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Antitrust Law in the High-Technology Industry: Recent Developments in United States v. Microsoft Provides Insight to Department of Justice's Stance on Antitrust Violations

I. Introduction

On November 5, 1999, United States District Judge Thomas Penfield Jackson issued his much anticipated Findings of Fact in United States v. Microsoft, 65 F. Supp. 2d 1, 1999 WL 1001107 (D.D.C. 1999). The federal government and Attorneys General for 20 states, in separate actions, brought this lawsuit against Microsoft on May 18, 1998, alleging that Microsoft used its popular Windows software to illegally extend the company's dominance to other products. (See Footnote 1.) Essentially, Judge Jackson has accepted this assertion, finding that "Microsoft enjoys market power in the relevant market" and has used that market power to inflict harm on both competitors and consumers.

The Findings of Fact provide the framework for the Justice Department and states' arguments that Microsoft has monopoly power and has used it to harm competition, and the springboard for the likely conclusion that Microsoft violated the antitrust laws in a variety of ways. For example, the Court found that Microsoft had used its monopoly power in the personal computer operating system market to diminish the market share of Netscape's Navigator browser, which had the potential to function with operating systems that Microsoft saw as a threat to its stranglehold on that market.

The Findings of Fact pointed to electronic mail ("e-mail") messages from Microsoft executives, including chair man and co-founder Bill Gates, as evidence of these constrictive actions. Although Microsoft had long argued that the e-mails were "snippets" taken out of context, Judge Jackson relied heavily on them in his Findings. James Allchin, a senior executive at Microsoft, sent an internal e-mail advocating using Microsoft's market power with Windows to bundle Internet Explorer and Windows together. Allchin wrote that Windows 98 "must be a simple upgrade, but most importantly it must be killer on OEM [original equipment manufacturers', or PC manufacturers'] shipments so that Netscape never gets a chance on these systems." Findings of Fact 6 166. Another Vice President warned that "[t]he situation is threatening our operating systems and desktop applications . . ." and declared "Netscape pollution must be eradicated." See United States v. Microsoft, 1998 WL 614485 at *4 (citation omitted).

Shortly after issuing his Findings of Fact, Judge Jackson appointed Judge Richard Posner, a lifelong antitrust scholar and Chief Judge of the U.S. Court of Appeals for the Seventh Circuit, to serve as a mediator to encourage and facilitate settlement talks. Based on the Findings of Fact, the Department of Justice and 20 states filed their Joint Proposed Conclusions of Law on December 6, 1999. (See Footnote 2.) Microsoft has not yet filed its final arguments, but will file two legal briefs by January 17, 2000. After reviewing all parties' briefs, Judge Jackson will issue his Conclusions of Law, most likely in March.

Speculation as to what, if any, remedies the Court will impose on Microsoft is of great interest to the technology industry. Judge Jackson could impose general remedies against Microsoft, such as issuing a fine or ordering compulsory licensing of Microsoft's source code to competitors. Microsoft gained its preeminence in the market for operating systems in part from licensing a PC operating system from another company in 1980. Microsoft modified this operating system, and in 1981 introduced MS-DOS. See United States v. Microsoft, 1998 WL 614485 at * 2. Microsoft eventually created the user friendly Windows application and has cornered more than 90% of the market for Intel-compatible personal computers. Based on this precedent, an open-book licensing remedy would exact a heavy toll on Microsoft.

In addition to conduct remedies, there also is the possibility that Judge Jackson will order structural remedies, namely breaking Microsoft into smaller units, or "Baby Bills." This type of remedy could involve setting the operating system business apart from the applications business, or setting limitations on Microsoft's business and licensing practices. An example of this type of remedy was the breakup of AT&T in the late 1970s into "Baby Bells." Even if Judge Jackson decides to levy this type of remedy, the subparts might end up being worth more than the whole - the Baby Bells today are worth 1300% of what AT&T was worth as a whole at the time of the breakup. See Lance Robbins, Newsday at 169, December 9, 1999.

Although Judge Jackson has not yet rendered his final decision, nor decided upon an appropriate remedy, his ruling has generated an enormous amount of press coverage and comment, and sparked approximately 50 class action lawsuits, with more likely to follow. (See Footnote 3.) Although the case is an extraordinary one in many ways, we want to highlight several issues of particular and immediate significance to our clients. First, we believe that our clients should take this case as a cautionary tale about the need for an electronic mail retention policy. Second, this case demonstrates the risk - in terms of remedies, class action exposure (based on the findings of the Court), and publicity - of taking on the Justice Department. Finally, we will use this case as the latest legal position from the Department of Justice on what conduct can constitute monopolization, attempted monopolization, tying and unlawful exclusionary agreements. Of course, we expect further developments in this case.

II. Justice Department's Proposed Conclusions of Law

According to the legal brief filed by the Justice Department and 20 states ("Brief"), Microsoft violated the Sherman Antitrust Act by using its monopoly power to thwart competition. The Brief essentially argues that the Findings of Fact establish that Microsoft violated the Sherman Act in at least four ways. First, the Justice Department alleges that Microsoft violated Section 2 of the Sherman Act through a series of actions that illegally maintained the critical barrier to entry into the market for operating systems for Intel-compatible personal computers. Second, the Justice Department alleged that Microsoft's several related means of tying a web browser to its operating system violated Section 1 of the Sherman Act. Third, the Justice Department contended that Microsoft also violated Section 1 of the Sherman Act when it entered into a variety of illegally exclusionary agreements with personal computer manufacturers, with Internet access and on-line service providers, and with Internet content providers. Finally, the Justice Department claimed that Microsoft's use of an anticompetitive campaign to impede Netscape Navigator's competitive access to consumers constituted an unlawful attempt to monopolize the browser market in violation of Section 2 of the Sherman Act. See Brief at 1-2.

A. Illegally Maintaining Monopoly

In order to prove a violation of Section 2 of the Sherman Act, the government must show that Microsoft: (1) possessed monopoly power in the relevant market; and (2) willfully acquired or maintained that power. Eastman Kodak Co. v. Image Technical Servs, 504 U.S. 451, 481 (1992). The Brief alleges that "Microsoft's multiple actions to repel promising efforts to lower the critical barrier to entry into its monopoly market constitute unlawful maintenance of a monopoly." See Brief at 2.

1. Possession of Monopoly Power

a. Relevant Market

Monopoly power is defined as "the power to control prices or exclude competition." United States v. Grinnell, 384 U.S. 563, 571 (1966). To measure market power, a court first must define the relevant market. In the Findings of Fact, Judge Jackson defined the relevant market as "the licensing of all Intel-compatible PC operating systems worldwide." Findings of Fact 6 18. Once a person purchases an Intel-compatible PC, he or she must use compatible system and compatible application software products. Once a person purchases an Intel-compatible PC -- which only operates with an Intel-compatible operating system -- that person will incur great inconvenience and costs, up to and including purchasing a new PC and peripheral devices, if he or she decides not to use an Intel-compatible operating system. As a result, the Court found that a substantial increase in price to an Intel-compatible PC operating system would likely not cause a large change in demand for that system.

The Supreme Court has held that a single brand can constitute a relevant market. Eastman Kodak Co. v. Image Technical Servs, 405 U.S. 451, 481-82 (1992). Judge Jackson's application to this rule in defining the relevant market, however, is attenuated. The relevant market is not a brand of PC manufacturers. Rather, it is licensing of Intel-compatible PC operating systems.

b. Microsoft's Power in the Relevant Market

Once the relevant market is defined, a Court will look at the defendant's power in the relevant market to determine whether there is monopoly power. In the Findings of Fact, Judge Jackson pointed to three main facts to indicate that Microsoft enjoys monopoly power: (1) Microsoft's share of the market for Intel-compatible PC operating systems has been more than 90% every year in the last decade, and more than 95% in each of the last several years; (2) Microsoft's dominant market power is protected by a high barrier to entry; and (3) largely as a result of that barrier, Microsoft's customers lack a commercially viable alternative to Windows. Findings of Fact 6 34.

Judge Jackson found that Microsoft controlled more than 90% of the relevant market. (Even if Apple's Mac OS Operating System were included in the relevant market, Microsoft's share still would be more than 80%.) The Justice Department pointed out that monopoly power generally has been inferred from somewhat smaller market shares, with a market share of 80-95% easily sufficient. Kodak, 405 U.S. at 481. In the absence of exceptional countervailing circumstances, monopoly power exists when market share is sufficiently high and there are significant enough barriers to entry or expansion that the defendant can charge supracompetitive prices without the loss of enough customers to make such pricing unprofitable. See Brief at 8 (citations omitted). The Brief points out that, among other factors in Judge Jackson's Findings, the historic inability of IBM and Apple to compete effectively with Microsoft is evidence of the barriers to entry. According to Judge Jackson, even if Microsoft raised prices for its software, the effect on its sales would be minimal.

2. Wrongful Use of Monopoly Power

The second element of a Section 2 monopoly claim is the use of monopoly power "to foreclose competition, to gain a competitive advantage, or to destroy a competitor." Kodak, 504 U.S. at 482-83. Judge Jackson's findings strongly suggest that this element has been satisfied:

Through its conduct toward Netscape, IBM, Compaq, Intel and others, Microsoft has demonstrated that it will use its prodigious market power and immense profits to harm any firm that insists on pursuing initiatives that could intensify competition against one of Microsoft's core products . . . . The ultimate result is that some innovations that would truly benefit consumers never occur, for the sole reason that they do not coincide with Microsoft's self-interest. Finding of Fact 6 412.

Examples of these anticompetitive actions mentioned in the Findings of Fact include: Microsoft's withholding technical details from Netscape when Netscape refused to agree to a "special relationship" with Microsoft in 1995 (6 90); threatening to cut support for Intel PCs if Intel did not stop working on new technology that Microsoft felt could undermine Windows (6 78); and offering Intuit's CEO "a favor . . . that would cost [Microsoft] something like $1M" to entice Intuit to switch from the Navigator Browser to Internet Explorer on Intuit's popular Quicken software (6 324). Judge Jackson also found that Microsoft created its own "polluted" version of Sun Microsystem's Java programming language that worked only with Windows in order to mitigate Sun's success with Java (6 390).

B. Allegations of Unlawful Tying Arrangements

1. General Tying Principles

The Justice Department also alleges that, by forcing licensees - whether personal computer manufacturers or end users - to take (and often actually to use) Microsoft's Internet Explorer browser along with its Windows operating system, Microsoft violated Section 1 of the Sherman Act. The Justice Department contends that Microsoft committed per se violations of Section 1 by engaging in "tying arrangements" where: (1) there are two separate products; (2) the defendant has a market power in the tying product (Windows); (3) the arrangement in fact requires the customers to take the tied product (Internet Explorer) in order to obtain the tying product; and (4) the arrangement affects a "substantial volume of interstate commerce" in the tied product. See Eastman Kodak Co. v. Image Technical Servs, Inc., 504 U.S. 451, 461-62 (1992). The Justice Department claims that, even if it is not a per se violation of Section 1, Microsoft has no business justification for its tying practices, and that those practices have threatened anticompetitive effects in the browser market and maintained Microsoft's monopoly in the operating system market. The particular danger in this situation is where a monopolist such as Microsoft uses tying to protect its monopoly.

The Justice Department notes Microsoft's repeated actions of forcing customers to use Internet Explorer over Navigator. The Brief states that Microsoft forced OEMs, as customers, to install Internet Explorer along with Windows and, if already installed, not to remove it. Microsoft forced the OEMs to remove the icon for Navigator. In the early versions of Internet Explorer, Microsoft forced the end-user to incur the costs of removing the browser by means of the uninstall or add/remove program. More recently, in Windows 98, Microsoft made its Internet Explorer Browser the default browser. The Justice Department argues that "[t]he vice here is not that Microsoft offered OEMs and users a bundled version of Windows and Internet Explorer. It is that Microsoft did not give them an option of taking Windows without the browser. It thus compelled those OEMs and users that wished otherwise to take Internet Explorer in order to get Windows." See Brief at 61.

The United States District Court, District of Columbia ("District Court"), refused to grant summary judgment for Microsoft on the tying claim in a 1998 decision. United States v. Microsoft, 1998 WL 614485 at *13 (D.D.C.1988). The District Court noted that "where, as here, products in the tied product market (browsers) are potential 'partial substitutes' for the tying product, antitrust concerns are heightened because tying agreements not only reduce competition in the tied product, but also reinforce market power in the tying market." Judge Jackson's findings should favor the Justice Department on this issue. The internal e-mails by Microsoft executives regarding their plan to use Windows to gain market share with Internet Explorer are strong evidence of tying. Since Microsoft has more than a 90% share in the relevant market, these actions would affect a substantial volume of interstate commerce.

2. "Tentative" Standard for Tying in Technology-Related Cases Proposed By D.C. Circuit Court

In United States v. Microsoft, 147 F.3d 935 (D.C. Cir. 1988), the D.C. Circuit addressed the complicated issue of determining whether two products were "integrated," and thus considered one product, in the context of tying cases involving technological innovation. The Supreme Court had discussed the issue of product integration generally in Jefferson Parish Hosp. Dist. No. 2 v. Hyde, 466 U.S. 2 (1984). The Supreme Court explained that "the question whether one or two products are involved turns not on the functional relation between them, but rather on the character of the demand for the two items." Id. at 19 (footnote omitted). The D.C. Circuit, in construing a consent decree, stated a "tentative" new standard for when two products might be deemed "integrated" in technology, but the Court made it clear it was not deciding any antitrust law issues. The new standard would apply only when two items are technologically commingled, rather than merely joined for marketing or distribution as a contractual or packaging matter: "[a]n 'integrated product' is most reasonably understood as a product that combines functionalities (which may be marketed separately and sold together) in a way that offers advantages unavailable if the functionalities are bought separately and combined by the purchaser." United States v. Microsoft, 147 F.3d at 948. The D.C. Circuit noted that two products would not be viewed as "integrated" if the defendant has engaged in "[c]ommingling for an anticompetitive purpose (or for no purpose at all)," that is, "has done nothing more than to metaphorically 'bolt' two products together." Id. at 949 n.12, 950 (citation omitted).

The Justice Department contends that even if Judge Jackson accepts the D.C. Circuit's standard in deciding the case, Microsoft is still guilty of unlawful tying. The Findings of Fact state that Web browsers and operating systems are separate products. Findings of Fact 6 154. Each can function on its own, and there is a separate demand for each. See Findings of Fact 66 150-153. Microsoft will have a difficult time succeeding with the argument that it had a legitimate business justification in bundling Internet Explorer with Windows. The e-mails and other evidence identified by the Court point to the anticompetitive effects of "bolting" Internet Explorer with Windows. The Court will likely, therefore, deem the products to be "integrated."

C. Allegations of Unlawful Exclusionary Agreements

The Justice Department contends that Microsoft violated Section 1 by entering into agreements that constitute an "unreasonable restraint on competition." The Supreme Court has condemned certain agreements, such as price-fixing or market-division, as illegal per se. See State Oil Co. v. Khan, 118 S. Ct. 275, 279 (1997); United States v. Topco Assocs, Inc., 405 U.S. 596, 608 (1972). Under the rule of reason analysis, any agreement is unlawful if its restrictive effect on competition is not reasonably necessary to achieving a legitimate procompetitive objective; i.e., an interest in serving consumers through lower costs or improving products. See National Soc'y of Prof'l Eng'rs v. United States, 435 U.S. 679, 691 (1978).

The Justice Department argues that Microsoft's conduct in using incentives and threats against individual OEMs to secure their cooperation to use Internet Explorer over Navigator restrained trade in the market for operating systems and browsers. Microsoft was able to "choke off meaningful access to Navigator for the two channels of distribution" and thereby substantially lessen competition from Navigator in the browser market and maintain Microsoft's monopoly in the operating systems market. See Brief at 65. In the 1998 District Court case, Microsoft disputed that any of its agreements were unlawful; Microsoft argued that it "may refrain from vending or licensing and content [itself] with simply exercising the right to exclude others from using [its intellectual] property." Id. (citation omitted). The court in that case, however, was quick to point out that "[a] copyright does not give its holder immunity from laws of general applicability, including antitrust laws." United States v. Microsoft, 1998 WL 614485 at *15 (citation omitted). The legal significance of this allegation is that not all exclusivity agreements violate the antitrust laws. One that is exclusionary in that it forecloses a substantial share of the relevant market from competitors - "a very large majority" of users (See Findings of Fact 6 144) - and has no countervailing procompetitive effects is, however, unlawful.

D. Attempt to Monopolize

The Justice Department's final allegation against Microsoft is that Microsoft attempted to monopolize the browser market in violation of Section 2 of the Sherman Act. Section 2 prohibits attempts to monopolize where "(1) . . . the defendant has engaged in predatory or anticompetitive conduct with; (2) a specific intent to monopolize; and (3) a dangerous probability of achieving monopoly power." Spectrum Sports, Inc. v. McQuillan, 506 U.S. 447, 456 (1993). The Justice Department alleges that the Court's findings establish that Microsoft "set out to maximize Internet Explorer's share of browser usage at Navigator's expense," and its exclusionary actions to the detriment of Navigator, establish the intent to monopolize the browser market. See Brief at 68. The Justice Department noted that by 1998, Internet Explorer had achieved 60% of the new browser usage; its share of the installed base had already reached 50%; and all signs indicated that it is increasing and that Internet Explorer will have more than a 60% share of overall usage by 2001. See Findings of Fact at 66 372-373. The Justice Department contends that these figures show that Microsoft could obtain monopoly power in the browser market. See Brief at 68.

III. Likelihood of Settlement or Appeal

In setting out his Findings of Fact and appointing Judge Posner as the mediator, Judge Jackson may have provided the impetus to settlement. Judge Posner has already convened at least three highly confidential meetings among the parties in Chicago. Judge Posner's status as one of the most frequently cited legal scholars in the past half-century should encourage both sides to welcome his opinion on the antitrust issues.

At first glance, it appears that Microsoft has little leverage in settlement negotiations due to Judge Jackson's Findings of Fact, which could leave the Justice Department and 20 states with little reason to compromise. Judge Posner's job, therefore, is to convey the benefits of settlement to both sides.

The main incentive for the Justice Department to settle is the danger that a victory might be overturned on appeal. This danger is not unfounded, since the District of Columbia Court of Appeals is known for its conservative decisions, and overturned a 1998 ruling against Microsoft. Microsoft may wish to settle because it may not want to bank on an appellate court's overturning Judge Jackson's ruling.

The Justice Department also has compelling reasons not to settle. The Findings of Fact are so favorable to the Justice Department that the Judge will most likely find against Microsoft in his Conclusions of Law. The Justice Department has also invested so much time and money in this case that a settlement giving it anything less than a complete victory could be viewed as disappointing. In addition, there are so many interested parties, including 20 states, that it is unlikely that all of their interests could be met in a compromise.

Microsoft also has strong reasons to oppose settlement. Gates seems to view the attacks on Microsoft's way of doing business as a personal affront. Gates is committed to the position that Microsoft's monopoly benefits consumers, and the Justice Department is undermining this benefit by requesting the Court to order him to change his practices. In past cases, Microsoft has never accepted any meaningful remedies, and received a very favorable deal in the opinion of many observers on the consent decree it signed with the Justice Department in 1997.

IV. Conclusion

Judge Jackson's Findings of Fact are significant in that it used the "M" word to describe Microsoft's position in the Intel-compatible PC operating systems market. The Justice Department has the leverage in settlement negotiations at this point. The Brief lays down its argument how, based on the Findings of Fact, Microsoft violated the antitrust laws. Judge Posner's job, therefore, is to mitigate the Justice Department's confidence, and allow both sides to see the benefit of compromise.

The next important event is Microsoft's filing of its legal briefs. A few months later, Judge Jackson's Conclusions of Law are due. If the parties do not settle before Judge Jackson's final decision, there is little doubt that this case will be held up in appeals for years to come.

1/ The Court subsequently consolidated the cases. return

2/ For the purpose of this Client Alert, all plaintiffs will be referred to as the "Justice Department." The states filed a separate brief alleging state antitrust violations. This brief will not be covered in the Client Alert. return

3/ To defend these suits, Microsoft hired Steve Berman, a well-known Seattle attorney who usually represents plaintiffs in class-action suits against corporate defendants. In the past, Berman has worked both for and against Microsoft, including a class-action suit he filed against Microsoft in 1997 that settled for a nominal amount. Two of the most well-known plaintiffs' class action firms in the country - Cohen Milstein Hausfeld & Toll, and Milberg Weiss Berhsad Hynes & Lerach, are opposing Berman and Microsoft. return

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