The Hague, 28 January 2005

1. The Hague, 28 January 2005 The EU Microsoft Case: Where we are and why does it matter? An Economic PerspectiveA presentation to the Dutch Competition Policy AssociationDr. Jorge PadillaManaging Director LECG EuropeBrussels-London-Madrid-Paris

2. Goals • Critically review the Commission’s Decision in Microsoft • Discuss the economic and policy implications of this Decision

3. Where are we now?

4. The Commission’s Decision in a “nutshell” • Two abuses: • Refusal to provide interoperability information necessary for competitors to be able to effectively compete in the workgroup server operating system market • Tying its Windows Media Player with Windows • Remedies: • Compulsory licensing • Mixed bundling • The appeal process

5. The Technology Server-to-servercommunication Client Servers Client-to-servercommunication Tightly coupled communication Loosely coupled communication

6. The Commission’s Theory • Refusal to Deal: • Microsoft refusal to provide client-to-server and server-to-server interconnection protocols • Threatens to exclude competitors and limit innovation. • Exceptional circumstances: • MSFT’s refusal risks eliminating competition in the workgroup server OS market • Limits technical development in the impacted market to the detriment of consumers • IP ownership does not constitute objective justification

7. The Technology • Streaming Media Players Relying on Proprietary Infrastructure

8. The Commission’s Theory OEM Pre-installation Content Providers Downloading Other Installed Media Players Users

9. Should we be here?Refusal to deal

10. LINUX SHARE OF WORKGROUP SERVER OPERATING SYSTEM REVENUES Actual Forecasts File & Print + Networking File & Print Foreclosure? • The past and projected growth of Linux in the WGSOS market demonstrates that neither the indispensability nor the exclusion criteria are met: Source: IDC Server Workload Model, 2004.

11. Foreclosure? • IDC predicts well Forecasts based on data through … Source: IDC Server Workload Model, 2000-2004, restricted to server computers costing less than $25,000 and employed to perform file and print or networking workloads.

12. Innovation? • Statement by Commission: Remedy will be good for innovation • Competitors will be able to commercialize interoperable products • Microsoft will be forced to innovate to maintain its market position • Competition fosters innovation • We have four observations: • FIRST,Commission has presented no evidence specific to the market defined by the Commission in this case in support of these allegations. • SECOND, the evidence used to support these claims is irrelevant from an economic perspective. The relevant question is not whether innovation is correlated positively or negatively with the degree of concentration of the market, but whether innovation in the WGSOS market will be enhanced by the remedy.

13. Innovation? • THIRD, Commission economists ignore common observation that compulsory licensing of IP is likely to reduce innovation in the long –run. This is precisely why societies have IP laws. • FOURTH, the economic literature has clearly recognized the perverse effect of compulsory licensing on the incentives to innovate. As Professors Shapiro and Gilbert (former Chief Economists DoJ and Professors at the University of Berkely) stated: An obligation to deal do not necessarily increase economic welfare even in the short run. In the long run, obligations to deal can have profound adverse incentives for investment and for the creation of intellectual property. Although there is no obvious economic reason why intellectual property should be immune from an obligation to deal, the crucial role of incentives for the creation of IP is reason enough to justify skepticism toward policies that call for compulsory licensing.

14. Should we be here?Tying

15. Use of Media Formats by Content Providers Notes: Percent in Top 1K is out of set of sites with any content (400; not full 1,000); Top 25 movie exclude sites in Media Metrix list that do not feature content prominently; Percent in Top 100 is the number of songs from the Top 100 offered by each store divided by the number offered by any store. Sources: Raw results of Commission's Article 11 inquires, questions 27 (formats) and 3-4 (APIs); Media Metrix/MS Data - Top 1k Web sites; Media Metrix comScore June 2004; content Web sites; Billboard Top 100 Charts; music store Web sites.

16. Media Formats Show No Tendency of Tipping NUMBER OF WEB SITES WITH MEDIA CONTENT BY FORMAT NUMBER OF TOP 1,000 WEB SITES Source: Media Metrix and Microsoft Digital Media Presence Study - Top 1k Web sites.

17. July 2004Windows Media Player58.3 Million Competitors58.3 Million Monthly Users, Home and Work 120 Million WinAmp MusicMatchJukebox 100 Million Quicktime (Net) 80 Million RealPlayer (Net) 60 Million WindowsMedia Player (Net) 40 Million 20 Million Media Formats Show No Tendency of Tipping

18. Availability of Third-Party Media Players on Computers Sold to Home and Small Business * Based on a sample of readily available PCs purchased at local retail stores and, when necessary, over the Web in the U.S. and the E.U.

19. MarketShares Time Conditions for Tipping • Markets subject to strong and firm-specific network externalities may be subject to a phenomenon known as “tipping”: • Convergence to monopoly • Not always – depends on a number of economic factors • May or may not be efficient No Tipping Tipping MarketShares Time

20. MarketShares Time Application to Media Players Tipping • Product Differentiation • Different video and audio functionality • Exclusive content • Multi-homing • Users: Cost of installing an additional media player is negligible • Content: Cost of encoding to additional format is negligible Media Players MarketShares Time

21. Where are we heading?

22. Commission’s remedies and their likely effects • Forced disclosure • Impact on the incentives to innovate • Direct impact • Spillover effects • Royalties? • Impact on overall welfare • Short-term versus long-term competition • How to strike the balance?

23. Commission’s remedies and their likely effects • Partial unbundling: • Media playback integration: • Common commercial practice • Platform competition • Software integration typically benefits consumers in various ways • Economies of scale and scope • Impact on demand • Facilitates further innovation • This is what the remedy puts at risk

24. Legal precedents and policy implications • Refusal to share proprietary information: • New set of exceptional circumstances • Balancing costs and benefits of intervention • Technological integration: • Pure bundling • Potential foreclosure Impact on innovation

25. The EU Microsoft Case: Where we are and why does it matter? Dr. Jorge Padilla Managing Director jpadilla@lecg.com LECG Europe Brussels: +32 2 517 6070 London: + 44 207 269 0500 Madrid: + 34 91 555 6979 Paris: + 3315 568 1280 www.lecgcp.com The author acted on behalf on Microsoft and was responsible for various submissions during the course of the Commission’s investigation and the appeal of the Decision to the Court of First Instance. The opinions in this presentation do not represent the views of LECG or Microsoft, and constitute the author’s sole responsibility.