A finding by the European Union that Microsoft has abused its power in the market for personal computers represents a blow to the company, but the software giant is so flush with cash and so dominant a player in the PC industry that it will not sustain long-term harm as a result of the ruling, according to faculty members at Wharton and elsewhere.

These experts differ, however, on whether the EU made the right decision. Some say the company plainly violates antitrust laws. Others say it’s not so clear-cut.

Just days after the EU decision, Microsoft again made news. In a surprise announcement, Microsoft and longtime rival Sun Microsystems said they had reached an agreement to settle an antitrust suit that Sun had filed against Microsoft. One Wharton expert says it is uncertain how the settlement with Sun could affect Microsoft’s appeal of the EU ruling.

The European Commission – which is the EU’s operating arm and enforces EU competition laws – announced on March 24 in Brussels that a five-year investigation showed that Microsoft has abused its near-monopoly power in markets for PC operating systems which resulted in restricting the interoperability of Windows PCs with non-Microsoft servers. The company also broke the law by abusing its power in markets for the technology that allows people to play music and videos on their PCs, regulators said.

To remedy the abuses, the EU ordered Microsoft to disclose to competitors, within 120 days, the “interfaces” needed for competitors’ products to communicate with Microsoft’s Windows operating system, which is installed on about 95% of the world’s PCs. In a statement, the EC described the interfaces as “hooks at the edge” of Microsoft’s secret source code for Windows. The EC indicated that the interfaces do not involve the source code, which it said was “not necessary to achieve the development of interoperable products.” The EC also fined Microsoft $613 million and ordered the firm to offer customers a version of Windows without Media Player within 90 days.

“Dominant companies have a special responsibility to ensure that the way they do business doesn’t prevent competition on the merits and does not harm consumers and innovation,” EU Competition Commissioner Mario Monti said. “Today’s decision restores the conditions for fair competition in the markets concerned and establishes clear principles for the future conduct of the company with such a strong dominant position.”

Microsoft plans to appeal the ruling to the European Court of First Instance in Luxembourg, according to Brad Smith, senior vice president and general counsel at Microsoft.

The Bundling Issue

Eric K. Clemons, professor of operations and information management at Wharton, says European officials correctly judged that Microsoft violated antitrust laws.

“Under any technical definition of antitrust, any technical definition of abuse of market power, it’s self evidently true that Microsoft has monopoly power and that it abuses it,” Clemons states. “The classic definitions involve things like cross-subsidizing product lines. Any time you give away products free, then by definition you’re overcharging for something else. You have to be. If you’re overcharging for something else, then you’re crushing competitors …   [Microsoft] can charge whatever they want for Windows and they can give away Media Player. They can do that because they can charge whatever they want for Windows. The fact that they give away Media Player, under traditional antitrust law, [makes] it clear that they are overcharging for the operating system.”

Gerald R. Faulhaber, professor of business and public policy and management, doesn’t believe that Microsoft violated antitrust rules by bundling Media Player with Windows. “My personal view is that [bundling Media Player] is okay,” he says. Noting that RealNetworks, a Microsoft rival that sells RealPlayer music and video software, was a primary challenger in the EU case, Faulhaber adds: “[Bundling] kind of stinks if you happen to be RealNetworks, but the fact is there’s a long history of this.”

Faulhaber notes, for example, that regulators do not blink an eye when manufacturers of aftermarket automobile parts develop a set of fancy wheel covers and a car maker next year decides to offer a similar product as standard equipment on new cars. Faulhaber also points out that when Microsoft years ago included an e-mail program with Windows called Mail Client, no one seemed to complain about the practice. Later, in response to competition from free, downloadable e-mail programs like Eudora, Microsoft improved its e-mail product and introduced Outlook Express. “You got that free with Windows and I don’t recall anybody getting upset about it,” notes Faulhaber. “So it’s a judgment call. Maybe [bundling] doesn’t foster competition. But too bad for Eudora.”

David Farber, a member of the University of Pennsylvania Computer and Information Science Department, says he is “sympathetic” to the EU decision against Microsoft. Farber, who testified against Microsoft in a U.S. Justice Department antitrust case against the company in the late 1990s, predicts that the EU may in the future try to prevent Microsoft from bundling other products from Windows. “While they focused on Media Player in the first round, my impression is they will come back and try to split other things from the Windows operating environment. That’s the first step, which is what I think Microsoft is worried about.”

Immediately following the EU announcement, Microsoft CEO Steve Ballmer called the decision “unfortunate.” He said that company proposals to settle the case beforehand would have provided more choices for Microsoft’s European customers and addressed EU concerns about Windows’ interoperability with non-Windows technology, as well as media player functionality. Microsoft said it had offered “wide-ranging” proposals to provide competitors with “unprecedented access” to its technology. What’s more, the company said that as part of its proposed settlement, any PC sold with Windows would have carried three non-Microsoft media players, “leading to the distribution of more than one billion competing media players over the next three years.”

David Croson, a Wharton faculty member who is currently a visiting professor of information strategy at MIT, says the most important part of the EU decision deals with preventing Microsoft from using other companies’ distribution platforms, such as PC hard drives, to deliver its software to customers.

“Piggybacking on other companies’ distribution platforms is an excellent low-cost way to get your product into customers’ hands,” says Croson. “Adobe used this strategy to great effect with its free Acrobat Reader, which found its way onto practically every CD-ROM distributed to customers, including those ubiquitous AOL disks. The EU has told Microsoft that it can no longer pre-install Media Player along with Windows, and would apparently need to include a separate installation disk for Media Player. That mandate will increase costs a little bit – but as broadband penetration increases, providing a link to the Media Player download takes the place of the installation CD, and these costs go away.”

Croson says he is not sure how consumers will be helped by the EU directive that Microsoft sell Windows without Media Player, adding that he has “always been puzzled by the courts demanding that Microsoft make a version of Windows available without some particular version of software pre-installed. In the U.S. antitrust case, Microsoft’s Internet Explorer was the target; in the EU case, Media Player is the target. “Imagine that Microsoft offered two products: Windows XP with Media Player and Windows XP without Media Player for the same price. Who in their right mind would buy the “without” package, unless Media Player contains software that the typical user doesn’t want (for example, that prevents pirated music from playing on Media Player)? Creating two versions of the retail packaging adds extra costs and complexity, and for what gain?”

An Insignificant Fine

Farber, Clemons and Croson agree that the $613 million fine is insignificant since Microsoft has massive cash reserves of more than $50 billion. “What difference does a $600 million fine make?” asks Clemons. “Financially, it’s totally irrelevant. I can’t imagine what difference it would make. Will it make them look like predatory bad guys? How many people think they’re anything other than predatory bad guys?” Croson calls the fine a “red herring.”

Clemons and Farber also say that the EU decision holds little long-term threat to Microsoft. “The only thing left is knowing how Microsoft writes code and whether that in any way would eliminate their advantage, and of course it doesn’t,” says Clemons. “Any time Microsoft wants to change an interface it can change an interface and send a notice and everyone has to scramble to catch up. But Microsoft can continue to provide a moving target for its competitors.”

Says Farber: “Does [the EU ruling] damage Microsoft irreversibly? No, I think Microsoft still has the dominant position” in its industry.

A Major Settlement

Under the agreement between Sun Microsystems and Microsoft announced on April 2, Microsoft will pay Sun $700 million to resolve antitrust issues and another $900 million to settle issues related to patents. Microsoft will pay another $350 million as a down payment on a new agreement calling for the two companies to pay royalties for using one another’s technology. Sun had sued Microsoft in 1997, alleging that Microsoft violated a contract with Sun by making a version of software technology known as Java that was designed to work only with Windows. Microsoft was using Java under a licensing agreement with Sun.

It is unclear whether its agreement with Sun will help or hurt Microsoft’s appeal of the EU antitrust case. “The Sun settlement ends a private suit, as opposed to a government-brought suit, and so is not directly comparable to the EU situation,” Croson says, adding: “At least Sun shareholders will benefit from the settlement. In the EU case, consumers who bought Microsoft products won’t receive the money, but presumably it will be used for general governmental purposes. It’s basically a tax for doing business in the EU.”