Microsoft - Monopolizing Operating Systems for Personal Computers

Microsoft Case Study

John E. Hayes

California Southern University

HayesJ ECO 87501-11

January 2, 2017

Dr. Mike Ewald

Microsoft Case Study

Introduction

In economic theory, competition encourages markets and economic growth.  Ideally, competition results in goods and services to consumers at competitive prices and drives efficiency, productivity, and innovation among competitors.  This case is about the role of competition in a technologically driven market.  In 1994, the government began oversight of Microsoft's business practices.  In May of 1998, it was alleged that Microsoft had engaged in monopolizing operating systems for personal computers.

Microsoft maintained that not only had they not engaged in monopolizing tactics; but they had also provided innovative and high-quality products and services at competitive prices to consumers.  In its 2001 Annual Statement (Microsoft Investor Relations, 2016), Microsoft concedes an important change in their marketing for the new millennium placing people at the center and intertwining technology with our customers and businesses.  

Analysis

In the mid-1990s, Microsoft was the most dominant firm in the market for Intel-compatible PC operating systems.  Microsoft’s Revenue Statement (Microsoft Investor Relations, 2016) from the 1997 Annual Statement details that their revenue grew 46% in the 1996 fiscal year and 31% in 1997 fiscal year.  This was due to the introduction of the Microsoft Windows 95 operating system in 1995.  The crucial issue in this case is the degree of monopoly power that Microsoft exhibits in the operating systems market.  Microsoft intended to protect its current share and rapidly growing new markets.  Baye and Prince (2014) point out that Microsoft spent $4 million on a proposed merger with Intuit and paid $40 million to Intuit to scrap the merger rather than contest legal issues in court.  Microsoft's monopoly power is revealed by its use of dominant tactics in the operating systems PC market to cripple competitors, especially Netscape’s Navigator Web browser.  For example, Microsoft painstakingly excluded and destabilized Java by promoting a Windows-specific version of Java because it feared that Java based Netscape Navigator would replace Microsoft Windows Explorer.  In fact, over several years Microsoft took actions that were beneficial to reinforcing their monopoly power.  In 1998, the Department of Justice charged that Microsoft had engaged in monopolistic practices by demanding computer manufacturers license and install Internet Explorer in exchange for agreements to use the Windows’ operating system.  

Microsoft’s predatory nature extended beyond Netscape.  IBM and Apple failed to challenge Microsoft.  The inability of Apple and Linux operating systems equally fails to contest Microsoft in the market.  Windows' dominance over non-Microsoft operating systems illustrates the strength of Microsoft’s barrier to entry.  Microsoft’s pricing policies significantly constrained competition based on unlimited licenses for new operating systems from revenue of new personal computer systems.  Microsoft held a massive and stable 90% market share which was protected by the high barrier to entry and the ability to change prices at will.  Gavil and First (2014) conclude that the courts and the European commission both determined that Microsoft’s dominant position for PC operating systems based on a strong market share and their network effects were substantial barriers to entry.  Its monopoly power is relevant in the market and limits customer alternatives for products other than Windows’ products.

         Microsoft's pricing conduct is consistent with a firm operating in monopoly power.  Its pricing decisions did not consider competitor pricing is suggestive of monopoly power.  Microsoft felt that it had extensive options in setting the price.  A 1997 Microsoft study (U.S. v. Microsoft, 1999) disclosed that they could have charged $49 for an upgrade to Windows 98 which would have been profitable; however, they chose an $89 revenue-maximizing price.  Many of the actions Microsoft took are evidence of a winner-take-most market where extreme market share and profit inequality are apparent.  Increased share in the Windows’ compatible PC operating system increases profit of other associated Microsoft platforms.    

Solution

Microsoft was inclined to use and leverage monopoly power as it engaged in a wide range and persistent pattern of behavior with the purpose of maintaining a monopolist position and reducing competition.  Microsoft's unchallenged conduct was not limited to Netscape (Gavil & First, 2014).  Microsoft used its Windows’ license to force Compaq to restore MSN and Explorer icons.  Bill Gates personally delivered the demand to Intel to not sell software directly to the PC producers and bypass Windows.  Microsoft also pressured IBM to stop competing in the market for applications software.  When IBM refused, Microsoft squashed technical and marketing support, levied increased pricing, and delayed licensing for Windows 95.  Microsoft’s anticompetitive conduct included Apple, AOL, Intuit, Real Networks, and Sun Microsystems.  Another allegation by Gavil and First (2014) was that developers had no compelling incentive to write applications, other than for operating systems for Microsoft, enabled Microsoft to behave independent of its competitors.  Microsoft’s dominance insured a de facto standard operating product for client PCs.  

Microsoft violated the Sherman Antitrust Act by binding Internet Explorer to Windows.  The court and plaintiffs viewed this as a monopoly in the market for PC operating systems and that Microsoft had maintained its monopoly power by anti-competitive means (U.S. v. Microsoft, 1999).  Gilbert and Katz (2001) say that these types of behaviors were costly in monetary damages paid to plaintiff companies and to the broad oversight of government regulations along with other general corporate legal risks.  Microsoft could have developed Windows as a neutral and unbiased platform, instead of linking it unilaterally to Windows, and by supporting innovation for middleware products.  Microsoft could have created value by making their products more attractive to consumers and not by seeking to reduce usage of its competitor’s products by predatory tactics.  Microsoft’s behavior was ethically problematic.  Bill Gates declared that the court was putting Microsoft on a level playing field, unmistakably confirming that Microsoft had no intention of competing in a competitive environment (U.S. v. Microsoft, 1999).  Microsoft and Gates should have considered ethical self-regulation by paying more attention to a level playing field and by demonstrating a readiness to listen to objective feedback from the market place.      

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