Microsoft: A Case of Justice or Abuse of Power?

The verdict has come out. Microsoft will have to pay 280.5 million euros ($354 million) for its failure to comply with the sanctions imposed on it by the European Commission in 2004. It is the end of another chapter in the long history of the software giant in European courts. But apparently, it is not the end of the entire story. The company run by Bill Gates has until July 31 to comply with the sanctions imposed by the European Union. If it fails to do so, the penalty could increase by the hair-raising amount of three million euros ($3.8 million) a day. It seems that the noose around Microsoft’s neck is starting to tighten. But is the Brussels decision fair? Will it wind up being harmful for innovation? Experts interviewed by Universia-Knowledge@Wharton defend the position taken by Europe.

 

“The key unknown is whether a fine of that magnitude will be enough to induce a change in Microsoft’s behavior,” notes Ramón Casadesus-Masanell, a professor at Harvard. “The answer is simple. If the value of a similar penalty in the future is greater than the earnings that the company derives from continuing to exploit its monopolistic position in operating systems, then the company will change its behavior. If the contrary is true, Microsoft will not change.”

 

In his view, these kinds of financial penalties do not act as a threat to innovation. On the contrary, Casadesus-Masanell believes that the obligation of authorities is to promote competition. The more competition there is, the more interest companies have in making improvements — and the more innovation results. “Competition is the greatest incentive for innovation. The high level of competition in the automotive sector has historically been responsible for the level of innovation in that sector. The low level of innovation that characterized socialist economies was attributed to [those countries’] state-owned monopolies and the lack of competition,” adds Casadesus-Masanell.

 

José Ignacio López Sánchez, director of the Complutense University of Madrid’s manufacturing research division, agrees. “I totally agree that intellectual property rights for software are an impetus for innovation. Nevertheless, in this case, there is a higher reason for the Commission to relegate this factor to a secondary level: If Microsoft does not share ‘part’ of its code (which does not coincide precisely with its core nucleus but with some of its application programming interfaces, known as APIs), its competitors will not have any incentive to make innovations, nor even to fight for markets, such as the operating systems used by large computers.  Microsoft is managing to dominate by leveraging its dominant position in a market that is very interrelated – operating systems for PCs.”

 

BrusselsAnnounces its Verdict

 

Neelie Kroes, European commissioner for competition, provided the final word on this subject on July 12. On behalf of the European Union, Kroes imposed a fine of 1.5 million euros on Microsoft for each day that the software giant had failed to comply with the sanctions imposed on it by Europe in 2004. Although that figure was substantial, it is not the maximum amount that Microsoft might have been obliged to pay out. The Commission had threatened to impose a penalty of as much as two million euros a day on Microsoft.

 

The case goes back to March 2004, when Brussels demanded that Microsoft pay a fine of 497 million euros on the grounds that Microsoft had abused its dominant position. In addition, Microsoft was obliged to open part of its Windows code to its competitors, and release a new version of Windows that did not include its Media Player. Microsoft immediately paid that fine, and also complied with the second requirement. However, Microsoft did not comply with the first of the three requirements. Kroes reacted by imposing a new fine. [Regarding the first requirement,] Microsoft has assured the EU that it has provided its competitors with more than 12,000 pages of documents, and opened part of its source code to them.

 

Microsoft is expecting a decision on its appeal to the European Court of Justice by the end of this year or early 2007. Meanwhile, Microsoft has already begun to demonstrate its good will. According to Reuters, Microsoft has decided that the new version of its operating system, Windows Vista, will be more open to its competition. Among other novelties, computers with this operating system will be equipped by default with the search engine that each buyer desires – such as Google, for example. In other words, PCs will not be obliged to be equipped with Microsoft’s search engine, MSN Search. At the same time, buyers will be able to freely choose their Internet browser and multimedia player. Neither the Windows Media Player nor the Internet Explorer will be incorporated into new PCs.

 

Despite such moves and the penalties imposed on Microsoft, Casadesus-Masanell believes that Microsoft’s [long-term] attitude will depend on how much economic impact these measures have on the company’s earnings. The reasoning is clear. If Microsoft makes more money by pursuing its monopolistic practices than the company pays out in fines, Microsoft will have an interest in pursuing business as usual. However, if Microsoft’s earnings suffer [significantly] as a result of the fines, Microsoft will change its attitude. This argument is even more convincing when you consider that the financial penalties imposed by the authorities are lower than the payments Microsoft made when it reached an out-of-court settlement with its competitors. According to the Wall Street Journal, Microsoft has paid $1.95 billion to Sun Microsystems; $850 million to IBM; $760 million to Real Networks; $750 million to Time Warner; $540 million to Novell, and so forth.

 

However, Microsoft’s true enemy does not carry the label of any large company. Beyond its battles against competitors, Microsoft must also confront the growing importance of the software that users can obtain free-of-charge, and for which users themselves can contribute improvements. Casadesus-Masanell argues that Microsoft executives view free software as their principle threat. “In the famous Halloween documents (internal Microsoft documents that were revealed to the public and which can be viewed online at http://www.opensource.org/halloween, the company says: ‘Free software represents a short-term threat to Microsoft’s revenues and its platform, especially in the server segment.” As early as January 2001, Steve Ballmer, Microsoft’s CEO, declared, “Linux is our number-one enemy.”

 

Gates’ Defenders

Not everyone is attacking Microsoft or supporting the European Commission’s decision. Public opinion is divided, according to a survey that the Spanish newspaper El Pais made of various publications and Internet chat rooms. For example, writing in the International Herald-Tribune, Ronald A. Cass criticized Kroes’ decision, and compared Microsoft’s operational approach to that of a shoe manufacturer. Shoemakers always sell shoelaces along with their shoes. As a result, they cannot be accused of trying to corner the market for manufacturing shoelaces. In much the same way, Cass argues, it is entirely normal for Microsoft to try to enrich and improve its operating system with new applications.

 

For his part, López Sánchez argues that “just because a company is in a dominant position, that is no reason for having the company prosecuted by EU competitiveness officials. That happens only if the anti-competitive practices are done with the goal of impeding the advance of new competitors or getting into new, related markets, to take advantage of its privileged, advantageous position compared with its rivals.”

 

This is the real source of Microsoft’s sin. According to the charges made in Brussels, Microsoft has taken advantage of the dominant position of its Windows operating system to try to monopolize other market niches, such as music players. The key to the problem is in treating external factors in the network — situations where incompatible standards and technologies co-exist. To make this more comprehensible, López Sánchez recalls the war between Beta and VHS a few decades ago. Those two standards for recording [videos] were unable to co-exist because they were incompatible. Ultimately, Beta was kicked out of the market.

 

To prevent history from repeating itself, López Sánchez makes this recommendation: “Once something has reached a dominant position in the market, its behavior must focus on eliminating abusive conduct. The way to assure equal conditions in related markets is to watch carefully and see that you have free competition not only in a specific market, but that you also guarantee equal conditions in related markets. Since it’s natural [for companies] to look into these [related] markets, so all efforts that aim at reestablishing a balanced structure for market-share competition will wind up being insignificant and counter-productive.”

 

Nor should it be forgotten that Microsoft’s competitors could pursue another path for dislodging the software giant: They can bring out better products. “Users want products that are technologically advanced and sell at reasonable prices. Many companies will have to bring out innovative products. Let’s not forget that Microsoft can lose its entire market share if another operating system or search engine winds up the winner. In such a case, who will remember Microsoft? The mathematical models that were developed to represent competition in network models predict a natural trend toward monopoly — the winner takes all, or nearly all. However, they also predict that it is possible to replace a standard that is already well established (and has a higher market share) when a significantly superior new product is introduced,” explains López Sánchez.

 

At the moment, free software appears to be the product best positioned to compete with Microsoft. Nevertheless, even free software is lagging far behind. Today, Microsoft controls 90% of the market [for operating systems], while its strongest competitors, Linux and Apple, have market shares that barely add up to 5%. This means that Microsoft’s health remains sound. However, as Microsoft itself recognizes, such phenomena as free software can be harmful to its health [in the long term]. And, if the mathematical models noted by López Sánchez prove to be true, Microsoft could lose its monopoly one day. That bleak scenario could get even darker as a result of the decision in Brussels. On the other hand, competition always provides a clear incentive for making innovations, and Microsoft could still supply plenty of its own surprises.

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