In 1997, in one of the most ambitious

anti-trust actions of the 20th century,

the United States Department of Justice

and the Attorneys General of 19 States sued Microsoft.

Just as they had with John D. Rockefeller’s

Standard Oil and American Telephone & Telegraph

(AT&T), the government’s lawyers launched

an all-out assault on the nation's

most valuable company.

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side from inviting unwel-come comparisons betweenMicrosoft founder Bill Gatesand John D. Rockefeller –the richest men of their

respective epochs – the Microsoft casehas captured a great deal of attention.And when Microsoft refused to settle,the case went to a lengthy and closelywatched trial, with an all-star witnesslist that included Gates himself as wellas other computer industry luminaries.

U.S. vs. Microsoft raised seriousissues. The government had chargedMicrosoft with a range of abuses,including the alleged monopolizationof the market for operating systems(“OS”) for personal computers byWindows, anti-competitive bundlingof Internet Explorer with Windows,and various other exclusionary andanti-competitive acts against com-petitors and buyers.

In December 1999, U.S. DistrictCourt Judge Thomas Penfield Jacksonissued a far-reaching “findings offact” that found for the plaintiffs inalmost all the allegations. (The judge’sfindings of law, expected by the end ofMarch, will most likely rule the same

way.) Jackson found, among otherthings, that:

➣ Microsoft has a monopoly inthe PC operating systems marketwhere it enjoys a large and stablemarket share;

➣ Microsoft used its monopolypower in the PC operating systemsmarket and harmed competitors;

➣ Microsoft hobbled the inno-vation process;

➣ Various Microsoft contractshad anti-competitive implications;

➣ Microsoft actions harmedconsumers.

These findings by no means sig-naled the end of the case. But theyprovide important guidance for theultimate outcome, which will definethe value of Microsoft and the com-puter industry’s rules of competitionfor years to come.

What next? Given Judge Jackson’sacross-the-board siding with theplaintiffs, a negotiated settlementseems extremely unlikely in the shortrun, even though Judge RichardPosner, a prominent antitrust scholar,was appointed as a mediator. For anysettlement would be based on

Jackson’s “findings of fact,” whichwould make Microsoft unlikely to set-tle. Instead, the company will proba-bly exhaust all appeal possibilitiesand try to settle the case after thePresidential election.

Microsoft has already sufferedsubstantial fallout from the process,however. The company has essentiallyforesworn making any aggressivemoves while the case continues. Soeven as America Online (AOL) agreedto buy Time Warner, and as compa-nies in a range of industries continuedto strike alliances and merge,Microsoft has largely been forced tostay on the sidelines.

Microsoft’s future will be verybleak if the Department of Justiceprevails and breaks it up. Threebreak-up plans have been proposed.In the first, Microsoft would be divid-ed along lines of business into threecompanies: one for operating systems(Windows 98, NT, and 2000), one forInternet applications (InternetExplorer), and one for other applica-tions (MS-Office, MS-Money, etc.).The second plan would separateMicrosoft into three “identical” parts,

THE REAL LOSERS IN THEMICROSOFT

ANTI-TRUST CASEBy Nicholas Economides

The government’s crusade against Microsoft and the world’s richest man could end up costing customers and

the computer industry dearly.

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with each part acquiring thesource code of all the programsthe company presently sells andone-third of all employees. Theseprospective entities have beendubbed “Baby Bills.” The thirdplan is a combination of the pre-vious two: First Microsoft wouldbe divided into three companiesaccording to the type of programproduced, and then the operat-ing systems company would bebroken into three parts, thus cre-ating five Baby Bills.

Microsoft views the breakupattempt as a very serious threat.Steve Ballmer, Microsoft’s newchief executive officer, noted athis appointment ceremony thata break-up “would be utterlyirresponsible.” Such a movewould undoubtedly cause greatinconvenience and challenges toBallmer and his colleagues. Butwould it have a similarly negativeeffect on Microsoft’s customers andshareholders? The answer: Yes.

First, consumers have directlybenefited from the free distribution ofInternet Explorer and the bundlingof Internet Explorer with Windows –two tactics that Judge Jackson iden-

tified as keyanti-competi-tive actions.When Microsoftstarted seriouslycompeting withNetscape in the

Internet browsermarket, Netscape– essentially thesole provider –charged non-academic users$40 - $50 todownload thep r o g r a m .

Microsoft, by contrast,

gave its Internet browser away.Today, with at least 40 million

browsers installed in the UnitedStates, the actions of Microsoft creat-ed a direct benefit of $1.6 to $2 bil-lion to American consumers. Andsince Microsoft’s actions intensifiedcompetition, which in turn producedhigher quality browsers, they provid-ed further value.

Second, consumers have directlybenefited from the relatively low priceof Windows. Microsoft’s operatingsystem, for which computer manufac-turers pay $40-$60 per copy, is cheapcompared to the historical and cur-rent prices of other operating systems.For example, in the late 1980s, IBMsold OS/2 (which ran many fewerapplications than Windows) for hun-dreds of dollars. Some Linux pack-ages – essentially add-ons to the freeLinux source code – currently sell for$150, and run far fewer applicationthan Windows does. These price dis-

crepancies highlight a huge con-tradiction in the government'scase and in the judge’s findingsof fact. If Microsoft were a truemalevolent monopoly, it wouldcharge far more for Windowsthan it does. The annual con-sumer benefits from Windows’relatively low price may be manybillions of dollars.

In arguing for a break-up,some Microsoft critics point to thesuccessful 1982 break-up ofAT&T. The company was dividedinto the long-distance company(AT&T) and seven regionaloperating companies, each ofwhich remained a regulated localtelecommunications monopoly.The destruction of AT&T’s long-distance monopoly encouragedcompetition, which broughtsharply lower prices and

immense consumer benefits.However, there are a number of

key differences between the two com-panies and their competitive situa-tions. And these differences make itvery likely that a Microsoft breakup,besides harming Microsoft, wouldharm consumers and the computerindustry.

In 1981, AT&T was a 100-year-old company with many layers ofmanagement. For historical reasons,the local phone companies withinthe old AT&T, such as New YorkTelephone, were managed separately

from the “long lines”division. Thus, it wasnot difficult to separate

the divisions sincethey functioned

on many

“Microsoft has already suffered

substantial fallout from the process. . .

even as AOL agreed to buy Time Warner,

and as companies in a range of indus-

tries continued to strike alliances and

merge, Microsoft has largely been forced

to stay on the sidelines.”

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levels as separate companies.And AT&T’s rigid managementstructure and abundance of man-agers helped it avoid managerialproblems in the break-up.

By contrast, Microsoft is ayoung, entrepreneurial companyrun by very few top executives(about 20), and its divisions arevery fluid. While this has madeMicrosoft one of the most efficientand successful companies around,it also means that a break-upwould pose significant managerialproblems and severely reduce thecompany’s flexibility.

Second, the industries are differ-ent. Telecommunications companiesare regulated as public utilities. In the1930s, all phone companies wereforced by the government to intercon-nect so that anyone could place a callto anyone else. The companies emerg-ing from the AT&T breakup wereguaranteed to stay interconnected.

By contrast, it is almost certainthat each of the Baby Bills, within afew months after a Microsoft break-upinto three identical parts, would beginproducing its own “improved” ver-sion of Windows. Each would likelybe incompatible with the Windows ofthe other two baby Bills. Some soft-ware vendors would write programsthat would be compatible with eachversion of Windows, while othersundoubtedly would not. This wouldinevitably reduce the range of soft-ware that would be compatible withconsumers’ computers.

Emerging incompatibilities wouldalso hurt shareholders, since the com-bined value of the resulting Baby Billswill be smaller than that of the origi-nal Microsoft. The situation wouldalso be a nightmare for corporate ITdepartments until, in a few years, oneof the three Microsofts becomes the

dominant platform.Three alternatives to a far-reach-

ing breakup have been proposed. Andthey may offer a set of more reason-able alternatives.

One is auctioning the Windowssource code. Given the present stockmarket value of Microsoft, Windowssource code may be worth as much as$200 billion. No company can bidthat much cash in an auction.(Practically speaking, only a handfulof foreign governments could.) Thisimplies that the source code ofWindows will be sold forcibly at asmall fraction of its worth, and thatwould severely reduce the value ofshareholders’ equity. Auctioning theWindows code would not only effec-tively confiscate Microsoft’s intellec-tual property, it would also seriouslyreduce the incentive for innovation.Moreover, source code evolves. Overtime, different firms will add andalter the Windows code. Soon, incom-patibilities will arise, with all the neg-ative consequences described earlier.

A second solution would be toforce Microsoft to disclose the so-called “APIs” (lines of software codethat define interfaces between appli-cations) that permit it to includeInternet Explorer in the operatingsystem. Microsoft routinely disclosesAPIs that hook applications to theoperating system and allow for inter-

operability. Currently, it doesnot disclose the APIs that tietogether parts of the Windowsoperating system, whichincludes Internet Explorer. IfMicrosoft were to disclose theAPIs that hook InternetExplorer to other parts of theoperating system, Netscape(or any other browser) couldget the same interoperabilitywith Windows.

A third solution – and inmy mind, the best – would be to con-sider imposing various restrictionson the contracts that Microsoft canwrite with sellers of complementarygoods and with competitors. This isa likely remedy that is easy to tailoraccording to the violation.

This remedy, combined with forc-ing Microsoft to disclose certain APIs,should be sufficient to guarantee thatMicrosoft will be precluded from tak-ing anti-competitive actions. At thesame time, it preserves the managerialand other benefits that have madeMicrosoft one of the most successfuland profitable companies ever.

Regardless of the final outcome,the effects of U.S. vs. Microsoft arelikely to be felt for a long time. A far-reaching break-up would likelyimpose the dark shadow of radicalantitrust intervention on the wholecomputer industry. And if the JusticeDepartment wins big on Microsoft,anti-trust suits against AOL, Yahoo,and other pioneers of the NewEconomy will not be far behind.

For more information, see the“Economics of Networks” Internetsite at http://www.stern.nyu.edu/networks.

NICHOLAS ECONOMIDES is professorof economics at Stern.

“[A break-up] would

undoubtedly cause great

inconvenience and challenges

to Ballmer and his colleagues.

But would it have a similarly

negative effect on Microsoft’s

customers and shareholders?

The answer: Yes.”

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