In this article Marija J Danilunas gives anoverview of the anti-trust claims being made against Microsoft, and predicts adifficult time for both anti-trust regulators and the world’s third largestcompany, as both claim to be protecting the best interests of consumers. MarijaJ Danilunas is a partner in the IP/Competition law unit of Hammond Suddards andcan be contacted at 0171 655 1000 or by email to marija.danilunas@hammondsuddards.co.uk.
In December 1997 the United States Department of Justice (DOJ)obtained an interim injunction against Microsoft. The injunction orderedMicrosoft to stop ‘bundling’ or ‘tying-in’ products to its licences ofpersonal computer operating system software (including Windows 95 and anysuccessor version) by requiring as a condition, express or implied, of thelicence that the licensee also license and preinstall any Microsoft Internetbrowser software (including the Internet Explorer or any successor thereof)(Judge Thomas Penfield Jackson, US District Court for the District of Columbia,11 December 1997 – ‘the December Injunction’). During the injunctionproceedings, the DOJ had alleged that Microsoft had ‘enjoyed for some time avirtual monopoly in the sale of PC operating systems software, and presentlypossesses a market share approaching eighty percent. Because most retailpurchasers of PCs expect to receive a preinstalled operating system on the PCsthey buy, OEMs (original equipment manufacturers of PCs) routinely preinstalloperating system software on the hard disk drive memory of nearly all PCs theymanufacture. Consumer preference for Microsoft’s most recent and mostsuccessful PC operating system, Windows 95, has made it a commercial necessityfor OEMs to pre-install Windows 95 as the operating system software of choice ofthe vast majority of the PCs they manufacture, and virtually all of them doso’.
Presumably, Microsoft would not disagree with the statement that virtuallyall OEMs preinstall Microsoft’s operating system software with the result thatit has become the ‘industry standard’ for PCs, since Microsoft views thestandardisation of all operating system software as a benefit to the IT industryand consumers alike. A strong argument can be made that having a single,standard operating system software package would be a bonus to consumers,simplifying installation, training, reducing costs, increasing sales, andenabling competitors to focus their research and development on better softwareapplications that would run on any PC. While this may provide a benefit toconsumers in the short term, in the long term, however, that may not be the casewith the growing interdependence and convergence of the computer, Internet,television, telecommunications and media industries. If these industries allbecome dependent upon the Internet, which in turn functions only with the‘industry standard’ operating systems software and browser software ownedand controlled by Microsoft, Microsoft will be free to act and adopt pricing andmarketing strategies unhindered by its competitors’ activities. AllowingMicrosoft to achieve that degree of control and autonomy in such an importantarea of technology for the future will not be in the long-term interest ofconsumers or the IT industry unless the exercise of its dominance is regulatedby the anti-trust regulators in the USA, Europe and other jurisdictions.
That these fears have become a reality can be seen by the level of interestin Microsoft’s activities in the USA among the IT industry, anti-trustregulators, economists and antitrust specialists. The need for conferences andSenate Committees further demonstrates that there is no quick or easy answer tothese issues. For example, over the last three months there have been thefollowing developments.
- It was learned that, notwithstanding the settlement of the contempt proceeding brought by DOJ in January 1998 against Microsoft, the DOJ was already investigating other alleged anti-trust practices which involved the withholding of key information about Microsoft’s APIs (applications programming interface) from other software developers, announcing the launch of phantom programs to discourage competitors from developing similar programs, attempts to make Microsoft’s program the industry standard for DVD-ROM (successor of CD-ROM) also controlled by Microsoft, and engaging in discriminatory price discounting which favoured OEMs who buy the ‘Bundled’ or ‘Tied’ version of Windows and Internet Explorer, all of which, if proven, could lead to new charges against Microsoft even if it succeeds in setting aside the December Injunction.
- A Conference was held in Washington on 5 February 1998 entitled ‘Competition, Convergence and the Microsoft Monopoly: the Future of the Digital Marketplace’. The Conference focused on Microsoft and general anti-trust questions, including the issue of whether the software industry required a different anti-trust approach, whether new technology like Java would limit Microsoft’s monopoly thus limiting the degree of government intervention required, and whether Microsoft was intentionally extending its monopoly to control the converged digital marketplace. Speakers at the Conference included some of the most highly influential anti-trust specialists and economists with the keynote address being delivered by Senator Colin Hatch.
- Senator Colin Hatch is also the chair of the Senate Judicial Committee set up to examine the roles of Microsoft, Sun, Netscape, and generally anti-trust policies, and how such policies can best serve consumers and the long-term health of the software industry and Internet generally.
- After issuing subpoenas in support of their State investigations into Microsoft’s marketing practices (including those surrounding Windows 98 due to be released later this year), representatives from 11 US States met on 19 February 1998 with the DOJ in California ‘to plan a strategy in the Microsoft anti-trust case’.
European Complaints
This level of activity and interest in Microsoft is not, moreover, limited tothe USA. The European Commission is responsible for the regulation ofanti-competitive practices which affect trade between Member States of theEuropean Community, the most common complaints being breaches of Article 85 andArticle 86 of the Treaty of Rome.
Article 85 provides:
(1) The following shall be prohibited as incompatible with the commonmarket: all agreements between undertakings, decisions by associations ofundertakings and concerted practices which may affect trade between MemberStates and which have as their object or effect the prevention, restriction ordistortion of competition within the common market, and in particular thosewhich:
. . .
(e) make the conclusion of contracts subject to acceptance by the other partiesof supplementary obligations which, by their nature or according to commercialusage, have no connection with the subject of such contracts.’
Article 85(2):
(2) ‘Any agreements or decisions prohibited pursuant to this Articleshall be automatically void.’
Article 86 describes conduct which can constitute an abuse of a dominantposition:
‘Any abuse by one or more undertaking of a dominant position within thecommon market or in a substantial part of it shall be prohibited as incompatiblewith the common market in so far as it may affect trade between Member States.Such abuse may, in particular, consist in:
. . .
(d) making the conclusion of contracts subject to acceptance by the otherparties of supplementary obligations which, by their nature or according tocommercial usage, have no connection with the subject of such contracts.’
As early as 1994, the Commission had already registered concerns aboutMicrosoft bundling or ‘tying in’ other products to Microsoft’s operatingsystem software. Microsoft was also reported to be in discussions with theCommission over its contracts with European Internet service providers and itsthird stage of growth into secondary markets such as telecommunications andmedia.
In November 1997, Microsoft resolved another Complaint to the Commission ofunlawful ‘tying-in’ made by the Santa Cruz Operation (‘SCO’). SCO hadacquired the UNIX business of ATT and then objected to terms of a contract ithad assumed by virtue of the acquisition. The contract between Microsoft and ATThad been made ten years earlier, but in 1997 SCO claimed that it was void underArticle 85(1). SCO alleged that, under the terms of the contract, Microsoftsought to control the development by UNIX of its operating system formicrocomputers. SCO’s Complaint to the Commission was resolved when Microsoftin November 1997 irrevocably waived restrictions that were imposed on UNIX underthe contract.
The fact that the contract was ten years old and had been voluntarilyacquired by SCO did not prevent the Commission from launching an investigation,and it illustrates a vital fact that should not be forgotten when dealing withanti-trust regulators, namely that there is no time-limit on their investigationinto marketing practices or agreements that have the effect or intention ofrestricting, distorting or preventing competition. Further anti-trust regulatorsfrom the US informally confer with the European Commission on anti-trust issuesaffecting both jurisdictions, and are reported to have done so in respect ofMicrosoft.
Long Arm of Anti-trust Regulators
The Microsoft case in the USA can be cited as another example of the longreach of anti-trust regulators. Microsoft claims that it has never made a secretof its intention to integrate more and more software applications into itsoperating system software. In August 1995 when the Consent Decree was enteredinto (which settled proceedings brought against Microsoft by the DOJ for abuseof monopoly and restraint of trade practices) Microsoft claims that the‘integration’ of Internet Explorer and Windows 95 was nearly complete, aversion had been supplied and fully revealed to the US government as an exampleof an integrated product, documentation was disclosed which showed its intentionto make Internet-related technologies including Web browsing an integral part ofWindows 95, and public announcements were made to this effect. Moreembarrassingly for the DOJ (if it is proven to be true), in 1995 the DOJdeclared that it was not challenging Microsoft’s inclusion of new softwarefeatures into its operating system products, and allegedly conceded that addingattractive features to its operating system products was acceptable. The DOJwere further on express notice of Microsoft’s intention when Microsoft enteredinto the 1995 Consent Decree, but expressly reserved for itself the right toincorporate new features into its operating system software as provided in theConsent Decree (‘which shall not be construed to prohibit Microsoft fromdeveloping integrated products).
It is not surprising therefore, that some confusion has resulted from theintense scrutiny and charges resulting from Microsoft’s ‘integration’ ofthe Internet Explorer into Windows 95, its proposed full integration intoWindows 98 and its intention to add more applications as an integral part of itsoperating systems software. What then are the specific grounds for complaint bythe DOJ, the State Attorney-Generals, the concerns expressed at Conferences andduring Senate Committee hearings? Although the complaints about Microsoft’sagreements and activities all relate to the future integration of more Microsoftapplications into their operating system software, the complaints can be brokendown into two very different lines of attack giving rise to very differentpractical, political and legal difficulties.
The first, is to stop Microsoft from entering into agreements and concertedpractices that constitute unlawful bundling or tying in by granting licences ofone product, the operating system software, on the condition that the OEM alsoagree to license a separate stand-alone product (or rather perhaps, given the‘integration’ issue, which could be a stand-alone product).
The second, and more difficult, problem is whether the anti-trust regulatorscan or should prevent Microsoft’s plan to integrate more and more softwareapplications into its operating system software, which is acknowledged to be thede facto industry standard, thereby extending its dominance into secondarymarkets. Since this may be perceived to be a direct attack and control by thegovernment on new product development by Microsoft, it is a much more difficultissue, in view of the express terms of the Consent Decree and statementsallegedly made by the DOJ made in 1995.
Each of these grounds of attack will be considered in turn.
Unlawful Bundling or Tying in
Both USA and Europe prohibit marketing practices which compel a licensee totake a licence to all products supplied by a dominant player in a particularindustry. In the USA ‘tying’ arrangements are defined as ‘an agreement bya party to sell one product (the tying product) but only on condition that thebuyer also purchases a different (or tied) product or at least agrees that hewill not purchase that product from any other supplier. A tying arrangement willgenerally be treated as per se unlawful, and thus prohibited withoutproof of an unreasonable anti-competitive effect if: (1) two separate productsor services are involved; (2) the sale or agreement to sell one product orservice is conditional on the purchase of another; (3) the seller has sufficienteconomic power in the market for the tying product to enable it to restraintrade in the market for the tied product; and (4) a not substantial amount ofinterstate commerce in the tied product is affected.’ (footnotes 5 & 7,Order of Judge Jackson, 11 December 1997.)
In Europe, such ‘tying’ practices are expressly prohibited both byArticle 85(1)(e), which prohibits anti-competitive clauses in agreements thataffect trade between Member States, and Article 86(d) as an abuse of a dominantposition. Article 86(d) provides that it is an abuse to make the conclusion ofcontracts subject to acceptance by the other parties of supplementaryobligations which, by their nature or according to commercial usage, have noconnection with the subject of such contracts.
The new UK Competition Law Bill, which is due to be passed this Spring,contains terms that mirror Article 85 and 86 although its jurisdiction islimited to trade affecting the UK. Thus unlawful bundling or tying in ofproducts will also render void such terms in contracts affecting only the UK ifthe complaint to the Office of Fair Trading is upheld. The new UK CompetitionBill will further reinforce other national UK legislation banning tying inpractices, such as s 44 of the Patents Act 1977, which renders void licences orother agreements that require a licensee to acquire from the supplier anyproducts other than the patented product, for example, raw material which is notprotected by a patent.
The requirement that, to be unlawful, the agreement must compel the bundlingtogether of two ‘separate’ products explains the focus by anti-trustregulators (as seen in the December Injunction proceedings in the USA and thepending appeal) on when a program like Internet Explorer is fully integratedinto the operating system software and when it is a ‘separate’ product.Microsoft may lose on this point in respect of Windows 95 and the currentlyavailable Internet Explorer (which appears to be a ‘stand-alone’ productwith a physical and commercial existence of its own like the competing Internetbrowsers), but the new version of Windows 98 is said to have the Explorer fullyintegrated and unable to be uninstalled. The question then is whetherintegration is technically or commercially necessary or is a means to circumventaction by anti-trust regulators.
Control of Product Development
The more interesting issue, therefore, is not whether a program is integratedor not into the Microsoft operating system software, but whether Microsoft canbe stopped from integrating more and more programs into the operating systemsoftware, which then become the industry standard – leaving Microsoft in aposition of total dominance, not only within the IT industry but in secondarymarkets and products.
Microsoft maintains that blocking Microsoft’s integration ofInternet-related technologies into its operating system software would serve nopro-competitive purpose, and that every ‘software company including Microsoftmust have the ability to continually innovate and continually create newfeatures for consumers . . . a preliminary injunction would have a chillingeffect on innovation throughout the software industry’ (Wired News,10 March 1998).
If the intention or the effect of such integration, in concert withother alleged marketing practices, however, is to restrict, distort, or preventcompetition, then this can constitute an abuse of a dominant position givingrise to intervention by anti-trust regulators, who will then need to decide themost effective remedy or penalty. Practices which might be viewed as an abuse ofa monopoly or dominant position include:
- Predatory pricing: offering products for free that others charge for initially. Netscape charged for its Navigator browser until Microsoft developed and offered the Explorer at no charge to OEMs.
- If the monopolist adopts a practice of attacking new software applications by immediately adding equivalent programs into existing operating system software controlled exclusively by the monopolist. This will inevitably result in bankers and venture capitalists not being willing to fund rival software companies, thereby threatening their financial stability, with the consumer and IT industry losing the benefit of any innovations such companies may have been developing.
- Using the ‘industry standard’ to ensure that new businesses related to their industries, such as media and telecommunications, are made dependent upon that ‘industry standard’, thus extending its monopoly into those secondary markets.
- Changing competitor’s products so that they are dependent upon the ‘industry standard’. For example, Java (Sun) is a programming language that enables applications to run on any operating system (‘network computer’) which would diminish the need for PCs and for Microsoft’s operating system software. This would not be the case if Java was altered into a Windows programming language. Sun maintains that consumers would be better off with simpler network computers that link to host computers much as telephones are linked to central exchanges.
If any practices such as those outlined above are found to exist then,notwithstanding the fact that Microsoft may win its appeal in April 1998 and befound not to be in violation of the Consent Decree, it may still find itselfunder intense scrutiny by the DOJ, the Senate, the 11 State Attorney-Generals,and the Commission and national UK anti-trust authorities. The question thenarises as to who should decide whether and how such future integration should bestopped, and what is in the best interest of the consumer and IT industry?
Best Interests?
Microsoft says that determining what is in the best interest of the consumerand the software industry should be left to the marketplace and that the USgovernment should not dictate how the operating system should develop and whichfeatures it should incorporate. In his judgment granting the interim injunctionon 11 December 1997, Judge Jackson held that Microsoft’s ‘unfettered’liberty to impose its idea of what should be integrated into its operatingsystems stops at least at the point at which it would violate establishedanti-trust law. The issuance of an injunction was necessary because the USgovernment had reason to believe that ‘Microsoft’s licensing strategy wasmotivated by a threat it apprehends in the foreseeable future to its operatingsystem’s monopoly’. As stated in the judgment, ‘whether the government hascorrectly divined Microsoft’s intentions, the probability that Microsoft willnot only continue to reinforce its operating system monopoly by its licensingpractices, but might also acquire yet another monopoly in the Internet browsermarket is simply too great to tolerate indefinitely until the issue is finallyresolved. Those practices should be abated until it is conclusively establishedthat they are benign.’
Conclusion
Microsoft is an innovative and futuristic company that wisely identified andseized commercial opportunities. These traits should be encouraged, but has itbecome a victim of its own success? Even if its intentions are benign, can thegovernment and other government bodies simply ignore the growing dominance andcontrol by Microsoft in all IT-related industries? Probably not, but perhaps itcan try to do so without the adversarial methods which result in this innovativecompany being portrayed as a villain which is ‘holding the world hostage’.According to Michael Mahony, head of the IT group at Hammond Suddards, ‘Theother key objective of the anti-trust authorities on both sides of the Atlanticmust be to avoid long-term investigation and complaints of the type involvingIBM in the 1970s and early 1980s. Given the fast moving nature of the ITindustry, the subject matter of any complaint may be out of date by the timethere is any resolution, aside from which it would absorb enormous resourcesboth on Microsoft’s and the anti-trust regulator’s part’.
