Working draft 7 August 2005 PREDATORY

AND EXCLUSIONARY INNOVATION: WHICH LEGAL STANDARD FOR SOFTWARE

INTEGRATION IN THE CONTEXT OF THE

COMPETITION
CLASH?

INTELLECTUAL PROPERTY RIGHTS

Maria Lill Montagnani University of Bocconi - Institute of Comparative Law "A. Sraffa" (IDC)

Abstract This paper aims to address two questions: first, how to identify the legal standard that courts use to assess a specific behavior (software integration) commonly adopted by firms possessing IPRs. Second, whether this standard enables us, on the one hand, to draw a line between predatory and competitive innovation, and, on the other, to strike a balance between: the market leaders freedom to innovate and the public interest towards the persistence of competitive markets. The research consists of an examination of the main hardware and software integration cases in the US and the EU, from which a standard echoing the predatory innovation doctrine principles and increasingly aware of network effects and high-tech market features emerges. The conclusion is thus that, as long as IPRs work as incentives to innovate, a system of rivalry is to be maintained. However, when exploitation of IPRs by rightholders becomes a means to limit competition in the market (in that it enables to prevent both competitors and rightholders further innovation); then IPRs loose the function of innovation incentives and remedies are to be undertaken in order to maintain competition effective in the market.

1 INTRODUCTION

Innovation has historically been deemed a competition driver and, therefore, rewarded through the granting of IPRs (1). However, in high-tech markets innovation may be twofold. On the one hand, it promotes competition and deserves reward, such as IPRs; on the other hand, it may be a means to prevent competition due to the high-tech market specific features, such as network, spill over, consumer lock in and winner-takes-all effects (2). The twofold nature of innovation in high-tech markets has been theorized by those scholars asserting the predatory innovation doctrine, under which innovation in network markets can be a means to predation and, as such, can violate competition law (3). Distinguishing good from bad innovation is not an easy task, since the high-tech market specific features are counterbalanced by hightech market operators ownership and exploitation of IPRs, granted as a result of their innovative efforts and entitling rightholders to act freely. Both these aspects (market features and IPRs) emerge when dealing with a specific behavior adopted in the software market: software integration. First, the software market is a classic example of network market in that one product or standard tends towards dominance. In this context, the
1

IPRs are granted to foster innovation since they are an (economic) reward for creative and inventive works. Granting an exclusive right is considered an incentive to further creation and invention, and it benefits society in terms of culture, science, and economy. Such a process invention-IPRs- incentives to further innovate, thus, benefits competition itself by developing new products and markets and suites the Schumpeterian perspective, under which innovation is competitive when it promotes the technological progress necessary to produce more and better quality goods. With this regard, the market process appears segmented in (i) introduction of a product innovation into a market; (ii) increase of innovators revenues; (iii) imitation of that product innovation by competitors; (iv) introduction of the imitated product into the market by competitors; and (v) decrease of innovators revenues [FREDERIC M. SCHERER, INDUSTRIAL MARKET STRUCTURE AND ECONOMIC PERFORMANCE 350 (Rand McNally College 1970). See also JOHN M. CLARK, COMPETITION AS A DYNAMIC PROCESS 178-270 (Brooking Institution 1961)]. Through the above mentioned process, technological and economic progress develops. However, innovators will be likely to aim at making phase (ii) as much longer as they can in order to postpone phases (iv) and (v), and IPRs appear to be useful means to stretch phase (ii) and block or slow down the innovation circle.
2

ILKA RHANASTO, INTELLECTUAL University Press 2003).

3

PROPERTY RIGHTS, EXTERNAL EFFECTS AND ANTITRUST LAW

183 passim (Oxford

Janusz A. Ordover & Robert D. Willig, An economic Definition of Predation: Pricing and Product Innovation, 91 YALE L. J. 8 (1981). Contra J. Gregory Sidak, Debunking Predatory Innovation, 83 COLUM. L. REV. 1121 (1983).

utility that a user derives from the consumption of a good increases with the number of other users consuming that good. Thus, once one product or standard achieves wide acceptance, it becomes entrenched (4). At the same time, such entrenchment may be temporary because innovation may alter the field altogether (5). At least the latter is deemed to be the mechanism to keep the software market (and, generally speaking, the high-tech markets) competitive (6). Recent cases, such as the European Microsoft case, however, seem to demonstrate that network effects and IPRs tend to strengthen the innovators position. Second, software programs are protected by copyright and this protection has been progressively extended from source code to other elements (7), not least communication interfaces. Besides, patents are granted for software programs showing technical effects which further expand these products protection (8). Software integration can thus exemplify the issue in exam: innovative behaviors adopted by IP rightholders generating both pro- and anticompetitive effects. When adopted by a firm leading a forehead market (such as the operating system market), software integration may be capable of hampering competition in an aftermarket (such as the server or browser markets). In this case, innovation can be considered predatory, and predation can be challenged. On the other hand, software market operators are rewarded for their innovation through the granting of IPRs that, in turn, are supposed to provide an incentive to further innovate. However, in this market and in certain circumstances, IPRs are unlikely to offer an incentive to innovate, but, rather, a means to limit further innovation and developments.

This mechanism has been defined competition for the field, instead of in the field, by Harold Demsetz, Why regulate utilities?, 11 J.L. & ECON. 55, 57 n.7 (1968).
5 6

JOSEPH. A. SCHUMPETER, CAPITALISM, SOCIALISM

AND

DEMOCRACY 81-90 (Allen & Unwin 1943).

Herbert Hovenkamp, Post-Chicago Antitrust: A Review and Critique, 2001 COLUM. BUS. L. REV. 257, 332.
7

For a complete overview of software protection under the US copyright law see MARK A. LEMLEY ET AL., SOFTWARE AND INTERNET LAW (Aspen Law and Business 2nd ed. 2003). For a comparative approach, see ADRIAN STERLING, WORLD COPYRIGHT LAW (Sweet & Maxwell 2nd ed. 2003).
8

On Software patentability see Micheal Guntersdorfer, Software Patent Law: United States and Europe Compared, DUKE L. & TECH REV 6 (2003).

For these reasons software integration cases appear to be an ideal scenario for finding the legal standard to distinguish good from predatory innovation in network markets. And, too, the predatory innovation doctrine principles constantly emerging in hardware and software integration cases appear to be a good means towards achieving this goal. Hence, the aim of this paper is to find the legal standard used by case law to assess software integration and to verify: first, whether predatory innovation principles have therein been applied; and, second, whether this application enables the courts to strike a balance between actors freedom to innovate and public interest towards competitive markets. Besides, this assessment is to be carried bearing in mind that in the software market freedom to innovate is granted through the IPR ownership, which brings in the clash between Competition law and Intellectual Property law. The rest of part I will provide a definition of predatory innovation and the terminology used herein. Part II will survey the early software and hardware integration cases (IBM cases) since they are the early cases where the predatory innovation principles underpinned the allegations. Part III will survey the early software integration cases: Microsoft II and Caldera v. Microsoft and the blurring of monopolization and tying offenses. Part IV will address whether predatory innovation principles were applied in Microsoft III and IV. And, finally, part V will try to work out a system to assess software integration and, more broadly, innovative conducts generating both antiand pro-competitive effects in the light of predatory innovation doctrine principles. With regard to the software market, this assessment can not be carried without considering the presence of IPRs enabling the innovator to justify his behaviors. Innovation being counterbalanced by IPRs, software integration needs to be addressed and inserted within the context of the clash between Competition law and Intellectual Property law. 1.1 Predatory and exclusionary innovation in the

hardware and software markets

Predation is that conduct which has the purpose and the effect of advancing the actors competitive position, not by improving the actors market performance, but by threatening to injure or actually injuring potential competitors, as to drive and keep them out of the market, or force them to compete less effectively (9). Such predatory behaviors can center on prices (predatory pricing) or other elements, such as innovation, research and development, advertising, and product designs (non-pricing predatory practices) (10). In both cases a key element to raise competition concerns is the actor being a monopolist or possessing a dominant position. The focus is herein on those behaviors centered on innovation. This competition driver may generate both anti- and pro-competitive effects so as to raise the question as to when innovation stops being beneficial and starts being detrimental. The question becomes even more relevant in network markets, such as software and hardware markets, for several reasons. First, lock-in, network, winner-takes-all and similar effects together with low marginal costs can amplify innovations anticompetitive effects (11). Second, in such markets the actors positions is strengthened by IPRs either rewarding rightholders for their previous innovative efforts or protecting their freedom to further innovate. Although changing design or updating (upgrading) of patented or copyrighted products are rightholders choices as well as bundling two different products however, exploitation of IPRs may higher barriers to entry. Therefore, with regard to the software and hardware markets, the question to pose is as to whether markets features and IPRs are to be taken
9

LAURENCE A. SULLIVAN, HANDBOOK

OF THE

LAW

OF

ANTITRUST 108 (West 1977).

10

HERBERT HOVENKAMP, FEDERAL ANTITRUST POLICY. THE LAW OF COMPETITION AND ITS PRACTICE 289 (West end ed. 1999). Non-prices behaviours centered on innovation consist in: (i) manipulation of leading firms main technology in order to make it incompatible with competitors accessories and leverage secondary markets (so called technological or implicit - tying); (ii) constant updating of leading firms main technology to raise competitors costs to regain compatibility (technological manipulation or design change); (iii) vapourware (on the latter practice, see Robert Prentice, Vaporware: Imaginary High-Tech Products and Real Antitrust Liability in a Post-Chicago World, 57 OHIO ST. L. J. 1163 (1996). For a categorization of behaviours falling in the predatory practices, see also Carlos Acuna-Quiroga, Predatory Innovation: A Step Beyond? (Understanding High-technology Markets), 15 INTL REV. OF L. COMPUTERS & TECHNOLOGY 7, 8-9 (2001).
11

John Temple Lang, European Community Antitrust Law: Innovation Markets and High Technology Industries, in INTERNATIONAL ANTITRUST LAW AND POLICY 519 (Bender 1996).

into account in assessing when innovation stops being beneficial and starts being detrimental. In other words, assuming that the innovations exclusionary effects outweigh pro-competitive effects, is this boundary to be struck according to market features and actors ownership and current or potential exploitation of IPRs? According to those scholars formulating the predatory innovation doctrine, a different assessment is needed for monopolists operating in network markets due to market power possibility of being entrenched by innovation (12). Both the United States and European courts have been wary of these principles granting a different treatment to the incumbents innovation when aiming to prevent competition in network markets. This does not mean that courts have always been consistent in assessing behaviors dealing with innovation, and a progressive change appears to have taken place. While, in the early cases, innovative behaviors at that time hardware integrations were implicitly per se lawful, in that an assessment involved technical evaluations was deemed difficult to undertake and falling outside courts competence; predatory innovation doctrine principles appear to underpin the recent decisions involving software integrations. As markets have changed (integration in the hardware market has been progressively replaced by integration in the software market), courts approach has changed either, and allegations grounded on predatory innovation principles have progressively been accepted. A premise is however necessary in order to clarify the wording predatory innovation. Although this term originates from the antitrust law doctrine stating the principles we deal with, however, in this work a slightly different wording is adopted. Predatory innovation is used to indicate that
12

Ordover & Willig, supra note 3, at 8. In details, the Authors doctrine can be applied to vertical integration, such as the software integration in question, by a three-prong test: 1. Analysis of the likelihood and the sources of monopoly profits from exclusion; 2. Profit sacrifice; 3. Recoupment of the forgone profits. See also Laurence J. White, Microsoft and Browsers: Are the Antitrust Problems Really New?, New York University, Center for Law and Business, Working Paper No. 98-018 www.ssrn.com/abstract=164499 (March 1998).

conduct falsely innovative but exclusively aimed to drive and keep competitors out of the market; whereas exclusionary innovation is adopted to indicate that conduct whose effects on competition can be both detrimental and beneficial at the same time, regardless of the actors purpose. A survey of cases dealing with, firstly, hardware and, secondly, software integration can show how predatory innovation doctrine principles have progressively emerged and, with them, the assessment of market features and exploitation of IPRs. This survey may also provide a means to assess software integration by eliciting the legal standard applied. Since in the case-law predatory innovation doctrines principles are often melted with the tying doctrine principles, a few remarks on this point are necessary.

1.2

Hardware and software integration: technological tying between monopolization (or abuse of dominant position) and tying

Hardware and software integration can fall under different provisions: monopolization (section 2 US Sherman Act) or abuse of dominant positions (art. 82 EC Treaty); and, tying (section 1 US Sherman Act and art. 82 (d) EC Treaty). In the U.S., besides these provisions, an allegedly exclusionary innovation conduct may also be challenged as an attempt of monopolization (section 2 US Sherman Act). Although an attempt of monopolization claim was accepted in the predatory innovation leading case Bard v. M3 System (13) this offense has little relevance in the hardware and software

13

157 F.3d 1340 (Fed. Circ. 1998).

integration cases (14) (15). For this reason, it will not be dealt with in this paper (16). Monopolization (or abuse of dominant position) on the one hand, and tying on the other hand, are rather differently assessed under the US and the EU competition laws. These differences are worth pointing out as they affect the legal standard to be applied. In the US, two different legal standards can be applied depending on whether an integration is being challenged under sec 2 or sec 1 of the Sherman Act: the Grinnel standard and per se illegality rule, respectively. As to the former, monopolization offense has two elements deriving from the Grinnell case: (i) the possession of market power in the relevant market and (ii) the willful maintenance of that power as distinguished from growth or developments as a consequence of a superior product, business acumen, or historic accident (17). As to the latter, tying has traditionally been assessed the following way: whenever four conditions are considered present (namely: (i) two separate products; (ii) market power in the tying product market; (iii) no consumer choice to obtain the tied product separately from the tying product; and, finally, (iv) foreclosure of competition in the tying market), the tying practice is deemed illegal per se (18) no matter the efficiencies the tying could generate for consumers. However, since the legal standard to evaluate tying in high-tech markets needs to balance the efficiencies a tying can generates with the anti-competitive effects it can yield, a rule of reason assessment is progressively emerging (19).
14

Herbert Hovenkamp, The Monopolisation Offense, 61 OHIO ST. stresses that, as long as its product is complement of competitors firm is unlikely to design change or integrate in that there compatibility. Rather, a non dominant firm has incentive to maximising its compatibility. Hence, an attempt of monopolisation less likely to happen than a monopolisation offense.
15

L. J. 1035, 1046 (2000), products, a non dominant is no incentive to limit maximize its profits by by a non dominant firm is

The attempt of monopolizations three element test, deriving from Swift & Co. v. United States [196 U.S. 375, 396 (1905)], are: (i) specific intent to control prices or destroy competition in some part of commerce; (ii) predatory or anticompetitive conduct directed to accomplishing the unlawful purpose; and (iii) a dangerous probability of success.
16 17 18

For an analysis of Bard v. M3System see Herbert supra note 6, at 327-332. United States v. Grinnell Corp. 384 U.S. 563, 570-571 (1996).

For a discussion of tying arrangement assessment see HOVENKAMP, FEDERAL ANTITRUST POLICY, supra note 18, at 392.
19

Amongst the several scholars criticising the tying per se illegality rule, see David S. Evans, A. Jorge Padilla & Christian Ahlborn, The Antitrust Economics of Tying: A Farewell to per se

Conversely, in the EU, tying is a species of the abuse of dominant position genus, thereby sharing the same rule of reason approach applied to behaviors falling under art. 82 EC Treaty. This tying assessment is thus focused on four elements (the same elements the US tying assessment is grounded on). Their presence, however, does not determine a tying per se illegality, because a balance has always been deemed necessary to be undertaken between pro- and anti-competitive effects. As long as the US and the EU apply two different rules in assessing tying, hardware and software integration assessments will be different. However, because of the current trend in the US towards the adoption of a rule of reason approach, differences between the US and the EU systems are progressively being blurred. It is still worth bearing in mind, though, that these differences did affect the early cases and, even now, parties try to make claims or a defense under one or the other category according to the results that they are pursuing.

2 EARLY

LEGAL

STANDARDS

FOR

EXCLUSIONARY
CASES

INNOVATION

IN

THE

HARDWARE AND

SOFTWARE MARKETS:

THE IBM

In the late 70s and beginning 80s the first relevant claims underlying predatory innovation doctrine took place in the hardware market and involved IBM, challenged of using innovation to monopolize and attempt at monopolizing, in violation of section 2 of the Sherman Act. Even the early cases show concern over the twofold nature of innovation: as triggering competition and, at the same time, harming competition. However, courts awareness that the markets at hand presented specific features capable of altering the competition mechanism did not modify the very conservative approach adopted in assessing IBMs behaviors under the monopolization legal standard. Therefore, that

Illegality, 49 ANTITRUST BULL. 287 (2004). See also David S. Evans, A. Jorge Padilla and Michele Polo, Tying in Platform Software: Reasons for a Rule-of-Reason Standard in European Competition Law, 25 WORLD COMPETITION 509 (2002).

approach did not take into consideration market features and IPRs as means to raise barriers to entry (20). 2.1 IBM hardware integration cases At the time that IBM cases took place, computers were rather different from now. What we now call a computer was a minicomputer, while computers occupied an entire room or office, where the central unit machine and its accessories not only printers but also memories and tape drives and the like were located. Conversely, software was not that important and was often given free to customers buying a central unit. In this context, IBM was manufacturing both central unit machines and its peripherals. However, accessories were also manufactured by IBM competitors, and, although not being original, they were IBM compatible as well. IBM then started to integrate these accessories (peripherals) or to change the design of interfaces between the main frame machine and peripherals, thereby making the competitors accessories incompatible with its main frame machines. By doing this IBM was innovating. We would probably not have the machines we have now if IBM had been prevented from doing it. However, this same innovative behavior was alleged to limit competition in the accessories markets since precluding the compatibility of competitors peripherals, thereby forcing them to move to another product or seek compatibility again.

20

As to IPRs in the hardware and software markets, it is to bear in mind that copyright on software was introduced in the 1980 in the US and later in EU [on this point, see Manander Grewal, Copyright protection for computer software, 18(8) E.I.P.R. 454 (1996)]; while the sui generis rights on microchip is slightly more recent, at least in the US [see Jay A. Erstling, The Semiconductor Chip Protection Act and Its Impact on the International Protection of Chip Design, 15 RUTGERS COMPUTER & TECH. L.J. 303 (1989)]. Therefore, in the earlier IBM cases, more relevance was given to trade secret law, since IBM, after having integrated accessories, used to refuse to disclose the new interfaces by claiming a secret on them. The courts, however, tended to affirm the principle that trade secret, even though granted as an incentive to invent, should not prevent competitors reverse engineering [as an example of the mentioned conduct and courts reasoning, cf. ILC Pheripherals Leasing Corp. v. IBM, 458 F.Supp. 423, 437 (N. D. Cal. 1978).

10

No claim brought against IBM was accepted by the American Courts, though. Its interesting to examine the outcomes because every case adds a bit more information on the courts reasoning. 2.1.1 IBMs behaviors More specifically, IBMs challenged practices were: (i) design changes for the interfaces between central processing units and certain peripherals, such as tape drive (21); (ii) integration of disk functions, such as disk controller (22) and disk driver (23), into the central processing unit; (iii) behaviors not directly related to innovation rather to contracts, advertisements and prices. The practices were challenged under the section 2 of the Sherman Act stating unlawful for a firm to monopolize (monopolization offense) and to attempt at monopolizing (attempt of monopolization offense) (24). 2.1.2 The courts decisions The courts reasoning on exclusionary innovation conducts have in common the adoption of a generalized standard applicable to all types of behaviors adopted by monopolists regardless of the relevant market features and IPRs. Although all the decisions rejected the predatory innovation claims, they still present a slightly different approach to the issue which is worth pointing out. While the early decisions state that innovation was always good; the later ones started out by refusing to admit that innovation could both harm and benefit competition, but ended up by affirming that, from a
21 22 23 24

Transamerica Computer Company Inc. v. IBM, 698 F.2d 1377, 1382 (9th Cir. 1983). California Computer Products Inc. v. IBM, 613 F.2d 727, 743-744 (9th Cir. 1979). ILC Peripherals Leasing Corp. v. IBM, 458 F.Supp. 423, at 438-439.

For a complete overview and analysis of the IBM case, see also Lawrence A. Sullivan, Monopolization: Corporate Strategy, the IBM Cases, and the Transformation of the Law, 60 TEX L. REV. 587 (1982); Robert E. Barkus, Innovation Competition: Beyond Telex v. IBM, STAN. L. REV. 285 (1975-1976).

11

theoretical

point

of

view,

innovation

could

unreasonably

restrict

competition, and, thereby, violate the Sherman Act sec. 2. On the other hand, however, a product improvement could never be restrained, even when its effect would severely injure competitors (25). The point, therefore, was and, partially, still is to figure out when a product improvement was occurred. Even on this issue the courts reasoning was still theoretical. A balance between the level of superiority and the effects on competition was invoked but never explained. An improvement was deemed to possibly harm competition whenever that level of product superiority was, with respect to the former product, not compensated for by the harm done to competition. In the IBM cases, the courts never moved from theory to practice since the challenged integrations did always constitute an improvement, and, before than that, IBM was deemed not to have market power. In other words, time was unlikely to be ripe for accepting an exclusionary innovation claim since network effects were not that worrisome and IPRs on hardware products were hardly considered. 2.2 IBM software integration cases

The last case involving IBM took place, rather than in the hardware market, in the software market; and dealt with IBMs having integrated a proprietary software in its operating system (26). Such a behavior was alleged to harm competition in the software market since it could have driven out all the software manufacturers competing with IBM. 2.2.1 The IBMs behaviors IBMs challenged behavior was the tying of an application software program and the operating system. This software had two functions: transferring data between the computer disk into the operating system, and loading for the first time IBMs operating system (27).
25

In re IBM Peripheral EDP Devices Antitrust Litig. Transamerica Computer Co. Inc. v. IBM, 481 F.Supp. 965, 1004 (N. D. Cal. 1979) (emphasis added).
26

Innovation Data Processing Inc. v. IBM, 585 F. Supp. 1470, 1472-1473 (N. J. Dist. Ct. 1984).

12

A little background information is necessary to understand the case facts and the outcome. At that time IBM was marketing two different versions of its operating system: the former had integrated the software performing the above mentioned functions; the latter had kept it unbundled. However, even in the case of the integrated software, it could have been used to upload the operating system and, after that, removed without paying fees within thirty days (28). Since an IBM competitor was manufacturing a software program performing the same functions of the software IBM had integrated in its operating system it challenged IBMs integration claiming that it constitutes tying under sec. 1 of the U.S. Sherman Act. This integration was thus alleged as being illegal per se (29). 2.2.2 The courts decision Although at that time, and under the American antitrust law, tying assessment was quite strict, in this case the court decision stated that the integration was lawful since the users were not coerced into buying the integrated version of IBMs operating system. And, even when they bought it, they were still free to unbundle it. The courts reasoning expressly grounded on (i) the presence of these two different versions of IBMs operating system; and (ii) the possibility of either licensing the software without the operating system (in the segmented version), or removing it from the integrated version whenever the customer wanted (and without paying any fee if removed within thirty
27

Of some interest, even for the following, is the definition of operating system that the court gave in Innovation v. IBM (id. at 1472): An operating system is a set of computer programs which guide and control the basic function of a computer. These operating system programs also provide the necessary link between the physical hardware and the various applications programs software, designed to perform specific tasks, such as accounting, world-processing, payroll or even video games.
28

Id., at 1474.

29

Differently from the current legal standard for tying (see supra p. 6 and note 18), at that time, the elements of the test to affirm a tying illegal per se were: (i) an agreement to by a party to sell the tied product provided that the tying one is bought; (ii) market power in the tying product market; (iii) harm of competition in the term of not insubstantial amount of interstate commerce affection (Id., at 1475), since the coercion was implicit in the concept of leverage (while in the later standard it will be explicitly required).

13

days from the hardware purchase). Given this context, the coercion implicit in the concept of leverage, and, at that time, not explicitly required was not deemed present, and the tied product as such was always remaining a possibility of licensing.

2.3

The European perspective on IBMs behaviors

In the late 90s there was a European IBM case as well ( 30), and it never reached the courts since it was settled through the Commissions intervention. In Europe, IBM was selling a series of hardware and software products designed to complement one another. And, like in the US, IBM was horizontally integrated, whereas its competitors each sold some, but not all, of the same range of products, for use with IBM products. At a certain point IBM started (i) selling its main frame machines coupled with main memory and basic software; (ii) refusing to sell certain proprietary software to users of non-IBM main frame machines; and, finally, (iii) advertising new products long before the technical details and interfaces were disclosed. By doing this, IBM was challenged for tying its products and, thereby, preventing the compatibility of competitors products. The Commission stated that IBMs behaviors were creating, firstly, an artificial advantage for itself by (i) delaying disclosure of interface information on its new products while taking orders for them; and by (ii) denying the competitors an opportunity to adapt their products to IBM products. Secondly, IBMs behaviors were creating a disadvantage for its competitors by refusing to supply software to users of non-IBM machines. Finally, IBMs behavior was tying-in because software or memory could only be purchased with the mainframe machine. Although the Commission never elaborated the legal reasoning behind its Statement of Objection, IBMs behaviors would likely have been
30

Case 60/81, International Business Machines Corp. v. Commission, 1981 E.C.R. 2639 (1984).

14

fallen under art. 86 (now art. 82) of the EC Treaty because it placed competitors at a competitive disadvantage (31); a settlement was duly reached when IBM undertook to disclose the interface information, and to supply the software to users of non-IBM machines. Even though it not involved a technological tying like the American IBM cases, the European IBM case was worth mentioning so as to have a complete overview of what was happening in both the EU and the US systems with regard to hardware and software integration. 2.4 Summation

IBM cases are a good starting point on the issue of hardware and software integration for several reasons. Firstly, they show the development of the courts reasoning and the increasing awareness of the anti-competitive effects that innovation can generate in the high-tech markets. Secondly, a progressive openness towards economics appears to progressively emerge due the more in-depth knowledge of high-tech market specific features. Thirdly, the courts seem to be consistent in keeping technological tying separate from traditional tie-in practices. Such separateness makes a relevant difference on the standard to apply in assessing the challenged behavior lawfulness (32). In this context, however, it is to stress the changing approach in the tying assessment. Even though, when tie-in claims are raised to challenge software integration, decisions on these allegations are to be adopted under the tying standard, instead of the monopolization one; in Innovation Data Processing v IBM, the court expressly stated that as a
31

John Temple Lang, Defining Legitimate Competition: Companies Duties to Supply Competitors, And Access To Essential Facilities, in INTERNATIONAL ANTITRUST LAW AND POLICY 245, 258 (Bender 1994).
32

Dustin Rowles, Is a Tie-In or an Integration? U.S. v. Microsoft Weighs In, 6 B.U. J. SCI. & TECH. L. 12, 15 (2000).

15

general rule we hold that the development in introduction of a system of technologically interrelated products is not sufficient alone to establish a per se unlawful tying arrangement even if the new products are incompatible with the products then offered by the competition and effective use of any one of the new products necessitates purchase of some or all of the others (33).

MICROSOFT II

AND

CALDERA

MICROSOFT:

LEGAL STANDARDS FOR

EXCLUSIONARY

INNOVATION IN THE SOFTWARE MARKET

The early integration cases involving subjects other than IBM are Microsoft II and Caldera v. Microsoft. The former needs to be analysed since some scholars believe it to be the leading case in assessing software integration (34), and since it tells us what the courts thought level of superiority was. The latter is to be examined since it gives an interpretation of level of superiority different from the one given in Microsoft II.

3.1

Microsoft II (35): a leading case for software integration conduct? Microsoft II involved the practices adopted by Microsoft in marketing

the operating system (OS) Windows 95 in the primary market of original equipment manufacturers (OEMs); and the proper interpretation of a 1994 consent decree. In the following some background information is provided to understand the differences between this case and the subsequent Microsoft cases, and the affirmation that Microsoft II is the leading case to assess software integration. 3.1.2. Microsofts behaviors

33

Innovation Data Processing Inc. v. IBM, 585 F. Supp. at 1476 [quoting Foremost Pro Color v. Easterman Kodak Inc., 703 F. 2d 534, 542-543 (9th Cir. 1983)].
34 35

J. Gregory Sidak, An Antitrust Rule for Software Integration, 18 YALE J. United States v Microsoft Corp., 147 F.3d 935 (D.C. Cir. 1998).

ON

REG. 1, 34 (2001).

16

Before Windows 95 was released, Microsoft used to manufacture DOS and graphical user interfaces separately. The former being the central nervous system of the computer, controlling the computers interaction with peripherals such as keyboard and printers (36); the latter being the technology by which the operator performs functions not by typing at the keyboard but by clicks of his mouse (37). DOS products and graphical user interfaces were not directly offered to end users, rather, they were marketed through OEMs. The latter were in charge of making computers; installing operating systems and other software that they licensed from vendors such as Microsoft; and selling the packages to end users either individual consumers or businesses. In this context, it is to point out that Microsofts graphical interfaces were compatible with DOS manufactured by Microsofts competitors. Complaints were lodged with both the U.S. Department of Justice and the European Commission vis--vis Microsofts tying its DOS to its graphical user interfaces so as to limit the latters being used with non-original DOS products. In detail, Microsoft was accused of creating economic incentives for OEMs to preinstall Microsoft interfaces and Microsoft DOS, thereby influencing OEMs choices in the DOS market, and preventing competitors DOS being installed and marketed in this market. In 1994 the U.S. Department of Justice filed a complaint against Microsoft, claiming that its license agreements with OEMs and software developers contained anticompetitive terms aiming to unlawfully maintain its monopoly in the OS market. The complaint was accompanied by a proposed consent decree intended to regulate those practices and negotiated amongst Microsoft, the Department and the Commission. In this context, an anti-tying provision was included whereby Microsoft was prohibited from entering into any licensing agreement on its products so as to leave OEMs free to license, use, and distribute any non-Microsoft products. At the same time, the same consent decree stated out that this

36 37

Id., at 938. Id., at 938.

17

provision in and of itself should not be construed to prohibit Microsoft from developing integrated products. After the consent decree was signed by the parties (38) thus preempting a trial on the merits Microsoft released Windows 95 with integrated graphical user interfaces without raising competition concerns and the new version of its browser Internet Explorer 3.0 which, on the opposite, raised competition concerns as to the above mentioned consent decrees violations. The concerns over both Internet Explorer 3.0 and its subsequent updated versions integration into the OS centered on Microsoft requiring the OEMs to shortly shift to the latest service release for Windows, as soon as it was publicly released. The OEMs had to do this by installing the OS copies to be distributed to end-users. The question thus arose as to whether such an obligation was infringing the consent decree. 3.1.2. The Courts decisions In 1997 the anti-tying agreement condition was alleged to have been infringed by the Microsoft integration, and an injunction was sought by the Department of Justice. Although Jackson J. deemed the 1994 consent decree decision to be too vague to be enforceable, he granted an injunction due to the high probability of Microsofts behavior constituting monopolization under Section 2 of the Sherman Act. Integration was thus not deemed to infringe the consent decree, but to constitute a monopolization offense. However, in 1998 the Court of Appeal for the District of Columbia Circuit reversed the injunction and gave the interpretation on the consent decrees anti-tying provision that the Court of First Instance had not provided. In this respect, the Court of Appeal stressed the difference between a combination offered by the manufacturer (integrated products) and a combination created by the purchaser through OEMs from separate products. In other words, Microsoft integrations (even though installed by
38

United States v. Microsoft Corp., 56 F.3d 1448 (D.C. Cir. 1995).

18

OEMs) differed from installations by OEMs, which were based on purchasers requests, but had often been conditioned by Microsofts license agreements. Although in both cases OEMs were installing OSs and software together, in the former Microsoft had innovated and installation was grounded on that in the latter Microsoft had not innovated and it was just seeking to impose a tie on OEMs in order to sell more products. In the Court of Appeals opinion, since integration is the creation of the design that knits together two separate products, it had to occur at Microsofts level, in that OEMs cannot do it. Once two products had been integrated, OEMs could just install what Microsoft had given them according to Microsofts instructions. The Court of Appeal, thus, deemed that the consent decrees antitying provision could not limit Microsofts freedom to innovate, and innovation was not a net plus but merely a question of whether there is a plausible claim that it brings some advantages ( 39). Therefore, as long as consumers gain advantages from the integrated versions of the OS, there is no room for competition concerns and no need to bring in IPRs to strengthen Microsofts position. To sum up, the software integration rule underpinning Microsoft IIs decision is somewhere in the middle between predatory innovation and tying principles, tilting more towards the latter. Although software integration itself is more likely to be included in a predatory innovation behavior and judged under the section 2 Sherman Act standard, the Court of Appeal expressly rejected the idea of both technological tying and balance between integrated product synergies and distinct market evidence. Rather, it applied a plausible consumer benefit rule deriving from antitrust law principles and deemed Microsofts practice lawful since the software integration was producing a plausible benefit. However, this interpretation was given in the context of an alleged infringement of a consent decrees provision, and, in a subsequent decision,

39

United States v Microsoft Corp., 147 F.3d at 950.

19

the same court remarked the analysis provided had not been sufficiently indepth (40) (41).

3.2

Caldera

Microsoft

(42):

comparison

between

two

different texts The same reasoning as in the Microsoft II case underlay the courts decision in rejecting Calderas claim against Microsofts having integrated DOS and Windows in a single product: Windows 95. Although the reasoning and outcome were the same, a relevant difference between Caldera v Microsoft and Microsoft II cases lies in the interpretation of level of superiority, and, therefore, in the criterion adopted to make a balance between product superiority and anticompetitive effects. 3.2.1. Microsofts behavior In Microsoft v Caldera, Microsoft was challenged vis--vis

technological tying since it integrated MS-DOS and Windows 3.0 in a new and innovative product: Windows 95 OS (an early version of the Windows operating system as we know it). By doing this, Microsoft took two functions belonging to two different products and combined them into one new and innovative product, thus limiting competition in the DOS market. IBMs competitors could not have effected the same combination because, while IBM was horizontally integrated, they were only producing DOS products. IBMs integration, therefore, was to drive them out of the market. 3.2.2. The Courts decision

40

United States v. Microsoft Corp., 253 F.3d 34, 92 (D.C. Cir. 2001).

41

Basically, the consent decrees anti-tying provision was related to a contractual tying Microsoft had previously undertaken. Therefore, having Microsoft adopted a technological tying, the court deemed it not to infringe that anti-contractual-tying provision. Moreover, by technologically integrating, Microsoft was innovating. And, asking Microsoft not to innovate would have meant limiting its freedom and harming innovation.
42

Caldera Inc. v. Microsoft Corp., 72 F. Supp. 2d 1295 (Utah Dist. Ct. 1999).

20

In Caldera v Microsoft the courts reasoning relied on the same concepts emerging in Microsoft II, specifically the idea that technological innovation is an important defense in defending antitrust allegation (43). Even though the court rejected Calderas antitrust claim, it recognized, however, that product innovation can be stifled if companies are allowed to dampen competition by unlawfully tying products together and escape antitrust liability by simply claiming a plausible technological advance (44). The court did not apply Microsoft II cases plausible advantage claim, rather, it required a valid, not insignificant, technological improvement has been achieved by the integration (45). A rejection of the previous standard is clear when the court stated that the technological improvements must have demonstrated efficiencies. This is more than just a plausible claim that brings some advantage (46). However, since this Microsofts integration was highly innovative, it represented a net plus compared with the prior art. Therefore, Microsofts behavior was deemed lawful even in the light of the standard adopted. 3.3 Summation

Although outcomes were the same, these two decisions differ widely in defining how those integrations were deemed innovative and what was meant for level of superiority. The Microsoft II court affirmed that no a net plus was needed, but, rather, a plausible claim that integration will bring some advantages. Therefore, a product is superior every time its latest version generates a plausible advantage. That is, it is superior whenever it is better in some respect. This plausible advantage, thus, is what has to be weighed against the effects on competition in the market. In this context, consideration of market features such as network effects and IPRs as amplifier of the anticompetitive effects of innovation, is almost negligible, in that a complex analysis was unlikely due to the limited scope of the courts decision in
43 44 45 46

Id., at 1323. Id., at 1324. Id., at 1325. Id., at 1325.

21

Microsoft II. In fact, even though Microsoft II is supposed to be the leading case in assessing software integration, this decision stopped at an interpretation of a consent decrees anti-tying provision, and did not seem to have provided a possible legal standard for software integration. In Caldera v Microsoft case, instead, the court rejected the plausible advantage claim. Rather, it stated that a valid, not insignificant, technological improvement was to be effected by the integration of two products. This difference in the definition of level of superiority is quite relevant since it affect the competition balance. In the plausible advantage claim standard the balance is tilted towards the pro-competitive effects that the integration can generate; instead, the net plus standard appears to be more aware of all the factors affecting the competition balance. This balance is the central point of the later cases. In particular, what emerges in these cases is the progressive relevance of market features in striking a balance between anti- and pro-competitive effects of software integration, and, in the latest case, the increasing consideration of IPRs and the need for a regulated exploitation of them.

4 RECENT
TYING?

SOFTWARE INTEGRATION CASES: A NEW LEGAL STANDARD FOR TECHNOLOGICAL

Since the IBM cases, integration has been a common practice in both the hardware and software markets. With specific regard to the latter the software market leading firms, such as Microsoft, have constantly integrated applicative software programs into operating systems to innovate and improve their products. This behavior has not always raised competitive concerns (not every integration has been challenged). However, recent integration practices have been challenged in the US and the EU courts in order to address their anti-competitive effects. In these cases, the outcomes have not always been consistent with the earlier legal standards applied in the IBM, Microsoft II and Caldera v Microsoft cases, while a more economicoriented standard seems to have progressively emerged.

22

The recent cases all involving Microsoft as the software market leader present common features absent in the previous ones: the assessment of IPRs and network effects in the relevant markets, whose potential anti-competitive effects appear to be increasingly acknowledged.

4.1

Microsoft III (47) Microsoft III involved the integration of a new version of Microsofts

Internet Explorer (IE) browser in the Windows 98 OS. Although Microsofts challenged behaviors in Microsoft III were substantially similar to those of the Microsoft II case, both outcome and reasoning are remarkably different. 4.1.1 Microsofts behaviors Among the several challenged behaviors, such as withholding crucial technical information, predatory prices, contractual restrictions on OEMs in order to affect distribution channels, and so forth, the software integration at issue was IE integration in the Windows 98 OS. The integration was further protected by contractual provision at the distribution level so as to prevent the purchase of OSs and browsers separately. To end-users this did not constitutes a burden since it did not really affect Windows 98s purchase price. However, it mattered to Microsoft competitors. In particular, Netscape and Sun Microsystems found the integration a means of (i) preventing their products namely, Netscape web browser and Java class libraries from competing with the Microsoft products in the OS and browser markets; (ii) preventing them from entering the OS market; and (iii) driving them out of the browser market. Specifically, Microsofts behaviors were challenged for (i)

monopolization; (ii) attempt of monopolization; and (iii) tying. While all the complaints were accepted by Jackson J. (48) who even required Microsoft to submit a proposed plan of divestiture in order to split the company into an
47 48

United States v. Microsoft Corp., 253 F.3d 34 (D.C. Cir. 2001). United States v. Microsoft Corp., 87 F.Supp.2d 30 (D.D.C. 2000).

23

OS business and an applicative software business (49) the Court al Appeal upheld the sole monopolization offense. 4.1.2 The Courts decisions Before entering the merits of Microsoft III and in order to understand both the District and Appeal Courts reasoning (as well as the reasoning in Microsoft IV), some technical information is to be mentioned. OSs and software programs interact through Application Program Interfaces (APIs) which also enable software developers to write programs compatible with an OS. However, OSs are not the only software programs exposing APIs. Other non-OS programs do the same, among them: Netscape and Sun Mycrosystem products. Programs like this are called middleware since they rely on an OS and its APIs, but, at the same time, they expose their APIs to software developers. While the Microsoft III controversy was taking place, no middleware exposed enough APIs to offer a full range of applications. Users still needed to rely on an OS. However, a middleware such as Netscape would have been capable once program developers had written enough middleware applications to satisfy all user needs. Had this happened, users might have chosen less expensive middleware compatible applications rather than OS direct compatible applications. For this reason, Jackson J. stated that: The growth of middleware-based applications could lower the costs to users of choosing a non-Intel-compatible PC operating system like the MAC OS (50). Both District and Appeals courts grounded their analysis on the above technological background. However, the only complaint that the Court of Appeal upheld was the monopolization offense; while the attempt of monopolization in the browser market was reversed; and the tying remanded to a lower court.

49 50

United States v. Microsoft Corp., 97 F.Supp.2d 59 (D.D.C 200). United States v. Microsoft Corp., 83 F.Supp.2d 9, 18 (D.D.C. 1999).

24

As to the monopolization offense, the Court of Appeals upholding of Jackson J.s opinion was grounded on the application of the Grinnell test (51). Microsoft was deemed to possess monopoly power in the relevant market and to adopt an anti-competitive behavior in order to maintain its position. The existing monopoly power was derived not only from Microsofts market share, but also from the OS market structure. In this regard, entry barriers were deemed to increase Microsofts market power so as to make entry to the market difficult. It is worth pointing out that the Court of Appeals structural approach considered software market features only with respect to their network effects and their capacity to raise barriers to entry. The recognition that the network effects raised barriers to entry constituted a step toward a more complex standard in dealing with software and network markets. Microsofts anticompetitive behavior derived from the exclusionary practices it engaged in so as to maintain its monopoly by preventing the effective distribution and use of products that might threaten it. In detail, these practices were: (i) the way in which it integrated IE in Windows 98; (ii) its various dealings with OEMs and IAPs; (iii) its efforts to contain and to subvert Java technologies; and (iv) its course of conduct as a whole. A relevant point here is the test that the Court of Appeal used to assess whether the IE integration was an exclusionary practice. Did the Court of Appeal consider the software market features and Microsofts owning IPRs? Or, rather, did it apply the standard that the courts had applied in the IBM cases? The test applied consisted in balancing the pro- and anti-competitive integration effects. Once the anticompetitive effects i.e. the competition harm were deemed present; a lack of pro-competitive justification for the integration, or, alternatively, the anticompetitive effects outweighing procompetitive effects, was to be proved to establish an exclusionary practice. Although, in principle, the Court of Appeal was skeptical about an integration having anti-competitive effects since integrations were still considered mainly pro-competitive in this case, even the second instance court showed concern for the way the integration could affect the
51

United States v. Microsoft Corp., 87 F.Supp.2d at 46.

25

emergence of products alternative to Microsoft OS (i.e. middleware). Since IE was bundled into the OS code, it was deemed to prevent OEMs from preinstalling other browser programs, thereby reducing rivals usage share and developers interest in rivals APIs as an alternative to the API set exposed by the Microsoft OS. In other words, both Courts appear to be aware of the integrations refraining middleware potential competition to OSs. In this context, Microsoft provided a general justification about substantial benefits to customers and developers which the Court of Appeal did not deem sufficient to overturn the monopolization offense. It is here worth noting that software and network market features appear be relevant to the Court of Appeal decision since it asserted that judicial deference to product innovation () does not mean that a monopolists product design decisions are per se lawful (52) in such markets. This was stated by the Court of Appeal as to say that not only a net plus was needed in order to the pro-competitive integration effects outweighing the anti-competitive ones, but also that behaviors of monopolists lawfulness is to be more carefully considered according to the relevant market in exam. As to the attempt of monopolization, the Court of Appeal overturned Jackson J.s decision because of a pervasive flaw: the same behavior (IE integration in Windows 98) had been challenged for both monopolization in the OS market and attempt of monopolization in the browser market. However, the events that formed the basis for the monopolization offense could show additional liability to Microsofts behavior, but not prove an attempt of monopolization (53). Therefore, relying on the monopolization liability, attempt of monopolization standards were not proved as to the relevant market and the barriers to entry. As to the tying, the facts underlying the monopolization offense were deemed to partially overlap this allegations facts as well, with particular regard to the way in which Microsoft had integrated IE. In particular: (i) Microsofts refusal to allow OEMs to uninstall IE or remove it from Windows desktop; (ii) IE entry removal from the Add/Remove Programs utility in
52 53

United States v. Microsoft Corp., 253 F.3d at 65. Id., at 80.

26

Windows 98; (iii) IEs overriding consumers choice as to the browser; and (iv) the predatory prices allegation. While Jackson J. applied the per se illegality rule and condemned Microsoft practices with regard to the IE tying (54), the Court of Appeal remanded the decision to the District court. It called for: (i) the application of a rule of reason, instead of a per se illegality rule, and (ii) a reconsideration of the remedies. In the meantime, the parties reached a consent decree whose alleged violation was the starting point of Microsoft IV thereby preventing the lower court decision from being adopted. The Court of Appeals reasoning on tying is relevant in that it explains the rationale for a rule of reason application through the analysis of: (a) dynamic market features; (b) the test to adopt in these markets; and (c) the relationship between monopolization and tying offense when they rely on the same facts. Firstly, the Court stressed that, in dynamic markets, integration is more likely to bring innovation and benefits for consumers (even though a strong consumer demand for the tied product is present). Therefore, an indepth analysis of the integration effects needs to be developed in order not to stunt innovation. When two products are prima facie separate, this analysis is not necessary and a per se illegality rule can be straightforwardly applied. Software and hardware integrations being in question, a more cautious approach is to be adopted so as not to stifle welfare-enhancing innovation. Secondly, the Court recalled the four elements necessary to allege tying conduct, namely: (i) the tying and the tied goods are two separate products; (ii) the defendant has market power in the tying product market; (iii) the defendant affords consumers no choice but to purchase the tied product from it; and (iv) the tying arrangement forecloses a substantial volume of commerce.
54

In the first instance decision, even though Microsoft invested financial and labor resources to develop a browser as efficient as Netscape was, the court was aware that users would not have easily switched to IE unless Microsoft employed other devises to induce users to use its browser instead of Netscape. Therefore, in addition to improve its browsers quality, Microsoft started giving away its browser for free and in many cases even coupled with other valuable things (at substantial costs) in exchange for their commitment to distribute and promote IE. At the same time Microsoft sought to exclude Navigator from important distribution channels such as the OEMs and IAPs (Internet Access Providers). Thus, Microsoft required OEMs to preinstall IE, and IAPs to bundle IE with their own proprietary software so that subscribers would, by default, use that browser whenever they connected to the web.

27

In particular, the Court focused on the separate-product-enquiry test because of the difficulties it presents in itself and in the software market. In fact, the two items being complements (one is useless without the other) does not make them a single product, rather, the tying anticompetitive effects on the consumer demand are still relevant and need to be considered. At the same time, even when there are distinct consumer demands for each individual component, efficiencies from the tying could be expected. For this reason the consumer-demand test needs to be assessed under a rule of reason aiming at a comparative in-balance of separate demands for the tied product, on the one hand, and welfare efficiencies, on the other hand (55). This is even truer in the software market, where assessing such a balance with regard to the current asset may jeopardize innovation if the benefit-consumer demand comparison is only focused on the historic consumer behavior so as to ignore integration potential efficiencies (56). Finally, the Court stated that, even though a more accurate approach was needed when dealing with tying in the software market, the integration at hand did not show these high efficiencies when evaluated under the monopolization offense (57). However, this lack of demonstration not being sufficient to apply a per se illegality rule, the assessment was to be remanded to a lower court for further analysis. 4.1.3 The Final Judgments remedies for the monopolization offense Unfortunately the lower court never entered into the merits of the remanded points since the parties signed a consent decree ( 58) which put an end to the proceeding and imposed many obligations on Microsoft, amongst which is worth recalling: (i) the disclosure of the new APIs in use between OS and browser (59), and (ii) the compulsory licenses of Microsofts IPRs to enable licensees (i.e. OEMs) to promote non-Microsoft middleware (60).
55 56 57 58 59 60

Jefferson Parish Hosp. Dist. No. 2 v. Hyde, 466 U.S. 2, 12-18 (1984). United States v. Microsoft, 253 F.3d at 89. Id., at 89. United States v. Microsoft Corp., 231 F.Supp.2d 144 (D.D.C.2002). Id., at E. Id., at I.

28

As to the former, although protected under copyright and trade secret laws, the new API disclosure was deemed necessary so as to enable software developers to create new browser versions competitive with the new IE version. As to the latter, Microsofts past behaviors had showed how IPRs could be a means to refrain OEMs from promoting non-Microsoft products. Therefore, compulsory licenses could be a viable solution to this. It is worth pointing out that the IPR issue emerges only at this stage and not at the stage of the competition balance. In principle, IPR ownership itself does not amplify the anti-competitive effects of an incumbent behavior, such as Microsoft. Rather, it is the way in which IPRs are exploited that can possibly harm competition. Therefore, IPRs consideration seems to emerge whenever their ownership and exploitation are claimed as a means to limit courts intervention.

4.2

Microsoft IV (61) Microsoft IV involved the integration of other middleware Windows

Media Player (WMP) in a new version of Microsoft OS. The starting point for Microsoft IV is the above mentioned consent decree, as implemented in Kollar-Kotelly J.s final judgment (62), and its alleged violation. Although the Microsoft III and IV decisions are often compared, and the Microsoft IV decision is deemed stricter than the Microsoft III one (63), they do not appear to involve identical practices, rather, to address different aspects of a similar behavior. In other words, we could say that the reasoning underlined the Microsoft IV decision starts where the reasoning of the Microsoft III decision left off. 4.2.1 Microsofts behaviors

61

Commission Decision of 24.03.2004, relating to a proceeding under Article 82 of the EC Treaty (Case COMP/C-3/37.792 Microsoft), C(2004)9 final (Brussels 21.4.200) (unofficial publication).
62 63

United States v. Microsoft Corp., 231 F.Supp.2d 144.

Rudolph Peritz, Re-Thinking U.S. v. Microsoft in Light of the E.C. Case, NYLS Legal Studies Research Paper No. 04/05-4 http://ssrn.com/abstract=571803 (22 March 2004).

29

Microsoft was challenged for abuse of dominant position under art. 82 of the EC Treaty with regard to both the OS and work group server markets. As to the latter, Microsoft refused to comply with the disclosure obligation. Whereas, with regard to the media player market, in 1999 Microsoft started to integrate Windows Media Player into Windows OS and, since 1999, it persisted in bundling it in all subsequent versions (64). This practice, alleged to constitute tying under art. 82(d) of the EC Treaty, and to harm competition in the OS market, falls under the software integration category, and therefore it needs to be dealt with. 4.2.2 The European Commissions decision WMP integration was addressed under art. 82(d) prohibiting the making contract conclusions subject to acceptance by the other parties of supplementary obligations, which, by their nature or according to commercial usage, are not connected to the subject of such contracts. The following elements are to be present in order to claim an art. 82(d) violation: (i) dominance in the tying market; (ii) product separateness; (iii) no consumer choices in obtaining the tied product separately from the tying one; and (iv) foreclosure of competition. As to Microsofts dominance in the OS market, the proof of it was deemed reached not only by Microsofts market share, but also by the fact that Microsoft did not dispute it in appeal (65). As to the products distinctness, the Commission assessed it through the consumer demand test. The presence of consumers demand for media player on its own, independently of the OS, was deemed to prove they were distinct products and they were so perceived by consumers (66). The Commission (as well as the Court of Appeal in Microsoft III) recognized that a test should not focus on historic consumer behavior
64

Integrations of WMP previous versions were not challenged in that it was in the 1999 that WMP reached both the functions of streaming over the Internet and local playback of content. Instead WMP previous versions could just perform local playback (see, Commission Decision of 24.03.2004 at 819).
65 66

Case T-201/04, Microsoft Corp. v Commission, 4 C.M.L.R. 5, 397 (Ct. First Instance 2005). Commission Decision of 24.03.2004 at 807.

30

which, considering consumers behavior at that moment, may ignore the efficiency benefits deriving from new product integration (67). In the case at hand, even after years of Microsofts integrating WMP in its OSs, there was still significant demand for alternative players (68). This showed that consumer behavior had not changed despite constant integrations. It is worth pointing out that the WMP versions Microsoft integrated before 1999 did not present the current WMP functionalities since they just offered local playback functionality; while the WMP under discussion offered both streaming over the Internet and local playback functionalities. The Commission stressed the competitive advantage that the integration of the last WMP version was giving to Microsoft, regardless of whether the two were distinct products or not. A different position was maintained by the Court of Appeal in Microsoft III and the Commission in Microsoft IV on the question of consumer choices being prevented by the integration. In Microsoft III, this condition appears to be satisfied whenever a consumer has the choice to uninstall the middleware (in that case IE) and launch alternative middleware programs. What Microsoft could not do was to prevent consumers (and OEMs) from doing this by removing such a functionality and the add/remove tool from the desktop, or select its own middleware as the default program. The unlawfulness of such behavior was, thus, stated in Kollar-Kotelly J.s consent decree. In Microsoft IV, instead, the Commission asserted that complying with that consent decrees provisions as to the uninstall choice did not fully restore consumers choices as to whether to acquire WMP without the OS. This was because the Microsoft III decision did not deal in-depth with the tying allegation (it only considered the monopolization offense) ( 69). Therefore, integration itself still affected consumers choices, even though
67 68

Id., at 808.

This argument appears to be in contrast whit what previously recalled (supra n. 55) to assert that Microsoft behaviour challenged started in 1999 as at that time WMP could offer a full array of functions. Consumers demand for alternative player, at the time in which Microsoft integrated a WMP not performing streaming functionality, is not likely to indicate that this test does not have an historic perspective. The WMP after which integration consumers demand for alternative products remained is rather different from the WMP integrated in 1999. The former did not offer streaming functionality, while the latter does.
69

Commission Decision of 24.03.2004 at 828.

31

the tied product did not affect the tying products price and did not coerce consumers to use it. Insofar as consumers were likely to use the tied product, there would be competition foreclosure in the Commissions decision, the most relevant element of the tying allegation. Consequently, as to the competition foreclosure the Commission deemed it not only to be a matter of consumer choices but also of producers access to the market. Even when consumer choices might not be completely stifled, effects on the tied product market might be such as to eliminate potential competition in that market, thereby making consumer choices impossible because of the absence of alternative products ( 70). For this reason, art. 82 EC of the Treaty was deemed applicable even when Microsofts behaviors affected consumer choices only indirectly by affecting access to the market and behaviors of stakeholders, such as OEMs, content providers, and software developers. As to OEMs, WMP bundling into WOS was deemed to limit their incentives to bundle an additional media player for two main reasons: first, an additional player would use up hard-drive capacity to offer essentially similar functionalities; second, users would be unlikely to pay higher prices to have an additional player when they could have one at the standard price (71). As to content providers, in the presence of a widely disseminated media player, such as WMP, they were deemed to encode their content for access by end-users through the most widespread technology in order to maximize the potential reach of their own products. Moreover, the more content available for a given media player, the higher the consumer demand for this media player would be. Network effects were, thus, considered to play a significant role in content providers choice of technology (72). As to software developers, being WMP a program for which applications are being developed, the same above mentioned mechanism was deemed likely to occur. The more a platform, such as WPM, spread, the
70 71 72

Id., at 835. Id., at 849. Id., at 883.

32

more incentives software developers would have to write for it. The presence of WMP APIs in every PC carrying WOS was thus deemed to make software developers to write applications for it (73) (74). The Commission recognized, however, that tying can generate efficiencies but, in the case at hand, these efficiencies were deemed to have been reached even without the integration. Neither the fact that the transactions costs of tying outweighed its anticompetitive effects (75), nor the fact that the tying benefited software developers by exhibiting WMP APIs in all PCs, were deemed generating sufficient efficiencies (76). Such a result could have been reached only through showing net efficiencies (77). Again, the Commission seemed to apply the net plus standard established in the Caldera v Microsoft case, as did the Court of Appeal in Microsoft III. 4.2.3. The Commissions remedies to tying With regard to the WMP integration, the main remedy adopted was the obligation to offer to OEMs two WOS versions: one with WMP unbundled and one with WMP bundled. At the same time, Microsoft was not allowed to: (i) hinder the APIs in use between WOS and WMP or select preferential APIs, thereby privileging compatibility with Microsoft programs; (ii) give favorable treatment to WMP on WOS (i.e. providing a link for an easier download); (iii) affect or otherwise condition OEMs freedom to choose WOS without WMP; (iv) otherwise tie Microsofts application to WOS. 4.3 Summation
73

Id., at 892.

74

Id., at 897. In reason of this integration, thus, WMP was deemed to be as ubiquitous as WOS was no matter it could be uninstalled in compliance with the U.S. consent decree (or better final judgment) since its binary code would still be pre-installed together with the OS on every PC. Moreover, spill-over effects were deemed to possibly alter other markets structure, such as media player on wireless devices, on set-top boxes or DRM solutions and on line music delivery (so called complementary business areas).
75 76 77

Id., at 956. Id., at 962. Id., at 969.

33

Although both Microsoft III and IV involved middleware integrations, the decisions appear to assess different aspects of this behavior, and, with regard to the legal issues discussed, the Microsoft IV decision seems to complete Microsoft III. As to similarities, even though the integrations were evaluated under different provisions belonging to different systems in Microsoft III, IE integration was assessed only under the monopolization offense, while a definitive assessment under the tying offense was not provided; in Microsoft IV, instead, WMP integration was assessed under tying offense (thereby falling in the overall category of abuse of dominant position) the reasoning followed by the Commission and Court of Appeal seems similar. A common standard, too, appears to be adopted to assess the integrations in question. However, this standard can be identified as mutual only between monopolization offense, on the one hand, and tying as a subset of the abuse offense, on the other hand, in that the standard used to assess IE integration as a tie-in in the US system was never expressly formulated (the remanded decision was not issued due to the settlement amongst the parties) (78). In both decisions, market power and exclusionary practices form the test for the section 2 of the Sherman Act and art. 82(d) of the EC Treaty violations; the focus is on the balance between anti- and pro-competitive integration effects; and the level of superiority required tends more toward the net plus benefit criteria than the plausible advantage claim (79). Moreover, in both cases, a thoroughly examination of network effects shows the outcomes of monopolization and abuse similar. In this context, network effect consideration severely amplified the threat to current and potential competition in the OS market that middleware integration can generate, to the extent that both IE and WMP integrations were deemed to enable Microsoft to possibly prevent any non-Microsoft middleware from efficiently competing with WOSs. In fact, a middleware program can be compatible
78

It is however known that that a rule of reason approach was called for by the Court of Appeal which rejected the per se illegality rule applied by the District Court (United States v. Microsoft Corp., 253 F.3d at 81).
79

See supra paragraphs 3.1 and 3.2.

34

with every OS, thereby providing incentives to write middleware-compatible applications instead of specific OS compatible applications. Even though, at the time WMP and IE were integrated, neither player nor browser exposed such a high number of APIs to effectively compete as a platform, both Court of Appeal and Commission believed that this might occur in the future. Therefore, preventing the development of browser- or player-compatible applications not only yielded anti-competitive effects in the browser and media player markets, and the above categories of stakeholders operating there, but also prevented potential general platform substitutes from being developed in the future. In spite of the similarities, it is important to bear in mind that Microsoft IV starts where Microsoft III ends and it completes the analysis started therein. Even though, in both cases, the behavior in question was defined as software or better middleware integration, this behavior can be split (or at least it seems to have been split in Microsoft III decision) ( 80) into technological integration (or technological tying) and contractual tying (the latter appearing to be a means to strengthen the former in both American and European cases). Thus technological tying was the focus of the assessment carried out in Microsoft III, and, in this respect, the behavior was evaluated under the monopolization offense (the tying not having been assessed but remanded). In Microsoft IV, instead, since the technological tying complied with the consent decree as to disclosure obligations (i.e. the new APIs in use between WOS and WMP were disclosed) (81), the assessment dealt more broadly with other non-technological components of that tying
80

The distinction between technological and contractual tying is quite evident HOVENKAMP, FEDERAL ANTITRUST POLICY, supra n. 303, where the Author stresses that the most obvious difference between the 2 tying () and the traditional 1 or Clayton Act 3 offenses consists in the lack of any agreement requirement in the former. Monopolization is a unilateral practice. So when a dominant firm unilaterally imposes tying () under circumstances where a qualifying agreement cannot be proven, the practice may still constitute an antitrust violation. To be more precise, in Microsoft III the Court of Appeal identified four behaviors: two of them namely, preventing OEMs to uninstall or remove IE from WOS desktop; and designing WOS so as to withheld from consumers the ability to remove IE by use of the Add/Remove Programs utility in Windows constituting technological tying, thereby assessed through the monopolization offense test; and the remaining two namely, Microsofts requiring WOS licensees to license IE as a bundle at a single price; and Microsofts designing WOS so as to override the users choice of default web browser in certain circumstances constituting tying and needing for a rule of reason analysis by the remanded court. On the difference between technological and contractual tie-ins, see also David S. Evans, A. Jorge Padilla and Michele Polo, supra note 19, at 509.

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practice that is contractual tying (those same practices remanded to the lower court in Microsoft III and never assessed due to the settlement). The different approach adopted within the European framework can be justified by: (i) use of same provision (and common standard) to assess both technological and contractual tying i.e. art 82 of the EC Treaty (82); and (ii) no need to assess the technological integration of WMP since the consent decrees obligations were complied with. The European decision can thus be deemed a logical complement to the US one, in that it assessed those aspects not covered in the US case because of the settlement. In the analysis of the US and the EU decisions on Microsoft integrations, other issues come up, however, different from those emerging in the strict comparison of those decisions. These issues, related to the coherence of the assessment of software integration behaviors, need to be examined herein. Firstly, the question arises as to whether to maintain the distinction at least in the US system between tie-in and monopolization (under which technological tying should rationally fall), since tying (whether contractual or technological) can be considered as one possible mechanism of predation (83). In the US, maintaining the distinction causes different standards to be used to assess predatory behaviors: monopolization, on the one hand, and tying, on the other hand (the latter also giving rise to wide debate on the tying being per se legal or illegal or needing a rule of reason approach). Whereas, in the EU, the abuse offense test is common for both
81

The obligation of disclosure, deduced form United States v. Microsoft Corp., 231 F.Supp.2d at E, was complied with by Microsoft when it integrated WMP (Commission Decision of 24.03.2004 at 315).
82

It is here worth recalling that, in the US system, technological tying falls under the monopolization offense i.e. section 2 of the Sherman Act; whereas, in the EU system, technological tying falls under the abuse provision, contractual tying being a subset of it. For this reason, in the European decision the difference between technological tying and contractual tying does not emerge, both behaviors falling under the same provision.
83

Jean Tirole, The Analysis of Tying Cases: A Primer, 1 COMPETITION POL. INTL 1,2 (2005). The Author expressly asserts that Like many other corporate strategies that make ones products attractive to consumers, tying has the potential of hurting competitors, and therefore is just one in a range of strategies that can be employed to prey on them. Competition policy therefore should analyze tying cases through the more general lens of predation test.

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contractual and technological tie-ins. This distinction, likely to lead to different outcomes, depending on the system under which a tying is assessed (84), does not even consider that tie-ins (whether contractual or technological) may be a perfect legitimate strategy, even for dominant or monopolistic firms; it is only the extent that they turned into predatory tools that they became a concern (85). Therefore, whenever these behaviors turn out to be means to predation, they need to be assessed under a sole and common standard. However, even if a solution were to be found for this first question, a second and more important question would still be addressed. Assuming that innovative behaviors were considered (regardless of being defined tying or monopolization) means of predation, how could good or bad innovation be distinguished? When these practices are means to predation or legitimate strategy? This brings up the initial question posed under the predatory innovation doctrine: when does innovation stop being beneficial and start becoming detrimental? Or, using the terminology herein adopted: when does innovation stop being an incentive for competition but start being exclusionary, thereby limiting competition in the market and preventing innovation? A criterion to distinguish between good and bad innovation can be elicited from the recent Microsoft decisions where both Court of Appeal, in Microsoft III, and Commission, in Microsoft IV, appear to have adopted a standard grounded on the balancing of pro-and anti-competitive effects and echoing the predatory innovation doctrine principles. The identification of this criterion, however, needs to be inserted in the wider context of to the

84

While certainty on how the assessment under section 1 of the Sherman Act would be carried the reminded decisions on this point not having been adopted the Commissions approach toward the tying in Microsoft IV consisted of an overall balance between anti- and pro-competitive effects, which took into account all the specific factual circumstances and (including an examination of the possible benefits of Microsofts conduct (see Jurgen Mensching, The Microsoft Decision promoting innovation, Addressed at the Sweet and Maxwell 4th Annual Competition Law Review Conference (October 22 2004) (transcript available at http://europa.eu.int/comm/competition/speeches/text/sp2004_017_en.pdf). It has to be borne in mind, though, that in the European version of Microsofts integration, this approach is easier to adopt due to the tying falling under the abuse provision.
85

Jean Tirole, supra n. 34, at 22.

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unresolved contrast between Competition law and Intellectual Property law (86).

5. COMPETITION

IPRS

CLASH IN THE SOFTWARE MARKET

Predatory (and exclusionary) innovation doctrine principles appear to underlie the above examined decisions, and courts appear to have increasingly opened up to their application, at least in the software market. Moreover, in Microsoft IV these principles seem to affect the outcomes of both technological and contractual tie-ins, thereby stretching from typical innovative practices such as technological integration at the manufacturing level to practices innovative in a broader sense such as contractual tying at the distribution level (87). Hence, it becomes even more crucial to answer the question as to which standard to adopt to draw a line between exclusionary and nonexclusionary innovation (a standard that could be valid even for other allegedly exclusionary behaviors not centered or not fully centered on innovation). Since awareness of network effects and openness towards market features have not always been present, a line between good and bad innovation has differently been drawn in the above surveyed decisions where the reasoning echoes the predatory innovation doctrine principles. However, progressively more weight has been given to evaluation of network effects and market features affecting the results of the innovative behaviors adopted by undertakings in relevant markets. In this context, the ultimate solution adopted in Microsoft III and IV cases appears the most evolved and efficient, in that it provides a criterion balancing both innovation and competition instances.
86

For an overview of relevant American cases involving such a clash see Peter M. Boyle, Penelope M. Lister, J. Clayton Everett, Jr., Antitrust Law at the Federal Circuit: Red Light or Green Light at the IP-Antitrust Intersection?, 69 ANTITRUST L.J. 739 (2002).
87

This can be affirmed if consideration is given to the fact that in Microsoft IV the Commission applied pro- and anti-competitive balance test to both technological and contractual tying.

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Broadly speaking, it can be elicited from Microsoft III and IV that innovation can be deemed exclusionary, and, therefore, violate antitrust law, whenever it prevents competitors further innovation (88). That is to say that, when innovation becomes a means to block further innovation, and it entrenches the innovator in its own dominant position, the innovation may be considered exclusionary. This phenomenon appears to be more likely in high-tech markets, such as the hardware and software markets, because of the role that network effects can play. Moreover, in this context, network effects can also affect future competition, and they should be evaluated in order to assess the effects of exclusionary practices on rivals future competitiveness. For example, with regard to the software market, a clear link can be found between integration today and competition tomorrow. Integrating proprietary software exposing APIs (such as middleware and OSs themselves) can create incentives for programmers to write for that software so as to trigger self-reinforcing network effects (89), as in the case of WMP integration and its effects on OEMS, content providers, and software developers (90). The high-tech markets in general, and the software market in particular, however, are also characterised by the presence of undertakings possessing IPRs as reward for their innovation and incentive for further innovating. IPRs may justify innovative behaviors adopted by rightholders in that they entitle them to freely dispose of the objects covered by the exclusive rights. Undertakings adopting software integration behaviors,
88

This idea was initially formulated in a time in which innovation was per se lawful by James W. Brock, Structural Monopoly, Technological Performance, and Predatory Innovation: Relevant Standards under Section 2 of the Sherman Act, 21 AMERICAN BUSINESS L.J. 1983, 291, 305-306 (1983). The Author also claims for a close investigation of and appreciation for the nature, degree and significance of structural monopoly power. This analysis should precede and condition the evaluation of performances in attempting to distinguish lawful and unlawful monopoly under section 2 of the Sherman Act.
89

Kai-Uwe Kuhn, Robert Stillman, Cristina Caffarra, Economic Theories of Bundling and their Policy Implication in Abuses Cases: An Assessment in Light of the Microsoft Case, University of Michigan John M. Olin Center for Law & Economics Working Paper Series 12 (transcript available at http://law.bepress.com/umichlwps/olin/art33) (September 2004). The Authors provide a systematic economic framework for marshalling arguments and evidence for an effective evaluation of bundling practices.
90

Richiamare la sentenza o, ancora meglio, lordine,

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thus, tend to assert that their freedom to act is reinforced by the IPR ownership and it is within the lawful exploitation of their IPRs (91). Although they are granted to promote innovation, when IPRs are used to justify predatory (or exclusive) behaviors, they end up limiting competition to the point to bring up, once more, the competition v IPRs clash. It is, thus, within this unresolved contrast that the software integration behaviors are to be assessed. In this context, the broad principle mentioned above, under which innovative behaviours become predatory (or exclusionary) whenever they prevent competitors innovation, still appears valid to the extent that it does not stifle innovation or, better, competition based on innovation. Such a principle, thus, needs a strict interpretation when applied to undertakings possessing IPRs, in order to allow them to maintain their freedom to compete on innovation through the lawful exploitation of their rights. In other words, as long as the innovation circle is in force (92), exploitation of IPRs cannot be deemed a means of predation, since this would mean limiting the incentive to further innovate and, consequently, limiting competition itself. However, when the undertaking possessing IPRs reaches what can be called the technological frontier, it cannot be allowed to prevent competitors from reaching that frontier as well by exploiting its IPRs. This would mean preventing competitors from further innovating and, consequently, stifling its own incentives to further innovate. IPRs exploitation can thus affect competition when the innovator has reached this technological edge or technological frontier as in the case of the software market where there seems to be no way to overtake that frontier without starting from the edge the innovator has already reached. To put it in another way, the IPRs v competition clash could be solved by implementing a system of rivalry until a standard emerges (93) (and a
91

This argument has emerged in the latest cases (Microsoft III and IV) where the courts attitude towards the software integration behaviors has been more doubtful than in the previous cases. Or, to put it in another way, there were more doubts that the behaviors in question were less innovative than those adopted in the earlier hardware and software integration cases (such as the IBM cases or the Caldera v Microsoft case).
92 93

See supra note 1 and and accompanying text.

Philip .J. Weiser, The Internet, Innovation, and Intellectual Property Policy, 103 COLUM. L. REV. 534 (2003). The Author expressly affirms that intellectual property law should resist allowing

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competitor is entrenched in it). At that point, intellectual property law remedies have to be put in place in order to enable products further developments (94). In the software market, due to network effects, having reached this technological frontier enables the incumbent, first, to block subsequent innovation (not only the subsequent innovation of competitors - unable to overtake that edge, but also subsequent innovation of the incumbent himself - not having any incentive to overtake it). And second, having reached this technological frontier enables the incumbent to prevent competitors from reaching it as well. Basically, because of these market features, competitors can always be kept a step behind. This is the concept appearing to underlie the courts towards disclosure of APIs. In fact, by having access to the new APIs of IE and WMP, competitors were deemed capable of further innovating and ameliorating their products, and, by doing this, they were deemed to produce incentives for the incumbent to further innovate in turn.

6. CONCLUSION The competition v IPRs clash can find a solution by implementing a threshold, below which IPRs still work as market based incentives to innovate, and above which they do not work as incentives anymore because the innovator has reached the technological frontier. In such a situation, IPRs are more likely to entrench the innovator in this technological frontier,
the copying of a user interface or allowing access to a platform standard where competition is otherwise sustainable in that market.
94

Philip .J. Weiser (supra at 534) asserts also the necessity for a compulsory licence system whenever a de facto standard is achieved in the software market. Same opinion is expressed by Makan Delrahim, Forcing Firms to Share the Sandbox: Compulsory Licensing of Intellectual Property Rights and Antitrust, Addressed at the British Institute of International and Comparative Law, London, England (transcript available at www.usdoj.gov/atr/public/speeches/203627.htm) (May 10 2001). However, the Authors favor towards compulsory licenses (whenever there is harm to competition) is conditioned to a narrowly drafting. Different opinion is adopted by Robert P. Merges, Who Owns the Charles River Bridge? Intellectual Property and Competition in the Software Industry, UC Berkeley Public Law and Legal Theory Working Paper No. 15 http://ssrn.com/abstract=208089 (October 1999). The Author affirms that standards-setting and pooling arrangements are a more useful remedial model whenever a head-on clash between property rights and innovation is present.

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thereby preventing competitors from reaching that frontier and innovator from further innovating. For this reason, in such a situation exploitation of IPRs should be regulated. And this regulation is necessary to enable competition on the merits to take place. It is to bear in mind that, in this way, incentives to innovate will not disappear, because competition on the merits will still be present and force the incumbent to further innovate. What the latest courts seem to consider necessary to enable the innovation circle to take place and not be blocked by the exploitation of IPRs by the rightholders entrenched in the technological frontier is disclosure. In fact, as to patents (assuming that patents on software are valid) (95), compulsory licences have been granted. And, as to copyright (assuming there is a copyright on APIs) (96), APIs and communication protocols disclosure has been constantly affirmed. This solution is also likely to reconcile competition and IPRs instances. Since both Competition and Intellectual Property laws aim at promoting innovation, a mechanism tilting toward the former or the latter, depending on the relevant market features and maturity, can maintain competition in the market and enable the innovation circle to take place (97).

95 96 97

On this point see Case T-201/04, Microsoft Corp. v. Commission, 4 C.M.L.R. at 177-185. Id., at 167-176.

A non dissimilar system for the software market has been theorized by John Hogan, Competition Policy for Computer Software Markets, J.I.L.T., 2002(2), at 14 (available at <http://www2.warwick.ac.uk/fac/soc/law/elj/jilt/2001_2/hogan/). The Author affirms that once a software standard has succeeded on the market, the economic features of the software industry dictate a shift to a compatibility regime. Quality access to the information necessary to produce interoperable products will be indispensable for effective, ongoing competition. From here the Author identify a positive obligation on dominant firms to allow rivals access to interface information to the extent necessary to develop interoperable products.

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