12/02/98

CONTACT: Kathleen O'Toole, News Service (650) 725-1939;

e-mail kathleen.otoole@stanford.edu

Microsoft no monopolistic threat to Internet, economist says

Anyone trying to sort through the issues in the Microsoft antitrust case would be wise to distinguish between the mature desktop computing market and the rapidly evolving Internet content market, says Stanford economist and Hoover senior fellow Robert E. Hall.

"Microsoft owns the desktop," but it is likely to remain only one of many competitors on the Internet, said Hall, who helped write the Justice Department's settlement of its earlier antitrust case against the giant software company.

That case ended in 1995 in a consent decree in which the government "didn't go far enough," said Hall, the Robert and Carole McNeil Professor, at a recent lecture on the new antitrust case to associates and guests of the Stanford Institute for Economic Policy Research on Nov. 19. "We should have said, 'In all your business operations, you have got to use a non-exclusionary contract.' We were too limited in the scope of that, and Microsoft, amazingly, blithely went ahead and used the same kind of contracts that were condemned by the consent decree in areas that were not reached by the consent decree," Hall said. "They didn't get it, so one possibility [now] is to make them get it."

Hall, an avid user of computer technology as well as a sometime consultant to companies on mergers and lawsuits, also said that the government still has to prove its current antitrust case against Microsoft. The trial in a Washington, D.C., courtroom is garnering daily news coverage that often focuses on the impolite language used by Microsoft and Silicon Valley executives in their e-mail. Even if the government wins the case, Hall said, it should be careful to devise an appropriate punishment that does not hamper free market competition in the future. "The idea that we should do anything that erodes the awards that Microsoft has achieved for producing good products is certainly not what I stand for," Hall said.

Nor is it the purpose of U.S. antitrust policy, he said, which has been to "keep the doors open as wide as possible" in any given industry for market competition on the theory that consumers benefit. Not all industries, however, have the same potential for long-term, thriving competition, he said.

The current antitrust case involves allegedly illegal practices by Microsoft to maintain its control of computer desktops ­ the operating system and related software that people use to manipulate numbers and words, Hall said. Competition in that area is complicated by so-called network effects. As with telephones, part of the benefit that users get from these products is derived from being part of a network of other users. "People today rationally choose Microsoft software because other people use it," Hall said, which makes it more difficult for any new product to compete with the leading seller.

Another problem for competition in these markets is that it can be unprofitable because the cost of software is almost totally in its development, not its manufacture, Hall said. "It's a natural characteristic of software markets that gives incentives [to companies] to go beyond the legal [practices]."

According to economic theory, "a truly competitive price is the cost of making an incremental unit. In software, that's zero. So it's perfectly possible ­ in fact, in the [web] browser market we saw this ­ the price becomes zero when you have competition."

Given this situation, he said, a potential second developer of a given type of software is discouraged from entering the market because the first seller can drive the price to an unprofitable level, and the first seller, not wanting to lower the price, has the "the incentive to create a reputation for ruthless competition. Microsoft invested very heavily in saying, 'We'll do whatever it takes to get the business by way of cutting our prices.' It happened with DOS, it happened somewhat with Windows. There's no real major competition to the Windows market. It certainly happened with browsers."

The result can be software at very low prices for consumers, he said. One difficulty the government faces in its case against Microsoft is proving, as the law requires, that consumers, not just competitors of Microsoft, were harmed by the company's allegedly illegal practices. Microsoft's Windows operating system costs computer makers about $50 to load onto their machines for sale, Hall said, which does not strike him as a high price. On the other hand, "Office," Microsoft's suite of software programs for business, is "very expensive and seems the closest to the kind of classic adverse outcome of monopoly," he said.

If the government wins its case, it has many potential remedies to consider, Hall said. The current case does not involve monetary damages, but states could file on behalf of their consumers for damages, he said, and use the damages to offset state taxes. Other private parties, such as Netscape, also may be able to file lawsuits and collect damages.

The government also can propose structural remedies. In the past it has broken oil and aluminum firms into rival companies and required IBM to cooperate with rivals. More recently, it broke AT&T into seven non-rival local phone service providers so that long-distance service would become competitive. Hall praised the AT&T restructuring, developed by Stanford law Professor Emeritus William Baxter, partly because it did not create a sudden loss in value for AT&T stockholders. (Baxter, who died Nov. 27, was in the audience.) Some people have suggested that the government should break Microsoft into a company that makes operating systems and another that makes software, but Hall said he didn't see that analogous to the division between local and long-distance phone service.

While desktop computing is a huge, valuable market, development in that area is "stagnant" and "the center of gravity" is switching to the Internet, an area where competition works better, Hall said. Already about half of all computer-related incremental sales are to households for products to access content on the Internet, he said, rather than to people seeking to improve their ability to crunch numbers, write reports and presentations, or play games on their computers.

"Microsoft does not dominate in any major content area, and I think it's likely to remain true," he said.

"If you look at the major content providers on the Internet, you see healthy competition" among so-called "portal" companies such as Yahoo and Excite, among online news and entertainment providers, and among retail outlets such as bookstores," he said. Amazon.com, which is a $9 billion company, faces very effective competition from Barnes and Noble, and it is probably going to evolve into symmetric competition in which the consumer benefits enormously and [market competition ] is stable," Hall said.

"There isn't any way Microsoft can stop people from getting the content they want," he added.

One member of the audience, however, wondered if new monopolies will form through marriages of telecommunications and computer businesses. Several others suggested America's judicial system is too slow to be useful, given the rapid pace of technological change. Hall conceded that technology can move in unpredictable directions: "I confess I missed the Internet in thinking about the issues in 1994, only four years ago, so obviously we can make the same mistake again."

The slowness of the legal system is less of a problem, he said, as long as people realize its purpose is "developing big principles that are going to govern people's behavior in the future."

"You do something [wrong and] five years later you get punished for it. . . . The fact that it took five years doesn't lessen the fact that when somebody thinks about doing something similar, they are going to say, 'Wait a minute, five years from now I'll be nailed for that, and I better be careful now.'"

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