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The saga of the European Commission's investigation into aspects of Microsoft Windows has reached another milestone. On 17 September 2007, the European Court of First Instance substantially upheld the European Commission's complaint against Microsoft that it had anti-competitively 'tied' Windows Media Player to the rest of Windows and had anti-competitively refused to supply interoperability information to rival providers of work group server operating systems.
While not directly relevant to New Zealand, the case will be indirectly relevant in how to consider the conduct of a monopolist, particular when in a dynamic and innovative market. The case highlights differences in antitrust enforcement in the EU and US and the difficulty in analysing and remedying competitive concerns in fast-moving markets.
History of the EU Case
Following a five-year investigation, the European Commission (the Commission) had decided in March 2004 that Microsoft had abused its dominant position contrary to Article 82 of the EC Treaty. The Commission's case was two-fold.
First, it argued that Microsoft had anti-competitively 'tied' Windows and Windows Media Player, effectively forcing consumers to take Media Player and risking foreclosing competition for media-playing applications.
Secondly, it believed that Microsoft had refused to supply data required by competitors to make work group server (WGS) operating systems (OSs) fully interoperable with Windows running on other WGSs or PCs. The Commission concluded that this reduced competition, innovation and value to consumers.
As a result the Commission ordered Microsoft to offer a version of Windows without Media Player and to provide the necessary confidential information to competitors to enable interoperability. It also ordered Microsoft to pay 497 million Euros (NZ$929 million) in fines.
Microsoft then appealed the Commission's decision to the Court of First Instance. It disputed the tying and refusal to supply cases, although not its dominance of the OS market.
In the period since that decision, Microsoft unsuccessfully applied for suspension of the Commission's orders and the Commission has sought to enforce the perceived non-compliance by Microsoft with the required remedies. In particular, in July 2006 the Commission imposed a further fine of 280.5m Euros (NZ$524 million) for non-compliance with the interoperability remedy.
The US case
The European Commission's case follows a US case against Microsoft brought by the US Department of Justice and 20 states as well as the District of Columbia. This focussed primarily on the tying of Windows with Internet Explorer and the alleged harm caused to web browsers such as Netscape as a result. The judge at first instance found that, contrary to the Sherman Act, Microsoft had committed:
monopolization by increasing barriers to entry to middleware – middleware is software that sits between operating systems and applications and includes Internet Explorer and Media Player; and
per se illegal tying of Windows and Internet Explorer.
The judge then ordered the break-up of Microsoft at the request of Department of Justice into an OS business and an applications business.
However, on appeal, the findings of monopolization were curtailed, and the findings of tying remanded to the District Court for re-consideration. The case was remitted to the District Court to consider any tying arguments under the rule of reason rather than per se rule and to apply an appropriate remedy. After this development, and the change in administration following George W Bush's inauguration as president, the Department of Justice no longer sought the break-up of Microsoft and instead a settlement was agreed and approved in court in 2002.
Under the settlement, Microsoft must not prevent any computer manufacturer from adding non-Microsoft middleware. Microsoft was also required to provide the information used by Microsoft middleware products to interoperate with Windows to a number of parties including rival developers of software.
Tying of Windows and Windows Media Player
Prior to this case, it was not possible to buy Windows in the EU without Windows Media Player.
To establish anti-competitive tying, the Court agreed with the Commission that the following factors were necessary:
the tying and the tied product are separate products;
the firm is dominant in the market for the tied product;
the firm does not give customers a choice to obtain the tying product without the tied product; and
the practice forecloses competition – ie. prevents competition.
The Court accepted that the Media Player was a separate product from the rest of Windows. Media Player was sufficiently distinctive from the perspective of customer demand. The fact that customers tend to want an OS with a media-playing application was not sufficient to suggest that it was not a separate product, as customers may want these programs from different suppliers. In coming to this finding, the Court had regard to factors such as the nature and technical features of the products, market facts, the history of development of the products, and Microsoft's commercial practice.
The Commission had not applied its usual rule that the tying of itself foreclosed competition, but decided an analysis of the actual effect was desirable as customers can and do to an extent obtain third party media players through the Internet, sometimes free of charge. The Court accepted that:
"the bundling of Windows Media Player with the Windows client PC operating system – the operating system pre-installed on the great majority of client PCs sold throughout the world [93.8% in 2002] – without the possibility of removing that media player from the operating system, allows Windows Media Player to benefit from the ubiquity of that operating system on client PCs, which cannot be counterbalanced by the other methods of distributing media players".
The Court held that this was sufficient to prove foreclosure. Nonetheless, it considered Microsoft's further arguments in this regard. It upheld the Commission's arguments that:
the existence of "positive feedback" increased the risk of foreclosure; that is that the increasing share of media-playing applications on PCs led to increased provision of media in that format by content providers which led to further demand from customers; and
the increasing share of computers with Media Player provided evidence of foreclosure.
The case appears to suggest that the use of a competitive advantage by a monopolist that cannot be counterbalanced by other firms would be anti-competitive. This wide interpretation – and the Court's arguably cursory analysis – of harmful conduct creates a risk of deterring pro-competitive actions by monopolists.
The Court rejected as unproven Microsoft's claims that the practice should in any event be objectively justified as efficiency gains outweighed any anti-competitive effects.
Interoperability with work group server operating systems
Before explaining the Court's logic, it is necessary to introduce some of the relevant terminology.
Servers are computers that are networked to PCs to provide certain central functions, such as file and printer sharing and security. WGSs tend to operate as part of small to medium-sized networks.
Operating systems are the "foundation" software working on a computer and are the framework in which all other programs operate and interact. Windows is the most common operating system on PCs today. There are, however, rivals, such as LINUX, an open-source program used by Sun Microsystems amongst others.
Microsoft, as the dominant provider of OSs to PCs, was alleged to be making competition more difficult for rival providers of WGS OSs by withholding information necessary to achieve interoperability. WGSs need to communicate regularly and efficiently with the operating systems of interlinked PCs and other networked WGSs. The loss of interoperability could therefore significant harm the competitiveness of rival companies' products.
Interoperability is a matter of degree. The Commission judged what degree of interoperability a rival needed in order to be viable in the market. It then judged what information was necessary to be disclosed to achieve this objective. Microsoft argued that there was sufficient interoperability already and the amount of information required to be disclosed would allow rivals to "clone" its products or features of its products.
The Court rejected these arguments. It was satisfied that the Commission had not manifestly erred in judging that, to be viable, non-Windows WGS OS has to operate with Windows domain architecture on an equal footing with Windows WGS OS. It also found that the degree of information required to do this would not allow rivals to clone internal aspects of Windows functionality but would only provide information in relation to external aspects necessary for interoperability.
The Court proceeded on the basis that some of the information required to be disclosed was protected by intellectual property (IP) rights, including patents. Microsoft argued that its case was not within the narrow set of circumstances in which it could be abusive for a dominant company not to supply information subject to IP rights.
The Court accepted that a refusal to supply information covered by IP rights would be abusive only in exceptional circumstances, those being:
the refusal relates to a product or service indispensable to the exercise of activity in a neighbouring market;
the refusal risks excluding any effective competition in that market; and
the refusal prevents the appearance of a new product for which there is potential customer demand.
The Court held all of these conditions were fulfilled.
The evidence reviewed by the Court included internal emails and external speeches, which supported the Commission's conclusions. For example, an internal email between two senior directors of Microsoft stated "[Microsoft] has a huge advantage in enterprise computing market by leveraging the dominance of the Windows desktop". In a speech in 1997, Bill Gates said "[w]hat we are trying to do is use our server control to do new protocols and lock out Sun and Oracle specifically…". This highlights the risks to companies of loose language – if that is what it was – when communicating internally or externally.
The Court, having upheld the two elements of the Commission's case, went on to consider the fine and remedy imposed by the Commission.
Fine and remedy
The Court upheld the Commission's fine of 497 million Euros (NZ$929 million) as necessary and proportionate.
It held that, contrary to Microsoft's arguments, the remedy requiring a version of Windows to be sold without Media Player was proportionate to the competition concerns identified by the Commission. This version has not, however, had any significant sales in the EU: Microsoft announced in April 2006 that by then only 1,787 copies of Windows without Media Player had been sold in the EU (0.005% of the total). The effectiveness of this remedy is therefore doubtful.
The ineffectiveness of the remedy may flow from the fact Microsoft may apparently offer Windows with and without Media Player for the same price under the Commission's remedy. In such circumstances, or if there was only a slight premium, consumers are likely to favour Windows with Media Player. The bluntness of the Commission's remedy in this regard may reflect the difficulty of assessing what price difference there should be between Windows with and without Media Player, given that:
Media Player's marginal cost of production is likely to be very low compared to the fixed cost of development;
Windows and Media Player are complements, suggesting that the bundle should be sold at a discount;
Media Player operates in a two-sided market: one side for content providers and another for end consumers; and
the existence of network effects1 in Media Player (as well as Windows) may mean that below cost pricing is justified for long periods (ie. it may compete for the market rather than in the market).
As noted above, many third party media players are available for free on the internet to end users. Pricing, and therefore fashioning a more robust remedy to anti-competitive tying, in this type of market – which will include many software markets – is unlikely ever to be straightforward.
To remedy the interoperability concerns, the Commission ordered that Microsoft disclose the relevant information within 120 days of notification of the decision to anyone having an interest in developing a WGS OS for that purpose. Its decision provides for the appointment of an independent monitoring trustee whose remuneration would be borne by Microsoft. The Court held that the monitoring trustee provision of its decision had no legal basis in the relevant regulation and annulled it. This was a minor success for Microsoft in the context of fines of a combined value of nearly 780 million Euros (NZ$1.46 billion).
Conclusions
The Commission's case was complex technically, economically and legally. The importance to the IT sector of innovation and dynamic competition provides exceptional challenges to competition law, resulting in the protracted duration of this case so far. The saga may not yet be over as Microsoft may appeal the judgment to the European Court of Justice on a point of law within the next two months.
The outcome of the Commission's WGS OS interoperability case is in many ways similar to that in the US middleware interoperability case. Increasing interoperability may increase rivals' incentives to innovate, but has an ambiguous effect on Microsoft's incentives to innovate in creating new products. Both the US and EU interoperability cases effectively required Microsoft to provide interoperability information regarding Windows that put rivals on the same footing as Microsoft as regards other software. The case could be seen as part of a growing trans-Atlantic public consensus that interoperability benefits competition at least in some circumstances.
Many commentators on the other hand are concerned about a divergence in analysis between the US and EU. For example, analysis in the US under the rule of reason would likely be more detailed and require more evidence than that carried out by the Court of First Instance. Furthermore, following the US Microsoft case, the US Supreme Court in Verizon v Trinko has narrowed the circumstances in which refusals to supply by a monopolist might infringe US competition law. US courts may also more rarely order disclosure of information protected by IP rights. Nonetheless, while there are differences in approach between the US and EU, concerns about the divergence in approach to interoperability may be overblown.
The EU Media Player case is somewhat different to the US middleware case. Arguably, the Court of First Instance's analysis was considerably less detailed than would have been required under the US rule of reason. The US case required, amongst other things, that interoperability information be supplied to other developers of media-playing applications and prevented Microsoft from stopping any computer manufacturer from adding non-Microsoft media-players. The EC case went a step further and required separate marketing of a version of Windows without Media Player – the success of which has been limited. This highlights the difficulties faced by competition authorities when seeking to redress competitive concerns regarding the tying of software products and suggests that at least this type of regulatory intervention is unlikely to be in the public interest.
The Court's logic also creates issues for Microsoft in considering which other applications Microsoft should not tie with Windows. On the basis of the broad test used in this judgment, the Commission could possibly require Windows to be sold without other applications such as Word and Excel and fine Microsoft. In any event, the case will impact on Microsoft and other providers of WGS OSs globally in the coming years.
This newsletter is produced by Simpson Grierson. It is intended to provide general information in summary form. The contents do not constitute legal advice and should not be relied on as such. Specialist legal advice should be sought in particular matters.
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