DOJ "Summary" of Warren-Boulton : LUSENET : MS-DOJ : One Thread

Frederick Warren-Boulton (WB), an economist in a private consulting firm who worked an the chief economist for the DOJ antitrust division, testified about the economic effects of MSs actions regarding browsers. His basic point is that through its exclusionary and predatory conduct, including exclusionary contract restrictions and tying, MS has attempted to monopolize the browser market and maintain its monopoly in OSs. His main conclusions are the two browser stories we discussed in classdefensive monopolization of browsers to maintain the OS monopoly and offensive monopolization of the browser market for its own sake.

Although WB repeatedly refers to the fact that hes not a lawyer during the trial, his direct testimony is basically a brief without case citations. His conclusions are the elements of antitrust monopolization claims, with assertions that, if accepted by the court, would allow the DOJ to prevail in the rule of reason analysis used for monopolization claims.

Note: The following summary is quite long. My apologies! I believe that summaries should be short and manageable, but I had a lot of trouble getting all this testimony into a manageable size. Ive tried to make things a bit easier for people who are in a rush by marking the section headings with *s so you can find out WBs basic arguments and read the ones that most interest you. Ive put a few of the most important arguments first.

***A Couple of Economic Points***

Throughout cross, WB assets that monopolists have incentives to innovate so people will continue to buy their products. Thus evidence of MSs improvements or response to customer demand does not disprove the claim that MS has monopoly power. For example, MSs adding APIs in response to requests by software vendors for them is profit maximizing behavior for MS and does not suggest that MS doesnt have monopoly power.

In cross, WB repeatedly emphasizes the importance of market tests. If OEMs want to offer their customers choice of browsers, they should be permitted to do so, even if MS feels it makes a better product thats integrated.

***IE and Windows are Two Separate Products***

As we know, the central debate about tying is determining whether or not there are two products. In WBs opinion, browsers and OSs are separate products because an item is a separate product if there is "sufficient demand such that it is efficient to offer that item separately from other items." (par. 71) (This economic analysis bears a striking resemblance to the Jefferson Parish test.) In cross, WB emphasizes that the focus of the test should be on the value to the people who want the two products separately, not the benefits that may accrue to people who receive the product as an integrated whole. It seems WB would allow MS to charge users who want Windows without IE more, the costs of separating them. Because he considers removing the users awareness of IE as untying the products, this cost is probably not prohibitively high.

WBs lists several facts to support the conclusion that Windows can be offered profitably without IE and IE can be offered profitably without Windows. IE is already sold as a separate product. Windows is also a separate product, because there is demand for it without IE (e.g. from OEMs and corporate buyers) and removing IE costs MS little/nothing (Uninstall works in Win95, and a substitute browser can be used without harming Win98). Further illustration that theyre separate: MS tracks demand for IE separately from demand for Windows. Other OSs who arent threatened by browsers consider browsers separate products. Note: WBs basis for the crucial point about Win98 is Prof. Feltons report.

In cross, WB stated that generally economists wouldnt be concerned if firms add functions to OSs that had previously been offered separately, but there is a concern when a firm with monopoly power does so because it can manipulate network effects. WB dealt with the need to limit the ramifications of his position by stating it is not of economic concern if MS does not offer Windows without every feature that fits his definition of separate product, but browsers are a special case because they are also potential competitors with Windows. The fact that Netscape Communicator bundles software is thus not a concern.

***There Has Been Significant Exclusionary Impact*** Evidence? MS predicted it would substantially gain market share in browsers. IE has a high flow percentage and Netscapes is declining. (In cross, he said IE had 60% and Netscape had 30%.) It seems one of his central pieces of evidence is data he received from Adknowledge, a company that monitors Internet ad viewing and clicking, which kept track of the ISPs and the browsers of the people viewing the Web pages. WB identified 4 groups of ISPs1)AOL/Compuserve, which have severe restrictions against their associating with non-IE browsers, 2) those which prefer one browser and have some shipping restrictions, 3) those which prefer one browser but dont have shipping restrictions, and 4) the parity group, which is neutral as to IE and Netscape. He found that the restrictions correlate with higher use of the unrestricted browser. His central finding seems to be that IEs share in the AOL/Compuserve group is 49% and in the parity group is 30%, from which he concludes the exclusive arrangements between AOL/Compuserve and MS have caused IE to gain a significant amount of market share.

Ill just note that (of course) MS disputes much about this data, whether it is representative, how to interpret it etc. Ill have to admit that I am having difficulty making the leap from the correlation shown in this data to WBs conclusion that the agreements with AOL and Compuserve caused the shift in IEs market share from what it would have been. MS suggested other explanations of Netscapes loss of market share, MS including IEs higher quality, Netscapes initial higher price, Netscapes being difficult for programmers to work with while MS courts programmers, and MSs larger sales force. WB didnt have much information about these.

***MS Conduct Was/Is Predatory***

MSs exclusionary actions were predatory because MSs expectations of profits came from excluding rivals and gaining or preserving market power. MS gave up money for its desk top real estate in order to make exclusionary arrangements. Giving IE away for free lost revenue for them in terms of fees and reduced demand for Win98. WB doesnt believe that MS really wanted to make money on IE through ancillary services. Furthermore, there is no evidence that MS even bothered to calculate whether or not its actions were profitable. In redirect, WB pointed out that other firms wont enter the browser market because MS is giving the browser away for free.

***The Relevant Market is PC OSs***

WB uses the hypothetical monopolist test (find the smallest group of products over which a monopolist could sustain a small but significant increase from a competitive price) to determine that PC OSs are the relevant market. He asserts that MS OSs are priced significantly above competitive level, though he seemed unenthusiastic during cross about disclosing exactly what that price is or how one is to determine it. He thus relied on other indications to determine that PC OSs are the proper market. If the price of a PC OS is raised, people will just pay more instead of switching away from PCs, because of network effects (high number of applications written for PCs), time/money learning a new OS, and potential compatibility with others. Furthermore, the OS is a small part of the computer price, so a significant increase in OS price is barely felt by the computer buyer. Other evidence includes that fact that OEM executives say they wont switch to a new OS if Windowss price were increased by 10%.

WB doesnt win the consistency award this year for his discussion of market definition. One of his central points is that MS felt its OS monopoly was threatened by Netscape + Java, because cross-platform applications could be written. Then others OSs could enter the market and compete with MS. But he doesnt consider Netscape/Java to be part of the relevant market for purposes of discussing monopoly power. On redirect, he explained that this was because Netscape/Java is only a partial substitute for an OS.

***Browsers Are the Main Threat to MSs OS Monopoly.***

You know the storyprogrammers could write to a browsers APIs instead of the OSs. Cross-platform applications written for browsers could make the OS less important. MS was aware of this threat. Also, WB asserts that there are network effects with browsers which create barriers to entry since Websites can be written for specific browser technology. WB offers no support for this. He mentions that there are also economies of scale for browsers but doesnt explain why browsers are different from other software in this regard.

In cross, WB notes that it would be almost impossible for someone to clone the full set of Windows APIs, so the threat of other companies creating a substitute OS is unlikely.

***MS Has Monopoly Power in the Relevant Market***

WBs proof of MSs monopoly power is somewhat dubious. He suggests that there are several indications of MSs monopoly power in PC OSs: MSs high share level (measured by flowIEs percentage of new browsers), the economies of scale in software, the high barriers to entry, network effects (applications written for Win), and the high sunk costs for developing a new OS. WB wasnt overly successful in cross at distinguishing the sunk costs for OSs and those for any other software.

Further evidence of monopoly power: MS engaged in conduct that "it could not profitably pursue" (par. 60) if it didnt have monopoly power. It threatened to terminate Compaqs license because Compaq was going to take IE off the desktop. Another indication of MSs monopoly powerMS has very high profit margins.

In cross, WB notes that the fact that MS tried to determine from a focus group whether they should charge $49, $89, or $120. Only an entity with monopoly power would be able to make a decision like this, reasons WB. (MSs suggestion during cross that these prices are lower than other operating systems prices does not seem to address his point.)

Another indication of monopoly power: OS prices have accounted for an increasingly higher percentage of the price of computerswhile hardware components have gone down in price even though they increased significantly in quality, Windows has gone up in price. WB denied that he was claiming that Windows and the components quality increases were the same. Maybe Warden (MS lawyer) and I are alone in not quite understanding the point of this comparison.

***Exclusionary Conduct ***

(Note: as we have discussed MSs exclusionary agreements with OLSs, ISPs, and ICPs already, I am not going into detail about the specific arrangements.)

MS gets users to use IEand cuts off Netscapes access to the best distribution channel, OEMs-- through many types of exclusionary conduct, including tying IE to Windows, giving IE free with Windows, requiring OEMs to install IE and disallowing the removal of IE.

Although MS allows other browsers to be installed, its costly to do so, even if the other browser had no license fee, since there are testing costs as well as increased support costs, especially because consumers are confused by having two products that perform similar functions. MS used placement on the desktop, in bootup sequences, on the Online Service Folder, in the Internet Connection Wizard, and in the start menu to induce Online Service Providers (OLSs), ISPs, and ICPs to promote and/or distribute IE as their exclusive or primary browsers, even sometimes refusing to ship more than a certain percentage of competing browsers to customers who request them. MS gave discounts to ISPs if they used technologies that worked better with IE such as ActiveX.

WB deals with the fact that many of the restrictions were lifted last spring by arguing that 1) some restrictions still remain, 2) reversing the restrictions will not reverse their effects, and 3) MS can impose these types of restrictions again if its not sanctioned. Also, although ordinarily it is not anti-competitive for MS to sell its desktop real estate, states WB, the deals MS has made are exclusionary.

***MS Has Dangerous Probability of Monopolization in Browser Market***

WB projected using a somewhat mysterious model that IE will soon have 80% market share, as opposed to its current 60%. Thus, there is a dangerous probability of monopolization in the browser market (which, interestingly enough, is an element of attempt to monopolize). Thus, MS will also preserve its monopoly in the OS market. Once Netscapes market share is small enough, or software developers fear that this is so, developers wont write their software for Netscape/Java.

***MS Couldnt Have Legitimate Business Justifications for MSs Conduct/ Less Restrictive Alternatives Exist ***

WB suggests various justifications MS could claim to have for its exclusive conduct and rejects them because the justifications arent credible or their are less restrictive alternatives. For instance, even if the integration of Windows and IE is beneficial to users, MS does not need to have agreements with OEMs disallowing the removal of IE since IE can be removed without impairing Windows functionality. A competitive market should be allowed to decide.

Consistency of start-up experiences is difficult to believe as a justification, since MS allows many modifications of the initial boot sequence and desktop. Also, this justification doesnt explain why OEMs cant promote third party brands but can promote their own.

Having a consistent platform for software developers is not a convincing justification because important shared files can be left in the OS. Furthermore, the IE icon can be removed, but the IE functions can remain for programmers. Older versions of Windows force developers to include necessary program libraries with their software.

Maintaining high quality can be achieved through preventing only modifications that impair the ability of software developers to access Windows APIs.

MS doesnt need restrictions to prevent the reduction of quality. The competitive market will take care of OEMs, for example that produce low quality products. Also, MS can require an OEM to label its changes so the users know whom to blame if theres a problem.

Instead of making restrictive arrangement in exchange for desktop real estate, MS could simply get money for this valuable commodity.

***Some of My Reactions*** From the DOJ perspective, WBs testimony has some flaws. He makes too many broad assertions with little support.

I can accept as reasonable his story that MS is using tying and other exclusionary practices in a predatory fashion to gain market share in browsers to protect its OS monopoly. But his claim that MS is attempting to monopolize the browser market for its own sake by tying and predatory pricing (among other things) doesnt work well, in my opinion, especially as I am not convinced by WBs assertions that there are high barriers to entry in the browser market. It doesnt make sense to me that a monopolist would leverage his monopoly power in the tying market to force people to buy the tied product for free. Instead of telling one coherent economic story based on the facts, he seems to be analyzing in the alternative.

-- Anonymous, December 04, 1998

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