Trust on Trial: How the Microsoft Case Is Reframing the Rules of Competition

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The Microsoft antitrust case is, and will remain, an event of historic proportions. It is a case that has very publicly pitted the legal power of the United States government, the free world's undisputed leader, against the legal power of the Microsoft Corporation. Trust on Trial presents dramatic and compelling reasons to recast our view of modern monopolies and rewrite the rules of business with regard to the new economy companies that hang in the balance. This groundbreaking book argues cleanly and ...

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Overview

The Microsoft antitrust case is, and will remain, an event of historic proportions. It is a case that has very publicly pitted the legal power of the United States government, the free world's undisputed leader, against the legal power of the Microsoft Corporation. Trust on Trial presents dramatic and compelling reasons to recast our view of modern monopolies and rewrite the rules of business with regard to the new economy companies that hang in the balance. This groundbreaking book argues cleanly and convincingly that antitrust law-the variety being tested in the current landmark case-is useless in today's landscape where technology is changing the accepted standards of business.The author, a notable economist and professor at the University of California at Irvine, conducted a year-long study of the Microsoft antitrust case as the basis for this book. An exceptional narrative of new-economy business practices and an analysis of the most important antitrust case of the last half-century, Trust on Trial presents conclusions that will surely affect business here and abroad for decades to come.

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Editorial Reviews

Thomas Zizzo
Trust on Trial is very easy to read, the economic terms are not that confusing and even the ones that aren’t that familiar are explained in some detail by the author. McKenzie...bring[s] up some good points about the case and the future of antitrust enforcement. His arguments, however, would have come across more strongly if he didn't seem to show such overwhelming support and praise for Microsoft.
Electronic Business Magazine
Wall Street Journal
WHAT A STRANGE antitrust case. A "natural monopoly" facing many competing firms. A company driving market prices down after it becomes a "monopolist." Richard McKenzie 's insightful "Trust on Trial" lays out the often bizarre theories behind the government's case against Microsoft. With last week's verdict, the book could not be more timely. Even those steeped in this antitrust action will learn from Mr. McKenzie's account.
Publishers Weekly - Publisher's Weekly
A professor in the Graduate School of Management at the University of California-Irvine, McKenzie uses the Microsoft antitrust trial to ask, "Are the efficiency goals of the U.S. economy as a whole best served by using existing antitrust legislation to assess the business practices of an industry leader in the New Economy?" His answer is a resounding "no": the motivations behind antitrust actions in the past century remain suspicious, he writes, and such actions ultimately hurt industry. McKenzie ardently believes that Microsoft's unusual profitability (its $8 billion profit in 1999 represents a return on sales of 39%, the highest of any major American corporation) has nothing to do with any monopoly power; rather, he says, it stems from the company's production of superior products, which are sold at prices other firms can't match. The author posits a conspiracy among Microsoft's competitors, who he claims have courted and convinced (unnamed) corrupt politicians to exploit antitrust policy to crush the software giant. McKenzie's rigid ideological position ultimately limits the intellectual reach of his book. In wholeheartedly supporting Microsoft's freedom to act as it pleases, McKenzie often presents unfounded theories. For example, he ominously predicts that any penalties assessed against Microsoft will inhibit innovation in the software industry. Yet earlier he acknowledges that Microsoft regularly buys market-proven software developed by others, which it integrates into and distributes with its own existing products. Thus, McKenzie undermines his own credibility--and he also misses an opportunity to propose more appropriate corrections for market imbalances in the New Economy. (May) Copyright 2000 Cahners Business Information.|
From The Critics
Sometimes, when the telephone calls, faxes and e-mail messages pile up in The Standard's Washington bureau, it's easy to get the urge to live in a cave for a while.

That's apparently what University of California at Irvine professor Richard B. McKenzie has been doing for much of the two-year antitrust battle that's been waged by the Department of Justice, the District of Columbia and 19 state attorneys general against Microsoft. Although the trial's endgame is still unfolding - as of this writing, U.S. District Court Judge Thomas Penfield Jackson has found Microsoft guilty of a laundry list of federal and state antitrust violations - McKenzie has put out Trust on Trial: How the Microsoft Case Is Reframing the Rules of Competition. The 229-page book - which was wrapped up at the end of last year, before Jackson issued his "conclusions of law" in the case - excoriates the government for daring to interfere with Microsoft's track record of software revolution and innovation.

McKenzie's central thesis has two parts. First, the government used specious evidence in a failed attempt to prove its case against Microsoft. Second, federal and state antitrust laws are designed to protect nonmonopoly businesses, not consumers. Therefore, McKenzie argues, this case is spurred by Microsoft's competitors, including America Online, IBM and Sun Microsystems, and conducted by political opportunists (namely, U.S. Assistant Attorney General Joel Klein and the 19 state attorneys general) looking to make reputations in legal and political circles.

It's probably true that folks like Scott McNealy and Larry Ellison are happy to see Microsoft burdened with its current legal troubles. But it's a bit cynical to suggest that Klein and the rest of the government's lawyers are in the employ of Microsoft's competition. Nevertheless, McKenzie brushes up against the dirty little secret of antitrust law: It's not about protecting consumers, as many government attorneys will piously allege; it's about protecting the viability of the capitalist system against malevolent actors armed with disproportionate resources.

McKenzie repeats one of the Microsoft legal team's key trial mistakes: He tries to defend the indefensible position that Microsoft has monopoly power in the market for Intel-compatible personal computer operating systems. McKenzie counts 19 different operating systems offered by companies such as Wang, FreeBSD and GEM as proof that leading computer makers, contrary to what many of them testified in the trial, have viable commercial alternatives to the Windows operating system.

"If the characterization is tolerably accurate," McKenzie writes, "it follows that Microsoft's main products can be represented by very long strings of 1s and 0s, which ... are not likely to be a source of vast and enduring monopoly power." McKenzie says that, unlike monopolists such as AT&T and Standard Oil, Microsoft can't physically prevent new actors from usurping its dominant market position. Furthermore, he argues, Microsoft could easily be toppled by anyone with a good software idea and enough seed money.

Although McKenzie defends Microsoft's conduct with computer makers, Internet service providers and others as merely good business, he neglects half the equation. Microsoft not only threw its market share around to promulgate its Internet Explorer Web browser, but it also actively penalized business partners for promoting Netscape's Navigator browser.

McKenzie attacks as chimerical the idea that a software "applications barrier to entry" reinforces and maintains Microsoft's monopoly. But the author misses a few key points: Software written for non-Windows operating systems tends not to work on Windows.

At this point, sparking a groundswell of competition big enough to dislodge Microsoft is akin to persuading Americans to start driving their cars on the left side of the road. No one's opposed to the switch in principle, but they won't do it without looking over their shoulder to make sure everyone else is moving over with them.

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Product Details

  • ISBN-13: 9780738204819
  • Publisher: Basic Books
  • Publication date: 4/11/2001
  • Pages: 336
  • Product dimensions: 6.06 (w) x 9.18 (h) x 0.70 (d)

Meet the Author

Richard B. McKenzie, Ph.D., is Professor of Economics and Management in the Graduate School of Management at the University of California, Irvine. He has written extensively on public policy and his columns have appeared in the Wall Street Journal, the Los Angeles Times, and Investor's Business Daily.

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Read an Excerpt




Chapter One


From Railway Time to
Internet Time


The last quarter of the twentieth century was remarkable for its technological and economic progress. During those twenty-five years, any number of new household and business devices—including videocassette recorders, answering machines, cordless phones, camcorders, cellular phones, and CD players—spread rapidly through American homes and businesses.

    But nowhere was progress more evident than in personal computing. At the start of the 1970s, no American home had a personal computer, for one good reason: the personal computer had not yet been developed. Back then, if people needed computing power, they had to make a trek to a computer center with boxes of punch cards in hand. Over the last quarter century, the personal computer advanced from a primitive box that could do very little to a machine that today has far more power than one of the mainframe computers in use when personal computers were first introduced in the mid-1970s.

    The history of personal computing was written by many very smart people, all of whom were building on each other's good ideas and hard work. However, that history was in no small way pressed forward at an ever-faster pace by developments at the Microsoft Corporation, which just happened to be founded at the start of the last quarter of the twentieth century and which is today the world's premier software company, dominating many of the markets it has entered and developed. What is remarkable today, at the start of the twenty-first century, is that the Microsoft Corporation finds itself under legal assault by the federal government, plus nineteen states. Why have the federal government and the states undertaken this legal attack? Is success being punished? Has politics played a role? What will be the consequences?

    The antitrust suit that the Department of Justice brought against the Microsoft Corporation in the spring of 1998 is important in its own right. It involves substantive legal issues, such as whether Microsoft is a monopolist and has acted like one. It also involves intriguing courtroom dynamics, if not drama, as the legal and financial power of the federal government are tested by an aggressive American corporation determined to beat the odds and win the case. In early November 1999, U.S. District Court Judge Thomas Penfield Jackson handed down one of the strongest declarations of monopoly wrongdoing in the history of antitrust prosecutions.

    On the surface, it's the Justice Department against Microsoft, but behind the courtroom scenes there has been a good deal of political maneuvering by other major American corporate high-tech combatants—Sun Microsystems, Oracle, Netscape, IBM, and America Online, to name just a few—who would like nothing better than to see their market rival, Microsoft, get its comeuppance in the court of law. The case is also a human interest story that involves the wealthiest man in the universe, Bill Gates, pitted against a covey of other bigger-than-life luminaries—Sun's Scott McNealy, Oracle's Larry Ellison, and Netscape's Jim Clark and Jim Barksdale—who are also extraordinarily wealthy business leaders with egos as big as their bank accounts. They have made no secret of what they think of Bill Gates and Microsoft. In no small way, they see the trial as the only way they have to play out their fondest dream, which is to humble the "Menace from Redmond" (Microsoft's headquarters are in Redmond, Washington).

    But the importance of the case extends far beyond the particulars of the courtroom and the industry personalities who awaited the trial judge's final decision, his "Conclusions of Law." This is because more than Microsoft has been on trial in the courtroom. The efficacy of antitrust law enforcement has been on trial. The Microsoft case has been the first large-scale antitrust proceedings of the digital age; it has tested the appropriateness of new economic concepts such as "network effects," "tipping," "path dependency," and "lock-ins" and has forced us to ask whether nineteenth-century antitrust law, combined with twentieth-century enforcement norms, are applicable to twenty-first-century problems of business organization. It has also been a case in which competitors, via political pressure, have once again used the antitrust laws not to fight monopoly, but to throttle an aggressive competitor. The ultimate outcome of the case, which could go to the Supreme Court if a settlement is not reached, could affect the way business is done for decades to come.


From Smokestacks to Microchips


By practically all accounts, we live and work in an world radically different from that of the last quarter of the nineteenth century, the world in which the economic and political forces were taking shape that later led to the country's code of antitrust laws. At the turn of the nineteenth century, the icons of even advanced economies like that of the United States were horse-drawn plows and belching smokestacks. The plows represented the dominant but shrinking sector of the economy, agriculture, where in the United States over 40 percent of the gainfully employed labor force still worked, with little mechanized farm equipment. The smokestacks represented the expanding industrial sector of the economy, where as yet less than 20 percent of the American workforce labored in dank, dusty, and dirty conditions that would not be tolerated today.

    In this earlier era, real capital—not the money kind financiers talk about, but the tangible kind that represents man-made means of production—largely consisted of real, material objects such as concrete and steel, formed into ever-expanding superstructures, plants, that could extend practically the length of whole towns. The bigger the plants and the more they smoked, the more powerful and more prosperous the economies were, or so local chambers of commerce were inclined to claim with the pictures they proudly printed in their promotional brochures.

    In this earlier era, markets in different parts of the country and world were far more separated than they are today, meaning that many markets did not overlap extensively; the phenomenon of large numbers of competing firms moving fluidly among markets did not exist. Competition was restricted by many mundane factors, not the least of which was the cost of firms changing their product mixes and shifting their locations. Geography may have been the more pressing restriction on production, given the expense of transporting products by road, rail, and ship. For much of the first half of the twentieth century, business gurus could smartly repeat what was widely believed to be the three most important factors in doing business—"Location, location, location"—implying that physical position in markets was crucial to earning above-competitive rates of return.

    At that time, when people wrote about the "American economy" or the "French economy" or any other national economy, it was clear what they meant, since production and distribution chains covering more than one country were not well integrated. The reasons? Business integration was costly. The means of communicating with far-flung suppliers were limited, as was the ability of firms to monitor their distant suppliers, distributors, and buyers.

    Everywhere production largely involved the creation of real stuff (like food or housing) made from real stuff (such as cloth or wood) at a real cost that faithfully obeyed an economic dictum that had been known for a century or more, the "law of diminishing returns." Under diminishing returns, as every undergraduate business major learns, the cost of production invariably rises (at least when production expands beyond some undefined level). At that time (and, in some industries, even today) diminishing returns imposed a check on how much of any market any given company could profitably serve. As a company sought to expand its market share, production costs would rise, which would tend to choke off the economic rationale for further expansion.

    Granted, a century ago, competition among firms became progressively more intense as technology evolved, production costs fell, and firms could more readily move their goods and their plant and equipment across invisible market boundaries. But by today's standards, movement was still sluggish and costly. At best, firms could move their goods at the pace of rail traffic, which was maybe the breakneck speed of sixty miles an hour. Firms that wanted to move their plants to more profitable locations could do so, but they had to close their plants in one place and open plants in other places—after more concrete was poured and more steel girders were formed and erected.

    Clearly, production at the turn of the nineteenth century proceeded at a faster pace than had ever before been known, but business still operated on what can now be dubbed "railway time." Just as clearly, most producers did not see themselves as actual or potential competitors to their counterparts in different parts of the country, much less the world.

    Accordingly, firms that formed and passed their initial market tests of producing a product consumers wanted could relax, somewhat assured that they could continue operations with modest changes made at the speed of "railway time" for a decade or more. They could expect to pass their businesses down to their children, who would pass them on to the grandchildren. Workers who started careers in a local plant could with reasonable confidence anticipate retiring in the same job. "Railway time" in this earlier era may have been demanding by the historical standards of the day, but a century later the pace of change seems to be one that only snails could appreciate.

    This book on the Microsoft antitrust case begins with a brief description of economic conditions at the turn of the nineteenth century because those were the conditions under which the core of the nation's antitrust laws, the Sherman Act, passed in 1890, was devised. In that time it might have been reasonable for legislators at the state and federal levels to fear the growth of trusts, or monopolies, that would have enduring market power. In that earlier time, the terms "market share" or "market dominance" may have been meaningful because "markets" were more or less distinct and identifiable and may even have had enduring qualities. People expected the markets of the future to have much the some look and feel as markets then. Potential competition was costly (or more costly than now), given the limited mobility of capital across national borders and across product lines. Perhaps it was reasonable for governments to want to closely monitor the extent of competition in markets and to take corrective action, because the revitalization of competition, where it had been suppressed by mergers or cartels through natural market movements, might be slow in coming. Perhaps it was reasonable to assume that the government could orchestrate antitrust policy with some expectation of doing it right, because it could see the future of markets with reasonable clarity by observing what existed then.

    In this book I do not advocate eliminating antitrust enforcement altogether. But I do question the wisdom of a return to antitrust activism at a level never before seen, in which I see the threat of the country's software industry's being extensively regulated under the guise of antitrust enforcement. With the help of issues raised in the Microsoft case, the book does carry an important message for those who believe that nineteenth-century antitrust law needs to be and should be enforced with the same vigor that it always has been. That message is simply that times have changed—dramatically.

    Production has changed. Agriculture is now a trivial part of the national economy, especially in terms of employment (less than 3 percent). Industrial employment today represents a smaller share of the employed labor force than when the Sherman Act was passed. The employment growth sector at the turn of the twenty-first century is services. And production of both goods and services takes place on a global scale, so much so that it is hard to identify products as "American made" or "French made." Products are made in parts everywhere. And they are made and remade on production cycles that are measured in a few months, not in the years it used to take.

    Products have changed. Sure, we all still buy a lot of things, but the value of the things we buy today, from cars to clothes, exceeds the value for the materials used to a far greater extent than it once did. And then so much of what we buy does not consist of things at all. We buy services—from diet plans to pay-per-view movies—where much of the value comes from very little that is material. Or the services are computer programs or databases in which the "material" is limited to the electrons that are transmitted through wires and the disks they are stored on. In a real sense goods have become "immaterial" or "unreal," a point that the business management guru Tom Peters drove home by noting in one of his seminars, "Welcome to a world where, in the words of one executive I know, `If you can touch it, it's not real.' I don't know about you, but that's a tough concept for an old (me) civil engineer (me, again) to get." Perhaps more important, because technology and market conditions are changing so rapidly, manufactured products are constantly under revision, which means that many goods that will appear in markets a year or two from now will have only faint resemblance to the goods that are on the market today. And don't forget, commerce is shifting relentlessly to the Internet.

    Long-standing economic dictums have changed or have had to be seriously revised. For much of this century, economists could faithfully repeat to their students the law of diminishing returns (or, more descriptively, decreasing returns to scale) as if there were no exceptions. They could also say with confidence that as products become more abundant in markets, their market values are bound to decline. For some products—most notably software—old expected relationships between the quantity produced and the cost of production have clearly been broken. Indeed, the cost of producing additional units of some products—again, software—may have evaporated altogether, given that additional units can be duplicated by electronic means at virtually zero cost. As the Justice Department and economic theorists have argued with reference to the Microsoft case, for some products the law of diminishing returns may never kick in within the scope of the market. Moreover, as some products—those called "network goods," a term I will discuss in later chapters—become more abundant, their value to consumers increases, not decreases.

    The nature of capital has changed, as I have argued at length in previous books. Much capital is no longer stuff, which is difficult and costly to transport. The principal capital of many firms has become brainpower (education and the creative skills of their employees), good ideas, and information, all of which are highly mobile, meaning they can be shipped around the globe at the touch of a few keys on a computer keyboard and at the cost of a long-distance telephone call. It is now widely recognized that the growing mobility of capital has thrown firms through a time warp, forcing them to do business at a substantially higher pace; this new speed has, appropriately, been dubbed "Internet time": the Net will likely be the medium on which a growing share of business will be conducted.

    Governments have changed. Over the past hundred years, governments around the world have grown dramatically in their influence over the economy (although their power may have slipped in recent years owing to the growing mobility of capital). As a consequence, an array of special interest groups stand ready to manipulate, via a variety of payments to politicians, governmental powers in hot pursuit of their own personal gain at the expense of the public. Escalating campaign contributions from business is a symptom of this. With the growing competitiveness of the national and world economies, it is all too tempting for special interest groups to use whatever governmental powers they can tap to abate some of the growing competitive pressures they might feel.

    All of these changes imply that over the past hundred or so years, the economy has gone through a metamorphosis of major proportions. In this new economic universe we now inhabit, which the technology writer George Gilder calls the "microcosm," millions of people already go to work and opportunities abound, unchecked by former material constraints, because the critical resources in this universe, ideas, "are not used up as they are used," as Gilder writes. In the microcosm, the economic burdens of matter decline, and "space and time expand as size and power drop. In the age of the microcosm, the inventive inputs of producers launch a spiral of economic growth and productivity at steadily declining cost in every material domain: land, energy, pollution, and natural resources." Coming up with an icon for this new age is tough, because the best icon would be a "virtual icon," something that is unreal. But maybe the microchip will do.

    None of these market changes, in and of themselves, imply that the nation's antitrust laws should be scrapped, but they certainly do require that we—Justice Department officials, judges, and citizens—think much longer and harder than in the past about the efficacy of antitrust actions, given that the speed of business has shifted from "railway time" to "Internet time." Antitrust doctrine is unavoidably grounded in the proposition that its enforcers can identify "products" and "markets" and can say with some certitude that this or that firm has a "monopoly," has exploited its "monopoly powers," and will continue to be able to do so for some time to come.

    Can such decisions be rendered with the same certitude that was once possible? There are good reasons to doubt this, no matter how much confidence judges' decisions reflect.

    To improve the workings of the economy, the antitrust enforcers must also be able to predict the contours of markets into the distant future and, on the basis of what they know about future market conditions, take appropriate and timely legal action today that will improve, not worsen, competitive market conditions both today and in the future. All the while, the enforcers must avoid taking actions at the behest of disgruntled competitors against targeted rivals whose greater business skills have elevated them to a position where they have the appearance of trusts or monopolies. These changes represent a serious challenge to antitrust law. All of the requisite conditions for effective enforcement have radically changed from what they once were, and the rate of change can only be expected to increase, so that making predictions about future market conditions will be all the more difficult and fraught with the potential for policy error. The shift from "railway time" to "Internet time" over the past hundred or more years raises important questions:


· If markets have become more fluid, as capital has become more mobile, should market forces be expected to correct problems that might arise from trusts exercising their powers? Should we expect antitrust enforcement to be conducted ever more judiciously and more reluctantly?
· If problems of trusts are ever evident, should we expect appropriate antitrust action to be taken in a timely manner? After all, it is doubtful that government, including the legal system, will ever be able to operate on "Internet time" or "at the speed of business."
· Have old ways of identifying trusts, with reference to market shares and market dominance, become outdated, especially now that markets are much more amorphous than they once were, both in terms of what products are actually covered by any defined market and in terms of their fluidity?
· If antitrust enforcement is pursued with the same vigor it once was, might the enforcement process be subject to corruption by politics, given the private gains that can be had by competitors from antitrust action and the ability of competitors to share the gain from enforcement with cooperative politicians?


    The Microsoft case is important because an examination of the issues raised in the trial will allow us to answer, albeit tentatively, these kinds of questions, as well as permit us to explore the strictly legal issue of whether Microsoft is in violation of any antitrust law. As readers will quickly realize, this book takes a dim view of the Justice Department's charges and Judge Thomas Penfield Jackson's Findings of Fact. Not because Microsoft is a high-tech angel whose every business practice is commendable. Hardly. The Microsoft business record may be no more commendable than that of any other high-tech firm. Microsoft may or may not have always abided strictly by the terms of its contract; Sun Microsystems has charged in one lawsuit that it has not (Microsoft denies Sun's charge). Microsoft may or may not have attempted years ago to undermine the credibility of an alternative operating system, DR-DOS; the company that developed it, Caldera, claims that it did (Microsoft denies Caldera's allegation). These are the kinds of issues that need to be settled in court, not here or in the press.

(Continues...)


Excerpted from TRUST ON TRIAL by RICHARD B. McKENZIE. Copyright © 2000 by Richard B. McKenzie. Excerpted by permission. All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.


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Table of Contents

Preface
The Nation's Major Antitrust Laws
1 From Railway Time to Internet Time 1
2 Monopoly Mantra 27
3 Little Linux 49
4 Digital Predation 67
5 Digital Switching 83
6 Innovative Thinking 115
7 Mud Farming 141
8 Politics 101 165
9 Politicizing Antitrust 191
10 Antitrust Ironies 217
Epilogue 231
Appendix I 253
Appendix II 257
Notes 263
Index 301
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