This document is provided for reference purposes only. Statements in this document do not reflect the opinions of Reactor Core staff or Jonathan Walther. If you find ought to disagree with, that is as it ought be. Train your mind to test every thought, ideology, train of reasoning, and claim to truth. There is no justice when even a single voice goes unheard. (1 Thessalonians 5:21, 1 John 4:1-3, John 14:26, John 16:26, Revelation 12:10, Proverbs 14:15, Proverbs 18:13)

In Microsoft We Trust

IN MICROSOFT WE TRUST

article by Phil Lemmons

published by Upside as the July 2002 cover story.

To win its antitrust suit against Microsoft, Sun Microsystems will have to overcome judges trained to disregard the law.

Bill Gates owes Henry Manne, founder of the Law & Economics Center (LEC) at George Mason University School of Law in Virginia, a billion-dollar cup of coffee. Manne provided one of the three key ingredients to Microsofts success. Certainly Microsofts leaders were among the first to understand the possibilities of the PC as a mass-market product, calling for different business strategies from those of the big-computer world. They were brilliant, ruthless, and relentless. Nevertheless, Microsofts success mostly flowed from its expertise in wielding monopolistic power and the knowledge that the American judicial system would do little to prevent any means of trade, predatory pricing, or monopolization Microsoft chose to pursue. For this, as we shall see, Manne deserves much of the credit.

If Gates owes Manne a billion dollars, Sun Microsystems Chairman and CEO Scott McNealy owes him a punch in the nose. Sun filed an antitrust suit against Microsoft in March 2002, alleging numerous violations of the antitrust laws. Whether Sun prevails has little to do with Suns specific allegations and the evidence supporting them. The larger question is whether Sun can surmount the obstacles presented by Mannes well-funded LEC, which gives federal judges all-expense-paid courses explaining why every antitrust law should be ignored. The one-sidedness of the instruction amounts to indoctrination. The judges expenses are paid by vehement opponents of antitrust law-by potential defendants in antitrust suits in the centers early days, and later by foundations that are on its side.

DISPENSING WITH JUSTICE

Privately funded indoctrination of federal judges sounds like a great way to take justice out of the federal judiciary. The brightest star of the "law and economics" movement, Richard A. Posner, would consider that a good thing. Posner, a circuit judge and former chief judge for the 7th U.S. Circuit Court of Appeals in Chicago, once wrote "justice" on the blackboard while teaching a law class. He then told his students he didnt want to hear that word in his class. While many believe moral philosophy must underlie a system of justice, Posner says, "I hate the moral-philosophy stuff." Its a sign of the times in antitrust law. When Sun seeks justice against Microsoft in the U.S. District Court in San Jose, Posner will not be the judge. But Suns complaints will be judged in terms of Posners ideas and those of other luminaries of the law and economics movement, such as Robert Bork and Phillip Areeda. Those ideas now carry far more weight than the antitrust laws themselves.

The written antitrust laws should give Sun excellent chances of victory. The relevant statutes seem to outlaw unfair methods of competition, contracts and combinations that restrain trade, monopolization or attempts at monopolization, and price discrimination or acquisitions that may reduce competition or create a monopoly.

Suns complaint alleges that Microsoft broke the antitrust laws in 12 different general ways mostly falling under the Sherman Antitrust Act. The alleged violations include: illegally maintaining its monopoly of the Intel-compatible PC operating system market, monopolizing the browser market, illegally tying Internet Explorer to Windows, attempting to monopolize the workgroup server operating system market, illegally tying the Windows server operating system to the Windows PC operating system, illegally tying the Internet Information Server Web server software to the Windows workgroup server operating system, illegally tying the Microsoft .NET framework to the Windows PC operating system and workgroup server operating system, unlawful exclusive dealing and other exclusionary agreements, and illegally monopolizing the office productivity-suite market. While the laws certainly seem to outlaw the alleged actions, the law and economics movement takes a very different view.

TIMING IS EVERYTHING

Now well-entrenched, the doctrines of the law and economics movement advanced step by step with perfect timing for Microsoft and its ambitions. In 1974, Intel introduced the 8080 microprocessor, which was to serve as the basis of the first personal computers. The LEC and Microsoft were born almost simultaneously. The centers first session took place in the winter of 1974-75 as Bill Gates and Paul Allen were forming the Microsoft partnership. Gates and Allen wrote the bulk of their 8080 Basic language in January 1975.

In 1977, Microsoft licensed Basic to Apple Computer for inclusion in the Apple II. This license would be the first of many used by Microsoft in brute-force anti-competitive acts. Meanwhile, Posners enormously influential Antitrust Law: An Economic Perspective was released. Posners new book argued that efficiency should be the only goal of antitrust law, and that "the doctrines of monopolization and of attempts and conspiracies to monopolize have no proper place in a sound system of antitrust policy and, indeed, that every antitrust provision except section 1 of the Sherman Antitrust Act could be repealed without serious loss." Antitrust enforcement in the courts was already starting to loosen up. In Continental T.V. Inc. v. GTE Sylvania Inc., a federal court ruled that vertical price fixing was no longer illegal per se. In Brunswick Corp. v. Pueblo Bowl-O-Mat Inc., et al., the U.S. Supreme Court set aside a jury verdict against a dominant company.

BORK BORKS ANTITRUST

While Microsoft was introducing its version of Cobol in 1978, Robert Bork was publishing The Antitrust Paradox: A Policy at War With Itself. Bork asserts "the only legitimate goal of antitrust is the maximization of consumer welfare" and discusses "the full range of modern rules that significantly impair both competition and the ability of the economy to produce goods and services efficiently." In Antitrust Law, which came out the same year, Phillip Areeda and Herbert Hovenkamp write that "product improvement is protected and beyond antitrust challenge" and "product superiority is one of the objects of competition and cannot be wrongful, even for a monopolist." Over the years, Microsoft briefs spoke tirelessly of consumer welfare and product improvement, citing Areeda countless times.

In 1979, Microsoft moved its version of Basic to the new Intel 8086 processor and its headquarters to Bellevue, Wash. Posner brought joy to monopolists by asserting that new entrants in a market are not at a price disadvantage versus a dominant company-that this major barrier to entry was a myth. It follows that monopolists face competitive pressures from the mere fact that somebody might enter the market at any moment; no real competitors are needed. Meanwhile, antitrust enforcement continued to wither away. In Berkey Photo Inc. v. Eastman Kodak Co., the court ruled that the dominant Kodak had no obligation to give film-processing competitors advance information needed to develop new types of film, and that invention and development are legal methods of acquiring a monopoly. Eastman Kodaks lawyer, John Warden, represented Microsoft two decades later in its antitrust trial. He was well-armed to defend Microsoft against allegations of unfairly withholding technical information competitors needed to write DOS and Windows programs.

GANGING UP ON PLAINTIFFS

Microsoft reached an agreement with IBM in 1980 to provide an operating system for the IBM PC, retaining the right to sell the operating system to others. In 1981, the IBM PC and MS-DOS were introduced, Microsoft was incorporated, and President Reagan was inaugurated. Reagan named William Baxter assistant attorney general in charge of antitrust enforcement in the U.S. Department of Justice (DoJ). A devotee of the "Chicago school" of economics, which advocates a hands-off antitrust policy, Baxter developed new merger guidelines that introduced increased efficiency as a consideration to offset reduced competition. Baxter also made the extraordinary move of having the DoJ intervene as a friend of the court in numerous private antitrust suits, asking judges not to rule against defendants accused of violating the antitrust laws. The U.S. government was ganging up with accused lawbreakers against companies that claimed the law-breaking harmed them. The man who gave the law and economics movement its name, Richard Posner, was appointed to the U.S. Court of Appeals.

When Microsoft was rounding up licensees for its MS-DOS operating system and introducing its Multiplan spreadsheet in 1982, a federal court was loosening restrictions on predatory pricing in Northeastern Telephone Co. v. AT&T. The court defined predatory pricing as selling below marginal cost-consistent with the teachings of the Chicago school of thought-and AT&T got off. This decision would be a boon to any predatory business, but especially to the Microsoft monopoly. The marginal cost of pre-loaded, downloaded, and bundled software is zero. Microsoft would face no future restrictions on predatory pricing.

MACINTOSH BASIC MUST DIE

Microsoft illustrated its attitude toward competition in late 1983 when Macintosh Basic was about to be introduced. Microsoft threatened not to renew an expiring license for Microsoft Basic code that was an essential component of the Apple II Plus, Apple Computers major revenue product of the day. A sudden shutdown in Apple II Plus sales would have destroyed Apple. Gates demanded that Apple kill Macintosh Basic. Apple did.

The IBM PC/AT was introduced in 1984 with MS-DOS standard. This came on the heels of the Supreme Courts decision to reverse a Circuit Court opinion in Jefferson Parish Hospital Dist. No. 2 v. Hyde, which had found a clear product-tying arrangement illegal per se. Once again, the DoJ was there as a friend of the court urging reversal. Microsoft began shipping Windows in 1985 and would tie many products to it.

In 1986, Microsoft, now 11 years old, raised $61 million in its IPO. By year-end, Microsoft had revenue approaching $200 million and profits approaching $40 million. But upstart Lotus Development, barely 4 years old, had $258 million in revenue the previous year, easily surpassing Microsoft. Sales of Lotus 1-2-3 dwarfed those of Multiplan, Microsofts spreadsheet introduced four years earlier. Lotus was a threat. Microsoft had already slipped some code into MS-DOS 2.0 to cause problems for 1-2-3, and now Microsoft proposed a merger with Lotus. Attacking a competitor with a combination of deliberate incompatibilities and a merger offer would be another recurring pattern for Microsoft.

TAKE OUR MARKETS, PLEASE!

Microsoft trailed its competitors in spreadsheets, word processing (WordPerfect), and databases (dBase II). But it was getting the ammunition it needed to kill them all. The Law & Economics Center had been in operation for a dozen years. The case of Matsushita Elec. Industrial Co. v. Zenith Radio was one of the most remarkable yet. There was compelling evidence that Japanese firms, coordinated by the Ministry of International Trade and Industry (MITI), had fixed the prices of TV sets in the U.S. market at predatory levels with the intent of driving American competitors like Zenith out of the market. Matsushita even argued that it could not be held liable because the MITI required it to do what was alleged.

Despite the evidence, the Supreme Court found in favor of Matsushita, ruling that Matsushita could not be found guilty of predatory pricing because the company would never make back the money it lost on price cuts. The Matsushita example is relevant to the Sun case because of the climate it reveals. If the law and economics arguments can explain away a documented foreign conspiracy to use predatory practices to drive major American companies from a major American market, what chance does Sun have when Java is being driven from the market by the greatest icon of American technology, Microsoft? That is especially true because the law and economics movement has continued its march since the Matsushita case. In Brooke Group Ltd. v. Brown & Williamson Tobacco Corp. in 1993, the Supreme Court not only rejected allegations of predatory pricing as inherently implausible, but also said, "Even if the ultimate effect of the cut is to induce supracompetitive prices, discouraging a price cut and forcing firms to maintain supracompetitive prices, thus depriving consumers of the benefits of lower prices in the interim, does not constitute sound antitrust policy." In other words, predatory pricing is OK now even if it forces consumers to pay higher prices in the long term. Posner was cited.

MICROSOFT TAKES ADVANTAGE

The FTC opened an antitrust investigation of Microsoft in May 1990. From now on, much of the antitrust news would relate to Microsoft itself. But Microsoft could rely on precedents that used claims of efficiency and consumer benefit to bless monopolization, predatory pricing, discriminatory pricing, and a variety of exclusionary contracts and trade restraints. Digital Research Inc. (DRI)/Novell and IBM tried to offer competing operating systems for PC hardware. Sun tried to offer an alternative world of low-cost clones with its bundled operating system, and IBM and Apple collaborated to do the same thing with IBM hardware and the Macintosh operating system. Netscape Communications and Sun tried to offer alternative software standards that run on top of Microsoft operating systems. Microsoft felt unrestrained in crushing them all, even while under investigation or on trial for antitrust violations.

DEATH TO DR DOS

When Digital Researchs DR DOS posed a threat to MS-DOS starting in 1988, Microsoft first tried to prevent it from reaching the market by offering to license MS-DOS to DRI instead. DRI spurned the offer, and DR DOS began winning market acceptance. Microsoft altered its application programs to check for DR DOS and warn users that applications might not work. Microsoft also planned to combine Windows and DOS licenses so that MS-DOS could not be bought separately. Above all, Microsoft used licenses that effectively excluded DR DOS. In 1990, a Microsoft report crowed, "Another DRI prospect bites the dust with a per processor DOS license." Per-processor licenses required computer companies to pay Microsoft for its operating system even if the operating system was never loaded onto the computer. Vendors would have to pay for two operating systems on any machine that used DR DOS.

Discriminatory pricing was another weapon. In March 1991, Joachim Kempin, senior vice president of Microsofts OEM division, wrote, "Second option: Scratch the DOS clause, pay $35 for Windows instead of $15." Companies that didnt choose MS-DOS would pay more than double for Windows. When network software giant Novell decided to acquire DRI and DR DOS, Microsoft started talking merger with Novell. But there was a catch. At a July 1991 meeting, Gates told former Novell CEO Ray Noorda he wanted to merge, "but that DRI thing will have to go." Noorda said the government might object to the merger. Gates said, "I know how to handle the government."

Novell went ahead with the DRI acquisition, which closed in October 1991. Around the same time, Microsoft inserted code into the beta version of Windows 3.0 that popped up when DR DOS was detected. Windows displayed the message, "nonfatal error detected," and told the user to call Microsoft for assistance. This scared users and told Microsoft who was using DR DOS. Microsoft also stepped up its efforts to buy Novell, offering on Feb. 13, 1992, to pay a premium of 20 percent. Meanwhile, Microsoft OEM representatives were sending out messages like, "I am writing to confirm that Microsoft will only sell you Windows as a combined package with MS-DOS 5." By 1993, former Microsoft Senior VP Brad Silverberg recommended binding MS-DOS to Windows in such a way that no other DOS could be used with Windows.

After deadlocking 2-2 in July 1993 on whether to take action against Microsoft, the FTC dropped its investigation in August. The DoJ took over. By July 1994, Microsoft had negotiated a settlement with the DoJ that promised to drop exclusionary licensing provisions such as per-processor licenses. However, U.S. District Judge Stanley Sporkin rejected the settlement because he thought it did too little to curb Microsofts anti-competitive behavior. Sporkin was overruled in June by a three-judge panel of the U.S. Court of Appeals for the District of Columbia Circuit. U.S. District Judge Thomas Penfield Jackson, replacing the allegedly biased Sporkin, approved the settlement in August, just three days before the launch of Windows 95. The new Windows design made it almost impossible to substitute another DOS for the MS-DOS still present underneath. Novell gave up and sold DR DOS to Caldera in 1996. Caldera filed an antitrust suit against Microsoft in July of the same year. That suit lived on until January 2000, when Microsoft paid a settlement estimated at $155 million. It was a cheap insurance premium for a monopoly that would generate $22.96 billion in revenue and $9.4 billion in profits the same year. Microsofts revenue had been $521 million when DR DOS arrived on the scene. DRI and Novell hadnt slowed the Microsoft monopoly in the slightest.

While DRI and Novell were placing their hopes in DR DOS, IBM tried to end the Microsoft monopoly with OS/2. IBM started selling OS/2 in competition with Windows 3.0 in 1990. Microsoft worked hard to keep Windows applications from running acceptably on OS/2 and to prevent the development of OS/2 applications. Besides holding back technical information needed to make Windows applications work on OS/2, Microsoft prohibited users of its software-development tools and otherwise freely redistributable software modules from using them for any operating system but Windows. The lack of applications alone would have doomed OS/2, but Microsofts attack on IBMs PC business was even more damaging. In October 1994, Microsoft proposed a new Windows license that raised the royalty IBM paid to $75 per machine for Windows 95 from the $9 IBM had paid for Windows 3.1. Because IBM sold between 5 million and 6 million PCs per year, these basic terms would have raised IBMs royalty payments to Microsoft from around $40 million to $330 million a year. IBM could reduce the royalty if it agreed to Microsofts demands to "adopt Windows 95 as the standard operating system for IBM" and ensure that "Windows 95 is the only OS mentioned in advertisement." This meant nothing less than killing OS/2 to get a lower price on Windows. In July, IBM bought Lotus Development. IBM planned to bundle Lotus SmartSuite on its PCs and sell SmartSuite to other manufacturers in competition with Microsoft Office. Three days later, Microsoft completely cut off negotiations for Windows 95. Microsoft later demanded that IBM not ship SmartSuite for six months or a year as a condition to resuming Windows 95 negotiations.

Microsoft was trying to kill OS/2 while Jackson was reviewing the proposed DoJ-Microsoft settlement. On Aug. 8, 1995, the DoJ announced it would not block shipment of Windows 95. On Aug. 21, Jackson approved the settlement. Microsoft was still refusing to license Windows 95 to IBM. With the settlement in place and the prospect of hundreds of millions of dollars in lost PC sales without Windows 95, IBM caved in 15 minutes before Windows 95 was announced. Microsofts Mark Baber had asked IBMs Garry Norris, "Where else are you going to go? This is the only game in town." IBM ended up paying $47 a copy for Windows 95. At the previous rate, IBM would have paid around $120 million to $200 million in royalties from 1996 to 1998, but the new terms exacted a price of $998 million and made IBMs PC prices uncompetitive with other major vendors. Ultimately, IBM had to kill either OS/2 or the PC business it had founded.

SPIKING THE SPARC CLONES

Sun created SPARC International in 1988 and persuaded numerous vendors to bring out SPARC-compatible computers. Besides SPARC clones, there were add-in cards, a pre-loaded operating system, and a graphical user interface called Open Look. In April 1990, Scott McNealy said, "We have ... shipped approximately 8,000 Open Look developers kits and we expect about 300 Open Look applications to be porting by midyear."

Sun succeeded in signing up processor and add-in card manufacturers for the SPARC market, with the first cards announced for the SPARC SBus in December 1989. Major companies such as Fujitsu, Toshiba, Texas Instruments, and Cypress Semiconductor, as well as startups, backed the SPARC initiative. The same Taiwanese companies that were pumping out PCs by the millions were going to manufacture low-priced SPARC systems in high volumes, too. However, according to sources at companies that would have provided components for high-volume SPARC clones, Microsoft intervened. There were 13 or 14 Taiwanese companies scheduled to announce SPARC clones. Microsoft told them that if they proceeded, they would never see another copy of DOS or Windows. That, of course, would shut down the clone vendors thriving PC businesses. Only a few companies went ahead with SPARC clones. That kept volumes of SPARC systems down and prices above PC levels. Sun could mount no mass-market challenge to the PC and Windows.

MAC CLONES COLLAPSE

Apple and IBM planned to flood the market with Macintosh clones based on IBMs PowerPC processor and the Macintosh operating system. Motorola and IBM would make the PowerPC processors. At the time, this seemed like an irresistible combination. Apple started licensing the Mac operating system in 1994. The first Mac clones started pouring out in May 1995. Machines from multiple vendors followed and sold well. The Apple-IBM collaboration failed for many reasons, including quarrels between IBM and Apple and internal dissension at Apple about the cloning strategy when Apple lost market share to Mac compatibles. But Microsoft also played a role. Companies making PC compatibles were afraid to make Mac compatibles because Microsoft could cut off their Windows licenses. The timing of Apples decision not to supply operating systems for Mac clones is also worth noting. On Aug. 6, 1997, Microsoft agreed to invest $150 million in Apple and provide new versions of Office for the Mac. On Sept. 2, 1997, Apple confirmed that it would stop licensing the Mac operating system to clone vendors, exiting the broad operating system market.

NO AIR FOR NETSCAPE

The 1997 Microsoft-Apple deal struck hard at both Netscape and Sun. Released in December 1994, Netscape Navigator had market share estimated at more than 80 percent within a year. Netscapes IPO raised more than $2.6 billion in August 1995, the same month as the launch of Windows 95. Netscapes market share, capital, and deals with Sun to use Java with Navigator made Netscape a threat to Microsoft. In May 1995, a memo from Gates said Netscapes browser threatened to "commoditize the underlying operating system." According to testimony by former Intel software executive Steven McGeady, Microsoft Group Vice President Paul Maritz told Intel at a November 1995 meeting that Microsoft intended to "cut off Netscapes air supply" by giving away Internet Explorer to keep Netscape from generating revenue.

McGeady also said Maritz described Microsofts strategy to counter the Internet as "embrace, extend, extinguish." This meant extending HTML so that Web pages would not work with Netscapes browser. Microsoft did this and more. Among other things, Microsoft coerced, paid, and otherwise induced software vendors, Web sites, and Internet service providers to replace Navigator with Internet Explorer and to support the Internet Explorer extensions that were not interoperable with Navigator. Microsoft gave away Internet Explorer to everyone, including corporations, in perpetuity. Microsoft sometimes paid bounties of $15 to $45 to ISPs for each user who used Explorer and paid sums in the hundreds of thousands of dollars to ISPs that agreed not to purchase any software from Netscape.

As usual, Microsofts biggest club was its Windows license. Compaq Computer learned this when it bundled Netscapes browser on its Presario computers. In June 1996, Microsoft sent Compaq a "notice of intent to terminate" Compaqs Windows 95 license unless Compaq put the Internet Explorer and Microsoft Network icons on the Windows desktop. Like IBM, Compaq had to cave. New restrictions were added to Windows licenses to prevent computer companies from putting the Netscape Now button on the Windows desktop. And Microsoft paid a huge sum to a financially desperate Apple for kicking Netscape Navigator off the Mac. In 1998, the DoJ filed a broad antitrust suit against Microsoft.

JAVA JERKED AROUND

The Java story is similar and brings us back to Sun. As a cross-platform language with a wildly enthusiastic developer following, Java threatened Microsoft. Unable to stop Javas runaway success, Microsoft licensed Java from Sun. The license was negotiated in December 1995 while Microsofts "embrace, extend, extinguish" strategy was already in full swing. Signed in March 1996, the license required Microsoft to create a Java implementation that would pass Suns compatibility test, which is plainly at odds with the intent to "embrace, extend, extinguish." Microsoft evolved its version of Java to be incompatible with the original and distributed the incompatible version for free. Developers who used Microsofts Java tools created programs that often ran only on Windows systems. The September 1997 Microsoft-Apple deal required Apple to support Microsofts extensions to Java, further undermining Javas cross-platform compatibility. By October 1997, Sun was suing Microsoft for breach of contract.

In January 2001, as President George W. Bush was taking office, Sun and Microsoft were reaching a settlement of the 1997 suit. Microsoft paid Sun $20 million and Sun terminated Microsofts license. Microsoft signed a new limited license with more stringent compatibility requirements. Its announcement of Windows XP in October 2001 revealed that it would not contain Java. Sun filed its sweeping antitrust suit in March 2002.

CATCHING MONOPOLY CRUMBS

U.S. District Judge Thomas Penfield Jacksons 2000 finding that Microsoft is a monopoly and his order to break up Microsoft were encouraging signs for Sun. But the U.S. Court of Appeals threw out the breakup order, partially reversed the District Courts judgment that Microsoft violated section 2 of the Sherman Antitrust Act by employing anti-competitive means to maintain the operating system monopoly, and reversed the determination that Microsoft illegally attempted to monopolize the Internet browser market. Seven appeals court judges participated in the reversal, the majority of whom have spent time at George Mason Universitys Law & Economics Center. Chief Judge Douglas Ginsburg and Judge Raymond Randolph, in fact, serve on the LECs Judicial Advisory Board.

Can Sun prevail before judges who believe monopoly results from efficiency, competitors are not needed to curb monopolistic behavior, and predatory pricing is both implausible and good for consumers? Even if Sun prevails in the trial court, can it win on appeal? And if Sun wins, will anything be done to relax Microsofts stranglehold on the software industry?

More important than Suns fate is the prospect facing companies in any industry with a dominant firm. In the current antitrust climate, businesses have only two choices: They can either fight over the crumbs a monopolist is willing to leave or try to invent a new industry and monopolize it. Gone are opportunities like the one Microsoft took to challenge IBMs dominance. Had IBM tried to crush Microsoft in infancy, Microsoft could have sought protection in the antitrust laws. Thanks to the law and economics movement, however, Microsoft is free to crush anything that threatens its monopoly.

[Back to the Reactor Core]

This document is provided for reference purposes only. Statements in this document do not reflect the opinions of Reactor Core staff or Jonathan Walther. If you find ought to disagree with, that is as it ought be. Train your mind to test every thought, ideology, train of reasoning, and claim to truth. There is no justice when even a single voice goes unheard. (1 Thessalonians 5:21, 1 John 4:1-3, John 14:26, John 16:26, Revelation 12:10, Proverbs 14:15, Proverbs 18:13)
Glory to
  God, Ad Dei Gloriam