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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 Case?

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 defense?

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.
 

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