IN THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF COLUMBIA
UNITED STATES OF AMERICA,
Plaintiff,
v.
MICROSOFT CORPORATION,
Defendant.
STATE OF NEW YORK ex rel.
Attorney General DENNIS C. VACCO, et al.,
Plaintiffs,
v.
MICROSOFT CORPORATION,
Defendant.
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Civil Action No.
98-1232 (TPJ)
Civil Action No.
98-1233 (TPJ) |
DIRECT TESTIMONY OF
FREDERICK R. WARREN-BOULTON
TABLE OF CONTENTS
I.
BACKGROUND.................................................................................................................
1
II. INTRODUCTION
................................................................................................................2
III. SUMMARY OF
CONCLUSIONS......................................................................................6
IV. MICROSOFT HAS
MONOPOLY POWER IN THE PC OPERATING SYSTEM
MARKET
.............................................................................................................................9
A. PC Operating Systems Comprise
a Relevant Antitrust Market.............................10
1. Background Industry
Facts.........................................................................10
2. Principles of
Market Definition.................................................................13
3. PC Operating
Systems Comprise a Relevant Market................................16
B. Microsoft Possesses Monopoly Power In the PC Operating System
Market........20
1. Market
.......................................................................................................20
2. Barriers to
Entering the PC Operating System Market are High...............21
3. Microsoft's
Monopoly Power is Evidenced by its Use..............................28
4. in the Market Value of its Equity
.............................................................28
V. INTERNET WEB BROWSERS POSE A THREAT TO MICROSOFT'S
PC
OPERATING SYSTEM MONOPOLY
............................................................................29
A. Browsers and Operating Systems
Comprise Separate Products............................32
1. Efficiently be Provided
Separately.............................................................34
2. Internet
Explorer and Windows 95/98 are Separate Products...................38
B. System
Monopoly..................................................................................................39
VI. MICROSOFT'S EXCLUSIONARY
CONDUCT.............................................................41
A. Microsoft's Tying is
Exclusionary.........................................................................42
B. Microsoft's OLS and ISP
Restrictions are Exclusionary.......................................46
1. Microsoft's
OLS Agreements are Exclusionary........................................46
2. Microsoft's Restrictions on
Other ISPs are Exclusionary..........................49
C. Microsoft's ICP Restrictions are
Exclusionary......................................................53
D. Browsers
................................................................................................................ 56
E. Exclude Rival Browsers
........................................................................................60
VII. THE CUMULATIVE
EFFECT OF MICROSOFT'S PRACTICES IS SIGNIFICANTLY
TO IMPAIR COMPETITION AMONG
COMPETING BROWSERS.............................63
A. Anticompetitive
Practices......................................................................................63
B. Anticompetitive
Practices Have Substantially Foreclosed Competition...............64
C. Anticompetitive Practices
Have Substantially Foreclosed Competition...............66
VIII. THERE IS A DANGEROUS PROBABILITY THAT
MICROSOFT WILL GAIN
MONOPOLY POWER IN THE
BROWSER MARKET; AND, EVEN IF IT DOES NOT,
IT COULD SIGNIFICANTLY REDUCE
OR DELAY THE THREAT TO THE OS
MONOPOLY.....................................................................................................................
69
A. Dangerous Probability of
Monopolization.............................................................69
B. System Monopoly May be
Strengthened...............................................................70
IX. MICROSOFT'S EXCLUSIONARY CONDUCT LACKS LEGITIMATE
BUSINESS
JUSTIFICATION
...............................................................................................................70
A. Microsoft's Prohibition on OEMs'
Removing Internet Explorer is Unjustified...71
B. Windows
Platform.................................................................................................74
C. Restrictions on OEM Modification of
Desktop and StartUp Sequence.................78
1. User
Experience.........................................................................................78
2. of the User's Windows
Experience............................................................81
D. Achieve any Legitimate
Business Purpose............................................................82
X. MICROSOFT'S ACTIONS
TO INCREASE ITS BROWSER USAGE SHARE ARE
PREDATORY
....................................................................................................................83
XI. THE COSTS TO
CONSUMERS AND COMPETITION FROM MICROSOFT'S
EXCLUSIONARY CONDUCT ARE
SIGNIFICANT AND FAR REACHING..............86
.
Page 1.
DIRECT TESTIMONY OF
FREDERICK R.
WARREN-BOULTON
I. BACKGROUND
1. My name is Frederick R. Warren-Boulton. I am a Principal with
MiCRA
(Microeconomic Consulting
and Research Associates, Inc.), a Washington-based economics
consulting and research firm
specializing in antitrust and regulatory matters. I hold a B.A. degree
from Yale University, a
Master of Public Affairs from the Woodrow Wilson School of Public
and International Affairs at
Princeton University, and a Ph.D. in Economics from Princeton
University.
2. From 1972 to 1983, I was an Assistant and then Associate Professor
of Economics
at Washington University in
St. Louis. From 1983 to 1989, I served as the chief economist for
the Antitrust Division of the
U.S. Department of Justice, first as the Director of its Economic
Policy Office and then as the
Deputy Assistant Attorney General for Economic Analysis. Since
leaving the Department of
Justice, I have served as a Resident Scholar at the American Enterprise
Institute, a Visiting Lecturer of
Public and International Affairs at the Woodrow Wilson School
at Princeton University, and a
Research Associate Professor of Psychology at The American
University.
3. My area of specialization is in the economics of industrial
organization. I have
authored numerous
publications, primarily in the application of industrial organization
economics to antitrust and
regulatory issues, including a number of papers dealing with aspects
of the computer industry. A
complete description of my background and papers can be found in
my Curriculum Vita, a copy of
which is attached to this testimony as Attachment 1.
4. I have been asked by the plaintiffs in these actions to perform an
economic
Page 2.
analysis of certain actions by
Microsoft Corporation ("Microsoft") with regard to PC operating
system software and Internet
browser software. In conducting that analysis, I have considered (1)
public documents containing
relevant information; (2) certain confidential Microsoft and
third-party documents
supplied to me by the plaintiffs; (3) deposition transcripts of personnel
from Microsoft and other
industry participants; (4) relevant publications from the economics
literature; and (5) filings
made in these actions, including the reports of other expert witnesses.
As additional material
becomes available that is relevant to the testimony offered here, I will, to
the extent that is possible,
seek to include it in my analysis.
II. INTRODUCTION
5. Based on my analysis of Microsoft's conduct and its competitive
effects, I have
drawn the following three
basic conclusions:
6. First, Microsoft has monopoly power in a relevant market. Using the
basic
methodology for defining
markets supplied by the 1992 Horizontal Merger Guidelines1 – an
accepted approach for
delineating antitrust markets in Sherman Act cases – I conclude that
operating systems
compatible with Intel x86/Pentium architecture personal computers (PCs)
comprise a relevant market.
7. The evidence also demonstrates that Microsoft possesses monopoly
power in that
market. Microsoft for several
years has enjoyed, and is projected for several years to retain, a
market share in excess of
90%.2 This
market share is protected by substantial barriers to entry.
Page 3
Operating system markets exhibit "network effects." The greater the number of users a particular
operating system enjoys, the more likely it is that software developers will write applications for
that operating system. This, in turn, makes the operating system still more attractive to users and,
as a consequence, makes software developers more likely to develop applications for that
operating system, and, given scarce resources, less likely to develop applications for alternative
operating systems. The end result is that in such markets, the very network effects that drive
users toward the dominant firm make displacing that firm difficult.
8. Second, Microsoft has engaged in a number of practices that
significantly impede
the commercial opportunities
of rival producers of Internet web browsers, a product that is a key
element of a threat to
Microsoft's operating system monopoly. Because of the nature of the
barriers to entry created by
network effects, the most likely long-term threat to Microsoft's
monopoly power does not
come directly from other operating systems, but rather from the spread
of cross-platform
technologies, that can serve (like Microsoft's operating system) as a platform to
which application developers
write.
9. Internet web browsers are a key component of precisely such a
threat. PC users
demand browsers principally
to locate, access, display, use, and navigate applications located on
the Internet's World Wide
Web. At the same time, although browsers may never develop into
full-fledged operating
systems, browsers can serve as a platform to which application developers
Page 4
write. Should application
vendors use a browser platform other than the Windows platform, the
applications barrier to entry
that protects Microsoft's monopoly could be diminished, and
competition in the PC
operating system market created. Microsoft itself recognizes the threat
non-Microsoft web browsers
pose. As Bill Gates stated: "They [Netscape] are pursuing a
multi-platform strategy where
they move the key API into the client [browser] to commoditize
the underlying operating
system."3
10. Subsequent
to Netscape's launching of its browser, Microsoft implemented a
number of contractual
restrictions in its licenses with Original Equipment Manufacturers
("OEMs"), Internet Service
Providers ("ISPs"), Online Services ("OLSs") and Internet Content
Providers ("ICPs"). These
restrictions bias consumers' choice of browser in favor of Microsoft's
browser, Internet Explorer
("IE"), disadvantage rival browsers, such as Netscape Navigator, and
restrain effective competition
between them.
11. Microsoft's
practices are exclusionary; that is, they impede the commercial
opportunities for rival web
browsers. Microsoft's tying of Internet Explorer as a condition of
licensing its Windows
operating system to OEMs and Microsoft's restrictions on OEMs' ability
to customize the Windows
desktop and start-up sequence inhibit OEMs from offering or
promoting non-Microsoft
browsers with their PCs. Microsoft's agreements with ISPs and OLSs
severely restrict (or, until
recently, significantly restricted) the ability of these firms to distribute
or promote non-Microsoft
browsers. And Microsoft's agreements with ICPs not only place
significant restrictions on the
distribution and promotion of competing web browsers, but also
restrict the ability of ICPs to
pay competing browser suppliers for promoting their services. The
restrictions, moreover, are
mutually reinforcing and, when considered in the aggregate, make it
Page 5
significantly more difficult for
Netscape and others to gain usage of their browser products.
12. Microsoft's
restrictions have constricted, and continue to constrict the distribution
channels available to
Netscape and other independently-supplied browsers. The majority of users
obtain a browser through
OEMs, ISPs, or OLSs. Downloading of browsers from Internet sites is
increasingly time-consuming
and fraught with technical difficulties. Although Netscape can
distribute disks containing its
browser software to potential users through the mail and other
channels, this marketing
strategy is not an effective substitute for the OEM, ISP, and OLS
channels.
13. The
impairment of rivals caused by Microsoft's agreements matters; Microsoft's
constriction of distribution
channels has significantly impaired the ability of Netscape and other
non-Microsoft browsers to
effectively offer consumers a choice between their browser and
Microsoft's. Since 1996,
when Microsoft imposed most of its restrictions, Netscape's overall
share of browser usage has
fallen markedly. More importantly, in the wake of Microsoft's
exclusionary practices,
Netscape's share of new browser users has declined even more.
According to Microsoft's
estimate of the "run rates" for browsers – the percentage of new
Internet connections that use
a particular browser – IE's current run rate is approximately 62%,
and is projected to rise to
70%.4
14. Third,
Microsoft's practices cannot be justified on efficiency grounds.
Microsoft's ISP, OLS, and
ICP restrictions are not necessary to further pro-competitive purposes.
Similarly unjustified is Microsoft's tying of Internet Explorer to OEMs.
If users want the combination
of operating system and IE provided by Windows 95 or Windows 98, they will
select the combination on
their own volition. Microsoft's restrictive practices, however, prevent
Page 6.
operation of a "market test," in
which OEMs would be free to offer the product configuration of
their choice and those
product configurations would be tested against consumer preferences in
the market. Furthermore,
Microsoft's restrictions on OEM modification of the Windows desktop
and start-up sequence are
more restrictive than reasonably necessary to achieve any
pro-competitive goals.
15. The costs to consumers from Microsoft's maintenance of its PC
operating system
monopoly, and its creation of
a new monopoly in Internet browsers, through its exclusionary
practices would be
substantial. The price paid for personal computer systems likely will be
higher than it otherwise
would have been. Moreover, and perhaps more importantly, the artificial
barriers to entry erected by
Microsoft's conduct will slow or halt the natural tendency of the
marketplace to provide
alternative technologies in the affected markets, and Microsoft's
operating system monopoly
would be further entrenched.
III. SUMMARY OF CONCLUSIONS
16. I have reached the following conclusions:
(1) First, operating systems
("OSs") for the x86 architecture PCs comprise a relevant
antitrust market within which
Microsoft has, and has exercised, monopoly power.
(2) Second, Internet browsers and PC operating systems,
including Microsoft's
Internet Explorer browser and
Windows 95 and 98 operating systems, comprise separate
products. Products are
separate in an economic sense when they would be provided separately
under competitive conditions;
that is, when there is sufficient demand such that separate
provision is efficient. In
competitive markets, we would observe products being provided
separately when that is
efficient, and one could therefore ordinarily determine whether doing so
Page 7
is efficient simply by looking at
what products are supplied in the market. Here, however,
Microsoft's use of its
monopoly power to tie the browser to the operating system has prevented
such a "market test." Under
the circumstances, therefore, it is appropriate to examine other
evidence to determine
whether the requisite separate demand exists. And the available evidence
of demand for IE alone and
for the Windows 95 and 98 OSs without IE, and of the costs of
providing them separately,
supports the conclusion that browsers and operating systems are
separate products.
(3) Third,
independently-developed browsers represent, as Microsoft itself has
recognized, a threat to the
continued dominance of its Windows operating system product. This
threat arises from the ability
of the browser to provide a user interface and platform for
applications so that, either by
itself or in combination with cross-platform technologies such as
Java technologies,
widespread use of independent browsers can facilitate the availability of a
substitute for the Windows
platform and operating system. Thus, while browsers and operating
systems are complements in
demand (e.g., in terms of features as experienced by users), the
widespread usage of
non-Microsoft browser products can serve to facilitate the entry and
expansion of a substitute for
Microsoft's operating system.5
(4) Fourth,
Microsoft has acted to forestall this threat to its operating system
monopoly by imposing a set
of restrictive agreements on, or taking advantage of restrictions in
existing agreements with,
other market participants, including PC manufacturers, Internet service
Page 8
providers, on-line services
providers and Internet content providers. Microsoft's doing so has
had the purpose and effect of
biasing consumers' choice of browsers in favor of Microsoft's
browser, Internet Explorer;
hindering the distribution of rival browsers, notably Netscape
Navigator; and injuring
effective competition between them.
(5) Fifth, the cumulative effect
of these restrictive agreements has been to make it
more difficult for competing
browsers to acquire new users. These agreements, together with
Microsoft's tying of IE to its
operating system, both in upgrade sales and in sales to OEMs, and
its pricing at zero to the
installed base of Windows users, have increased IE's market share
significantly.
(6) Sixth, under
current conditions, Microsoft's share of browser usage can be
expected to continue to
increase rapidly. Should Microsoft's anticompetitive conduct continue,
there is a dangerous
probability that Microsoft will monopolize the browser market.
(7) Seventh, Microsoft could
significantly reduce or delay the threat to its operating
system monopoly even
without fully monopolizing the browser market, a relevant antitrust
market. Preserving the
barrier to entry created by the large stock of Windows applications
requires only that Microsoft's
expected or actual browser usage share be high enough to induce
independent software
developers ("ISVs") not to develop a stock of cross-platform applications
sufficient to encourage entry
or expansion of competing operating systems.
(8) Eighth, the imposition and
use by Microsoft of contractual restrictions on OEMs,
ISPs, OLSs, and ICPs to
exclude competition are not justified by the need to achieve significant
efficiencies or are more
restrictive than reasonably necessary to achieve such efficiencies.
(9) Ninth, based on the
evidence I have seen, I conclude that Microsoft's distribution
of its browser at a zero price,
the tying of its browser to its operating system, and its other
Page 9.
exclusionary contractual
restrictions with ISPs, OLSs, ICPs, and OEMs were undertaken without
regard to whether those
actions were profit-maximizing -- or even profitable -- absent the future
revenue gains from
weakening rival browsers and thereby preserving Microsoft's Windows
operating system monopoly
and from gaining a monopoly in the browser market. Microsoft
regarded the goal of winning
the browser "war" as an overriding strategic objective, driven by the
need to preserve its PC
operating system monopoly and was prepared to pursue this goal despite
the large costs it
incurred.
(10) Tenth, if Microsoft is permitted to crush
the incipient threat to its PC operating
system monopoly that
independent browsers and cross-platform technologies pose, the adverse
consequences for
competition and innovation are likely to be substantial. They include the
reinforcement of barriers to
entry into the operating system market and the reduction of
incentives to innovate by
other firms, especially new technologies whose independent provision
may be regarded as a
substitute for, or threat to, the Windows operating system.
IV. MICROSOFT HAS
MONOPOLY POWER IN THE PC OPERATING SYSTEM
MARKET
17. The starting
point for an antitrust analysis of Microsoft's actions is the question:
Does Microsoft have
monopoly power in a properly defined relevant market? In answering this
question, it is important to
keep in mind that the purpose of defining markets in this case is to
determine whether
Microsoft's conduct has the potential to harm consumer or social welfare. If
Microsoft lacks monopoly
power in any relevant market, any profit-maximizing unilateral
conduct is unlikely
significantly to harm consumer welfare.
18. My
assessment of whether Microsoft possesses monopoly power proceeds in the
Page 10.
following steps. First, I will define the relevant market. I
begin by setting out certain relevant
industry facts and defining some terms for the purpose of
the ensuing discussion. I then briefly
summarize the principles of market definition I believe are
appropriate here. Next, I apply those
principles to the facts, and explain how they lead me to
the conclusion that PC operating
systems are an antitrust market. Second, having defined
the market, I then assess Microsoft's
power within it. I show that Microsoft possesses
monopoly power in the PC operating system
market, and that this power, in large measure, is secured
by barriers to entry created by the large
number of applications available exclusivelyfor
Microsoft operating systems.
19. I then explain
how non-Microsoft browsers, both by themselves and in
conjunction with Java cross-platform technologies,
threaten that monopoly. I will show that
browsers and Java threaten to eliminate the most
significant of the entry barriers that shields
Microsoft's monopoly from effective competition and,
therefore, that Microsoft stands to gain
significantly from eliminating the browser threat.
A. PC Operating Systems
Comprise a Relevant Antitrust Market
1. Background Industry
Facts
20. Personal
computers are computers designed to be used by one person at a time.
They include desktop and laptop models. Because
personal computers are actually computer
systems, they are made up of many components, each of
which must be technically compatible
with the others for the system to function properly. A
typical personal computer includes at
least one CPU ("Central Processing Unit"), dynamic
memory, a hard disk drive, a floppy drive,
a keyboard and monitor, and an operating system. The
operating system is "the software that
controls the allocation and usage of hardware resources
such as memory, central processing unit
time, disk space, and peripheral devices. The operating
system is the foundation on which
Page 11
applications are built."6
21. When
desirable for clarity in this testimony, I distinguish the operating system
itself from the operating system product sold to
consumers, which may include software or
features that are not part of the operating system. For
example, Microsoft's Windows 95
operating system product includes a software Solitaire
card game which is not part of the
Windows 95 operating system. Operating system
software is software that can be part of the
operating system (e.g., either substitutable for
part of the operating system, or closely related to
the functioning of the operating system – for example, a
hard disk clean-up utility is closely
related to the operating system and would be operating
system software). Operating system
software may be sold as a product that is separate from
the operating system and produced by
vendors other than the OS vendor.
22. Applications
are software programs designed to assist in the performance of a
specific task. They include such things as spreadsheets,
word processors, and database
management programs. Applications are said to "run on
top" of the operating system. In
particular, applications must communicate with the
operating system to request services from
the operating system. Applications do so by using (or
"calling") the operating system's
application programming interfaces ("APIs").
23. The
components of PCs are assembled by computer makers or OEMs. The great
majority of operating systems installed on PCs are
installed on new machines by OEMs.7 The
Page 12
OEM stage of the PC industry is competitive, as indicated
by the large number of computer
makers, thin profit margins, and the absence of a
dominant firm.8
24. Both
businesses and households purchase PCs. Businesses and households have
different preferences and make different purchase
decisions. Customers who purchase an OS as
an upgrade (e.g., the Windows 98 upgrade) to
the operating system already on their PC have
different demand characteristics from customers who
purchase an OS for a new PC either at
retail or pre-installed from an OEM.
25. IBM
introduced the original PC in November, 1981 and offered Microsoft's MS-
DOS as one of its operating systems. Since then,
Microsoft has become the leading supplier of
operating systems for PC OEMs. In the early 1990s,
Microsoft began to enjoy widespread
acceptance of its "Windows" graphical user interface
("GUI") that runs on MS-DOS. Windows
and MS-DOS were often pre-installed on OEM PCs. In
1995, Microsoft introduced a successor
self-contained operating system product called "Windows
95."9 In June
1998, Microsoft
released Windows 98, the successor to Windows 95. As
with Windows 95 prior to June 1998,
OEMs believe it is commercially necessary to offer
Windows 98 on the PCs they sell to end
users.10
2. Principles of Market
Definition
26. The first step
in ascertaining whether a firm possesses monopoly power is to
Page 13.
define the market. For this task, I draw upon the principles
for defining markets set forth in the
1992 Horizontal Merger Guidelines, promulgated
jointly by the U.S. Department of Justice and
the Federal Trade Commission. The Guidelines
supply a well-accepted method for delineating
markets and arecommonly relied upon by both
economists and courts to define relevant
antitrust markets.11
27. The basic
idea underlying the Guidelines is to find the smallest group of
products, and smallest geographic area, over which a
monopolist in those products could
exercise market power by profitably imposing "at least ‘a
small but significant and
nontransitory' increase in price."12 This test, known as
the "hypothetical monopolist" test,
reflects the underlying rationale for defining markets: to
assess whether conduct has the
potential to cause anticompetitive effects. If a
"hypothetical monopolist" in the relevant product
could not effectively exercise monopoly power, then we
can be confident that attempts by firms
operating in such a market to impose anticompetitive
restraints could effectively be checked by
other forces, such as competing firms, entry by new firms,
or a shift by consumers to a substitute
product. In contrast, if the "hypothetical monopolist" can
exercise power over the product in
question, then a dominant producer of that product might
well be able to inflict harm on
consumers through its conduct.
28. Just as it is
important to define the market broadly enough to ensure that a
monopolist over all the products in that market would
cause significant harm, it is also
important not to define the market too broadly, for that
might understate the power of the firm
Page 14
whose conduct is being examined. Thus, the
Guidelines' hypothetical monopolist inquiry
begins with a product (and geographic area) that the
relevant firm produces and asks if the
hypothetical monopolist could exercise power over those
products. If the answer is "no," the
market has not been drawn broadly enough; other forces
would defeat the hypothetical
monopolist's attempt to exercise market power. In such
circumstances, the next closest
substitute for the product considered is added, and the
question of whether the hypothetical
monopolist could exercise power in this possible market
asked again. This process is repeated
until the answer is "yes"; at that point, the market has
been properly defined. Completing the
analysis at the earliest point at which the hypothetical
monopolist could exercise power is
known as the "smallest market principle."
29. There is an
important distinction I should mention about applying the Guidelines
to this case. As I have explained, the Guidelines
inquire as to the profitability to a hypothetical
monopolist of raising price. In a merger case, the prices
used as the starting point in the analysis
are prevailing or existing prices. This is because, in a
merger case, the concern is not so much
whether the merging firms presently are exercising
market power, but rather whether the merger
will increase the market power of the merging
firms.
30. In contrast,
in a monopolization case such as this, the question is whether the
firm in question already possesses monopoly power. In
such circumstances, the appropriate
benchmark is not the prevailing price but rather the
competitive price; and the question is
whether a hypothetical monopolist of the candidate
market could profitably charge a price in
excess of the competitive level. Because the
prevailing price might be a monopoly price, it is
not meaningful to ask whether a hypothetical monopolist
could profitably increase the price
above the prevailing price; even a monopolist cannot
charge greater than a monopoly price
Page 15
without having its conduct constrained sufficiently to make
that price increase unprofitable.
Using the competitive price thus yields a proper market
definition in the circumstances of this
case.
31. In applying
the hypothetical monopolist test to possible markets (that is,
determining whether such a firm could profitably impose a
"small but significant and
nontransitory" price increase over the competitive price),
an economist ideally would like to
have reliable and precise estimates of what is known as
the "own price elasticity" (considered
over the relevant price range) for the product or group of
products that comprise the possible
market.13 The own price elasticity, together with the
marginal cost, essentially tells an
economist when the imposition of a particular price
increase will be profitable.
32. Such data,
however, are often not available -- either to economists or to antitrust
tribunals.14 It is thus appropriate to rely, as the
Guidelines explain, on "all relevant evidence"15
in applying the hypothetical monopolist test. This
includes, but is not limited to, the perceptions
of market participants and the characteristics of the
industry in question.
3. PC Operating Systems Comprise a
Relevant Market
33. Applying the
hypothetical monopolist test, it is my opinion that PC operating
systems comprise a relevant antitrust market. I reach
this conclusion based on two distinct
Page 16.
types of evidence. First, the characteristics of the product
in question, and the demand for it,
readily support the conclusion that operating systems
designed for other (non-PC) hardware
platforms would not constrain, and have not constrained,
the ability of a monopolist of PC
operating systems to exercise monopoly power. Second,
evidence from OEMs, the major direct
purchasers of PC operating systems, confirms that even a
large increase in the current price of
the dominant PC operating system, Windows, would not
result in significant switching by them
or their consumers to other PC operating systems, let
alone to operating systems designed for
other processors.
34. As an initial
matter, it is important to observe that consumers do not demand
operating systems simply for the sake of having an
operating system. Rather, consumers
demand computers, for which an operating system is one
(albeit a key) component. In economic
terms, this means that demand for an operating system is
a derived demand: demand for an
operating system is derived from demand for a computer
system. Moreover, an operating
system is essential on every PC and consumers generally
demand only one operating system per
personal computer.
35. A
consequence of these facts -- that operating systems are demanded in fixed
proportions and that demand for operating systems
derives from consumer demand for PCs -- is
that consumers faced with an increase in the price of PC
operating systems can effectively
substitute away from PC-compatible operating systems
only by substituting away from PCs.
Such substitution, however, would impose significant
costs on end users and on
PC-manufacturers.
36. Both end
users contemplating switching to alternatives to PCs and new users
considering such alternatives would face significant costs
or disadvantages. End users purchase
Page 17
computers, not for the operating system itself, but rather to
run applications; and applications
are typically designed for a particular operating system.
Because the PC platform is dominant,
other platforms (and, as discussed below, non-Microsoft
operating systems that also run on the
PC platform) typically have far fewer applications
available. Thus, both new end users and
users considering switching to another platform would
face the disadvantage of a smaller
portfolio of available applications. Switchers would also
need to expend time and money
learning how to use a computer designed for a different
processor. And both switchers and new
users would have to bear costs resulting from any
incompatibility or impaired compatibility
between their computer and PCs used by colleagues or
others with whom the users may wish to
communicate or share files.
37. Because
there is generally one operating system on a PC, the increase in the price
of the PC that would result from a given percent increase
in the price of the operating system
would be at most the increase in the price of the operating
system times the share of the
operating system cost in the price of a PC. But the
operating system for PCs accounts for only a
small share of the price of the PC – on average about
2.5% – and at most 10% for very
inexpensive PCs.16 Thus, even a 10% increase in the price of the OS
would result at most in a
1% increase in the price of even inexpensive PCs. Given
the cost to users of switching to
another platform, such a small increase in the price of the
PC platform would not be expected to
result in a large reduction in the demand for PCs, and
thus for PC operating systems. In
economic terms, the price elasticity of derived demand for
PC operating systems must be very
low for at least a significant price range above the
competitive price for PC operating systems,
leading me to conclude that PC operating systems are a
separate market.
Page 18
38. The large
costs that PC manufacturers and end users would incur in substituting
away from the PC platform reinforces this conclusion.
OEMs make a significant investment in
developing the machines they sell; to substitute to
another hardware platform (one not based on
the Intel-chip), such as the "PowerPC" chip, would require
incurring significant costs.17
39. The
testimony of, and documents authored by, OEM executives further supports
this conclusion. These executives explain that, if
confronted with a 10% increase in their
Windows license, they would not switch to operating
system products for other hardware
platforms.18 To the contrary, they make clear that preloading
Microsoft's Windows operating
system is commercially necessary.19
40. OEM
executives also explain that Intel-compatible operating system products
that are designed, not for personal computers, but rather
to operate "servers" are not viable
substitutes for a desktop operating systems.20 Server operating
systems are generally more
expensive yet do not provide the features consumers
demand when they purchase PC operating
systems.21 Therefore, the existence of server operating
systems would not constrain the ability
Page 19
of a monopolist of operating systems for PCs to exercise
monopoly power. Accordingly, I
conclude that operating systems for Intel-compatible
personal computers comprise a relevant
product market.
41. I should add
that, even if the market were defined more broadly to include
operating system products for all personal computers –
such as those offered by Apple and some
vendors of UNIX based operating systems that do not use
an Intel-compatible microprocessor –
my conclusion that Microsoft possesses monopoly power
in a relevant market would still stand.
B Microsoft
Possesses Monopoly Power in the PC Operating System Market
42. Once the
market is properly defined, the next step is to determine whether
Microsoft possesses monopoly power within it. Monopoly
power is the ability of a firm
profitably to raise market price above the competitive
level for an extended period of time or to
exclude competition.
43. There are
four reasons why I believe that Microsoft possesses monopoly power
in the PC operating systems market. First, Microsoft's
share of this market has been at a very
high level since at least the early 1990s and is expected
to remain high. Second, barriers to
effective entry into the PC operating system market are
high, and other PC operating systems
cannot easily increase their shares of that market
because the huge stock of applications written
for Windows 95/98 will not run on those systems. Third,
Microsoft has engaged in conduct that
would not be effective or profitable if it did not have
monopoly power. Fourth, the pattern of
OS prices, Microsoft's margins, and the market value of
Microsoft equity are themselves
consistent with Microsoft possessing monopoly power.
Page 20.
1. Microsoft has an Overwhelming
Share of the PC Operating System
Market
44. The first step
in determining whether a firm has monopoly power is usually to
determine the level and stability of its share of the
relevant market. According to Microsoft's
figures, 80.8% out of the estimated 209.2 million PCs
shipped worldwide since July of 1995
include a Microsoft operating system.22 During this period,
naked PCs, e.g., PCs shipped
without any operating system at all, accounted for 31.5
million units, or 15% of the total PCs
shipped. In other words, of the PCs shipped with an
operating system, Microsoft's share was
95.1%.23
45. This high
market share has been remarkably stable. As shown in Pl. Ex. 1,
Microsoft's share of PCs shipped with an operating
system has been above 90% since at least
the early 1990s and this dominance is forecast through at
least 2001.
2. Barriers to Entering the PC
Operating System Market are High
46. Microsoft's
high market share has been protected by high -- indeed formidable --
barriers both to the entry of new PC operating systems
and to the ability of rival PC operating
systems to acquire market share, even in response to
prices above competitive levels. First, as I
will explain, PC operating systems are characterized by
scale economies and sunk costs that
make the cost of entry high. Second, switching operating
systems would impose significant
costs on users; this tends to "lock" users into Microsoft
operating systems. Third, operating
systems exhibit network effects, a consequence of which
is greatly to increase the costs of, and
Page 21.
reduce the probability of, a successful challenge to
Microsoft's market dominance.
47. First,
operating systems in particular, and software in general, are characterized
by economies of scale. The bulk of the costs are
development costs -- the costs that must be
expended to create the software, irrespective of how
many copies ultimately are sold. These
costs include, for example, writing, testing and debugging
program code. The cost of producing
and marketing individual copies of the product ("the
marginal costs") are, by comparison, quite
small.
48. The costs of
developing an operating system to compete with Microsoft's
Windows operating system would be immense.24 For instance, IBM,
a company that is very
experienced in developing competitive software, was
reported to have spent a staggering
amount on the OS/2 project through 1996.25 Moreover, these
cost are what in economic terms
are called "sunk" because only a small portion of either
initial fixed development costs and any
subsequent negative cash flow could be recovered if the
entrant were to exit the market.
Moreover, competition between two suppliers, each with
very high fixed costs and very low
marginal costs, would likely result in a decrease in prices,
further reducing the profitability of
entry to the would-be entrant. Entry into head-to-head
operating system competition with
Microsoft thus would be time consuming, risky, and costly;
profiting from such entry would be
at best very uncertain and long in coming.
49. A second
barrier both to entry and to expansion by an existing competitor is that
users tend to become "locked in" to a particular operating
systems. As discussed above, users
Page 22
are reluctant to switch from Windows to another operating
system, even another PC operating
system, because to do so requires them to replace
application software, to convert files, and to
learn how to operate the new software. Often, switching
operating systems also means
replacing or modifying hardware. Businesses can face
even greater switching costs, as they
must integrate PCs using the new operating systems and
application software within their PC
networks and train their employees to use the new
software. Accordingly, both personal and
corporate consumers are extremely reluctant to change
PC operating systems. The software
"lock-in" phenomenon creates a barrier to entry for new
PC operating systems to the extent that
consumers' estimate of the switching costs is large
relative to the perceived incremental value of
the new operating system.
50. Additional
switching costs arise from the fact that, for most users, operating
systems are only a means to an end – it is the application
software that was designed to work
with the operating system that users want.26 Once they have
purchased an operating system,
users are naturally reluctant to consider a different
operating system. Unless their current
operating system product prevents them from using new
applications or hardware, they are
likely to continue to use that operating system; for
operating systems, unlike other goods, do not
wear out.
51. A third entry
barrier is created by the well-understood fact that operating systems
are characterized by "network effects." Network effects
occur when the value of an item to a
Page 23
user increases as the total number of users increases.
Examples of products subject to network
effects include fax machines and both local and long
distance telephone networks. A fax
machine is not particularly valuable until a large number
of other people have fax machines that
use the same standards and protocols. Similarly, the
more users within a given region that a
local phone network serves, the more valuable that
network is to each user.
52. Operating
systems are subject to network effects because, among other things,
the value of an operating system product is largely
dependent on the number of applications
available for it. Today, applications written for one
vendor's operating system product generally
will not work on another vendor's operating system.
Thus, to write an application for more than
one operating system, a software developer generally
must incur additional development costs,
and doing so could also divert scarce resources from the
task of enhancing the application for
use with the first operating system. As a consequence,
ISVs are often reluctant to "port" (or
convert) their software from one operating system to other
operating systems.
53. As an
operating system gains popularity, the incentive to develop software for
that operating system increases because the larger
number of users for the operating system
product implies a greater potential market for software
developers. The development of yet
more applications for that operating system, in turn,
increases the value of the operating system
to end users who, as explained, purchase operating
systems in significant part based upon the
quality and variety of applications available for it.27 As
Hewlett-Packard's Frank Santos
explained, demand for an operating system is driven by
the availability of "applications that run
Page 24
on the operating system."28 The operating
system's market share, therefore, is likely to increase,
and that, in turn, is likely to cause software developers to
devote yet more resources to writing
applications for that operating system product.
54. This
phenomenon – known in economics as "positive feedback" – creates what is
best termed the "applications barrier to entry." Simply
put, an operating system product can rise
to dominate the market, and once that dominance is
achieved maintain it, because of both the
large number of complementary software applications
available for it and the flow of new
applications that are written to it. This too is
well-recognized by Microsoft. As observed by Dr.
Nathan Myhrvold, chief technology officer of Microsoft,
"the laws of positive feedback govern
any system where compatibility with other users is either
directly or indirectly a key factor in the
utility of a product or service," and these laws "ha[ve]
been responsible for the phenomenal
strength of leading software products in both applications
and operating systems [products]."29
Microsoft has further stated: "The availability of a rich
variety of quality applications software
that will run on a particular operating system [product] is
fundamental to its success. This fact
has been recognized by publishers of operating systems
[products] for years."30 This was
reiterated by Microsoft's Brad Chase, who explained:
"speaking very generally, a developer's
interested in building applications when there's a lot of
users who could run those applications
on the platform."31
Page 25
55. The
applications barrier to entry is supplemented by other barriers to entry that
derive from network effects. Books, publications, training,
user groups, and news groups for the
incumbent operating system product provide a large
sense of community for its users. Users can
exchange files, and perhaps more readily use their
computers to communicate, with other
members of the group. Finally, when the incumbent
operating system is installed at work, it
leads users to select the same operating system product
for use at home.
56. It is clear that
the applications barrier to entry sustains Microsoft's dominance,
critically contributes to its monopoly power, and helps
explains why other Intel-compatible
operating systems, such as OS/2 and Linux, have
persistently small market shares. As I
previously explained, because of economies to scale, the
marginal costs of producing additional
copies of these operating systems is very low. Thus, one
might expect that, if Microsoft
attempted to exercise monopoly power, vendors of these
operating systems would flood the
market with their product and constrain Microsoft's
behavior. This, however, has not occurred.
No rival has succeeded in mounting a sustained effective
threat to Microsoft's market
dominance.
57. One reason
for the lack of success is that alternative operating systems lack the
installed base of applications that Microsoft's PC
operating system products enjoy. To offer a
product that a significant number of consumers wish to
have installed on their PCs, vendors of
these operating systems would have to create, or induce
others to create, an extensive set of
compatible software applications. This would be not
merely expensive, but also very risky
because it would involve significant sunk costs, as
explained above.
58. The failed
attempt of IBM to enter the PC operating system market with its OS/2
operating system illustrates the strength of the
applications barrier to entry and confirms that
Page 26
Microsoft's dominant share of the operating system market
is indicative of monopoly power.
IBM's OS/2 operating system, first released in 1987, was
designed to replace Microsoft's DOS
and DOS with Windows. In 1994 and 1995, IBM, which
also competes as an OEM, installed
OS/2 on its own Aptiva line of computers. Retailers, and
consumers, however, routinely
demanded application software that was not available for
OS/2.32
Applications written for
Windows 3.x could also run on OS/2, but not the
increasing number of applications written for
Windows 95. In response, IBM abandoned its practice of
installing OS/2 on the Aptiva
computer, choosing instead to license Windows from
Microsoft. As Mr. Kozel of IBM
explained, "the market . . . moved to the Windows 95
platform," so IBM "ship[ped] a hundred
percent of [its] Aptiva products with Windows 95."33
59. Microsoft
itself recognizes that the failure of a new entrant, such as OS/2, to
attract customers is attributable to the "applications
barrier to entry." As Joachim Kempin,
Microsoft's Senior Vice President for OEM Sales,
explained in discussing what might "derail"
Microsoft's pricing strategy in January 1997:
Our high prices could get a single OEM
(Compaq might pay us 750M$ next
year) or a coalition to fund a competing
effort (say in India). While this
possibility exists I consider it doubtful
even if they could get a product out that
they can market it successfully, leapfrog
us and would not deviate from their
own standard to differentiate. Could they
convince customer [sic] to change
their computing platform is the real
questions [sic]. The existing investments
in training, infrastructure and applications
in windows computing are huge and
will create a lot of inertia. No bundling of
OS on low end systems would be the
easiest way to hurt us – but who would
want to start with this and loose [sic] business.34
Page 27
3. Microsoft's Monopoly Power is
Evidenced by its Use
60. Microsoft has
engaged in conduct that it could not profitably pursue unless
it possessed monopoly power. For instance, when one
OEM removed the IE icon from the
Windows 95 desktop, Microsoft responded by threatening
to terminate that OEMs'
Windows 95 license. The OEM capitulated to Microsoft's
demands.35
It is plain it did so
because, as OEMs universally explain, a Windows license
is essential to remaining
competitive in the OEM market.36 This capitulation is
itself evidence of Microsoft's
monopoly power.
4. Margins, and in the Market
Value of Its Equity
61. Although
accurate historical data on Microsoft's operating system product
license fees are not readily available, it is my
understanding that since at least 1987 the
operating system has accounted for a steadily increasing
share of the cost of a PC. An
internal Microsoft document acknowledges that it has
increased its operating system product
"prices over the last ten years [while] other components'
prices [for PC computers] have
come down and continue to come down. This is
particularly true of CPU prices."37
Page 28.
62. Microsoft's
monopoly power in operating systems has translated into
extraordinarily high net profit margins that have been
increasing over time.38 Even more
telling is Microsoft's extraordinarily high market
capitalization. With a price/earnings ratio
more than double the S&P 500 average, the financial
markets are signaling very optimistic
investor expectations regarding Microsoft's future growth
in earnings.
63. My analysis
thus far has shown that Microsoft possesses monopoly power
in the desktop operating system market. Although the
barriers to entry and to the growth
of other PC operating systems that protect Microsoft's
monopoly power are formidable, they
are not impenetrable. There is no reason to believe that
the market, if left to function
properly, will not in time generate alternatives to
Microsoft's operating system that will be
sufficiently superior to overcome the entry barrier
advantage that Microsoft enjoys.
64. Microsoft,
however, has interfered with these market forces. As I explain
below, Microsoft has engaged in a course of conduct with
the apparent purpose, and
evident effect, of reinforcing its monopoly power in the PC
operating system market.
V. INTERNET WEB BROWSERS POSE A
THREAT TO MICROSOFT'S PC
OPERATING SYSTEM MONOPOLY
65. Given the
natural barriers to entry described above, a competitive threat to
Microsoft's operating system monopoly is less likely to
come from other operating system
products than from extensions to complements of
Windows that also can serve as platforms
Page 29.
to which ISVs write applications programs. Although a PC
operating system cannot
successfully compete against Microsoft's operating
systems without first overcoming
formidable barriers to entry, the situation is different for a
product (e.g., browsers or Java
technology) that is both initially a complement from an
end user perspective and a potential
substitute for the Windows 95/98 platform to which
applications developers can write.
Because applications written to such a complement are
compatible with Windows, their
developers can sell their applications to users of the
Windows operating system.
Eventually, a sufficient number of such applications may
become available to support an
alternative platform to Windows. This alternative platform
can then be combined with other
operating systems to offer a complete and viable
substitute for Windows.
66. To be sure, if
the technology is to realize its full potential as a substitute for
Windows, it would eventually need to become an
attractive platform for many applications.
However, because such a technology can gain wide
marketplace acceptance based on its
value as a complement to Windows, the hurdle of
attracting application developers is
substantially reduced. The wide dissemination of the
complement among PC end users
means that application developers can reach a broader
base of potential customers by
writing to it than by writing to an operating system that
competes directly with Windows
95/98 and starts with very low market penetration and
installed base.
67. As more applications are written that work with the new platform, it
will
become more attractive to users and ISVs as a substitute
for Windows. Ultimately, the
choice between the Windows platform and the alternative
platform may be made by users
on the basis of the price and other characteristics of those
platforms, rather than on the
availability of compatible applications.
Page 30
68. Internet
browsers are complements that pose precisely this sort of threat to
Microsoft's operating system monopoly. A browser is
software that enables computer users
to navigate and view content on the World Wide Web.39 Today the
typical browser product
includes additional related software such as an e-mail
program, a web-authoring tool and
a news group reader. Browser products support
sophisticated security/encryption and may
include the ability to run Java programs.40 Competition has
resulted in the porting of the
most popular browsers to a variety of desktop
platforms.41
Competition among browsers
for PCs, principally between Microsoft's Internet Explorer
and Netscape's Navigator and
Communicator products,42 has benefitted
consumers significantly.43
69. Internet
browsers may serve as an alternative software development platform
by exposing APIs that other software developers may use
to perform particular functions.
Page 31
An API is essentially a method pre-defined by one
software developer that enables other
software developers to access functions provided by the
original software developer's
product. A platform for the development of software is a
sufficiently rich set of APIs that
ISVs can use them to supply applications. Some
browsers expose APIs that enable ISVs
to create "plug-ins" that expand the capability of the
browser, independently access the
functions of the browser itself, and, through the Java
Virtual Machine that comes with the
browser, provide other useful applications such as word
processors and spreadsheets.44
A. Browsers
and Operating Systems Comprise Separate Products
70. An issue
of central concern in this case is whether IE is a "separate product"
from the Windows 95 and 98 operating systems.
Microsoft contends that IE is an integrated
feature or "technology" of Windows 95/98 that cannot be
"removed" without significantly
degrading the performance or value of Windows 98.
Therefore, according to Microsoft, IE
and the Windows 95/98 operating system are a single
integrated product.
71. The appropriate economic definition of a separate product is an item
for
which there is sufficient demand such that it is efficient to
offer that item separately from
other items. This test is a "demand based" or "market"
test. Thus, for example, the
Windows operating system and IE are separate products
if there is sufficient demand for one
without the other such that competing firms (including
possibly Microsoft itself) could
profitably supply a product consisting of the Windows
operating system but, from the user's
perspective, without IE. The "market" test is an
appropriate separate product test because
it ascertains what product configurations would be
supplied in a market where no firm could
Page 32.
exercise monopoly power.45
72. Applying
the market test when firms producing the items in question lack
monopoly power is straightforward. In the absence of
monopoly power, the product
configurations marketed by firms can be assumed to be
efficient and comport with
consumer demand.
73. When,
however, a firm has monopoly power over one product, that firm may
have an anticompetitive motive to tie the monopolized
product to a complementary product.
One circumstance under which anticompetitive tying is especially likely
to occur is when
the complementary product is also a "partial substitute" for
the monopolized product.46
74. When a
firm possessing monopoly power in a product employs it to force
customers to take another product, it prevents the market
from determining whether the
components of the combined package – in this case,
Windows 95/98 and IE – are one
product or two. It then becomes necessary to look to
other evidence to determine whether
the components are one product or two. That evidence
would include both evidence of user
demand for one without the other and of the cost of
providing them separately.
75. As the
following discussion explains, the available evidence strongly supports
the conclusion that IE and the Windows 95/98 operating
systems are separate products. IE,
like other browsers, has been, and continues to be,
offered as a separate product, and users
regularly acquire IE and other browsers as separate
products. The evidence also shows that
there is substantial demand for Windows 95 and Windows
98 without IE and that it would
Page 33
inexpensive for Microsoft to provide Windows 95 and
Windows 98 in a way that would
satisfy this consumer demand.
1. be Provided
Separately
76. Internet
browsers are currently provided separately from operating systems.
Netscape Navigator for several different operating system
products is offered as a stand-
alone product through the retail channel, through the
download channel, and supplied with
access services by some ISPs. Similarly, Opera, which
has limited presence in some
distribution channels, is distributed independently of an
operating system product. Mosaic,
the first browser with a graphical user interface ("GUI") is
still available as a stand alone
product. Indeed, there are a large number of lesser
known browsers still distributed
independently from any operating system.
77. Similarly, Microsoft has provided Internet Explorer separately from
its
Windows operating system in the past and continues to
do so to this day. Moreover, as
Microsoft executives have explained, the company's
decision to produce an "unintegrated"
version of Internet Explorer for non-Microsoft operating
systems, including a version of
Internet Explorer for the Apple Macintosh and Sun Solaris
operating systems, indicates that
there is a demand for Internet Explorer separate from
those operating systems and that it is
efficient to provide the browser separately in order to
meet that demand. For instance,
Microsoft Vice President Brad Chase testified:
Q. Going back
to IE4. Why did Microsoft develop a version of IE4 for those
other operating systems --
the Mac, Solaris, Win 3.1?
A. We developed business for other
operating systems because customers
requested it and for some
customers they didn't want to roll out Internet
Page 34.
Explorer unless they had
cross-platform versions and because for certain of
the -- and because that also
impacts developers.47
78. Microsoft tracks the market usage share of its browser separately
from
Windows. As Brad Silverberg, then-Senior Vice-President
of Microsoft's Applications and
Internet Group testified:
Q. Within Microsoft, after Windows 95
was released, did the company track the
share of usage of IE?
A. Yes, it did.
Q. And it tracked that separately from
usage of Windows?
A. Yes, it did.
Q. Why? Why did you track share of
IE?
A. See how -- compare IE share with
competitive products, competitive technologies.
Q. And what competitive technologies
were you comparing IE usage to?
A. Navigator, Cyberdog, others.48
79. Consistent with Microsoft's marketing of Internet Explorer to meet a
demand
separate from that for an operating system, many OS
vendors that do not view the browser
as a threat and that distribute a browser application with
their OS view the browser as a
separate product.49 At one time Apple distributed Netscape Navigator
as its default
Page 35
browsers for the Mac OS, and Apple currently distributes
IE as its default browser.50 In
either case, the browsers were identified as separate
products with their own brand names.
Most UNIX vendors have also distributed browsers with
their operating system products.51
These browsers are always identified as separate
products with separate brand names. Most
important, OEMs that license operating systems from
these vendors are not required to
pre-install browsers on their desktop computers,
indicating that operating systems and
browsers are separate products.52
80. There is also evidence of separate demand for operating systems
generally,
and for Windows 95 and Windows 98 in particular. First,
many corporate users purchase
only an operating system and do not want a browser at
all. For instance, Joseph J. Kanicki,
Jr., Strategic Commodity Manager, Dell Computer
Corporation, stated in a recent
declaration:
Some business and government customers prefer not to have
Internet
Explorer preinstalled on their computer because: (1) the
customer
may have its own software or software standards which do not
include
the latest version of Internet Explorer, (2) the customer may
wish to
install a competitive browser instead of Internet Explorer, or (3)
the
customer may wish to prevent its employees from accessing or
attempting
to access the Internet or the World-Wide Web.53
81. Mal Ransom of Packard Bell expressed
the same point in a recent deposition.
Mr. Ransom stated: "In the
commercial end of the business depending upon what part . . .
Page 36
you're selling to, on some
days all they want is the operating system. They don't want other
things. They don't want any
access to the Internet because companies don't want their
employees potentially being
able to get on the Internet or play games."54
82. Second, whether in response to
perceived corporate demand or for other
reasons, several OEMs
requested that Microsoft permit them to remove an end-user's visible
means of accessing IE
from both Window 95 and Windows 98.55
83. Microsoft responded to this corporate
demand for operating systems without
IE by designing Windows 95
so that Internet Explorer could be "uninstalled" using the
Add/Remove programs utility
that comes with the Windows 95 operating system. This
utility removes the ability of
end users to use Internet Explorer to browse the web (web
browsing functionality) and,
thus, from an economic perspective, unties the browser from
the operating system.
Confirming that the "uninstall" capability for Internet Explorer was
created in response to
consumer demand for a browserless operating system product, David
Cole, the Microsoft Vice
President responsible for overseeing the development of Internet
Explorer, testified that the
capability was added in response to "feedback from corporate
customers that wanted to
prevent access to the Internet, so that when they . . . buy a new
machine from a PC
manufacturer they want the ability to remove easy access to the Internet
so their employees, you
know, aren't spending their time out on the Web doing whatever."56
Page 37
84. Microsoft's creation of the "uninstall" utility
that, from an economic
perspective, removes IE,
shows that it was efficient for Microsoft to meet the demand for an
operating system without a
browser in the case of Windows 95. Indeed, having designed the
utility, it would have been
virtually costless for Microsoft to permit OEMs, in effect, to use
the utility to remove IE.
85. It is my understanding that Windows 98
does not contain the same ability as
Windows 95 to "uninstall"
Internet Explorer. Nonetheless, I understand that Professor Felten
has shown that it is easy to
remove from Windows 98 the ability to browse the Web using
Internet Explorer and to
substitute a different browser in its place.57 It would thus be
efficient for Microsoft to
provide, or to permit OEMs to provide, the operating system
without the ready means of
invoking IE.
2.
Internet Explorer and Windows 95/98 are Separate Products
86. Because the evidence shows that there is
separate demand for IE and the
Windows 95 and Windows 98
operating systems (e.g., demand for each without the other)
and because the evidence
shows that it would be inexpensive for Microsoft to provide both
those products separately, I
conclude that it would be efficient for Microsoft to meet that
separate demand. In a
competitive market, therefore, I would expect that OEMs would have
the option of licensing or
distributing Windows 95 and Windows 98 without the visible
means of access for IE, just
as OEMs have that option from PC operating system vendors
Page 38.
that do not have monopoly
power.58 I
therefore conclude that IE and Windows 95/98 are
separate products.
B. Operating
System Monopoly
87. As I explained above, Internet browsers
produced by firms other than
Microsoft, by themselves and
in combination with the Java technologies they distribute, pose
a threat to Microsoft's
operating system. Microsoft internal documents show that the firm
understood this threat. As
noted above, Bill Gates wrote in May 1995 that "[Netscape is]
pursuing a multi-platform
strategy where [it] move[s] the key API into the client [browser]
to commoditize the
underlying operating system."59 Similarly, Microsoft Vice President
Brad Chase warned
that competing Internet browsers could eventually "obsolete
Windows,"60 and Group Vice
President Paul Maritz worried that Netscape's browser might
make Windows
"replaceable."61 As Brad Silverberg, another Microsoft
Executive,
succinctly put it: "the
Internet Battle" is "not about browsers. Our competitors are trying to
create an alternative
platform to Windows."62 More recently, Microsoft's James
Allchin
explained that, in his
view, "[t]he goal, the stated goal of Netscape was" among other things
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"to create a new set of
APIs that developers would write to."63 When asked how Netscape
could threaten
Windows, Mr. Allchin stated: "You get developers to write the APIs, you
cover up Windows,
you've just got this layer running on top, and if the size [and]
performance was
acceptable, it becomes irrelevant. Windows becomes irrelevant."64
88. Because competing browsers, such
as Netscape Navigator, pose a threat to
Microsoft's operating
system monopoly, Microsoft protects the profits it earns in the OS
market by dominating
the browser market. By reducing the market share of competing
browsers to low levels,
Microsoft could significantly diminish the possibility that
applications
developers will write to those browsers' APIs. Microsoft's browser dominance
also would impede the
distribution of a cross-platform Java technologies. Microsoft,
therefore, has a
significant incentive to gain a large share of the browser market in order to
protect its desktop
operating system monopoly.
89. Browsers, like operating systems,
exhibit not only economies of scale, but also
network effects.
Websites can be written to standards that favor one browser over another.
For instance, websites
can use technologies that are accessible only by a particular browser
or work better with that
browser. If Microsoft were to gain a dominant share of the browser
market, it might
succeed in inducing website developers to write their content using
Microsoft-specific
technologies. If a large number of websites are written to such a
technology, more end
users would switch to IE, which in turn would increase the incentives
of website developers
to embrace Microsoft-specific technology. The consequence of this
instance of "positive
feedback" is that the browser market could tip to a Microsoft
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monopoly, in which the
installed base of Microsoft specific web sites, along with switching
costs, create barriers
to entry. Microsoft, of course, would benefit from such a monopoly
because it would mark
the death knell of the threat posed by non-Microsoft browsers to its
operating system
monopoly.
VI. MICROSOFT'S EXCLUSIONARY
CONDUCT
90. The
analysis thus far established has led me to two conclusions: First, that
Microsoft possesses
monopoly power in the market for PC operating systems and, second,
that Internet browsers
marketed by firms other than Microsoft pose a threat to Microsoft's
monopoly and that
hindering the success of rival browsers would thus serve to protect and
extend that monopoly.
I now turn to an examination of Microsoft's practices with respect
to browsers. For ease
of exposition, I will examine each component of Microsoft's conduct
separately. However,
the economic significance of any particular conduct cannot be
understood unless set
in its proper context. Accordingly, I consider the effect of particular
practices in light of
Microsoft's other conduct and its dominance in the PC operating system
market. My principal
conclusion is that Microsoft's practices, taken as a whole, are
anticompetitive and are
likely to facilitate monopolization in the browser market and the
preservation of
Microsoft's monopoly in the PC operating system market.
A. Microsoft's Tying is
Exclusionary
91. Microsoft has engaged in a number of
practices with respect to the
distribution of its Windows operating system to OEMs
that, taken together, have the effect
of excluding competing Internet browsers. First, although
Microsoft did not bundle IE with
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the initial retail version of Windows 95, it subsequently
bundled Internet Explorer with its
Windows operating system for licensing to OEMs. By
bundling, I mean that Microsoft
provides the browser with the operating system in a single
"package" at no additional cost.
Second, Microsoft has tied the Internet Explorer browser
to the operating system in both
Windows 95 and Windows 98. By tying, I mean that
Microsoft requires OEMs to install
IE on, and prohibits them from removing IE or access to
IE from, the PCs they sell. The
combined effect of these practices is exclusionary. They
ensure that OEMs will pre-install
rival browsers on fewer machines.
92. It is true that Microsoft does not
contractually prohibit OEMs from
pre-installing a competing browser, or even pre-installing
a competing browser as the
default browser. But Microsoft's tying of IE to the
Windows 95 and Windows 98 operating
systems has made it more costly and burdensome for
OEMs to install other browsers and
has thus significantly, although not completely, deterred
OEMs from doing so.
93. Pre-installing a second browser imposes
significant costs on OEMs and
yields them few benefits when the second browser is not
perceived to be of significantly
higher quality. Even if the OEM is not required to pay a
license fee in order to install a
second browser, the costs of including a second browser
along with IE may be significant.
They include increases in support costs that result from
customer confusion and increased
testing costs.65
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94. In particular, OEMs report that customers
become confused by the presence
of two or more applications that perform similar functions
and by desktop screens populated
with multiple icons.66 Because Microsoft
requires OEMs to bear all support costs
associated with the PCs they sell, OEMs have a keen
interest in reducing customer
confusion, which can lead to increased support costs.
For this reason, OEMs pre-install
only a limited number of software programs with the PCs
they ship and do not cover the
desktop screen with icons.67 Microsoft also
recognizes that multiple products performing
similar functions may cause consumer confusion. For
instance, Microsoft's OEM account
manager for Gateway, Gail McClain, explained in a recent
deposition that "redundan[t]
icons on the desktop" may "be confusing to end users."68
95. Thus, Jim Von Holle of Gateway
testified that Gateway sought permission
to remove the IE icon from Windows 98 because it
sought to lessen support costs that would
result from also installing Navigator.69 Von Holle
explained that "general usability studies
. . . indicate that the less cluttered the desktop . . . the
less confusing it is for the customer to use
the product."70
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96. The value to an OEM from adding a
product, such as Netscape Navigator,
that performs the same functions as Internet Explorer is
small compared to the increased
costs imposed on OEMs and the resulting customer
confusion. If OEMs were permitted
either not to install IE or to remove the visible means of
access to it, their costs of including
a rival browser would be lower, and the benefits to
consumers from having such a browser
would be greater.
97. Microsoft executives both in depositions
and in its documents confirm that
the requirement that OEMs install IE, combined with the
contractual prohibition on OEMs'
removing any part of that browser, can significantly deter
OEMs from installing competing
browsers. Microsoft's Senior Vice President of OEM
Sales, Joachim Kempin, has testified:
Q. ....[D]oes Microsoft sometimes
essentially make this argument to [OEMs]; Why
do you need to incur the extra testing
costs and the extra user education and maybe
undergo the longer loading time --
A. I believe we have.
Q. Is that sometimes successful in
persuading OEMs that they don't really need to
distribute another browser because they
already have Internet Explorer?
A. That is sometimes successful.71
98. The foreclosure of the Netscape browser
as a result of Microsoft's tying of
its browser to its Windows operating system is significant.
The OEM channel is one of the
two principal channels through which users obtain
browsers.72
Moreover, because of
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reluctance to install new software themselves, many less
sophisticated PC users simply use
whatever browser comes pre-installed on their machines.
For example, one marketing study
explains that the response "`[i]t came with my computer'
is the #1 reason people switch to
Internet Explorer" and concludes that "OEMs are the best
vehicle to gain browser share."73
99. Contemporaneous Microsoft internal
documents confirm this analysis. They
show that Microsoft believed that its forced licensing of
Internet Explorer to OEMs would
serve to deny rivals access to the OEM channel and, by
doing so, increase Internet
Explorer's market share at the expense of other browsers.
For instance, Microsoft's Jim
Allchin wrote in January 1997: "I do not feel we are going
to win on our current path. We
are not leveraging Windows from a marketing perspective
. . . . We do not use our strength
-- which is that we have an installed base of Windows and
we have a strong OEM shipment
channel for Windows . . . . I am convinced we have to
use Windows -- this is the one thing
[Netscape] do[es]n't have."74 Christian Wildfeuer
echoed this a month later. She wrote:
"It seems clear that it will be very hard to increase
browser market share on the merits of
IE 4 alone. It will be more important to leverage the OS
asset to make people use IE instead
of Navigator."75
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B. Microsoft's OLS and ISP
Restrictions are Exclusionary
100. The second set of restrictions I examined were Microsoft's
agreements with
Internet Service Providers, which are firms that provide
PC users with access to the Internet.
Some important ISPs, such as America Online (AOL) also provide
proprietary content to
users: these ISPs are known as Online Service Providers.
Along with OEMs, OLSs and
ISPs comprise the two most significant channels through
which users obtain browsers.76
As with Microsoft's restrictive OEM agreements, the
terms of its contracts with ISPs
exclude competing browsers and significantly
impede competition on the merits among
competing browsers.
1. Microsoft's
OLS Agreements are Exclusionary
101. As I will explain in detail in connection with Microsoft's screen
restrictions,
the Windows 95/98 desktop and boot-up sequence
provide an attractive advertising vehicle
for OLSs. Placement on Windows screens is
valuable to OLSs because, among other
reasons, it ensures that the OLS reaches many
potential new subscribers at the precise time
when those new subscribers must open an account
to secure access to the Internet. As
Kevin Knott, an executive of CompuServe, Inc.,
testified, placement in the Online Services
Folder was important to CompuServe because
"Windows 95 reaches such a large number
of people and is on such a large percentage of new
computers, it represents a very large
distribution opportunity for us . . . . No other single
hardware [or] software company can
give it that level of distribution . . . . There are other
ways to try to do that, but it would
require separate deals and probably at much
greater expense to try to match what we could
achieve through Windows 95.77
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102. Microsoft used this asset to induce OLSs to enter into agreements
that
restricted the distribution and promotion of competing
browsers. It did so by creating for
the Windows 95 desktop the "Online Service Folder," in
which it featured participating
OLSs, and placed icons for them in the Windows "Start"
menu. Because of screen
restrictions, which I describe below, OEMs could not
remove these items or advertise other
OLSs in a more prominent way. Microsoft, the evidence
shows, was aware of the value
that OLSs attached to favorable desktop placement, and
sought to exchange this valuable
asset for exclusionary restrictions. For example, Brad
Silverberg, former head of
Microsoft's Internet Group, told AT&T during
negotiations:
You want to be part of
the Windows box [desktop], you're going to have to
do something very
special for us. There are very, very few people we allow
to be in the Windows
box. If you want that preferential treatment from us,
which is extraordinary
treatment, we're going to want something very
extraordinary from you.78
103. In exchange for favorable desktop
placement, the OLSs typically agreed to
the following:
(a) To promote and distribute Internet Explorer as the "exclusive"
or primary browser;
(b) not to
distribute a non-Microsoft browser unless specifically
requested by the customer or "express or
imply" that a
competing browser is available;
(c) not to ship non-Microsoft browsers more than 15% of the time,
even upon customer request for
alternative browsers; and
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(d) to restrict
the ability of users to employ or download
non-Microsoft browsers.79
104. These agreements explicitly
(although not completely) exclude competing
browsers from an important channel for acquiring
new users and maintaining existing users.
And, as I will explain below, this exclusion matters. A substantial
number of users obtain their browser through OLSs
such as America Online (AOL). Indeed, recognizing the
importance of their agreements with OLSs to
maintaining IE's overall market share,
Microsoft has not relaxed those restrictions in
Windows 98.
105. It is ordinarily not anticompetitive for
a firm, such as Microsoft, that has
created a valuable asset, like desktop real estate,
to charge customers for the use of that
asset. My concern with Microsoft's conduct is not
that it has extracted compensation for
Windows desktop real estate. Rather, my concern
involves the form or nature of the
payment Microsoft has extracted; namely,
agreements that raise the distribution cost of
competing browsers and tend to exclude those
browsers from the market.
2. Microsoft's
Restrictions on Other ISPs are Exclusionary
106. In addition to creating the Online Service
Folder in Windows 95, Microsoft
developed a feature called the "Internet Connection
Wizard" (ICW). In Windows 95, the
ICW was prominently displayed on the Windows 95
desktop and OEMs were not permitted
to remove it. If selected by a user, the ICW would display
a list of ISPs generated by the
Microsoft Internet Referral Server. As with the Online
Service folder, ISPs viewed the ICW
as an attractive way of promoting their service and
acquiring new subscribers. As discussed
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below, Microsoft took advantage of the screen restrictions
on OEMs to capture the full
value for itself of being the first to recommend ISPs to
new users.
107. As with the Online Service Folder,
Microsoft exchanged this desktop
placement in the ICW for exclusionary agreements.
Indeed, Microsoft's Cameron
Myhrvold testified that Microsoft created the Internet
Connection Wizard in part to induce
ISPs to grant preferences for Microsoft's browser.80 In order to
secure placement in the
ICW, ISPs agreed to restrictions similar to those Microsoft
imposed on OLSs. The ISPs
typically agreed to:
(a)make Internet Explorer the default or preferred browser;
(b)ship a rival browser no more than 15% of
the time;
(c)not express or imply that a competing browser is available;
(d)limit the ways in which a user could link to
a site promoting, or
download, a competing browser; and
(e) in exchange for discounts,
employ technologies that made the service
function better with Internet Explorer than with rival browsers.81
108. The economic effects of the first four
restrictions are essentially the same as
the restrictions imposed on
OLSs. The provision regarding use of Microsoft-specific
technologies, however,
requires separate discussion. The effect of this provision is to reward
ISPs that configure their
services in a way that reduces the cross-platform threat to
Microsoft's operating system
monopoly. The reason is that ISP use of Microsoft-specific
technologies reinforces the
dominance of the Windows platform. For instance, one of the
Microsoft-specific
technologies is known as "ActiveX." As I understand it, ActiveX is "a
Page 49.
set of technologies . . . built
on Microsoft's Component Object Model (COM) . . . that
enables software
components to interact with one another in a networked environment,
regardless of the language in
which the components were created."82 ActiveX controls are
"reusable software
components that incorporate ActiveX technology [and] can be used to add
specialized functions . . . to
Web pages, desktop applications, and software development
tools."83 The crucial feature
of ActiveX for my purposes is that it is operating system
(typically Windows) specific.
Use of such technologies by ISPs serves to blunt the
cross-platform threat that, as
explained above, rival browsers might pose.
109. I understand that, faced with the threat of
this litigation, Microsoft last Spring
relaxed its ISP restrictions on certain ISPs, but not the most important
ones -- OLSs'. The
only remaining requirement is
that ISPs promote Internet Explorer on a par with
non-Microsoft browsers. For
two reasons, however, the ISP restrictions nevertheless are
important to my analysis.
First, the remaining restriction is itself exclusionary. Some ISPs
will choose to promote or
support only a single browser at any given time in order to reduce
its costs.84 For such ISPs, a
requirement of "parity" for Internet Explorer in order to secure
access to the ICW may
amount to a defacto requirement that the ISP exclusively support
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Internet Explorer. Second,
and perhaps more important, Microsoft's ISP restrictions had
significant anticompetitive
effects while they were in place, and if Microsoft's statements
that some ISPs will support
only one browser are accurate, those effects cannot be reversed
simply by removing the
restrictions. Third, absent intervention, Microsoft would be free to
reimpose all the ISP
restrictions.
110. In addition to entering agreements with
ISPs that involved the Internet
Connection Wizard, Microsoft
by late 1996 had entered into more than 2,500 "IE preferred"
licenses.85 For fifteen of the
top seventy-five providers, these agreements required that a
certain percentage of
browsers shipped be Internet Explorer.86 Moreover, more that fifty of
the top seventy-five providers
had agreed to make Internet Explorer the "preferred" or
"default" browser.87 As with Microsoft's
other agreements with OLSs and ISPs, these
agreements serve to bias
browser distribution toward Internet Explorer in ways that may not
reflect consumer demand
and impaired distribution of other browsers.
111. Testimony of ISP executives confirms that
the restraints at issue restricted
their ability to distribute
competing browsers that users might prefer. Kevin Knott of
CompuServe testified that
CompuServe agreed to the restrictions even though "we prefer to
have flexibility in software
that we use."88 Stephen von Rump of MCI testified that
"there
are certainly users out there
that prefer browsers and e-mail clients that are not Microsoft.
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And our ability to reach them
and entice them to sign up for our service is presumably
enhanced by the ability to
promote and distribute those."89 As discussed above, ISPs have
costs that may induce them
to support only one browser, and some may choose to do so; but
the choice of which browser
to support is one that ISPs try to retain. It is in their interest to
respond to consumer
preferences in determining which browser to ship at any point in time.
112. Indeed, internal Microsoft documents
confirm that ISPs, reflecting consumer
demand for competing
browsers, resisted agreeing to Microsoft's restrictions. In a series of
E-mail messages, Cameron
Myhrvold, who had a key role in dealing with the ISPs and OLSs
on this issue, noted that
"ISPs have to swear allegiance to IE for typically 75% of browsers they distribute
in order to get into the referral server." (emphasis in original) 90 But
Myhrvold emphasized that
ISPs, for their own business reasons, resisted Microsoft's efforts
to bias their browser
distribution in favor of IE: "ISPs are agnostic on the browser. It's
against their nature to favor a
browser or even a platform. This has been damn hard for us
to influence... I have had a
hard time guiding the ISPs to IE loyalty even when I made them
sign explicit terms and
conditions in a legal contract."91
C. Microsoft's ICP Restrictions are
Exclusionary
113. Microsoft developed for Internet Explorer
4 a feature known as the "Active
Desktop." The Active
Desktop, if enabled, overlays the standard Windows desktop with
content that makes the
desktop resemble a web page. Microsoft also created a number of
"channels" on the Active
Desktop. These channels display the content of Microsoft-selected
Internet Content Providers.
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114. Because the IE 4 Active Desktop was
anticipated to be shipped on a
substantial number of PCs,
the channels -- just like Microsoft's On-Line Service Folder and
Internet Connection Wizard --
provided ICPs with an attractive way of promoting their
service. For instance,
Wadsworth of Disney explained that "entering in to a promotional deal
with Microsoft was highly
valuable because of Microsoft's ability to create icons or
‘channels' that would be
located on the Windows ‘desktop.'"92 Another ICP opined that "a
preferred position on the
active desktop . . . is of almost incalculable value."93
115. And, just as with its agreements with ISPs
and OLS, Microsoft conditioned
ICPs' right to placement on
the desktop on their agreement to exclusionary terms. In
exchange for placement on
the top level of channels, those immediately visible to end users
on the Active Desktop, ICPs
agreed:
(a) not to
promote or advertise any "Other Browser" product;
(b) not to pay
compensation in any manner to the producer of an "Other
Browser";
(c) to use
Internet Explorer "and no Other Browser" as part of any client the
ICP develops
for the Windows or Macintosh operating systems;
(d) to implement
certain Internet Explorer-specific and Windows-specific
technology in
their web sites (such as ActiveX), the effect of which is to
make the
web site best viewable with Internet Explorer.94
116. These restrictions impede the commercial
opportunities of independent
Page 53.
browsers in several ways.
First, they directly inhibit the promotion and dissemination of
non-Microsoft browsers in
ways similar to the ISP restrictions. The economic effect is to
prevent Netscape and other
rivals from effectively competing with Microsoft in promoting
their browser.
117. Second, ICPs are also prohibited from
paying compensation to "Other
Browsers" (a term restricted
to the top two non-Microsoft browsers by market share95). This
prohibition inhibits the
continued development of Netscape's browser by depriving Netscape
of important ICP partners and
revenues from promoting those ICPs.
118. Both of these effects are illustrated by
Netscape's experience with Intuit.
Intuit has made clear that,
absent its ICP agreement with Microsoft, it would have promoted
Netscape on its web site and
would have "entered into an agreement with Netscape to
provide financial content on
Netscape's Web Sites."96 Indeed, because Intuit also is an ISV,
the effect of its agreement
with Microsoft was to force Intuit to abandon distributing
Netscape's browser with its
popular Quicken software.97
119. Third, by
conditioning access to the Windows desktop on ICPs agreeing to use
Windows-specific
technologies in their web sites, Microsoft biases consumers' choice of
browser toward Internet
Explorer and away from browsers that do not support their
Microsoft-controlled
technologies. This is because the writing of web sites to IE- and
Windows-specific standards
reduces consumer demand for other browsers.
120. In April 1998,
Microsoft relaxed most of these exclusionary restrictions.
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Nonetheless, in my judgment,
these restrictions, in combination with Microsoft's other
conduct, substantially
contributed to the impairment of rivalry among competing browsers --
an impairment that is not
eliminated by the relaxation of the restrictions. The ICPs subject
to Microsoft's agreements
included some of the most popular content providers, such as
Disney, Time Warner, and
Intuit. Their Microsoft-induced endorsement of both the IE
browser and IE-specific
standards could be expected to significantly influence browser
adoption. Moreover,
Microsoft documents shows that its personnel expected these restrictions
to have an exclusionary
effect. For example, one document explains that "Windows
distribution -- for IE, and as a
draw for partners" provided a "competitive lever" over
Netscape.98
D. Browsers
121. When a
personal computer on which Windows 95 or Windows 98 has been
pre-installed is turned on for
the first time, the user is presented with a series of screens and
menus that appear prior to
the Windows desktop. This series of screens, known as the
"start-up" or "boot-up"
screens or sequence, is a user's first point of "contact" with his PC.
Purchasers of new PCs generally will view the start-up
sequence before they see the
Windows desktop. Software
products (such as browsers) and services (such as ISPs)
promoted in the start-up
sequence will be displayed to those end-users before they can
consider any competing
software products or services the OEM might have pre-installed in
the Windows desktop. And,
because of the very high share of new PCs that come with
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Windows pre-installed, this
will be true for a correspondingly high share of purchasers of
new PCs.
122. For these
reasons, the start-up sequence is a particularly effective vehicle for
promoting software or
services, especially for firms interested in promoting their products to
first-time PC purchasers.
With respect to browsers, it is apparent that the ability to reach new
users first offers an important
advantage in acquiring browser market share. For example,
before Microsoft made the
decision partially to lift its restrictions and permit OEMs to place
OEM-selected ISPs in the
Inter Connection Wizard, Brad Chase wrote: "In order to protect
our position on the desktop
and increase the likelihood that Internet Explorer gets the
prominent position with the
end user, we should move the [Internet Connection Wizard] into
the boot up sequence."99 Mr.
Chase went on to explain that moving the ICW into the boot
up sequence would
"increase[] the likelihood that an end user gets the option to sign up for
solutions that promote
IE before they get into the desktop or any customized shells that feature
other browser
solutions."100
123. The
principal reason why it is advantageous to have a "first-to-market"
position in the boot up
sequence is simple: It is apparently quite difficult to induce new
browser users to
switch to a competing browser. This is confirmed by Microsoft's own
documents, which
conclude that "it is very hard and expensive to make people switch
[browsers]."101 The same
conclusion emerges from market research conducted by Microsoft.
For example, a study of
"Switcher Intentions" found that of approximately 6 million users
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who were aware of Internet
Explorer but not using it, "81% will not switch to IE."102 A
February 10, 1998
"Platforms-Desktop 3 Year Business Outlook" discussing browser share,
noting that "many customers
see MS and NS [Netscape] as parity products, no strong reason
to switch," described as
"critical success factors" in Microsoft's attempts to increase its
browser share "ISP, OEM,
corp deployment, customer retention."103 In short, as one
Microsoft document explains,
"since only 30% of Internet users have ever downloaded a new
browser (they use what
comes with their pc or comes with their ISP sign up kit), the only real
chance IE has of getting
them to switch is thru a new pc, an OS upgrade or a new ISP kit."104
124. Since the
initial beta releases of Windows 95, Microsoft, in its contracts and
OEM pre-installation kits
(OPKs), has restricted the ability of OEMs to customize the
Windows start-up sequence.
These restrictions were strengthened in Microsoft's later
Windows 95 licenses.105 The two
most important restrictions are:
OEMs cannot modify the "sequence or
appearance of any screens"
displayed during the initial start-up sequence; that is, until the
Windows
desktop screen has been displayed, and
OEMs cannot configure their PCs to run
automatically any program
(including a program that would add screens at the end of the
start-up
sequence or create an alternative desktop or "shell" for the end-user)
at the
completion of the initial end-user boot.106
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125. hese
restrictions have significant exclusionary effects. First, these restrictions
raise the cost of promoting
and distributing non-Microsoft Internet browsers. Absent the
restrictions, OEMs could
change the start-up sequence (or provide an alternative desktop
shell) and thereby
differentiate and promote non-Microsoft Internet browser offerings at lower
cost, and thus increase the
value to OEMs of carrying a non-Microsoft browser. Microsoft's
restrictions on OEMs' ability
to customize the Windows 95 desktop similarly inhibit OEMs
from distributing or
promoting other browsers on the desktop itself. Together, these
restrictions substantially
reduce both the OEMs' incentive to offer browser choice and the
effectiveness of any such
offering.
126. Second,
because these restrictions mean that Microsoft alone controls access
to the most valuable
placement – the start-up sequence – they create for Microsoft a unique
asset, which Microsoft
bartered in exchange for anticompetitive, exclusionary agreements
with ISPs and OLSs. For
instance, by prohibiting OEMs from inserting advertisements for
ISPs and OLSs in the
boot-up process, Microsoft was able to increase the value to On-Line
Services (such as AOL) of
placement in the On-Line Services folder, and to ISPs of placement
in the Internet Connection
Wizard (which has been moved in Windows 98 into the start-up
sequence).
127. At the same
time, however, these restrictions exacerbated the exclusionary
effect of Microsoft's
agreements with ISPs and OLSs. If OEMs had been permitted to replace
Microsoft's ICW with their
own ISP referral screens, and thus recommend ISPs to new PC
owners first, they might have
promoted ISPs that did not have preferred or exclusive contracts
with Microsoft. Indeed,
Microsoft's Cameron Myhrvold explained that he "definitely" was
concerned that "if OEMs
were allowed to select the ISPs," those OEMs might "select ISPs
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that did not support IE as the
primary browser."107 Further, these ISPs might induce the PC
owner to use a non-Microsoft
browser, especially if that ISP received special inducements
from alternative browser
producers. The OEM screen restrictions thus served to reinforce
other Microsoft-created
distribution barriers to Netscape.
128. Microsoft has
recently relaxed certain start-up and desktop restrictions. But
its doing so neither suggests
that the restrictions were not anticompetitive nor undoes the
anticompetitive effects they
have had to date – and, as I explain below, the effects have been
substantial. Microsoft has
permitted six OEMs to insert their own Internet Connection
Wizard into the Windows 98
start-up sequence.108 These OEMs, and certain additional ones,
also have been allowed to
include in Microsoft's Internet Connection Wizard the Internet
access providers of the
OEMs' choice in place of those selected by Microsoft.109 But
Microsoft has still not
permitted OEMs to promote third party browser brands in the start-up
sequence, nor has it allowed
OEMs to configure a PC to boot automatically into an alternative
desktop screen (including
one supplied by a competing browser.110
E. Desktop
Exclude Rival Browsers
129. As a
condition of licensing both Windows 95 and Windows 98, Microsoft
compelled OEMs to agree to
a number of restrictions on the ways in which OEMs can
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customize the Windows
desktop. The restrictions provided, among other things, that:
- OEMs may not delete any icons or
folders from the Windows desktop, and
- OEMs may add icons or folders to the
desktop only if such icons and
folders are the same size and substantially the similar shape as the
icons
and folders included on the Windows 95 desktop by Microsoft.111
130. Microsoft's
refusal to permit OEMs to delete icons or folders is exclusionary
for essentially the same
reasons that Microsoft's refusal to permit OEMs to license and
distribute Windows without
Internet Explorer is exclusionary. Because of Microsoft's license
agreements, OEMs must
distribute Windows with the Internet Explorer icon on the desktop.
For the reasons explained
above, the presence of that icon on the desktop both raises the costs
to OEMs of shipping their
PCs with another browser and reduces the value to them of
including such a
browser. Thus, the restrictions substantially inhibit OEMs from
preinstalling
non-Microsoft browsers on
the Windows desktop.
131. The
requirement that folders and icons added to the desktop must be the same
size and substantially the
same shape increases the exclusionary effect of the prohibition on
removing the Internet
Explorer icon. Differentiating the appearance of a second browser's
icon on the desktop might
reduce the customer confusion that results from having two
browsers on the desktop. In
turn, this might reduce the OEM's support costs from including
the second browser and thus
create a greater incentive to preinstall a second browser.
132. Microsoft
introduced its Internet Explorer 4.0 browser in October 1997. This
browser includes the Active
Desktop feature. The restrictions on the depiction of icons is
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somewhat different for OEMs
that ship Windows 98 with the Active Desktop feature as the
default desktop. The idea of
the Active Desktop, as I explained earlier, is to display the
Windows desktop using
World Wide Web standards and protocols. Doing so gives users
greater freedom to modify
their desktops and enables them to place hyperlinks on the desktop
giving them easy access to
various locations on the web or their hard drive. In addition, the
Active Desktop is able to
display ActiveX controls and Java applets, which cannot be
displayed on the standard
Desktop. The Active Desktop, which is layered over the "standard"
Windows desktop, also
contains a "Channel Bar" that enables the user to access a number
of "channels" which display
the content of certain ICPs. The Active Desktop remains a
feature of Internet Explorer
and is included in the Internet Explorer browser shipped with
Windows 98.
133. Microsoft
allows OEMs to customize the Active Desktop to some degree.
OEMs can add background
"wallpaper" to the Active Desktop. They also can add to the
Active Desktop "items,"
which serve a purpose similar to icons and folders on the standard
desktop, and are permitted
to include on the Active Desktop items of different shapes and
sizes. But OEMs are not
allowed to include an icon featuring any third party (non-OEM, non-
Microsoft) brand on the
Active Desktop (including, for instance, another browser).112 The
purpose of this limited
restriction is to prevent the promotion of non-Microsoft software; it
cannot be related to any
desire on the part of Microsoft to maintain a consistent "look and
feel" for the Windows
product. The restrictions are thus exclusionary in the same way as
Microsoft's restrictions on the
standard desktop. They prevent OEMs from differentiating the
appearance of a second
browser and, therefore, inhibit them from pre-installing a second browser.
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VII. THE CUMULATIVE EFFECT OF MICROSOFT'S
PRACTICES IS
SIGNIFICANTLY TO IMPAIR
COMPETITION AMONG COMPETING
BROWSERS
134. Microsoft has
prevented its browser competitors from competing on the merits
in the browser market.
Because most browser users stay with the browser that they receive
either through their PC
purchase or through their ISP, Microsoft practices that inhibit
Netscape's ability to have
OEMs install, or ISPs distribute, its browser restrict Netscape's
ability to compete in the
browser market.
135. The
exclusionary impact of Microsoft's practices has been significant. This
is demonstrated by (1)
Microsoft's own prediction that its conduct would foreclose browser
competition; (2) empirical
evidence that Microsoft's conduct blocked available browser
distribution channels; and (3)
data showing that Microsoft's anticompetitive contractual
practices have resulted in
substantial foreclosure of the browser market. I discuss each of
these types of evidence
below.
A. From its
Anticompetitive Practices
136. Microsoft
expected to gain browser market share in the aftermath of its
anticompetitive practices.
Using an internal forecasting model, Microsoft estimated browser
sales and shares based on a
variety of market and user characteristics, including the sales and
retirement rates of desktop
computers in the home, business, educational, and international sectors.113
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137. Microsoft's browser market share was 6
percent at the end of Fiscal Year 1996
and 31 percent in 1997. In
February 1998, Microsoft used a model to project browser market
shares for fiscal years 1998
through 2001. It estimated that its IE market share would increase
to 48 percent in 1998 and
then to 65 percent by the end of Fiscal Year 2001.114 Microsoft's
actual share of browser
users through 1997 and its projections are shown in Pl. Ex. 14.
138. Control over
the OEM and ISP channels was critical for Microsoft's gains in
browser user share. As
Microsoft's Randy Haas explained in an email to Brad Chase
discussing the importance of
various modes of IE distribution, "[a] critical success factor in
gaining browser share is
continued focus on ISP's, OEM's[,] and corporate deployments to
target the growth of new
users."115
B. Anticompetitive Practices Have Substantially Foreclosed
Competition
139. The "market
share" measure I have discussed to this point is a "stock." It
shows IE's share of the
"active installed base" of users, some of whom are using a browser
they installed several years
ago. For purposes of evaluating many of the consequences of
Microsoft's anticompetitive
restraints, a "flow" based share of new users is the more
appropriate measure
because it shows a particular browser's share of new installations, either
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by people who are using any
browser for the first time or by those replacing an old browser.
Unlike a stock measure, a
flow measure does not measure browsers previously installed,
which of course reflects only
the browsers' past success. The flow measure is what
economists ordinarily use to
measure market share in antitrust analysis. (Thus, for example,
General Motors' share of the
U.S. automobile market is well expressed by its share of new
car sales, as opposed to the
percentage of GM cars on the road.) The flow measure is also a
better guide to the future of
the installed base: if a flow share is higher than installed base
share, the installed base
share will rise toward the flow share.
140. Because
there are no direct measures of browser user "flow", I have calculated
a quarterly flow measure
using (1) data describing the "active installed base" by browser type;
(2) information on the
numbers of users of the Internet; and (3) an estimate of the percentage
of people who switch from
one browser type to another. The resulting flow measures of
browser market share are
shown in Pl. Ex. 261. The data that underlie the figure are given
in Pl. Ex. 337, along with a
set of notes that explains the derivation of the numbers in the
table.
141. The flow
measure of user market shares shows that Netscape's share of new
users has declined
dramatically since the second quarter of 1997 and is far less than its current
48 percent share of the installed base. Similarly, IE's
flow-based share has increased dramatically
over the same period, and is well above its stock-based
share of the installed base.
142. Of course,
product improvements and other actions by Netscape and by
Microsoft have also affected
browser shares. For example, during the fourth quarter of 1997
when Internet Explorer 4.0
was released, Internet Explorer's flow market share grew to
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approximately 50 percent
while Netscape Navigator's market share fell to approximately 48
percent. However,
Netscape's market share increased to approximately 52 percent and
Internet Explorer's fell to 45
percent in the first quarter of 1998, when Netscape started
distributing its browser for
free. Internet Explorer's market share began to increase again and
reached approximately 60
percent in the next quarter, while Netscape's declined to
approximately 38 percent.
143. The flow
measures of IE market share show that Microsoft's share of new
browser users is high and
increasing. Further, they suggest the real possibility that Microsoft
will gain monopoly power in
the browser market.
C. Anticompetitive Practices Have Substantially Foreclosed
Competition
144. The effect of
Microsoft's exclusionary practices can be seen by comparing IE's
share among ISPs and OLSs
that made IE their default browser with its share among ISPs and
OLSs that did not agree to
make IE the default browser.
145. Browser
usage market shares can be measured by examining data showing
visits to Internet sites ("hits")
by IE, Netscape, and other browsers. The data are reported by
AdKnowledge, a company
that markets web advertising management services.
AdKnowledge manages a set
of servers that deliver web advertisements to browser users
when they visit particular
web sites. To aid firms in monitoring the effectiveness of their web
advertisements,
AdKnowledge maintains a database for each day that logs information every
time a web advertisement is
delivered to, or "clicked on" by, an end user.116 This log records
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information about the user's
"domain name," operating system, and browser type. In certain
cases, the information about
a user's domain name may be used to determine the user's ISP.
146. To evaluate
differential browser usage overall, an AdKnowledge data sample
was selected from the vast
daily log of more than 5 million "ads served."117 A browser's
usage share in this database
is simply the percentage of all "ads served" or "clicked on" by
users of that browser,
divided by the total number of all ads served or clicked on by users of
all browsers. Calculated in
this manner, Microsoft's share of the browser market started at
twenty percent in January
1997 and grew to forty-nine percent by August 1998. Over the
same period, Netscape's
market share fell from seventy-seven percent to forty-eight percent,
just below Microsoft's share.
This is shown graphically in Pl. Ex. 4.
147. Because the
AdKnowledge database contains information about not only the
user's type of browser but
also the user's domain name, it is possible to estimate browser
market usage share by
individual ISP. These data were obtained for those ISPs that were
considered by Microsoft to
have more than 10,000 subscribers,118 and for which domain name
information was available.
Information about the two largest OLSs, AOL and CompuServe,
also was collected.
148. Pl. Ex. 5
shows Microsoft's monthly browser usage share from January 1997
through August 1998. The
top line in the graph represents the market share of Internet
Explorer for America Online
and CompuServe (now one company), both of which signed
agreements with Microsoft
that contractually limited their ability to distribute Netscape
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Navigator.119 From January
1997 to August 1998, Internet Explorer's share of browser usage
among the customers of
these two firms grew from approximately 22 percent (a share which
was almost identical to the
share for all Internet users) to more than 87 percent. As illustrated
by the middle line, Internet
Explorer's overall share for all ISPs had grown by far less during
that period to 49 percent.
149. In a
document prepared by Microsoft captioned the "Netscape Competitive
Analysis", Microsoft identified
12 ISPs as being in neither the "Netscape Preferred" nor the
"IE Preferred" category and
listed them as having "IE parity." The average market share for
IE and Navigator among
users of ISPs listed as "IE parity" is shown as the bottom line of the
Exhibit. IE's market share
among these users was approximately 20 percent in January 1997,
just as it was among other
ISPs' customers. These ISPs were not contractually required to
favor Internet Explorer. By
August 1998, Internet Explorer's market share among these ISPs'
customers had increased
only ten percentage points, to approximately 30 percent. These ISPs
can reasonably be used, in
effect, as a control group that shows what would have happened
absent Microsoft's
exclusionary agreements.
150. The
difference between the IE market usage shares for the IE parity group on
the one hand and AOL and
CompuServe (both of which were subject to Microsoft's
exclusionary agreements),
and the average of all unconstrained ISPs (the control group), on
the other hand, can be used
to show the effect of Microsoft's exclusionary agreements. If no
ISPs had been party to
exclusionary agreements, assuming no other changes, it is reasonable
to expect that IE's market
share would be its share of customers of these unconstrained IPSs
– approximately 30 percent
in August 1998. The differences between that share and IE's
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actual overall share – 49
percent – shows the impact on the market of the Microsoft ISP
agreements.
151. Differences
between the IE parity and the other two groups cannot readily be
explained by factors other
than contractual restrictions; improvements in the IE browser, for
example, could have been
expected, other things the same, to affect IE's market share for all
three ISP aggregations
shown in the figure. Moreover, differences between the IE parity
group and the others groups,
if anything, understate the exclusionary impact of Microsoft's
practices because the IE
parity group itself may have been affected by Microsoft's
exclusionary conduct. 120
VIII. THERE IS A DANGEROUS PROBABILITY THAT
MICROSOFT
WILL GAIN
MONOPOLY POWER IN THE BROWSER MARKET;
AND, EVEN
IF IT DOES NOT, IT COULD SIGNIFICANTLY
REDUCE OR
DELAY THE THREAT TO THE OS MONOPOLY
A. Dangerous Probability of Monopolization
152. Market
shares in the browser market have changed dramatically in just two
years. As explained above,
IE's share of all browsers installed has increased from 6 percent
in 1996 to 49 percent today,
and Microsoft itself projects that its share will soon exceed 60
percent. Moreover,
Microsoft's share of current installations – its current market share –
already exceeds 60 percent
and is projected soon to exceed 70 percent.121 Under these
circumstances, I thus
conclude that there is a dangerous probability that Microsoft will gain
monopoly power in the
browser market.
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B. System
Monopoly May be Strengthened
153. The
foreclosing effects on the browser market of Microsoft's tying of its
Internet browser to its
Windows operating system are likely to be substantial. First, in my
opinion, anticompetitive
foreclosure in this case does not require that Netscape be wholly
unable to distribute its
product or unable profitably to maintain indefinitely a significant share
of the browser market.
Microsoft can achieve its anticompetitive goal of preserving its
Windows operating system
monopoly simply by discouraging or preventing ISVs from
developing a stock of
cross-platform applications sufficient to encourage the development of
an alternative platform and
thus of competing operating systems. This will occur if
independent browser
suppliers either exit the browser market or decide to support only
Windows-specific software
development technologies. Indeed, even if Netscape remains in
the browser market and does
not support Windows-specific technologies, foreclosure is
achieved if the market share
of independent browsers that do not support Windows-specific
technologies is small enough
(or if ISVs believe it will shortly become small enough) to
discourage ISVs from writing
cross-platform applications. In principle, therefore, Microsoft
can foreclose competition in
the operating system market by foreclosing Netscape from only
a small share of the browser
market.
IX. MICROSOFT'S EXCLUSIONARY CONDUCT LACKS
LEGITIMATE
BUSINESS JUSTIFICATION
154. Thus far in
my analysis, I have established three propositions based on the
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evidence. First, Microsoft
possesses monopoly power protected by substantial barriers to
entry. Second, browsers
pose a threat to Microsoft's monopoly power which Microsoft
recognized. Third, Microsoft
has engaged in practices that substantially impair the
commercial opportunities of
competing browsers and thereby serve to blunt this threat.
155. Now, I will
examine whether Microsoft's exclusionary practices – tying IE to
Windows 98 in the OEM
channel; imposing screen restrictions on OEMs; adopting ISP
exclusivity agreements and
adopting ICP exclusivity agreements – have legitimate business
justifications. I will analyze
these practices by asking three questions. First, are there
legitimate business purposes
that could explain Microsoft's practices? Second, do the
exclusionary practices
actually further those purposes? And third, could any such legitimate
business purpose of the
restriction be achieved without restricting other parties' distribution
and promotion of competing
browsers? I conclude below that Microsoft's practices either do
not further efficiency
objectives or are not reasonably necessary to achieve them.
A. Microsoft's Prohibition on OEMs' Removing Internet Explorer is
Unjustified
156. Microsoft has
argued that it has designed and tied IE to its Windows 95 and
Windows 98 operating
systems in order to provide users with superior browsing functionality
that could not have been
achieved if Windows 95 and Windows 98 and IE were treated as
distinct products. That
proposition, I understand, is disputed, and if Microsoft is wrong, then
of course its forcing OEMs to
license and distribute IE would not serve any legitimate
purpose.
157. Even if it
were true that what Microsoft calls the "integrated" design of
Windows 95 and 98 does
further some legitimate business purpose, Microsoft would still not
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be justified in prohibiting
OEMs from removing the icon or other ready means of access to
IE.
158. As an initial
matter, it should be noted that Microsoft's claim cannot be that
forcing users to browse the
web using Internet Explorer is efficient because Internet Explorer
is superior to other browsers.
Even if Internet Explorer is preferred by some users, it is not
preferred by all users.
Consumer welfare is maximized when the market is responsive to
consumer demand, not when
a firm with monopoly power over one product requires
purchasers also to take an
unwanted product or makes it difficult or costly for them to obtain
a related product they desire.
Therefore, Microsoft's argument must be that compelling
OEMs to license and
redistribute IE is necessary in order to provide those users who want IE
with all the features they
desire.
159. This
concern, however, plainly cannot justify Microsoft's practices with
respect to Windows 95.
Microsoft itself designed Internet Explorer to be easily removed from
Windows 95 without
impairing any non-browser related feature of the Windows package. It
is doubtful Microsoft would
have done this if uninstalling Internet Explorer caused ill
effects.122 My
understanding is that Internet Explorer is "hard wired" into Windows 98 to a
greater degree than in
Windows 95. However, it is my understanding that Dr. Felten's work
demonstrates that it is
possible to remove from Windows 98 most means of invoking Internet
Explorer to browse the Web
and to replace Internet Explorer with another browser in a way
that achieves a comparable
user experience and does not denigrate any operating system
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function.123 Thus, even in
the case of Windows 98, Microsoft's restrictions are not reasonably
necessary to ensure that
users have the option of the benefits Microsoft claims result from its
combination of Internet
Explorer and Windows.
160. In any event,
even if Microsoft's combination of Windows and Internet
Explorer achieves a superior
browser experience, there is no reason to believe that Microsoft's
exclusionary practices are
necessary to achieve that experience. If consumers prefer the
Microsoft-supplied package
of Internet Explorer and Windows to Windows combined with
another browser, the
bundled Microsoft product should thrive in the marketplace. OEMs
would chose to license and
distribute both IE and Windows on their own volition. As
Microsoft has acknowledged,
OEMs are in the business of satisfying their customers. They
are exceedingly unlikely to
market a product that does not meet user demand. Indeed,
Microsoft's General Manager
for Multinational OEM Operations, Bengt Akerlind, conceded
that OEM actions that reduce
the value of the product they offer to consumers will come home
to roost in the form of
diminishing that OEMs' business in the future.124
161. Microsoft
also has argued that its requirement that Internet Explorer be
pre-installed on every
Windows machine OEMs ship is necessary to preserve "the same initial
user experience" across
different OEMs.125 For reasons I will explain in more
detail later, this
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justification is
undermined by Microsoft's own conduct. Microsoft permits OEMs to vary the
user's initial
experience in substantial ways. By doing so, Microsoft makes plain that
maintaining a
consistent user experience is a minor concern and easily gives way when OEMs
create value by
differentiating their products: for example, by pre-installing a particular set
of applications. There
is no reason why it should not similarly give way when OEMs believe
that end-users will find
their machines more attractive when they come with a non-Microsoft
browser, rather than
Internet Explorer, pre-installed. This is particularly true because, as I
have explained, OEMs
that decrease the value of their products will be punished by the
marketplace.
162. At
bottom, Microsoft's forced licensing of Internet Explorer, and Microsoft's
prohibition on OEMs
removing Internet Explorer, furthers no substantial efficiency. Rather,
the principal effect of
the forced bundling, as the above analysis explains, is simply to exclude
non-Microsoft
browsers. This is precisely what Internal Microsoft documents predict. For
example, Microsoft's
Christian Wildfeuer wrote: "It seems clear that it will be very hard to
increase browser
market share on the merits of IE 4 alone. It will be more important to
leverage the OS asset
to make people use IE instead of Navigator."126
B. Windows
Platform
163. Microsoft
both compels OEMs to license Internet Explorer as a condition of
licensing Windows and
prohibits OEMs from removing any part of Internet Explorer from the
PCs they ship to customers.
The effect of this conduct, as I have explained, is substantially
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to impede the commercial
opportunities of rival browsers by increasing the costs, and
reducing the benefits, to
OEMs of pre-installing non-Microsoft browsers on the machines they
ship.
164. One possible
justification for these restrictions, advanced in this litigation by
Microsoft, is to perform a
standardization function. By prohibiting OEMs from modifying
the package of software
Microsoft markets as Windows, the argument runs, Microsoft
preserves its ability to offer
ISVs a consistent platform to which they can write applications.
If each OEM were to modify
the Windows package in different ways so as to create different
versions of Windows,
Microsoft argues, ISVs might have to support multiple versions of their
software. A consequence
could be a reduction in the software developed for Windows and
an increase in its cost.
165. For several
reasons, however, Microsoft's objective of supplying ISVs with
a consistent platform does
not provide an economic justification for biasing OEMs' choice
of which browser to feature.
In the first place, as Professor Farber will explain, Microsoft's
design decision was
arbitrary; Microsoft could have put "platform" files (such as shared files)
entirely in the operating
system and not included any such files in its browser product.127
166. Moreover,
even if that was not the case – or, in any event, taking Microsoft's
design decision as given –
Microsoft's platform fragmentation argument does not justify
Microsoft's practices.
Microsoft's conduct is anticompetitive because it prevents OEMs from
removing the icon and other
visible means of end-user access to Internet Explorer. If a user
cannot invoke a program,
then from that user's perspective it is as if that program is not
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present.128 And, if IE is not
present in that sense, it is in effect removed, and the OEM will be
more likely to distribute other
browsers to users who would rather purchase such a browser.
Removal of IE in this sense
thus removes an obstacle to the distribution of other browsers.
And – this is the key point –
removing IE in this way does not remove any of the shared files
or any of the platform files
found in either Windows 95 or Windows 98.
167. Thus,
removing other aspects of IE, but leaving behind any "shared program
libraries" upon which IE
might rely, will not impair or fragment the Windows platform.
Microsoft recognizes this,
and it instructs software developers to configure their programs to
be removed in precisely this
manner. "Resources that other programs might use, such as
DLLs," Microsoft explains,
"[are] better [left] behind."129
168. Internet
Explorer can easily be removed from both Windows 95 and Windows
98 in just this fashion.130 In the
case of Windows 95, Microsoft provided the ability to
remove Internet Explorer 3.0
and Internet Explorer 4.0 using the Windows-supplied
"Add/Remove" utility.131 David
Cole testified that Microsoft configured Internet Explorer to
be removed from Windows
using the "Add/Remove" utility to meet the demand of users who
wanted to remove Internet
Explorer.132 Because invoking the Add/Remove utility
to
"uninstall" Internet Explorer
leaves behind shared program libraries upon which ISVs rely,
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configuring Windows 95 with
Internet Explorer removed in this fashion would not impair the
consistency of the Windows
95 platform in any meaningful way. Indeed, if that were not the
case, it is doubtful Microsoft
would have configured Internet Explorer to be so easily
removed.
169. In contrast to
Windows 95, Microsoft has designed Windows 98 such that
Internet Explorer cannot be
removed through invoking the Add/Remove utility. Nonetheless,
in his report, Dr. Felten
explains that the ability to browse the Web using Internet Explorer
can easily be removed from
Windows 98, and another browser can supply that functionality
in such a way that the
consistency of the Windows platform for ISVs would not be
undermined.133
170. Furthermore,
even if (contrary to my understanding) it were necessary to
remove certain shared
program libraries from the Windows 98 package to remove Internet
Explorer, the effect on ISVs'
practices is likely to be insignificant. There are millions of PCs
running earlier Windows
releases that lack the latest versions of Windows 95 or Windows 98.
To ensure that the software
they develop runs no matter which version of Windows a PC
contains, ISVs commonly
redistribute necessary shared program libraries with their
software.134 In
short, Microsoft's own practice of continually updating its platform means
that application developers
must replicate part of the platform with the software they
distribute and, therefore, that
the effect of an OEM removing certain parts of the "platform"
is likely to be small.
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C. Restrictions on OEM Modification of Desktop and Start-Up
Sequence
171. Microsoft's
restrictions on OEMs' modification of the Windows desktop and
start-up sequence, as I have
explained, serve to exclude competing browsers and reinforce the
exclusionary effects of
Microsoft's other restrictions. As with Microsoft's forced licensing
of, and prohibition on
removing, Internet Explorer, these restrictions either serve no legitimate
business justification or any
legitimate business justification could be achieved by
substantially less restrictive
means.
1. the User Experience
172. Microsoft's
principal justification for both the Desktop and Start-up
restrictions is that they
promote consistency of user experience. But this concern cannot
justify the restrictions.
173. Taking the
Desktop restrictions first, as an initial matter, Microsoft's own
conduct makes plain that this
asserted justification cannot support forcing all OEMs to present
users with the exact same
initial user experience because Microsoft permits OEMs to vary
substantially the "initial user
experience" with their PC. Among other things:
OEMs are permitted to ship Windows 95 and Windows 98 with
Internet Explorer's "Active Desktop" either on or off, and
depending
on whether the Active Desktop is on or off, the user will be
presented
with a very different appearance.
OEMs that ship their PCs with the Active Desktop enabled may
add
items of various different shapes and sizes.
OEMs that ship their PCs with only the standard Windows
Desktop
may preinstall other applications and make other icons and
folders
appear on the desktop.
A number of OEMs are permitted to populate the
Microsoft-supplied
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Internet Connection Wizard with ISPs of the OEMs' choice.
A number of OEMs are permitted effectively to replace the
Microsoft-supplied Internet Connection Wizard with one supplied
by
the OEM.
174. Because
Microsoft permits this substantial variation among OEMs (and,
indeed, among different lines
shipped by the same OEM), end users have different initial
experiences, a fact
conceded by Microsoft.135 I therefore conclude that preserving "the
same"
end user experience is an
insubstantial justification and cannot support Microsoft's
restrictions on customizing
the desktop.
175. Nor can
preserving a consistent user experience justify Microsoft's restrictions
on the start-up sequence.
Although Microsoft has a legitimate interest in ensuring that users
receive basic warranty and
registration information and in ensuring that the start-up does not
take an inordinate amount of
time to complete, this interest cannot justify the exclusionary
aspects of the restrictions
Microsoft imposed. First, these concerns cannot justify Microsoft's
prohibition on promoting third
party brands in the start-up sequence because Microsoft
permits the OEM to promote
its own products in that sequence. For example, Microsoft's
recently-signed license with
Compaq provides that: "For COMPANY's ‘Presario' branded
Customer systems,
COMPANY may insert an Internet Service Provider (‘ISP') sign up wizard
into the boot up process
provided that . . . (2) MSCORP's WWW-based services (i.e.,
Expedia, CarPoint,
Sidewalk.com, MSNBC, Internet Gaming Zone, MSN Investor, etc.), are
promoted . . . in such ISP
sign up Wizard."136 If this promotion impaired legitimate
interests,
Microsoft likely would
not permit it.
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176. Moreover, Microsoft could easily permit OEMs to advertise third party
brands
in the start-up
sequence, subject to guidelines specifically designed to protect its legitimate
interests in providing
information to, and obtaining information from, end users. That
Microsoft easily could
do this is confirmed by the fact that it permits certain OEMs effectively
to replace the
Microsoft-supplied Internet Connection Wizard with one supplied by the
OEMs, sometimes with
the requirement that the OEM promote Microsoft products in that
alternative ICW. This
substitute Internet Connection Wizard must conform to Microsoft
guidelines, and
Microsoft has conferred the right to include a substitute ICW in large part
based on the
demonstrated ability of the OEM in question to implement it without causing
technical difficulties.137
177. Second,
Microsoft's purported concern with preserving the consistency of the
initial-boot experience across
end-users cannot justify its prohibition on OEMs' using
Windows to run certain
programs, including alternative browsers, automatically upon
completion of the end-user
boot. This interest can be fully protected by a labeling
requirement. Such a
requirement would ensure that users get whatever experience they
choose, rather than the
experience dictated by Microsoft. It would also remove an
unnecessary obstacle to the
efficient distribution of non-Microsoft browsers.
178. Similarly, the
efficacy of a labeling requirement demonstrates that the concern
with providing users a
consistent experience cannot justify Microsoft's refusal to permit
OEMs to configure their PCs
to boot into an alternative shell, a vehicle through which
competing browsers could
be promoted. To be sure, some OEM shells in the past might have
been of poor quality. But
Microsoft could meet this concern by establishing certain minimum
Page 79
requirements, including a
labeling requirement, with respect to OEMs that decide to utilize
an alternative shell.
Microsoft itself acknowledges that OEMs face competition in the
consumer segment of the PC
market, and that competition creates for OEMs incentives to
provide only features of a
kind and quality that users find desirable.138 As one OEM has
explained, the marketplace
will "weed out" those OEMs that provide their users with a shell
that fails to meet with
approval.139
2. the
User's Windows Experience
179. Microsoft has also asserted that the screen restrictions are necessary
to prevent
OEMs from
"degrading" Microsoft's Windows product, as Microsoft contends happened
when Packard Bell
substituted its own shell for the Windows shell. To a large degree, this
contention simply
recapitulates Microsoft's (incorrect) argument that its restrictions are
necessary to preserve
the consistency of the user experience. Just as Microsoft's concern with
providing a consistent
user experience cannot justify its exclusionary restrictions, neither can
the concern with
ensuring delivery of a quality product.
180. While
the screen restrictions might have prevented the problem that developed
with Packard Bell's
shell – namely, the failure of some APIs to be installed – they are not
necessary to prevent
such problems. To maintain the integrity of its platform, Microsoft needs
to restrict or prevent
only those modifications of the start up sequence that impair the ability
of ISVs to access the
APIs provided by the Windows operating system product.
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181. Finally,
even if OEM modifications of the desktop would in certain
circumstances reduce
product "quality," Microsoft's restrictions are unnecessary to protect
that interest. As
explained, because the markets in which OEMs operate are competitive,
OEMs have little
incentive to take actions that disappoint their customers.140 The
market will
serve to punish those OEMs
that disappoint consumers by marketing sub-optimal product
configurations. A labeling
requirement, moreover, will ensure that the market operates
efficiently. OEMs that modify
the Windows desktop in ways Microsoft deems undesirable
could simply be required to
advise customers of the modification.
D. achieve any
Legitimate Business Purpose
182. Microsoft's
restrictions on the ability of ISPs, OLSs, and ICPs to promote and
distribute competing Internet
browsers are unrelated to any efficiency purpose; alternatively,
any legitimate efficiency
purpose could be accomplished by substantially less restrictive
means.
183. One possible
justification for Microsoft's restrictions against ISPs, OLSs, and
ICPs distributing or
promoting competing browsers is to ensure that Microsoft is compensated
for the desktop real estate
that it supplies those service providers. But this interest cannot
justify Microsoft's restrictions.
There is no reason why Microsoft had to take its
Page 81.
compensation in the form of
exclusionary agreements rather than a simple payment. That
ISPs commonly agree to pay
for customer referrals and promotion of their services
demonstrates that selling
desktop real estate does not involve prohibitive transaction costs.
184. The ICP
agreements differ from the ISP and OLS agreements in that the ICP
agreements call for the
employment of Internet Explorer-specific technologies. However, there
is no reason to think that
compelling ICPs to make their web-sites work less well with
competing browsers is
reasonably necessary to compensate Microsoft for placement on the
"channel bar." Microsoft
could instead have charged ICPs a fee for such placement. Indeed,
one aspect of the ICP
agreements – the prohibition on ICPs payment from Netscape for
promotional services –
plainly serves no legitimate purpose. The only reason for that
restriction is to impede
Netscape.
X. MICROSOFT'S
ACTIONS TO INCREASE ITS BROWSER USAGE
SHARE ARE
PREDATORY
185. The available
evidence indicates that Microsoft pursued the practices I have
examined for the purpose of
preserving its Windows operating system monopoly and gaining
monopoly power in the
browser market, and pursued them without regard to whether they
would have been profitable
in their own right. Accordingly, it is my opinion that Microsoft's
intent in engaging in this
course of conduct, when considered as a whole, was predatory.
186. Conduct is
predatory when it is expected to be profitable only if it excludes
rivals and thereby creates or
enhances market power. The pertinent question in determining
whether Microsoft's conduct
is predatory, therefore, is: would Microsoft's actions to increase
browser usage share have
been profitable if they did not injure Netscape or other rivals and
enable Microsoft to gain or
preserve market power? Based on the evidence I have seen, it is
Page 82.
my opinion that the answer to
this question is no.
187. To be sure,
Microsoft has a legitimate interest in ensuring that Windows users
are able to acquire high
quality browsers at low prices, because that would increase the demand
for Microsoft's operating
system. But even if achieving this objective were furthered by
Microsoft's decision to offer a
quality browser product, its further efforts to increase IE's share
by excluding Netscape and
making it more difficult for users to obtain Netscape's browser
could only reduce the value
of its operating system to consumers.
188. Moreover,
Microsoft's own documents show that its exclusionary restrictions
were implemented, not to
increase the value of the browser as a complement or to obtain
ancillary revenues, but rather
as part of a "jihad" to win the browser war and thereby eliminate
a threat to Microsoft's
monopoly power. The documents make clear that Microsoft both feared
the browser would be a key
component in a substitute to the Windows platform and viewed
the conduct examined here
as instrumental in blunting that threat.
189. Microsoft's
actions to increase IE's usage share and to exclude rival browsers
were expensive for Microsoft
in at least two respects. First, Microsoft's OEM restrictions and
its exclusionary contracts
with ISPs, OLSs, and ICPs imposed burdens on those parties, and
thus diminished the value of
other consideration those parties were willing to pay to
Microsoft. As noted above,
Microsoft's tying of IE to its operating system made distribution
of rivals browsers infeasible
or more costly for OEMs and thus reduced the OEMs' demand
for Windows. Microsoft's
agreements with ISPs and OLSs provided those firms with
preferential access on highly
desirable terms to valuable Desktop real estate. This is a unique
asset; its value was
enhanced by the OEM screen restrictions; and it could have generated
substantial direct revenue for
Microsoft if it had been sold rather than bartered or exchanged
Page 83.
for exclusivity
agreements.
190. Second,
Microsoft's decision to give IE away free to the installed base of
Windows users meant
sacrificing substantial revenue from two sources. First, Microsoft lost
revenue from not licensing IE
at a positive price as a stand-alone application -- whether
through downloads directly
to end users or through positive licence fees to ISPs, OLSs and
ICPs.141 Second,
Microsoft lost revenue from retail sales of Windows 98 upgrades because
providing IE free to the
installed base reduced the demand for the Windows 98 upgrade and
the revenue Microsoft earns
from that source.142
191. As is true for
other software, the marginal production and marketing cost of
licensing IE to another user,
once it has been developed, is very low. However, this does not
imply (nor does experience
in the software industry indicate)that if there are two suppliers of
browsers, such as Microsoft
and Netscape, the market price for browsers would invariably
equal zero. Indeed, the
standard oligopoly models used by economists predict that price in a
market with two competing
suppliers will not be zero even if marginal costs for both firms are
zero and the products are
identical.143 And, importantly, we commonly observe
instances in
which the prices for two or
more similar software applications (such as WordPerfect and
Page 84
Word) are not zero.
192. The browser
market arguably has characteristics that might reduce browser
prices further than would be
expected for other software products. Specifically, Microsoft and
Netscape might price their
browser products at a low level because higher browser usage share
could generate higher
revenues from ancillary products, such as advertising on browser-related
web sites and sales of
complementary software, such as server software or development
tools.144 Yet these same
incentives were present when Netscape first decided to charge a
positive price for its browser.
It was not the potential for the generation of ancillary revenue
that brought the market price
of the browser down to zero, but rather Microsoft's actions.
193. Ideally, one
would like to measure the costs Microsoft incurred through its
pricing policies and
exclusionary agreements and to compare those to the revenues Microsoft
could have expected to gain
absent any effect on the competitiveness of the browser and
operating system markets.
There are, however, no data currently available to me that would
provide an accurate estimate
of those costs and revenues. In particular, I have seen no
documents indicating that
Microsoft ever performed such a calculation at the time these
decisions were made.
(Indeed, if Microsoft performed such a calculation today and determined
that it earned substantial
ancillary revenues from increasing its browser usage share, that result
would not be meaningful
unless it could be shown to provide a reliable guide to what
reasonably could have been
anticipated by Microsoft at the time of the decision was made.)
194. The
evidence I have seen supports the inference that Microsoft took
Page 85
exclusionary actions and
incurred costs without regard to whether its actions were profit-
maximizing – or even
profitable – absent the future revenue gains from weakening rival
browsers and thereby
preserving its Windows operating system monopoly and from gaining
monopoly power in the
browser market. Instead, Microsoft viewed winning browser share at
almost any cost as being of
overwhelming strategic importance.
195. Accordingly,
on the basis of the available evidence, I conclude that Microsoft's
conduct, in the aggregate,
was not expected to be profitable except for the market power
Microsoft expected to gain
from the exclusion of browser rivals and therefore was predatory.
Page 86.
XI. THE COSTS TO
CONSUMERS AND COMPETITION FROM
MICROSOFT'S EXCLUSIONARY CONDUCT ARE SIGNIFICANT
AND FAR
REACHING
196. Consumers
will be significantly harmed if Microsoft succeeds in crushing the
cross-platform threat that
independent browsers pose to the Windows operating system
monopoly. The development
of cross-platform technologies can be expected to bring
substantial benefits to end
users. Because cross-platform technologies enable an application
to run on top of many
different operating systems, they substantially reduce the applications
barrier to entry. This might
have at least two important benefits.
197. First,
compatibility between an application and multiple operating systems
makes it more practical or
attractive for end users to choose operating systems that have been
optimized to their specific
needs or requirements, rather than a general purpose OS like
Windows. For example,
engineers, scientists, and even economists often run esoteric
applications programs using
very large data sets, and an operating system can be specifically
designed for those
applications. Similarly, other professionals do a large share of their
computer-related work with
applications such as word processing or spreadsheets, and an
operating system also can
be optimized to run those types of applications. Optimizing
operating systems in this
way has the attractive feature of making the operating system simpler
and more "stable." At the
same time, a large stock of cross-platform applications can run on
top of such operating
systems. In effect, this compatibility allows users to achieve OS
"specialization" without
sacrificing versatility.
198. Second, by
reducing the demand for general purpose PC operating systems and
the barriers to entry into the
PC OS market, cross-platform technologies can be expected to
reduce the price that end
users pay for operating systems.
Page 87
199. There is no
guarantee, of course, that independent browsers will bring these
benefits or reduce the
monopoly power of Microsoft in the operating system market, even if
Microsoft did not engage in
exclusionary conduct. That is a matter for the market – not
monopolists or engineers or
economists – to decide. The important point is that the market
should not be prevented by
Microsoft's anticompetitive practices from making that decision.
200. Indeed, the
stakes in the current dispute go beyond the browser threat. If
Microsoft can use
anticompetitive conduct to extinguish the threat to its operating system
posed by independent
browsers, others are likely to expect it to use similar tactics to prevent
them from developing other
types of cross platform technologies that would threaten the
Windows platform. Having
seen Microsoft successfully leverage its Windows monopoly
against one threat, there will
be less incentive to invest in other technologies that Microsoft
might view as a similar threat
and, thus, less innovation in the software industry.
201. I declare
under penalty of perjury that the foregoing is true and correct.
_______________________________
Frederick R. Warren-Boulton
FOOTNOTES
1
See 4 Trade Reg. Rep. (CCH) ¶ 13,104 (1992).
2
See Pl. Ex. 1 below, "Microsoft's Actual and Projected Share of the
(Intel-based) PC Operating System Market."
3 MS6
5004553.
4
See MS98 0203023-25.
5
Non-Microsoft browsers and Microsoft's operating system thus fit the meaning of the
term "partial substitutes" as used by Areeda in his treatise. See 10 Phillip E.
Areeda, et al., Antitrust Law ¶ 1747c, at 232-33 (1996) (explaining that
"driving out producers of partial substitutes more likely" will "reduce the likelihood of
entry into the tying market" because producers of partial substitutes "have the skill to be
potential entrants in the tying market more frequently than producers of
complete nonsubstitutes do").
6 Microsoft
Press Computer Dictionary (Third Edition, 1997, Microsoft Press) (hereinafter
"Microsoft Dictionary").
7 In 1997,
87.6% of all copies of the Microsoft's Windows 95 operating system product were
installed by OEMs, while 7.3% were sold through retail channels as upgrades.
Windows 95 is available at retail only as an upgrade from a Microsoft licensed
operating system See Appendix B to Microsoft's Responses to Interrogatories,
March 23, 1998.
8
See Akerlind Dep. 78 (Aug. 26, 1998) (explaining that "[t]he end user segment
[of the OEM market] is competitive").
9 Microsoft
also develops and sells other operating systems targeted to more specialized markets,
including operating systems for workstations (Windows NT Workstation), servers
(Windows NT Server) and embedded and special purpose systems (Windows CE).
10
See, e.g., Brown Dep. 8-11 (Mar. 5, 1998); McKinney Dep. 9-11 (Mar. 13,
1998).
11
See, e.g., United States v. Baker Hughes Inc., 908
F.2d 981, 985-86 (D.C. Cir. 1990); Community Publishers, Inc. v. Donrey
Corp., 892 F. Supp. 1146, 1153 (W.D. Ark. 1995), aff'd, 139 F.3d 1180
(8th Cir. 1998).
12
Guidelines § 1.0.
13 More
precisely, the price elasticity for a product (or group of products) is the percentage
reduction in unit sales for the product that would result from a one percent increase in
the price of that product, holding all else constant.
14
SeeU.S. Anchor Mfg., Inc. v. Rule Indus., Inc., 7 F.3d 986,
995 (11th Cir. 1993).
15
Guidelines § 1.11.
16
See MS98 0113387 and MS7 007194.
17
See Brownrigg Dep. 9-10 (Mar. 5, 1998) (explaining that "switch[ing] from
manufacturing personal computers based on the Intel-based processor". . ."would be a
very daunting task" because it would entail a "[s]ignificant amount of engineering work,"
. . . "[a] lot of retraining of technical support," and other costs).
18See Ransom Dep. 13-14
(Mar. 19, 1998); Ransom Dep. 16 (Aug. 7, 1998); Brown Dep. 10-11 (Mar. 5, 1998).
19See Ransom Dep. 9, 17
(Aug. 7, 1998); Brown Dep. 10-11 (Mar. 5, 1998); Romano Dep. 50-52 (Apr. 13, 1998);
Von Holle Dep. 12-13 (Sept. 9, 1997); Kies Dep. 16-17 (Sept. 11, 1998); Santos Dep.
7-8 (Apr. 13, 1998); McKinney Dep. 11-12 (Mar. 13, 1998).
20SeeBrown Dep.
10-12 (Mar. 5, 1998)
21See Sanders Dep. 104-06
(Aug. 26, 1998).
22
SeeMS7 000634.
23
See MS7 000634.
24
See Sparks Dep. 131-33 (July 9, 1998).
25
"Note on the Desktop Operating System Industry in 1996," Stanford
University Graduate School of Business (August, 1997), p. 23.
26
As Professor Kenneth Arrow stated "The value of the operating system product is in its
capability to run application software. The larger the installed base of a particular OS,
the more likely it is that independent software vendors will write program that run on the
OS, and, in this circular fashion, the more valuable the OS will be to customers."
Declaration of Kenneth J. Arrow dated January 17, 1995, submitted in United
States v. Microsoft Corp., No. 94-1564 (D.D.C. 1994), on behalf of the
Government and in opposition to Amici Curiae.
27See Microsoft's Answer
¶ 58 (explaining that "(i) the popularity of an operating system [product] is to
some extent a function of the number, variety and quality of application available for
use with that operating system [product]; and (ii) software developers tend to write
applications for operating systems [products] that are popular").
28
SeeSantos Dep. 9 (Apr. 13,
1998);seealso Von Holle Dep. 9-10 (Sept. 19, 1997).
29 MS 154265-4279, 154268, Nathan
Myhrvold, file attachment (InterOffice Memo) to email to Bill Gates, Peter Rinearson,
and Jonathan Lazarus (July 24, 1993).
30See Confidential
Submission of Microsoft Corporation to the Staff of the Antitrust Division of the United
States Department of Justice 61 (Sept. 19, 1993).
31
See Chase Dep. 97 (Mar. 25, 1997).
32As Brad Chase explained: "The
OS/2 application market is small and getting smaller. Windows applications now
account for almost 60% of all dollars spent worldwide on applications software, with $4
billion sold in 1993. In the same period sales of OS/2 applications have declined and in
1993 accounted for only 2% of the market, or $128 million." MS98 11434-44 (Aug. 8,
1994).
33 Kozel Dep. 11 (Sept. 19, 1997).
34 MS7 7193-7196, 7196.
35 Decker
Dep. 18-21 (Oct. 17, 1997).
36See Ransom Dep.
9, 17 (Aug. 7, 1998); Brown Dep. 10-11 (Mar. 5, 1998); Romano Dep. 50-52 (Apr. 13,
1998); Von Holle Dep. 12-13 (Sept. 9, 1997); Kies Dep. 16-17 (Sept. 11, 1998); Santos
Dep. 7-8 (Apr. 13, 1998); McKinney Dep. 9 (Mar. 13, 1998).
37
MS7 007194, Joachim Kempin to Bill Gates (Dec. 16, 1997).
38
For Microsoft as a whole, net revenue as a percentage of total revenue
increased from 20% in FY86 to 26% in FY92, falling to 24% in FY95 before rising again
to 30% in FY97 (See Microsoft Annual Reports). Among the Fortune 500 largest U.S.
corporations, Microsoft ranks 137th in revenue, 165th in assets, 15th in profits, 7th in
growth of earnings per share, 3rd in profits as percentage of assets, 2nd in market
value, and 1st in profits as a percentage of revenues. Fortune (Apr. 27,
1998).
39
See, for example, Brad Chase deposition 206 (Mar. 25, 1998).
40
Browsers generally also contain a limited set of application programming interfaces
("APIs") to which software writers can "write" to extend the functionality of their
application products to "Internet-oriented tasks." This set of API's is not a substitute for
the set of API's provided by the operating system.
41
Netscape Communicator -- Standard Edition -- is available for almost all Windows
products, Mac System 7.5 and above, all major UNIX desktop systems and soon for
OS/2. See http://www.netscape.com/navigator/index.html. Microsoft's Internet
Explorer 4.0 is available on all Windows products, on Macintosh OS 7.1 and above, and
on UNIX Solaris 2.5 and above and other UNIX platforms. Seehttp://www.microsoft.com/ie/
download/sysreq.html; seealso Chase Dep. 98 (March 25,
1998); Mehdi Dep. 32, 45 (April 2, 1998).
42
Other browsers include Lynx, Mosaic, Opera, Web Explorer and
WebSurfer.
43
Microsoft itself argues that there are consumer benefits deriving from
the competitive race. In a memorandum entitled "The Internet PC" dated April 10,
1996, Bill Gates noted that Netscape Navigator "led the way with speed and features . .
. . Netscape and Microsoft have overlapping visions of the future of the Internet. Each
company is working as hard as it can, as fast as it can, to develop software that
supports its approach. One consequence of this feature race is that browsers are
evolving from relatively simple pieces of software into large programs, enhanced with
various extensions . . . ." MS6 6012977-78.
44
See, e.g., Smith Dep. 16-21 (Oct. 10, 1997).
45
This is consistent with the test the Supreme Court applied in the Jefferson
Parish case. SeeJefferson Parish Hosp. Dist. No. 2
v. Hyde, 466 U.S. 2 (1984).
46
See 10 Phillip E. Areeda, et al., Antitrust law ¶ 1747c, at 232-33
(1996)
47
Chase Dep. 99 (Mar. 25, 1998).
48
Silverberg Dep. 19 (April 14, 1998).
49
See, e.g., Frasca Dep. 45 (July 24, 1998); seealso Clark
Dep. 125 (July 22, 1998) ("You don't see Sun Microsystems integrating the browser
into their UNIX operating system. You don't see DEC integrating it in their UNIX
operating system. You don't see Hewlett Packard integrating it in their UNIX operating
system, and you don't see Silicon Graphics integrating it in their UNIX operating
system. They treat it as an application . . . .").
50
See Trevanian Dep. 61-63 (July 17, 1998).
51
See Sparks Dep. 74 (July 9, 1998) and Croll Dep. 71-72 (July 14).
52
See Bergland Dep. 29-32 (Aug. 11, 1998).
53See Kanicki Decl.¶ 2
(Apr. 29, 1998); seealso Kanicki Dep. 26-29, 106-07 (Aug. 27, 1998).
54 Ransom Dep. 9-10 (Mar. 19,
1998).
55
Decker Dep. 17-21 (Oct. 29, 1997); Kies Dep. 10-12, 14-15 (Apr. 23, 1998); Kies Dep.
21-28 (Sept. 11, 1998); Von Holle Dep. 39-40, 59-60 (Oct. 6, 1998); McClain Dep.
43-44 (Aug. 7, 1998); Declaration of Eric Browning, ¶¶ 7-9 (October 14,
1997).
56 Cole Dep. 49-50 (Jan. 9, 1998)
57
Expert Report of Edward W. Felten ¶¶ 48-54.
58
See Frasca Dep. 35-38, 86-87, 106-07 (July 24, 1998); Croll. Dep. 74, 188
(July 14, 1998); Limp Dep.123-25, 128 (July 30, 1998); Bergland Dep. 24-30 (Aug. 11,
1998).
59 MS6 5004550, 4553; Dunn Dep.
37-42 (Apr. 24, 1998).
60 MS7 004127 PI Ex. 15.
61 MS6 6008247, 8248 PI Ex. 35.
62 MS6 6005550 (PI Ex. 33).
63 Allchin Dep. 120 (Mar. 19, 1998).
64Id. at 121.
65
Webb Mckinney Dep, 27 (Mar. 13, 1998) ("Obviously it costs us money to bundle
software, so we don't want to put a lot of software on a system that people don't value,
and the amount of software on the system also increases our test burden and makes it
harder for us to get to market quickly, so it's a pretty wide range of reasons to try to
keep the amount of software on the system to what's really needed"); Kempin Dep. 37
(October 2, 1997). Mr. Kempin also testified that "[i]f the OEM wants to install the other
browser, he can do it. And it's just a matter of how much cost he is willing to have.
Because he will probably have to test all our product first then he has to test the other
products..." Id. at 34.
66
See McClain Dep. 51 (agreeing that "icons can cause clutter on the screen").
Indeed, Microsoft explained to OEMs that, although it permitted multiple icons for ISP
sign-up on the desktop, it "recommend[s that] OEMs do not overwhelm the user by
providing additional sign-up mechanisms." MS98 0109575 (4/16/98);
seealso MS98 109900 (2/27/98) (Microsoft e-mail exchange
reflecting concern that offering icons for two or more products or services in the same
category on the desktop would cause consumer confusion).
67See McClain Dep. at
52-53; McKinney Dep. 27 (Mar. 13, 1998) ("[O]ne thing is that we found a lot of
software required, you know, creates a lot of support, so it creates a support burden for
us. It creates confusion for the consumer.").
68 McClain Dep. 122-23; id.
at 57.
69
Von Holle Dep. 42, 61 (Oct. 6, 1998).
70
Von Holle Dep. at 42; seealso Brownrigg Dep. 14, 18 (Oct. 6, 1998).
71
Kempin Dep. 37 (Oct. 2, 1997).
72See, e.g., IE Market
Review, April, 1997 (TXAG 0026734-770); MS7 006062; Myhrvold Dep. 43-44 (Apr. 24,
1998). The other principal channel is through OLSs and ISPs, the foreclosure of which
is discussed below.
73 IE5 OEM Marketing Review, MS98
012655.
74
MS7 005526.
75
MS7 007468; MS7 006062-64 (Jeff Johnson e-mail) ("[I]t is pretty clear that current IE
users are often getting it with their PC, and the focus group data . . . also stated that
Netscape users aren't likely to switch to IE until it is integrated into the OS"); MS7
006352 (Jonathan Roberts e-mail) ("This distribution leads me to believe we are better
off with a tighter tie to Windows.").
76See Myhrvold Dep. 43
(Apr. 24, 1998).
77
Knott Dep. 21-23 (Feb. 20, 1998). Indeed, Knott testified that CompuServe had tried
but failed to put together a comparable package through OEMs. Id. at 22;
seealso Von Rump Dep.14-15 (Apr. 28, 1998); Colburn Dep. at 29-33
(Mar. 6, 1998).
78 Silverberg Dep. 159 (Apr. 15,
1998).
79 MS6 5001199-1245 (AOL
agreement); MS6 5000168-89 (CompuServe Agreement).
80
Myhrvold Dep. 64-65, 68 (Apr. 24, 1998).
81See, e.g., MS6
5001127-51 (Spry); MS6 50000920-47 (Mindspring).
82
Microsoft Dictionary 15.
83
Id. at 15-16.
84
Testimony from ISP executives and internal Microsoft documents show that there are
significant costs for ISPs which arise from distributing two browsers. See Von
Rump Dep. 17 (Apr. 28, 1998) (expenses incurred for support of an additional browser
include "marketing resources, whatever expenses are required in the promotion and
distribution, advertising, literature, training for sales and customer service
representatives"); Solnik Dep.81-82 (June 15, 1998) (explaining that "there are lots of
costs" including testing, training, and support costs, for an ISP to distribute two
browsers); seealso Beran Dep. 52 (Aug. 5, 1998); Schwartz Dep.
41-42 (Sept. 9, 1998); MS7 005526.
85
Silverberg Dep. 142-44 (Apr. 14, 1998).
86
See MS98 0112834-36.
87
Seeid.; MS6 6009919; MS7 000584. See also MS7 00591, a 1997
Mid-year review in which Microsoft noted that "46 of top 50 ISPs/OLSs [are] shipping IE
as their preferred browser."
88
Knott Dep. 25 (Feb. 20, 1998)
89
Von Rump Dep. 16-17 (Apr. 28, 1998)
90
MS98 0151667-68.
91
MS98 01516667.
92
Wadsworth Decl.¶ 4 (Apr. 23, 1998).
93
ZD 0127.
94
See, e.g, AOL 0000145-73 (AOL); CNET 00028-55 (CNET); TWDC 0704-55
(Disney); INT 00001-25 (Intuit).
95
See, e.g., INT 00003; See Chase Dep. 206-08 (Mar. 3, 1998).
96
Dunn Dep. 37-42 (Apr. 24, 1998).
97
Id.
98
MS 6003202-3227.
99 MSV 9137A.
100Id.
101
MS6 5005719-720 (Apr. 4, 1996, Chase Planning Memo).
102
MSV 10558.
103
MS7 000353-366-387.
104
MS7 006062.
105
Compare MSV 000163 (IBM 8/24/95 Windows 95 License) with MSV
000203-04 (IBM 8/16/96 Windows 95 License).
106See, e.g., Amendment
12 to August 1, 1996, License agreement between Microsoft Corporation and AST
Research, Inc., Ex. C1 (Aug. 8. 1996) (MSV 0006245).
107
Myhrvold Dep. 73-74 (Sept. 24, 1998).
108
See, e.g., MS98 0113937; MS98 0113961; MS98 0113962; MS98
0113963.
109
See Kempin Dep. 45-46, 49-50 (Sept. 9, 1998).
110
See, e.g., MS98 0113849-52 (May 27, 1998 Letter to Packard Bell/NEC
authorizing alternative ISP sign-up process); Kempin Dep. 94 (Sept. 9, 1998).
111See, e.g., Amendment
12 to August 1, 1996, License agreement between Microsoft Corporation and AST
Research, Inc., Ex. C1 (Aug. 8. 1996) (MSV 0006245).
112
See Kempin Dep. 96-98 (Sept. 9, 1998).
113
Microsoft made assumptions concerning the percentage of new Internet
connections who use Internet Explorer in each of the sectors just described (the "run
rate") and the rate at which people switch browser types (the "switching rate").
114
MS98 0203007.
115
MS98 0203007.
116
A user "clicks on" on an ad to get more information about the product.
117
Because of the size of this database, data were acquired for only the second
Wednesday of each month.
118
"Netscape Competitive Analysis." MS98 0112834-36.
119
"Netscape Competitive Analysis." MS98 0112834-36.
120
The difference between the two groups (i) takes OEM restraints as given; (ii)
measures a stock rather than flow of browser shares; and, (iii) does not take into
account the possibility that network effects in the browser market will cause the effect of
Microsoft's anticompetitive practices to accumulate over time.
121
See MS98 0203023-25.
122
See Kanicki Dep. 36, 40 (Aug. 27, 1998). It is also unlikely Microsoft
would have agreed to a licensing agreement with Dell, see MS98 0128328,
that lifts the screen restrictions, including the prohibition on removing the IE icon, when
Dell is presented with a specific customization request by a large-volume customer,
such as corporate customers, if such customization would have harmful effects.
123
See Expert Report of Edward W. Felten ¶¶ 48-64 (hereinafter
"Felten Report").
124
See Akerlind Dep. 115 (Aug. 26, 1998) (agreeing that "[i]f Compaq's
removal of the Internet Explorer icon caused . . . problems" that Compaq would "be
punished by the marketplace."); seealsoid. at 87 ("I would
agree . . . that if a company in this market or any market, you know, has weak products,
that sooner or later they're either going to have to fix the problem or get out of the
business, because what they try to sell is not going to be profitable business for
them.").
125 Microsoft's Memorandum in
Support of Summary Judgment at 58.
126
MS7 004246.
127
Expert Report of David J. Farber ¶ 23.
128
Expert Report of Glenn E. Weadock ¶ 26 ("The existence of a software product .
. . depends on both the presence of a feature set and the means to use that feature
set.") (hereinafter "Weadock Report").
129
Felten Report ¶ 52 (quoting Handbook for Applications 29).
130
Felten Report ¶¶ 48-57.
131
Weadock Report ¶ 24.
132
Transcript Jan. 14, 1998 a.m. 4, 48-50 (United States v. Microsoft,
No. 97-1564 (TPJ))
133
See Felten Report ¶¶ 48-57.
134
See Weadock Report ¶ 27; seealso Gailey Decl
¶ 4 (Nov. 17, 1997); Allaire Decl. ¶ 2 (Nov. 17, 1997); Bourdeau Decl
¶¶ 3-4 (Nov. 17, 1997); Bickel Decl. ¶ 8 (Nov. 19, 1997) (all
introduced in United States v. Microsoft, No. 94-1564 (TPJ)).
135
See Akerlind Dep. 155-56 (Aug. 26, 1998).
136 MS98 0102953 (Apr. 1, 1998).
137
See Kempin Dep. 84-85 (Sept. 9, 1998); Akerlind Dep. 150-55 (Aug. 26,
1998).
138
See Akerlind Dep. at 83-88.
139 Akerlind Dep. at 83.
140
It is important to keep in mind that, from an economic perspective, the value of a
product to consumers is determined by both its quality, including all of its features, and
its price. For example, some consumers may prefer an Oldsmobile to a Cadillac
because the additional features a Cadillac provides are not worth paying the higher
price, or because they prefer the features the Oldsmobile provides and would chose it
even if the price were the same. One cannot say that the Cadillac is superior simply
because some or many of its features are not provided by, or are superior to
counterparts provided by, the Oldsmobile.
141
Although early versions of IE might have had only modest revenue-generating
potential, because they were widely regarded to be substantially inferior to Netscape's
browser, that is no longer the case.
142
See TXAG 0012832; MS7 005732.
143
For example, the Cournot model, the oldest and still most widely used model to
predict behavior in oligopolistic markets, predicts that, with two suppliers producing an
identical product with zero marginal cost, price will be below the monopoly level but will
not equal zero. Although a zero price is possible under a Bertrand model of oligopoly
that assumes that the products are identical and that the cost to users of switching
products is zero, these assumptions do not comport with the realities of the browser
market.
144
Microsoft has suggested in this litigation that it might set a non-predatory price of zero
in the expectation that the resulting increase in IE usage would generate increased
revenues from increased sales of its Windows 95 and Windows 98 operating system
products. For reasons explained above, I do not believe that this argument can help
explain Microsoft's pricing of IE to Microsoft's installed base.
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