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[8](1): Sherman Act - Section 2. Section 2: “Every person who shall monopolize , or attempt to monopolize , … any part of the trade or commerce among the several States, or with foreign nations, shall be deemed guilty of a felony” Supreme Court interpretation

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8 1 sherman act section 2
[8](1): Sherman Act - Section 2
  • Section 2: “Every person who shall monopolize, or attempt to monopolize, … any part of the trade or commerce among the several States, or with foreign nations, shall be deemed guilty of a felony”
  • Supreme Court interpretation
    • (1) possession of monopoly power in the relevant market
    • (2) willful acquisition OR maintenance of that power
    • (3) as distinguished from growth or development as a consequence of a superior product, business acumen, or historical accident
  • What is monopoly power (market power)?
    • ability to raise prices or reduce services
    • ability to drive existing competitors out of business
    • ability to create barriers to entry which prevent new competitors from entering
8 2 monopolization section 2
[8](2): Monopolization (Section 2)
  • What must government or private plaintiff prove?
    • (1) Monopoly Power in a relevant product and geographic market
      • very high market share, certainly over 60%, often as much as 80%
      • significant natural barriers to entry for new competitors
    • (2) Predatory or Exclusionary Practices
      • predatory practices harm existing competitors, possibly driving them out of business
      • exclusionary practices are artificial barriers to entry that prevent new competitors
    • (3) Practices have no legitimate business justification
  • Different standard to prove attempted monopolization
    • (1) Current market share can be much smaller, maybe as low as 30%
    • (2) Dangerous Probability of Success in gaining a monopoly market share
      • certainly over 60%
    • (3) Predatory Practice designed to drive existing competitors out of business
8 3 microsoft market power
[8](3): Microsoft - Market Power
  • What are the product markets?
    • Operating systems for Intel-compatible personal computers: Windows
    • Internet Browsers: Netscape Navigator and Microsoft Explorer
  • What is the geographic market?
    • World-wide market, but same as U.S. market
  • What is Microsoft’s market share?
    • Operating Systems: Windows had 90% - 95% of new sales throughout 1990’s
      • As a result, Windows had 80% - 90% of installed base
    • Browser Shares: Explorer Navigator
      • 1995: 0% 100%
      • 1996: 10% 75%
      • 1998: 50% 50%
      • 2000: 60% 40%
8 4 microsoft potential competition
[8](4): Microsoft - Potential Competition
  • What is the existing competition in operating systems?
    • Apple: declining share except in certain niche markets
    • OS/2: IBM system, died with decline in IBM PC sales
    • Unix (Linux): popular on networks, but not common on PCs
  • What is the potential competition? AOL-Netscape-Java
    • AOL = dominant supplier of Internet access
    • Navigator (Netscape) = major Internet browser
    • Java (Sun) = flexible programming language that allows applications software to run on any operating system
  • What are the barriers to entry in operating systems?
    • Network externalities (applications barrier to entry)
      • Designers write new software applications for the dominant operating system
      • Consumers benefit from standardized operating systems and applications
8 5 microsoft netscape negotiations
[8](5): Microsoft - Netscape Negotiations
  • Microsoft Offers a “special relationship” to Netscape (79-89)
    • Stop development of Navigator as a platform for applications software
    • In return, Microsoft will let Netscape have the “solutions” market for special commercial applications within Windows
    • In return, Netscape could control browser markets for Apple, OS/2, and UNIX
  • Problem: Joint Venture or Allocation of Markets?
  • Microsoft withholds technical information from Netscape (90-92)
    • Applications programming interfaces for Windows 95 were necessary for Netscape to design Navigator to work with Windows 95
    • Netscape must postpone release of Navigator compatible with Windows 95 until after Windows 95 is released, and thus Netscape lost holiday sales
  • Problem: Legitimate Business Reason?
8 6 microsoft explorer marketing
[8](6): Microsoft - Explorer Marketing
  • Microsoft starts a crash development of Explorer (133 - 135)
    • $100 million per year on development of Explorer
    • Rapid increase in developers from 5 or 6 in early 1995 to 1000 in 1999
  • Microsoft includes Explorer for free with a Windows license (137)
    • Bundling the Explorer Internet application to the Windows operating system
  • Microsoft negotiates exclusive arrangements for Explorer (139 - 142)
    • Microsoft allows Internet Access and Service Providers (IAPs and ISPs) to distribute Explorer for free when the enroll new customers
    • Microsoft provides free services to IAPs and ISPs to promote Explorer exclusively instead of Navigator
    • AOL adopts and promotes Explorer (until acquisition of Netscape in 1998)
      • Microsoft pre-installs AOL access software and icon on Windows
      • Microsoft pays AOL a bounty for converting Netscape customers to Explorer
8 7 microsoft oems
[8](7): Microsoft - OEMs
  • Contracts with OEMs for licensing Windows 95 (155 - 159)
    • OEMs cannot remove Explorer when pre-installing Windows
    • OEMs cannot remove Explorer icon
    • OEMs cannot modify boot sequence to load Navigator
    • OEMs cannot install programs to launch Navigator
  • Microsoft Threat to Apple Computer
    • Microsoft developed MAC Office for Apple PCs
      • MAC Office derived from its Microsoft Office
    • But Apple was distributing Navigator on its PCs
    • Microsoft threatens to discontinue development of MAC Office unless Apple exclusively distributes Explorer on its PCs
    • Apple agrees to distribute Explorer for its PCs
8 8 microsoft explorer integration
[8](8): Microsoft - Explorer Integration
  • Microsoft redesigns Explorer for Windows 95 in 1996 (160 - 165)
    • Explorer shares routines with Windows
    • Deleting Explorer will delete important aspects of Windows
  • Microsoft Integrates Explorer into Windows 98 (166 - 174)
    • Neither OEMs nor users can uninstall or override Explorer
    • Installing and using Navigator interferes with Windows functions and Microsoft applications
  • Integration provides no benefits to users
    • Windows is slower and less reliable for non-browsing applications
    • Compromises security by making Windows more vulnerable to viruses obtained from browsing on Explorer.
8 9 microsoft intel and ibm
[8](9): Microsoft - Intel and IBM
  • Microsoft Offer to Intel and Threat (94 - 103)
    • Offer: Stop software development of NSP for video and graphics applications
      • In return: Microsoft would speed its development of similar applications
    • Threat: Microsoft will not support Intel’s next generation of microprocessors
    • Result: Intel discontinues NSP project
  • Microsoft Offer to IBM and Retaliation (115 - 130)
    • Offer: Stop promoting OS/2 and preinstall Windows 95 on at least half its PCs
      • In return: Microsoft would give IBM an $8 reduction in the royalty for Windows, with a yearly savings to IBM of $40-48 million
    • IBM rejected the offer, buys Lotus, promotes SmartSuite for office applications
    • Retaliation: Microsoft refuses to release master code for pre-installing Windows to IBM (until 15 minutes before formal release on August 24, 1995), even though other OEMs had received the master code on June 17, 1995
      • IBM loses 1995 back-to-school sales of PCs to the other OEMs
8 10 microsoft windows pricing practices
[8](10): Microsoft - Windows Pricing Practices
  • Discounts and incentives in licensing Windows 95 and 98
    • Compaq and Gateway received lower license fees and promotional allowances for promoting Explorer exclusively over Navigator
    • Other OEMs paid higher license fees for pre-installing and promoting Navigator
      • IBM paid the highest license fee to pre-install Windows
  • Pricing by PCs shipped (Settled with JD by prior consent decree)
    • Microsoft charges its license fee to OEMs for pre-installation of Windows on the basis of the number of PCs shipped, rather than the number of PCs with Windows installed
    • As a result, Windows becomes free to pre-install on all PCs
      • OEM is paying the license fee to Microsoft, even if it pre-installs another operating system on the PC
      • Installing another operating system on the PC requires the OEM to pay a license fee for the other operating system
8 11 microsoft defense
[8](11): Microsoft - Defense
  • (1) No Market Power
    • Wider product market (include operating systems for network servers)
    • Actual and potential competition from existing firms (AOL-Netscape-Sun)
    • No barriers to entry by new firms (software designers)
    • Price of Windows is “low” ($89 for Windows 98, up from $49 for Windows 95)
  • (2) Practices are Normal Business Practices
    • Exclusive contracts are common for promoting products
    • Quantity discounts for OEMs are common for selling products
  • (3) Legitimate Business Reasons for Practices
    • Economies of integration of Windows and Explorer
    • Economies from standardization of operating system
      • compatibility and transportability of software
8 12 microsoft what remedy
[8](12): Microsoft - What Remedy?
  • Criminal Fines: Twice the gain to Microsoft?
    • What would have been the price of Windows? Price of Explorer was zero!!!
    • Criminal penalties have been extremely rare in monopolization cases because it is never obvious what will constitute a violation of Section 2 (unlike Section 1)
  • Structural Remedy: Divestiture?
    • Horizontal: License or auction Windows source code
      • Problem: competition may eliminate efficiencies of standardization
    • Vertical: Divest Windows from all applications software (Explorer)
      • Problem: eliminate efficiencies from integration of software
  • Behavioral Remedy: Injunction?
    • Prohibit Microsoft from making exclusive agreements with OEMs and IAPs
    • Provide Windows source code for applications programming interfaces (APIs)
    • Problem: court supervision of a technologically dynamic industry
8 13 microsoft district court decision
[8](13): Microsoft - District Court Decision
  • November 1999: District Court Findings of Fact
    • Judge defines market and characterizes practices in favor of JD
    • Judge postpones legal decision and urges settlement (none reached)
  • April 2000: District Court Conclusions of Law
    • Microsoft violated Section 2: invites proposals for a remedy
    • Justice Department proposes a remedy, Microsoft asks for more time
  • June 2000: District Court Judgment = Vertical Divestiture
    • Operating System Company (OpsCo): Windows
    • Applications Company (AppsCo): Explorer, Word, Excel, Office
    • Goal: eliminate the applications barrier to entry in operating systems
      • AppsCo will have an incentive to adapt and design applications for other operating systems and platforms
      • AppsCo will have an incentive to develop other operating systems and platforms
8 14 microsoft final judgment
[8](14): Microsoft - Final Judgment
  • 2001: Court of Appeals Decision
    • Upheld violation of Section 2 for monopolization
    • Reversed vertical divestiture as a remedy
    • Remanded to a new District Court Judge for a new hearing on remedy
  • November 2002: Final Judgment
    • New District Court judge approves new settlement between Microsoft and JD
    • Settlement is a behavior remedy with extensive monitoring by the JD
  • States lawsuit against Microsoft will continue
    • Certain states refused to accept the settlement negotiated by the JD
  • Private lawsuits against Microsoft will continue
  • EU is also pursuing a case against Microsoft
8 15 behavioral remedy
[8](15): Behavioral Remedy
  • Microsoft cannot retaliate against OEMs, ISPs, or IHVs for developing or distributing other operating systems or applications software (A and F)
  • Microsoft must offer uniform licensing agreements to OEMs (B)
  • Microsoft cannot impose license restrictions on OEMs for pre-installing other software (C)
  • Microsoft must disclose APIs and Protocols (D and E)
  • Microsoft cannot enter into a large variety of exclusive contracts (G)
  • Microsoft must allow OEMs and users to remove and replace Microsoft applications with other competing applications (H)
8 16 u s v american airlines 2002
[8](16): U.S. v. American Airlines (2002)
  • What is Predatory Pricing?
    • Dominant firm lowers prices until its competitors go bankrupt and exit
    • Dominant firm then raise prices to recoup the losses
    • Predation also deters future entry by other potential competitors
  • JD sues American Airlines for monopolizing Dallas/Ft. Worth airport
    • American has 70% of passenger revenue to and from Dallas/Ft. Worth airport
    • Predatory practices in response to entry by new airlines
      • AA matches the lower fares of any entrant on the routes served
      • AA increases the number of flights on these routes to reduce load factors of entrants
      • Entrants experience low load factors, no profits, so they exit or go bankrupt
      • AA then raises fares and reduces the number of flights on these routes
  • American wins at trial, not guilty of monopolization
    • AA did not lower its fares below its costs, or below the fares of its competitors
8 17 kodak cases
[8](17): Kodak Cases
  • What is an “aftermarket”?
    • Durable goods often require repair, service, or maintenance
    • Durable goods often require replacement parts
    • Durable goods often require consumable goods for their use
  • Eastman Kodak v. Image Technical Services (Kodak I) (1992)
    • Kodak refuses to sell replacement parts for its copy machines to independent service organizations (ISOs)
      • Kodak also prevents OEMs from selling parts to ISOs
      • Kodak also refuses to sell parts directly to customers who want to use ISOs
    • Kodak then monopolizes the service on its own copiers
  • Can an aftermarket be a relevant product market?
    • Supreme Court says YES!!!
    • Even if the manufacturer has no market power in the durable good!!!
8 18 pricing in aftermarkets
[8](18): Pricing in Aftermarkets
  • Suppose you are trying to sell a durable good (car)
    • Potential customer asks about the costs of consumable goods (gas and tires), replacement parts (engine parts), and service (tuneups)
    • What do you want to tell him? There are cheap!!!!
  • Now suppose the customer has already bought the durable good
    • And suppose you are the only supplier of the aftermarket goods and services
    • What prices do you want to charge? High prices!!! Why?
    • Customer is “locked in” because it is costly to switch to another durable good
  • Now think about installed base versus new sales
    • How does this affect your pricing of the aftermarket goods and services?
    • Low prices if the new sales are much larger than the installed base
    • High prices if the installed base is much larger than the new sales
8 19 why monopolize aftermarkets
[8](19): Why Monopolize Aftermarkets?
  • Suppose you did not control the aftermarket goods and services when you introduced the durable good
    • You would be happy to have competitive suppliers provide them at low prices
  • But once the installed base of the durable good is large relative to the new sales
    • Revenue and profits from new sales are declining
    • If you controlled the aftermarkets, you could charge high prices for the aftermarket goods and services to the installed base of the durable good
  • Incentive to monopolize the aftermarkets in whatever way possible
    • Since the manufacturer often produces the replacement parts, this is a typical mechanism for monopolizing the other aftermarkets
    • Even if the manufacturer does not produce the parts, he often has control over the OEMs who do
8 20 red lion v ohmeda markets
[8](20): Red Lion v. Ohmeda - Markets
  • What is the relevant product market?
    • Plaintiffs argue “service on Ohmeda machines”
    • Defendant argues “anesthesia systems”: system include machines, consumables, parts, service, and even related monitors
  • What does Court decide? On summary judgment
    • Definition of the product market requires a trial on the facts
    • But court clearly indicates that it is disposed to defining a service aftermarket
    • film (for cameras), software (for computers), and tires (for cars) are markets
  • Does Ohmeda have market power in service on its machines?
    • Yes, Ohmeda does 71% of the service on its machines
      • Biomeds service another 20% and ISOs only 10%
    • But only 46% of service on all anesthesia machines because there is another major manufacturer of machines (Drager)
8 21 red lion v ohmeda practices
[8](21): Red Lion v. Ohmeda - Practices
  • Service Restricted Parts are the major parts of the anesthesia machines
  • Ohmeda Policy prior to 1997
    • Ohmeda would not sell service restricted parts to ISOs
    • Ohmeda prohibited OEMs from selling service restricted parts to ISOs
    • Ohmeda required a “waiver of liability” from the hospital if a service restricted part was going to be installed by an ISO
  • ISOs could only provide service with non-service restricted parts
  • Ohmeda Policy after 1997 - after the lawsuit was filed
    • Ohmeda defined “qualified ISOs” as ISOs with a trained employee
    • Training for all Ohmeda machines costs at least $30,000
    • Training classes are infrequent and often full (with biomeds)
    • Qualified ISOs receive no discounts on the parts and cannot advertise
8 22 red lion v ohmeda justifications
[8](22): Red Lion v. Ohmeda - Justifications
  • Does Ohmeda have Legitimate Business Justifications?
  • (1) Protect patients from breakdowns or accidents
  • Does this justification require a restrictive policy toward ISOs?
  • Not really, it only requires training OR certification
    • Ohmeda could offer the training classes more often at a lower cost
    • ISO employees are former service employees of Ohmeda
  • (2) Preserve the reputation of its machines
  • Does this justification makes sense?
  • Not really, because anesthesiologists make the decisions about which machines to buy (Ohmeda or Drager) and it would usually be a simple matter to identify the cause of any accident
8 23 defenses in kodak cases
[8](23): Defenses in Kodak Cases
  • Manufacturer cannot increase the prices of aftermarket goods because he will lose sales of the durable good to other manufacturers
    • Customers compare “life-cycle” costs in making purchase decisions
    • New customers will purchase from the other manufacturers
    • Installed base of old customers can costlessly switch to other manufacturers
  • Counter arguments
    • Installed base is too large relative to new sales
      • Stronger incentive to charge high aftermarket prices
      • Installed base of Ohmeda machines was 10 - 15 the yearly sales
    • Switching by the installed base customers is not easy
      • Anesthesiologists have strong preferences for Ohmeda or Drager
      • No market for used machines - most used machines sold to developing countries
      • Drager has similar incentives to charge high aftermarket prices