The New York Times
January 12, 1999

Microsoft Puts Its First Defense Witness, an M.I.T. Economist, on the Stand

Message Is Simple: Microsoft Is Good for Consumers


WASHINGTON -- The Microsoft Corporation began its defense in the Government's antitrust lawsuit Monday with an economist from the Massachusetts Institute of Technology bearing a massive tome of written testimony with a simple message: Microsoft's business practices are good for consumers, and any Government meddling with the software industry would likely do more harm than good.

Richard L. Schmalensee of MIT

The 328-page testimony by Richard L. Schmalensee of M.I.T. is a blunderbuss rebuttal to the Justice Department's two-and-a-half-month attempt to prove that Microsoft used its monopoly in personal computer operating system software to thwart competitive challenges posed by the rise of the Internet.

The Government's case, Schmalensee wrote in his direct testimony, amounts to "speculation" based on a "morass of e-mails" from Microsoft executives that at first glance may seem damaging, but are not. Forget the atmospherics, he tells the court, and focus on the outcome -- what he insists is a lack of measurable harm, current or future, to consumers from Microsoft's business practices.

"Proper economic inquiry into whether a company is engaged in anticompetitive conduct should end if it concludes that consumers have not been harmed by the conduct at issue and are not likely to be harmed in the future," Schmalensee wrote.

High and rising product prices are typically the litmus test of whether a monopolist has the power to punish competitors and gouge consumers. The Government's evidence shows that Microsoft has increased the price it charges personal computer makers for its Windows operating system in recent years, even as the prices of other components of computer systems have declined. Still, the cost of Windows accounts for less than 5 percent of the price of a typical personal computer -- not really evidence of the kind of price-gouging normally associated with a monopolist, as some economists have noted.

But the Government's case is focused as much on the future as on the recent past. If Microsoft is allowed to continue to thwart competition, the Justice Department says, consumers will surely suffer from less product choice, less innovation and higher prices in the long run.

The case will be decided by Judge Thomas Penfield Jackson in this nonjury trial based on his determination of which side the "preponderance of the evidence" favors. Microsoft's objective is to convince the court that there are enough flaws in the Government's case that the balance should tip toward the company.

In his testimony, Schmalensee describes the suit by the Justice Department and 19 states as "fundamentally inconsistent."

The Government asserts, he notes, that Microsoft has an enduring monopoly because its Windows operating system controls the basic operations on more than 90 percent of personal computers sold, and that barriers to entry in that market are high. On the other hand, he adds, the Government says that Microsoft invested hundreds of millions of dollars because it was scared of losing its dominance to an upstart maker of Internet browser software, the Netscape Communications Corporation.

The company line: Consumers came out ahead.

"What is striking about the late-night e-mails and the almost frantic concern over competitive threats is that they show that Microsoft itself was extremely insecure about its leadership in operating systems," Schmalensee said.

David Boies, the Justice Department's lead trial lawyer, replies that Microsoft was indeed deeply worried and "did work to improve its software, but it also had its thumb on the scale."

The Government has made several allegations against Microsoft, but a central one is that the company used its market power to prod personal computer makers, Internet service suppliers and Internet programmers to enter into "exclusionary" contracts that limited the distribution and promotion of Netscape's rival browsing software.

The Microsoft defense, again, is that the outcome in the marketplace shows that Netscape could and did widely distribute many millions of copies of its browser despite Microsoft's purportedly anticompetitive business practices. In the last two years, Schmalensee notes, Netscape has gained an additional 14 million users of its browsing software.

But to gain these 14 million users, the Government replies, Netscape distributed about 200 million copies of its browsing software at considerable extra cost, even as Microsoft gave away its browser for free and bundled it with Windows.

Such Microsoft tactics, the Justice Department asserts, are part of a pattern of predatory practices intended to stifle competition. Schmalensee counters that Microsoft's contracts requiring personal computer makers to ship the company's browser with Windows "offers more choices to consumers" and are "therefore procompetitive."

His testimony is an advocate's brief, so Schmalensee, like the 12 prosecution witnesses, seems to interpret the evidence to suit his argument. For example, when the experience of America Online Inc. supports the Justice Department, Schmalensee refers to the leading online services company as "Microsoft's fickle partner and bitter rival."

But roughly 200 pages later in his testimony, Schmalensee cites America Online's success against Microsoft's MSN online service as proof that bundled placement on the Windows desktop screen -- an advantage MSN enjoyed since 1995 -- does not thwart rival products from being distributed. America Online, Schmalensee writes, "skillfully exploited the many distribution channels open to it (or any other competitor) to beat MSN."

Far from being the most valuable real estate in cyberspace, Schmalensee declares, the Windows desktop is not an "even particularly important channel of distribution" -- a view not held by Microsoft executives, according to several internal e-mail messages in evidence.

Schmalensee also attacks the Government's case for trying to apply outdated "textbook models of competition" and "chalk-board theories" to the fast-changing facts of the software industry.

The Government replies that the economist's stance amounts to trying to get an antitrust exemption for Microsoft and the software business. "He is very close to saying you should never intervene in dynamic, high-technology industries," said Daniel Rubinfeld, a senior economic adviser to the Justice Department's antitrust division.

In courtroom action today, Judge Jackson closed the trial to the news media and public while he heard testimony from Franklin M. Fisher, an economist and Government witness, about the prices Microsoft charges personal computer makers for Windows. The company-by-company pricing data, the judge explained, was "confidential, sensitive, commercial information."

Lawyers for several media organizations appealed. But they only asked that the closed sessions be as limited as possible and that the judge consider releasing transcripts with the sensitive price data redacted. The judge reopened the courtroom in the afternoon, and Fisher continued his testimony, which is expected to end Tuesday.