Microsoft Case

1
Microsoft Case

• Competition Policy - Prof. D. Neven
• 27 January 2005
• Ursula Ferrari, Gözde Oktay, Nathalie Müller,
  Reinier De Jong

2
Overview

• Chronology
• Technical Background
• Microsofts Behaviour
• Relevant Markets
• Dominant Position
• Abuses of Dominant Position
• Not sharing interoperability information
• Bundeling Windows Media Player
• Conclusion

3
Microsoft case COMP/C-3/37.792 Microsoft

• Commission Decision of 24 March 2004 relating to
  a proceeding under art. 82 of the EC Treaty

4
Parties

• Microsoft Corporation, USA, present within all
  EEA countries
• Sun Microsystem, Inc., USA, present within all
  EEA countries

5
Chronology
6
Chronology (I)

• 10 October 1998 complaint of Sun againts
  Microsoft to the Commission
• 1. Microsoft has an overwhelming dominant
  position in the PC operating system market
• 2. Microsoft is reserving informations to itself
  for work group server operating system

7
Chronology (II)

• Two statements of objections (August 2000, August
  2001) sent to Microsoft
• Interoperability issue
• Windows Media Player (WMP)
• Microsoft responded to both statements of
  objections and rejected them.
• Microsoft requested an oral hearing
• Market enquiry of the Commission send to 75
  companies

8
Chronology (III)

• The decision of the Commission, 24 March 2004
  Microsoft abused its dominant position under
  art.82 of the EC Treaty.
• Remedies
• fine of 500 million Euros
• obligation to give the information demanded for
  guaranteeing interoperability
• obligation to offer a Windows operating system
  version that does not include WMP.

9
Chronology (IV)

• Microsoft did not accept the decision and went to
  the Court of First Instance (CFI) in june 2004,
  for demanding the suspension of the remedies.
• The CFI, 22 December 2004, ordered to dismiss
  Microsofts application for a suspension of
  remedies.
• The final decision of the CJE is still
  pending.

10
Chronology (V)

• Microsoft case in the US
• In 1998, the US federal government and 20 States
  made a complaint against Microsoft, saying that
  there are 4 violations of the Sherman Act on
  monopoly maintenance.
• The Courts decision Microsoft acted illegally
  in protecting its monopoly and in monopolizing
  the web-browser market. But there were not
  sufficient evidence that Microsofts product
  bundling was violating the Sherman Act.

11
Technical Background
12
Technical Background (I)

• Computer system
• made of hardware and software
• an open system
• ? interoperability needs to be ensured between
  products of different suppliers.
• System software controls the hardware
• Application software gets instructions from the
  hardware

13
Technical Background (II)

• Operating System (OS) controls the basic
  functions of a computer .
• API (Application Programming Interfaces) not
  always standardised, but proprietary.
• Application network effect the distributing
  system of software resources across the network
  must be transparent.

14
Technical Background (III)

• Work group server OS
• services are used by office workers
• function sharing files that are stored on
  servers, sharing printers and determine how
  users and groups can access these services and
  other services of the network.

15
Technical Background (IV)

• Media Player
• a software product that is able to play back
  audio and video content
• functionality to decode, decompress and play
  digital audio and video files downloaded or
  streamed over Internet

16
Products concerned
17
Products concerned

• MS-DOS client PC operating system Windows 3.0,
  3.1 Windows NT and Windows 2000 which relied on
  NT technology
• WMP, WMP9

18
Microsofts behaviour
19
Microsofts behaviour

• Commission Microsoft abused a dominant position
  under art. 82 of the EC Treaty. They have a
  dominant position in the relevant market for the
  supply of client PC OS and also in the relevant
  market of the work group server OS.
• The Commission distinguished two different abuses
  

20
(1) Microsofts refusal to supply
interoperability information

• Sun and the other suppliers of server OS were not
  able to compete effectively against Microsoft,
  because they did not have the inter-operability
  information needed.

21
(2) Bundling of Windows Media Player with Windows

• No version of the Windows PC OS was available
  without including WMP. This weakens the effective
  competition in the market for the supply of media
  players. Reason it is a very effective form of
  distributing, but only Microsoft can do it.

22
The relevant markets
23
The relevant markets

• The client PC operating system market
• The Workgroup server operating system market
• The streaming media player market

24
Demand side substituability

• A relevant product market compromises all those
  products and / or services which are regarded as
  interchangeable or substituable by the consumer,
  by reason of the products characteristics, their
  prices and their intended use (321)

25
Supply side substituability

• Suppliers are able to switch production to the
  relevant products and market them in the short
  term without incurring additional costs or risks
  in response to small and permanent changes in
  relative prices (322)

26
The client PC operating system market
27
Demand Side Substitutability

• There are OS especially designed and marketed as
  OS for Client PC s. This means that OS intended
  for different computers (such as a server) are
  not used on client PC Hardware
• There is no substitutability between other client
  appliances and the Client PC OS
• There is no substitutability between Server
  operating system and Client PC OS

28
Demand Side Substitutability

• There are no realistic substitutes on the demand-
  side for client PC OS

29
Supply Side Substitutability

• Software developers not producing client PC OS
  would not be able to switch their production to
  client PC OS without incurring additional costs
  and risks
• Marketing perspective aggressive advertising,
  which entails significant costs and risks
• Technical perspective modification of OS for
  other devices to a client PC OS is very costly
  and risky.

30
Supply Side Substitutability

• There are no realistic substitutes on the supply-
  side for client PC OS

31
The server operating market
32
Demand Side Substitutability

• Other OS (ex Web serving) are not substitues for
  work group server OS.
• Workgroup servers fulfil a distinct set of
  interrelated tasks that are demanded by
  consumers.
• Contrary to other OS, work group server OS are
  optimised to fulfil these tasks
• Microsofts pricing strategy confirms the absence
  of demand-side substitutability between work
  group server OS and other server OS

33
Demand Side Substitutability

• There are no products that exercise sufficient
  competitive pressure on work group server OS

34
Supply-side substitutability

• Other OS vendors are not able to switch their
  production and distribution assets to Work group
  server OS without incurring significant
  additional costs and risks and within a
  timeframework sufficiently short so as to
  consider that supply side-considerations are
  relevantin this case (399)

35
Supply-side substitutability

• There is no supply- side substitution for Work
  group Operating Systems.

36
The media player market
37
Streaming media players

• Is the streaming media player a product distinct
  from an OS ?

38
Demand Side Substitutability

• The classical play back devices (CD and DVD
  players) are not a substitue for Media Players.
  They do not have the same demand.
• Media Players with similar functionalities are
  the only products competitive to WMP Consumers
  want a media player wich is able to play and
  stream audio and video files. So, there is not
  substitutability in both ways.

39
Supply Side Substitutability

• To develop, innovate and promote a new media
  player, including codecs, formats and media
  streaming technology, significant investments in
  terms of research, development and promotion are
  needed.
• Market entry is difficult
• The network effects make that there are barriers
  to entry for new firms

40
Conclusion Media Player Market

• Because there are no subsitutions, neither on
  demand nor supply side, the market for streaming
  media players is a relevant product market in
  this case.

41
Geographical market

• For PC operating system, work group server OS and
  media player, the relative geographical market is
  world-wide.

42
Dominant Position

• Legal background and application to Microsoft Case

43
Overview

• The General provisions set out in Articles 2 and
  3 EC Treaty
• Article 82 and a general definition of Dominant
  position
• The dominant position in the case of Microsoft

44
General provisions set out in the EC Treaty (i)

• Article 2 of the EC Treaty
• The Community shall have as its task, by
  establishing a common market and an economic and
  monetary union and by implementing common
  policies or activities referred to in Articles 3
  and 4, to promote throughout the Community a
  harmonious, balanced and sustainable development
  of economic activities, a high level of
  employment and of social protection, equality
  between men and women, sustainable
  andnon-inflationary growth, a high degree of
  competitiveness and convergence of economic
  performance, a high level of protection and
  improvement of the quality of the environment,
  the raising of the standard of living and quality
  of life and economic and social cohesion and
  solidarity among Member States.

45
The General provisions set out in The EC Treaty
(ii)

• Article 3(g) of the EC Treaty
• For the purposes set out in the Article 2, the
  activities of the Community shall include, as
  provided in this Treaty and in accordance with
  the timetable set out therein
• (g) A system ensuring that competition in the
  internal market is not distorted

46
Relationship between Articles 81 and 82

• They both serve the principals set out in
  Articles 2 and 3 of The EC Treaty
• Article 82 impose special responsability on
  companies with dominant position, while Article
  81 doesnt.

47
Article 82

• Safeguards Article 3 (g) by prohibiting abuse of
  dominant position
• establishing a system ensuring that competition
  in the internal market is not distorted by firms
  holding a dominant position

48
The two objectives of Article 82

• To protect the degree of competition in a defined
  market, and therefore its customers and,
• To ensure fair play between the companies in this
  defined market

49
Definition of a dominant position

• Article 82 does not provide for a definition
• Firms holding a substantial amount of market
  power in one or more of the markets in which they
  operate1
• List in Article 82 is only indicative
• Therefore the ECJ states that
• any kind of behaviour by a dominant undertaking
  that appreciably distorts competition or exploits
  customers in the market in question.

50
Is dominant position prohibited?
51
Exclusionary and Exploitative practices

• Exclusionary practices -harm or exclude
  competitors
• Exploitative practises-exploit opportunities
  provided by its market strengh

52
Refusal to deal

• Considered abusive when this refusal weakens
  competition in the relevant market.
• Refusal to provide information. (Mostly
  technical).
• Refusal to deal also includes tying.

53
Refusal to grant access to an essential facility

• facility or infrastructure which is essential
  for reaching customers and/or enabling
  competitors to carry on their business, and which
  cannot be replicated by any reasonable means.
• Case London European-Sabena

54
Intent of the undertaking(i)

• Abuse of dominant position justifiable if
• -it is justified on business grounds
• The intention to eliminate a competitor when
  having a dominant position cannot be accepted as
  a business strategy.

55
Intent of the undertaking (ii)

• DEFENSE v. EVIDENCE
• Sheds light on the motivation of an undertaking
• -element for the level of fine

56
Intent of the undertaking(iii)

• Internal communication at Microsoft concerning
  strategy choices regarding its competitor UNIX
  (internal mail)
• Do we treat UNIX like NetWare or like Vines?
  i.e. love it to death (invest a lot of money and
  kill it slowly) or ignore it (invest no money on
  the expectation it will die quickly).

57
Jungle law or EC law?

• A firm only abuses its dominant position when
  the exclusion of competitors is not the
  consequence of better performance.
• To be considered a good sportsman you are
  expected to follow the rules and to play a fair
  game

58
Microsofts dominant position

• The ECJ states that
• (Case27/76 United Brands v. Commission)
• a position of economic strength enjoyed by an
  undertaking which enables it to prevent effective
  competition being maintained on the relevant
  market by affording it the power to behave to an
  appreciable extent independently of its
  competitors, its customers and ultimately of the
  consumers

59
Market Shares (i)

• Usual Indicator-market shares
• very large market shares are in themselves, and
  save in exceptional cases, evidence of the
  existance of a dominant position1

60
Market Shares (ii)

• High market shares (over 50)1 held over a period
  of time are considered enough evidence that an
  undertaking has a dominant position.
• The two requisites are fulfilled in the Microsoft
  case
• They control a large market share
• Has done so for some time

61
Dominance in Relation to its competitors?(i)
62
Dominance in Relation to its competitors?(ii)

• Already in 1996 Microsoft held extremely high
  market shares
• 76,4
• The only real competitor is Apple
• 2,9

63
Overwhelmimgly dominant position

• Commission says
• Microsoft, with its market shares of over 90 can
  be said to hold an overwhelmingly dominant
  position

64
Justification arguments

• Wrong market
• Market is very different and special(dynamic
  factors of the new-economy)
• A dominant position may be limited in time but
  that does not change the present situation of a
  companys market power!

65
Barriers to entry

• To exert market power
• .only possible if potential competitors
  are prevented from entering the market.
• Strong network effects constitute a difficult
  barrier to entry for potential competitors.

66
Strong network effects

• Backward compatibility
• Client PC operating systems.
• the more popular an operating system is, the
  more applications are written to an operating
  system, the more popular it will be among users.
  

67
Bill Gates consideration of network effects

• Before the US District Court on 18 April 2002 he
  says Economists call this a network effect but
  at the time we called it the positive feedback
  loop.

68
Further considerations

• Commission says
• This positive feeback loop constitutes an
  actual barrier to entry for new entrants and this
  hinders effective competition.

69
Further justification grounds

• Not a monopoly
• Technical revolution
• Commission
• We never said you were a monopoly
• Relevant market is already defined

70
Work Group Server Operating system
71
Market shares (i)

• Different Market
• Measure the market by considering
• Unit shipments
• HardwareSoftware1

72
Market Shares (ii)

• Servers shipped Year 2002 costing under USD
  25,000
• Unit by shipments 64,9 of the market
• Revenues 61,0 of the market

73
Presumption of dominant position

• Market shares of at least 60 is a presumption of
  dominant position.
• Competitors weak position

74
Barriers to entry

• network effects in this market do not exist.
• However the network effects that do exist (?)
  are the result of internal Windows competence,
  hence Available skill-sets and cost/availability
  of support. (in-house or external).

75
Interoperability - a barrier to entry

• Commission finds that an important barrier to
  entry is the fact that withholding
  interoperability information constitutes an,
  although artificial, barrier to entry.

76
Strong links between the two markets

• Link between the markets for
• -Client PC operating system and,
• -Work group operating system.
• an isolated analysis of the competitive
  conditions on the market for work group server OS
  ignoring Microsofts overwhelming dominance in
  the neighbouring client PC OS fails to deliver
  an accurate picture of Microsofts true market
  power.

77
Conclusion

• Commission finds Microsoft having a dominant
  position in both markets.
• Unnecessary for Microsoft to try to distinguish
  the situation since there are such strong links

78
Conclusion (ii)

• Market Survey III shows the quality of server
  systems and network effects are in fact a
  result of this quality and performance.
• Commission does not give Microsoft any credits
  for this and finds that this is anticompetitive
  since it constitutes a barrier to entry for new
  entrants.

79
Abuses

• Not Supplying Interoperability Information

80
The abuse in the interoperatbility case

• The Commission argues that Microsoft holds key
  Interoperability information from its client PC
  domninant position, which could enable to
  influence competition on the related server OS
  market, as evidence at its dominance of the
  server OS market

81
Abuses

• Bundling of Windows Media Player with Windows

82
Overview

• Current Literature on Bundling
• Historic Perspective
• Mixed evidence from economic theories
• Rule of Reason approach
• Microsoft Case Bundling of WMP
• Arguments put forward by the Commission
• Analysis of Commissions approach
• Conclusion

83
Current Literature on Bundling
84
Bundling

• Definition
• Conditioning the purchase of one product on the
  purchase of another
• Pure bundling tying
• Mixed bundling
• Involves both costs and benefits
• Ubiquitous
• Desirability\legality?

85
Rules

• Per se illegality rule
• Modified Per se illegality rule
• Rule of Reason framework
• Modified Per se legality rule (Post- Chicago
  School)
• Per se legality rule (Chicago School)

86
Historic Perspective

• Gradual evolution in US
• per se illegality (Northern Pacific Railway v.
  U.S., 1958)
• Parrish Jefferson case 1984 modified per se
  illegality
• Microsoft III case 2001 Rule of Reason approach
  (yet specific technological integration case).
• No evolution in EU, yet dealt with only few
  cases. Does Microsoft case 2004 indicates Rule of
  Reason approach?

87
Anti-Competitive Effects

• Short Run
• Price discrimination by monopolist
• Extract consumer surplus from buyers with extreme
  valuations
• Ambiguous welfare effects
• If goods are complements, tying unprofitable
• Asymmetric product lines between competitors can
  lead to significant price increases Cournot
  effect
• Competition with similar product lines reduces
  bundling incentives to the extent that bundling
  becomes unlikely
• Commitment to bundling might hurt competition in
  tied product market (must be credible!)
• Product differentiation
• Entry deterrence

88
Anti-Competitive Effects

• Long Run
• Effects of current bundling on future
  competitiveness of tied product market
• Complementary products form potential
  substitute/competitive threat for monopolist
• ? Reduce market share by bundling own complement
• Important Network effect

89
Efficiency Justifications

• Main points
• Factual evidence ex ante view
• Economies of scope
• Consumer Side
• Transaction cost savings
• Higher functionality/quality
• Network effect homogeneity
• Production Side
• Economies of scale

90
Rule of Reason Approach

• 3 screen set-up
• Necessary (but not sufficient!) conditions
• Market power in tying product market
• Complementarity
• Asymmetry in product range
• (superfluous?) Status of Competition in tied
  market (imperfectly competitive), Commitment to
  Tie, Competitors, Likelihood of Competitor exit,
  Entry barriers, Absence of buyer power
• Use criteria that make it possible to decide
  whether this specific case of bundling is
  sufficiently likely to generate anticompetitive
  effects in the future
• Consider efficiency-enhancing effects that might
  balance the anticompetitive effects

91
Microsoft Case

• Tying of Windows Media Player with Windows

92
Approach by the Commission

• Definition of bundling by Commission
• Bundling two or more distinct products and
  forcing the customers to by the product as a
  bundle without giving the choice to buy the
  products individually
• Does Microsofts conduct fulfills the conditions
  stipulated in Art 82 d?
• Tying and tied good two separate products
• Firm dominant in tying product market
• No choice for consumer to obtain tying product
  without tied product
• Tying forecloses competition
• If so, burden of proof shifted to defendant to
  show efficiencies outweighing the anticompetitive
  effects

93
Tying and tied good two separate products

• EC Consumer demand test (Jefferson Parish)
  clearly identifies two separate products

94
Firm dominant in tying product market

• EC Microsoft holds a dominant position in the
  market for OS.

95
No choice for consumer to obtain tying product
without tied product

• EC Consumer cannot buy Windows without WMP
  (embedded)
• Microsoft WMP for free, no forced usage
• EC Art 82 contains no payment/forced usage
  provision

96
Tying forecloses competition

• Does bundling foreclose future competition?
• EC WMP will become platform of choice for
  content and application
• ? Very probably halting innovation and
  foreclosing competition
• Why?

97
Tying forecloses competition

• Unmatched ubiquity on client PCs
• EC Computer builders have no incentive to ship
  other media player
• EC Other distribution channels not nearly as
  efficient (not even downloading)

98
Tying forecloses competition

• Effect on content providers and software
  developers
• EC Tying of WMP gives Microsoft competitive
  advantage unrelated to merit of product strong
  network effect
• ? Spill-over effect if Microsoft becomes
  dominant, significant barriers to entry will
  arise, also in related markets
• (e.g. handhelds)

99
Tying forecloses competition

• ECMarket research shows that consistent trend in
  favour of using WMP and WMP format to detriment
  of competition
• NB. Survival of firms does not prove absence of
  foreclosing effects

100
Approach by the Commission

• EC has shown that Microsoft fulfills the
  conditions stipulated in Art 82 d and that
  anticompetitive effects are present
• Can Microsoft show tying efficiencies that
  outweighing the anticompetitive effects?

101
Tying efficiencies

• Tying efficiencies related to distribution
• Reduced transaction costs?
• ? Neglects consumer benefit of choice
• Quod licet bovi, non licet Jovi dominant firm
  has special responsibility (Apple bundles
  QuickTime, 2.9of the market
• Alleged absence of incentives by Microsoft to
  foreclose cannot be accepted
• No benefits that could not have been achieved
  without bundling

102
Commissions Conclusion

• The manner in which competition unfolds in the
  media player market is a concern for the EC.
  Through tying, Microsoft uses its Windows
  distribution channel to anti-competitively ensure
  a competitive advantage in the market for media
  players. Competitors are a priori at a
  disadvantage. A position of market strength
  attained in a market with strong network effects
  is sustainable entry barriers for potential
  competitors will prevent innovation. In addition,
  tying might allow Microsoft to weaken effective
  competition in related media markets as well. In
  fact, all competition in product markets that
  might be bundled with Windows might be distorted.
  In conclusion, Microsoft is held liable for tying
  (as of May 1999).

103
Conclusion

• According to the Commission Microsoft has abused
  its dominant position by refusing to supply
  interoperability information in the server
  operating system market and by bundling Windows
  Media Player to Windows.

104
Conclusion on Interoperability

• Commission puts aside any efficiency gains and
  finds that Microsofts behaviour is
  anticompetitive since it constitutes a barrier to
  entry for new entrants

105
Conclusion on Bundling

• Generally
• Narrow scope for efficiency gain arguments
• Yet, often not anticompetitive (not profitable in
  competitive market)
• Bundling should be generally accepted
• EXCEPT
• When bundling firm has dominant position
• Use rule of reason approach
• Microsoft case
• Although possibly not all arguments
  well-supported or even valid, one of few cases in
  which bundling is indeed convincingly
  anticompetitive

106
Discussion

• OR
  ?

107
Used Secondary Literature

• Motta, M. Competition Policy, Theory and
  Practice. Cambridge University Press (2004)

• Ahlborn, Evans and Padilla.The Antitrust
  Economics of Tying A farewell to Per Se
  Illegality (April 2003).
• Kühn, Stillman and Caffarra. Economic Theories of
  Bundling and their Policy Implications in Abuse
  Cases An Assessment in Light of the Microsoft
  Case (September 2004).