Is the DOJ on the right track?

By Lewis A. Mettler, Esq.

This article will discuss a few antitrust concepts that may be present in the consumer OS marketplace but that have not been addressed by the DOJ complaint. It is possible that after discovery has been completed this may change.

The DOJ complaint makes the following allegation or observation in paragraph #120.

"120.One consequence of tying Internet Explorer to Windows is that the Internet browser is made available to purchasers of Windows at no additional charge. Microsoft is devoting more than a thousand people and hundreds of millions of dollars to various aspects of browser development, and Microsoft has recognized that it would ordinarily be desirable for the company to earn a direct return on some of this investment by charging customers of Windows 98 separately for Internet browser functionality. Even though the leading browser supplier (Netscape) was charging OEMs for its browser, Microsoft made a decision to forgo the revenue that would have resulted from charging separately for Internet browsing functionality in Windows in order to gain Internet browser market share and exclude competition."

''121.Microsoft could have charged for Internet Explorer separately, and it considered doing so. Microsoft's Vice President of Advanced Technology Sales Cameron Myhrvold testified that there was "a time where we thought we could charge for the browser" but that view was disavowed "quickly." (C. Myhrvold 4/24/98 Tr. 74). A proposal to separately price the "Active Desktop" shell (believed at the time to be an important way for Windows 98 users to use IE for web browsing) was made by Microsoft's Joe Belfiore and supported by Microsoft's Moshe Dunie. Microsoft Group Vice President Paul Maritz acknowledged that the proposal was "tempting" and "had merit" but ultimately rejected it because requiring customers to pay for the "shell" would impair Microsoft's ability to achieve its "number 1 goal" of becoming dominant in the Internet browser market. ''

Despite the above allegations I observe that perhaps Microsoft is in fact charging for IE as it is bundled with 98. The above quotes in #121 relate to the decision not to charge extra for IE or to make it an option. But, they do not rule out the following scenario.

The DOJ complaint does allege that hundreds of millions have been spent by Microsoft in R&D for the browser and its integration or bundling with 98. If we look at the relative dollars spent on R&D for the core OS functionality and the R&D related to the browser, it is possible to derive a ratio between them. Publicly, I have already estimated this ratio as 30/70. 30% of the R&D for the core OS and 70% for the browser and its incorporation into 98. Since Microsoft has not published R&D figures as between these two products (and is not likely to do so willingly) we may never know the accuracy of this estimate. (I do not know if the DOJ is going to elicit this information from Microsoft employees during depositions or other discovery).

However, I do not believe that the price of the 98 product is being totally allocated to the OS and not in part being attributed to the browser. Again, if you read official announcements from Microsoft (see latest financial report supplementary comments), no revenue is being attributed to the browser except for consideration as part of the "unearned revenue" which also covers such things as uncharged for support and training, etc. However, this is a representation completely within the control of Microsoft (and of course its attorneys). It does not necessarily reflect any pricing or bundling decision that may have been made in consultation with economists, etc. (Do monopolists really hire economists to tell them what they can get away with in the market?) Allocating 20% of the OS revenues as "unearned revenue" may be standard practice in the industry. Not charging anything for a product attached to a dominate one may be more of a marketing ploy than an accurate representation of reality. Microsoft does now consider the browser market to be extremely important to them. (Whether they are in fact giving it away or just selling it with a promotional campagne claiming it to be free is the question presented by this document.)

If one can show that Microsoft has a monopoly in the consumer OS market, then Microsoft should have associated powers. Such powers include the ability to overcharge for products or to bundle a lessor product with a dominate one and force the sale of both at combined but normal prices. Microsoft claim that there is only one product is false. Looking at the source code that may be the case. But products are defined by the perception in the market not some jimmied source code. (I can personally modify the code for the Flight Simulator and Accell so that neither can run by themselves, but that does not mean they would be one product.)

So the question is whether Microsoft is charging $100 for 98 and $0 for IE, or in the alternative, if they are charging $30 for 98 and $70 for IE. The two products are effectively bundled. Under either plan the total price for the upgrade product would be the $100 or so as announced by Microsoft. One could argue that either plan could succeed in the market. Does it matter which is the case? To Microsoft, the answer is no. To the consumer, the answer is yes. But, would Microsoft really give away a major product if it could sell it instead? If the price for the old Windows 95 product is only being maintained due to the addition of the browser, then maybe the separate prices are $30 and $70 for the OS and IE respectfully. Whether Microsoft could consistently charge $100 for an upgrade OS or $200 for a full license (without a bundled browser) is a question that economists would have to address. If a fair price for an OS is only about $30 or so today, then maybe Microsoft can only get $100 for the upgrade either by exercising its monopoly power and forcing the price or by bundling an application with the OS (which would also be exercising its power). Microsoft has been able over the years to maintain a relatively consistent price for its consumer OS. But, many would argue this has only been the case due to the practice of continally adding additional functionality to the OS. Whether this is "product improvement" or "bunding precluding competitors" is a real question.

Well. If reading the complaint is any indication, the DOJ is accepting the former ($100 & $0).

I think that the DOJ may be missing an opportunity by making such an allegation or observation. Or, they think that suggesting only the zero price for the browser makes a stronger case than offering both alternatives (price manipulation and zero prices verses fair prices for two bundled products).

If you assume that no price is being paid for the browser (certainly this is Microsoft's position), then Microsoft can argue (in court and in public) that no one is being harmed by the exercise of monopoly power. After all, how can a "free" product be harmful to the consumer? Of course, the argument can be made that the browser is free now and will have a price attached to it later. And experts can easily testify that to establish a market presence sometimes products are given away for a short while(legal act or not). Either way harm to the consumer must be proven by the DOJ.

However, I would argue that Microsoft could be (and may be) charging a price for the browser now. I have not seen any comments from any Microsoft employee to this effect. But, the public does not yet have access to all of the discovery material nor is it likely to get full access. If however, Microsoft does have a monopoly power they could either be overcharging for 98 (from $30 to $100) or simply bundling IE with 98 ($30 + $70). Certainly, evidence would have to be produced supporting this position. And, economists would have to testify that such a plan would be able to succeed if implemented. I happen to think that such a plan could be supported by the market and in fact has been implemented by Microsoft.

What is the real difference between those two alternatives? The second, combining the $30 OS with the $70 browser would show real financial harm directly to consumers who are buying the products today. Being forced to install a free application and take up disc space is one thing. Being forced to purchase a $70 application, install and maintain it is quite another. Convincing the court that future harm may result is very different than showing present financial harm. Courts have accepted arguments that even low prices by a monopolist can harm consumers in the long run due to the effect it has on keeping competitors out of the market. But, showing direct financial harm to present consumers is stronger.

Again, I present this view or perspective on the case because I do not see it being offered by the DOJ complaint. Could it be? Should it be? Would this alternate approach to the case be appropriate for an action under the antitrust laws? Would separate causes (one alleging a free product and another alleging a bundle of priced products) be inappropriate? My guess is not. However, the evidence for the bundle of priced products may be more difficult to come by. Perhaps not for the economic aspects of the position, but, trying to show intent to sell two separate products for money as a package might be difficult. Certainly, the desire and need to sell the browsers to the consumer is present. And the desire by Microsoft to be paid for products it develops would be easy to show. But, showing that the separate products are being sold at fair prices (only available as a bundle to force the sale and preclude competition) may be more difficult. Presenting sufficient evidence to support a finding by the court may not be too difficult. In many ways, $30+$70 is more believable than $100+$0. (this despite the fact that the browser is given away for the Solaris, HP-UX and Mac, which are lessor markets, and that some versions can be downloaded without charge - of course 98 is not subject to downloading..for the OS and IE in 98, you must pay money)

Lewis A. Mettler, Esq.