Predatory Pricing - Microsoft's Modus Operandi

Introduction

There has been much debate recently, spurred by the antitrust trial brought against Microsoft by the Department of Justice (DOJ), about whether Microsoft is a monopoly, and if it is a monopoly, is it nonetheless good for the public. It is apparent from reading the pros and cons about Microsoft that many people don't understand what a monopoly is (although they think they do), and why it isn't good for the public. While Judge Jackson has done an excellent job of showing Microsoft as a monopoly (U.S. v. Microsoft: Court's Findings of Fact), this trial focused mainly on the tying of Internet Explorer (IE), Microsoft's web browser, with Microsoft's Windows operating systems, where it has a de facto monopoly in PC operating systems. Because Microsoft is not explicitly charging for IE, this is also an example of predatory pricing — pricing products below their cost of development and distribution to drive competitors out of the market. Predatory pricing is the major tool that Microsoft uses to establish its various monopolies. Although Microsoft's free distribution of IE is a classic case of predatory pricing, Microsoft has attempted to muddy the waters in the current DOJ trial by claiming that IE is part of the operating system. Furthermore, Microsoft claims in its Proposed Conclusions of Law (original source: https://www.microsoft.com/presspass/trial/p-col/col.asp, no longer available) that even if IE were a separate product, predatory pricing as a cause of action must fail because Microsoft never recouped any of IE's costs of marketing and development, and never will, and therefore fails to establish the second requirement of predatory pricing as a cause of action, that of recoupment of costs, clarified by the Supreme Court in BROOKE GROUP LTD. v. BROWN & WILLIAMSON TOBACCO CORP. These arguments are specious, as the rest of this article will show. Predatory pricing has been a Microsoft tradition since its early days, with no better illustration of its modus operandi than its greatest success story and most profitable product, a product that is NOT being covered by the antitrust trial and where Microsoft has definitely recouped its costs — Microsoft Office.

Monopoly Defined

There are various definitions of monopoly. Often, a monopoly is described as a single seller of goods or services without close substitutes and for which there are high barriers to entry. However, this definition does not accurately characterize a monopoly, because it is possible for a monopoly to exist, even if none of the above criteria is true. Such is the case for Microsoft.

Consider Microsoft's monopoly of the office-suite market with its product, Microsoft Office. Microsoft isn't the only seller of office suites. Corel WordPerfect Office, Lotus SmartSuite, and StarOffice are comparable products and close substitutes. Moreover, even though it would be expensive for a new company to create another office suite to compete with the established players, thus creating a high barrier to entry, this is not what makes Microsoft a monopoly. What makes Microsoft a monopoly is a high barrier to competition. In economic terms, a monopoly is often described as a price setter. Certainly, Microsoft sets prices without regard to competitor's prices, which is why MS Office is the most expensive office suite. But Microsoft is also a value setter. Constrained by market expectations, Microsoft doesn't raise prices. It simply maintains historically high prices while giving the least value for the money.

Artificial and Natural Barriers to Competition in the Software Business

A monopoly cannot exist without strong barriers to competition. Obviously, the traditional factors, such as a high barrier to entry, or lack of close substitutes can help establish a monopoly, but there are strong natural barriers to competition in the software industry that are unique and exist only if one company predominates. The more it predominates, the greater the natural barriers. Thus, the key to establishing a monopoly is by gaining predominance as quickly as possible. Once a monopoly is achieved, the natural barriers to competition will maintain the monopoly. The primary and most effective method that Microsoft has used to establish predominance is predatory pricing — either giving the software away for free, as with Internet Explorer, or distributing it through OEMs, as it has done for years with Microsoft Office, and still continues to do so. (Look at the back cover of virtually any issue of PC Magazine. Dell Computer regularly advertises there, and almost every system they sell is sold with some version of Microsoft Office or Works.)

However, to establish a monopoly more quickly, Microsoft also created artificial barriers to competition.

Artificial Barriers

Microsoft gave OEMs an incentive to distribute Microsoft products with every computer sold.

1. Per-Processor License — For years, Microsoft stipulated that OEMs must pay a per-processor price for Windows — the OEM must pay Microsoft for each computer sold, whether that computer had Microsoft's operating system or not. Thus, an OEM had a strong disincentive to sell any other operating system, regardless of how little the competing products cost, or how great their quality. Although Microsoft was forced to stop charging a per-processor fee by the DOJ, it was too late. Microsoft's market share had increased tremendously, allowing the natural barriers to competition to continue stifling Microsoft's competitors.
2. Price Discrimination — Microsoft gave the best prices for Windows to those OEMs that also sold or distributed Microsoft's other products. Thus, OEMs could lower their own costs by distributing Microsoft's other products, which, in turn, foreclosed competition in other areas.

Natural Barriers

1. Network Effect — As a company's software becomes widely distributed, it draws more third-party support. There will be more schools, businesses, websites, and private tutors using, teaching, and supporting the software, and there will be more books and magazine articles. For instance, the computer section of just about any bookstore has far more titles on Microsoft software than that of any other company. Third-party support helps to advertise Microsoft's products, and increasingly, people and businesses see it as a standard, and a safer investment in both time and money. Buying non-Microsoft software would be seen as increasingly risky, for as more people buy the standard and fewer people buy competing products, then one questions how long the other companies will have enough money to continue improving and supporting their product, or even if they will be around much longer. For as a company's sales diminish, so does the network effect, causing a downward spiral of the company's sales and prospects. WordPerfect Office is a good example. In the early 1990's, there were many books on Quattro Pro, the spreadsheet in WordPerfect Office. Now, it would be hard to find a single book about it, even in a large bookstore. The best one could find is a few chapters in one of the few remaining books on WordPerfect Office.
2. Investment Effect — When people and businesses invest time and money for particular software, they will continue to upgrade to the same software to minimize lost productive time. Learning the new features of an upgrade will be quicker, easier, and less stressful than learning entirely new software, and it helps maintain compatibility with old files. Because Microsoft has been distributing its software with new computers for years, most people and businesses already have a large investment in Microsoft software, and thus, are effectively locked to the company.
3. The software business is a natural monopoly business. Although it is generally expensive to produce software, it is very cheap to make copies. The marginal cost of software is virtually zero, so average total costs decline with each copy sold. Once a company establishes a lead, it will become more difficult for competitors to compete against the leader with lower prices, since their own costs have to be recouped with fewer sales. The fewer the sales, the greater the price competitors must charge to remain profitable. However, because the network and investment effect for Microsoft products is already great, Microsoft doesn't need to lower prices to maintain its monopoly, which is why it doesn't.

These natural barriers will insure that Microsoft will be the predominant software company for years to come, no matter what the courts finally do about Microsoft!

Predatory Pricing

The idea of predatory pricing is simple enough. Lower prices below cost to drive out competitors, then raise prices for maximum profits. When true competition exists, a company can only raise prices slightly above its costs, because competition prevents the company from raising prices further. But a monopoly can raise prices much higher, because it doesn't have to consider the competition. This isn't the highest price it could charge, because a monopoly has control only on the supply, not the demand for a product, and thus is subject to price elasticity just as other companies are. The higher the price, the lower the demand. Another factor that limits the price that can be charged for software is illegal copying. The higher the price of software, the greater the distribution of illegal copies. So a price exists at which profits are maximized. A higher price will reduce the number of copies sold that will lower profits more than the higher price will increase it, and a lower price will reduce profits more than the greater number of copies sold will increase it.

Let's look at a simplified, abstract example. A company sells widgets and it costs $20 to make a widget. The company has no competitors, so it's a monopoly. The company measured the price elasticity of widgets, by varying its price, and found the following demand schedule:

Without competition, the monopoly can freely set its price at $60, even though it costs the company only $20 to produce a widget. But what if competitors moved in, and starting charging $30 for a widget. Obviously the company would no longer be able to charge $60 a widget; otherwise, the company's customers will buy from its competitors at the lower price. A monopoly charges a price significantly higher than its costs, and higher than what it could if the company had true competition.

If the company responded to its new competition by lowering the price of a widget to $10 until it bankrupted or drove out its competitors, then resumed charging $60 for a widget, this would be an example of predatory pricing. Of course, for predatory pricing to work, there must be a high barrier to entry; otherwise new competition will move in as soon as the monopolist raised prices.

Predatory Pricing of Microsoft Office Through OEM Distribution

Microsoft Office is, by far, the dominant office suite today. Microsoft Office was and is a good office suite, but so is WordPerfect Office and SmartSuite. Plenty of reviews list the various office suites as editor's choices through the years, which underscores their comparability. In fact, even listing an office suite as an editor's choice isn't really too informative. Since each suite has its strengths and weaknesses, it would be better just to list those strengths and weaknesses so that people could choose based on what they do. For instance, WordPerfect has a vastly superior mail merge than Microsoft Word, even today. Where Microsoft did lead is that it came out with an office suite for Windows earlier than the others, and had better integration. Of course, this is because Microsoft developed Windows and OLE, a Windows technology that allows programs to communicate better. The other predominate advantage was that Microsoft had a better and more consistent macro language, based on BASIC, the computer programming language. Nonetheless, it can't be denied that Microsoft Office's rapid and widespread popularity resulted primarily from distribution by OEMs, such as Compaq and Dell Computer. And this same distribution curtailed sales of WordPerfect Office and SmartSuite. Here's an interesting quote: "...a huge quantity of new PCs are shipped with a version of Microsoft Office already installed on the hard disk." More about this later.) (Quote was based on a review of the Office suites in https://www.zdnet.co.uk/pcdir/content/2000/05/software/gr_office_suites/, which is no longer available).

Microsoft has been distributing its software for years through OEMs, as evinced by the many ads, both old and new, for computer systems, which almost always included some version of Microsoft Office as part of the system. This is a form of predatory pricing. To establish a monopoly in the office suite, predatory pricing was the perfect method for Microsoft to use. Because Microsoft has had a de facto monopoly in PC operating systems for many years, and computer manufacturers, such as Dell and Gateway, needed the operating system to sell computers, Microsoft parlayed this relationship by having the PC manufacturers distribute Microsoft Office on each of their systems sold.

Indeed, the pressures that Microsoft exerted to promote Microsoft Office are illustrated by how it dealt with IBM. In 1995, IBM acquired Lotus Development Corporation, which had the Lotus SmartSuite that competed with Microsoft Office. Joachim Kempin was in charge of Microsoft's sales to the computer manufacturers. According to Judge Jackson's findings, Microsoft was going to delay the issuance of the license for Windows 95 to IBM to "resolve an ongoing audit of IBM's past royalty payments to Microsoft for several different operating systems." Paragraph 124 of Judge Jackson's findings of fact are particularly instructive:

Note Kempin's concern about competition! Does this sound like a competitor or a monopolist? To tell a company — not only one of the largest companies in the world, but the very company that helped establish Microsoft's operating system monopoly in the first place — not to sell its own products! Only a monopoly could consider such an outrageous act; otherwise, how can Microsoft expect a company not to sell its own products that competed with Microsoft? Why would Microsoft think it had that kind of power except that the company was already well aware that it was a monopoly? And why did Microsoft want to prevent IBM from bundling SmartSuite for six months to a year? The only reason that would make sense is because by then, Microsoft Office would have a large enough share of the market to make it a standard, and then the other office suites wouldn't matter anymore. This characterizes the office-suite market today.

Price Discrimination

A seller charging competing buyers different prices for the same commodity or discriminating in the provision of allowances — compensation for advertising and other services — may be violating the Robinson-Patman Act. This kind of price discrimination may hurt competition by giving favored customers an edge in the market that has nothing to do with the cost efficiency of those customers. However, price discrimination is lawful, if they reflect the different costs of dealing with different buyers or result from a seller's attempts to meet a competitor's prices or services. Price discrimination also might be used as a predatory pricing tactic — setting prices below cost to certain customers — to harm competition at the supplier's level. Antitrust authorities use the same standards applied to predatory pricing claims under the Sherman Act and the FTC Act to evaluate allegations of price discrimination used for this purpose. Note that a firm in a competitive industry couldn't practice price discrimination, because such a firm is a price taker, so the firm must sell at the market price.

Price discrimination was one method of coercion that Microsoft used with the OEMs to have them distribute MS Office, partly why these contracts were secret. Microsoft gave the lowest prices for its software, especially its operating systems, which every OEM needed, to those companies most compliant to Microsoft's wishes. Did the OEMs pay Microsoft for Office, or did Microsoft give it away, as it is currently doing with Internet Explorer? My Gateway invoice listed it as free, but the recent Dell ads seem to indicate that Microsoft is getting some money for Office. Of course, whether Microsoft got paid for Office by the OEMs may have changed over time, and depending on the OEM. What is clear is that Microsoft had the OEMs distribute MS Office to their customers as if the customer were getting it for free, or at no additional charge. In most of the computer ads and catalogs, the price for MS Office is not itemized, unlike some other peripherals, such as monitors. When a customer sees a certain price for a monitor that's itemized, the customer assumes that he can order the computer without the monitor, and save the cost of the monitor. But MS Office was almost never itemized like this in the ads; so most customers would think that they would not be saving anything by not getting MS Office; they would think that they're getting it for free, or at no extra charge. So even if Microsoft did receive payment by the OEMs for Office, the way the OEMs distributed Office gave the impression to most people that they were getting it for free. The effect of all this is the same as predatory pricing, even if Microsoft were receiving payment for Office. The effect will certainly be the same for IBM and Corel — they won't be selling very many copies of their software. (According to https://www.computerworld.com/cwi/story/0,1199,NAV63_STO27310,00.html, which is no longer available, covering a consumer lawsuit filed against Microsoft about high prices, it was reported that Microsoft charged little or nothing for Word and Excel in the beginning to establish widespread distribution of its software, then, afterward, started charging the OEMs.)

Of course, another reason for the secrecy of the contracts between Microsoft and the OEMs was the nature of the licensing deals. If the public could read these contracts, they might be outraged by the unfairness of it (see parts of the agreement of Apple Computer and Microsoft below, and Microsoft's attempts to destroy DR-DOS in table above), and see clearly that Microsoft wasn't competing on quality, efficiency, or innovation; that, in fact, it wasn't competing at all. It was dictating what the public should have — their software. One of the constraints imposed by the 1995 consent decree indicates that Microsoft was using its operating system monopoly to get its other software distributed, and competitors' software not distributed. The decree obtained by the Department of Justice from Microsoft contained the following provision, under Section IV, Prohibited Conduct:

Microsoft is enjoined and restrained as follows: ... E. Microsoft shall not enter into any License Agreement in which the terms of that agreement are expressly or impliedly conditioned upon: (1) the licensing of any other Covered Product, Operating System Software product or other product ... or (2) the OEM not licensing, purchasing, using or distributing any non-Microsoft product.

This would indicate that Microsoft did use exclusive dealing and tying contracts to distribute its products; otherwise, why prohibit such conduct if Microsoft were not doing it. Judge Jackson's findings of fact also amply show price discrimination.

Since Microsoft is always saying that it competes on quality and innovation, then why have exclusive dealing and tying contracts, and price discrimination? Why use the tactics that Microsoft employed to destroy DR-DOS? Why pressure IBM to distribute Office rather than its own product? Why threaten Apple to include and make default Internet Explorer? Let the market decide, based on quality and features!

Microsoft Office was distributed by almost every major computer manufacturer, and thus, as more computers were sold each year, more and more people got Microsoft Office. And unlike most other software companies that gave beta software or older software away for free in the hope of getting upgrades, Microsoft distributed its current version.

Microsoft had an ideal situation. First-time computer buyers would already have Microsoft Office, so why spend hundreds of dollars to buy WordPerfect Office or SmartSuite? And if they already owned a computer and had an older version of WordPerfect or SmartSuite, why pay hundreds of dollars for an upgrade, since Microsoft distributed their latest edition of Office. But couldn't people just refrain from buying Microsoft Office, and just wait until they upgraded their computers to get the latest version of Office? Most systems are being shipped with less than full versions of MS Office, such as MS Word, or with Microsoft Works, a lesser version of Office (although some OEMs, since the consent decree, have been distributing non-Microsoft products, such as Corel WordPerfect). If Microsoft Works users want to upgrade, they are far more likely to buy MS Office, since they have already invested time and effort into learning Works. Microsoft's dominance of the market is so complete that it now even charges for beta software (https://www.microsoft.com/PressPass/features/1998/11-12office.asp)!

Would it not behoove the computer manufacturers to let the customer choose what software they wanted on their machines, especially when many people already have lots of software, and don't want their machines preloaded with unwanted or unneeded software, especially if they are paying for this software without realizing it? And by offering customers a choice of software, would this not help the OEMs sell their systems, especially in the days when WordPerfect, Lotus, and dBase were more popular than Microsoft's products? Had it been this way, then the people would have chosen what software they were receiving, not Microsoft.

Thus, predatory pricing worked wonders for Microsoft. At one time, WordPerfect and Lotus (part of SmartSuite) were far more popular than Microsoft's products. In fact, you might even remember dBase, that de facto standard of databases in years past! Or maybe not! So completely has Access supplanted it. Microsoft prevailed, not because its product was better, or because it was a more efficient company; it achieved its market share by leveraging its relationship with the computer manufacturers to distribute its software to every personal computer buyer, the only people who would need personal computer software. As more Microsoft software is distributed, the natural barriers to competition increase, particularly the network effect, thereby making it increasingly difficult for anyone to compete against Microsoft.

Predatory Pricing of Internet Explorer

Much of the current debate about Internet Explorer and Netscape focused about whether Microsoft's practice of giving away software was good for the consumer. Free software would seem to be good for the consumer. This is a great marketing gimmick for Microsoft, for many people like Microsoft for this reason. Indeed, this is one reason why the Justice Department did little or nothing about Microsoft for years. And while Judge Jackson's findings of fact do depend on much testimony and the credibility of witnesses, no such detailed examination and cross-examination is necessary to see what Microsoft has done with Office. The evidence is plainly visible to anyone who wishes to look, and it isn't disputable.

Marginal Cost

The additional cost of producing 1 extra unit of product. The marginal cost of retail software is the cost of the packaging and its physical contents, but doesn't include software development costs, or other costs of production. If the software is distributed by licensing or the Internet, then the marginal cost of software is zero, or nearly so.

I'm sure when the consumer was getting Microsoft Office for free (or he thought he was getting it for free), the consumer felt he was benefiting, but clearly the free lunch has ended. Microsoft is now reaping the rewards of the end game in predatory pricing, by being able to charge prices far above its costs, and without regard to the competition. Office is now Microsoft's most profitable product, even more profitable than its operating systems. The consumer is being milked, and the digital divide that is being reported frequently in the press, and addressed by President Clinton in his State of the Union speech (the government even put up a special site to address the issue: https://www.digitaldivide.gov/), that divide that separates the digitally literate who can afford computers and software from those who can't, will be wider because of the prices of Microsoft software. This is especially true in other countries, where people are much poorer and Microsoft's prices are even higher. If Bill Gates truly wanted to bring computing power to the masses, he could do no better than reducing the price of software as the installed base expands. Here's an interesting quote from Bill Gates: "Maybe kids of a certain age or people of a certain income should get to access intellectual property royalty free or royalty reduced. Why not? There is no marginal cost." Exactly!

Microsoft's distribution of IE is predatory pricing. Not only is Microsoft not receiving any direct revenue from its distribution of IE, it's actually spending a lot of money developing and promoting it, more than $600 million so far. Thus, IE's cost is actually negative. From the start, Microsoft offered its browser for free in an effort to establish a monopoly in browser software. Furthermore, Internet Explorer was mainly distributed by the computer manufacturers, just as Microsoft Office was. And just as before, Microsoft's main competition, in this case, Netscape, will be minimized. After all, what other result was possible when Netscape's major revenue source was being diminished because Microsoft was giving its browser away for free. Microsoft understood exactly what it was doing. Bill Gates said it clearly in an interview published in the Financial Times on July 3, 1996: "Our business model works even if all Internet software is free," says Mr. Gates. "We are still selling operating systems. What does Netscape's business model look like if that happens? Not very good."

Obviously!

Microsoft argues that even if IE and the operating system are separate products, distributing IE for free isn't predatory pricing, because it is not recouping its costs. Microsoft is actually recouping its costs (see below), but, even if it weren't, recoupment of costs need not be a fait accompli. There only needs to be a dangerous probability of succeeding at recoupment, and, let's face it, if Netscape is eliminated, what's to stop Microsoft from subsequently charging for IE. But, as argued later, Microsoft is recouping its $600 million dollar investment in IE, by allowing Microsoft to maintain its high upgrade prices for Windows.

Windows and Internet Explorer Are Separate Products

In its conclusion of law, Microsoft argues that the browser is actually part of the operating system. Microsoft relies heavily on the Court of Appeals decision (147 F.3d at 951) (Original source: https://www.cadc.uscourts.gov/common/opinions/199806/97-5343a.txt, no longer available) it obtained earlier. That decision stated that there is nothing wrong integrating two products if it is beneficial to the consumer. Wouldn't it be beneficial to integrate Microsoft Office with the operating system? Or any other software product for that matter? Clearly this ludicrous decision doesn't distinguish between separate products. With a decision like this, Microsoft can tie any product it wishes into the operating system.

The appeals court specifically argued that computer manufacturers couldn't combine the operating system and Netscape in the same way that Microsoft combined Internet Explorer with the operating system. It even cited this specific example: "Windows 95 without IE's code will not boot, and adding a rival browser will not fix this." (Id. at 948 n.11) First, it's obvious that since Microsoft develops both operating system and browser, it can easily arrange this. Second, nothing inherent in the boot sequence requires browser code. Operating systems have been booting up long before there were any browsers. In fact, when I bought my retail copy of Windows 95 shortly after it came out, it didn't even have Internet Explorer! So how could it be required for the boot sequence, and indeed, what aspect of the boot sequence would require browser code?

The appeals court made another dubious argument, which Microsoft argued in its conclusions of law:

But isn't Internet Explorer a stand-alone browser? There's an Internet Explorer for both the Macintosh and Unix operating systems! Clearly, IE isn't a part of those operating systems, so, perforce, it must be a separate software product!

A more probative approach to determine whether the browser is separate from the operating system is to look at the fact that there was a company, Netscape, that was selling a browser, but not an operating system. Opera is another browser that isn't distributed with its own operating system. Even Microsoft sold Internet Explorer separately, in its own shrink-wrapped box. Indeed, Microsoft's own book publishing company, Microsoft Press, publishes books that have CD-ROMs with the complete Internet Explorer software. One of the goals of antitrust law is to foster competition. If there are separate companies selling a similar product, then isn't that prima facie evidence that they're separate products? And certainly, in view of the goals of antitrust law, particularly that of promoting competition among companies, shouldn't this be the accepted definition — the bright line — that would best promote public policy?

Piracy as a Form of Predatory Pricing

Ironically, piracy can be an effective way of establishing a monopoly, working in the same way as predatory pricing. Although Microsoft probably doesn't intend to establish its monopoly in China this way, its inability to stem piracy now may benefit Microsoft in the future. The wide dissemination of pirated Microsoft software will help to standardize the software in China, and augment the other natural barriers to competition. If technical and political advances allow Microsoft to enforce the law more vigorously in the future, this may yield a windfall for Microsoft. If Microsoft succeeded in enforcing the law today, it would thwart software distribution significantly, since most Chinese can't afford to pay Microsoft's exorbitant prices. More importantly, since China is a communist country and controls business to a much greater extent than the government does in the United States, China may decide to force the country to standardize on open source and free software, such as Linux and StarOffice rather than shell out billions to an American company, much as France intends to do (Original source: https://www.independent.co.uk/?story=42482, no longer available)! On the other hand, as the natural barriers to competition become stronger with greater distribution of pirated software, then Microsoft software will become so entrenched in homes and businesses — and even the government — that not even the Chinese government will be able to change it.

Predatory Pricing is the Perfect Method to Establish a Software Monopoly

There are some who believe that predatory pricing is a myth and that antitrust laws are no longer relevant or useful in today's high-tech economy. Predatory pricing is a myth, they argue, because:

• It would cost too much for the predator, since the predator would be selling at below-cost, and the larger the company, the greater the loss it would incur, because of its higher sales volume.
• The predator couldn't know how long the price war would last. It would be foolish to sell at a loss in the hope of making monopoly profits in the uncertain future.
• There is nothing to stop the competition from shutting down until prices rose again after the would-be monopolist attempted to recoup its losses. Even if the monopolist bankrupted its competitors, new competitors would enter the market when the monopolist started charging higher rates again.
• The theory of predatory pricing assumes the prior existence of a "war chest of monopoly profits" that the predator can use to subsidize its practice of pricing below average cost. But how does that war chest come into being if the firm has not yet become a monopoly?
• The opportunity cost of the money used for predation must be accounted for. Later monopolistic profits must yield a greater rate of return than any other investment for the company; otherwise it wouldn't be rational for a company to attempt predatory pricing.

It is easy to see why these arguments fail with Microsoft. Not only do these arguments NOT show that predatory pricing is a myth, but that, in fact, predatory pricing is the perfect method to establish a software monopoly!

When Microsoft has the OEMs distribute its software, Microsoft's cost is zero. The OEMs pay for distribution and supplemental materials such as books. And because Microsoft makes plenty of money from its operating systems and from retail sales, it doesn't have to wait until its competitors are eliminated. Indeed, once customers and businesses start using Microsoft software, Microsoft can sell upgrades at a high price because of the network and investment effect, regardless of the presence of competitors. If Microsoft includes software as part of its operating system or other software as it has done with IE, then that cost is already covered by the extremely high price of Microsoft's software. Microsoft doesn't have to worry about any new competitors entering into the market, because of the natural barriers to competition that only become stronger with greater distribution of Microsoft software. And, of course, Microsoft's "war chest" could have come from its operating system monopoly that IBM gave it, if it needed it, but Microsoft doesn't need it, because the marginal cost of its software as distributed by OEMs is zero. And since Microsoft's software prices are many times what its costs (more than 33 times in the case of Office!), Microsoft would never be able to find any other investment that would yield the rate of return that Microsoft is achieving with its monopoly, and the proof is in its profits.

Economists are finally seeing clearly that predatory pricing works, and in the software industry, it works beautifully. The question is, will the courts see the truly harmful effect of predatory pricing?

Clearly, antitrust laws are needed today more than ever.

Because the Marginal Utility of Software Upgrades is Declining, Microsoft has been and will be Forced to Include More and More Software in Each of its Packages

Marginal Utility

The extra satisfaction gained from an additional unit of a good or service. Marginal utility usually declines with each additional unit.

Declining marginal utility of software upgrades — not generosity!— is what's forcing Microsoft to include more software for the consumer dollar, and since Microsoft wants to monopolize the browser market and control the Internet, IE was a natural choice to include in Windows. People will not pay Microsoft's high upgrade prices just for a more stable Windows, or for fixes and modest improvements. That's also why Microsoft added PhotoDraw and FrontPage (and now, Visio 2000) to Microsoft Office Premium Edition, so that it can maintain its high upgrade price and still have decent sales. Years ago, people upgraded constantly because computer systems and software had serious shortcomings, but now that both hardware and software satisfy the needs of most people, the demand curve is shifting, and the price for maximum profits is declining. And, of course, piracy, which is rampant in poorer countries, will be more pervasive at higher prices. Nonetheless, prices haven't dropped nearly as much nor as fast as they would have if Microsoft had true competition.

So by including IE in Windows, Microsoft is recouping its costs for IE; it's just not itemizing the revenue. Without the inclusion of additional software, Microsoft would have had to charge a lower price for Windows. (Although true, that people can download IE for free, many people don't. They would rather buy it as a complete package, and not worry about download times or installation problems.) And since IE is part of the operating system, and Microsoft has raised prices on its OS yet again (Windows 2000 is the most expensive operating system ever, and, eventually, Microsoft wants to move everyone up to it.), do you think Microsoft is making a profit? Absolutely! And a hefty one at that. Microsoft said it spent $1 billion developing Windows 2000. Since Microsoft already said that it spent $600 million developing IE and IE is part of Windows 2000, then more than half of the development costs went to IE. Ergo, Microsoft is recouping its costs through the revenue it obtains from the operating system. (Although Microsoft is also getting advertising revenue from IE, this is only a small fraction of the revenue obtained from the sales of Windows itself. Netscape was getting advertising revenue, also, but this revenue wasn't sufficient to cover development, marketing, and distribution costs, as Microsoft noted in its own research! Thus, without retail sales, Microsoft knew that Netscape would either be bankrupted or seriously weakened.)

As a Monopolist, Microsoft Adds as Little Value as Possible To Each Upgrade It Sells, and Not to Upgrade Too Quickly.

While Microsoft will be forced to include more software for the consumer's dollar, it will do so as slowly and as little as possible. If Microsoft tried to raise prices for its software, people would balk. People would ask why software prices are rising while hardware prices are plummeting, creating bad public relations for Microsoft. It doesn't want any more scrutiny into its practices than is already occurring. The solution, of course, is to keep prices the same, but only add enough value to each upgrade to make the price look at least a little reasonable. And it can also create separate products, such as Microsoft Plus! 98, to generate more revenue. It could have easily added Plus! 98 features to Windows 98, but that would be adding too much value. Microsoft wants people to get the least for their money. Eventually, of course, Microsoft will add the Plus pack features into the operating system, because, as I have said, it has no choice. But the mere existence of the Plus pack just shows that Microsoft really does want to stretch out the upgrade cycle, by adding the least value at the greatest cost to the customer! Thus, Microsoft earns a higher rate of return on its development costs even without raising prices. Microsoft is helped in this by the buzz created by computer magazines. Magazines are always looking for new material, and obviously, new editions of software provide that material. The magazines write about the new software, give tips on how to use it, and, in effect, help Microsoft sell its wares.

Why wouldn't Microsoft upgrade faster? If upgrades came out too fast, people would probably scrutinize the cost-effectiveness of the upgrades more. Moreover, upgrades take time to sell. If Microsoft upgraded too quickly, people who were slow to purchase would just skip the intervening upgrade and buy the new upgrade that just came out. Consumers may also delay their purchase because of anticipation of a new upgrade. More people would start skipping upgrades, and just wait until they actually needed the features of the new upgrade, if they would ever need it, and at some point, they won't. Thus, Microsoft can maximize its profits not only by setting the right price, but also by adding minimal value to each upgrade, thereby allowing the upgrade cycle to be extended.

Now what if Microsoft had competition? Then Microsoft would add as much value as possible to each upgrade and release it as soon as possible, so that it can sell more copies and lower its development costs per copy and therefore enjoy higher profits. Thus, Microsoft the competitor is the complete opposite of Microsoft the monopolist! Microsoft the competitor adds the most value to its customers; Microsoft the monopolist adds the least value. Which one is better for the public?

Software Bundling

Software bundling is problematic. While it is certainly desirable for the consumer to have more software bundled together, because supplementing Windows with other software is expensive, it also makes it difficult for competitors to compete, even if their product is vastly superior. Furthermore, bundling does have a legitimate business purpose, because bundling is one way that a software company can add more value to its product, and, as argued above, this will be necessary as software matures. However, lack of effective competition has allowed Microsoft to be discrete in its bundling, adding products where it wants to dominate, such as browsing software, or products that Microsoft thinks will help to sell more upgrades, such as Windows Movie Maker bundled with Windows ME. Otherwise, Microsoft provides the minimum value that it perceives will be effective in selling upgrades. That's why Internet Explorer is a great product, and thus, nobody buys a browser, but a big market still exists for Norton Utilities and other operating system utilities, much of it shareware.

The ideal competitive situation would have prevented this "innovation trickling." Lack of competition allows Microsoft to dollop improvements and features to extend the upgrade cycle. Only where Microsoft has real competition in areas where it clearly wants to be a leader does it deliver. One thing that could have, and still might, prevent this slow dolloping of improvements is Microsoft's diminishing sales unless it starts adding real value to its upgrades. I said could have because Microsoft wants to try to force people to pay it constantly through the use of subscriptions, thereby obviating any need to add significant value to its upgrades-or no value at all, if it so chooses. I said still might because I don't think Microsoft will be successful with subscriptions, unless they add real value for the money. But how can one know the value of a software subscription beforehand? According to a CNN article, subscriptions will be more expensive than buying upgrades. Without competition, the only factor impelling Microsoft to add more value for the money is by people refraining from buying upgrades with little value, or worse yet, that require subscriptions.

The Courts Need to Recognize that there are Different Methods of Predatory Pricing and Different Methods of Recoupment in the Software Industry

Because the essential elements of predatory pricing have been developed in case law long before the existence of a software industry, OEM distribution and bundling cannot be easily characterized as predatory pricing in the legal sense, because Microsoft is probably now getting paid for Office by the OEMs, and Microsoft does make a profit on bundled software, thus making prosecution of Microsoft uncertain under a predatory pricing cause of action. Moreover, because bundling has a legitimate business objective, it requires a rule-of-reason analysis. However, it is predatory pricing because (1) the customer is getting the software for no apparent charge; (2) it reduces competition, and (3) it allows Microsoft to keep prices far above competitive levels. The effectiveness of this strategy can easily be seen in the office-suite market, where the markets for WordPerfect Office and Lotus SmartSuite are mere vestiges of what they once were.

The Sherman Antitrust Acts were written in broad language because it was difficult — indeed, impossible — to predict what methods a business would use to gain and maintain a monopoly. Congress left the details to the courts and, eventually, to the Department of Justice and the Federal Trade Commission. What the courts, the DOJ, and the FTC need to recognize is that the software industry allows new variations on both predatory pricing and recoupment.

Software bundling is obviously a form of predatory pricing, because the consumer doesn't have to pay anything additional for the software. Note that this is not the same thing as not paying for it. As discussed above, the consumer is paying for it — just not separately. OEM distribution is another form of predatory pricing, even if Microsoft is getting paid for the software by the OEMs. The consumer is not paying additionally for it, or he doesn't realize that he is, and, therefore, this just as effectively locks out competition unfairly. This has the same effect as the traditional form of predatory pricing — that of giving the software away for free. In fact, OEM distribution is even better because the software is already installed and set up!

The software monopolist also has a new variation on recoupment of costs. As can be seen with Windows and IE, software bundling allows the recoupment of costs because the monopolist gets to maintain high upgrade prices by bundling more software. This isn't explicit recoupment, but it's recoupment, nonetheless. Adding IE to Windows allowed Microsoft to maintain its high upgrade price on Windows. Without additional software for Windows, Microsoft would have had to lower upgrade prices or accept fewer sales. This trend is continuing with the addition of Windows Movie Maker and Windows Media Player to Windows ME, the next upgrade of Windows for consumers. Thus, Microsoft not only gets to eliminate competitors, but it gets to recoup its costs in a subtle way that courts have yet to recognize!

While OEM distribution and software bundling are not strictly predatory pricing as developed in case law, they are anticompetitive, and thus, violate the Sherman Acts. Case law needs to encompass these anticompetitive acts peculiar to the software industry.

Not only can Microsoft recoup its costs, it can even raise prices without raising prices! Consider this hypothetical scenario: Microsoft spends $100 million for development to upgrade Windows 95 to Windows 98. Retail price of Windows 95 and Windows 98 is the same $209 for a full install. Now Microsoft spends $50 million dollars to upgrade Windows 98 to Windows ME, and charges the same price for Windows ME, $209. Thus, Microsoft receives more money for less cost of development, thereby raising its profits. The same effect could be achieved by spending the same for development and raising the price of its software, but Microsoft doesn't want to raise prices which might raise the ire of customers who have come to expect technology prices to drop. Furthermore, while price increases are easy to see, it is very difficult to quantify improvements in the upgrades. Thus, it can clearly be seen in this situation how Microsoft can raise prices without raising prices — simply by spending less for improvements, then charging the same price for those improvements.

Average Total Cost

A company's total cost divided by its total output, equals the sum of average fixed and variable costs in the production of each item sold. Average total cost includes a normal profit. Market price=average total cost in long-run competitive and monopolistic competitive industries.

Monopolistic Competition

A market characterized by many sellers of slightly different products, and where entry and exit from the industry is easy.

Oligopoly

A market characterized by few sellers, a high barrier to entry, and mutual interdependence with its rivals. Mutual interdependence exists when one firm's decisions about prices affects other firms' decisions about their prices. Thus, an oligopolistic firm, when deciding at what price to sell its products, must consider the response of rivals. Although Microsoft might seem to be part of an oligopoly, it's not, because its competition is moribund, and thus, inconsequential. The natural barriers to competition are now so high and still increasing, that Microsoft is insulated from pricing pressure from its rivals.

Diseconomies of Scale

Factors relating to a company's large size that cause the average cost of production to increase. Most diseconomies of scale are caused by the difficulty of managing enormous enterprises, stretching facilities beyond their limit, and adding additional fixed costs.

Natural Monopoly

A market condition where one company, because of economies of scale, can produce the total market output at a lower average cost than a plurality of companies could. Average total costs continually decline with increased output. Utilities were a classic example of natural monopolies, although many technology companies are also natural monopolies. The government allows utility monopolies because the company can provide the product at a lesser cost than if it had competition. To prevent abuses by the monopoly, the government regulates the traditional natural monopolies, especially its prices, otherwise the monopoly would charge a higher price to maximize profits at the expense of the consumer.

Microsoft is a natural monopoly because the marginal cost of software is virtually zero. Since there are no diseconomies of scale in copying software, average total costs continuously declines with increased output, asymptotically approaching marginal cost, which, even with packaged software, is less than $5. Note that if Microsoft had real competition, software prices would be at average total cost, which, with Microsoft's huge sales volume, would be slightly more than $5! Of course, as a true monopoly, Microsoft can sell at many times that price, and does.

Microsoft is a Natural Monopoly

Microsoft has a great reason to establish and maintain a monopoly, if it could do so without true competition forcing it to reduce prices. Software is unlike any other business. Because the marginal cost of software is virtually zero (and in the case of OEM distribution and volume licensing (original source: https://www.microsoft.com/enterprise/licensing/Default.htm, no longer available), it actually is zero, since the licensee pays for any packaging and distribution), its average total cost continually declines with volume, and because expanding the number of software units only involves making copies, there are no diseconomies of scale and no necessity to increase fixed costs. Because marginal cost is so low, average total cost continually declines as it asymptotically approaches marginal cost, and unlike many other industries, average total cost never rises. Thus, Microsoft is a natural monopoly.

Sales figures and cost of development for software are hard to come by, especially with multiple versions and constant upgrades becoming available, but consider this. According to Microsoft (Microsoft Office Now Fastest-Selling Business Application Ever), Microsoft sold more than 20 million licenses of Microsoft Office 97 in less than a year, at the average of rate of 60,000 per day! Furthermore, Microsoft already had an installed base of 55 million for its desktop applications prior to the release of Office 97 (Microsoft Office 97 Released to Manufacturing). With the number of computer users still growing rapidly during the late 90's, it certainly is not unreasonable to assume that Microsoft sold at least 50 million copies of Office 97 in the 2 ½ years between its initial release on November 19, 1996 and the release of Office 2000 on June 10, 1999. (An average rate of 60,000 copies per day for 933 days yields 55,980,000 copies, so 50,000,000 is a conservative number.) Let's further assume that Microsoft received an average of $200 per copy, not an unreasonable figure considering that MS Office prices ranged from a little over $200 to over $400 for an upgrade, depending on version, and almost double that for a full version. Let's further assume that it cost Microsoft $50 million dollars to develop Office 97. Again, not unreasonable when you consider that Office 97 was an upgrade to Office 95, so it wasn't like they were creating the software from scratch. The cost could be considerably less than this, because, (1) as I have already argued, Microsoft's goal is to add as little value as possible to each upgrade; and (2) much of the code between programs is shared, thus reducing costs even more. Multiplying price per copy by the number of copies sold yields a staggering $10 billion in revenues. (It has recently been reported that Microsoft receives 40% of its revenue from Office; thus, that's almost $10 billion in ONE YEAR!) Subtract the cost of development and the cost of packaging yields $9.7 BILLION in profit! That's a staggering profit margin of 97%! The profit earned per unit sold is more than 33 times what the unit cost! Of course, Microsoft as a company doesn't earn this much profit or have a margin this high, because it is diluted by fixed costs, administrative and marketing expenses, and the company's other, less profitable, endeavors and other monopolizing efforts, but, nonetheless, its profit margin as a whole for 1999 was 39.4%, far higher than most other companies. In the last 5 years, Microsoft's profit margin has increased from 24.5% in 1995 to 39.4% in 1999 (https://www.stockselector.com/earnings.asp?symbol=MSFT&ref=344, page still available but info has changed), and this trend will only continue as Microsoft sells more software to a wider, worldwide market, simply because the marginal cost of software is small, so the average total cost of each unit continually declines! (Compare Microsoft's profit margin and growth to super-efficient Dell Computer (page still available, but displayed info reflects latest data), which has an average profit margin of less the 8.5%!)

Let's consider a different scenario, a much better one for consumers. Suppose Microsoft got only $20 per copy of Office, instead of $200. Using the same figures above, this would yield revenues of $1 billion, profits of $450 million, and a profit margin of 45%— still pretty hefty! Of course, if Microsoft were selling Office wholesale for $20 per copy, then, in today's competitive retail market, Office would be selling for under $30 instead of $225 to $400 or more for an upgrade! And as the user base expands, as it surely will, Microsoft software could come down even more! Microsoft has already reported that sales for Office 2000 are 31% ahead of Office 97 for a comparable period.

As a natural monopoly, Microsoft's costs keep falling, but Microsoft doesn't want to pass the savings on to customers, which is why its profit margin is so large and continually increases, at least for software! Consider this: One reason why Dell Computer was so profitable as a computer manufacturer was because when component prices dropped, Dell Computer didn't drop their prices right away. Thus, Dell earned a higher profit. Of course, Dell Computer couldn't do this indefinitely, because it has real competition. If Dell didn't lower prices at some point, it would lose market share to Gateway and other competitors as they lowered their prices. But now imagine that Dell had no or nominal competitors. It could maintain its prices even as components costs were dropping dramatically. Thus, it would earn a much higher profit that would continually increase as component costs dropped. With Microsoft, this is the actual situation. Its costs have dropped dramatically and continue to do so, but it doesn't want to pass the savings to customers! It doesn't have to, because it has pricing power, the true sign of a monopoly. It wants to keep the extra money as profit!

It is the continual decline in average total cost of software that makes Microsoft a natural monopoly. True competition would have forced Microsoft to reduce its prices, but, because it eliminated the competition though anticompetitive means, it didn't need to respond to competitors' prices. In fact, Microsoft has increased prices for its operating systems, and it wants to negate any attempts to lower those prices (OEM Pricing Thoughts - a Microsoft confidential memo). Not only does Microsoft not want to compete with anyone else on prices, it doesn't even want to compete with itself! That's why Microsoft raised the price of Windows 95 to OEMs when it released Windows 98, because Microsoft didn't want customers choosing the cheaper Windows 95.

True Competition Would Have Lowered Software Prices to Average Total Costs and Eliminated Any Differences Between Full and Upgrade Prices

So how can the consumer ever be sure of getting the best value for his money? By buying from a competitive industry. In a truly competitive software world, each company would continually produce better software products at lower prices to increase sales, thereby allowing them to lower prices further to try to gain greater market share. As sales volume increases, research and development costs per unit of software would decline to low levels. Average total cost would approach marginal cost, allowing competitive firms to charge very low prices, and still make a profit. Eventually, in a natural monopoly industry, a monopolist would arise, even with true competition, but the monopolist wouldn't be able to raise prices after its competitors are gone, because, by then, after years of competition and development, the current software would satisfy the needs of most people, and if the monopolist raised prices, most people just wouldn't buy the upgrade, and unlike most products that are manufactured, such as computers, software doesn't break. As long as people have adequate backup plans, the software will last as long as people do.

As software companies would have strived to increase their market share, they would have also eliminated the price differential between upgrades and full editions, because companies that lowered prices as much as possible, especially to new customers, would benefit from greater sales volumes and the ability to lower prices even more. This scenario befits a natural monopoly industry, but Microsoft has prevented this by using anticompetitive practices to thwart competition.

Microsoft has recouped its costs in its early editions of its software years ago. There is no reason why Microsoft should continue charging full price to new customers that don't have either Microsoft products, or competitor's products that would qualify for a Microsoft upgrade. After all, computer prices are the same for everyone, whether they owned a computer before or not. The same should be true for software, but here again, the lack of competition lets Microsoft charge the much higher price.

Does Competition Really Lower Prices? Just Look at Windows CE Pricing!

If anybody has any doubts that competition truly helps to lower prices, just look at Microsoft's pricing of Windows CE. Windows CE is the Windows for handheld computers, informational appliances, and embedded devices. Because these devices are much more limited in capabilities and are built for specific purposes, the consumer doesn't care as much about the underlying operating system. This gives Linux and other free operating systems a big advantage, because the cost of the hardware is much less than for a PC, and cost will be a major factor in how well these devices sell. Manufacturers that can cut costs will have an advantage, and one way to do that is to use a free operating system. Microsoft currently charges about $10 to $15 per Windows CE license to undercut its main competitor in handheld computers, the Palm, which charges about $20 for its OS. However, Microsoft may have to go even lower as major manufacturers, including Microsoft's own desktop allies such as Compaq and Hewlett-Packard, are developing handheld prototypes using Linux. Microsoft may have to give Windows CE away for free just to meet the competition, and, according to this report (original source: https://www.zdnet.com/zdnn/stories/news/0,4586,2468874,00.html, no longer available), it's contemplating just that. What else can it do? It can't get rid of Linux, since Linux is already free. Competition works! More choices and much lower prices.

Price Competition amongst the PC Manufacturers Benefited Microsoft by Expanding its Market and Eliminating Apple Computer as a Real Threat

Ironically, it was price competition among the computer manufacturers that greatly increased Microsoft sales, because software is worthless without computers to run them. Software and computers are complementary products. Therefore, as computer prices dropped, computer sales increased greatly, increasing Microsoft's sales proportionately. But Microsoft doesn't want to benefit the consumer by lowering its own prices, and this is why Microsoft software now accounts for a larger percentage of the cost of a computer system.

Price competition among the computer manufacturers had another beneficial effect for Microsoft — it eliminated Apple Computer as a real competitor! In earlier years, the Apple Macintosh computer was widely regarded to be superior to the IBM compatible computers, and the Mac OS was considered much better than Windows. (Some people consider this to be true even today!) In fact, the mere existence of Windows was due, in large part, to the success of the Mac OS, from which Microsoft copied heavily. So why didn't Apple succeed? Because it wanted to be a monopoly, and strove hard for those monopoly profits, and subsequently, it charged high prices before it really had a lock on the market. Apple was very successful in the educational market because it charged much lower prices to schools and students, and, thus, gained the lion's share of the educational computer market. Apple hoped to recoup its costs later, after the students graduated and upgraded their machines. Unfortunately for Apple, Apple didn't extend the price cuts beyond the educational market. Apple's prices for everyone else were much higher, allowing the IBM compatibles to capture most of the market share, and this, in turn, generated much more revenue for Microsoft. With the rest of the world embracing IBM compatibles, eventually, even the schools had to follow suit. Otherwise, students would be learning one system in school, only to find, after graduation, another system in the business world.

Apple was also unwilling to market its OS to the IBM world, because Apple recognized that one of the biggest assets of the Macintosh was the operating system. Had Apple developed its OS for the IBM compatibles, this could well have been Apple's greatest cash cow, and Apple probably could have sold more of its own computers. It might have supplanted Microsoft as the dominant OS provider and standard setter. But, alas, Apple, too, wanted to play monopoly — but it lost.

Microsoft Could End Most Piracy of its Software by Charging Reasonable Prices

Microsoft is constantly complaining about and prosecuting software pirates. Although Microsoft claims (Piracy Facts and Figures, original source: https://www.microsoft.com/piracy/basics/facts_figures.asp, no longer available) that piracy causes loss of jobs, wages, and tax revenues, this isn't the true picture, because they don't account for how the saved money is spent elsewhere. If I had spent $30 for MS Office instead of $430, then that's $400 that I could have spent elsewhere, thus generating jobs and wages for those other businesses that I patronized and tax revenues for governments.

Ironically, Microsoft limits jobs in the software industry. Because a monopoly restricts output to maintain high prices, it uses less of each factor of production, including labor. Additionally, because Microsoft wants to upgrade its software as slowly as possible to extend the upgrade cycle, this lessens the demand for labor even more. And because competitors are selling less of their products as Microsoft expands its monopoly, this, too, reduces the demand for labor by the competitors. Thus, total employment in the software industry is less than it would be in a competitive industry.

Software pirates are Microsoft's true main competitors, and they make it hard for Microsoft to maintain high prices on its software. This is why Microsoft coerced OEMs, through discriminatory pricing, to agree on per-processor licenses. Microsoft received payment on all computer systems shipped, whether those systems had Microsoft software or not. Microsoft ostensibly argued that this would deter piracy since people wouldn't buy pirated software if their computer already came with the operating system. Of course, this policy also locked out competing operating systems, and forced many customers to pay for the same operating system more than once. So not only does Microsoft get to maintain high prices with this policy, it also thwarts both pirates and competition!

Allocative Efficiency

The production of the most desirable goods in the desired quantities.

Now that Microsoft is prohibited from stipulating a per processor license in its contracts, pirates will be more effective in keeping Microsoft's prices lower by providing more competition with Microsoft. Thus, pirates serve a public interest by lessening Microsoft's price gouging of its victims "customers". This is an important public benefit, because there is a fundamental difference between pirates stealing from Microsoft and Microsoft stealing from its customers by charging high prices. When a pirate sells copies of Microsoft software, it merely deprives Microsoft of some potential revenue, and most sales of pirated software would not have been revenue for Microsoft, anyway, because pirates sell at a lower price (typically, $5 to $20), which allows many more people to buy the software. Most of those people would not have paid Microsoft's much higher price, even if there were no pirated copies to buy. This follows from price elasticity — the lesser the price, the greater the sales volume. Thus, pirates also increase allocative efficiency, another great benefit to society. However, when Microsoft steals from its customers, Microsoft is arrogating real money from buyers of legitimate software, money that most buyers had to work for, and pay taxes on.

Ironically, the only reason pirates can even exist is because Microsoft wants to maintain high prices. Because Microsoft is a natural monopoly and because it has the greatest economies of scale for packaging and delivering its software, and with development costs at pennies per unit of software, it could end most piracy of its software, wherever it is found, simply by lowering the price of its software to slightly above marginal cost, as they would have had to if they had true competition. Pirates would not be able to compete against such low prices, because pirates are very small, isolated distributors, who have additional costs besides lower efficiency, such as evading the law. This is especially true if Microsoft offered electronic delivery of all its software over the Internet, and it is certainly true in volume-licensing deals that Microsoft provides for businesses and organizations, because in both cases, the marginal cost is zero, thus, prices could easily be less than $10 per unit. Because of Microsoft's sales volume, such low prices could still cover the cost of development and marketing, and still provide Microsoft with a reasonable return of its investment. Sales would skyrocket, even without marketing, giving Microsoft an even greater efficiency. But, alas, Microsoft doesn't want to do this. Microsoft wants to maintain its status as the largest software pirate in the world — a pirate that steals money from people through its high software prices!

As a Monopolist, Microsoft's Best Strategy is NOT to Innovate!

Microsoft repeatedly says that it should be free to innovate. It even has a separate website called the Freedom to Innovate Network (original source: https://www.microsoft.com/FREEDOMTOINNOVATE/default.htm, no longer available). This is ironic, because Microsoft has never been known as an innovator. And, yet, this is perplexing. How is it that a company with so much wealth and resources at its disposal innovates so little? Because it is more cost-effective to see what sells, then either copy the idea or simply buy the technology outright. Sometimes, Microsoft invests in a company only to learn its secrets, then divests itself of the company to make its own product, as it did with RealNetworks. Although software code is copyrightable, software ideas are not, as Gates himself noted in Congressional testimony, quoted above. So why risk money developing products that nobody may want (like Microsoft's Bob!), when, as a monopolist, Microsoft can just observe the market to see what sells. Microsoft doesn't have to be the first in anything, which is why it isn't. With its installed base, and proven techniques of creating and maintaining a monopoly, Microsoft can take any market it wants, after it has been proven profitable. Only when Microsoft feels sufficiently threatened, as it did with Netscape, does it work hard to produce a better quality product. Otherwise, Microsoft is, in Bill Gate's own characterization, "a lazy monopolist," always attempting to give the least value for the most money.

Microsoft also Causes Allocative Inefficiency, and Redistributes the Wealth from Poorer to Richer People

Microsoft causes allocative inefficiency in two ways:

• Microsoft deprives poor, honest people of valuable products and the benefits of those products, such as better jobs and better lives.
• Microsoft, because of its tendency to supply the least its software for each upgrade, to lengthen the lucrative upgrade cycle, deprives people of better quality software and better features than they would have had in a competitive world, and those same people work less productively. The amount of work that could have been accomplished by people had they had better software sooner is incalculable, and underscores the need for competition.

Microsoft, like all monopolies, redistributes the wealth from poorer people to richer people. This is especially true in other countries where people are much poorer than Americans and where Microsoft's prices are even higher. You might call this the "anti-Robin Hood effect."

Refuting Arguments in Support of Microsoft

With a clear understanding of what Microsoft is doing, let's examine arguments advanced in favor of Microsoft.

Argument: If Microsoft is a monopoly, why doesn't it charge a lot more for Windows?

Answer: Microsoft has no real competition in operating systems for the PC. It is also keenly aware of antitrust laws, and that many people view Microsoft as a monopoly simply because of its dominance in PC operating systems. If Microsoft charged a much higher price, it would invite greater antitrust scrutiny, and greater public disapproval. It would provide strong evidence that Microsoft is, indeed, a monopoly. Furthermore, OEMs would really balk at higher prices for Windows, since they were required by Microsoft to ship the operating system with every system they sold to obtain the lowest prices for Windows. Higher prices for Windows would mean higher prices for PC systems, and fewer sales, both for Microsoft and the PC manufacturers. Thus, there would be a real danger that the OEMs themselves would have filed antitrust lawsuits against Microsoft. Microsoft felt it could charge much higher prices for its other products, such as Office, because it, at least, has nominal competition in those areas — nominal because its not enough to force Microsoft to lower prices, but enough so that it at least seems that Microsoft has competition. This is a big reason why Microsoft has invested in both Apple Computer and Corel, to prevent them from going bankrupt, so that at least a semblance of competition can be maintained.

Besides, Microsoft didn't have to charge higher prices for Windows. It got high prices anyway, because the amount that each new Windows version was improved was minimal, thereby obtaining a high price per improvement without anyone really noticing. Isn't this the better way to do it? To be able to charge high prices without anyone noticing? When buying upgrades, the price itself doesn't tell the whole story. The price must be compared to how much better the upgrade is, and in the case of DOS and Windows, the difference between versions has always been minimal. This is how Microsoft has gotten the most bucks for the least bang, with very few people complaining. Indeed, Microsoft has duped the public so well, that Microsoft is consistently in the top 5 of Forbe's list of most admired companies.

Argument: Software prices have declined in every market that Microsoft entered, and plenty of software, such as AutoCAD, is much more expensive.

Refutation: Many people think Microsoft's prices are reasonable, because software prices have always been fairly high. However, Microsoft usually only enters mass markets, or what will become mass markets, because that is where the real money is. That is where a natural monopoly can reduce its costs significantly. On the other hand, niche markets, because of their much lesser sales volume, have to cover their costs of research, development, and marketing by charging higher prices. Their average total cost is much higher than it is for a mass market, such as operating systems and office suites. This is also why software was much more expensive in the early years of the PC. Lesser sales volumes means higher average total costs, which necessitates higher prices. However, once sales volumes increase, then, in a truly competitive world, prices should drop commensurately. That this hasn't happened with Microsoft's products only shows without doubt that Microsoft is a monopoly, earning monopoly profits by charging monopoly prices.

Argument: Competitors are merely using the law to compete unfairly. Some have even suggested that antitrust laws should be abolished entirely, because businesses use these laws to subdue competition.

Refutation: Quid pro quo! Microsoft didn't compete fairly. Why should its competition be hobbled by fairness?

Argument: Microsoft's prices have declined.

Refutation: Not true for the operating systems; their prices have steadily risen. Windows 2000 is the most expensive Microsoft operating system ever. However, even in the case of Office, where prices have declined somewhat due to declining marginal utility of upgrades, prices aren't nearly as low as they could be. The question here is not "Have Microsoft's prices declined?" The question is whether they have declined to the same level that they would have had if Microsoft had true competition. Clearly, they have not, since this price would only be slightly higher than marginal cost.

Argument: Predatory pricing of software is impossible because competition drives costs to slightly above marginal cost, and since the marginal cost of software is nil, it's impossible to price below cost. According to this Salon article (no longer available), Microsoft was arguing that since the marginal cost of Internet Explorer is practically zero, it can't be guilty of predation, since it was just "selling" IE at marginal cost.

Refutation: I love this argument. It merely reinforces what I have been saying all along. What Microsoft has conveniently left out of this argument is the fact that the marginal cost of ALL software is nil, because the marginal cost of software is just the packaging and distribution, and, of course, if it is distributed by the Internet or by licensing, then it truly is zero. So that means that Office 2000 Premium Edition, Windows 2000, SQL Server 7.0 and every other software Microsoft sells should be the same price as IE — zero! Obviously, Microsoft wants to make something. The only reason Microsoft is pricing IE at zero and not its other software is because it wants to monopolize the browser market, and its merely advancing that predatory pricing is a myth in the hopes of being able to get away with it. Two final questions concerning this ridiculous argument. If the marginal cost of software is virtually zero, then why is Microsoft selling us the software for hundreds of dollars? And if true competition forces companies to sell at near marginal cost, and Microsoft is selling well above that, isn't that clear evidence that Microsoft has no real competition, and therefore has pricing power, and therefore is a monopoly?

Argument: "The Judge says charging a zero price for Internet Explorer was 'predatory' (too cheap). Never mind that Sun gives away the entire Star Office Suite and/or the Solaris operating system for Intel machines, that K-Mart and others give away free Internet services, or that many vital programs such as Adobe Acrobat and Zip have long been free."

Refutation: Predatory pricing is only illegal for a monopoly. Antitrust laws promote competition, which fosters innovation and lowers prices. If a business gives something away for free, but it has no potential of achieving a monopoly and recouping its costs later on, then the business is not guilty of predatory pricing, since recoupment is a necessary element of predatory pricing. Free items are good for the consumer as long as it doesn't lead to a monopoly, that can charge much higher prices later on. If a business attempts predatory pricing in the hopes of greater future profits, but fails, then that's good for the consumer, and better prices is one objective of the antitrust laws.

Argument: Monopoly means "One choice", not ten choices.

Refutation: A monopoly is simply a business that has pricing power, which Microsoft clearly has. It has such complete control of the market that the competition doesn't matter, no matter how much competition there seems to be.

Argument: People chose Microsoft products.

Refutation: Did they? For years, you couldn't buy a computer that didn't have a Microsoft operating system on it, EVEN IF YOU REQUESTED IT. So where was the choice? Ditto for other Microsoft software, such as MS Office. Sure, many people choose it today, because Microsoft has already established its monopoly, and because of the network effect (discussed above), competitors have little chance of selling their software. The other reason why people and businesses choose Microsoft is because they recognize what's plainly obvious, that Microsoft is a monopoly, and since it is, then what is the future of its competitors? How long will competitors be able to support their products if they aren't getting any money?

Argument: A product is worth whatever someone is willing to pay for it.

Refutation: A competitive market allocates resources best and provides the lowest prices for consumers. A product may be worth what one is willing to pay for it, but does one want to pay that price if they could pay a lower price? Everyone, without exception, would rather pay the lower price, not the highest price that they'd be willing to pay. The difference between what one is willing to pay and what one actually pays is referred to by economists as consumer surplus. Microsoft's high prices greatly reduce consumer surplus. To illustrate, consider gasoline. If the major oil companies conspired to raise prices for gasoline, most people would pay those prices, because their lifestyle depends on the car, and, needless to say, a car without gasoline is useless. But do these people actually want to pay the higher prices? Of course not. Or suppose General Motors were the only car manufacturer. GM would be able to charge far more for its cars than it can now, and most people would pay the higher price, because a car is more valuable to most people than what GM currently charges. So why doesn't GM charge the higher price? Competition. GM is not the only car manufacturer and its competitors have real market power, so, unlike Microsoft, it's not free to set prices. Therefore, people can buy cars for less money than they'd be willing to pay a monopolist, thereby enjoying a greater consumer surplus. Isn't this the better situation for consumers? There have been several articles published comparing revenues and profits for GM and Microsoft, showing that Microsoft's ratio of profits to revenue is much higher than GM's. This results because Microsoft is free to set prices at the profit-maximizing level, whereas GM is not, because GM has real competition. The fact that Microsoft is making such great profits is prima facie evidence that Microsoft is a monopoly.

Argument: What about Microsoft quality?

Refutation: Let's face it, DOS sucked, and Microsoft did little to improve it for more than 10 years. So did early versions of Windows. For instance, computers with Intel's 386 chip — a true 32-bit processor that could address up to 4 gigabytes of memory — became available in 1986, yet Microsoft only released a true 32-bit operating system — Windows NT — in 1993 for businesses, and consumers had to wait even longer, until 1995, when Microsoft provided Windows 95, that took advantage of the power and efficiency of the 32-bit chip. Even current versions of Windows can only be described as adequate. Microsoft rarely produced the best software in the beginning. I can't think of one example. Sure, Microsoft produces some pretty good products today. After all, when you design the operating system, the foundation of all other software, and you have billions of dollars of monopoly money for development, I guess at some point, you should be able to surpass your competitors, especially when your competitors aren't getting any money because you're a monopoly. Netscape is a great example of this. There's no question that early versions of Netscape were much better than early versions of IE. But Netscape couldn't make any money, because Microsoft was giving away IE for free. So how can Netscape afford to improve its product? On the other hand, Microsoft has billions of dollars it got by charging high prices for its monopoly products, so it can afford to spend huge sums of money developing IE and still not charge for it separately. Is this fair competition? What's surprising is how long Microsoft took to surpass its competition, and this is sometimes questionable. Even though Microsoft gets far more revenue for MS Office than Corel gets as a company, the WordPerfect Office suite is still comparable to MS Office. There is hardly anything you can do in MS Office that you can't do in WordPerfect Office even today.

Argument: The AOL-Netscape merger will give Microsoft more competition.

Refutation: While AOL-Netscape will probably give Microsoft more competition in the browser market and certainly as a portal, this really won't affect Microsoft's monopoly. Microsoft isn't charging for IE separately, and Microsoft doesn't have a monopoly in Internet portals. AOL certainly will not compete against Microsoft with office suites, operating systems, and programming tools, and AOL certainly cannot force Microsoft to reduce prices in these monopoly products. Thus, the competition here is not significant.

Some have argued that Microsoft's distribution of IE for free was not predatory pricing because of potential profits from advertising and e-commerce. While both Microsoft and Netscape recognized this recently, they certainly didn't consider these sources of revenue during the beginning of the browser wars. There is ample evidence, some of which I presented above, that Microsoft specifically used predatory pricing to bankrupt Netscape, that this was, indeed, Microsoft's intent. Note Bill Gate's quote in the Financial Times: "Our business model works even if all Internet software is free. We are still selling operating systems. What does Netscape's business model look like? Not very good." Microsoft wants to be the standard setter on the Internet, and it can't do this if it has real competition. And, of course, this answers another current argument, that most people choose IE because it is superior. Yes, that's true now, but it certainly wasn't true through the first 3 versions of the browsers. With Netscape deprived of money for research and development by Microsoft's anticompetitive tactics, and Microsoft spending billions of dollars of monopoly money, why is it surprising that IE is now better than Netscape? While Microsoft's predatory pricing of IE didn't bankrupt Netscape, as Microsoft clearly wanted, it certainly weakened it considerably.

It is also argued that Microsoft will not be supreme in the future because everything is moving to the Internet and away from the desktop. While the Internet will certainly assume greater importance, it will not obsolete the desktop; it will not deprive Microsoft of its monopoly profits, at least for the foreseeable future. While Microsoft's dominance will eventually come to an end — such is the fate of all monopolies — does that mean that we should let Microsoft to continue to bilk consumers out of billions of dollars in the meantime?

Of course, one can advance many other arguments for or against Microsoft. But none of these arguments can really obscure the fact that Microsoft is a monopoly that has competed unfairly, and charges exorbitant prices for its monopoly products.

Microsoft Remedies

Because the Software Industry is a Natural Monopoly Industry, a Software Monopoly is Inevitable. Thus, Microsoft Should Not be Broken Up.

One of the main remedies in the Final Judgment (original source: https://www.usdoj.gov/atr/cases/f4900/4909.htm, no longer available) is to break Microsoft up into two companies. A good reason why Microsoft should not be broken up is because a software monopoly is inevitable.

1. The average unit cost of software continually declines with increased output. Thus, software companies have great incentive to continually lower prices, so that they can expand their output and lower their costs. This, in turn, would lead to more sales for the companies, allowing them to lower prices further. Eventually, a victor will emerge, and it will be a true monopoly. Pure competition in a natural monopoly industry will always lead to a monopoly.
2. While Microsoft could be forced to eliminate all artificial barriers to competition, the courts will not be able to eliminate or even reduce the natural barriers to competition in the software business. Thus, Microsoft's dominance, or that of any spin-offs, is assured.

Microsoft achieved this monopoly through anticompetitive means, which allowed it to maintain high prices, and it's clear that Microsoft's monopoly will only expand. But breaking Microsoft into two companies, one with the operating systems, and the other with the rest of the applications, including Office, will only create two monopolies instead of one, and much more importantly, it won't force the companies to reduce prices.

However, the conduct remedies in the final judgment are certainly reasonable and necessary. They include:

1. Microsoft will be prevented from punishing any OEM that supports competing products.
2. Microsoft will be forced to license Windows on equal terms and equitable prices, and both terms and prices will be published on a public website.
3. Microsoft shall afford Covered OEMs equal access to licensing terms; discounts; technical, marketing, and sales support; product information; technical information; information about future plans; developer tools or developer support; hardware certification; and permission to display trademarks or logos.
4. OEMs will be free to configure Windows for their customers. (Microsoft argues that this violates their copyright rights. But think about it. If Microsoft had true competition, competitors would gladly allow the OEMs to configure the software, so that their operating system gets distributed and not their competitors'. Microsoft has no real competitors, therefore it is free to dictate.)
5. Microsoft shall disclose to independent software vendors (ISVs), independent hardware vendors (IHVs), and OEMs in a timely manner, in whatever media Microsoft disseminates such information to its own personnel, all APIs, technical information and communications interfaces.
6. Microsoft shall not change Windows code that will have a deleterious effect on other software unless such code changes are communicated to any affected parties in advance. (Although this seems a little vague, I believe what is being said here, is that, if Microsoft changes any code, such as APIs, that current software depends on, then those changes should be communicated to the other software companies. This is only fair, because if Microsoft Windows programmers changed some APIs, for instance, then they must communicate those changes to other Microsoft programmers so that other Microsoft software continues to work properly. So it would only be fair to also communicate those changes to competitors; otherwise, Microsoft can simply disable competing software by changing the underlying code, thus giving its own software an unfair advantage.)
7. Equal terms and access must be given to all ISVs and IHVs regardless of whether they support Microsoft software or competing software.
8. No exclusive dealing or contractual tying.
9. Microsoft shall not bind middleware products to any OS unless it provides a way to remove the middleware from the operating system by end users or OEMs. If OEMs remove the middleware, then the price of Windows charged to OEMs must be reduced by the ratio of the byte size of the middleware as a separate product to the applicable version of Windows.
10. No agreements limiting competition.
11. Microsoft shall continue licensing prior versions of Windows at the same or lower price as that product was sold initially.

Stay

An order that suspends the enforcement of a judgment or some aspect of it, preserving the status quo, for a certain length of time, so as to accomplish something related to the case, usually an appeal. It does not invalidate the judgment.

Even the most ardent supporter of Microsoft could not disagree with these remedies, because they're fair. But Microsoft doesn't want to play fair. It was seeking to stay all the above conduct remedies in its appeal, but Judge Jackson has sent the case directly to the Supreme Court, and stayed all remedies until completion of the appeals (original source: https://www.microsoft.com/presspass/trial/appeals/06-13dojstay.asp, no longer available). Unfortunately, even if these conduct remedies would have taken effect, it would not end Microsoft's monopoly because it is already well established, and thus, the natural barriers to competition will remain. These simple remedies would have been far more effective in 1990 while there was still some effective competition. Nonetheless, these conduct remedies would certainly help competitors.

I would add at least two more requirements. (1) Microsoft should be forced to reduce prices to average total costs, which would include a normal profit, and the prices should continually decline as sales volumes rise, as would happen under true competition. The main reason why Microsoft can add IE to Windows without raising prices is because it is already charging so much for Windows (relative to its costs). This would be the greatest benefit to consumers.

(2) OEMs should be required to itemize Microsoft software so the public can see what software they are being charged for, and to give the consumer a choice as to whether they want it or not, especially if they are paying for it. As long as the OEMs continue to distribute Microsoft software, other companies have little chance and little incentive to compete against Microsoft. Remember, it's the other companies that do most of the important innovation. The most important paradigms in computer technology originated with other companies — the Internet, browsers, email, spreadsheets, word processors, the mouse, graphical user interface, handwriting recognition, instant messaging, voice interaction, HTML, XML — even most aspects of the operating system were copied from Unix, and especially Apple, as well as from shareware and utilities constantly being developed to make up for the deficiencies of Microsoft operating systems. And needless to say, most of its other products, including Office, incorporate ideas largely derived from competitors' products. Here's an interesting quote from one of the DOJ's Remedies document collection (original source: https://www.usdoj.gov/atr/cases/f4600/4643.htm, no longer available), 1st footnote at the bottom of the document, referring to Microsoft's assimilation of other people's ideas:

According to one Microsoft insider, this has been the pattern at the company: "and let's face facts. Innovation has never been Microsoft's strong suite. we're much better at ripping off our competitors. For example, we did not invent either ASP [active server pages] or IE, we bought them!" RX8

Microsoft was rarely the first in anything. For all the billions that Microsoft claims to invest in research and development, it has little to show for it.

This is why competition is important. It not only lowers prices to near marginal cost, but provides greater utility and responsiveness to the market. A monopolist has much less incentive to satisfy the needs of the market, because there is no competition to impel it. There is no question in my mind that Internet Explorer is a much better product because Netscape was giving it stiff competition, and hopefully, with the new release of Netscape 6 imminent, this will continue. And it is highly unlikely that IE would have been free, at least in the beginning, if Microsoft wasn't so desperate to monopolize Internet software. (In fact, Internet software was part of the Plus! pack before Microsoft decided to make an all-out effort to monopolize the browser market.) After all, Microsoft is charging us for almost everything else. Only in those market areas where it wants to monopolize does Microsoft give software away for free, or has its software distributed by OEMs. This, of course, is the basis of predatory pricing, and it has worked well for Microsoft.

No question, the public does benefit by having a standard in software, and Microsoft's anticompetitive practices did accomplish this sooner than it would have under true competition. The advantages of software standards and software's nil marginal cost makes Microsoft a natural monopoly, and thus, it should be forced to reduce prices on those products which are unlikely to be dislodged by competition — notably Windows, MS Office, and Visual Studio, Microsoft's programming tools. Microsoft should be free to develop new products, but it shouldn't be allowed to use anticompetitive means to win market share. These conduct remedies would also minimize a major concern of the DOJ, that of regulating Microsoft. There would be little need for it.

Microsoft Has Effectively Won the Antitrust Lawsuit

Yes, technically, Microsoft lost the trial at the district level. Even so, Microsoft has, in effect, won. Why? The Supreme Court has sent the case back to the Court of Appeals. Now the case could easily drag on for years, and thus, during that time, Microsoft will be free to gouge the public of billions of dollars and to stifle competition. Even if Microsoft eventually loses completely, the loss would be moot, because, by then, Microsoft would have made its fortune from its software monopoly and will have moved on to other things, which it is doing even now, because the software upgrade business is will only last so long at such lucrative levels. Time and the glacially slow legal process are definitely on Microsoft's side. The longer Microsoft can extend the litigation, the better for it.

Some people argue that, just for this reason, the antitrust laws can't deal effectively with high-tech companies, because the industry changes too fast. However, it is not antitrust laws per se that cannot deal with the pace of change, it's the legal system itself, with its grotesquely inefficient adversarial system that allows lawyers to argue ad infinitum, ad nauseam, and ad absurdum about even the most obvious facts.

I think the DOJ's approach to the current antitrust trial is feeble. They should have focused on Microsoft's conduct in general, its use of anti-competitive methods — especially OEM distribution — and its exorbitant prices rather than focusing specifically on the browser wars. Microsoft's monopoly is much broader than that. If the DOJ had focused on the exorbitant prices that Microsoft charges, they not only would have had more concrete evidence of Microsoft's monopoly power, but they would have had much more public support. By understanding that the software business is a natural monopoly business, and understanding the natural barriers to software competition, it becomes easy to see what Microsoft has done, and what it is doing.

Conclusion

Microsoft has been very successful in bamboozling the public. After all, once a monopoly has been achieved, less money is needed for advertising its products, and more money is needed for public relations, aimed at convincing people that it's not a monopoly. Such money has been used for direct advertising, and indirect public relations tactics, such as paying conservative groups to publish papers supporting Microsoft as if they were independent opinions, lobbying Congress, and asking the government to limit the funds available for antitrust actions. Microsoft's tactics have been very successful. Many a forum poster has argued endlessly about things they know nothing about, convinced, in spite of the glaring evidence to the contrary, that Microsoft is not a monopoly. Indeed, Microsoft is regularly listed in the top 3 of the most admired companies in America, even as it steals billions from the very people who admire it. Now that's great marketing!

It is now apparent that Microsoft, with its new version of Microsoft Office, Office XP, is continuing its tradition of charging hundreds of dollars for small improvements. (Original source: https://www.zdnet.com/products/stories/reviews/0,4161,2708939,00.html, no longer available.)

Microsoft wants to try a new tactic for extending the upgrade cycle, and to generate more sales and revenues — selling software by subscription. Although Microsoft has not released the details of its subscription model, Microsoft will probably continue its tradition of giving the least value for the money. In fact, with subscriptions, Microsoft may even be able to raise prices without people realizing it, because it will be more difficult to evaluate the price-value ratio. Other good reasons Microsoft wants to sell subscriptions is that it lowers the initial investment for the consumer, thereby making it more affordable (although not a better value), and making software purchases more of an impulse buy, with less consumer evaluation as to whether the software is worth it or not. In fact, you, the potential consumer, will not be able to evaluate the worth of software subscriptions because you can't know what you are getting for your money, or whether you need what you are getting. Even the computer magazines that regularly evaluate software upgrades will not be able to make recommendations except on the initial upgrade.

Microsoft intends to test market the perpetual license fee. Maybe this is what Microsoft is really talking about when it talks about software subscriptions. Microsoft wants users to pay periodic fees, probably annually, for as long as they use Microsoft's software. Yes, you bought it, but it still is Microsoft's software. You merely bought a license to use it. Up till now, you were entitled to use the software indefinitely without paying any more money, but Microsoft knows that upgrade sales are coming to an end, so, to keep the copious milk coming out of the cash cow, it wants to change the license agreement. Microsoft wants you to pay it perpetually for as long as you use their software. Presumably, they will even add a little value for your money, just as they have always done, and I do emphasize a little. Or maybe not. You'll still have to pay Microsoft anyway!

Why does Microsoft think it can get away with this outrageous scheme? Here's an interesting quote from the Yahoo article reporting the new licensing model: "Microsoft is also negotiating from a position of strength." (i.e., has monopoly power) "I don't think there are any customers today who have the option to walk away from Windows and Office. It's as entrenched on the desktop as it ever has been.''

I must say these quotes are absolutely true. All of those years of OEM distribution are really paying big dividends, but isn't that the goal of predatory pricing, to sell cheap or give away software for the opportunity to raise prices far above competitive levels later, and not only that, but to collect those revenues for ETERNITY! Wow! And so many people think Microsoft isn't a monopoly!

I don't think Microsoft's new licensing scheme will work. It will just outrage too many people. If the very hallmark of a monopoly is pricing power, would this not be the ultimate proof that Microsoft is a monopoly!

If Microsoft is split, it will continue to be a great stock investment, since neither company will be required to lower its software prices, and therefore, as the user base expands, profits will only increase for both companies — at the expense of the consumer.

While many people bemoan what is happening to Microsoft today, it is the direct result of Microsoft's anticompetitive behavior. Microsoft could have succeeded as a legal monopoly. A monopoly isn't illegal per se. It's the use of anticompetitive methods of establishing and maintaining a monopoly that are illegal. If Microsoft simply used its advantages to develop the best software, then Microsoft could have just let the market decide. They would have attained their monopoly legally, and there would have been no antitrust violations, no antitrust trials, or consent decrees. But, as clearly shown above, Microsoft didn't do this, because it would have taken longer for Microsoft to establish its monopoly, it would have been forced to improve the software faster, thereby adding much more value to each upgrade, causing the upgrade cycle to end more quickly for more people (since they'll have what they want), and it would have been forced to reduce prices as it competed fairly against other companies, which Microsoft wanted to avoid, and did.

I constantly read in forums and magazine articles talking about Microsoft's great success and profitability. I can understand why some magazines support Microsoft, since Microsoft is one of the biggest advertisers on the Internet, but it baffles me why so many people never consider where all these profits are coming from. They're coming from you. You're paying hundreds of dollars for software that could easily be $30 or less. And this, in my opinion, is where Microsoft hurts the most.

4/1/2000 © William C. Spaulding