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Microsoft Case Competition Policy - Prof. D. Neven 27 January 2005 Ursula Ferrari, Gözde Oktay, Nathalie Müller, Reinier De Jong Overview Chronology Technical Background Microsoft’s Behaviour Relevant Markets Dominant Position Abuses of Dominant Position:

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microsoft case

Microsoft Case

Competition Policy - Prof. D. Neven

27 January 2005

Ursula Ferrari, Gözde Oktay, Nathalie Müller, Reinier De Jong

overview
Overview
  • Chronology
  • Technical Background
  • Microsoft’s Behaviour
  • Relevant Markets
  • Dominant Position
  • Abuses of Dominant Position:
    • Not sharing interoperability information
    • Bundeling Windows Media Player
  • Conclusion
microsoft case comp c 3 37 792 microsoft
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
parties
Parties
  • Microsoft Corporation, USA, present within all EEA countries *
  • Sun Microsystem, Inc., USA, present within all EEA countries **
chronology i
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**
chronology ii
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**
chronology iii
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.
chronology iv
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 Microsoft‘s application for a suspension of remedies.**
  • The final decision of the CJE is still pending.***
chronology v
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 Court’s decision: Microsoft acted illegally in protecting its monopoly and in monopolizing the web-browser market. But there were not sufficient evidence that Microsoft’s product bundling was violating the Sherman Act. ***
technical background i
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*****
technical background ii
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.***
technical background iii
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.
technical background iv
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**
products concerned17
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**
microsoft s behaviour19
Microsoft‘s 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 :
1 microsoft s refusal to supply interoperability information
(1) Microsoft’s 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.
2 bundling of windows media player with windows
(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.
the relevant markets23
The relevant markets
  • The client PC operating system market*
  • The Workgroup server operating system market**
  • The streaming media player market***
demand side substituability
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)*
supply side substituability
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)*
demand side substitutability
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***
demand side substitutability28
Demand Side Substitutability
  • There are no realistic substitutes on the demand- side for client PC OS
supply side substitutability
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.
supply side substitutability30
Supply Side Substitutability
  • There are no realistic substitutes on the supply- side for client PC OS
demand side substitutability32
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**
  • Microsoft’s pricing strategy confirms the absence of demand-side substitutability between work group server OS and other server OS***
demand side substitutability33
Demand Side Substitutability
  • There are no products that exercise sufficient competitive pressure on work group server OS
supply side substitutability34
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)
supply side substitutability35
Supply-side substitutability
  • There is no supply- side substitution for Work group Operating Systems.
streaming media players
Streaming media players
  • Is the streaming media player a product distinct from an OS ? *
demand side substitutability38
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.
supply side substitutability39
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
conclusion media player market
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.
geographical market
Geographical market*
  • For PC operating system, work group server OS and media player, the relative geographical market is world-wide.**
dominant position

Dominant Position

Legal background and application to Microsoft Case

overview43
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
general provisions set out in the ec treaty i
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.

the general provisions set out in the ec treaty ii
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

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 doesn’t.

Relationship between Articles 81 and 82
article 82
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”

the two objectives of article 82
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
definition of a dominant position
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 operate”1

  • 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”.

exclusionary and exploitative practices
Exclusionary and Exploitative practices
  • Exclusionary practices-harm or exclude competitors
  • Exploitative practises-exploit opportunities provided by its market strengh
refusal to deal
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.
refusal to grant access to an essential facility
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

intent of the undertaking i
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.

intent of the undertaking ii
Intent of the undertaking (ii)
  • DEFENSE v. EVIDENCE

Sheds light on the motivation of an undertaking

-element for the level of fine…

intent of the undertaking iii
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)”.

jungle law or ec law
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”

microsoft s dominant position
Microsoft’s 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 effectivecompetition 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”

market shares i
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 position”1

market shares ii
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
dominance in relation to its competitors ii
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%

overwhelmimgly dominant position
Overwhelmimgly dominant position

Commission says;

  • Microsoft, with its market shares of over 90% can be said to hold an overwhelmingly dominant position
justification arguments
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 company’s market power!

barriers to entry
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.

strong network effects
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.”

bill gate s consideration of network effects
Bill Gate’s 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’.”
further considerations
Further considerations…

Commission says;

This ‘positive feeback loop’ constitutes an actual barrier to entry for new entrants and this hinders effective competition.

further justification grounds
Further justification grounds…
  • Not a monopoly
  • Technical “revolution”

Commission;

  • We never said you were a monopoly
  • Relevant market is already defined
market shares i71
Market shares (i)
  • Different Market:

Measure the market by considering:

  • Unit shipments
  • Hardware+Software1
market shares ii72
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

presumption of dominant position
Presumption of dominant position
  • Market shares of at least 60% is a presumption of dominant position.
  • Competitors weak position:
barriers to entry74
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).

interoperability a barrier to entry
Interoperability - a barrier to entry

Commission finds that an important barrier to entry is the fact that withholdinginteroperabilityinformation constitutes an, although artificial, barrier to entry.

strong links between the two markets
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 Microsoft’s overwhelming dominance in the neighbouring client PC OS – fails to deliver an accurate picture of Microsoft’s true market power”.

conclusion
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…

conclusion ii
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.
abuses

Abuses

Not Supplying Interoperability Information

the abuse in the interoperatbility case
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
abuses81

Abuses

Bundling of Windows Media Player with Windows

overview82
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 Commission’s approach
  • Conclusion
bundling
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?
rules
Rules
  • Per se illegality rule
  • Modified Per se illegalityrule
  • Rule of Reason framework
  • Modified Per se legalityrule (Post- Chicago School)
  • Per se legality rule (Chicago School)
historic perspective
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?
anti competitive effects
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
anti competitive effects88
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
efficiency justifications
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
rule of reason approach
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, Competitor’s, 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
microsoft case91

Microsoft Case

Tying of Windows Media Player with Windows

approach by the commission
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 Microsoft’s 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
tying and tied good two separate products
Tying and tied good two separate products
  • EC: Consumer demand test (Jefferson Parish) clearly identifies two separate products
firm dominant in tying product market
Firm dominant in tying product market
  • EC: Microsoft holds a dominant position in the market for OS.
no choice for consumer to obtain tying product without tied product
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
tying forecloses competition
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?
tying forecloses competition97
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)
tying forecloses competition98
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)
tying forecloses competition99
Tying forecloses competition
  • EC:Market 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
approach by the commission100
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?
tying efficiencies
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, 2.9%of the market
    • Alleged absence of incentives by Microsoft to foreclose cannot be accepted
  • No benefits that could not have been achieved without bundling
commission s conclusion
Commission’s 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).”
conclusion103
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.
conclusion on interoperability
Conclusion on Interoperability
  • Commission puts aside any efficiency gains and finds that Microsoft’s behaviour is anticompetitive since it constitutes a barrier to entry for new entrants
conclusion on bundling
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
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).

Used Secondary Literature
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