier for malicious viruses that penetrate the system via Internet Explorer to infect non-browsing parts of the system.18
Nowhere in the trial record was the government able to support these claims. Furthermore, operating systems in competition with Windows have all integrated their browsers and Internet functions. Moreover, the marketing for Apple “OS 9” focuses on its Internet features, including its expanded Internet search function.19 If independent reviewers laud the integration, and nearly every competitor has integrated in a similar, if not more involved fashion, how could this innovation have harmed consumers?
Microsoft earned its browser market share though superior products that benefit consumers. Had Microsoft not improved upon Explorer 2.0, it is likely that hardware manufacturers would have turned to another source to distribute browsers. If Explorer 3.0 were not technically superior to Navigator 3.0, AOL would not have contracted for it. If Windows 98 had not further integrated Explorer into the operating system, consumers would not enjoy the benefits mentioned above.
Microsoft’s success in the so-called “browser wars” has done little to ensure its long run success. AOL, which purchased Netscape in 1998, has now integrated Navigator 6.0 into its software. If every AOL subscriber were to switch to Navigator, an outcome the browser switch is intended to bring about, Internet Explorer would command less than 40 percent of the browser market.
In addition, new Web access competition is likely to come from different sources than other browsers. Apple’s iMac and similar hardware could pose a threat; many iMac vendors sold out of the product just a few hours after its debut. Other products that go beyond the current desktop model could further erode Explorer’s position. Now that an estimated 96 million Americans are online, it is difficult to imagine the development of all the products that would satisfy consumer demand. To argue that Microsoft has a lock on this market is unsound.
Microsoft simply catered to the demands of consumers and was successful. If successful, the prosecution would not only punish Microsoft, but also place all innovative businesses in a very precarious position. For instance, should game-console makers like Sony be punished for integrating Web access and a DVD player into its PlayStation 2? Surely, the market for DVD players is separate from the market for game-consoles? Or perhaps Hewlett-Packard should be investigated for integrating scanners, printers, and fax machines into one product? If the government’s case is accepted as valid, there is no end to havoc government-sponsored lawsuit abuse could wreak on consumers.
1 U.S. v. Microsoft Corp. Civil Action No. 98-1232 and State of New York et. al. v. Microsoft Corp., Civil Action No. 98-1233.
2 Direct Testimony of Richard Schmalensee in U.S. v. Microsoft Corp.
3 Direct Testimony of Franklin Fisher in U.S. v. Microsoft Corp. Civil Action No. 98-1232 (TPJ), and State of New York et al v. Microsoft Corp., Civil Action No. 98-1233.
4 U.S. v. Microsoft. Nos. 97-5343 and 98-5012: 147 F.3d 935, *950, 331 U.S.App.D.C. 121, **136.
5 The Court’s Findings of Fact in the U.S. v. Microsoft Corp., Civil Action 98-1232, paragraph 408.
6 The Court’s Findings of Law in U.S. v. Microsoft Corp., Civil Action 98-1232 p. 29.
7 CNET News.com. – http://news.cnet.com/news/0-10050202-1550473.html.
8 U.S. v. Microsoft Corp., 84 F. Supp. 2d at 46 (FF 143).
9 Direct Testimony of Cameron Myhrvold in U.S. v. Microsoft Corp., Paragraph 55-56. See also,Direct Testimony of Richard L. Schmalensee in U.S. v. Microsoft Corp. Paragraph 443.
10 Evans, David S. “All the Facts That Fit: Square Pegs and Round Holes in U.S. v. Microsoft.” Regulation. Volume 22, No. 4., 1999. p. 57.
11 U.S. v. Microsoft: 84 F. Supp. 2d at 79 (FF 282).
12 Evans, Donald. p. 55.
13 Margolis, Steven E. “No-Tech Rules for the High-tech Economy.” The Independent Institute, July 13, 2000.
14 Coates, James. The Chicago Tribune, June 28, 1998.
15 Costa, Dan. “From Chicago to Memphis; Windows 98; Software Review; Evaluation,” Computer Shopper, October 1997.
16 Mendelson, Edward. PC Magazine. August 15, 1998.
17 Plantiff’s Proposed Findings of Fact in U.S. v. Microsoft. Civil Action 98-1232.
19 Evans, David S. p. 62.