The first antitrust case against Microsoft took place from 1990 to 1992. During that time, the Federal Trade Commission (FTC) examined whether Microsoft was engaging in the foreclosure of the software market. The suit against Microsoft was brought by IBM, which complained that Microsoft’s dominance of the operating systems prevented IBM’s allegedly superior OS 2 operating system from gaining a foothold. The FTC failed to find any evidence of this foreclosure, however, and dropped the case. Microsoft was not found guilty of engaging in any unfair market practices; rather, the market was simply characterized by extremely strong competition.
After the FTC dropped the first Microsoft antitrust case, an unprecedented event took place. Historically, the FTC and the Department of Justice (DOJ) held to an agreement whereby each agency was given oversight over a particular group of industries to the exclusion of the other. But in 1993, after Bill Clinton assumed the Presidency, the Department of Justice took over the case from the FTC – under the leadership of Anne Bingaman, the Clinton administration’s chief antitrust enforcer. The DOJ officials recognized that the high-tech industry would have a tremendous impact on the future and thereby decided to assume enforcement of antitrust policy over that industry. The DOJ obtained all of the Microsoft case documents from the FTC and pursued the case for several more years.
In 1994, the FTC charged Microsoft with several antitrust violations, which were resolved via a consent decree whereby Microsoft agreed to end certain questionable practices. For instance, Microsoft would not longer charge computer manufacturers fees per processor sold and per computer shipped – even if the computer in question had no Microsoft software on it. Instead, the Department of Justice mandated that Microsoft only charge for computers that had Windows on it. Furthermore, Microsoft was to cease requiring computer manufacturers to sign certain exclusionary agreements.
Microsoft would abide by the terms of this consent decree. In the meantime, the computer world began to change rapidly as increasing numbers of people began to use e-mail and the Internet. Microsoft had introduced its Windows operating system first as an add-on to MS-DOS. Microsoft also faced allegations of improper conduct for Apple, which claimed that Microsoft copied many of Apple’s innovations to incorporate them into its own software. However, Apple’s computers at the time were not nearly as powerful as Microsoft’s, and PCs were much more useful for performing calculations and other operations. Therefore, Microsoft could not have copied any of Apple’s innovations as such. Rather, Microsoft provided products that greatly improved over what Apple had to offer.
With the rise of the Internet, the browser became an increasingly vital tool. Netscape was one of the first companies to produce a browser – first the Mosaic and then the Navigator. Netscape initially sold the Navigator for around $30 to $40 and had 100 percent of the market share for browsers. Microsoft approached Netscape and offered to cooperate on the next version of its browser. Netscape refused, and Microsoft decided to compete instead. During the next several years, Microsoft introduced its own browser, the Internet Explorer, for free; anybody could download the Explorer at no charge. Microsoft further began bundling the Explorer with Windows, which had become a free-standing system by that time.
Netscape complained of Microsoft’s bundling practices to the antitrust authorities at the Department of Justice, arguing that Microsoft violated the 1994 consent decree. However, the courts decided in favor of Microsoft.
In 1998, the DOJ filed a new suit against Microsoft, based on the following allegations:
1. Microsoft had a monopoly in the operating systems market.
2. Microsoft used this monopoly to gain an advantage in the browser market.
3. Microsoft engaged in illegal exclusive dealing agreements with PC manufacturers and internet service providers.
Netscape complained that it was foreclosed from competing because Microsoft’s exclusive dealing arrangements forced PC manufacturers to leave off the Navigator from their computers. But these allegations were false. Microsoft never forbade any PC manufacturers from including the Navigator. Microsoft simply requested that only the icon for Microsoft Internet Explorer and not the icon for the Navigator appear on the startup screen the first time that users turned on the computer. To allege that this was a barrier to entry is ludicrous, as computer users could have easily created an icon for Navigator if they so wished.
Furthermore, Netscape relied on the insistence of many computer experts that its browser was a superior product compared to Explorer. However, most consumers thought differently from the experts. Netscape added numerous features to the Navigator that rendered it appealing to particularly technically minded people but also rendered it extremely slow and unintuitive to use. Consumer preference for the simpler, faster, more streamlined Explorer was overwhelming.
In 1999, District Court Judge Thomas Penfield Jackson decided that Microsoft had 92 percent of the relevant market share in the operating systems market – thereby having a monopoly in said market. Government lawyers convinced Jackson to use a highly constraining market definition which only considered operating systems based on Intel microprocessors. This definition automatically excluded operating systems based on Apple and Sun Microsystems computers; if these operating systems were considered, Microsoft’s market share would decline to about 70 percent.
In 2000, Jackson ruled that Microsoft was engaged in monopolizing behavior and ordered a breakup of the company; Microsoft immediately appealed, and the Circuit Court of Appeals reversed Jackson’s ruling and insisted on a compromise agreement.
In 2001, a settlement was reached, whereby Microsoft agreed to cease its former requirements of PC manufacturers – the very requirements that brought on the DOJ’s lawsuit. But Microsoft was permitted to continue to bundle Windows with Explorer and to pursue further product innovations in a relatively unhampered manner.
The Department of Justice made two claims during the course of the Microsoft case. First, it alleged that Microsoft took unfair advantage of network effects. The idea behind network effects is that larger user networks extend the benefits of a particular product, such an operating system. This extended benefit leads to even larger networks and profits for the network owners. Network effects were claimed to be in full force with respect to Windows, as it was expensive to develop several different applications for different operating systems, and most software developers would just develop applications for Windows. According to government attorneys, this fact gave an unfair advantage to Microsoft.
Dominick T. Armentano, author of Antitrust: The Case for Repeal, disagrees. He notes that business history is littered with the corpses of “first-movers,” the people who introduced various product networks. Network effects are insufficiently powerful to protect a firm from a more innovative rival producer. Furthermore, network effects are benefits of the competitive process to consumers, who can get a much wider variety of software choices without having to train themselves to use many different operating systems. The gain from these benefits should rightly flow to the innovators who made them possible. To punish Microsoft for this improvement in consumer well-being is absurd.
The second claim made by the Department of Justice against Microsoft relies on the idea of path-dependence. Government lawyers claimed that Windows was not the best technology available, but there existed path-dependence on it, implying that consumers could not readily switch to a superior operating system.
The path-dependence view holds that superior products may not ultimately win out due to the lock-in effects that maintain the dominance of previously introduced products. For instance, the QWERTY keyboard was claimed to be inferior to the Dvorak Keyboard – which allegedly failed to gain acceptance solely as a result of path-dependence. However, economists Margolis and Liebowitz decided to explore this claim and found that all of the studies that claimed the superiority of the Dvorak keyboard were conducted by its inventor, August Dvorak, himself. Dvorak’s studies were subject to numerous experimental and methodological errors and the studies’ design essentially set Dvorak up for success. Subsequent more scientific studies found that Dvorak keyboards may offer slight speed advantages, but these are outweighed by the cost of learning to use the new keyboard – since many people are already nearly as fast at using a QWERTY keyboard as they would be if they used a Dvorak keyboard.
Another alleged example of path-dependence is the ultimate victory of VHS tapes over Beta tapes in the 1980s. Beta tapes were smaller and more compact than VHS tapes; they furthermore had higher picture quality. Some claimed that path-dependence led VHS – an inferior product – to win out over Beta. However, this need not have been the case at all. Beta tapes had a major downside: one tape could only fit in 90 minutes of film at most, whereas VHS tapes could fit in anywhere from 120 to 135 minutes. Thus, it was much costlier to release longer films on beta tapes than on VHS tapes. Beta tapes did find their niche in television newsrooms, where their smaller film storage capacity was not a problem, since news stories tend to be substantially shorter than 90 minutes.
The strongest claim path-dependence theorists can successfully make is that history matters in determining which products will be adopted by the market. This by no means implies that there exists some kind of “market failure” or that Microsoft committed any kind of misconduct. After all, Microsoft was engaging in behavior the improved the welfare of consumers; it integrated a tremendous range of application software at minimal cost to users, and it did this without government helps. Microsoft readily gives licenses for the use and distribution of its products and has not tried to artificially restrict output and raise prices.
Despite its clearly benign behavior, Microsoft has again come under fire – this time from European Union antitrust authorities, who have recently become substantially more stringent than their counterparts in the United States. Tragically enough, EU antitrust policy may soon limit the options available to consumers in America and in the rest of the world.
Pongracic, Ivan. Lecture on Horizontal Mergers and Armentano’s Antitrust: The Case for Repeal. Hillsdale College. Hillsdale, MI. November 29, 2007.
All lecture material is used with explicit permission.