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The Microsoft Case: Tying It All Together

A critical deadline looms in the Microsoft Corp. (MSFT) antitrust case. On Dec. 7, the nine state attorneys general who are still suing the company plan to tell U.S. District Judge Colleen Kollar-Kotelly what restrictions they believe should be imposed on the software giant's conduct. Last month, Microsoft settled with the Justice Dept. and nine other states.

The key issue facing the dissenting states is whether they will target the company's most potent predatory tactic: bundling. That's the term used to describe Microsoft's practice of continually adding new features to Windows, the operating system installed on more than 90% of America's desktop computers. Because customers are essentially locked in to Windows, it's easy for the company to get them to use its other software--even if competitors make better products. That dampens competition, reduces choice, and could retard innovation.

Microsoft's rivals wanted Justice to restrict the company's right to bundle, but antitrust chief Charles A. James declined to do so. His position--and the company's--is that the D.C. Circuit Court of Appeals ruling in the case blocked a bundling remedy. But competitors and many antitrust experts disagree. Now they're trying to convince the states to try to restrict the company's bundling. If they succeed, it could have an enormous impact on the future of the entire software industry. Here is a close look at this confusing issue.

What did the D.C. Circuit Court of Appeals say about bundling?

The appeals court, in a decision that the U.S. Supreme Court has declined to review, held that the way Microsoft bundled its Internet Explorer into Windows violated Section 2 of the Sherman Antitrust Act. That's a law preventing companies from using predatory tactics to defend a monopoly. A wide variety of business practices can run afoul of Section 2, including everything from forcing business partners to sign exclusive contracts to predatory pricing. In this case, seven appellate judges unanimously found that "the commingling of code [had] an anticompetitive effect" because it deterred personal-computer makers from installing Netscape Communication Corp.'s (now a part of America Online) browser after it was introduced in 1994.

Three weeks after the ruling, on July 18, Microsoft petitioned the court to reconsider this part of its conclusions. The company acknowledged that the commingling finding "might be read to suggest that [computer makers] should be given the option of removing software code." It also asked the appeals court to bar trial judge Kollar-Kotelly from imposing any remedy that would force the company to unbundle some software from Windows. The D.C. Circuit responded with a curt "no." In another unanimous ruling, it rejected the petition and wrote: "Nothing in the court's opinion is intended to preclude the lower [court]'s consideration of remedy issues."

So the bundling issue was a total loss for Microsoft, right?

Not entirely. Justice had also charged that the company's bundling violated Section 1 of the Sherman Act, which outlaws tying. That's the legal term used to describe the practice of exploiting a monopoly by forcing customers who need one of a company's products to buy a related product. It is the main weapon that is usually aimed at business practices such as bundling.

Former trial Judge Thomas Penfield Jackson ruled for the government, but the D.C. Circuit put aside his decision. It instructed the next judge to reconsider the facts in the light of a new legal standard. As a practical matter, this test would have involved balancing the convenience of a particular type of bundling against the potential loss of consumer choice and technological innovation. The court, in essence, punted. So this part of the ruling was a standoff between the government and Microsoft--with the result to be determined sometime in the future.

This point has confused many people. That Microsoft's bundling was a violation of the law against monopolization, but not the law against tying, seems illogical. But such rulings are common in the U.S. legal system. To make a rough analogy, imagine a crime in which Bob shoots and kills Jim on a street corner. Prosecutors will charge Bob with at least two things: first-degree murder and reckless endangerment of all the bystanders who might also have been killed. Two different legal theories can be applied to the same underlying action. Say a jury convicts on both counts. If appellate judges instruct the lower court to reconsider the murder charge--because some improper evidence was shown to the jury--Bob still might be convicted of reckless endangerment.

Did this ruling give the government enough ammunition to attack bundling?

That's the controversial question. Had Justice won an unambiguous victory on the tying, it clearly would have had the right to force Microsoft to stop bundling. But it didn't. And on Sept. 6, James decided to drop the tying claim altogether--depriving the judicial system of the best chance it may ever have to rule squarely on the legitimacy of Microsoft's bundling.

After Justice dropped the tying allegation, the government still had its Section 2 monopolization victory. But there is a question as to how much punishment could be supported by this ruling--just as there would be a question about how much jail time Bob would deserve for a reckless endangerment conviction. Still, to many experts, the fact that Microsoft's bundling was deemed to be illegal under Section 2 gave the government plenty of ammunition to attack bundling, with or without Section 1. "Monopoly maintenance gives [James] the same legal firepower that the tying language would have given him," says Brookings Institution antitrust expert Robert E. Litan.

What does James think?

The government's top trustbuster disagrees. He says the only ruling that could have supported unbundling was a victory on tying. "Those who would like to see this à la carte sales process are not appropriately relating the legal theory that was left in the case to the" remedy, he says. "That dis-integration remedy was a remedy for the tying claim."

The Justice Dept. is taking a narrow view of the scope of the government's victory under Section 2. As Philip Beck, the outside lawyer for Justice hired to replace David Boies in the case, argues: "The reason [the appeals court] said commingling was bad was because the effect of the specific commingling they were talking about was to render it impossible [for computer manufacturers] to use the add-and-delete function," he explains. "What the commingling prevented was the problem, not the commingling itself."

Translation: The way Microsoft bundled its Internet Explorer into Windows made it impossible for PC makers to remove it. This is a problem that Justice believes it has fixed in the proposed settlement, which gives computer manufacturers broader rights to pair non-Microsoft software with Windows. Therefore, Beck says, there is no need for limiting Microsoft's right to bundling.

If the remaining states want to restrict Microsoft's ability to bundle new software into Windows, what remedies might they seek?

In a word, unbundling. That is to say, forcing Microsoft to allow PC manufacturers to offer a version of Windows without an Internet browser, media player, or other types of software thrown in. That would theoretically give rivals a better chance to distribute their products.

There are many different types of unbundling. Had the government won an outright victory on tying, it potentially could have stopped Microsoft from putting any new features into Windows. But the company's critics acknowledge that a Section 2 monopolization ruling supports only a narrower form of unbundling--specifically, a restriction on the addition of so-called "middleware" into Windows. The definition of middleware is notoriously vague. But most people consider it to be software that, like Windows, supports a variety of independent applications. If the company was prohibited from bundling middleware, it probably couldn't add a media player to the operating system. In contrast, it probably could continue to improve the basic plumbing in Windows, say by adding new file management or disk compression software.

What are the odds that the nine dissident attorneys general will attack bundling?

Hard to say. The attorneys general are being lobbied by Microsoft's foes, who say that no remedy will work unless it deals with bundling. But the states are also apprehensive about imposing an unbundling remedy, which would require them to define what belongs in the operating system and what should be excluded--a thorny technological issue. That's why the betting is that Microsoft will retain its right to put whatever it wishes in Windows. By Dan Carney in Washington and Mike France in New York

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