washingtonpost.com
Home   |   Register               Web Search: by Google
channel navigation


News Home Page
Photo Galleries
Politics
Nation
World
Metro
 Business/Tech
 Market News
 Company Research
 Mutual Funds
 Portfolio
 Personal Finance
 Columnists
 Fast Forward
 Tech Thursday
 Special Reports
 Live Online
 Business and Tech Index
Sports
Style
Travel
Health
Opinion
Weather
Weekly Sections
News Digest
Classifieds
Print Edition
Archives
News Index
Help
Partners:


Conclusions of Law and Order

Page 3

II. SECTION ONE OF THE SHERMAN ACT

Section 1 of the Sherman Act prohibits "every contract, combination . . . , or conspiracy, in restraint of trade or commerce . . . ." 15 U.S.C. § 1. Pursuant to this statute, courts have condemned commercial stratagems that constitute unreasonable restraints on competition. See Continental T.V., Inc. v. GTE Sylvania Inc., 433 U.S. 36, 49 (1977); Chicago Board of Trade v. United States, 246 U.S. 231, 238-39 (1918), among them "tying arrangements" and "exclusive dealing" contracts. Tying arrangements have been found unlawful where sellers exploit their market power over one product to force unwilling buyers into acquiring another. See Jefferson Parish Hospital District No. 2 v. Hyde, 466 U.S. 2, 12 (1984); Northern Pac. Ry. Co. v. United States, 356 U.S. 1, 6 (1958); Times-Picayune Pub. Co. v. United States, 345 U.S. 594, 605 (1953). Where agreements have been challenged as unlawful exclusive dealing, the courts have condemned only those contractual arrangements that substantially foreclose competition in a relevant market by significantly reducing the number of outlets available to a competitor to reach prospective consumers of the competitor's product. See Tampa Electric Co. v. Nashville Coal Co., 365 U.S. 320, 327 (1961); Roland Machinery Co. v. Dresser Industries, Inc., 749 F.2d 380, 393 (7th Cir. 1984).

A. Tying

Liability for tying under § 1 exists where (1) two separate "products" are involved; (2) the defendant affords its customers no choice but to take the tied product in order to obtain the tying product; (3) the arrangement affects a substantial volume of interstate commerce; and (4) the defendant has "market power" in the tying product market. Jefferson Parish, 466 U.S. at 12-18. The Supreme Court has since reaffirmed this test in Eastman Kodak Co. v. Image Technical Services, Inc., 504 U.S. 451, 461-62 (1992). All four elements are required, whether the arrangement is subjected to a per se or Rule of Reason analysis.

The plaintiffs allege that Microsoft's combination of Windows and Internet Explorer by contractual and technological artifices constitute unlawful tying to the extent that those actions forced Microsoft's customers and consumers to take Internet Explorer as a condition of obtaining Windows. While the Court agrees with plaintiffs, and thus holds that Microsoft is liable for illegal tying under § 1, this conclusion is arguably at variance with a decision of the U.S. Court of Appeals for the D.C. Circuit in a closely related case, and must therefore be explained in some detail. Whether the decisions are indeed inconsistent is not for this Court to say.

The decision of the D.C. Circuit in question is United States v. Microsoft Corp., 147 F.3d 935 (D.C. Cir. 1998) ("Microsoft II") which is itself related to an earlier decision of the same Circuit, United States v. Microsoft Corp., 56 F.3d 1448 (D.C. Cir. 1995) ("Microsoft I"). The history of the controversy is sufficiently set forth in the appellate opinions and need not be recapitulated here, except to state that those decisions anticipated the instant case, and that Microsoft II sought to guide this Court, insofar as practicable, in the further proceedings it fully expected to ensue on the tying issue. Nevertheless, upon reflection this Court does not believe the D.C. Circuit intended Microsoft II to state a controlling rule of law for purposes of this case. As the Microsoft II court itself acknowledged, the issue before it was the construction to be placed upon a single provision of a consent decree that, although animated by antitrust considerations, was nevertheless still primarily a matter of determining contractual intent. The court of appeals' observations on the extent to which software product design decisions may be subject to judicial scrutiny in the course of § 1 tying cases are in the strictest sense obiter dicta, and are thus not formally binding. Nevertheless, both prudence and the deference this Court owes to pronouncements of its own Circuit oblige that it follow in the direction it is pointed until the trail falters.

The majority opinion in Microsoft II evinces both an extraordinary degree of respect for changes (including "integration") instigated by designers of technological products, such as software, in the name of product "improvement," and a corresponding lack of confidence in the ability of the courts to distinguish between improvements in fact and improvements in name only, made for anticompetitive purposes. Read literally, the D.C. Circuit's opinion appears to immunize any product design (or, at least, software product design) from antitrust scrutiny, irrespective of its effect upon competition, if the software developer can postulate any "plausible claim" of advantage to its arrangement of code. 147 F.3d at 950.

This undemanding test appears to this Court to be inconsistent with the pertinent Supreme Court precedents in at least three respects. First, it views the market from the defendant's perspective, or, more precisely, as the defendant would like to have the market viewed. Second, it ignores reality: The claim of advantage need only be plausible; it need not be proved. Third, it dispenses with any balancing of the hypothetical advantages against any anticompetitive effects.

The two most recent Supreme Court cases to have addressed the issue of product and market definition in the context of Sherman Act tying claims are Jefferson Parish, supra, and Eastman Kodak, supra. In Jefferson Parish, the Supreme Court held that a hospital offering hospital services and anesthesiology services as a package could not be found to have violated the anti-tying rules unless the evidence established that patients, i.e. consumers, perceived the services as separate products for which they desired a choice, and that the package had the effect of forcing the patients to purchase an unwanted product. 466 U.S. at 21-24, 28-29. In Eastman Kodak the Supreme Court held that a manufacturer of photocopying and micrographic equipment, in agreeing to sell replacement parts for its machines only to those customers who also agreed to purchase repair services from it as well, would be guilty of tying if the evidence at trial established the existence of consumer demand for parts and services separately. 504 U.S. at 463.

Both defendants asserted, as Microsoft does here, that the tied and tying products were in reality only a single product, or that every item was traded in a single market.(3) In Jefferson Parish, the defendant contended that it offered a "functionally integrated package of services" - a single product - but the Supreme Court concluded that the "character of the demand" for the constituent components, not their functional relationship, determined whether separate "products" were actually involved. 466 U.S. at 19. In Eastman Kodak, the defendant postulated that effective competition in the equipment market precluded the possibility of the use of market power anticompetitively in any after-markets for parts or services: Sales of machines, parts, and services were all responsive to the discipline of the larger equipment market. The Supreme Court declined to accept this premise in the absence of evidence of "actual market realities," 504 U.S. at 466-67, ultimately holding that "the proper market definition in this case can be determined only after a factual inquiry into the 'commercial realities' faced by consumers." Id. at 482 (quoting United States v. Grinnell Corp., 384 U.S. 563, 572 (1966)).(4)

In both Jefferson Parish and Eastman Kodak, the Supreme Court also gave consideration to certain theoretical "valid business reasons" proffered by the defendants as to why the arrangements should be deemed benign. In Jefferson Parish, the hospital asserted that the combination of hospital and anesthesia services eliminated multiple problems of scheduling, supply, performance standards, and equipment maintenance. 466 U.S. at 43-44. The manufacturer in Eastman Kodak contended that quality control, inventory management, and the prevention of free riding justified its decision to sell parts only in conjunction with service. 504 U.S. at 483. In neither case did the Supreme Court find those justifications sufficient if anticompetitive effects were proved. Id. at 483-86; Jefferson Parish, 466 U.S. at 25 n.42. Thus, at a minimum, the admonition of the D.C. Circuit in Microsoft II to refrain from any product design assessment as to whether the "integration" of Windows and Internet Explorer is a "net plus," deferring to Microsoft's "plausible claim" that it is of "some advantage" to consumers, is at odds with the Supreme Court's own approach.

The significance of those cases, for this Court's purposes, is to teach that resolution of product and market definitional problems must depend upon proof of commercial reality, as opposed to what might appear to be reasonable. In both cases the Supreme Court instructed that product and market definitions were to be ascertained by reference to evidence of consumers' perception of the nature of the products and the markets for them, rather than to abstract or metaphysical assumptions as to the configuration of the "product" and the "market." Jefferson Parish, 466 U.S. at 18; Eastman Kodak, 504 U.S. at 481-82. In the instant case, the commercial reality is that consumers today perceive operating systems and browsers as separate "products," for which there is separate demand. Findings ¶¶ 149-54. This is true notwithstanding the fact that the software code supplying their discrete functionalities can be commingled in virtually infinite combinations, rendering each indistinguishable from the whole in terms of files of code or any other taxonomy. Id. ¶¶ 149-50, 162-63, 187-91.

Proceeding in line with the Supreme Court cases, which are indisputably controlling, this Court first concludes that Microsoft possessed "appreciable economic power in the tying market," Eastman Kodak, 504 U.S. at 464, which in this case is the market for Intel-compatible PC operating systems. See Jefferson Parish, 466 U.S. at 14 (defining market power as ability to force purchaser to do something that he would not do in competitive market); see also Fortner Enterprises, Inc. v. United States Steel Corp., 394 U.S. 495, 504 (1969) (ability to raise prices or to impose tie-ins on any appreciable number of buyers within the tying product market is sufficient). While courts typically have not specified a percentage of the market that creates the presumption of "market power," no court has ever found that the requisite degree of power exceeds the amount necessary for a finding of monopoly power. See Eastman Kodak, 504 U.S. at 481. Because this Court has already found that Microsoft possesses monopoly power in the worldwide market for Intel-compatible PC operating systems (i.e., the tying product market), Findings ¶¶ 18-67, the threshold element of "appreciable economic power" is a fortiori met.

Similarly, the Court's Findings strongly support a conclusion that a "not insubstantial" amount of commerce was foreclosed to competitors as a result of Microsoft's decision to bundle Internet Explorer with Windows. The controlling consideration under this element is "simply whether a total amount of business" that is "substantial enough in terms of dollar-volume so as not to be merely de minimis" is foreclosed. Fortner, 394 U.S. at 501; cf. International Salt Co. v. United States, 332 U.S. 392, 396 (1947) (unreasonable per se to foreclose competitors from any substantial market by a tying arrangement).

Although the Court's Findings do not specify a dollar amount of business that has been foreclosed to any particular present or potential competitor of Microsoft in the relevant market,(5) including Netscape, the Court did find that Microsoft's bundling practices caused Navigator's usage share to drop substantially from 1995 to 1998, and that as a direct result Netscape suffered a severe drop in revenues from lost advertisers, Web traffic and purchases of server products. It is thus obvious that the foreclosure achieved by Microsoft's refusal to offer Internet Explorer separately from Windows exceeds the Supreme Court's de minimis threshold. See Digidyne Corp. v. Data General Corp., 734 F.2d 1336, 1341 (9th Cir. 1984) (citing Fortner).

The facts of this case also prove the elements of the forced bundling requirement. Indeed, the Supreme Court has stated that the "essential characteristic" of an illegal tying arrangement is a seller's decision to exploit its market power over the tying product "to force the buyer into the purchase of a tied product that the buyer either did not want at all, or might have preferred to purchase elsewhere on different terms." Jefferson Parish, 466 U.S. at 12. In that regard, the Court has found that, beginning with the early agreements for Windows 95, Microsoft has conditioned the provision of a license to distribute Windows on the OEMs' purchase of Internet Explorer. Findings ¶¶ 158-65. The agreements prohibited the licensees from ever modifying or deleting any part of Windows, despite the OEMs' expressed desire to be allowed to do so. Id. ¶¶ 158, 164. As a result, OEMs were generally not permitted, with only one brief exception, to satisfy consumer demand for a browserless version of Windows 95 without Internet Explorer. Id. ¶¶ 158, 202. Similarly, Microsoft refused to license Windows 98 to OEMs unless they also agreed to abstain from removing the icons for Internet Explorer from the desktop. Id. ¶ 213. Consumers were also effectively compelled to purchase Internet Explorer along with Windows 98 by Microsoft's decision to stop including Internet Explorer on the list of programs subject to the Add/Remove function and by its decision not to respect their selection of another browser as their default. Id. ¶¶ 170-72.

The fact that Microsoft ostensibly priced Internet Explorer at zero does not detract from the conclusion that consumers were forced to pay, one way or another, for the browser along with Windows. Despite Microsoft's assertion that the Internet Explorer technologies are not "purchased" since they are included in a single royalty price paid by OEMs for Windows 98, see Microsoft's Proposed Conclusions of Law at 12-13, it is nevertheless clear that licensees, including consumers, are forced to take, and pay for, the entire package of software and that any value to be ascribed to Internet Explorer is built into this single price. See United States v. Microsoft Corp., Nos. CIV. A. 98-1232, 98-1233, 1998 WL 614485, *12 (D.D.C., Sept. 14, 1998); IIIA Philip E. Areeda & Herbert Hovenkamp, Antitrust Law ¶ 760b6, at 51 (1996) ("[T]he tie may be obvious, as in the classic form, or somewhat more subtle, as when a machine is sold or leased at a price that covers 'free' servicing."). Moreover, the purpose of the Supreme Court's "forcing" inquiry is to expose those product bundles that raise the cost or difficulty of doing business for would-be competitors to prohibitively high levels, thereby depriving consumers of the opportunity to evaluate a competing product on its relative merits. It is not, as Microsoft suggests, simply to punish firms on the basis of an increment in price attributable to the tied product. See Fortner, 394 U.S. at 512-14 (1969); Jefferson Parish, 466 U.S. at 12-13.

As for the crucial requirement that Windows and Internet Explorer be deemed "separate products" for a finding of technological tying liability, this Court's Findings mandate such a conclusion. Considering the "character of demand" for the two products, as opposed to their "functional relation," id. at 19, Web browsers and operating systems are "distinguishable in the eyes of buyers." Id.; Findings ¶¶ 149-54. Consumers often base their choice of which browser should reside on their operating system on their individual demand for the specific functionalities or characteristics of a particular browser, separate and apart from the functionalities afforded by the operating system itself. Id. ¶¶ 149-51. Moreover, the behavior of other, lesser software vendors confirms that it is certainly efficient to provide an operating system and a browser separately, or at least in separable form. Id. ¶ 153. Microsoft is the only firm to refuse to license its operating system without a browser. Id.; seeBerkey Photo, Inc. v. Eastman Kodak Co., 603 F.2d 263, 287 (2d Cir. 1979). This Court concludes that Microsoft's decision to offer only the bundled - "integrated" - version of Windows and Internet Explorer derived not from technical necessity or business efficiencies; rather, it was the result of a deliberate and purposeful choice to quell incipient competition before it reached truly minatory proportions.

The Court is fully mindful of the reasons for the admonition of the D.C. Circuit in Microsoft II of the perils associated with a rigid application of the traditional "separate products" test to computer software design. Given the virtually infinite malleability of software code, software upgrades and new application features, such as Web browsers, could virtually always be configured so as to be capable of separate and subsequent installation by an immediate licensee or end user. A court mechanically applying a strict "separate demand" test could improvidently wind up condemning "integrations" that represent genuine improvements to software that are benign from the standpoint of consumer welfare and a competitive market. Clearly, this is not a desirable outcome. Similar concerns have motivated other courts, as well as the D.C. Circuit, to resist a strict application of the "separate products" tests to similar questions of "technological tying." See, e.g., Foremost Pro Color, Inc. v. Eastman Kodak Co., 703 F.2d 534, 542-43 (9th Cir. 1983); Response of Carolina, Inc. v. Leasco Response, Inc., 537 F.2d 1307, 1330 (5th Cir. 1976); Telex Corp. v. IBM Corp., 367 F. Supp. 258, 347 (N.D. Okla. 1973).

To the extent that the Supreme Court has spoken authoritatively on these issues, however, this Court is bound to follow its guidance and is not at liberty to extrapolate a new rule governing the tying of software products. Nevertheless, the Court is confident that its conclusion, limited by the unique circumstances of this case, is consistent with the Supreme Court's teaching to date.(6)

B. Exclusive Dealing Arrangements

Microsoft's various contractual agreements with some OLSs, ICPs, ISVs, Compaq and Apple are also called into question by plaintiffs as exclusive dealing arrangements under the language in § 1 prohibiting "contract[s] . . . in restraint of trade or commerce . . . ." 15 U.S.C. § 1. As detailed in §I.A.2, supra, each of these agreements with Microsoft required the other party to promote and distribute Internet Explorer to the partial or complete exclusion of Navigator. In exchange, Microsoft offered, to some or all of these parties, promotional patronage, substantial financial subsidies, technical support, and other valuable consideration. Under the clear standards established by the Supreme Court, these types of "vertical restrictions" are subject to a Rule of Reason analysis. See Continental T.V., Inc. v. GTE Sylvania Inc., 433 U.S. 36, 49 (1977); Jefferson Parish, 466 U.S. at 44-45 (O'Connor, J., concurring); cf. Business Elecs. Corp. v. Sharp Elecs. Corp., 485 U.S. 717, 724-26 (1988) (holding that Rule of Reason analysis presumptively applies to cases brought under § 1 of the Sherman Act).

Acknowledging that some exclusive dealing arrangements may have benign objectives and may create significant economic benefits, see Tampa Electric Co. v. Nashville Coal Co., 365 U.S. 320, 333-35 (1961), courts have tended to condemn under the § 1 Rule of Reason test only those agreements that have the effect of foreclosing a competing manufacturer's brands from the relevant market. More specifically, courts are concerned with those exclusive dealing arrangements that work to place so much of a market's available distribution outlets in the hands of a single firm as to make it difficult for other firms to continue to compete effectively, or even to exist, in the relevant market. See U.S. Healthcare Inc. v. Healthsource, Inc., 986 F.2d 589, 595 (1st Cir. 1993); Interface Group, Inc. v. Massachusetts Port Authority, 816 F.2d 9, 11 (1st Cir. 1987) (relying upon III Phillip E. Areeda & Donald F. Turner, Antitrust Law ¶ 732 (1978), Tampa Electric, 365 U.S. at 327-29, and Standard Oil Co. v. United States, 337 U.S. 293 (1949)).

To evaluate an agreement's likely anticompetitive effects, courts have consistently looked at a variety of factors, including: (1) the degree of exclusivity and the relevant line of commerce implicated by the agreements' terms; (2) whether the percentage of the market foreclosed by the contracts is substantial enough to import that rivals will be largely excluded from competition; (3) the agreements' actual anticompetitive effect in the relevant line of commerce; (4) the existence of any legitimate, procompetitive business justifications offered by the defendant; (5) the length and irrevocability of the agreements; and (6) the availability of any less restrictive means for achieving the same benefits. See, e.g., Tampa Electric, 365 U.S. at 326-35; Roland Machinery Co. v. Dresser Industries, Inc., 749 F.2d 380, 392-95 (7th Cir. 1984); see also XI Herbert Hovenkamp, Antitrust Law ¶ 1820 (1998).

Where courts have found that the agreements in question failed to foreclose absolutely outlets that together accounted for a substantial percentage of the total distribution of the relevant products, they have consistently declined to assign liability. See, e.g., id. ¶ 1821; U.S. Healthcare, 986 F.2d at 596-97; Roland Mach. Co., 749 F.2d at 394 (failure of plaintiff to meet threshold burden of proving that exclusive dealing arrangement is likely to keep at least one significant competitor from doing business in relevant market dictates no liability under § 1). This Court has previously observed that the case law suggests that, unless the evidence demonstrates that Microsoft's agreements excluded Netscape altogether from access to roughly forty percent of the browser market, the Court should decline to find such agreements in violation of § 1. See United States v. Microsoft Corp., Nos. CIV. A. 98-1232, 98-1233, 1998 WL 614485, at *19 (D.D.C. Sept. 14, 1998) (citing cases that tended to converge upon forty percent foreclosure rate for finding of § 1 liability).

The only agreements revealed by the evidence which could be termed so "exclusive" as to merit scrutiny under the § 1 Rule of Reason test are the agreements Microsoft signed with Compaq, AOL and several other OLSs, the top ICPs, the leading ISVs, and Apple. The Findings of Fact also establish that, among the OEMs discussed supra, Compaq was the only one to fully commit itself to Microsoft's terms for distributing and promoting Internet Explorer to the exclusion of Navigator. Beginning with its decisions in 1996 and 1997 to promote Internet Explorer exclusively for its PC products, Compaq essentially ceased to distribute or pre-install Navigator at all in exchange for significant financial remuneration from Microsoft. Findings ¶¶ 230-34. AOL's March 12 and October 28, 1996 agreements with Microsoft also guaranteed that, for all practical purposes, Internet Explorer would be AOL's browser of choice, to be distributed and promoted through AOL's dominant, flagship online service, thus leaving Navigator to fend for itself. Id. ¶¶ 287-90, 293-97. In light of the severe shipment quotas and promotional restrictions for third-party browsers imposed by the agreements, the fact that Microsoft still permitted AOL to offer Navigator through a few subsidiary channels does not negate this conclusion. The same conclusion as to exclusionary effect can be drawn with respect to Microsoft's agreements with AT&T WorldNet, Prodigy and CompuServe, since those contract terms were almost identical to the ones contained in AOL's March 1996 agreement. Id. ¶¶ 305-06.

Previous Page          Back to the top          Next Page

© 2000 The Washington Post Company




Search
News
Post Archives

Advanced Search




washingtonpost.com
Home | Register Web Search: by Google
channel navigation