The New York Times
January 3, 1999
Playing 'The Price Is Right' With Windows
By STEVE LOHR
If Microsoft Corp. is the predatory monopolist that the government claims it is, why isn't the price of its monopoly product -- its industry-standard Windows operating system -- higher?
That question is a central focus of a new study of Microsoft and the government's antitrust suit against the company by Robert E. Hall, an economist at Stanford University's Hoover Institution. Hall helped draw up the Justice Department's 1995 consent decree with Microsoft.
The 48-page paper, "National Policy on Microsoft: A Neutral Perspective," written with Hall's son, Chris Hall, an independent software developer, is being published this week and will be available on the Internet at www.netecon.com.
The paper says the government's evidence puts it on solid ground in challenging some of Microsoft's contracts as violations of Section 1 of the Sherman Act, which condemns contracts that restrain trade.
In an interview, Hall pointed in particular to Microsoft's pacts with America Online and other Internet service providers. These contracts require the service providers to guarantee that 75 percent or more of their customers use Microsoft's browser software, crimping the opportunity for its main rival in the browser market, Netscape Communications. For a company with so much market power, a clause like that "shows that Microsoft really does push the limits," Hall said.
On the pro-Microsoft side of the ledger, the Halls find little merit in the march of government witnesses confidently proclaiming that operating systems and browsers are distinct products, and that Microsoft fused them only to squelch competition. "Given the complete malleability of software," the authors wrote, "this is a debate at about the intellectual level of trying to decide if the Gulf of Mexico is part of the Atlantic Ocean."
The Halls' paper focuses most sharply on the contentious subject of Windows pricing. They say "the low price of Windows looks nothing like a monopoly price," amounting as it does to less than 5 percent of the total price of a personal computer.
The "low" price of Windows is a theme that will be forcefully presented by Richard Schmalensee, an economist at the Massachusetts Institute of Technology, when he takes the stand as a witness for Microsoft. Schmalensee has been making the argument since the early 1990s, when he prepared a paper expounding the low-price thesis for the Federal Trade Commission, which investigated Microsoft before the Justice Department did.
The Windows-pricing issue is crucial to the outcome of the case and, if the government wins, to the remedies it can seek from the court. A narrow victory under Section 1 of the Sherman Act would probably yield merely a court order that Microsoft must make its contracts less restrictive. The Justice Department did not sue Microsoft to accomplish so little.
But to win a broader, Section 2 victory, the government must prove, among other things, that Microsoft has a monopoly, that its exclusionary conduct against potential rivals like Netscape has a "dangerous probability" of preventing a challenge to its monopoly and that its conduct has caused substantial harm to consumers. Only then will stronger remedies -- including, perhaps, breaking up Microsoft -- move onto the agenda.
To try to show gouging of consumers, the government produced in court an internal Microsoft document showing that from 1990 to 1996 the average price it charged personal-computer makers for licensing Windows rose to $49.40 from $19.03. Its share of the PCs total price grew fivefold, to 2.5 percent.
The Justice Department also produced an e-mail written on Dec. 16, 1997, by Joachim Kempin, a senior Microsoft executive, to chairman Bill Gates and other company executives on the subject of Windows prices charged to PC makers. "While we have increased our prices over the last 10 years," Kempin wrote, "other component prices have come down and continue to come down."
The Justice Department says Microsoft's ability to raise Windows prices is strong evidence that the company is overcharging. The Halls are not convinced. Given Windows' 250 million users and market share of more than 90 percent, the authors wrote, PC makers would want it even if it cost "twice or even 10 times as much."
Microsoft contends that the Windows price is restrained by a sense that some competitive threat, though not yet in sight, is behind the next corner -- a fearful perspective that is all over parts of the December 1997 memo. In it, Kempin wrote that a big manufacturer like Compaq Computer, or a coalition of PC makers, could finance development of a competing operating system. Or, he wrote, if the chip maker Intel enters "our business, it will get ugly." (Compaq, incidentally, is sending an executive to testify in Microsoft's defense.)
For his part, Hall does not believe that the seemingly low price of Windows is explained by competition, real or feared. Instead, he suggests that the Windows price is part of Microsoft's broader strategy of making Windows PC's as cheap as possible, hooking new users and making them steady repeat buyers, not only of future generations of Windows but also of higher-priced Microsoft products like its Office suite of word processing, spreadsheet and data base software.
"The government has to make an argument as to why Microsoft keeps the price of Windows low as part of its monopoly strategy, which harms consumers over all," Hall said. "It's possible, but the government hasn't done it yet."
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