MS/DOJ: Govt grills about MS profits, boot-up

A U.S. government lawyer yesterday grilled Microsoft Corp.'s chief economic witness about whether the company's latest earnings, which were up 74 percent over last year, were indicative of a company enjoying monopoly status.

A U.S. government lawyer yesterday grilled Microsoft Corp.'s chief economic witness about whether the company's latest earnings, which were up 74 percent over last year, were indicative of a company enjoying monopoly status.

"Speaking of power, did you read the newspapers today? Did you hear what profits Microsoft announced?" attorney David Boies asked Richard Schmalensee, dean of the Sloan School of Management at the Massachusetts Institute of Technology, in reference to the US$1.98 billion [B], or 73 cents per share, second-quarter earnings Microsoft announced yesterday.

Schmalensee responded that "you can't infer monopoly power from quarterly profits," prompting Boies to ask if profits of that magnitude over time might indicate monopoly power.

"A valuable piece of intellectual property can indeed yield a long string of profits," said Schmalensee, who has been on the witness stand for four days now.

When asked what percentage of the profits came from the operating system sales, the economist said that Microsoft's internal accounting system doesn't distinguish between operating systems profits from applications profits because the two software types have a lot of common costs. Microsoft's accounting system isn't all that modern, Schmalensee conceded.

"They record operating systems sales by hand on sheets of paper," he said.

"The firm is highly profitable. The operating system is highly profitable. How highly profitable I don't consider relevant," Schmalensee said.

In his written testimony Schmalensee had concluded that if Microsoft had the type of monopoly power the government alleges the company would be charging 40 times what it currently charges for each copy of Windows. That would translate to about $2,000 per copy instead of the current $50 price.

"I remain convinced that analysis is the correct analysis," he said. "Enormous power would transfer into a very high price."

Earlier, Boies challenged Schmalensee on Microsoft's restrictions of computer manufacturers’ alterations to the first screen, or boot-up sequence, of the Windows operating system software.

Boies pointed to an e-mail from Bill Gates, Microsoft chairman and chief executive officer, to subordinates dated Jan. 5, 1996, in which Gates indicated he was not pleased that manufacturers had placed icons for Netscape Communications Corp.’s Internet browser “FAR more prominently” on the Windows screen than the icon for Microsoft’s own product.

Schmalensee maintained that the e-mail did not discuss imposing restrictions on computer manufacturers. Manufacturers were later barred from altering the first screen sequence on Windows by Microsoft. The software giant argued that alterations would violate the company’s copyright protections.

Boies also pressed Schmalensee about whether an internal Microsoft document that described Microsoft’s most recent version of the company’s Internet Explorer browser as “not compelling” disputes the company’s claim that its browser gained market share because of technological improvements. And the attorney attempted to press the economist on the amount of money Microsoft invested in developing, marketing and distributing the browser, which it ultimately gave away for free.

Schmalensee said he believed the development and marketing costs to be about $100 million [M] per year, since 1995. He said an estimate of about half a billion [B] dollars was “not unreasonable.”

However, Schmalensee was forced to concede that some Microsoft officials, other than Gates, drew a connection between computer makers’ placement of icons for Microsoft’s browser, Internet Explorer, and its online service, MSN, and the restrictions the company imposed on the first screen. A memo from another Microsoft executive, Joachim Kempin, listed “control over start-up screen, MSN, and IE placement” under the heading “What we missed in the first half of 1996.”

“I'm only presuming there is some link,” Schmalensee conceded.

The action by Microsoft enraged several computer manufacturers, who argued that the restrictions would force them to undertake costly product redesigns. One Hewlett Packard Co. official lamented in a complaint to Microsoft, “If we had a choice of another supplier, based on your actions in this area, I assure you would not be our supplier of choice.”

“If a (computer manufacturer) gets unhappy enough with Microsoft does it have any place to go to change suppliers?” Boies asked.

“In the short run,” answered Schmalensee, “the answer is no.”

Schmalensee is expected to be questioned by one of Microsoft’s attorneys tomorrow. The company’s second witness in its defense against the government's sweeping antitrust claims is expected to be called Monday. That witness, Paul Maritz, is Microsoft’s vice president of the platforms and

applications group. Maritz - through his numerous e-mails entered as evidence throughout the

trial - has already been a prominent figure in court. He was one of the key decision makers at Microsoft, in particular, on issues involving Internet Explorer.

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