Splitting hairs: Should Microsoft be broken up?

What will happen if Microsoft is broken into separate business units, following a US court's findings that it abused its dominant position in the market? Two teams of our regular TechLaw columnists take opposing views on the implications of such action and what each will mean for IT users.

What will happen if Microsoft is broken into separate business units, following a US court’s findings that it abused its dominant position in the market? Two teams of our regular TechLaw columnists take opposing views on the implications of such action and what each will mean for IT users. AGAINST

Chihaya Natusch & Craig Horrocks

US District Court Judge Thomas Jackson’s judgement on the Microsoft case has found, as matter of fact, that Microsoft has a monopoly and that it has used this monopoly position anti-competitively. The Techlaw arguments for keeping Microsoft intact rely on looking at the market failure that has been said to have caused consumer and competitor harm. To determine harm to consumers involves identifying what consumers look for in an operating system. Consumers typically look for a standard. Standards are the foundation of the modern day monopoly. Own the standard, own the market. This has been played out many times with fights such as that between Beta and VHS. Veni, vidi, vici

The drive for standards is because consumers do not just buy technology goods on the basis of intrinsic product characteristics. They want extrinsic characteristics, such as ubiquity, interoperability and investment protection. They know that these characteristics mean usefulness and mass production. Mass production leads to a consumer expectation of reduced price. Ubiquity of Microsoft’s software enables Microsoft to grant a franchise to software developers to write for the Windows platform which results in more customer value because more applications are available for the platform. More applications for that platform exponentially increases the ubiquity of that platform. The result, 90% of computer users are using Windows as a desktop operating system. Also linked to ubiquity is the consumers’ need for assurances that their chosen operating system and applications are interoperable with other software. Microsoft’s ubiquity helps ensure that this criteria is met. Finally, consumers value a supplier’s ability to protect the user investment in the operating system through upgrades and continuing service. Consumers are motivated to protect their own, often large, personal investment in an operating system. This can range from the investment made by the novice to master the strange world of computers to the massive investment made by an engineer with an MSCE (Microsoft Certified Systems Engineer) qualification. Consumers also know that an operating system can become obsolete within a matter of months because of continuing innovation. Examples such as digital photography generate new storage requirements or connection to the Internet which generates the need for faster modems etc are well understood by consumers. The Microsoft standard, Windows, meets all of these criteria of ubiquity, interoperability and investment protection. Microsoft’s success has brought order to the chaos of operating systems. Microsoft has achieved this by creating and developing an almost universal standard for operating systems software. Order is what consumers want. Choice is secondary. The victory of VHS taught us that. This leads to competitors and here the argument is not so simple. Some competitors in the channel will, even if they have gripes with Microsoft, want to support Microsoft as their fortunes are tied to having a healthy, strong Microsoft. Like video store retailers with VHS, channel partners also celebrate the standard. It lowers the cost and complexity of their business decisions. The few real competitors in the operating system and Web browser space are where the real push will come for dismantling Microsoft. Here the desire of competitors for a crippled Microsoft is, if the arguments of consumer benefit from aWindows standard are accepted, at odds with the consumers. The Microsoft case is an unprecedented case in the history of law and economics because it does not fit easily within the definition of a classic monopoly. Microsoft has not restricted output, stifled innovation nor increased its prices to the detriment of the consumer. The perverse outcome of the findings of fact is that although the law says the outcome of Microsoft’s conduct is wrong, the consumer benefit Microsoft has created outweighs the consumer loss because it has achieved what the consumer values the most, ubiquity, interoperability, investment protection and at a price that has not been shown to be unreasonable. A capitalist oversight

The problem is that capitalism and antitrust laws never anticipated that dominance in a market would be controlled purely by a standard. It is unlikely that the traditional anti-trust remedies provided for in the Sherman Act can offer an appropriate solution for this case. Conduct remedies to restrain Microsoft have proved futile in the past. Judge Jackson’s ruling points toward an interventionist remedy that runs the risk of destroying the Windows standard. It is a matter of speculation as to whether the consumer will be harmed by uncertainty and reduction in Microsoft’s capacity to innovate. This argument may be criticised as a "better the devil you know" argument but the question should be asked: do consumers want the courts to experiment with the Windows standard? If consumers do not want Microsoft broken up, what is the court protecting: the sanctity of monopoly law? The dwarf competitors? Competition law needs to make sense to consumers. Destroying the attributes in a supplier they have invested much of their financial and intellectual capital in by learning, adopting, working with Windows does not make sense. Structural remedies such as breaking up Microsoft are a gamble that, if they fail, will harm consumers, the US economy and future innovation in Windows and its franchised developer partners in the software industry. Already a few US politicians have expressed their concerns in imposing strong remedies on Microsoft. Republican Senator Cal Dooley stated that "a decision by a judge [to break up Microsoft] is not in the best interests of consumers or the economy". Replublican Senator Tom Bliley also added that a strong remedy could affect the competitiveness of the US dominated software market. Going public again

If conduct and structural remedies are not favoured, can all versions of Windows be taken away from Microsoft and made public? Can the jewel in Microsoft’s crown be compulsorily nationalised? Even if the courts are prepared to consider this, how would Microsoft’s stockholders be compensated for the theft of its own intellectual property? Can the US afford to do this after preaching about getting government out of business? Whether Windows is to be nationalised or Microsoft broken up, what about all the other consumers in the rest of the world? Why should a court in the US determine our future with Windows? Do we get a say? To be fair should Windows be given to the United Nations? Microsoft must continue its ownership and development of Windows just as Sun has insisted with Java. Judge Jackson must consider all Microsoft users worldwide. Their drachmas, pounds, lira etc have been part of the US success story that has resulted in the huge wealth that is now Microsoft. We are stakeholders and the idea that some Judge in America is going to decide what flavour of Windows we are to have in the future, is not the deal America promised the world when it championed Microsoft’s success and the creation of the standard. Transnational teething problems

The genie is out of the bottle. The genie belongs to the world and perhaps here lies the real problem. Microsoft is the world’s supplier of the desktop standard. It is only, with the Internet, the first of many companies that will create transnational issues of governance. The "Microsoft problem" could just as easily be the "Visa SET problem", or some problem arising out of the transnational dominance by the emerging super-telcos. The Microsoft case demonstrates that in our shrinking world, transnational corporations and national laws are a bad fit. The need to have some way of moderating a transnational corporation’s conduct is not something that is new. The OECD is already working developing the first global standards for corporate governance. There is already an International Corporate Governance Network. In New Zealand our Institute of Directors (IOD) has turned its mind to these problems with a keynote paper delivered to the IOD’s Annual Conference in Auckland on November 6. Dr Stephen Davis, a recognised world authority on corporate governance, was brought to New Zealand to address the issues of transnational corporations. His presentation titled "The Millennium Corporate Governance Agenda" concludes with the point "assume there are no borders in corporate governance". But those borders do remain. Steps for the future

Where to from here? Whatever is done: 1. Must recognise that the standard exists and consumers have an interest in the standard remaining intact. 2. Must be international in character. 3. Must not harm consumer and stockholder investment in Microsoft. 4. Must provide means of ensuring unlawful conduct is not repeated by conduct review and sanctions. 5. Must address the two practical issues of the power Microsoft holds as the owner and guardian of the Windows standard and the fact that the real harm is to consumers worldwide. The solution to the power of the Windows standard is met with oversight and transparency by forced publication of the standard and the requirement that Microsoft adhere to the standard. There is already the example of Sun promotion of Java as an international standard. The world’s experience in this area is wide with many strong examples of standards cooperation. The solution to protection of the consumer worldwide lies in both initiatives such as the OECD’s corporate governance initiative and new roles for organisations such as WTO. Given Microsoft has entered into mediation with the Department of Justice perhaps we will be pleasantly surprised. If there is any CEO in the world that understands the need to think globally in all aspects of business it has to be Bill Gates. On a lighter note if the WTO takes the role of being the police, what better person to deal with Bill Gates than our very own Mike Moore. Craig Horrocks is the managing partner and Chihaya Natusch is a solicitor in Clendon Feeney’s technology law team. craigeh@clendons.co.nz FOR

Averill Parkinson & Emily Fuller

Type "Microsoft sucks" into an Internet search engine and you will get inundated with search results. There are many that will be pleased to hear US District Judge Thomas Penfield Jackson’s finding of fact on November 5 that Microsoft was a monopolist in the "PC operating systems software" market and that it abused its power and bullied competitors in ways that stifled competition and blocked innovation. The question on everybody’s lips is … yes, but what happens next? The monopolist power that Microsoft has is due to the ubiquity and standardisation of product. Microsoft has also had monopoly power due to the economies of scale gained through having invested huge amounts of money in research and development. Economies of scale

The remedy must be aimed at gaining the benefits of competition and eliminate abuse of power. However, it must be done in a way that preserves economies of scale and encourages ongoing innovation and development. The four most popular options are: 1. Force Microsoft to either sell or give away its source code for Windows. 2. Split Microsoft vertically into two or three little Microsofts that would continue to make and sell the full range of Microsoft software. 3. Split Microsoft into separate companies operating in different software areas. 4. Prohibit Microsoft from using its monopoly power in an anti-competitive manner through various restrictions on behaviour. While the first two options will have different structural effects on Microsoft (for example, the second option would require Microsoft staff to be split into thirds), the end result is fairly similar — a number of different companies competing to sell the same base product. The economists’ argument is that this "commoditisation" of Windows will lead to lower prices to consumers as each competitor will be forced to price at or near marginal cost. Furthermore, as no single company would have the market power to engage in anti-competitive behaviour, the operating systems market would be self-regulating with no ongoing need for government monitoring. To prevent commoditisation, the various Windows sellers would inevitably look to differentiate their products. This would put at risk one of the key benefits of Windows to consumers — interoperability. To those who argue that none of the Windows sellers would risk destroying interoperability one only needs to recall the compatibility "issues" between Office 95 and 97 — and these two products were produced by the same supplier! Should one company prove more effective in developing or marketing its version of Windows (perhaps the company that gets to keep Bill?), we would end up with the same result we have today, albeit delayed by a few years. The third option, that of breaking Microsoft up into separate individual companies operating in applications and operating systems, also has flaws. First, one needs to be able to draw the line between operating systems and applications when determining exactly where the separation should occur. This is a complicated enough task if done once only, however, it is likely to require ongoing review as the products evolve. Microsoft and the Department of Justice would find themselves facing the same issues as those that arose in relation to the 1994 consent decree. Secondly, given the ongoing monopoly Windows would still have in the PC operating systems market, the company that retains Windows would need to be restricted from using this monopoly power in other markets. While a prohibition from operating in other markets will limit the ability to leverage off the operating systems monopoly to some degree, this is not the complete answer. As Judge Jackson’s findings of fact show, actions aimed at protecting a monopoly in one market can have substantial competitive implications in other markets. Given these two factors, a split along functional lines would be unlikely to be effective unless coupled with conduct restrictions and ongoing monitoring, ie regulation. The difficulty with regulation, whether by the courts or by an administrative body, is that it both removes the ability to innovate and increase efficiency and reduces the incentives for doing so as profits are expended on regulatory activities. Regulation can also be ineffective given the practical difficulties of monitoring a large company which operates in many different markets. Virulent competition

TechLaw’s view is that, if the US courts decide that some form of intervention is required, what is needed is virulent competition between established, differentiated and interoperable products. The obvious answer is to separate Windows 95/98 and Windows 2000. Windows 2000 has technological advantages, but if support and development for Windows 95/98 were to continue it would need to fight hard to gain market share. Conversely, as a fully developed product with a strong brand identity, the marginal costs of continuing to sell Windows 95/98 would be low. Windows 95/98 also has switching cost advantages for those upgrading from earlier systems such as Windows 3.11 and DOS. Conceivably, the two versions of Windows could be worth more separated than together, avoiding any arguments that intervention is stealing shareholder wealth from Microsoft investors. If Windows 95/98 stays within Microsoft, it will eventually be phased out and replaced. By separating Windows 95/98, not only will this product continue to grow and develop, the substantial investment that Microsoft has also made in ensuring interoperability between the two platforms will also live on. Separating the two platforms will not involve forging new ground. The Justice Department’s suit against AT&T in 1982 resulted in AT&T being split into seven regional Baby Bells. Here, instead of being split on geographical lines, Microsoft is being split on product lines. Judge Jackson’s strong and definitive findings of fact have laid the foundation for a strong remedy. Although there are a spectrum of remedies, only the creation of a strong competitor in the operating systems market would be effective in controlling Microsoft’s market might. Averill Parkinson is a senior associate and Emily Fuller is a solicitor in Clendon Feeney’s technology law team. This article, together with further background comments and links to other Web sites can be downloaded from www.clendons.co.nz.

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