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Microsoft Anti-trust Trial

Interview with Nicholas Economides

The trial of US vs. Microsoft is scheduled to resume again on June 1.
Professor Economides of the Stern School of Business
at NYU has again agreed to answer some questions on the trial. The interview
is broken into three parts. Basic Analysis, Remedies, and After Effects.


Nicholas Economides is a Professor of Economics at the Stern
School of Business, New York University. He earned his Ph.D. from University
of California at Berkeley and previously taught at Columbia University
and Stanford University.

Economides has published extensively on networks, network pricing, market
structure and other topics. He has edited a special issue of the International
Journal of Industrial Organization
on Network Economics and is currently
working on a book entitled The Impact of the 1996 Telecommunications
to be published by the American Enterprise Institute and MIT Press.

He also maintains web sites on the Economics
of Networks
and on the current Microsoft
Legal Battle


Photo courtesy N. Economides

The Microsoft anti-trust trial is set to resume
shortly. Do you think a settlement is likely?

First, let me make clear that, I am not involved in any litigation involving
Microsoft. In expressing these opinions, I rely only on public information.
I have not seen any privileged information that the parties have filed
in the case. I maintain a web server on the Internet on the “Economics
of Networks
” which contains an extensive discussion of the US
v. MS trial
and the proposed remedies.

A settlement seems extremely unlikely because the positions of Microsoft
on one side and the US Department of Justice (USDOJ) and the States on
the other side seem so far apart. The lack of progress toward a settlement
is really unfortunate because, as we will see below, there is considerable
difficulty in finding appropriate remedies if Microsoft is found guilty.

Why are the two parties’ positions so far apart?

Microsoft did a very bad presentation of its case in the trial this
far. Instead of bringing Bill Gates as a live witness, Microsoft relied
on a videotaped deposition that discredits him. At various points during
the trial, the judge seemed to disbelieve Microsoft witnesses. This makes
it more likely that the District Court judge will rule against Microsoft.
This has heartened USDOJ and States’ lawyers who now are likely to ask
for very severe remedies, including a breakup of Microsoft, huge fines,
and a forced auctioning of the Windows source code.

At the same time, last summer’s decision of the Washington DC Appeals
Court gives hope to Microsoft that it will prevail at the Court of Appeals.
Moreover, since the proposals of USDOJ and the States are so extreme, Microsoft
has little to lose by not settling. In some sense, things can only get
better for Microsoft in the second part of the trial, given the bad impressions
of the first part. It does not make sense for Microsoft to settle now with
onerous terms. Instead, I think that Microsoft will wait to see the judgment
of the District Court, appeal, and see how that goes.

What do you see as having been the main strengths
of the Government’s Case thus far?

The government has relied to a large extent on internal Microsoft e-mails
that discussed strategies towards various competitors. The government has
also focused on various contracts between Microsoft and its clients alleging
anti-competitive behavior. I think that USDOJ and the States are likely
to prevail in some of the contract issues.

What do think is missing from the Government’s

There is an underlying current of predation in the government complaint,
but it is never clearly articulated. The predation idea is that MS gives
away the browser now, so that it becomes a monopolist and leverage this
power now and later. The government could have made the argument that,
because of network externalities, the Areeda and Turner criteria do not
apply (or should be modified). [In the widely accepted Areeda and Turner
criteria, a requirement to show predation is charging below cost].

The government also decided to bring this case as if computer software
were a perishable good, while in fact, software is a durable good. This
affects the case on market definition, ability to charge monopoly prices
depending on the existence of a used goods (secondary) market, and level
of monopoly prices.

What do you see as the main strengths of the Microsoft’s
Case thus far?

One of the most important defenses that MS has articulated was that
it was not pricing as a monopolist, that is, that the price it charges
for Windows is low compared to the monopoly price. But, in discussing this
issue in Court, Microsoft made the claim that the monopoly price was $2000
for Windows 95 or 98 while MS was charging computer manufacturers only
$50. This claim was based on an analysis of Prof. Schmalensee and his associates
that treated software as a perishable good. The $2000 number was so unrealistic
that the judge questioned Prof. Schmalensee specifically on this point
and appeared to be unconvinced. [This is an example of legal fumbling:
an argument that is essentially correct (that MS is not charging the monopoly
price) is exaggerated to such an extent that it loses its credibility.]

There are two other potential strengths of the MS case. One is the innovation
argument. MS has argued that it is promoting innovation. Somehow, its economic
experts have not argued convincingly on this point. The other potentially
good argument for MS has hardly been made in Court: MS provides de facto
compatibility which is valuable to society. This issue is discussed in
detail below.

What do you think is missing from Microsoft’s

Microsoft failed to bring forward in the trial the issue of compatibility.
MS provides de facto compatibility through its Windows operating
systems. Backward and forward compatibility are crucial for software markets.
Compatibility is an important benefit to society that could get quickly
eliminated if MS is broken into competing pieces. In some sense, MS is
ignoring one of the best defenses it has arising from the fact that computer
software has network externalities.

The second important failure of MS’s defense has been that it ignored
that software is a durable good. It is totally absurd from an economist’s
point of view that both sides are arguing the case as if software were
perishable, like fish or fresh bread. But software is durable and does
not get diminished by use. Software manufacturers have to compete against
themselves to sell to purchasers of their older version. The economics
of durable goods are quite different than the economics of perishable goods.
Both sides are really fighting a case about an imagined market of perishable
software goods – a market that does not exist.

Do you think the AOL/Sun/Netscape deal will substantively
affect the case?

No. In my opinion, the AOL/Sun/Netscape deal, by itself does not significantly
alter the landscape of this litigation. However, during the trial, the
judge said in court that he thought that the AOL/Sun/Netscape deal
did change the landscape of competition in this market. Partly because
of these remarks of the judge, Microsoft’s defense in the second part of
the trial will focus on proving that the AOL/Sun/Netscape deal changed
the landscape of competition, and that, since things change so rapidly
and unexpectedly, the government should not intervene.

Assuming that either MS is found guilty on one
of the charges, or that an agreement is reached in which MS agrees to some
form of remedies, what should be the goals of any remedies? From the perspective
of promoting economic efficiency, what should be the goal(s) of policy
in such cases in general?

The remedies fall into two broad classes – first there are those that
attack the business side of MS by restricting their contracts or splitting
the company along various lines of business. The second broad class attacks
the control over the technology by either forcing MS to release or license
the source code, or disclose proprietary information (APIs). The remedies
can also be divided into those that affect conduct and those that affect
structure. For example, a restriction on contracts is a conduct remedy,
while a breakup is a structural remedy.

Assuming that liability is established in at least one or more part(s)
of the case, 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. what 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; and
  5. which remedies preserve and enhance incentives for innovation. In discussing
    whether or not a remedy helps consumers, one has to consider its effects
    on prices, on compatibility, and on variety.

In our previous discussion
you mentioned that you did not expect the outcome of the case to result
in any significant change in the market structure in the OS market and
other software markets. Do you still feel this way?

Yes, if one looks forward to the final appeals decision. But, although
my expectation is the same, there is much more uncertainty now than there
was before the start of the trial on the final outcomes.

What remedies proposals have been made?

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.
  2. Force Microsoft to disclose the APIs that allow it to include Internet
    Explorer in the operating system.
  3. Force Microsoft to give away the Windows source code or license it to bidders
    in an auction.
  4. Break up Microsoft according to lines of business (operating systems and
  5. Break up Microsoft in three identical parts, with each part containing
    an equal amount of each business (not clear how to break Bill Gates in
    three identical parts).
  6. Break up Microsoft along lines of business (operating systems and applications)
    and then break the operating systems division in three identical parts.

Which do you feel is more likely given the current
state of the trial?

Unless MS does much better in its presentation in the second part of
the trial, I expect that the District Court will find MS guilty of some
of the accusations. I also expect that an across-the-board conviction is
likely to be reversed by the DC Court of Appeals.

What are the pros and cons of each category of

The following table assesses the costs and benefits of each of the proposed
remedies and my assessment of the probability that each of these remedies
would be imposed and that they would be upheld on appeal. The probabilities
of the various remedies actions add to 50% because I believe that Microsoft
has a 50% probability of acquittal.



Filed under: Microeconomics