POLICY BRIEF FROM AMERICANS FOR TAX REFORM

By: Ron Nehring

In its ongoing suit against computer giant Microsoft, the Clinton Administration claims it is acting in the best interest of consumers. The government claims Microsoft has used its dominant position in the PC operating systems market to drive up prices and unfairly stifle competition.

Unless the government can effectively prove its claim, the suit quickly takes on the appearance of little more than government acting as a surrogate for Microsoft's competitors in the computer industry, shacking one company with litigation and regulation while leaving others free to compete. Hence, it is worth reviewing the today's state of the PC market, from the consumer's standpoint.

A recent report by the Council for Citizens Against Government Waste detailed the cost of current computing technology with that of several years ago. For example, while a PC with an Intel Celeron Processor, 32 MB RAM, and an 8.4 GB hard drive can be purchased for under $1,300, mainframe computers with one sixth the speed cost $1 million to install just ten years ago. Further, a computer with a price tag of $10 million in the 1980's could not match the throughput of today's Pentium II microprocessor. Finally, the World Bank and International Monetary Fund report that computing costs have declined by 10,000 times between 1975 and 1994.

Microsoft's products have been at the center of this computing revolution. In 1980 IBM agreed to install Microsoft's MS-DOS operating system on all of its personal computers. Later, Microsoft pioneered the transition from the text-based to graphic-based user-interface on the IBM PC-platform with its Windows 1.0, Windows/286, Windows/386, and later Windows 3, Windows 95 and now, Windows 98. In fact, Microsoft operating systems have been installed on most computers built on the PC platform for almost twenty years. Yet, computing costs have dropped continuously and dramatically over that same period of time.

Simply put, the government has failed to prove that consumers have endured harm as a result of Microsoft's business practices, a central premise in any anti-trust case.

One may argue that consumers may be poised to be harmed by Microsoft's practices even if they have not yet experienced price increases or diminishing options. This argument, however weak, could be made if it could be demonstrated that Microsoft has successfully stifled competition in the software industry, either by driving competitors out of business, or by achieving monopoly status through mergers and acquisitions.

Unfortunately for the government, the facts do not support such an argument. The software industry in the United States is growing at twice the pace of the rest of the economy. Between 1990 and 1999 the number of software companies climbed from 24,000 to 57,000, while the number of workers employed by the industry grew from 290,000 to 860,000. More companies, employing more programmers, designers, and innovators are developing more software for the PC platform, not less.

Further, it is important to note the significant benefit the Internet is providing small software developers. In the past, the successful software developers were those with the marketing power to physically deliver software packages to distributors and retailers. Small, innovative developers would need to contract with larger developers with the marketing strength and capitalization to get their product into stores. The Internet allows these developers to market their product directly to consumers, conducting the transaction online and delivering the product at lower cost (without the need for costly packaging, shipping, and steep markup from retailers).

While consumers benefit from a growing array of software that can now be delivered at lower costs (or at no cost, as is the case with many web applications), many technology companies, including Microsoft and its competitors, are also enjoying prosperous times. For instance, Microsoft's market value has increased 83% in 1999. Yet, for all of the complaining Microsoft's competitors have done in the press and in Washington, they have enjoyed even greater success this year. America Online, a main Microsoft enemy, has enjoyed an increase of 555% in its market value. Sun Microsystems is up 209%. Even IBM, which suffered badly in recent years, is up 91% in the last six months.

If consumers are winning, why did the Clinton Justice Department file the suit?

The Clinton Administration's Department of Justice (DOJ) filed its latest suit against Microsoft in February 1998, after Joel Klein, head of DOJ's Antitrust division had breakfast with Netscape CEO Jim Barksdale.(1) In that meeting, and meetings with other DOJ representatives, Netscape urged DOJ to take action against Microsoft, its biggest competitor in the Internet software market. On October 20, 1998, Barksdale admitted in court that successfully lobbying the government to act against Microsoft was part of his corporate strategy because the cost of filing the suit on its own would put an unacceptable financial strain on Netscape.(2) Barksdale and the DOJ apparently decided it was better for his shareholders if the American taxpayer picked up the tab instead.

Further indications that the DOJ is merely acting as a surrogate for Microsoft's corporate competitors can be found in their own public statement. For instance, on May 19, 1998 Sun praised the government for taking action against Microsoft, claiming "no one company should gain a chokehold on the Internet." At the time, Microsoft's share of the Internet browser market was 47%. Today, AOL and its new partner Netscape hold 58% of the browser market.(3) To date, Sun has not made similar complaints about AOL/Netscape. Instead, Sun formed its own partnership with AOL/Netscape in junction with their merger.

How U.S. v. Microsoft threatens consumers

Consumers are the clear winners in today's software market, with an array of software available at historically low prices. If the government is successful in its case against Microsoft, consumers could suffer in several ways:

Price controls. The government has decided that the $65 Microsoft charges original equipment manufacturers (OEM) to install Windows is a monopoly price. Some regulation what Microsoft can and cannot charge for Windows is entirely possible, opening the door for federal regulation of software pricing for any program that becomes sufficiently popular to warrant the government's attention. Such price controls could easily transform today's dynamic high-tech companies into tomorrow's fossilized public utilities.

Restricting innovation. The government filed its February 1998 suit against Microsoft for allegedly violating a July 1994 consent decree in which Microsoft agreed to not require OEMs that license Windows to license any other software product. The decree, however, specifically stated that the company was free to develop "integrated products." Simply put, the government claims that Microsoft violated the decree by "tying" two otherwise unrelated applications, Internet Explorer and Windows 95, together to create Windows 98. Microsoft points out, correctly, that Windows 98 will not function if its Internet components are removed, thus making Windows 98 an "integrated" product legal under the decree.

The computing public's increased reliance on the Internet for routine business and personal functions (exchanging e-mail and documents, software upgrades, games, etc.) makes it entirely possible that Microsoft was engaging in healthy innovation that serves the real life computing needs of its customers when it integrated Internet functions into its operating system. Further, Microsoft did not design Windows 98 to render the operation of competing Internet software inoperable. In fact, according to a Netscape sales representative contacted for this paper, Netscape's browser and other software will run on Windows 98 systems "just fine."(4) Further, the representative claimed that Netscape's Communicator 4.51 would perform faster than Microsoft's Internet Explorer 5.0 operating on a Windows 98 system.

Introducing federal oversight of product development at Microsoft would set an enormously dangerous precedent, potentially leading to similar oversight at other companies in the future. This can only have a chilling effect on the development of products necessary to meet the future needs of the computing public. Indeed, T.J. Rogers of Cypress Semiconductor, an opponent of dragging the federal leviathan into regulating the computer industry, wrote in the New York Times: "The Justice Department isn't just attacking Microsoft; it's attacking the way Microsoft does business - and, by extension, the way most successful high-technology companies do business."

The "way of doing business" referred to by Rogers has created an incredibly dynamic and growing sector of the American economy that is producing better products at low costs at an incredible pace. All of that is threatened by threat of new government regulation and oversight. While consumers are the clear winners in today's computer market, they would be definite losers if the center of America's technological decision-making is moved from Silicon Valley and Redmond, to Washington D.C.

Footnotes

1. "The New Trustbusters," by James V. DeLong, Reason Magazine, March 1999
2. Ibid.
3. "The Federal Assault on High Tech," Citizens Against Government Waste.
4. Telephone interview with Netscape corporate sales representative, June 24, 1999.