Economics of Networks

The Judge's Findings of Fact:

Very Preliminary Analysis and Reaction

Last Updated: 11/10/1999

Disclaimer: I am not now and have never been involved in any litigation involving Microsoft.

The judge's findings of fact (released November 5, 1999) find for the plaintiffs (US Department of Justice and 19 States) in almost all the allegations against Microsoft. The judge finds:

  • Microsoft has a monopoly in the PC operating systems market where it enjoys a large and stable market share
  • Microsoft used its monopoly power in the PC operating systems market and harmed competitors
  • Microsoft hobbled the innovation process
  • Microsoft actions harmed consumers
  • Various Microsoft contracts had anti-competitive implications

    I discuss below the expectations, and the consequences of the judge's decision on the findings of fact. Separately, I discuss and criticize the judge's finding of fact that consumers were harmed as a result of Microsoft's actions. See Is the Microsoft ruling a "great victory for American consumers?"

    Background and Expectations of the Judge's Ruling of "Findings of Fact"

    When the judge announced some time ago that he would release his decision on findings of fact before his decision on the findings of law (which are typically released together), many thought that the judge's decision on the findings of fact would be moderate, and the two parties would be urged to settle the case before the findings of law. The incentive for Microsoft to settle before the findings of law are released would have been to reduce the probability of civil antitrust suits that would be based on a decision by the judge that found Microsoft guilty of monopolization and other wrongdoings. (Remember the judge's findings of fact do not yet constitute a conviction.) There are two incentives for settling by the plaintiffs. First, there does not seem to be a remedy that would take care of the antitrust problems without creating possibly bigger efficiency losses (see further analysis below). Second, it is desirable to reduce the expenditure of the public's money. Thus, on the eve of the judge's decision on findings of fact, the expectation was that the decision would be moderate, so the parties would settle. The decision was expected to be adverse for Microsoft because the judge had let it be known that the decision would be announced on a Friday at 6:30, after the close of most US financial markets. Hence, the judge was expected to rule moderately for the plaintiffs.

    The Aftermath of the Judge's Decision

    Quick Settlement is Unlikely

    The "findings of fact" as decided by the judge on November 5, in almost all points, are favorable to the plaintiffs. In fact, it is hard to find even one major allegation for which the judge did not decide on facts that directly support the plaintiffs' positions. Given the across-the-board siding of the judge with the plaintiffs, a negotiated settlement seems extremely unlikely in the short run. The terms of a settlement would be based on the "findings of fact" that are very adverse to Microsoft. Microsoft is unlikely to settle on terms implied by such adverse findings. Moreover, in a similar case about 15 months ago, the Appeals Court ruled that Microsoft had the right to include whatever it wanted in the PC Operating System, including its browser. So, Microsoft can reasonably expect that the same Appeals Court will rule similarly on appeal, reversing a significant part of the findings of fact of Judge Jackson. On the other side, there are 20 plaintiffs (USDOJ and 19 States). It would be hard for all 20 to agree on major concessions in settlement talks given the very favorable findings fact. Thus, Microsoft is likely to wait for the final ruling on liability, fight the remedies battle, and keep appealing.

    There are two additional factors that make it more likely that Microsoft would prefer to wait. First, Microsoft has argued in court that the landscape changes quickly and radically in the software industry, citing the Netscape buyout by AOL and Sun. The longer the duration of the case, the more likely it is that more such radical changes will happen before the final decision is made. Second, it is likely that the final appeal will end during the next US Administration. This can only be beneficial to Microsoft, since a different Administration may be much softer on antitrust issues.

    Remedies: What Criteria Should be Applied

    A number of remedies have been informally proposed by sources close to DOJ. These remedies range from mild to very severe. The various remedies also differ to the extent that each deals with horizontal (within the same market) or vertical (across complementary markets) issues.

    In defining remedies, the following criteria should apply. First, appropriate remedies have to be proportionate to whatever liability is finally established. Second, remedies also must be consistent with a strategy that prevents Microsoft from repeating whatever activity is found to be illegal in the case. Third, remedies have to be in the public interest and should help rather than harm consumers. In other words, the treatment should heal rather than kill the patient. Fourth, remedies should minimize other interference in Microsoft's business, and in the business of the rest of the computer industry.

    Thus, when defining remedies one has to consider

    1. what specifically Microsoft is convicted of doing illegally;
    2. which specific remedies would prevent Microsoft from committing the same crime or crimes again in the future;
    3. which remedies help consumers;
    4. which of these remedies creates the least interference in the legitimate business of Microsoft and the rest of the computer industry;
    5. which remedies preserve and enhance incentives for innovation and technological progress.

    Two more issues need to be clarified. First, in discussing whether or not a remedy helps consumers, one has to consider its effects on prices, on compatibility, on variety and quality, and on the speed of innovation. Second, long before the present antitrust suit took shape, a loose coalition of IBM, Sun, Oracle, and Netscape was formed to fight Microsoft. This coalition has played a very significant role in bringing antitrust issues involving Microsoft to the attention of Congress and DOJ. In many ways, this coalition helped DOJ create and fight the case against Microsoft, even providing the idea of the Boies-Fisher team that had fought for IBM in the antitrust suit of USDOJ against IBM in the 70s. At the time of the remedies determination, it is crucially important that remedies are not imposed for the benefit of competitors (including those of this coalition) but rather for the benefit of the consumers and competition.

    Remedies' Proposals and Evaluation

    The following proposals have been made:

    1. Impose various restrictions on the contracts that Microsoft can write with sellers of complementary goods and with competitors. This is a likely remedy that is easy to tailor according to the violation.
    2. Force Microsoft to disclose the APIs (definitions of the interface) that allow it to include Internet Explorer in the operating system. Microsoft routinely discloses APIs that hook applications to the operating system and allow for interoperability. Currently, Microsoft does not disclose the APIs that tie together parts of the Windows operating system, which includes Internet Explorer. If the APIs that hook Internet Explorer to other parts of the operating system are disclosed, Netscape (and any other browser) can get the same interoperability with Windows as Internet Explorer. Such disclosure would solve all technological bundling problems.
    3. Force Microsoft to give away the Windows source code, or license it to successful bidders in an auction imposed by the government on Microsoft. Windows code may be worth as much as $200 billion. No company can bid that much. Practically speaking, only a handful of foreign governments can bid that much. This implies that the source code of Windows will be sold forcibly at a small fraction of its worth. Thus, this is a severe remedy that takes away the intellectual property of Microsoft. It will severely reduce the incentive for innovation, since dominant firms will no longer be guaranteed with certainty the value of their intellectual property. Moreover, source code evolves in time. Over time, different firms will add to and alter the Windows code. Soon, incompatibilities will arise. Applications vendors will have to write different applications for each version of the evolving version of Windows. It was exactly this problem that made Unix a failure in the individual consumer market. It is unlikely that all applications will be written for each of the incompatible versions of Windows. If, when there are three incompatible versions of Windows, each version has 1/3 of the applications, the benefits to a consumer from using a PC are reduced by 66%! By no means would this be a victory for the American consumer! In summary, auctioning the Windows code will result in incompatibilities that harm consumers and increase the cost of applications.
    4. Break up Microsoft according to lines of business. This remedy is favored by the software association. Remedies that break up a company in any form are very severe. They are likely to severely damage the company, and they usually accomplish little or no more than alternative remedies. Microsoft is an entrepreneurial company that is run by very few top executives (about twenty). This makes it flexible and efficient, qualities that the DOJ should try to preserve, although Microsoft's competitors would probably like to extinguish. Breakup along lines of business is a very severe remedy. Its function can be accomplished by disclosure of APIs instead.
    5. Break up Microsoft in three equal parts, with each part containing an equal amount of each business. Like other breakup proposals, this proposal may kill the managerial flexibility and efficiency of the company. Moreover, as with the auctioning the code proposal, one expects that significant incompatibilities will result within a short period of time. Incompatibilities harm consumers by significantly reducing the benefits that consumers get from applications, as explained above and by increasing the cost of applications. Finally, it is unlikely that this industry structure will result in significantly lower prices, since Windows prices are presently low, and each of the resulting three companies will have a much smaller scale of production. From a legal standpoint, this proposal has the weakness of also breaking up the applications division of Microsoft, although monopolization has not been established in applications.
    6. Break up Microsoft along lines of business (operating systems and applications) and then break the operating systems division in three equal parts. Like other breakup proposals, this proposal may kill the managerial flexibility and efficiency of the company. It is also likely to result in incompatibilities, as explained above, with significant reduction of benefits to consumers, and increases in the costs of application development.

    Preliminary Conclusion

    If the findings of law follow the findings of fact, and if the judge's decisions are upheld on appeal, the most appropriate remedy is the imposition of contract restrictions and possibly opening of the APIs that allow the Internet Explorer to hook to other parts of the operating system. Breakup of Microsoft is likely to create more damage than benefit, resulting in inefficiencies, incompatibilities, fewer applications available to each PC, and higher prices. Auctioning of the Windows source code will result in all the problems of a breakup of Microsoft, as well as severely discouraging future innovation.


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