Microsoft Antitrust Case: Monopoly, Litigation, and Outcomes

Introduction: Government Allegations Against Microsoft

Issues in antitrust cases tend to be very complex and technical, but in the case of the government versus Microsoft, they are quite understandable. The government alleged that Microsoft used predatory pricing tactics to destroy competitors and eliminate competition in the marketplace. The company was also accused of erecting technical barriers within its operating systems to make it difficult or impossible for non-Microsoft software to run on Windows. In 1993, the Department of Justice (DOJ) began an investigation into these practices, which resulted in a consent decree on July 15, 1994, in which Microsoft agreed that it would not tie other Microsoft products into its Windows operating system.

In the late 1990s, Microsoft began bundling its Internet Explorer web browser into Windows and soon acquired a dominant position in the browser market. As a result, an antitrust case was brought against Microsoft in October 1997. The four counts filed against Microsoft were:

Count 1: "Unlawful Exclusive Dealing and Other Exclusionary Agreements in Violation of Section 1 of the Sherman Act.... Microsoft's agreements with ISPs, ICPs, and... OEMs... unreasonably restrict competition... thereby restraining competition in the Internet browser market..."

Count 2: "Unlawful Tying in Violation of Section 1 of the Sherman Act.... Microsoft has tied... its Internet browser to its separate Windows operating system..."

Count 3: "Monopolization of the PC Operating Systems Market in Violation of Section 2 of the Sherman Act.... Microsoft possesses monopoly power in the market for PC operating systems.... Microsoft has willfully maintained, and unless restrained by the Court will continue to willfully maintain, that power by anticompetitive and unreasonably exclusionary conduct. Microsoft has acted with an intent illegally to maintain its monopoly power in the PC operating system market, and its illegal conduct has enabled it to do so..."

Count 4: "Attempted Monopolization of the Internet Browser Market in Violation of Section 2 of the Sherman Act."

The Origins and Rise of Microsoft

In order to understand the environment in which the Microsoft antitrust actions occurred, it is necessary to examine the beginnings of the company. After an early career as a hacker, Bill Gates and Paul Allen founded Traf-O-Data in Seattle, Washington — a company started to develop and market a machine to generate traffic flow statistics. This venture was not the success that Gates and Allen had hoped for. It may have been the youthfulness of the owners (Gates was 16 at the time), or it may have been that the state of Washington began to offer the same services for free.

By 1975, Gates and Allen were back in the computer business. They founded a company in Albuquerque, New Mexico, to develop and sell BASIC interpreters for the Altair 8800, a new computer built by MITS, for whom Gates and Allen had previously worked. Initially using the name Traf-O-Data, the company was later renamed Micro-soft — short for microcomputer software — and finally changed to Microsoft when the company filed for a registered trademark on November 26, 1976. Their second product was released in 1977: a Fortran compiler for the CP/M operating system. In 1978 they released a COBOL compiler for CP/M as well.

It was in the late 1970s that Microsoft had its big break. IBM was planning to release a personal computer in 1981 and needed an operating system. IBM initially approached Digital Research for rights to use their CP/M operating system, but the two parties were unable to reach an agreement. Gates stepped in and offered IBM QDOS (Quick and Dirty Operating System), a clone of CP/M that Microsoft had purchased from Seattle Computer Products for $50,000. They renamed it MS-DOS (Microsoft Disk Operating System). After settling infringement issues with Digital Research, IBM offered MS-DOS with each personal computer for $40 — compared to $250 for CP/M. MS-DOS outsold CP/M many times over, and Microsoft was on its way.

The company had retained the right to sell the operating system to other computer manufacturers, so when IBM clones began to flood the market in the early 1980s, Microsoft was perfectly positioned to dominate the operating systems market. MS-DOS soon became the industry standard, and in March 1986 Microsoft went public at $21 per share, raising $61 million.

In the late 1980s, Microsoft partnered with IBM in the development of an advanced operating system called OS/2. In 1989 at Comdex, Bill Gates announced that the 1991 release of Windows 3.0 would be the last version, and Microsoft continued to issue statements signaling that OS/2 was the operating system of the future. However, on May 16, 1991, Gates announced to employees that the OS/2 partnership with IBM was over and that Windows would be the operating system Microsoft would support going forward. Despite its technical advancements and superior functionality, OS/2 began a slide that would culminate in its extinction within a few years.

Market Dominance and Predatory Practices

Microsoft began diversifying into three main areas: additional operating systems, compilers and interpreters for programming languages, and a suite of office applications. Just as in the comparison between Windows and OS/2, many of Microsoft's early products were inferior to those of competitors, yet the company was able to dominate market share. The leading example of this was WordPerfect, a product superior to anything Microsoft could produce at the time, which nonetheless fell from its position as leader in word processing software to a distant second place.

This dominance resulted from several strategies. First, Microsoft developed a common user interface that allowed users to apply similar commands across each of its individual application products. Second, the company introduced the concept of backward compatibility, so that older versions of applications could work with newer versions of the operating system — a significant departure from hardware manufacturers of the era, who routinely produced new machines incapable of running earlier software. Third, the integration of Microsoft's individual applications allowed users to create and share data between programs. For example, a spreadsheet created in Excel could be imported directly into a PowerPoint presentation.

By the early 1990s, Microsoft's position in the PC market was completely dominant. Not only did it control the market for operating systems, it had extended that domination to applications. This dominance led Microsoft to adopt a policy requiring manufacturers to pay for a Windows license even if the machine was shipped with another operating system. Competitors began to complain about predatory pricing practices and the development of technical barriers designed to make competing software appear incompatible with Windows. The government began to take notice.

The Federal Antitrust Lawsuit and Judge Jackson's Ruling

The federal antitrust lawsuit against Microsoft began on October 19, 1998. Negotiations and testimony stretched on for over a year. On March 29, 1999, during the course of the trial, Microsoft reorganized its operations into four separate divisions; company officials stated the restructuring was unrelated to the ongoing lawsuit. On January 13, 2000, Bill Gates handed over day-to-day management duties to longtime friend Steve Ballmer in a corporate restructuring that Gates said would allow him to focus more on long-term strategy — though observers speculated it was also an attempt to reduce negative publicity, as Gates had been embarrassed by email revelations during the trial.

On April 3, 2000, Judge Thomas Penfield Jackson ruled that the company had violated its earlier consent decree and had abused its monopoly in the desktop operating systems market. He issued findings of fact establishing that Microsoft held monopoly power in the PC desktop operating systems market, supported by three core determinations. First, Microsoft's share of the market for Intel-compatible PC operating systems was extremely large and stable. Second, that dominant market share was protected by a high barrier to entry. Third, as a result of that barrier, Microsoft's customers lacked a commercially viable alternative to Windows.

Judge Jackson elaborated on the nature of the barrier as a self-reinforcing cycle: because so many people used Windows, the product was highly attractive to software developers; because it was attractive to developers, most application software was written primarily for Windows; and because so much application software existed for Windows, consumer demand for the platform was reinforced. This in turn raised the bar further for potential competitors, making it prohibitively expensive for any rival to develop a PC operating system capable of substituting for Windows. On June 7, 2000, Judge Jackson issued his final ruling calling for Microsoft to be split into two companies — one for the Windows operating system and one for its Internet and other businesses.

Conclusion: Lingering Perceptions and the Road Ahead

In November 2004, Microsoft reached an agreement with the Computer and Communications Industry Association (CCIA) and Novell, effectively ending an eighteen-month effort in which Microsoft spent nearly $3 billion to settle antitrust issues through agreements and payouts to AOL/Time Warner, Sun, and Novell. The company spent an additional $1 billion on class-action suits and indicated it might spend a further $950 million. While many analysts praised the settlement as bringing an end to Microsoft's predatory practices, others sounded a more cautionary note. "Microsoft has always been an aggressive company," said Matt Rosoff, an analyst with the independent research firm Directions on Microsoft. "But there's almost now this paranoia — a lot of times unwarranted — among potential customers and partners that Microsoft will get into their business space and they won't play fair. By clearing as many of these cases as they can, Microsoft is trying to reverse that impression a little bit."

Although Microsoft had been making efforts to change public perception in recent years — most notably through its "Realizing Potential" advertising campaign, described by the company as focused on "the promise of the company's new mission and brand — to help people realize their potential" — the depth of reputational damage accumulated over years of litigation made clear that the company still had considerable work ahead of it.