STATE of NEW YORK, Et Al., ) ) Plaintiffs, ) ) V
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IN THE UNITED STATES DISTRICT COURT FOR THE DISTRICT OF COLUMBIA _______________________________________ ) STATE OF NEW YORK, et al., ) ) Plaintiffs, ) ) v. ) Civil Action No. 98-1233 (CKK) ) MICROSOFT CORPORATION ) ) Next Court Deadline: April 8, 2002 Defendant. ) Remedies Hearing _______________________________________) DIRECT TESTIMONY OF PROFESSOR CARL SHAPIRO (REMEDIES 2, 3, 4, 5, 6, 7, 8, 9, 10, 12, 13, 14, 16) Direct Testimony of Carl Shapiro Table of Contents I. Qualifications and Scope of Testimony...................................................1 II. Economic Context & Key Provisions for Restoring Competition...........2 III. Legal Principles of Remedy.....................................................................4 IV. Microsoft Stifled a Rare and Serious Threat to its Monopoly ................6 V. “Restoring Competition” – An Economic Interpretation.......................9 A. Reducing the Barriers Facing Tomorrow’s Threats to Windows..................................9 B. The Need for Significant, Affirmative Remedial Provisions ......................................13 C. Restoring Potential Competition: Economic Principles..............................................14 D. How Far Should the Remedy Go in Restoring Competition? .....................................15 E. Lowering Entry Barriers Without Impeding Competition by Microsoft .....................16 VI. Benefits to Consumers and Impact on Innovation................................17 VII. Microsoft’s Causation Arguments ...................................................20 A. The Proven Effects of Microsoft’s Illegal Conduct.....................................................20 B. Uncertainty About the Effects of Microsoft’s Illegal Acts..........................................22 C. Microsoft’s Extreme Position......................................................................................23 D. Contemporaneous Assessments...................................................................................25 E. Additional Evidence of Economic Effects ..................................................................27 VIII. Treatment of Microsoft’s Intellectual Property...............................30 IX. Potential Threats to Microsoft’s Monopoly ..........................................33 A. Existing Rival Desktop Operating Systems.................................................................35 1. Apple Mac OS .......................................................................................................35 2. Linux......................................................................................................................37 B. Cross-Platform Middleware.........................................................................................44 1. Browsers ................................................................................................................45 2. Java ........................................................................................................................46 3. Other Middleware Threats.....................................................................................48 4. The States’ Proposed Remedy and Middleware....................................................52 5. Middleware Summary...........................................................................................60 C. Server-Based Computing.............................................................................................60 1. The Growing Importance of Client-Server Networks...........................................61 2. Microsoft Uses its Client Monopoly to Disadvantage Server Rivals ....................64 3. Disclosure to Enable Server Interoperation with Windows Clients ......................66 D. Handheld Computing Devices.....................................................................................68 X. Critique of Microsoft’s Proposed Remedy............................................70 A. Interoperability Disclosure in Microsoft’s Proposed Remedy is Flawed....................70 B. Stifling of Fledgling Middleware ................................................................................72 C. Interference with Rival Middleware............................................................................75 D. Term of Microsoft’s Proposed Remedy......................................................................75 E. Enforceability of Microsoft’s Proposed Remedy........................................................76 Direct Testimony of Carl Shapiro 5 April 2002 I. Qualifications and Scope of Testimony 1. I am Carl Shapiro, the Transamerica Professor of Business Strategy at the Haas School of Business at the University of California at Berkeley where I have taught since 1990. I also am Director of the Institute of Business and Economic Research at U.C. Berkeley. I have served as the Editor of the Journal of Economic Perspectives, a leading economics journal published by the American Economic Association. I am also a Senior Consultant with Charles River Associates, an economics consulting firm. 2. I am an economist who has been studying antitrust, innovation, and network industries for some twenty years. My recent book with Hal R. Varian, Information Rules: A Strategic Guide to the Network Economy, discusses competitive strategy in the information economy, emphasizing the pricing of information, the creation of multiple versions of information products such as software, the switching costs and lock-in associated with information technology, and network economics. I also have published numerous articles over the past twenty years on competition and innovation, licensing, network effects and positive feedback, and antitrust economics. For example, my article with Michael L. Katz, “Antitrust in Software Markets,” discusses the economic characteristics of software markets and draws out their implications for antitrust enforcement. 3. I have considerable experience in the application of economics for the purposes of enforcing the antitrust laws. I served during 1995 and 1996 as the Deputy Assistant Attorney General for Economics in the Antitrust Division of the Department of Justice. I have served on several occasions as an expert witness or consultant to the Antitrust Division or the Federal Trade Commission. Over the years I have also consulted or served as an expert witness on numerous antitrust matters for private companies in a range of industries, including several companies in the computer hardware and software business. My curriculum vitae is attached as Appendix A. Direct Testimony of Professor Carl Shapiro, Page 1 4. In this proceeding I have been asked by the Litigating States to offer an economic analysis of the likely effects of the States’ Proposed Remedy on competition, innovation, and ultimately the well-being of consumers. II. Economic Context & Key Provisions for Restoring Competition 5. This case is about Microsoft’s illegal maintenance of its monopoly over PC operating systems. Therefore, I will pay close attention to the most promising direct competitors to Windows today: the Linux operating system and Apple’s Mac OS. But the nature of the software industry is that competitive threats to leading products often arise from products in adjacent markets.1 The threats to Windows posed by Netscape Navigator and Sun’s Java were of this nature: products that were not operating systems and yet could, over time, undermine the dominant position enjoyed by Windows. 6. Because threats to the Windows monopoly are likely to be mounted by companies with products in adjacent markets, an effective remedy necessarily will affect business in adjacent markets, most notably markets for middleware and server operating systems. As a general principle, an effective and efficient remedy should prevent Microsoft from using its Windows monopoly to disadvantage products in adjacent markets that could, over time, play a role in undermining the dominant position of Windows. 7. Microsoft’s illegal conduct significantly raised the entry barriers protecting its Windows desktop monopoly. The thrust of my testimony is that the remedy should restore competition by lowering entry barriers back down. In particular, the remedy should go beyond preventing the recurrence of Microsoft’s illegal acts and should include provisions designed affirmatively to restore competition in the market for PC operating systems. 8. Before launching into my full analysis, I would like to highlight here three provisions in the States’ Proposed Remedy that I believe are especially important for the purpose of 1 “What eventually displaces the leader is often not competition from another product within the same software category, but rather a technological advance that renders the boundaries defining the category obsolete.” Findings Direct Testimony of Professor Carl Shapiro, Page 2 restoring competition. The first provision highlighted here directly attacks the applications barrier to entry that protects the Windows monopoly. Provision #14, Making Office Available on Other Operating Systems: This provision directly attacks the applications barrier to entry by ensuring the continued availability of Office on the Macintosh and by making Office available on other operating systems such as Linux. The costs of porting Office to other operating systems will be borne by the companies who win the licenses to port Office, not by Microsoft. Consumers will clearly benefit from this provision, which will not disrupt Microsoft’s ability or incentive