Microsoft Breakup?

April 28, 2000 at 12:00 AM EDT

MARGARET WARNER: Joining me now to explain the breakup proposal, and debate its potential impact, are Ken Wasche, president of the Software and Information Industry Association, a trade group for the computer software industry; and Richard McKenzie, a professor of economics and management at the University of California, Irvine, and author of Trust on Trial: How the Microsoft case is Reframing the Rules of Competition. Welcome, gentlemen.

Ken Wasche, we just heard it explained in rather technical terms what this breakup is. Fill in the picture for us, for someone who knows what Microsoft offers or uses it, how would the two companies be split and what would each do?

KEN WASCHE, Software & Information Industry Association: Well, the two companies will be an operating systems company. Let’s call it Gates Co., and the other will be an applications company that contains products like Office and all the Internet properties. We’ll call that Balmer Co., after Microsoft CEO, Steve Balmer. These two companies will become fierce competitors with one another and will unleash, we believe, a range of new products as they go after new markets.

MARGARET WARNER: But they will both each start out remaining a monopoly in its own market, won’t they?

KEN WASCHE: That won’t last very long. I mean, keep in mind Microsoft argued in court that Linux was a formidable competitor. But in the marketplace they argue that Linux doesn’t exist on the desktop and therefore they haven’t developed Microsoft Office for Linux. The only reason Microsoft hasn’t developed Office for Linux is because they’re protecting the monopoly and the operating system. The moment they no longer have to protect that monopoly, they’ll develop Office for Linux, making Linux a credible competitor on the desktop.

MARGARET WARNER: And just explaining, when you say operating system, that is the desktop that we see, the windows, the basic windows screen and the applications are all the Windows programs: Word, excel, office, whatever.

KEN WASCHE: Exactly. So what you’re going to see is the operating systems company will start developing applications so that there will be competitors to Word, Excel, Access and the presentation graphics like Power Point, and these major software categories have been a dead zone for many years because virtually no other product has been able to survive in competition against the components of Microsoft Office. That’s going to change under this proposal.

Will a breakup help or hurt consumers?

MARGARET WARNER: Mr. McKenzie, do you think breakup is the way to go, to address the problems that were uncovered during the trial or at least that Judge Jackson found?

RICHARD McKENZIE, University of California, Irvine: Absolutely not. I think the Justice Department is proposing to inflict more damage on American consumers than Microsoft ever dreamed of inflicting even if it were the abusive monopoly that it’s been declared to be. In my view, Microsoft is not a monopoly. It has demonstrated a fierce competitiveness. And what this proposal proposes to do — let’s be very clear — is hobble a competitor, somebody who is willing to go out and upgrade its Windows operating system to include a browsing capability and then basically give away that browsing capability.

MARGARET WARNER: I’m sorry. But do you agree with Ken Wasche that each of these two Microsoft derived companies will now become competitors?

RICHARD McKENZIE: No. What I see is a loss of synergy between Windows and Office and for that matter Internet Explorer. You’re going to have to go to one firm to get your operating system and you’re going to have to go to another firm in order to get your Internet Explorer and maybe another one to get your Office suite. Right now, Microsoft has an incentive to lower its price in order to sell more Windows but it also has an incentive to lower the price of Windows in order to sell more Office. Take Office out and the Windows company will not have that incentive to keep the price down and it won’t have the incentive to try to co-mingle the operating system with the applications, and I see a real loss here. By the way, you can expect Microsoft to develop a Linux version of Office once, in fact, Linux moves into the desktop. There is no reason why they wouldn’t.

What will happen to Internet Explorer?

MARGARET WARNER: Let me break to introduce that we’re now joined by William Kovacic, an antitrust professor at the George Washington University Law School. Glad you’re with us.

WILLIAM KOVACIC, George Washington University: Thank you.

MARGARET WARNER: We’ve been describing or fleshing out what has been said about these two companies. We haven’t yet talked about the Web browser which was behind this whole lawsuit. Explain what will happen to the Web browser Internet Explorer.

WILLIAM KOVACIC: The Web browser, it appears, will become part of the applications company that will be one of the assets that the applications company absorbs, and the assumption behind the breakup is that no longer will the successor companies have an incentive to distort design decisions in order to simply reinforce the preeminence of one product or another. Over time they’ll have an incentive to compete against each other, perhaps to replicate each other’s practice, each other’s products and maybe even develop competing products that go head-to-head in a number of areas.

MARGARET WARNER: What’s your view, Ken Wasche, of whether this will bring greater competition to the browser market?

KEN WASCHE: Well, absolutely. Under the proposal contrary to what we’ve just heard, is both companies will have access to the Internet Explorer browser. The operating system company will have a one-time license to the Windows — to the Internet Explorer source code, but it will be up to the applications company to develop it further. So you will not — ordinary users are not going to have to go to two different companies if they don’t want to, to get the operating system and the browser. They could get it from the same company or they could get it from different companies.

MARGARET WARNER: So, what you’re saying is if this goes through, you could look on your Windows screen and you might see Internet Explorer but it would be the current version, and that Windows company, that operating-system company, would no longer have access to the subsequent versions developed by the applications? They’d have to develop their own.

KEN WASCHE: That’s right. They’d have to develop their own. Exactly.

MARGARET WARNER: All right. Mr. McKenzie, do you think that this proposed remedy would address the browser situation adequately?

RICHARD McKENZIE: No, I don’t. I see it basically increasing the price of browsing and getting an operating system. Look, a monopoly is supposed to restrict output in order to raise prices and profits. And nowhere in the conclusions did the judge find that Microsoft is charging monopoly price. Indeed what the judge found is that Microsoft is charging too little for its browser. So you should anticipate the remedy to be consistent with that would mean that prices would go up. Consumers would be harmed. And you’re going to have a substantial regulatory cost of being heaped on Microsoft as well as the Justice Department and perhaps a variety of compliance committees. That’s in the works there. You’re also going to increase Microsoft’s incentives to charge higher prices because what they’re learning from this decision is that their dominance got them into trouble. Their low prices got their dominance. The way to keep the Feds off of their back is simply to reduce their dominance by increasing the prices.

Conduct remedies

MARGARET WARNER: Will Kovacic, lay out for us also, there are some conduct remedies proposed here. How would they work?

WILLIAM KOVACIC: The divestiture would be supplemented by conducted-related controls that are designed to facilitate the transition from the existing corporate structure to the new structure which would consist of two successor companies. One approach would be to preclude the companies from retaliating against customers who decide to deal with the products of other firms. Another would be to limit the ability of Microsoft to engage or the successor companies to engage in certain types of bundling. Another would basically preclude the consolidation of the two firms over time. There would be a limitation on their ability except to the relatively distant future, to recombine their operations so that the solution that the government has proposed today is really a hybrid. It doesn’t involve simply a clean cut between the applications and operating system unit but would entail continuing supervision. So, it doesn’t completely avoid the types of monitoring and compliance issues that tended to weigh against a pure conduct control solution.

MARGARET WARNER: From what I understood from Joel Klein’s explanation, he would like all these conduct remedies to extend three years into the breakup period but also to extend if they were to be ordered to actually start and run through the appellate process?

WILLIAM KOVACIC: The idea is to have some mechanism in place, interim measures, that run throughout the appeal. It’s a certainty that if Judge Jackson were to order a divestiture, that he would set aside that requirement until the appeals are exhausted because it is such an irreversible measure that there would be interim measures many of which resemble those that have been discussed before, put in place immediately, whether they in fact would take hold I think depends on how drastic, in fact, they would be seen to be. The more irreversible, the more dramatic their effect in the market, the greater the basis there is for Microsoft to say even those should be suspended during the appeal.

MARGARET WARNER: And explain one other part of this for us. Mr. Wasche jokingly said let’s call one company Gates Co., and one company Balmer Co., but in fact the proposal is that the top stockholders like Mr. Gates and I assume Mr. Balmer would only be allowed to own one company, have stock in one company.

WILLIAM KOVACIC: This is basically a way of learning, I think, from past divestiture experience — a major complaint levied against the Standard Oil breakup in 1911, the American tobacco breakup in 1911, is that even though the firms, in fact, were dissolved, the same owners were still in place. There was the perception that the fact of common ownership retarded the evolution toward a competitive framework. The measure you just described is designed basically to preclude that.

MARGARET WARNER: All right. Mr. McKenzie, I want you and Mr. Wasche to address something that I’m sure you disagree on which is, will this enable Microsoft to continue to innovate? Joel Klein said absolutely it does not preclude it. You heard Bill Gates said it will preclude it. What’s your view of that?

RICHARD McKENZIE: Well, in my case, I think it’s going to impair innovation just simply because you’re going to disentangled two companies that for several years are going to be impaired by the breakup itself. And it seems to me that there are a lot of innovations down the road that could come by integrating an operating system with a suite of Office application packages. Those innovations could come. This breakup disallows any kind integration of Office with Windows. Suppose that is more efficient? Suppose the consumers, indeed, want that, especially since 90 percent of consumers use Windows and 90 percent of consumers use Office? Why soak up hard drive space with all that extra code? Why not allow for the synergy?

MARGARET WARNER: All right. Ken Wasche?

KEN WASCHE: I have two points about this. The first thing is the beauty of the proposal that Joel Klein presented today is that there are no line of business restrictions. This is not as regulatory as many people had feared. It’s as minimally regulatory as possible. Gates Co., the operating system company, can purchase or develop a whole range of applications and sell them, they just can’t leverage the operating system anymore in a fashion that precludes other products. But what’s most interesting about this is in the little clip that we heard from Bill Gates, he argued to the public today the absolute opposite of what he argued in court. In court, he argued that having the operating system company and an applications business in the same company bestowed no particular advantage on the applications business because he argued that he treated the applications development at an arm’s length basis. In other words it was no more advantage than third party or other company’s products. But today he argued that there was some synergy between the two businesses. Well, which is it, Bill? Clearly, actually I believe him today, rather than what he said in court, is that the applications business has benefited to the detriment of third-party applications, and it has been detrimented or been in a detrimental position for many years.

MARGARET WARNER: Let me ask you about one other thing. Joel Klein spoke approvingly of the breakup of AT&T and how it had triggered this huge, you know, explosion in telecommunications. But also to a lot of people it meant a lot of confusion and there are just too many choices and so on. Is there a danger here, Ken Wasche, of that, that maybe consumers don’t want all of this if this were to go through?

KEN WASCHE: I think consumers want choices. If I can take a personal experience, two nights ago I went shopping for a lawn mower. I was blown away at the number of choices. If we could have half the number of application choices in software as we have in lawn mowers we’d be in good shape. There’s one more point about the AT&T breakup You know, the Department of Defense said a number of years ago at the time of the breakup, they said that if AT&T is broken up, the Department of Defense will be adversely impacted. They couldn’t deal in that kind of world. That’s proven not to be true at all.

MARGARET WARNER: What’s your view of this, Mr. McKenzie?

RICHARD McKENZIE: It seems to me that what this breakup does is propose that Microsoft incur all of the development costs that it once incurred to produce Office, do it once again, and basically it hobbles it. Suppose it’s more efficient for the Microsoft Windows firm to buy Office Suite back and offer that to consumers. They can’t do that. It has to go the more expensive route and develop a whole new suite of applications. To me I see that as wrong. Many of those costs are going to be passed through to consumers in the form of higher prices and less quality products.

MARGARET WARNER: And Bill Kovacic, what happens next now? Microsoft has said it’s obviously going to oppose this.

BILL KOVACIC: I think we’ll see a request when Microsoft responds to the government’s proposal. Microsoft will request a fairly elaborate process to evaluate the government’s proposal. After all, it will say we’re not a trivial part of the economy. And this is a very serious measure, which indeed it is. Notwithstanding the interesting experience in some of the previous divestitures even though cases such as AT&T show us how robust and resilient the economy can be, there were well defined organizational units within AT&T that were spun off. The assets were not basically ideas and human beings. It was relatively easier to draw the lines. I think that Microsoft is going to say, a rush job won’t do in evaluating this. I think it means that the remedies process extends well into the summer.

MARGARET WARNER: All right, gentlemen three, thank you all very much.