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The Effect of Microsoft's Monopolistic Approach to Software Bundling on Innovation and Competition.
Chapter 1 – Introduction
When mentioning Microsoft, one's thoughts naturally turn to computers, as the two are inexorably tied together. And while they both need each other, software was the latter development in this marriage of needs. Based upon digits, computers utilize this foundation as the basis for their computations (Berdayes, 2000, p. 76). A digit is a “… numeral … that represents an integer …” and includes … any one of the decimal characters ‘0' through ‘9' …” as well as “… either of the binary characters ‘0' or ‘1' …” (Atis, 2005). Computers utilize digits under the ‘base-2 number system', which is also termed as the ‘binary number system' (Berdayes, 2000, p. 3). The base-2 system is utilized in computers as it implements easier with present day technology. A base-10 system could be used, however its cost in terms of technology innovation would make computers prohibitively expensive (Berdayes, 2000, pp. 53-56). Via the utilization of binary digits as opposed to decimal digits, bits thus have only two values, ‘0 and 1' (Barfield and Caudell, 2001, p. 344, 368). The preceding is important in understanding the relationship of numbers to computers as well as Microsoft's later entrance into this world. The following provides a visual understanding of how this works:
Table 1 – Decimal Numbers in the Binary System
(Swarthmore University, 2005)
Decimal Number Binary Number
0 = 0
1 = 1
2 = 10
3 = 11
4 = 100
5 = 101
6 = 110
7 = 111
8 = 1000
9 = 1001
10 = 1010
11 = 1011
12 = 1100
13 = 1101
14 = 1110
In computers, bits are utilized in conjunction with bytes, which are represented as ‘8-bit bytes' that work as follows:
Table 2 – 8 Bit Bytes
(Barfield and Caudell, 2001. pp. 50-54)
Decimal Number Bytes
0 = 0000000000000000
1 = 0000000000000001
2 = 0000000000000010
65534 = 1111111111111110
65535 = 1111111111111111
The earliest computer has been traced back to the ‘abax', which is the Greek word that describes ‘calculating board' as well as ‘calculating table' which as invented in China and called the abacus, it was also used in ancient Greece, the Roman Empire, Russia, Japan, and is still in use by the blind (qi-journal.com, 2005). Operating much as the bits and bytes in the modern computer, the abacus has a vertical row of beads that represent multiples of 10, 1, 10, 100, 1,00 and so forth (qi-journal.com, 2005). The basic principle of the abacus operates in much the same manner as the modern computer, through numerical representation. The first generations of modern computers were huge in comparison with today's small, powerful and fast machines, and needed air-conditioned rooms to dissipate the heat. Programming on the first commercial computer in 1951, the UNIVAC, was a group of related mechanisms driven my mathematical equations that had to be written in order for the UNIVAC to work on problems (hagar.up.ac.za, 2006). It would take another 6 years for the first personal computer to be developed, the IBM 610 Auto-Point, which was termed as a ‘personal computer' because it only took one individual to operate it, however, the cost in 1957 termed at $55,000 translates in to well over $100,000 in today's value (maximon.com, 2006).
In 1975 saw the introduction of the Altair 8800, which sold for $439, with 256 bytes of RAM, which also represented the year that Bill Gates, along with Paul Allen founded Microsoft (maximon.com, 2006). Altair was seeking a computer language, which Gates and Allen delivered via a program called BASIC on 23 July 1975, which they gave the company “… exclusive worldwide rights to … for 10 years” (Rich, 2003, p. 34). Sold as an add-on with the Altair 8800 for $75, the preceding provided the revenue underpinnings for Microsoft (Rich, 2003, p. 35). Generating just $381,715 in 1977, Microsoft was upstaged by Apple Computers that made machines as well as their own operating system (Rich, 2003, p. 36). Apple's success caught the attention of IBM, which was not in the personal computer market, the foregoing was the means via which Gates entered the picture with IBM based upon DOS, program it secured from Seattle Computer for just $50,000 that heralded the beginnings of the industry giant (Rich, 2003, p. 51). Microsoft MS-DOS represented the foundation for the beginning financial strength of the company, which would enable it to develop Windows 95 and successive versions leading to Vista in 2007. Along the way, Microsoft has been accused, rightly or wrongly, of a monopolistic approach to software bundling that has stifled competition and innovation. This paper will seek to examine this facet, its effects, how it happened and the ramifications of the statement.
Chapter 2 – Literature Review
2.1 Monopolist or Fierce Competitor
In “Trust on Trial: How the Microsoft Case is Reframing the Rules of Competition”, by Richard McKenzie (2000, p. 1), reflects that Microsoft in the last 25 years has become “… the world's premier software company, dominating many of the markets it has entered and developed…” and also finds itself “…under legal assault …” for monopolist behaviour. McKenzie (2000, p. 2) indicates that in the United States “…it's the Justice Department against Microsoft, but behind the courtroom scenes there has been a good deal of political maneuvering by other major American corporate high-tech combatants -Sun Microsystems, Oracle, Netscape, IBM, and America Online, to name just a few - who would like nothing better than to see their market rival, Microsoft, get its comeuppance in the court of law”. In this instance it is the “…efficacy of antitrust law enforcement has been on trial” as the Microsoft case represents “…the first largescale antitrust proceedings of the digital age;” (McKenzie, 2000. p. 2). McKenzie (2000, p. x) reflects upon the government case against Microsoft as a monopolist, indicating that while its operating system comes “ … preloaded on at least nine of every ten computers containing Intel microprocessors sold in the country, if not the world” was it this that made the company a monopolist?
The market dominance that Microsoft has in the fact that its operating system comes preloaded in over 90% of the computers sold was expressed by the former United States Republican candidate Robert Dole, who stated “Microsoft's goal appears to be to extend the monopoly it has enjoyed in the PC operating system marketplace to the Internet as a whole, and to control the direction of innovation." (McKenzie, 2000, p. 28). This view was also repeated by the media as well as New York Attorney General Dennis Vacco who see Microsoft's “…product development strategies are evidence of monopoly power: …” in that the “ … Windows operating system has become almost the sole entry point to cyberspace” (McKenzie, 2000, p. 29). It is without question that Microsoft's dominance resulting from preloaded operating software provides it with an advantage in introducing other forms of software. But, is that simply good business practices or predatory behaviour? For consideration, McKenzie (2000, p. 47) points to the book written by Judge Bork “The Antitrust Paradox” where he stated repeatedly "… antitrust should not interfere with any firm size created by internal growth …". And like it or not, that is how Microsoft got into the position it now enjoys. But, in all the rhetoric, there is another facet to Microsoft's dominance, the PC manufacturers themselves. As stated by the manufacturers themselves, there simply is no other choice! (McKenzie, 2000, p. 29).
Eric Browning, the chief executive of PC manufacturer Micron has said "I am not aware of any other non-Microsoft operating system product to which Micron could or would turn as a substitute for Windows 95 at this time” (McKenzie, 2000, p. 30). This sentiment was also echoed by John Romano, an executive at Hewlett-Packard who advised "… we don't have a choice …" (McKenzie, 2000, p. 30). The tie-in between monopoly power and market dominance has been explained by Franklin Fisher, the chief economist for the Justice Department as "Monopoly power is a substantial degree of market power," or the ability of a firm "(a) to charge a price significantly in excess of competitive levels and (b) to do so over a significant period of time" (McKenzie, 2000, p. 30). Fisher further asserts that Microsoft's dominance in the market “… is protected by "barriers to entry" in the form of "economies of scale in production," "network effects," and "switching costs …" (McKenzie, 2000, p. 30). Fisher adds that “There are no reasonable substitutes for Microsoft's Windows operating system for Intel-compatible desktop PCs. Operating systems for non-Intel-compatible computers are not a reasonable substitute for Microsoft's Windows operating system" because there would be high costs to switching to non- Intel-compatible computers like Mac and Unix” (McKenzie, 2000, p. 30).
However, the monopolistic tendencies of Microsoft have not resulted in the company charging higher prices as a result of its dominant position. This view was put forth by the chief economic consultant for the state attorneys general in that “…the absence of viable competitors in Intelcompatible operating systems means that Microsoft doesn't have to worry about raising its price or using its economic weight in other ways …” (McKenzie, 2000, p. 30). He asserts that “ … a monopolist would continue to raise its price so long as its profits rose. …” (McKenzie, 2000, p. 31). Something that Microsoft has not done. Such is inconsistent with the manner in which
monopolists behave. The line of reasoning for the preceding is that “…the cost of the operating system represents on average 2.5 percent of the price of personal computers (and at most 10 percent for very inexpensive personal computers), so "even a 10 percent increase in the price of the OS [operating system] would result at most in a 1 percent increase in the price of even inexpensive PCs …” (McKenzie, 2000, p. 31). Warren-Boulton thus concludes “…that Microsoft's price for Windows is very likely far below the monopoly price …” which is a result of “…the so-called "coefficient" of the price elasticity of demand facing any firm (the ratio of the percentage change in the quantity to the percentage change in the price …” (McKenzie, 2000, p.31).
Therefore, argues McKenzie (2000, p. 32) a monopolist would not price its product in the very low range, “…because a very low elasticity implies that a price increase will increase profits …”, thus the government's case has opposing views of Microsoft's monopolist position, a telling facet in considering the overall implications of the company. The foregoing direct contradicts Franklin Fisher's, the chief economist for the Justice Department, claims that Microsoft earns “ … superhigh profits …”, which its low prices does not support (McKenzie, 2000, p. 32). Thus, in being a so-called monopolist, Microsoft's pricing policies do not reflect the behaviour of one. The complicated market, competitive, product and business realities of Microsoft in a competitive market must also be viewed as the company taking actions to protect its position through new product introductions as well as making it difficult for competitors to gain an edge, the manner in which all firms operate if they intend to remain in business and continue as market leaders. The fact that Microsoft provides its Internet browser free along with its operating system, serves the interest of customers in that they have this feature already available in the purchase of their computers. It also represents a competitive action that limits other browsers from gaining an edge in the market.
McKenzie (2000, p. 32) aptly points our that “ … Any firm that is dominant in a software market isn't likely to want to give up its dominance, especially if there are substantial economies of scale in production and network effects in demand …”, something with both Fisher as well as Warren- Boulton indicate is true in the software industry. McKenzie (2000, p. 32) adds that if Microsoft where to start losing market share for its operating system “…it could anticipate problems in keeping its applications network intact, which could mean its market share could spiral downward as a new market entrant makes sales and those sales lead to more and more applications being written for the new operating system …”. The flaw in the monopolist argue, as pointed out by McKenzie (2000. p. 34) is that even if a company had a 100% share of the market “…it must price and develop its product as though it actually had market rivals because the firm has to fear the entry of potential competitors …”. To make his point, McKenzie (2000, p. 34) points to classic microeconomics textbooks that teach that a monopolist represents a ‘single producer' “…that is capable of restricting output, raising its prices above competitive levels, and imposing its will on buyers …” therefore in the position of the U.S. Justice Department, Microsoft's high, 90%, market share is a near or almost monopoly, that McKenzie (2000, p. 34) aptly states is like almost being pregnant, you either are or you aren't.
To illustrate his point, McKenzie (2000, p. 34) points to the company called Signature Software, which at the time had “…100 percent of the market for a program that allows computer users to type their letters and e-mails in a font that is derived from their own handwriting”. He adds that despite it being the singular producer in the market, the company “…prices its software very modestly, simply because the program can be duplicated with relative ease.” McKenzie (2000, p. 34) also points out that Netscape at one time almost completely dominated the browser market, yet did not price its advantage in monopolist fashion. In protecting its position, Microsoft developed and introduced new products, all of which any other firm had the opportunity to do and thus innovate, yet such did not happen. McKenzie (2000, p. 137) asserts that the aggressive development of new products by Microsoft was in defense of its market position as well as being good marketing and customer satisfaction practices. He points to the following innovations by Microsoft that helped to cement is market dominance and stave off competitive inroads, all of which could have been created by other firms (McKenzie, 2000, p. 137):
Microsoft develops BASIC as the first programming language written for the PC. A feat that could have been accomplished by anther firm had they innovated and gotten the initial contract with Altair for the 8800.
Microsoft developed the first mouse based PC word processing program, Word.
The company develops the first PC based word processing system to support the use of a laser printer.
Microsoft's Windows/386 became the first operating system to utilize the new Intel 32-bit 80386 processor.
Microsoft's introduces Excel, the first spreadsheet that was designed for Windows.
Word became the first word processing system to offer tables.
Microsoft Office becomes the first business productivity application offering a full suite of office tools.
Word becomes the first productivity program to incorporate multimedia into its operation.
Word version 2.0 becomes the first word processing program to provide drag and drop capability.
Internet Explorer becomes the first browser to support multimedia and 3D graphics
Microsoft's Intellimouse is the first pointing device to utilize a wheel to aid in navigation.
Microsoft introduces Picture It, the first program to permit consumers to create, enhance and share photo quality images over their PC's.
DirectX becomes the first multimedia architecture to integrate Internet ready services.
Microsoft's WebTV in conjunction with the hit television show Baywatch becomes the first internationally syndicated Internet-enhanced season finale.
Windows 2000, which later becomes Windows NT adds the following innovations as firsts to a PC operating system,
- Text to speech engine,
- Multicast protocol algorithms that are reliable,
- Improvements in the performance registry,
- Inclusion of DirectX,
- Vision based user interfaces,
- Handwriting recognition,
and a number of other innovations to enhance its operating system, and maintain as well as increase its market position.
The preceding represents examples of innovation spurred by Microsoft that could have been introduced by its competitors in various fields first, but where not. Thus, Microsoft in these instances, as well as others introduce consumer enhancing innovations to further its market dominance through aggressive new product development, a path that was open to others as well.
2.2 Bundling, Innovative or Stifling Competition
Rosenbaum's (1998) book “Market Dominance: How Firms Gain, Hold, or Lose it and the impact on Economic Performance” provides a perspective on the means via which companies gain as well as lose market share, and the tactics they employ to best their competition. Few people remember that when Microsoft introduced Microsoft Word and Excel, the dominant software programs for word processing and spreadsheets were Lotus 1-2-3- and WordPerfect (Rosenbaum, 1998, p. 168). In fact, WordPerfect was the application found in all businesses, period (Rosenbaum, 1998, p. 168). Each of the preceding applications cost approximately $300, which Microsoft bested by selling his Office Suite program for $250. Through providing limited use Word programs in Windows, consumer had the chance to test Word before buying it (Rosenbaum, 1998, p. 168). More importantly, Microsoft's spreadsheet, word processing, presentation programs were simply better and easier to use that the competition. By innovatively offering a free limited version of Word with the operating system, Microsoft induced trial, to which it had to follow up on with a better product.
In looking at competitive practices and competition analysis, there is a relationship that exists between the structure of the market and innovation, to which Hope (2000, p. 35) poses the question as to “…whether monopoly is more conducive to innovation than competition …”. Hope (29000, p. 35) indicates that in response to the foregoing, there is no “…clear-cut answer, probably because there is none …”. Hope (2000, p. 35 puts forth the theory that “…Most economists, and virtually all designers of competition policy, take market structure as their starting point - as something which is somehow, almost exogenously, given (although it may be affected by competition policy), and which produces results in terms of costs, prices, innovations, etc …” However, Hope (2000, p. 35) tells us that this is wrong, based upon elementary microeconomics, as “…Market structure is inherently endogenous… (and is) … determined by the behaviour of existing firms and by entry of new ones, simultaneously with costs, prices, product ranges, and investments in R&D and marketing”. Exogenous variables, if they in fact exist in a particular situation, represent facets such as product fundamentals such as “…production processes, entry conditions, the initial preferences of the consumers, variables determined in other markets, and government policy …” (Hope, 2000, p. 35). As a result, Hope (2000, p. 35) advises that the questions as to whether “…there will be more innovation with monopoly than with competition is no more meaningful than to ask whether price-cost margins will be higher if costs are high than if they are low …”.
2.2.1 Bundling Examples in Other Industries
Aron and Wildman (1999, p. 2) make the analogy of Microsoft's bundling methodology with that of cable television whereby a broadcaster how owns a “… marquee channel can preclude competition in thematic channels (such as comedy or science fiction channels) by bundling their own thematic channels with the …” marquee channel. The preceding illustrates the idea that consumers tend to value channels such as HBO, Cinemax and Showtime that their reputation helps to cause consumers to consider other program platforms they offer. These channels advertise their other channels on their marquee stations and vise versa, offering bundling of channels at reduced prices to encourage purchase. Aron and Wildman (1999, p. 2) offer the logic that “…a provider that attempts to compete by offering a thematic channel on a stand-alone basis, without an anchor channel, would not be able to survive the competitive pressure of a rival with an anchor.” The argument that having a marquee channel, or anchor, is key to the viability of broadcasters is supported by the development of pay television in the United Kingdom. Aron and Wildman (1999, p. 2). The dominant pay television supplier is BSkyB which controls “…most of the critical programming rights in Britain, enabling it to use bundled pricing to execute a price squeeze against rivals …” which as in the case of Microsoft “…the pay television industry is that a firm that monopolizes one product (here, an anchor channel) can effectively leverage that monopoly to preclude competition in another product market by using bundled pricing” (Aron and Wildman, 1999, p. 2).
Aron and Wildman (1999, p. 3) provide another example of how firms utilize bundling to inhibit their competition, through the example of Abbott and Ortho laboratories, which produce bloodscreening tests utilized to test blood that is donated for viruses. Interestingly Abbott produced all five of the test utilized to check for viruses, whereas Ortho only produced three, thus Abbott bundled the five tests in a manner that Ortho was unable to compete, thus effectively making it a monopolist (Aron and Wildman (1999, p. 3). Were these good business practices that this enabled Abbott to increase its market share at the expense of another company that did not innovate in producing all five tests to complete? Ortho claimed that “…Abbott was effectively a monopolist in two of the tests, Ortho claimed that Abbott could and did use a bundled pricing strategy to leverage its monopoly into the other non-monopolized tests and preclude competition there” (Aron and Wildman, 1999, p. 3).
The preceding examples show “…that a monopolist can preclude competition using a bundled pricing strategy …” (Aron and Wildman, 1999, p. 3) and that in so doing can accomplish such without charging prices in excess of what is reasonable for their customers, which makes sound business sense in that capturing the market thus eliminates the need for such, and also provides the business condition that prevents competitors from re-entering the market at lower prices. Thus it is rational for a monopolist to behave as if competitors exist, which in fact they will if it provides such an opportunity through increased pricing. The examples indicated show that “ … it is indeed possible in equilibrium for a provider who monopolizes one product (or set of products) to profitably execute a fatal price squeeze against a rival in another product by using a bundled pricing strategy” (Aron and Wildman, 1999, p. 3).
2.3 The Case Against Microsoft
Spinello (2002, p. 83) in his work “Regulating Cyberspace: The Policies and Technologies of Control” inform us that there are four distinct aspects of the United States government case which is based upon violations of the Sherman Act, which are as follows:
1. The company's monopolization of the PC operating systems market was achieved via anticompetitive means, specially in the instance of the utilization of its browser, in violation of “Section 2 of the Sherman Act, which declares that it is unlawful for a person or firm to “monopolize…any part of the trade or commerce among the several States, or with foreign nations” (Spinello, 2002, p. 83).
2. That Microsoft engaged in “…Unlawful exclusive dealing arrangements in violation of Sections 1 and 2 of the Sherman Act (this category includes Microsoft's exclusive deal with America Online)” (Spinello, 2002, p. 83).
3. That Microsoft in its attempt to maintain it competitive edge in browser software “…attempted to illegally amass monopoly power in the browser market) in violation of Section 2 of the Sherman Act …” (Spinello, 2002, p. 83).
4. And that the bundling of its browser along with the operating system was in violation of “…Section 1 of the Sherman Act (Section 1 of this act prohibits contracts, combinations, and conspiracies in restraint of trade, and this includes tying arrangements) …” …” (Spinello, 2002, p. 83).
Spinello (2002, p. 89) provides an analysis of the Department of Justice case against the company utilizing a distinct example as represented by Netscape. He contends that the option for consumer choice was never inhibited by Microsoft, and that Netscape's own practices contributed to the decline in popularity of its browser.
Chapter 3 –Analysis
3.1 Bundling, Competitive or Market Restrictive?
The Concise Dictionary of Business Management (Statt, 1999, p. 109) defines a monopoly as “A situation in which a market is under the control or domination of a single organization ...”. The Dictionary continues that “This condition is generally considered to be met at one-quarter to onethird of the market in question ... (and that) … A monopoly is contrary to the ideal of the free market and is therefore subject to legal sanctions in all industrialized countries with a capitalist or mixed economy”. In addressing this facet of the Microsoft case, McKenzie (2000, p. 27) elaborates that Microsoft's market position as a ‘single seller' in the market as a result of its dominance represents “… latent, if not kinetic, monopoly power” and in the opinion of the judge presiding over the case, the company is “…illegally exploiting its market power in various ways to its own advantage and to the detriment of existing and potential market rivals and, more important, consumers”. This goes to the heart of the matter concerning the assertion that Microsoft's monopolist approach is stifling competition and innovation as its bundling practices effectively eliminates software such as Netscape and others from becoming an option for other companies as the Internet browser Explorer comes preloaded with Windows and Vista operating software. This view was publicly asserted by the United States Attorney General at the time, Janet Reno in a 1997 press conference where she stated on behalf of the Justice Department that "Microsoft is unlawfully taking advantage of its Windows monopoly to protect and extend that monopoly" (McKenzie, 2000, p. 27).
Gillett and Vogelsang (1999, p. xiv) in “Competition, Regulation, and Convergence: Current Trends in Telecommunications Policy Research” advise that “…Bundling is a contentious element of software competition that has been at the heart of the Microsoft antitrust litigation, and represents an integral aspect in the examination of how and if Microsoft's monopolistic approach to software bundling has an effect on innovation and competition. They state that “ … through bundling, can profitably extend this monopoly to another product, for which it faces competition from a firm offering a superior product (in the sense that it would generate more surplus than the product offered by the monopolist) (Gillett and Vogelsang, 1999, p. xiv). They continue that “…Bundling the two products turns out to be an equilibrium outcome that makes society in general and consumers in particular worse off than they would be with competition without bundling …”. Gillett and Vogelsang (1999, p. xiv) offer the idea that “…bundling is likely to be welfare reducing and that unbundling would not be a suitable remedy …”
Aron and Wildman (1999, p. 1) advise us that through the use of bundling a company can exclude its rivals through the combined pricing, thus successfully leveraging its monopoly power. They continue that the preceding represents part of an equilibrium strategy by which the monopolist acts in a rational manner for the long term and short term, however such a strategy representing exclusionary pricing “…would not be profitable in the absence of the competitor …” (Aron and Wildman, 1999, p. 1). They add that the bundling of software “…generates welfare losses, both in terms of social welfare and in terms of consumer surplus …” (Aron and Wildman, 1999, p. 1). The bundling of Microsoft's Internet Explorer browser with its operating systems means that such almost effectively excludes other browsers from gaining a significant market share. And while consumers can download other browsers, they do so utilizing the preloaded Internet Explorer. Having a browser already installed, which was also available in prior computers familiarizes consumers to Microsoft's Internet Explorer thus effectively eliminating the need to take the time to download what they already have, as well as what they are familiar with. Additionally, since most consumers have used or are using Internet Explorer, this fact tends to influence other and prohibit them from seeking another browser, specially if they have questions on how to surf the Internet or find items.
Aron and Wildman (1999, p. 2) claim that since Microsoft holds a monopoly over operating systems, representing over 90% of the global market, its “…claim that by bundling the browser with its monopoly operating system, Microsoft makes it impossible for other browser firms to compete in the browser market. This not only has an exclusionary effect on competition but, it is claimed, a chilling effect on innovation”. The nature of Microsoft's actions range from those who believe its practices are the tactics of a successful and aggressive competitor that is innovative has done, and is doing what any successful company needs to do to be, stay and remain successful (Aron and Wildman, 1999, p. 2). On the opposing side, there are those who believed that only a break up of Microsoft would force an end to the anticompetitive nature of its actions by reducing its size and thus making it more competitive (Aron and Wildman, 1999, p.
2). Thus, the analogy drawn by Aron and Wildman (1999, p. 2) is that the reward for market success is jurisdictional intervention.
Aron and Wildman's (1999, p. 3) examples also show that the common aspect of bundling in three completely different markets illustrates how bundling can enable a firm to increase its market share over competitors and then after having achieved that position, to limit inroads on its position through maintaining prices that are competitive, thus effectively eliminating re-entrance to the market by its competitors or new firms. Such a tactic does not eliminate competition, it restricts their ability to increase market share and limits them to peripheral markets and or customers. In the case of Microsoft, the company has eliminated the potential for choice in that its operating system comes pre-loaded, thus the first option available its their browser, which customer can supplant through downloading a different one to use. The bundling aspect does provide Microsoft with a huge competitive advantage, however it is not insurmountable in that if competitors developed uniquely innovative browsers with features in advance of Microsoft, that were more user friendly and enhanced their experience, the bundling tactic could be attacked. Thus the question of whether bundling effectively limits competition and innovation is dependent upon the way in which one is viewing it. It must be remembered that in all instances, all competitors at one time had basically equally access and or opportunity in any given market, meaning at its inception or when it was emerging. Thus, they all had the opportunity to offer a series of products, features, enhancements, and related benefits for the market on basically equal terms. This applies to Abbott and Ortho, BSkyB television and Microsoft, as their competitors all
had the opportunity to innovate at some critical point in the development of the market, however only Abbott, BSkyB and Microsoft did.
Hope (2000, p. 33) point on this provides an answer to the preceding in that he states “What may look like an unjustified and anti-competitive bundling of products or services (or of functions) if one looks at today's market definition may be an innovation which will change the standard functions of the product or service in question if one can anticipate tomorrow's market definition (or today's latent demand)”. Hazlett (1999, p. 52) in his article “Microsoft's Internet Exploration” advised that “The facts of the ‘browser war' lead inexorably to one conclusion: consumers have benefited enormously from the ferocious rivalry between Netscape and Microsoft”. He adds that Microsoft's “…actions should not be branded as anticompetitive, since they did not foreclose Netscape from the marketplace …” (Hazlett, 1999, p. 52). In fact Bill Gates himself makes it clear that “The fact that our browser was integrated into Windows 95 from the outset did not in any way prevent consumers from choosing another browser” (The Economist, 1998, pp. 19-21). The entire facet of bundling is not as clear-cut as the United States government's case attempted to make it, nor is it clear-cut from various potential competitive and anticompetitive standpoints. Lessig (2000) argues in support of a “New Product Rationale …whereby … two software products combined in a new way would be considered a ‘single product' for purposes of antitrust tying law” and adds a caveat that “this conclusion would be presumptive only”. This same position is also taken by Hovenkamp who states that bundling of a partial substitute can “…sabotage a nascent technology that might compete with the tying product but for its foreclosure from the market ” (Spinello, 2002, p. 91). Communications Daily (2000) points out that a clear case of anticompetitive bundling is provided by AOL-Time Warner, which bundled its AOL software with its cable service, without offering its customers alternative browsers thus “Caching technology allows popular Web sites to be stored closer to the end user, possibly at cable head end, in order to avoid Internet's backbone delays”.
3.2 Strategies to Gain Market Share
Hope (2000, p. 33) in the book “Competition Policy Analysis” stated “What may look like an unjustified and anti-competitive bundling of products or services (or of functions) if one looks at today's market definition may be an innovation which will change the standard functions of the product or service in question if one can anticipate tomorrow's market definition (or today's latent demand)”. Hope (2000, p. 33) further states that “…Thus in industries whose technology changes rapidly or in which innovations (and the definition of products or services) are likely to affect the expected perceived needs of consumers, there can be an interdependence between the practices of the innovating firms and the definition of the market on which they operate …”. He continues that “…firm strategies are often based on their expectations of what tomorrow's product definitions will be like rather than on what today's market looks like …” (Hope, 2000, p. 33). In viewing the methodologies employed by Abbott, BSkyB and Microsoft, Hope, 2000, p. 33) advises that “…On the one hand, the definition of markets depends to a certain extent on the objectives of the law for the purpose of which markets are assessed …”, and adds that “…On the other hand, even in the case of competition law, in an increasing number of situations, market definition contains an implicit judgment on the respective valuation of the short-term anticompetitive effects of the practice or structural change considered and their long-term effect.…”.
The Department of Justice in its suit against Microsoft contended that the bundling of its browser along with its operating system represented “… unlawful technological tying …” in that the browser was incorporated into the source code, thus making it impossible to disable it (Spinello, 2002, p. 86). The foregoing arrangement representing tying “…violates the Sherman Act if “the seller has appreciable economic power in the tying product market, and if the arrangement affects a substantial volume of commerce in the tied market” (Spinello, 2002, p. 86). However, there is another facet to the foregoing in that the bundling of the browser with the operating
system provided the browser for free to consumers, but the Department of Justice contended that this arrangement harmed consumers in their ability to select between Microsoft's Internet Explorer and other browsers (Spinello, 2002, p. 87). The bundling aspect in terms of limiting innovation and competition is addressed in the fact that Netscape's browser utilized a “…JAVAenabled platform would attract software developers. In the long run, then, it could displace Windows as an attractive platform for new applications and take advantage of the selfreinforcing network effect that made Windows so powerful …” (Spinello, 2002, p. 87). The United States Department of Justice termed the preceding as a barrier to entry as Microsoft controlled the platform for software developers in that its browser was not JAVA enabled, thus programs were written for its platform as it represented the dominant system on the market (Spinello, 2002, p. 87). The preceding represented a similar situation that faced Apple and IBM compatible PC's in that software developers wrote applications first for the larger IBM compatible market, then later for the smaller Apple market.
The subject of bundling is not as clear-cut when one looks at all of the various perspectives. Spinello (2002, p. 89) points out that Microsoft's appeal states the case against it in that “…suggests a dangerous precedent for other software companies that produce an industry standard: Could they too be accused of leveraging their monopoly power just by adding new functionality to their products? …” The Microsoft appeal further stated that “…Software products are dynamic and must be allowed to evolve; if not, consumers will suffer the consequences of outdated technologies … Moreover, does the Court's consumer demand test make sense, especially for software?” (Spinello, 2002, p. 89). Additionally, Microsoft's appeal adds “…word processors now include spell checkers and PCs now include modems, even though both features used to be sold separately as add-on products. Are these other examples of unlawful ties?” (Spinello, 2002, p. 89). The point Microsoft puts forth is that it innovated through the addition of new functionality to its software, to which the government lawyers responded that “the products are really separate and are bundled together not for the sake of efficiency but solely for an anticompetitive purpose” (Spinello, 2002, p. 89). The United States government further contends that “… Windows and IE are separate products because “consumers today perceive operating systems and browsers as separate products for which there is separate demand” (Spinello, 2002, p. 89).
3.3 Microsoft and The European Union
Microsoft has also been accused of software bundling to restrain competitors in the European Union with regard to its Windows Media Player as well as permitting competitors to access the company's server source code to allow better interoperability between software platforms (Worthington, 2005, p. 166). Levy (2004, p. 166) in his book “Shakedown: How Corporations, Government, and Trial Lawyers Abuse the Judicial Process” advises that the European Union has brought Microsoft up on similar antitrust charges as the United States government. In a ruling on a 1998 case brought before the EU by Sun Microsystems, the European Union “ordered Microsoft to pay a $613 million fine, disclose additional source code to ensure server interoperability, and provide an unbundled version of Windows XP, without Media Player, to PC makers in Europe (Levy, 2004, p. 166). Microsoft in 2004 entered into an agreement with Sun Microsystems that settled this piece of antitrust litigation and Sun dropped it suit, however the European Union continued to pursue the matter and fined the company (Levy, 2004, p. 166). The resulting fine of $610 million and ruling entails Microsoft having to “…disclose more of its programming code so that rivals' server computers can more easily interact with Windows, and offer dual versions of Windows for sale by PC makers in Europe—one version with Microsoft's Media Player included, and one without …” (Levy, 2004, p. 280).
Chapter 4 – Conclusion
In the United States, the long running Justice Department case resulted in a settlement whereby Microsoft had to permit “…PC makers and consumers to hide certain bundled Microsoft products—like its Internet Explorer browser and Media Player—and install competing products …” (Levy, 2004, p. 281). Further, the settlement called for Microsoft “…to reveal parts of its software code to companies producing larger-scale server computers that “talk” to Windowsbased PCs …” (Levy, 2004, p. 281). In the European Union, which basically addressed the same antitrust concerns as the United States Justice Department, filed by American companies over business decisions made inside of the U.S. Thus, the European Union has effectively become a haven for “…disgruntled businessmen who use political influence in an attempt to bring down their rivals …” (Levy, 2004, 281). In terms of settling so called bundling litigation, the EU's ruling does not clear the picture, nor provide any substance to the aspect of if bundling stifling innovation and competition. Levy (2004, p. 282) argues that the Commissioner of the European Union, Mario Monti, was more concerned about making history than settling the case, a debatable point, but one which must be considered in the light of the ruling by the United States Justice Department that ended in a settlement. Levy (2004, p. 282) contends that “ … the latest EU order, pure and simple, transforms antitrust into a corporate welfare program for market losers …” and that “Without some semblance of regulatory consistency, companies competing globally will not be able to conform their conduct to the dictates of divergent legal regimes”. He goes on to add that “special interests pursuing their favorite antitrust forum in an effort to exercise the most political clout” thus potentially resulting in “…fewer jobs, less innovation, inferior products, and higher prices …” (Levy, 2004, p. 281).
This last facet represents the status of where things state today. The question of bundling and its effect on innovation and competition has not been essentially decided upon in the courts in the United States, nor in Europe. In terms of understanding the effects of bundling, Levy (2004, p. 163) indicates that based upon its actions in the marketplace “Microsoft behaves not like a monopolist but like a company whose very survival is at stake”. This is in keeping with the views expressed by others. Gillett and Vogelsang (1999, p. xiv) “Competition, Regulation, and Convergence: Current Trends in Telecommunications Policy Research” advise that “…Bundling is a contentious element of software competition that has been at the heart of the Microsoft antitrust litigation, and represents an integral aspect in the examination of how, and if Microsoft's monopolistic approach to software bundling has an effect on innovation and competition. They state that “ … through bundling, a company can profitably extend a monopoly to another product, for which it faces competition from a firm offering a superior product (in the sense that it would generate more surplus than the product offered by the monopolist)” (Gillett and Vogelsang, 1999, p. xiv). They continue that “…Bundling the two products turns out to be an equilibrium outcome that makes society in general and consumers in particular worse off than they would be with competition without bundling …”.
Aron and Wildman (1999, p. 1) state that while bundling represents a process whereby companies can exclude their rivals as a result of combined pricing advantages, thereby leveraging monopoly power, that this tactic represents part of an equilibrium strategy. They continue that such a strategy representing exclusionary pricing “…would not be profitable in the absence of the competitor …”, and state that the reward for market success is jurisdictional intervention. Through the examples of cable advertisers, Abbot and BSkyB, Aron and Wildman (1999, p. 2) illustrated the damaging effects of bundling in its real sense as opposed to the case of Microsoft, who Levy (2004, p. 163) states does not behave as a monopolist in that it keeps its prices down, and that the company's “…technology is struggling to keep pace with an explosion of software innovation …”. He adds in that “…it faces an avalanche of competition from new operating systems, consumer electronics, and Web-based servers …” (Levy, 2004, p. 163). He concludes that “…antitrust officials are preoccupied with antiquated notions—tying arrangements, exclusionary contracts, predatory pricing, and a host of other purported infractions—all irrelevant, unless the real purpose, of course, is to pacify rivals trying to attain in the political arena what they have been unable to attain in the market” (Levy, 2004, p. 163.
Levy (2004, p. 178) makes a case for his conclusions in that “…MSN now loses an estimated $200 million annually providing service to fewer than 3 million customers. AOL, by contrast, has 9 million subscribers and will add nearly 3 million more with its acquisition of CompuServe's consumer business”. Further, Levy (2004, p. 185) contends, “…few manufacturers could risk offering a PC without Internet Explorer…. If they did, rival manufacturers might be tempted to entice customers by bundling Explorer free of charge”. In considering the aspect of bundling, Spinello (2002, p. 89) points out that Microsoft's appeal states the case against it in that “…suggests a dangerous precedent for other software companies that produce an industry standard: Could they too be accused of leveraging their monopoly power just by adding new functionality to their products? …” In looking at the facts, Levy (2004, p. 223) advises that in 1998 “More than 150 million copies of Netscape's browser were delivered …” and that “Over 65 million Internet users start up at Netcenter, which is the second most visited site on the Web after Yahoo!; Microsoft is far behind…”. Additionally he provides information that states “Over 400,000 Web sites link to Netscape's home page—more than twice the number of links to Microsoft's home page” (Levy, 2004, p. 223). Finally, Levy (2004, p. 223) gives the chilling answer that “Netscape still controls 42% of the browser market, and will soon control an additional 16% through its new partner, AOL, which paid more than $10 billion to acquire a 4-year-old company purportedly mangled by Microsoft”.
If Microsoft's bundling has damaged the browser industry, then Levy (2004, p. 223) points out why is AOL with 15 million users and generating a profit, doing better than Microsoft's Internet Explorer with 2 million users. In addressing the Netscape contention against Microsoft, Levy (2004, p. 224) adds that Netscape once controlled 90% f the internet browsing market, but declined sharply after PC magazines and consumers found “…that newer versions of Internet Explorer were superior ..” and then Microsoft's market share exploded. Levy (2004, p. 224) adds that “Netscape made some key mistakes … First, it didn't offer software developers a viable
platform onto which applications could easily be written …Then, it responded too slowly when its browser was outclassed…” Levey (2004, p. 224) continues that AOL “… twice spurned help from AOL; it was late in offering a free browser; and it took three years to exploit its Netcenter portal.” Netscape, which charged for its browser, was supplanted by Microsoft's Internet Explorer which did not cost consumers one cent, and in fact was a better browser. The fact is, as Levy (2004, p. 224) points out is that Microsoft offered a better price, zero, and a better product.
The ruling by the United States Department of Justice did not resolve the issue of bundling as a practice that stifles competition and innovation. The ruling states that the bundling of products constituted an illegal tying arrangement, and “that Microsoft will have to disclose its server protocols so that non-Microsoft servers (like those produced by IBM, Oracle, Sun Microsystems, and Novell) will be able to interoperate with Windows” (Levy 2004, p. 273). Through all of the legal maneuvering, and rulings in the United States and Europe, the question of bundling has been brought up as stifling competition, but not actually, and conclusively proved through the final court rulings as actually doing so. In fact there is a wealth of data, and examples as provided by Aron and Wildman (1999), (Gillett and Vogelsang, 1999), Spinello (2002, Communications Daily (2000), and Levy (2004) that call this into question.
Rosenbaum (1998, p. 158) probably makes the most telling observation and contribution to the assertion that bundling stifles innovation and competition, if one has a flair for open-minded thinking and irony. He reveals that Microsoft “ … sabotaged the development of OS/2 by continuing to invest resources in a partnership with IBM on the OS/2 development project while knowing full well that Microsoft was really committed to Windows as the operating system of the future. …” (Rosenbaum, 1998, p. 158). Secretly, the company had adopted the “…risky strategy of simultaneously working on the development of the OS/2 operating system with IBM and independent development of Windows …” (Rosenbaum, 1998, p. 158). And to accomplish the successful introduction of Windows “…most of the copies were sold by bundling Windows with MS-DOS, and only an estimated 20 percent of users actually installed Windows on their machines” (Cusumano and Selby, 1995, p. 161). Little mention has ever been made in the fact that IBM bundled “…CPUs, software, and maintenance allowed it to engage in price discrimination … (which) … allowed it more freedom in pricing to customers prone to competition … (and) … It also meant that customers could not observe real prices for peripheral equipment… (thus) …delayed the development of a peripheral market” (Rosenbaum, 1998, p. 236). Microsoft in bundling was simply doing what a number of firms in many differing industries have done and still are doing, seek a means to advance their market share through the introduction of new products in the most cost effective manner. Rosenbaum (1998, p. 169) notes “While Microsoft may well have used bundling of software applications to gain market share for its applications software programs, it is unclear that the net effects on welfare were negative”. He adds that “For one thing, there is little doubt that the net impact of bundling was to lower the price of many Microsoft applications programs.
Furthermore, Microsoft has been unable to gain a large market share in markets where its applications software is significantly inferior”, pointing to Microsoft Money as an example. Most importantly, Rosenbaum concludes “There is also little evidence that Microsoft has been able to leverage its market dominance over operating systems into power over most of its software applications”.
The facts remain, Microsoft's bundling practices have been used to market new product applications that the company has consistently delivered and innovated upon. This lower cost and more effective means has been achieved through its pre-loaded operating systems, however, with the exception of Windows Media player, consumers have and had the option to use competing products which Microsoft gave them the platform to use the Internet to obtain. Better products and or more innovative marketing cannot replace better products and lower prices. Competitors have the means through free Internet trial to use showcase their wares, and can use
Microsoft's Internet Explorer to help. Thus, the courts have not conclusively proved that Microsoft has stifling competition, but it sure has proven that Microsoft has outsmarted them!
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