THE IMPORTANCE OF OPEN NETWORKS IN
SUSTAINING THE DIGITAL REVOLUTION
DR. MARK COOPER
DIRECTOR OF RESEARCH, CONSUMER FEDERATION OF AMERICA
FELLOW, STANFORD CENTER FOR INTERNET AND SOCIETY
I. HISTORIC, LEGAL AND ANALYTIC FRAMEWORK
INTRODUCTION AND OUTLINE
In the five years since consumer advocates first asked the Federal Communications
Commission (FCC)1 to rule that the advanced telecommunications networks over which the
high-speed Internet flows are subject to the obligation of nondiscrimination there has been an
immense amount of policy activity -- FCC proceedings,2 court cases,3 antitrust consent decrees,4
1 Cf. Reply Comments of Center for Media Education, et. al., Inquiry Concerning the Deployment of Advanced
Telecommunications Capability to America Americans in a Reasonable and Timely Fashion, and Possible Steps to Accelerate
Such Deployment Pursuant to Section 706 of the Telecommunications Act of 1996, Federal Communications Commission, CC
Docket No. 98-146, October 10, 1998; Petition to Deny of Consumers Union, et. al., Joint Application of AT&T Corporation and
Tele-Communications Inc. For Approval of Transfer of Control of Commission Licenses and Authorizations, Federal
Communications Commission, CS Docket NO. 98-178, October 28, 1998.
2 Cf. Consumer Federation of America, Texas Office of People’s Counsel, and Consumers Union, “Reply Comments,”
before the Federal Communications Commission, In the Matter of In The Matter Of Deployment Of Wireline Services Offering
Advanced Telecommunications Capability, Etc., CC Docket Nos. 98-147, 98-11, 98-26, 98-32, 98-78, 98-91, CCB/CPD Docket
N. 98-15, RM 9244, October 18, 1998. Comments of CU, et al., Inquiry Concerning High-Speed Access to the Internet Over
Cable and Other Facilities, GEN Docket No. 00-185 (filed December 1, 2001); “Comments Of Arizona Consumer Council,
Center For Digital Democracy, Citizen Action Of Illinois, Citizens Utility Board Of Oregon, Consumer Action, The Consumer
Federation Of America, Consumers Union, Democratic Processes Center, Florida Consumer Action Network, Illinois PIRG,
Massachusetts Consumer Coalition, Media Access Project, New Jersey Citizen Action, Texas Consumer Association, Texas
Office Of Public Utility Counsel, USaction,” In the Matter of Appropriate Framework for Broadband Access to the Internet Over
Wireline Facilities Universal Service Obligations of Broadband Providers Computer III Further Remand Proceedings: Bell
Operating Company Provision of Enhanced Services; 1998 Biennial Regulatory Review – Review of Computer III and ONA
Safeguards And Requirements, Federal Communications Commission, CC Dockets Nos. 95-20, 98-10 (hereafter Wireline
Proceeding), May 3, 2002; Reply Comments, July 1; “Comments of Texas Office of Public Utility Counsel, Consumer
Federation of America, Consumers Union,” In the Matter of Inquiry Concerning High Speed Access to the Internet over Cable
and Other Facilities, Federal Communications Commission, GN Docket No. 96-262, December 12, 1999, January 12, 2000;
“Comments of Texas Office of Consumer, Consumer Federation of America, In the Matter of Inquiry Concerning High-Speed
Access to the Internet Over Cable and Other Facilities Internet Over Cable; Declaratory Ruling; Appropriate Regulatory
Treatment for Broadband Access to the Internet Over Cable Facilities, Federal Communications Commission, GN Dockets Nos.
00-185, CS Dockets No. 02-52, March 15, 2002; “Comments and Reply Comments Of The Consumer Federation Of America,
Texas Office Of Public Utility Counsel, Consumers Union, And Center For Digital Democracy,” In the Matter of Review of the
Section 251 Unbundling, Obligations of Incumbent Local Exchange Carriers, Implementation of the Local Competition
Provisions of the Telecommunications Act of 1996, Deployment of Wireline Services Offering Advanced Telecommunications
Capability, Federal Communications Commission, CC Dockets Nos. 01-338, 96-98, 98-147, April 5, 2002; Reply Comments,
July 1, 2002.
3 Cf. “Amicus Curiae Brief of Citizens’ Utility Board of Oregon, Consumer Action, Consumer Federation of America,
The utility Reform Network (TURN) and Utlity Consumer Action Newtwork, AT&T v. Portland, 216 F.3d 871 (9th Cir. 2000),
“Opening Brief of Consumer Federation of America, Consumers Union and Center for Digital Democracy, Brand X Internet
Service, et al., v. Federal Communications Commission, October 10, 2001.
1
and a great deal of congressional activity.5 In the economy, the Internet bubble has burst,
thousands of Internet Service Providers (ISPs) have gone out of business and Personal Computer
sales have suffered the longest slump in their history.6 Uptake of broadband services is
perceived to be lagging and policymakers are scrambling to fix the problem.7
In this paper I argue that the cure being administered – allowing proprietary closure of
communications networks – may be worse than the disease. The short-term fix creates much
more serious long-term problems. The failure of public policy to deal with the growing threats
to open digital networks has played a part in the current slowdown in these sectors and will
create even more severe problems in the long term.8 While policymakers have repeatedly
asserted a commitment to openness and promised that when they see a problem they will react to
it, they have turned a blind eye to obvious discriminatory and anticompetitive acts.
In this paper I try to open their eyes with empirical facts covering a broad range of
situations. I start with a long view of principles of open access in the development of capitalism,
from inns and roads to the Federal Communications Commission’s Computer Inquiries. After
establishing an analytic framework, I examine the problem caused by discrimination in two key
layers of digital networks, the code layer (Microsoft’s abuse of market power in operating
systems) and the physical layer (cable and telephone abuse of market power over facilities).
Only by taking a long term, broad view can policymakers appreciate that open
communications networks are a critical underpinning of our political and economic vitality.
Only by recognizing how deeply open communications and transportation networks are
embedded in the DNA of capitalism can we have a fruitful discussion about how to adapt this
fundamental principle to capitalism in the digital information age.
4
United States v. AT&T and MediaOne, Amended Complaint, Case No. 1:00CV001176 (RCL) (D.C. Cir.
May 26, 2000)
5
Tauzin dingel, etc.
Boardwatch, various issues.
7 “report and Order and Order on Remand and Further Notice of Proposed Rulemaking,” In the Matter of Review of
Section 251 Unbundling Obligations of Incumbent Local Exchange Carriers, Implementation of the Local Competition
Providsion of the Telecommunications Act of 1996, Deployment of Wireline Services Offering Advanced Teelcommunications
Capability, CC Docket Nos. 01-338, 96-98, 98-147, Augsut 21, 2003.
8 Support for open communications networks in the Internet age has been a pillar of consumer group policy, cf. Cooper,
Mark, Expanding the Information Age for the 1990s: A Pragmatic Consumer View (American Association of Retired Persons and
Consumer Federation of America, January 11, 1990). This was the first in a series of reports that analyzed the effects of
decentralized, open networks, prior to the dramatic commercial success of the Internet (see Cooper, Mark, Developing the
Information Age in the 1990s: A Pragmatic Consumer View, (Consumer Federation of America, June 8, 1992,, "Delivering the
Information Age Now," Telecom Infrastructure: 1993, Telecommunications Reports, 1993, The Meaning of the Word
Infrastructure (Consumer Federation of America, June 30, 1994).
6
2
HISTORICAL BACKGROUND
OPEN HIGHWAYS OF COMMERCE AND COMMUNICATIONS NETWORKS: A CORNERSTONE OF
CAPITALISM AND DEMOCRACY
As capitalism was dissolving feudalism, the emerging social order discovered an
important new social, political and economic function – mobility. Physical and social mobility
were anathema to feudalism, but it soon became clear that mobility was essential to capitalism
and democracy. Providing for open and adequate highways of commerce and means of
communications were critical to allow commerce to flow, to support a more complex division of
labor and to weave small distant places into a national and later global economy.
Common carriage and nondiscrimination were the solutions. For example, under
common law, innkeepers were obligated to serve all travelers, thereby supporting the movement
of people, goods and services. Not only were all to be served on a nondiscriminatory basis, but
when the innkeeper hung out his sign he brought upon himself the obligation to protect the
property of the traveler. A legal text provides the following summary:
There is also in law always an implied contract with a common innkeeper, to
secure his guest’s goods in his inn… Also if an inn-keeper, or other victualer,
hangs out a sign and opens his house for travelers, it is an implied engagement to
entertain all persons who travel that way; and upon this universal assumpsit, an
action on the case will lie against him for damages, if he without good reason
refuses to admit a traveler.9
Inns were critical to commerce since, given the technology of the time, only short
distances could be covered before rest and sustenance were needed. As critical as inns were to
the flow of commerce, obviously roads were more important. Turnpike trusts were the first
vehicle of the early capitalist political economy to provide for roads. Created in the 17th and 18th
centuries and building on principles of common law, these were private undertakings with a
public franchise to collect tolls on the section of a road whose upkeep was the responsibility of
the trustee. Fees were assessed and access provided on a nondiscriminatory basis.
By the 19th century, however, direct public responsibility for roads became the norm and
provided nondiscriminatory access without direct fees. Maintaining a network of
transcontinental roads became a governmental responsibility, first city, then state, then national.
Later, the principles of nondiscriminatory access were carried through to all national
communications and transportation networks. Roads and highways, canals, railroads, the mail,
telegraph, and telephone, some owned by public entities, most owned by private corporations,
have always been operated as common carriers that are required to interconnect and serve the
public on a non-discriminatory basis.
An early court decision regarding telecommunications provides an interesting historical
perspective:
9 Cited in James B. Speta, “A Common Carrier Approach to Internet Interconnection,” Federal Communications Law
Journal, 54 (2002) (hereafter Speta), at 254.
3
The telephone has become as much a matter of public convenience and of public
necessity as were the stagecoach and sailing vessel a hundred years ago, or as the
steamboat, the railroad, and the telegraph have become in later years. It has
already become an important instrument of commerce. No other known device
can supply the extraordinary facilities which it affords. It may therefore be
regarded, when relatively considered, as an indispensable instrument of
commerce. The relations which it has assumed towards the public make it a
common carrier of news – a common carrier in the sense in which the telegraph is
a common carrier – and impose upon it certain well defined obligations of a
public character. All the instruments and appliances used by the telephone
company in the prosecution of its business are consequently, in legal
contemplation, devoted to a public use.10
The early date of this observation, 1886, is notable, but so too is the comprehensive
history. The telephone network was in its infancy but its vital nature brought the obligation of a
common carrier upon it. Telephones would soon become a dominant means of business
communication. Traditional practice did not excuse it from public interest obligations because it
was new.
OBLIGATIONS EVOLVE TO KEEP NETWORKS OPEN
Interestingly, the railroads, whose transcontinental network was completed only two
decades before this decision, had already brought specific legislation to impose common carriage
upon themselves because of anticompetitive and discriminatory business practices. By price
gouging and discrimination against shippers, direct regulation was imposed, first at the city level,
but later at the state level and ultimately the national level. These large corporate entities had
failed to be restrained by the common law principles of common carriage or the common law
principles were inadequate to the more complex reality of industrial society. As the Collum
Committee found, “the paramount evil chargeable against the operation of the transportation
system of the United States as now conducted is unjust discrimination between persons, places,
commodities, or particular descriptions of traffic.”11 More discipline was needed to protect the
public interest and society responded with specific obligations of nondiscrimination and
interconnection and the provision of service at just and reasonable rates.
It is an important historical theme, to which I will return later, that the transformation of
the economy in the second industrial revolution gave rise to new forms of economic organization
that seemed unwilling to be bound by principles of commerce that were critical to the
maintenance of a dynamic capitalist economy. Private contract and common law had failed to
promote the public interest and was replaced by more direct public obligations. Moreover, as the
nature of the economy and economic organization change, the nature of conduct that is
considered anti-social changes as well. Policymakers must not be satisfied with mere economic
theory; they must examine the actual behavior and outcomes in the market. In my view, the
American economy benefited mightily from a half century of the reaffirmation of the
commitment to open communications and transportation networks (e.g. the Interstate Commerce
10
11
Hockett v. State Indiana, 1886, cited in Id. at 262.
Cited in Kahn, Alfred, The Economics of Regulation: Principles and Institutions (Cambridge, MA: 1988), p. 55.
4
Act (1887), the Mann Elkins Act (1910) and the Communications Acts (1934)) and to
competitive principles (the Sherman Act (1880), the Clayton Act (1914) and the Federal Trade
Commission Act (1914)).
This understanding of common carriage is quite prevalent, as an analysis prepared by
Morgan Stanley Dean Witter, The Digital Decade, noted in describing common carriers,
Generally, they are involved in the sale of infrastructure services in transportation
and communications. The legal principle of common carriage is used to ensure
that no customer seeking service upon reasonable demand, willing and able to pay
the established prices, however, set, would be denied lawful use of the service or
would otherwise be discriminated against.
. . . Significantly, a carrier does not have to claim to be a common carrier to be
treated as such under the law: a designation of common carriage depends upon a
carriers actual business practices, not its charter... .
Common carriage is also thought to be an economically efficient response to
reduce the market power of carriers through government regulation, preventing
discrimination and/or censorship and promoting competition. It is also said to
promote the basic infrastructure, reduce transaction costs from carrier to carrier,
and extend some protections for First Amendment rights from the public to the
private sector.12
Interestingly, the early days of the current technologica/industrial revolution, the digital
revolution, has experienced similar themes of constancy and change. Many participants in the
debate over advanced telecommunications services have pointed out that the FCC played a key
role in creating the dynamic environment that supported the development of the Internet with its
“Computer Inquiries.”13 These rulemakings found a way to allow computer data services,
enhanced services and later information services to grow by ensuring that the underlying
telecommunications services were open and available.
Lawrence Lessig is blunt about the government’s role, claiming, “[p]hone
companies…did not play… games, because they were not allowed to. And they were not allowed
to because regulators stopped them.” 14 Thus, a determined commitment to open communications
networks was critical to the widespread development of the Internet.
The government's activism imposed a principle analogous to [end-to-end] design
on the telephone network... By requiring the natural monopoly component at the
basic network level to be open to competitors at higher-levels, intelligent
12
Morgan Stanley Dean Witter, The Digital Decade, Apr. 6, 1999, at 177-178.
Comstock, Earl W. and John Butler. 2000. “Access Denied: The FCC’s Failure to Implement Open
Access as Required by the Communications Act.” Journal of Communications Law and Policy, Winter.
14 Lawrence Lessig, The Future of Ideas 2001, p. 148, emphasizes the break with the computer inquiries in approach
13
to advanced telecommunications services.
5
regulation can minimize the economic disruption caused by that natural monopoly
and permit as much competition as industry will allow.15
We certainly do not claim that a communications network would have been
impossible without the government's intervention. We have had
telecommunication networks for over a hundred years, and as computers matured,
we no doubt would have had more sophisticated networks. The design of those
networks would not have been the design of the Internet, however. The design
would have been more like the French analogue to the Internet--Minitel. But
Minitel is not the Internet. It is a centralized, controlled version of the Internet,
and it is notably less successful. 16
I suggest that the current deployment of broadband service is “notably less successful”
because the principle of nondiscriminatory access has been abandoned. Current arguments
against obligations to provide nondiscriminatory access are based on the claim that competition
exists between two networks and that is all the American economy needs. That claim is wrong
as a matter of historical fact and practical experience. Deregulation advocates have mistakenly
set up a mutually exclusive choice between competition and public obligations.17
Public roads competed against privately owned canals, but they were both subject to
common carrier obligations. Private railroads were added to compete with canals and roads, and
they were all subject to common carrier obligations. Telegraph, wireline telephone and wireless
are all common carriers. In other words, we have layered alternative modes of communications
one atop another, each using a different technology, each optimized for a somewhat different
form of communications and still we imposed the common carrier obligations.
Although an obligation to provide nondiscriminatory access to communications networks
has been a long-standing principle in the U.S., the most recent iteration of this policy had a
particularly powerful effect because it interacted with the spreading technology (computer) and
architectural principle of the Internet (end-to-end) to create a uniquely dynamic environment.
We find that the deeper and more pervasively the principle of openness is embedded in the
communications network, the greater the ability of information production to stimulate
innovation.
The notion that two competitors are enough to ensure a vigorously competitive market is
inconsistent with economic theory and decades of empirical evidence. Monopoly is not now and
never has been a necessary legal condition for common carrier status. The existence of
intermodal competition did not eliminate the obligation for nondiscrimination. The paramount
15 Mark A. Lemley & Lawrence Lessig, The End of End-to-End: Preserving the Architecture of the Internet in the
Broadband Era, 48 UCLA L. REV. 925, 935 (2001) [hereinafter Lemley & Lessig, End of End-to-End] (written as a direct
response to James P. Speta, Written Ex Parte, Application for Consent to the Transfer of Control of Licenses MediaOne Group,
Inc. to AT&T Corp. FCC DOC.NO. 99-251 (1999)) See also James B. Speta, The Vertical Dimension of Cable Open Access, 71 U.
COLO. L. REV. 975. (2000); Phil Weiser, Paradigm Changes in Telecommunications Regulation, 71 U. COLO. L. REV. 819 (2000)
(responding to an earlier piece by Lemley & Lessig, Written Ex Parte, Application for Consent to Transfer Control of Licenses of
MediaOne Group Inc. to AT&T Corp., FCC DOC. NO. 99-251 (1999) available at
http://cyber.law.harvard.edu/works/lessig/filing/lem-les.doc.html [hereinafter, Lemley & Lessig]).
16 Lemley and Lessig, supra note 14, at 936.
17 James B. Speta, The Vertical Dimension of Cable Open Access, 71 U. COLO. L. REV. 975. (2000); Phil Weiser,
Paradigm Changes in Telecommunications Regulation, 71 U. COLO. L. REV. 819 (2000
6
concern is the nature of the service, not the conditions of supply. The public convenience and
necessity is promoted by a service because it becomes a critically important, indispensable input
into other economic activity. The function provided by and the network characteristics of
transportation and communications industries are conducive to creating the conditions for
“affecting the public interest.”
Starting from the demand side to arrive at common carrier obligations does not mean that
the conditions of supply do not matter. On the supply-side, a key characteristic of common
carriers is the reliance on some public resource for the deployment of the network.
Transportation and communications networks are typically the beneficiaries of public largesse or
special considerations. The public support may take one of many forms, such as public funds,
use of public property, the right to condemn private property, or the grant of a franchise.
The manner in which the service is offered to the public is also important. Service that is
made widely available to the public becomes affected with the public interest. The presence of
market power over a vital service is another factor that leans in favor of common carriage status.
Viewed in this way, the presence of market power on the supply side is only one of several
considerations in determining whether common carrier status should be applied to a particular
service, and by no means the most important.
POLITICAL SUPERIORITY OF OPEN COMMUNICATIONS NETWORKS
Because of the age in which we live, most of the debate over open access has been about
economic value and values, but I want to start with and highlight the political aspects of the
issue. Leading analysts of industrial organization have long recognized the convergence
between truly competitive markets and democratic values. They “begin with the political
arguments, not merely because they are sufficiently transparent to be treated briefly, but also
because when all is said and done, they, and not the economists’ abstruse models, have tipped
the balance of social consensus toward competition.”18
Thus, atomistic competition is seen to promote individualistic, impersonal decisions with
freedom of opportunity and relatively low resource requirements for entry. The dispersion of
power that typifies atomistically competitive markets is extremely attractive as a base for
democracy.
One of the most important arguments is that the atomistic structure of buyers and
sellers required for competition decentralizes and disperses power. The resource
allocation and income distribution problem is solved through the almost
mechanical interaction of supply and demand forces on the market, and not
through the conscious exercise of power held in private hands (for example, under
monopoly) or government hands (that is, under state enterprise or government
regulation). Limiting the power of both government bodies and private
individuals to make decisions that shape people’s lives and fortunes was a
fundamental goal of the men who wrote the U.S. Constitution… A closely related
benefit is the fact that competitive market processes solve the economic problem
18
F.M. SCHERER & DAVID ROSS, INDUSTRIAL MARKET STRUCTURE AND ECONOMIC PERFORMANCE 4 (3d ed. 1990), at 18.
7
impersonally, and not through the personal control of entrepreneurs and
bureaucrats…19
The underlying dynamic of success in competitive economies which promote fluidity
because of a lack of barriers to entry is another key characteristic.
A third political merit of a competitive market is its freedom of opportunity.
When the no-barriers-to-entry condition of perfect competition is satisfied,
individuals are free to choose whatever trade or profession they prefer, limited
only by their own talent and skill and by their ability to raise the (presumably
modest) amount of capital required.20
The Internet principle of end-to-end converges with the strong commitment in our society
to democratic values. The transparency of the network and its reliance on distributed
intelligence foster innovation and empower speakers at the ends of the network. These are ideal
for populist forms of democracy. The Internet captures these qualities to an extreme degree.
Relative anonymity, decentralized distribution, multiple points of access, no
necessary tie to geography, no simple system to identify content, tools of
encryption – all these features and consequences of the Internet protocol make it
difficult to control speech in cyberspace. The architecture of cyberspace is the
real protector of speech there; it is the real “First Amendment in cyberspace,” and
this First Amendment is no local ordinance…
The architecture of the Internet, as it is right now, is perhaps the most important
model of free speech since the founding.21
The preference for atomistic competition in the economy applies with special force to
communications media, particularly in the information age.22 They are not only a means of
commerce; they are also the primary means of communications. The Communications Act
embraces competition as a goal, but it has always demanded more.
When economists tell us that digital networks industries exhibit extreme economies of
scale and scope that drives them toward a very small number of very large entities, we must
redouble our efforts to prevent the negative effects that centralized economic power can have on
our democracy.
19
Id. at 19.
Id.
21 Lawrence Lessig, LAWRENCE LESSIG, CODE AND OTHER LAWS OF CYBERSPACE 166-167 (1999).
22 See Yochai Benkler, From Consumers to Users: Shifting the Deeper Structures of Regulation Toward Sustainable
Commons and User Access, 52 FED. COMM. L.J. 561 (2000); Yochai Benkler, Intellectual Property and the Organization of
Information Production, 22 INT’L REV. L. & ECON. 81 (2002), available at
http://www.law.nyu.edu/benklery/IP&Organization.pdf.
20
8
ECONOMICS OF DIGITAL COMMUNICATIONS NETWORKS
ECONOMIC SUPERIORITY OF OPEN COMMUNICATIONS NETWORKS IN THE DIGITAL
INFORMATION AGE
In a 1994 publication, just as the commercial Internet was taking off, the National
Research Council referred to the Internet as a “bearer” service, underscoring the concept of open
access -- “An open network is one that is capable of carrying information service of all kinds
from suppliers of fall kinds to customers of all kinds, across network service providers of all
kinks, in a seamless accessible fashion.”23 Exhibit 1 presents the graphic they used to convey the
importance of the bearer service. The networks and protocols at the neck of the hourglass are the
link between diverse networks and a broad range of applications.
Not surprisingly, the NRC chose the then current example to make its point – “The
telephone system is an example of an open network, and it is clear to most people that this kind
of system is vastly more useful than a system in which the users are partitioned into closed
groups based, for example, on the service provider or the user’s employer.”24 The principles of
openness it identified bear repeating:
Open to users. It does not force users into closed groups or deny access to any
sectors of society, but permits universal connectivity, as does the telephone
network.
Open to providers. It provides an open and accessible environment for competing
commercial and intellectual interests. For example, it does not preclude
competitive access for information providers.
Open to network providers. It makes it possible for any network provider to meet
the necessary requirements to attach and become a part of the aggregate of
interconnected networks.
Open to change. It permits the introduction of new applications and services over
time. It is not limited to only one application, such as TV distribution. It also
permits the introduction of new transmission, switching, and control technologies
to become available in the future.25
We should also note that three components of the digital platform – the PC, the Internet
and the telecommunications network – were largely open at the time. The result has been a
vigorously competitive, consumer-friendly, democratic communications environment. The
economic impact of open communications networks in the digital age is more potent than ever.26
The Internet distribution technology or bearer service transforms economic activity, opens new
23
NATIONAL RESEARCH COUNCIL, Realizing the Information Future, 43 (1994).
Id. 43
25 Id. at 44.
26 Evans Phillip and Thomas S. Wurster, Blown to Bits: How the New Economics of Information Transforms Strategy
(Cambridge: Harvard Business School Press, 2000), p. 17; ; Castells, Manual, The Internet Galaxy (2001);
24
9
markets, and supports even faster development than transportation and communications
revolutions have typically done. As a business text observed:
Taken together these critical features of the Internet are understood by economics
by generalizing the concept of the Internet’s bearer service through the idea that
the Internet acts as a general-purpose technology or platform technology. The
reduced transaction costs and positive network externalities often found on the
Internet enable new products to be brought to market more easily and quickly
than in the past.27
The importance of open communications for advanced telecommunications networks has
been recognized by the industries that are dependent on that network. The High Tech Broadband
Coalition called on the FCC to “protect important ‘connectivity principles’ that have made the
Internet what it is today.” They offered four principles:
Consumers have a right to meaningful information regarding technical limitations
of their service.
Consumers should have unrestricted access to their choice of Internet content
using the bandwidth capacity of their service plan.
Cable modem customers should be allowed to run applications of their choice, as
long as they do not harm the providers network and are within the bandwidth
limits of their service plans.
Consumers should be permitted to attach any devices they choose, without prior
permission, to their ISP connection, so long as they operate within the agreed
bandwidth, do not harm the provider’s network, or enable the theft of services.28
In essence the High-Tech Broadband Coalition is advocating nondiscrimination or
neutrality of the network for consumers so that vigorous competition can continue between
developers and suppliers of devices, applications and content. The effect of this “network
neutrality” would be to restore or ensure the fundamental principle that service originating on
one network would be able to interconnect with all other networks, thereby preserving the
Internet as a network of networks.
NEW ECONOMY; NEW CHALLENGES
At every stage of the development of the Internet, owners of network facilities sought to
undermine its open nature.29 As it was being created in the 1970s, telephone companies argued
for centralization. Again, as it was being rolled out in its commercial form in the 1980s, the
telephone companies sought to impose centralized control and overturn the principles of the
“Computer Inquiries.” Today, yet again, the owners of network facilities and dominant software
27 McKnight, Lee W., “Internet Business Models: Creative Destruction as Usual,” in Lee W. McKight, Pauls M.
Vaaler, and Raul L. Katz (eds.) Creative Destruction: Business Survival Strategies in the Global Internet Economy (Cambridge:
MIT Press, 2001), p. 45.
28 “Comments of the High Tech Broadband Coalition”
29 Janet Abbate, Inventing the Internet (1999).
10
utilities seek to control the flow of innovation and services. Cable operators moving from the
video business into the telecommunications business have imported their closed, private carriage
model.
In a world of collegial collaboration and coordination, the ends of the network could be
relied upon to support the seamless flow and interoperability of data.30 The end-to-end principle
kept the network simple and cheap so that applications developers at the end points could
experiment and innovate with confidence that the network would not get in the way.31 A world
of commercial competition, spiraling technical complexity, and troubling human frailties gives
network operators and dominant software firms the impetus to begin fencing in the Internet, as
they insert choke points to monitor and control data flows. Hackers and viruses, spammers and
"bandwidth hogs” on the consumer side of the network, congestion and complexity in the
network, sticky features, and closed, proprietary systems on the provider side of the network,
now challenge the fundamental, open architecture of the Internet.
The greatest threat to openness and dynamic innovation on the Internet has not come
from technical glitches or even nefarious human actions, however.32 Rather, the most damaging
restrictions sought or imposed by commercial network owners or dominant software owners
have little to do with the technical problems of managing a complex, increasingly congested
network. They are not motivated by efforts to solve the social problem of creating trust in
cyberspace, or to further the effort to fight new forms of cyber-crime or old forms of physical
space crime made more challenging by their migration to cyberspace. The restrictions they seek
to impose are driven by business models intended to preserve market power in physical space
and extend it into cyberspace.
To the extent that there is a new, digital network economy of the 21st century, the refusal
to interconnect or interoperate, the withholding of network functionalities, or the denial of access
to content and applications are important socio-economic transgressions that demand much
greater scrutiny because they destroy the beneficial externalities that these networks are all
about. They are anticompetitive in the sense that they diminish significantly the level of
competition for content and applications and undermine the rich sources of economic progress in
the networked economy. They are anti-social because they undermine the ability of citizens to
speak and be heard.
ANALYTIC TOOLS FOR DIGITAL COMMUNICATIONS NETWORKS
A new economy requires some new analytic tools. The most popular approach is to
define the communications/computer/information industries as platform industries. Since
convergence is blurring the distinctions, I use shorthand and talk of a digital communications
platform. Antitrust authorities reviewing mergers or evaluating complaints of anticompetitive
conduct and Communications Act authorities considering obligations of interconnection and
30 Clark and Blumenthal, 2001 Clark, David D. and Marjorie S. Blumenthal, “Rethinking the Design of the Internet:
The End-to-End Argument vs. The Brave New World,” Telecommunications Policy , August 10, 2000
31 Reed, David P., Jerome Saltzer and David D. Clark, Active Networking and End-to-End Arguments, May 15.1998.
32 Mark Cooper, Open Access to the Broadband Internet: Technical and Economic Discrimination in Closed,
Proprietary Networks, 71 U. COLO. L. REV. 1011 (2000); Cooper, Mark N. and Christopher Murray, Technology, Economics And
Public Policy To Create An Open Broadband Internet, The Policy Implications of End-to-End, Stanford Law School, December
1, 2000
11
universal service must view digital media and communications networks as a platform that
provides an environment in which information or content is produced and in which new sources
of anticompetitive conduct must be recognized.
I use four layers in the platform (see Exhibit 2). Lessig and Yochai Benkler use three,
others use as many as seven. 33 The four layers that define the digital communications platform
are the physical layer, the logic or code layer, the applications layer and the content layer. It is a
platform because there are strong complementarities between the layers and each layer sustains
broad economic activity in the layer above it.34 It is an important platform because it will drive a
great deal of economic activity in the years ahead.
The physical layer is composed of three parts: a transmission medium (e. g. wires or
spectrum), communications equipment in the network and appliance or display devices at the
consumer premise (PC, TV). The logic (or code) layer involves the codes and standards with
which communications equipment and display devices interconnect, interoperate, and
communicate. Protocols interpret the signals. Operating systems allocate and coordinate the
resources of the system. The operating systems and communications protocols can be resident
in communications equipment and devices or network equipment or both. Applications
constitute the third layer. Applications are programs that execute a sequence of steps to solve a
problem or perform a task for the user. The content layer is made up of the specific task or
problem solved in a given execution of an application. The end-user or a service provider can
provide content.
Competition within a given layer, the equivalent of traditional horizontal competition,
can take place without competition across layers.35 Competition across layers is very important,
both because it can present dynamic change and because it can involve anticompetitive leverage.
If it is procometitive, it is very beneficial because it can move the whole platform to a higher
33 LESSIG, supra note 12 at (noting that TIM BERNERS-LEE, WEAVING THE WEB: THE ORIGINAL DESIGN AND ULTIMATE
DESTINY OF THE WORLD WIDE WEB BY ITS INVENTOR 129-30 (1999), identified four layers: transmission, computer, software and
content).
34 Shapiro and Varian, Information Rules (Cambridge: Harvard Business School Press, 1999), pp. 9 – 15; Richard N.
Langlois, Technology Standards, Innovation, and Essential Facilities: Toward a Schumpeterian Post-Chicago
Approach, in DYNAMIC COMPETITION & PUB. POLICY: TECHNOLOGY, INNOVATIONS, AND ANTITRUST ISSUES 193,
207 (Jerry Ellig ed., 2001), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=204069 (last visited Jan.
24, 2003) (calling platforms “system products” – “Most cumulative technologies are in the nature of system
products, that is, products that permit or require the simultaneous functioning of a number of complementary
components.”).
35 Michael L. Katz and Carl Shapiro, System Competition and Network Effects, 8 J. ECON. PERSP. 93, 105-06 (1994)
[hereinafter Katz & Shapiro, System Competition], argue that competition between incompatible systems is possible, depending
on consumer heterogeneity. Paul Belleflamme, Stable Coalition Structures with Open Membership and Asymmetric Firms, 30
GAMES & ECON. BEHAV. 1, 1-3 (2000), and Berd Woeckener, The Competition of User Networks: Ergodicity, Lock-ins, and
Metastability, 41 J. ECON. BEHAV. & ORG. 85, 86-87 (2000), reach a similar conclusion in a different theoretic framework.
Timothy F. Bresnahan and Shane Greenstein, Technological Competition and the Structure of the Computer Industry, 47 J.
INDUS. ECON. 1, 5-8 (1999), envision a great deal of competition within the layers of a platform and across layers in relatively
short periods of time. The description of IBM’s mainframe platform provided by Franklin M. Fisher, The IBM and Microsoft
Cases: What’s the Difference, 90 AM. ECON. REV., 180, 183 (1999), stresses both these points. See also Daniel L. Rubinfeld,
Antitrust Enforcement in Dynamic Network Industries, 43 ANTITRUST BULL. 859, 873-75 (1998); Willow A. Sheremata, New
Issues in Competition Policy Raised by Information Technology Industries, 43 ANTITRUST BULL. 547, 573-74 (1998) [hereinafter
Sheremata, New Issues in Competition].Timothy Bresnahan, The Economics of the Microsoft Case (available from the author);
Steven C. Salop and R. Craig Romaine, “Preserving Monopoly: Economic Analysis, Legal Standards, and Microsoft,” Geo.
Maons L. Rev., 1999.
12
level of production. If it is anticompetitive, it is very dangerous because it can pollute a
competitive layer and may undermine the best basis for introducing competition in a layer that
had not hitherto been competitive. The narrowness of the bottleneck makes threats to the
openness of the network very potent.
Communications industries have always exhibited network effects and strong economies
of scale.36 Their production and distribution become more valuable as more people have access
to them. As the number of users grows, economic benefits are created on both the supply and the
demand sides. By increasing the number of units sold, the cost per unit falls dramatically. Cost
savings may apply not only to initial production costs, but also to service and maintenance costs.
Computer industries exhibit other characteristics. As the installed base of hardware and
software deployed grows, learning and training in the dominant technology is more valuable
since it can be applied by more users and to more uses. 38 As more consumers use a particular
technology, each individual consumer can derive greater benefit from it. Larger numbers of
users seeking specialized applications create a larger library of applications that become
available to other users, and secondary markets may be created. These are all the positive
benefits of network externalities. Dominant firms at the physical and code layers can build up
large installed bases quickly and become beneficiaries of these economics. Decisions to keep
these layers open can spread the benefits. Digitization may reinforce these economic
characteristics. Economies of scope reinforce economies of scale. Adding service to the bundle
lowers average costs.
NEW SOURCE OF MARKET POWER IN NEW NETWORK ECONOMY INDUSTRIES
The great success and the growing concern about the platform industries derive from the
fact that the lower layers do not appear to be very competitive.39
It has become clear that the
physical infrastructure of digital communications networks and the code layer have immense
leverage and are unlikely to exhibit a great deal of horizontal competition.40 There are not now
nor are there likely to be a sufficient number of networks deployed in any given area to sustain
vigorous competition. Vigorous and balanced competition between operating systems has not
been sustained for long periods of time.
Scale and scope economies may be so strong in the lower layers that that may give rise to
a unique characteristic of a market called tipping. Interacting with network effects and the
36
Shapiro and Varian, supra note, pp. 22-23.
Gaines, Brian, R., “The Learning Curve Underlying Convergence,” Technology Forecasting and Social Change
Jan./Feb. 1998, pp. 30-31; Arthur, W. Brian, "Positive Feedbacks in the Economy.” Scientific American. Feb. 1990, p. 95; see
also Arthur, W. Brian. 1989, "Competing Technologies, Increasing Returns and Lock-in by Historical Events.” Economic
Journal. 1989:99..
39 Daniel L. Rubinfeld & John Hoven, Innovation and Antitrust Enforcement, in DYNAMIC COMPETITION AND PUBLIC
POLICY: TECHNOLOGY, INNOVATION, AND ANTITRUST ISSUES 65, 75-76 (Jerry Ellig ed., 2001).
40 T. Randolph Beard, George S. Ford, and Lawrence J. Spiwak, Why ADCo? Why Now: An Economic Exploration into
the Future of Industry Structure for the “Last Mile” in Local Telecommunications Markets (Phoenix Center, November 2001);
Computer Science and Telecommunications Board, National Research Council, Broadband, Bringing Home the Bits
(Washington, D.C.: National Academy Press, 2002) (hereafter, Bits), pp. 23; 152-154; Anupam Banerjee and Marvin Sirvu,
“Towards Technologically and Competitively Neutral Fiber to the Home (FTTH) Infrastrcuture,” Telecommunications Policy
Research Conference, 2003; Stagg Newman, “Braodband Access Platforms for the Mass Market, Telecommunications Policy
Research Conference, 2003.
38
13
ability to set standards, the market tips toward one producer. Firms seek to capture these
positive externalities and accomplish technological “lock-in.”42 These processes create what has
been called an ‘applications barrier to entry.’ After capturing the first generation of customers
and building a customer and programming base, it becomes difficult, if not impossible, for later
technologies to overcome this advantage.43 Customers hesitate to abandon their investments in
the dominant technology and customer acquisition costs rise for latecomers.
This creates an immense base of monopsony power. I use the term monopsony broadly
to refer to the ability to control demand. If a firm is a huge buyer of content or applications or
can dictate which content reaches the public (a cable operator that buys programming or a
operating system vendor who bundles applications), it can determine the fate of content and
applications developers. In fact, network effects are also known as demand side economies of
scale. To the extent that a large buyer or network owner controls sufficient demand to create
such effects, particularly in negotiating with sellers of products, they have monopsony power.
The platform nature of digital communications creates unique new sources of vertical
leverage. In old economy industries, vertical leverage is exploited by business practices.
Companies vertically integrate to internalize transactions. They may withdraw business from the
open market, driving up the cost of inputs for competitors or deny supply to the market. If they
constitute a large share of the market or refuse to buy or sell intermediate inputs (or raise the
costs of rivals) the impact can be anticompetitive.
In a platform industry, vertical leverage can take an additional and more insidious form,
technological integration/manipulation.44 Introduction of incompatibilities can impair or
undermine the function of disfavored complements. The ability to undermine interoperability or
the refusal to interoperate is an extremely powerful tool for excluding or undermining rivals and
thereby short circuiting competition. The mere threat of incompatibility or foreclosure through
the refusal to interoperate can drive competitors away.
One of the most important observations about the origins of a positive feedback process
is its openness in the early stages of development.45 In order to stimulate the complementary
assets and supporting services, and to attract the necessary critical mass of customers, the
technology must be open to adoption and development by both consumers and suppliers.46 This
42 Melissa A. Schilling, Technological Lockout: An Integrative Model of the Economic and Strategic Factors Driving
Technology Success and Failure, 23 ACAD. MGMT. REV. 267, 270 (1998); Willow A. Sheremata, Barriers to Innovation: A
Monopoly, Network Externalities, and the Speed of Innovation, 42 ANTITRUST BULL. 937, 941, 964, 967 (1997) [hereinafter
Sheremata, Barriers to Innovation].
Robin Cowan, Tortoises and Hares: Choice Among Technologies of Unknown Merit,
101 ECON. J. 807, 808 (1991). Dominique Foray, The Dynamic Implications of Increasing Returns: Technological Change and
Path Dependent Efficiency, 15 INT’L J. INDUS. ORG. 733, 748-49 (1997); Schilling, supra note Error! Bookmark not defined., at
268; Joseph Farrel & Garth Saloner, Standardization, Compatibility, and Innovation, 16 RAND J. ECON. 70, 70-83 (1986).
43 Jeffrey Church & Neil Gandal, Complementary Network Externalities and Technological Adoption, 11 INT’L J.
INDUS. ORG. 239, 241 (1993); Chou Chien-fu & Oz Shy, Network Effects Without Network Externalities, 8 INT’L J. INDUS. ORG.
259, 260 (1990).
44 See Langlois, supra note Error! Bookmark not defined., at 52 “The owner of a dominant standard may thus want
to manipulate the standard in ways that close off the possibilities for a competitor to achieve compatibility. This has a tendency
to retard the generational advance of the system.”
45.
Yoffie, supra note Error! Bookmark not defined., at 21; see also Bresnahan & Greenstein, supra note
Error! Bookmark not defined., at 36-37; Katz & Shapiro, System Competition, supra note Error! Bookmark not defined., at
103.
46.
Schilling, supra note Error! Bookmark not defined., at 280-81.
14
openness captures the critical fact that demand and consumers are interrelated.47 If the activities
of firms begin to promote closed technologies,48 this is a clear sign that motivation may have
shifted.49 While it is clear in the literature that the installed base is important, it is not clear that
an installed base must be so large that a single firm can dominate the market. As long as
platforms are open, the installed base can be fragmented and still be large.50 In other words, a
large market share is not synonymous with a large market.51 A standard is not synonymous with
a proprietary standard.52 Open platforms and compatible products are identified as providing a
basis for network effects that is at least as dynamic as closed, proprietary platforms53 and much
less prone to anti-competitive conduct.54
The economic literature provides ample basis for concern that the physical layer of
communications platforms will not perform well without a check on inherent market power. In
this layer, barriers to entry are substantial and go far beyond simple entrepreneurial skill that
needs to be rewarded. At the structural level, new entry into these physical markets is difficult.
Rents in markets with barriers to entry other than entrepreneurial skill are larger than they need
to be to attract investment and do not dissipate so quickly.
Similarly, at the code layer of the computer industry, it did not take Microsoft long to
discover that once the physical layer of the computer (a platform itself) was commoditized,
Microsoft possessed the market power position in the computer platform. In fact, Microsoft has
recognized well the potency of the physical layer as it moves from the computer world into the
digital communications platform. It vigorously opposed the expansion of a competing
applications developer into the facility layer and is supporting both efforts to impose nondiscrimination obligations on network operators and development of an alternative distribution
network – unlicensed spectrum.
The dominant players in the physical and code layers can readily distort the architecture
of the platform to protect their market power.55 They have a variety of tools to create economic
and entry barriers 56 such as exclusive deals,57 retaliation,58 manipulation of standards,59 and
strategies that freeze customers.60
47.
48.
Katz & Shapiro, Antitrust in Software, supra note Error! Bookmark not defined., at 424.
See generally, id.; Jay Pil Choi, Network Externalities, Compatibility Choice and Planned Obsolescence, 42
J. INDUS. ECON. 167 (1994).
49.
Robin Mansell, Strategies for Maintaining Market Power in the Face of Rapidly Changing Technologies, 31
J. ECON. ISSUES 969, 970 (1997).
50.
Schilling, supra note Error! Bookmark not defined., at 274.
51.
Sheremata, Barriers to Innovation, supra note Error! Bookmark not defined., at 965.
52.
HAL VARIAN & KARL SHAPIRO, INFORMATION RULES (1999).
53.
Bresnahan & Greenstein, supra note Error! Bookmark not defined., at 36-37; Joseph Farrell & Michael L.
Katz, The Effect of Antitrust and Intellectual Property Law on Compatibility and Innovation, 43 ANTITRUST BULL., 645, 650
(1998); Katz & Shapiro, System Competition, supra note Error! Bookmark not defined., at 109-12; Carmen Matutes & Pierre
Regibeau, Mix and Match: Product Compatibility Without Network Externalities, 19 RAND J. ECON. 221-233 (1988).
54.
Mark A. Lemley & David McGowan, Could Java Change Everything? The Competitive Propriety of a
Proprietary Standard, 43 ANTITRUST BULL. 715 (1998) [hereinafter Lemley & McGowan; Could Java]; Mark A. Lemley &
David McGowan, Legal Implications of Network Effects, 86 CAL. L. REV. 479, 516-18 (1998) [hereinafter Lemley & McGowan,
Legal Implications].
55See id. See also Franklin M. Fisher, Innovation and Monopoly Leveraging, in DYNAMIC COMPETITION AND PUBLIC
POLICY: TECHNOLOGY, INNOVATION, AND ANTITRUST ISSUES 138 (Jerry Ellig ed., 2001).
56See Joseph Farrell & Garth Saloner, Installed Base and Compatibility: Innovation, Product Preannouncements, and
Predation, 76 AM. ECON. REV. 940, 948-51 (1986); Michael L. Katz & Carl Shapiro, Product Introduction with Network
15
These anti-competitive behaviors are attractive to a new economy monopolist for static
and dynamic reasons. 61 Preserving market power in the core market by erecting cross-platform
incompatibilities, raising rivals’ costs, or preventing rivals from achieving economies of scale,
can preserve market power in the core product and allow rents to persist. Profits may be
increased in the core product by enhanced abilities to price discriminate. Conquering
neighboring markets has several advantages. By driving competitors out of neighboring markets,
new monopolies may be created or the ability to preserve market power across generations of a
product may be enhanced by diminishing the pool of potential competitors.
The emerging model for closed communications platforms is one in which the owner
with a dominant technology at the lower layers of the platform can leverage their control to
achieve domination of applications and content. With proprietary control for network layers in
which there is a lack of adequate alternatives, they can lock in consumers and squeeze
competitors out of the broader market.
Firms can leverage their access to customers to reinforce their market dominance62 by
creating ever-larger bundles of complementary assets.63 As the elasticity of demand declines
over the course of the product life cycle, market power lodged in the physical layer results in
excessive bundling64 and overpricing of products under a variety of market conditions.65 Control
over the product cycle can impose immense costs by creating incompatibilities,66 forcing
Externalities, 40 J.INDUS. ECON. 55, 73 (1992); Richard Makadok, Can First-Mover and Early-Mover Advantages Be Sustained in
an Industry with Low Barriers to Entry/Imitation?, 19 STRATEGIC MGMT. J. 683, 685-86 (1998); Ulrich Witt, “Lock-in” vs.
“Critical Masses”– Industrial Change Under Network Externalities, 15 INT’L J. INDUS. ORG. 753, 768-69 (1997); Robin Mansell,
Strategies for Maintaining Market Power in the Face of Rapidly Changing Technologies, 31 J. ECON. ISSUES 969, 970 (1997).
57See Melissa A. Schilling, Technological Lockout: An Integrative Model of the Economic and Strategic Factors
Driving Technology Success and Failure, 23 ACAD. MGMT. REV. 267, 276 (1998).
58See Willow A. Sheremata, “New” Issues in Competition Policy Raised by Information Technology Industries, 43
ANTITRUST BULL. 547, 573-74 (1998); Glenn A. Woroch et al., Exclusionary Behavior in the Market for Operating System
Software: The Case of Microsoft, in OPENING NETWORKS TO COMPETITION: THE REGULATION AND PRICING OF ACCESS 221
(David Gabel & David F. Weiman eds., 1998).
59 See Sheremata, supra note 116, at 560-61; see also CHARLES H. FERGUSON, HIGH ST@KES, NO PRISONERS: A
WINNER’S TALE OF GREED AND GLORY IN THE INTERNET WARS 307 (1999); Mark A. Lemley & David McGowan, Could Java
Change Everything? The Competitive Propriety of a Proprietary Standard, 43 ANTITRUST BULL. 715, 732-33 (1998).
60
See Joseph Farrell & Michael L. Katz, The Effects of Antitrust and Intellectual Property Law on
Compatibility and Innovation, 43 ANTITRUST BULL. 609, 643-50, (1998); Sheremata, supra note 116, at 547, 573-74.
61 See id., at 19-24; see also Michael Katz & Carl Shapiro, Antitrust and Software Markets, in COMPETITION,
INNOVATION AND THE MICROSOFT MONOPOLY: ANTITRUST AND THE DIGITAL MARKETPLACE, 70-80 (Jeffrey A. Eisenach &
Thomas M. Lenard eds., 1999); Lansuz A. Ordover & Robert D. Willig, Access and Bundling in High Technology Markets, in
COMPETITION, INNOVATION AND THE MICROSOFT MONOPOLY: ANTITRUST AND THE DIGITAL MARKETPLACE (Jeffrey A. Eisenach
& Thomas M. Lenard eds., 1999) ; Rubinfeld, supra note 110, at 877-81; Steven C. Salop, Using Leverage to Preserve
Monopoly, in COMPETITION, INNOVATION AND THE MICROSOFT MONOPOLY: ANTITRUST AND THE DIGITAL MARKETPLACE
(Jeffrey A. Eisenach & Thomas M. Lenard eds., 1999).
62See Makadok, supra note 113, at 685.
63See David B. Yoffie, CHESS and Competing in the Age of Digital Convergence, in COMPETING IN THE AGE OF
DIGITAL CONVERGENCE 1, 27 (David B. Yoffie ed., 1997); see also Robert E. Dansby & Cecilia Conrad, Commodity Bundling, 74
AM. ECON. REV. 377 (1984).
64 See Carmen Matutes & Pierre Regibeau, Compatibility and Bundling of Complementary Goods in a Duopoly, 40 J.
INDUS. ECON. 37 (1992).
65 See id.; see also Joseph P. Guiltinan, The Price Bundling of Services: A Normative Framework, J. MKTG. April
1987, at 74; Lester Telser, A Theory of Monopoly of Complementary Goods, 52 J. BUS. 211 (1979); Richard Schmalensee,
Gaussian Demand and Commodity Bundling, 57 J. BUS. S211 (1984).
66 See Jay Pil Choi, Network Externality, Compatibility Choice, and Planned Obsolescence, 42 J. INDUS. ECON. 167,
171-73 (1994).
16
upgrades,67 and by spreading the cost increases across layers of the platform to extract consumer
surplus.68
Antitrust authorities and much of public interest regulation focuses on price as the
measure of market performance, but in the digital age innovation and choice are at least as
important. Thus, I distinguish between consumer harm and economic harm. Consumer harm is
measured in terms of excess prices and profits. Economic harm is measured in terms of chilling
of innovation and denial of consumer choice, which imposes indirect costs on the consumer and
dulls the competitive process.
II. ANTICOMPETITIVE LEVERAGE IN THE LOGIC LAYER
MARKET POWER ABUSE
Imagine yourself a new attorney at the Department of Justice and the following document
comes across your desk in discovery (which is compiled from DOJ exhibits). I believe that
every new antitrust lawyer and Communications Act policy maker should be required to read the
ten most important exhibits in the Microsoft case. I have flagged antitrust issues and the analytic
concepts I have introduced previously. 69 Not all of these leads will pan out, but they should be
followed.
“I don’t understand how IE [Internet Explorer] is going to win. The current path is
simply to copy* everything that Netscape does packaging and product wise… We are not
leveraging* Windows from a marketing perspective and we are trying to copy Netscape and
make IE into a platform. We do not use our strength — which is that we have an installed base*
of Windows and we have a strong OEM shipment channel for Windows. I am convinced we
have to use Windows — this is the one thing they don’t have . . . We have to be competitive with
features, but we need something more — Windows integration.*
“Let’s [suppose] IE is as good as Navigator/Communicator. Who wins? The one with
80% market share.* Maybe being free helps us, but once people are used to a product it is hard to
change them.* Consider Office. We are more expensive today* and we’re still winning. My
conclusion is that we must leverage* Windows more. Treating IE as just an add-on to Windows
which is cross-platform [means] losing our biggest advantage — Windows market share. We
should dedicate a cross group team to come up with ways to leverage* Windows technically
more . . . We should think about an integrated solution — that is our strength.
67 See Glenn Ellison & Drew Fudenberg, The Neo-Luddite’s Lament: Excessive Upgrades in the Software Industry,
RAND J. ECON. (2000); Drew Fudenberg & Jean Tirole, Upgrades, Trade-ins, and Buybacks, 29 RAND J. ECON. 235, 235-36
(1998).
68 See id. at 176-77; K. Sridhar Moorthy, Market Segmentation, Self Selection, and Product Lines Design, 3 MKTG. SCI.
256 (1985); Marcel Thum, Network Externalities, Technological Progress, and the Competition of Market Contract, 12 INT. J.
INDUS. ORG. 269 (1994).
69 Mark Cooper, Antitrust as Consumer Protection in the New Economy: Lessons from the Microsoft Case, 52
HASTINGS L.J. 813 (2001)
17
“We will bind the shell to the Internet Explorer, so that running any other browser is a
jolting* experience.
“If you agree that Windows is a huge asset, then it follows quickly that we are not
investing sufficiently in finding ways to tie* IE and Windows together. . . most importantly it
must be killer on OEM shipments so that Netscape never gets a chance* on these systems.”
Do you think you have a case? Obviously, the Department of Justice did. These are
traditional antitrust practices – tying, foreclosure – with new economy twists on them. Tying
becomes integration. But notice the importance of installed base and customer lock in. Notice
the leverage through incompatibility – jolting other browsers.
Anticompetitive leverage across the layers of a platform played a prominent role in the
Microsoft case. Microsoft perceived the threat from applications – a web browser and an
applications language – to its operating system monopoly (see Exhibit 3). Microsoft knew that
the browser would be the principle interface between the user and the Internet. It sought to
capture that market functionality to prevent it from “commoditizing” the operating system.70 It
responded with such a vigorous anticompetitive campaign that even an extremely conservative
appeals court concluded 7-0 that the antitrust law had been violated.
Rather than rehash the case, I prefer to look to the future. We can start from the remedy.
The Department of Justice proposed a vertical divestiture that would eliminate leverage across
layers of the platform. By restricting rent collection to one layer and promoting new competition
across the layers, the goal was to restore the competitive process that had been snuffed out in the
mid-1990s.
The solution that was ultimately adopted involves modest regulation of access to
Microsoft’s code for a limited period of time. I am deeply skeptical that it will work. If we look
back at the description of the anticompetitive practices, there are at least four markets against
which the tactics were used – DR-DOS in the late 1980s/early 1990s, the desk top and other
applications in the early-mid 1990s, navigator in the mid-late 1990s, and hints of an e-commerce
assault in the late 1990s (see Exhibit 4). The XP.NET initiative raises similar concerns.71
Windows XP and the .NET initiative are a bundle of services glued together by
technological links (code embedded in the operating system), contractual requirements, and
70 Government Exhibit #20: Memorandum from Bill Gates, The Internet Tidal Wave, dated May 26, 1995, United
States v. Microsoft, 84 F. Supp. 2d 9 (D.D.C. 1999) (Nos. CIV. A. 98-1232, 98-1233.
71 Cooper, Mark. 2001b, “Consumer Federation of America and Consumers Union, Competitive Processes,
Anticompetitive Practices And Consumer Harm In The Software Industry: An Analysis Of The Inadequacies Of The MicrosoftDepartment Of Justice Proposed Final Judgment,” United States v. Microsoft Corp., Civil No. 98-1232, before Judge Colleen
Kollar-Kotelly of the U.S. District Court for the District of Columbia, January 25, 2002, analyzing U.S. v. Microsoft, 253 F.3d
34, 103 (D.C. Cir. 2001)(en banc).
18
marketing leverage. 72 The software, applications, and services that Microsoft has bundled
covers all of the functionalities that are converging on the Internet including the following:73
Communications
E-Mail (Hotmail)
Messaging (Microsoft Messenger)
Commerce
Identity Verification (Passport—names and addresses)
Utilities (e.g. calendars, contact Lists)
Transactions (e.g. documents, payment records)
Applications
Music (Media Player 8)
Video (Media Player 8)
Digital Photography (My Pictures)
Internet Services
MSN
Today these Internet activities are competitive, just as the browser was before Microsoft
launched its attack. Microsoft is seeking to leverage its operating system and browser
monopolies into a victory in the present “applications war.” 74 A familiar set of tactics is being
used again to help maintain Microsoft’s monopoly in operating systems and now Internet
browsers by “handicapping” another generation of “products with potential to ultimately erode
that monopoly.” 75
Microsoft uses the existing monopolies in operating systems, browsers and office suites,
to capture the consumer and vendor interfaces for the next generation of computing, controlling
communication, identify verification,76 and driving its proprietary languages into the interface
between vendors and the Internet.77 The clear attempt by Microsoft leverage its existing
Buckman, Rebecca, “A Titan’s Power – Potent Program: With its Old Playbook, Microsoft is Muscling Into New
Web Markets Using Aggressive Bundling, It Roils High-Tech World with Windows Overhaul Some Gains for Consumers,” Wall
Street Journal, June 29, 2001.
73 Electronic Privacy Information Center, et al, “Complaint and Request for Injunction, Request for
Investigation and Other Relief,” In The Matter of Microsoft, Federal Trade Commission, July 26, 2001 (hereafter, EPIC
Complaint), “Supplemental Materials in Support of Pending Complaint and Request for Injunction, Request for
Investigation and Other Relief,” In The Matter of Microsoft, Federal Trade Commission, August 15, 2001 (hereafter,
EPIC Supplemental).
74 Concerns are not limited to only these markets. For example, the effort to capture the wireless market involves the
following (Coursey, David, “How Microsoft is Planning to Conquer the Wireless Industry, Too,” ZDNet.com, August 30, 30,
2001; The European Union has also launched an investigation into Microsoft that covers the server market, see “European Union
Expands Antitrust Probe of Microsoft,” Associated Press, August 30, 2001, Mitchener, Brandon and Ted Bridis, “Microsoft
Faces New Allegations From Europe,” Wall Street Journal, August 31, 2001.
75 PC Magazine, April, 16, 2001.
76 Cooper, Charles, “Allchin Bangs the Drum for XP,” ZDNet News, August 29, 2001,
I want to talk about what’s in Windows XP and what it talks to on the back end. There are meta-Internet
services we talk about which we consider to be pretty fundamental, architecturally, for building and making
the Internet a little easier for people to use. Authentication and presence – in the future, we may have others
– both those two, for the present, are core. And we’re trying to support both of those in Windows XP.
77 Foley, Mary Jo, “Microsoft’s. NET: Integration to the Max,” ZDNet News, June 22, 2000, quote Steve Ballmer,
Microsoft’s CEO and President,
We are taking elements of the user interface and programming model, and nicely and tightly integrating
them, first into the client, and then into the server.
72
19
monopolies in the PC operating environment to frustrate potential competition from Internet,78 or
distributed computing79 not only relies on the same anticompetitive business and technology
practices, but it targets a wide range of activities that consumers are likely to conduct on the
Internet.80
Microsoft’s own description of the “Windows XP/.NET” strategy leaves no doubt that
this is what the bundle does.81 Microsoft declares this set of software programs and services as
“the next generation of the windows desktop platforms. An operating system for the internet…
with one infrastructure for developing for it.”82 Microsoft aims to drive communications through
proprietary e-mail and, more importantly, messaging technology.83 This new communications
technology will provide a new platform for a wide range of new applications.84 There is no doubt
that this is a computing platform.85
The bundle is built on commingled code,86 proprietary languages,87 and exclusive
functionalities88 that are promoted by restrictive licenses,89 refusal to support competing
applications,90 embedded links,91 and deceptive messages.92 The Internet Explorer browser is
78
Thurrott, Paul, “Microsoft Responds: Win2K is the Cornerstone of .NET,” Windows 2000 Magazine, November 7,
2000.
Network World, April 16, 2001,”Microsoft is shooting for the same degree of dominance in Web computing that it
had in the client/server model.”
80 Mossberg, Walter, Wall Street Journal, May 17, 2001.
81 “The Redmond Menace: Microsoft With Everything At Stakes, Is Gambling Its Future on Controlling the Net The
Way It Did PCs,” The Industry Standard, April 20, 2001.
82 Holland, Maggie, “Microsoft Users Face .NET Lock-In,” Computing, March 22, 2001. Web Services, an Interview
with Robert Hess, March 19, 2001.
83 Markoff, John, “Microsoft is Ready to Supply a Phone in Every Computer,” New York Times, June 12, 2001;
Gartner Examines Microsoft versus America Online Impending War in Instant Messaging and Web Services Space, May 1, 2001.
84 Fortt, Jon, “Battle Rages for Future of Instant Messaging,” Siliconvalley.com, January 12, 2001, quotes Bob Visse,
Project Manager for Microsoft Network.
85 “Bill Gates Unplugged,” Redherring.com, September 2000, “.NET is a Microsoft platform. Just like the
Windows platform.” “Letter for Gerald Waldron to Magalie Roman Salas,” In the Matter of Applications of America
Online, Inc. and Time Warner, Inc. for Transfer of Control, Federal Communications Commission, CS Docket No. 0030, October 13, 2000.
86 The distinction between technological bundling and contractual bundling presents complex analytic questions that
provided some of the most dramatic courtroom incidents as various experts sparred over how code could be removed and what
impact that would have on the functionality (John Heilemann, Pride Before The Fall 181-86 (2001). The Project to Promote
Competition and Innovation in the Digital Age, alleges a great deal of commingling of code (see Microsoft’s Expanding
Monopolies: Casting a Wider .NET, May 15, 2001, and to a lesser extent Passport to Monopoly: Windows XP, Passport, and the
Emerging World of Distributed Applications, June 21, 12001), which appears to be supported by the journalistic discussion of
embedded applications; see also Fester, Dave, CNET News.Com, May 1, 2001..
87
Microsoft’s proprietary run time environment pervades Windows XP and its browsers, (“Runtime Hosts,” Microsoft
.NET Framework Developers Guide, Microsoft, 2001.
88 Markoff, John, “Breaks in Talks Between AOL and Microsoft,” “New York times, June 17, 2001.
89 At a minimum, the restrictive licenses are the subject of the dispute over placement of icons (see Bass, Dina,
“Microsoft Requires PC Makers to Put MSN With Links,” Bloomberg, July 27, 2001; Clark, Don, “Microsoft Broadens Rules for
PC Makers,” Wall Street Journal, August 9, 2001).
90 While Microsoft advances it run time environment, it has pulled back on support for competitors, see Wilke, John,
and Don Clark, “Microsoft Pulls Back Is Support for Java: New Windows XP System Won’t Include Software Needed to Run
Programs,” Wall Street Journal, August 9, 2001; Copeland, Lee, “Sun Lashes Out at Microsoft for Javaless Windows XP,”
ComputerWorld, August 27, 2001.
91 Bass, Dina, “Microsoft Requires PC Makers to Put MSN With Links,” Bloomberg, July 27, 2001.
92 Electronic Privacy Information Center, Complaint and Request for Injunction, Request for Investigation and for
Other Relief, July 26, 2001.
79
20
hardwired into the operating system. Microsoft’s Messenger is hardwired into XP.93 Numerous
other programs are hardwired into the bundle including the Media Player, Dialer, Outlook
Express, and Hotmail.94
In a repeat of past actions against competing software, Windows XP will not fully
support critical applications from competing suppliers while it promotes Microsoft’s proprietary
offerings.95 In other words, the operating system is being manipulated to make competing
software less attractive.96 Windows media player will not fully support RealPlayer format.97
Windows media player will not support ripping of MP3 format.98 In other words, if you want to
record music, you must use Microsoft’s WMA format. 99 Content (music and videos) created in
Microsoft formats, WMA for audio and WMF for video will not play on competing players.100
Microsoft’s digital rights management programs are bundled with “Windows XP/.NET.”101
Taken together this is a comprehensive campaign to use the operating system to make it difficult
to use competing formats.102
93 Buckman, Rebecca, and Julia Angwin, “Microsoft, AOL Battle on Windows XP, Talks on Online Deal Falter As
Software Maker Plans Instant-Message Feature,” Wall Street Journal, June 4, 2001.
94 Chase, Steve, “Microsoft’s Media Mission, Software Giant Plans to Tie New Multimedia Tool to Windows, But
Rivals in Player Wars Slam Move as Anti-competitive,” Globe and Mail, May 3, 2001. ilcox, Joe, “Want Media Player 8? Buy
windows XP,” CNET News.com, April 24, 2001. Mossberg, Walter, S., “The New Windows: Best Yet, But beware, Windows XP
Rarely Crashes but Acts as a Trojan Horse to Tout Microsoft Services,” Wall street Journal,
95 Mossberg, Walter, S., “The New Windows: Best Yet, But beware, Windows XP Rarely Crashes
but Acts as a Trojan Horse to Tout Microsoft Services,” Wall street Journal,.
96 Swisher, Kara, “Microsoft Charts New Course, But is it the Right Approach?” Wall Street Journal, March 26, 2001,
No surprise, hailstorm works better with Microsoft’s dominant products, integrated with software
applications and based on existing free Microsoft services like Passport.
97
Graham, Jeffrey, “Windows Media Promise, But Snafus Remain,” USA Today, May 26, 2001:Helm, Kristi, Mercury
News Seattle, quoting Henry Blodget, Merryl Lynch analyst,
We continue to believe there is a significant risk that Microsoft will do to RealNetworks what it did
to Netscape – take over the market by bundling functionality in larger products and giving it away for free.
98 Hansen, Evan, “Windows XP and MP3 May Not Mix,” CNET News.com, June 12, 2001,
Test versions of the new operating system have alternatively included and excluded an encoder, or
“ripper,” that would allow people to convert audio tracks from CDs to the MP3 format, according to
Windows XP product Manager Tom Lammel…
Even if the company does include an MP3 ripper, it is likely to be a version that does not produce
high-quality copies because the cost would be prohibitive to the company, Lammel said…
Although previous versions of its operating system have supported MP3 rips from other companies,
Microsoft’s own audio and video software, Windows Media Player, has converted files only the Windows
media format, dubbed WMA.
Lammel said an early test version of Windows XP included a riper, but it has been dropped from
the most recent beta.
Mossberg, Walter, S., “The New Windows: Best Yet, But beware, Windows XP Rarely Crashes but Acts as a
Trojan Horse to Tout Microsoft Services,” Wall street Journal,
It’s the same story with Windows XP’s new Media Player, which plays music and videos. The
program is much improved, and Microsoft’s proprietary music format, WMA, is a very good competitor to
the widely used MP3 format. But while the Media Player can play MP# files, it can’t create them unless you
download an extra-cost “plug-in” from a third-party company. It can create only WMA files.
99Wilcox, Joe, “Windows XP: A Bundle of Trouble?”, CNET News.com, May 21, 2000.
100 The importance of the media player filters into a wide range of applications. Wilcox, Joe, “Want Media Player 8?
Buy windows XP,” CNET News.com, April 24, 2001,
101 EPIC, Complaint.
102 The forced upgrade cycle plays a key role here. By desupporting competing software and driving consumers to new
machines, Microsoft erases the installed-base of its competitors. Buckman, Rebecca, “A Titan’s Power – Potent Program: With
its Old Playbook, Microsoft is Muscling Into New Web Markets using Aggressive Bundling, It Roils High-Tech World with
Windows Overhaul Some Gains for Consumers,” Wall Street Journal, June 29, 2001
21
With the launch of Windows XP, Microsoft is for the first time requiring software
developers to “pre-certify” the launch of their software with Microsoft.103 Instead of simply
writing a piece of software and placing it on the market, developers must now go through
Microsoft to ensure “compliance” in the name of the stability of the XP platform, thereby giving
Microsoft control over technology development.104
With “Windows XP/.NET” Microsoft continues to impose anticompetitive restrictions
that bias computer manufacturers and consumers against non-Microsoft products.105 Microsoft
offers one bundle with all programs included. Computer manufacturers have no choice but to
take this entire bundle because there are no viable competing operating systems. 106 Microsoft
insists on equal or superior location for its products if a competitor is shown on the desktop.
Further, Microsoft insists on being paid for all the programs, regardless of whether the computer
manufacturer wants to use them all.107 As a result of the combination of pricing and onscreen
restriction, non-Microsoft products are forced to pay for space that Microsoft gets for free.
In essence, Microsoft requires computer manufacturers to either keep the screen “clean”
with only a few Microsoft-only Icons, or to clutter the screen and hard drive by presenting both
Microsoft and non-Microsoft products.108 Manufacturers are prohibited from presenting an
uncluttered screen with non-Microsoft products only. Since manufacturers are forced to take the
entire Microsoft bundle and must include Microsoft products whenever they include a nonMicrosoft product, they are discouraged from installing non-Microsoft products.
Microsoft had adopted other strong-arm tactics that rely on monopoly provided market
power. Microsoft seeks to impose exclusivity through code and or contracts on applications and
software.109 Concerns about pressure and intimidation to adopt the new bundle have surfaced.110
Similarly, charges of patent infringement have been filed.111 The pattern of preannouncing a
product, to freeze consumers into waiting for Microsoft’s offering rather than buy from
competitors is evident to some.112
Music is another battleground. Microsoft announced earlier this year that the latest version of its
Windows Media Player, which lets people listen to music and watch videos on the Web, will work only with
Windows XP and not with older versions of the operating system. Mitch Kapor, the founder of onetime rival
Lotus Development Corp., calls that a “forced March to upgrade.”
103 Vaughn, Steven, “Resisting The Windows XP Message,” ZDNet, May 9, 2001; Smart Partner ZDWire, May 8,
2001.
104 Vaughn, Steven, “Resisting The Windows XP Message,” ZDNet, May 9, 2001; Smart Partner ZDWire, May 8,
2001,
105 Mossberg, Walter, S., “The New Windows: Best Yet, But beware, Windows XP Rarely Crashes but Acts as a Trojan Horse to
Tout Microsoft Services,” Wall street Journal.; ckman, Rebecca S. “Microsoft Plan for Licenses Sparks Gripes,” Wall Street
Journal, September 25, 2001; Wilcox, Joe, “Microsoft Customers Balk at License Changes,” CNET New.com,” September
20, 2001.
106 Wilcox, Joe, “Want Media Player 8? Buy windows XP,” CNET News.com, April 24, 2001,
107 Appeals, p. 90.
108 Cooper, Charles, “Allchin Bangs the Drum for XP,” ZDNet News, August 29, 2001.
109 Klein, Alec, “Microsoft, AOL Clashed Over Media Player,” Washington Post, June 21, 2001.
110 Klein, Alec, “Microsoft, AOL Clashed Over Media Player,” Washington Post, June 21, 2001; Buckman, Rebecca,
“A Titan’s Power – Potent Program: With its Old Playbook, Microsoft is Muscling Into New Web Markets using Aggressive
Bundling, It Roils High-Tech World with Windows Overhaul Some Gains for Consumers,” Wall Street Journal, June 29, 2001.
Mrakoff, John, “Break in Talks Between AOL and Microsoft,” June 17, 2001.
111 Wilcox, Joe, “Windows XP Could See September Ship Date, CNET News.com, August 7, 2001.
112 Wong, Wylie and Robert Lemos, “HailStorm Still Thunders in the Distance,” ZDNet News, August 30, 2001,
22
Microsoft also biases consumer choices by leveraging its market power over the
operating system.113 Microsoft imposes restrictions on its licenses that require its programs to
launch automatically and/or require its programs to be the default option. Microsoft uses its
operating system and browser monopolies to repeatedly prompt consumers to choose Microsoft
programs.114 Microsoft has built biases into the list of frequently used applications that give an
advantage to Microsoft applications. Add/remove sequences are difficult and confusing for
bundled Microsoft applications.115 Microsoft sweeps icons off the desktop. Combined with the
list bias and the add/remove bias, this results in Microsoft programs being more likely to be
found and easier to use. Finally, Microsoft has embedded links to Microsoft products and
partners.116 These restrictions bias consumers toward Microsoft products and against nonMicrosoft products.
It should be stressed that none of these restrictions are technologically necessary.117
Screen bias, list bias, and add/remove bias are all business practices Microsoft uses to undermine
competing programs. Computer manufacturers can present uncluttered screens with nonMicrosoft products just as easily as they can present uncluttered screens with Microsoft only
products. They can have non-Microsoft products launch automatically or be the default options.
Add/remove sequences can be neutral with respect to any piece of software. The marketplace of
the computer screen could be scrupulously competitively neutral – a level playing field. The
Appeals Court was quite strong in this regard in upholding the District Court.118 It found
virtually all restrictions on computer manufacturer control of the start sequences and screen
presentation to be anticompetitive. 119
CONSUMER HARM
There are two readily identifiable areas of consumer harm in the court’s findings –
monetary harm to consumers and qualitative harm to innovation and competitive processes.120
The court focused on issues of quality and innovation, although it did note pricing abuse.121 A
precise quantitative estimate of monetary harm was not a focal point in the courtroom because
there could be no monetary penalty in this case. Identifying the pricing practices that indicated
abuse, and the various anti-competitive uses to which the ill-gotten gains have been put, was
sufficient.
Swisher, Kara, “Microsoft Charts New Course, But is it the Right Approach?” Wall Street Journal, March 26, 2001,
113 Associated Press, May 12, 2001.
114
Mossberg, Walter, S., “The New Windows: Best Yet, But beware, Windows XP Rarely Crashes but Acts as a
Trojan Horse to Tout Microsoft Services,” Wall street Journal.
115 Mossberg, Walter, S., “The New Windows: Best Yet, But beware, Windows XP Rarely Crashes but Acts as a
Trojan Horse to Tout Microsoft Services,” Wall street Journal,
116 Mossberg, Walter, S., “The New Windows: Best Yet, But beware, Windows XP Rarely Crashes but Acts as a Trojan Horse to
Tout Microsoft Services,” Wall street Journal,
117 Smith, Davie and Chris Le Tocq, “Commentary: Hailstorm’s Consumer Focus,” Gartner Viewpoint, CNET
News.com, March 20, 2001.
118 Appeals, pp. 29-36.
119 They could allow consumers to choose which operating system they want to invoke, however, see Hacker,
Scot, “He Who Controls the Bootloader,” Byte.com, August 27, 2001.
120. United States v. Microsoft Corp., 84 F. Supp. 2d 30, 110-12 (D.D.C. 2000).
121. Id. at 57-66.
23
Nevertheless, consumer harm is substantial. The concern about market power is its
ability to increase prices above competitive levels.122 Antitrust practice considers even fairly
small pricing abuse—as low as 5%—to be a source of concern if the aggregate amount of abuse
is large.123 Expert witnesses for Microsoft (Richard Schmalensee124) and the Government
(Franklin Fisher125) devoted considerable attention to the question of the monopoly price of
operating systems. An amicus brief by Robert Litan and Roger Noll took up the issue, as well.126
The centerpiece of Microsoft’s pricing strategy has been to increase operating system
prices while other components of the delivered PC bundle have been falling. Historic pricing
and strategic pricing plans demonstrate that operating system prices increased dramatically in the
1990s after Microsoft gained monopoly control over the operating system market (see Exhibit 5).
This reversed strong trends established during the 1980s towards declining prices and improving
quality. The internal Microsoft analysis shows that the price of the operating system increased by
almost 160% between 1990 and 1996. That is an annual increase of 17%. In contrast, between
1981, when the operating system was introduced, and 1990, when the last significant competitor
was driven from the PC operating system market, the price of the operating system fell from $40
to $19.127 That is an annual decline of 8% per year.
Microsoft defenders point to quality improvements as justification for the dramatic price
increases of the 1990s.128 Yet, the 1980s witnessed dramatic improvements in quality and prices
fell nonetheless. Because of economies of scale achieved from expanding production and
advances in software engineering, a competitive software market produced dramatic increases in
quality and dramatically declining prices. It is the monopoly, not quality improvements, that
produced rising prices in the 1990s.
Using the leverage of the operating system monopoly, Microsoft also went after the word
processing and spreadsheet markets. Using similar tactics to those litigated in the web browser
case—bundling and impairing the ability of competitors to work with Windows—Microsoft
captured market share equaling its operating system monopoly. A senior executive of Microsoft,
pointing to the successful bundling strategy in the desktop market as a model for the browser
wars, observed that Office is expensive.129
When this statement was made, prices were actually declining, yet this executive knew
the product was expensive. The explanation is well known. Two massive changes took place in
122.
123.
SCHERER & ROSS, supra note 15, at 70-71.
Roger D. Blair & Amanda Esquibel, Some Remarks on Monopoly Leverage, 40 ANTITRUST BULL. 371, 392
(1995) (citing William M. Landes & Richard A. Posner, Market Power in Antitrust Cases, 94 HARV. L. REV. 937 (1981)) (giving
an example using 10%).
124.
Report of Direct Testimony of Richard Schmalensee, United States v. Microsoft Corp., 84 F. Supp. 2d 9
(D.D.C. 1999) (Nos. CIV. A. 98-1232, 98-1233).
125.
Rebuttal Testimony of Franklin Fisher taken on June 1 and 2, 1999, United States v. Microsoft, 84 F. Supp.
2d 9 (D.D.C. 1999) (Nos. CIV. A. 98-1232, 98-1233).
126.
Remedies Brief of Amici Curiae, United States v. Microsoft, 84 F. Supp. 2d 9 (D.D.C. 1999) (Nos. CIV. A.
98-1232, 98-1233).
127.
Evans et al., supra note Error! Bookmark not defined..
128.
See Report of Direct Testimony of Richard Schmalensee, United States v. Microsoft Corp., 84 F. Supp. 2d 9
(D.D.C. 1999) (Nos. CIV. A. 98-1232, 98-1233); see also Leibowitz, supra note 129, at 2. Both Schmalensee and Liebowitz
mention the investment in quality improvement.
129.
United States v. Microsoft Corp., 84 F. Supp. 2d 30, 41 (D.D.C. 2000).
24
the software market during this period to dramatically lower costs that cannot be attributed to
Microsoft. First, marketing of software shifted from retail sales to wholesale (preinstallation),
which dramatically reduced distribution costs. 130 Second, the quantities of PCs shipped
increased from a few million per year to well over a hundred million, which dramatically
lowered average costs. Moreover, Microsoft prevented competing programs from being preinstalled. Microsoft enjoyed the benefits of these cost reductions, but because it did not face
sufficient competition, it did not pass the cost reduction through to the public. That is the sense
in which it was expensive. Microsoft is actually a high-priced seller, compared to its costs, not a
low-priced one.131
Robert Litan, Roger Noll, and William Nordhaus estimate that Microsoft’s return on
invested capital and research and development was 88% for the fiscal year ending 1999. The
implications of this analysis are staggering. If Microsoft had earned an average rate of return, its
profit over the four year period, 1996-1999, would have been between $16 and $20 billion less.
Keeping in mind that this is after tax dollars, the implicit excess charges to the public would be
between $25 and $30 billion. This is a huge sum of excess profits.
This manifestation of market power persists. For the quarter ending March 2003
Microsoft continues to enjoy a 90 percent profit margin in operating systems and an 80 percent
profit in desktop applications. In contrast, in server applications the profit margin is only 30
percent, about the average for the software industry. Consumer services – entertainment and
Internet services have a negative margin and have never been profitable for Microsoft.
Monopoly power and excess profits remain the cornerstone of the company.
ECONOMIC HARM
There is a range of indirect costs imposed on consumers, as well (see Exhibit 6). The
reduction in direct costs resulting from the elimination of monopoly rents is actually the smallest
part of the potential savings.
Forced Upgrades and Additional Support Costs: With no competition, Microsoft
upgrades, which are sold to the public, become extremely high margin products.132 Because
Microsoft does not face competition, it is does not face pressures to provide high quality
products and the public is forced to purchase systems that are much buggier than they should be.
Microsoft drives a rapid product cycle133 with inefficient software that requires bloated
hardware.134 Microsoft is able to sell excessive functionality.135 Consumers pay for more
130.
Charles H. Ferguson, High St@kes No Prisoners: A Winner’s Tale of Greed and Glory in the Internet Wars
309 (Three Rivers Press ed., 1999).
131.
Liebowitz & Margolis, Losers, supra note 12, at 154-57.
132.
Steve Lohr, Where Microsoft Wants to Go Today, N.Y. Times, June 5, 1998, at D-1 (“David Rearderman, an
analyst at Nationsbanc Montgomery Securities, estimates that operating system revenues in 1997 were $4.6 billion and produced
gross profit margins of 90 percent.”); see also Denise Caruso, Nimbly, Microsoft Has Taken Advantage of Ignorance to Reshape
the World, N.Y. Times, Dec. 1, 1997, at D-4.
133.
Ferguson, supra note 130, at 309-10.
134.
Id. at 310.
135.
See Caruso, supra note 132.
25
functionalities bundled into packages of software than they should and they are forced to buy
bigger machines. 136
Microsoft imposed strict discipline on companies shipping Windows to prevent them
from altering the configuration of Windows and related icons. The court was struck by the
extent to which Microsoft was willing to inconvenience consumers to preserve its hold on the
market and the inconvenience created by Microsoft’s steadfast control of the boot screen. The
court took special note of the fact that the computer manufacturers were the ones who actually
dealt with the public and they perceived a significant problem in Microsoft’s refusal to allow
modification of the boot screen. The costs they perceived were substantial. There were also
several instances in which Microsoft undermined the ability of software applications or
middleware to function properly with the operating system. Furgeson sums up linking the lack
of innovation with the distortion of the competitive process to consumer harm.
Microsoft’s position as the monopolist purveyor of mediocre software is another
source of large, and unnecessary, social costs. Training and recovery from
software errors and crashes are, along with rapid version cycling, major
contributors to service costs. . . . Conservative estimates are that the cost of
maintaining a desktop is several times higher than the cost of purchasing it.
Cleaner, simpler, better-designed software could reduce these overhead costs,
thereby freeing large numbers of technologists to do useful work.137The generally
accepted rule of thumb is that corporations spend three to five times their
hardware costs on service. New hardware and software products must be
installed, debugged and then serviced; employees must be taught how to use
them. These costs increase greatly with the novelty and heterogeneity of systems
in use; hence the more upgrade cycling, the higher these costs. 138
Precise estimates of indirect costs such as these are always difficult to make. Ferguson’s
discussion suggests that hundreds of billions of dollars of consumer savings would result from a
restoration of competitive processes in the industry. 139 Far larger savings would result from a
more rational product cycle,140 reduced support costs associated with less frequent upgrades and
reduced instability141 and reduced crash time.142 Although many of the savings are indirect, they
136.
137.
138.
139.
Gleick, supra note Error! Bookmark not defined., at 83.
Id. at 311.
Id.
Consider the following example calculation. Assume 100 million units shipped at an average hardware cost
of $750 and software costs of $250. Ferguson estimates bloated hardware costs at $100 per PC. FERGUSON, supra note 130, at
310. Earlier, we had identified software monopoly rents in the range of $80 to $125 per PC. Assume a total of $200 savings per
PC.
Current costs = $1,000/PC x 100 million PCs
=
$100 billion
Competitive costs = $800/PC x 100 million PCs
=
80 billion
Consumer Savings = 20 billion
140.
Continuing the example above, assume a 25% reduction in the product cycle.
Competitive costs = $800/PC x 100 million PCs
= $80 billion
25% reduction in product cycle = $800/PC x 75 Million PCs
=
60 billion
Consumer Savings = 20 billion
141.
Ferguson uses a rule of thumb of support costs, primarily associated with upgrades, of 3 to 5 times the
acquisition costs. Id. at 311. Assume the mid-point of 4 times. Further assume that support costs decline in proportion to the
slowing of the upgrade cycle (25%).
Support costs = 4 x $100 billion
= $400 billion
26
are substantial, nonetheless.143 If one is assessing the economic impact of the Microsoft
monopoly on consumers, they must be considered.
Stifling Innovation by Chilling Investment in Products That Might Compete with
Microsoft’s Core Products: There are a series of additional interrelated effects of the Microsoft
monopoly that must be considered in assessing the harm it imposes on the public—severe
negative effects on innovation.
Finally, there is Microsoft’s effect upon potential and actual innovation. It is
abundantly clear that any new entrant who creates a large market or a threat to
Microsoft’s monopoly platform position will be the object of a brutally effective,
often predatory retaliation in which Microsoft will use every unfair advantage it
possesses.144
The court noted that the repeated pattern of anti-competitive actions has a chilling effect
on the companies that would enter the Intel-based PC market. The court noted at least six
instances in which Microsoft sought to delay the development of competing products. It noted
several instances in which it delayed the delivery of its own products to accomplish an anticompetitive outcome. By denying or delaying the introduction of non-Microsoft products,
Microsoft restricts consumer choice. These tactics were not restricted to the browser. There was
a broad range of products that Microsoft slowed or prevented from getting to market.
III. ANTICOMPETITIVE LEVERAGE
IN THE PHYSICAL LAYER
CABLE MARKET POWER ABUSE
After a decade long fight with Microsoft, you are now a thirty-something attorney at the
Department of Justice when the following documents in the files of a cable company come
across your desk. The cable example is even more harrowing in some respects [quoted from
Cisco Systems – Controlling Your Network – A Must for Cable Operators, 1999, Interactive
Digital Network: More Than Just a Set-Top Decision, New Revenue Opportunities for Cable
Operators From Streaming-Media Technology, 1999; Fred Dawson, The Interactive Digital
25% reduction in support equal cycle
=
300 billion
Consumer Savings = 100 billion
142.
Ferguson does not offer an estimate of the value of reduced crash time, he points out that other products work
much better. The value of savings would be immense. For example, surveys show that consumers endure over 5 hours per
month of down time due to crashes. Even reducing this by two hours per month would be worth approximately $100 billion
dollars. Id. at 311.
2 hr/month x 12 x 300 million base = 7.2 billion hrs
Valuing each hour at $14 per hour
Savings = $100 billion
143.
Thus, one can quickly arrive at savings in the range of $200 billion per year, when considering the impact of
the Microsoft monopoly only on the operating system and the hardware costs it is driving. The U.S. accounts for half this both
because of computer purchases and intensive use of computers. See U.S. DEP’T. OF COMMERCE, U.S. INDUS. & TRADE OUTLOOK,
ch. 27-28 (2000). For example, the U.S. accounts for just under half of all computer systems and software purchases and almost
60% of all Internet traffic. See id.
144.
Id.
27
Network: More than Just a Set-Top Decision, 1999.] As I go through these documents, again I
have flagged antitrust and Communications Act issues and the analytic concepts I have
introduced. Exhibit 7 describes the cable operators’ use of strategic leverage in the platform.
Not all of these leads will pan out, but they should be followed. The Exhibit shows both the
video and the data sides of the platform. The data side is the subject of this discussion.145
“Multiple service delivery over IP networks brings with it an inherent problem: How do
these multiple services—packetized voice, streaming media, Web browsing, database access, and
e-mail—coexist without competing* with each other for bandwidth?
“Quality of service has solved the problem by putting absolute control,* down to the
packet, in your hands.
“The ability to prioritize and control traffic levels is a distinguishing factor and critical
difference between New World networks employing Internet technologies and “the Internet.”*
“But beyond that, new advanced QoS techniques give you the means to maximize
revenue generated through bandwidth capacity providing highest quality for your most valuable
services.*
“Admission control and policing is the way you develop and enforce traffic policies.
These controls allow you to limit the amount of traffic coming into the network with policybased decisions on whether the network can support the requirements of an incoming
application. Additionally, you are able to police or monitor each admitted application to ensure
that it honors its allocated bandwidth reservation.*
“Preferential queuing gives you the ability to specify packet types—Web, e-mail, voice,
video—and create policies for the way they are prioritized and handled.
“Conditional Access (CA) systems provide for selective access and denial of specific
services.* They also employ signal security techniques, such as encryption, to prevent a signal
from being received by unauthorized users. In addition to protecting traditional broadcast
content,* a contemporary Conditional Access system also must support interactive applications,
such as electronic commerce, video-on-demand, and high-speed data access. And it must protect
against tampering with authorized applications, downloading viruses, or downloading
unauthorized applications to the set-top.*
“For example, if a “push” information service that delivers frequent broadcasts to its
subscribers is seen as causing a high amount of undesirable network traffic, you can direct
Committed Access Rate to limit subscriber-access speed to this service. You could restrict the
incoming push broadcast as well as subscriber’s outgoing access to the push information site to
discourage its use. At the same time, you could promote and offer your own or partner’s
services with full-speed features to encourage adoption of your service, while increasing network
efficiency.*
145 The video side is discussed at length in Mark Cooper, Cable Mergers and Monopolies: Market Power in Digital
Media and Communications Networks (2002).
28
“Committed Access Rate also lets you discourage the subscriber practice of bypassing
Web caches. It gives you the ability to increase the efficiency of your network by allocating high
bandwidth to video and rich media coming from a Web-cached source and low bandwidth to the
same content coming from an uncached source. Further, you could specify that video coming
from internal servers receives precedence and broader bandwidth over video sources from
external servers.*
“Another backbone-based control capability is preferential queuing (PQ) ensures that
important traffic gets the fastest handling at each point where it is used. Because it is designed to
give strict priority to important traffic, PQ can flexibly prioritize according to network protocol,
incoming interface, packet size, source* or destination address.
At one time or another, every one of these “conditions” was written into a contract with a
service provider, a consumer service agreement or implemented in the network (see Exhibit 8).
In comments at the Federal Communications Commission, the High Tech Broadband Coalition
noted “troubling evidence of restrictions on broadband consumers’ access to content,
applications and devices.”146 The advanced telecommunications networks of cable operators
were closed for the first six years of deployment.147 When they talked about granting access,
they made it clear that they would control who could sell, under what terms and conditions, using
what functionalities, and at a price that made it a very unattractive business.
146
High Tech Broadband Coalition, supra note.
As variety of industry commenters who found themselves on the receiving end of cable industry discrimination and
exclusion expressed their concern from the earliest days of the commercial high speed Internet. AT&T Canada Long Distance
Services, “Comments of AT&T Canada Long Distance Services Company,” before the Canadian Radio-television and
Telecommunications Commission, Telecom Public Notice CRTC 96-36: Regulation of Certain Telecommunications Service
Offered by Broadcast Carriers, February 4, 1997. The AT&T policy on open access after it became a cable company was first
offered in a Letter to Chairman Bill Kennard, dated December 6, 1999, signed by David N. Baker, Vice President Legal &
Regulatory Affairs; Mindspring Enterprises; James W. Cicconi, General Council and Executive Vice President, AT&T Corp.;
and Kenneth S. Fellman, Esq., Chairman, FCC Local & State Government Advisory Committee. Virtually no commercial
activity took place as a result of the letter, which was roundly criticized. Subsequently their policy was described in Goodman,
Peter S., “AT&T Puts Open Access to a Test,” Washington Post, November 23, 2000 (hereafter Goodman). AT&T continues to
complain that the Regional Bell Operating Companies are continuing to impede competitors from gaining nondiscriminatory
access to advanced services unbundled network elements, see, for example, “Affidavit of Al Finnell on Behalf of AT&T
Communications of California,” before the Public Utilities Commission of the State of California, Notice of Intent to File Section
271 Application of SBC Communications Inc., Pacific Bell, and Pacific Bell Communications Inc., for Provision of In-region,
InterLATA Services in California, August 11, 1999, pp. 42-53: America Online Inc., “Open Access Comments of America
Online, Inc.,” before the Department of Telecommunications and Information Services, San Francisco, October 27, 1999
(hereafter, AOL). At the federal level, AOL’s most explicit analysis of the need for open access can be found in “Comments of
America Online, Inc.,” In the Matter of Transfer of Control of FCC Licenses of MediaOne Group, Inc. to AT&T Corporation,
Federal Communications Commission, CS Docket No. 99-251, August 23, 1999 (hereafter, AOL, FCC). America Online
continues to reiterate these arguments (see “Comments of AOL timeWarner, Inc.,” In the matter of Appropriate Framework for
Broadband Access to the Internet Over Wireline Facilities, Universal Service Obligations of Broadband Providers, Computer III
Remand Proceedings: Bell Operating Company Provision of Enhanced Services; 1998 Biennial Regulatory Review – Review of
Computer II and ONA Safeguards and Requirements, Federal Communications Commission, CC Docket NO. 02-33, 95-20, 9810, May 3, 2002; (Hereafter AOL, 2002); Jerry A. Hausman, J. Gregory Sidak, and Hal J. Singer, “Residential Demand for
Broadband Telecommunications and Consumer Access to Unaffiliated Internet Content Providers,” Yale Journal on Regulation,
18 (2001). John B. Hayes, Jith Jayaratne, and Michael L. Katz, An Empirical Analysis of the Footprint Effects of Mergers
Between Large ILECS, April 1, 1999, p. 1; citing “Declaration of Michael L. Katz and Steen C. Salop,” submitted as an
attachment to Petition to Deny of Spring Communications Company L.P, in Ameritech Corp. and SBC Communications, Inc., for
Consent to Transfer of Control, CC Dkt. No. 98-141 (filed Oct. 15, 1998) and Petition to Deny of Spring Communications
Company L.P, in GTE Corporation and Bell Atlantic Corporation for Consent to Transfer of Control, CC Dkt. No. 98-184 (filed
Nov. 23, 1998).
147
29
A Term Sheet offered by Time Warner to unaffiliated ISPs who had requested access to
its network during the summer of 2000 gives a new and troubling specificity to the threat to
innovation. There in black and white are all the levers of market power and network control that
stand to stifle innovation on the Internet. Time Warner demanded the following:
(1) Prequalification of ISPs to ensure a fit with the gatekeeper business model
(2) Applying ISPs must reveal sensitive commercial information as a precondition to
negotiation
(3) Restriction of interconnecting companies to Internet access sales only, precluding a
range of other intermediary services and functions provided by ISP to the public (e.g. no
ITV functionality)
(4) Restriction of service to specified appliances (retarding competition for video services)
(5) Control of quality by the network owner for potentially competing video services
(6) Right to approve new functionalities for video services
(7) A large nonrefundable deposit that would keep small ISPs off the network
(8) A minimum size requirement that would screen out niche ISPs
(9) Approval by the network owner of the unaffiliated ISP's home page
(10) Preferential location of network owner advertising on all home pages
(11) Claim by the network owner to all information generated by the ISP
(12) Demand for a huge share of both subscription and ancillary revenues
(13) Preferential bundling of services and control of cross marketing of services
(14) Applying ISP must adhere to the network operator's privacy policy.
Under these conditions, the commercial space left for the unaffiliated and smaller ISPs
(where much innovation takes place) is sparse and ever shrinking.148 This may explain why ISPs
have become active in fighting AT&T/AOL hegemony. 149 It took tremendous courage to put
the Term Sheet in the public record in violation of the nondisclosure agreements that Time
Warner had demanded,150 especially in light of the threats and actions that AT&T, Time Warner
and AOL have hurled at those who challenge their proprietary plans.151
From the point of view of the technical design features of the Internet that unleashed the
dynamic forces of innovation, the fact that these negotiations must take place at all is the truly
chilling proposition. Under the current marketplace model blessed by the Federal
Communications Commission (FCC) for broadband Internet service, it is a given that the owners
of the infrastructure can use control over access to gain a strategic advantage in negotiations for
148
Clark and Blumenthal, p. 24.
Earthlink, the first ISP to enter into negotiations with cable owners for access has essentially given up and is
vigorously seeking an open access obligation, see Ex Parte Letter from Earl W. Comstock and John W. Butler Regarding the
Application of America Online, Inc. and Time Warner Inc. for Transfer of Control, Federal Communications Commission,
Docket No. CS 0030, October 18, 2000 (hereafter Earthlink)
150 While Earthlink pointed out that the “nondisclosure provisions have an adverse impact on the ability of the market
to operate freely and on the ability of government agencies to evaluate the competitiveness of the market," it was others who
actually released the agreement.
151 AT&T has sued and threatened to sue every local jurisdiction that required open access and withheld investment in
those areas. Time Warner pulled the plug on Disney and threatened to extract full subscriber value from Disney for every
customer it lost, when Disney offered to give satellite dishes to the public. AOL threatened to sue Prodigy for the economic harm
it caused AOL when Prodigy hacked into the AOL’s instant messaging service.
149
30
open access. Once that is conceded, we have reverted to the communications environment that
prevailed before the Internet came into existence.
Once Time Warner merged with AOL, it was on the other side of the bargaining table,
with its value driven by an Internet Service Provider (ISP). After a five year struggle to gain
access to cable networks, AOL capitulated to the cable monopolists. Ultimately, AOL signed a
3-year contract for access to less than one-half of AT&T’s lines under remarkably onerous
conditions. They are paying $38 at wholesale, for a service that sells for $40 in the cable bundle.
They allowed AT&T to keep control of the customer and to determine the functionality
available. They apparently agreed to a no – compete clause for video. As AOL put it, the deal
turned the high-speed Internet into the equivalent of a premium cable channel, like HBO.
Nothing could be farther from the Internet as it was. Why did AOL agree? They were desperate
for carriage. You cannot be a narrowband company in a broadband world, and DSL just can’t
cut it. The AOL-ATT agreement punctuates a seven-year policy of exclusion.
TELEPHONE COMPANY MARKET POWER ABUSE
Telephone companies were forced to execute their exclusion in a more subtle manner,
since the Telecommunications Act of 1996 requires them to allow competitive local exchange
carriers (CLECs) and unaffiliated Internet Service Providers (ISPs) on their systems. They must
embed their anticompetitive strategy in day-to-day business conduct. 152 In this respect, the
152 The Federal Communications Commission has been presented with a mountain of specific evidence of
anticompetitive behavior by wire owners. Notwithstanding the grant of entry into long distance, many of these problems still
afflict the provision of DSL service, as recent testimony in Texas (the second state in which an incumbent RBOC was granted
entry) attest; see Onramp; “Response of Cbeyond, Inc.,” Ten Questions to Begin the Committee’s Inquiry Into State Broadband
Policy, Committee on State Affairs, April 3, 2002 (hereafter, Cbeyond); “Response of IP Communications,” Ten Questions to
Begin the Committee’s Inquiry Into State Broadband Policy, Committee on State Affairs, April 3, 2002 (hereafter IP
Communications); “Response of Hometown Communications,” Ten Questions to Begin the Committee’s Inquiry Into State
Broadband Policy, Committee on State Affairs, April 3, 2002 (hereafter Hometown); “Response of Texas CLEC Coalition,” Ten
Questions to Begin the Committee’s Inquiry Into State Broadband Policy, Committee on State Affairs, April 3, 2002 (hereafter
TxCLEC); “Reply Comments of the California ISP Association, Inc., Further Notice of Proposed Rulemaking in the matter of
the Computer III Remand Proceedings: Bell Operating Company Provision of Enhanced Services; 1998 Biennial Regulatory
Review – Review of Computer II and ONA Safeguards and Requirements, Federal Communications Commission, CC Docket
NO. 95-20, 98-10, April 30, 200 (hereafter, CISPA, 2001b); “Reply Comments of the Texas Internet Service Providers
Association, .Further Notice of Proposed Rulemaking in the matter of the Computer III Remand Proceedings: Bell Operating
Company Provision of Enhanced Services; 1998 Biennial Regulatory Review – Review of Computer II and ONA Safeguards and
Requirements, Federal Communications Commission, CC Docket NO. 95-20, 98-10, April 30, 200 (hereafter, TISPA, 2001a);
“Reply Comments of the Commercial Internet Exchange Association, .Further Notice of Proposed Rulemaking in the matter of
the Computer III Remand Proceedings: Bell Operating Company Provision of Enhanced Services; 1998 Biennial Regulatory
Review – Review of Computer II and ONA Safeguards and Requirements, Federal Communications Commission, CC Docket
NO. 95-20, 98-10, April 30, 200 (hereafter, CIX, 2001a); “Comments of the Information Technology Association of America,”
In the Matter of Review of Regulatory Requirements for Incumbent LEC Broadband Telecommunications Services, Federal
Communications Commission, CC Docket No. 01-337, March 1, 2002 (hereafter ITAA, 2002).; “Comments of the Information
Technology Association of America,” In the Matter of Review of Regulatory Requirements for Incumbent LEC Broadband
Telecommunications Services, Federal Communications Commission, CC Docket No. 01-337, March 1, 2002 (hereafter ITAA,
2002); “Comments of the IP Communications Corporation,” In the Matter of Review of Regulatory Requirements for Incumbent
LEC Broadband Telecommunications Services, Federal Communications Commission, CC Docket No. 01-337, March 1, 2002
(hereafter IPCommunications, 2002); “Comments of the Public Service Commission of the State of Missouri,” In the Matter of
Review of Regulatory Requirements for Incumbent LEC Broadband Telecommunications Services, Federal Communications
Commission, CC Docket No. 01-337, March 1, 2002 (hereafter MOPSC, 2002); “Joint Comments of NASUCA, et al.,” In the
Matter of Review of Regulatory Requirements for Incumbent LEC Broadband Telecommunications Services, Federal
Communications Commission, CC Docket No. 01-337, March 1, 2002 (hereafter NASUCA, 2002); “Comments of Ad Hoc
Telecommunications Users Committee,” In the Matter of Review of Regulatory Requirements for Incumbent LEC Broadband
Telecommunications Services, Federal Communications Commission, CC Docket No. 01-337, March 1, 2002 (hereafter Ad Hoc,
31
telephone company practices parallel those of Microsoft. Nevertheless, the telephone companies
continued to press hard for the legal right to discriminate by gaining the legal authority to
exclude competitors from another interconnection point in the physical layer, the remote
terminal, which would cut most competitors off from a large part of the residential market.154
A major source of potential discrimination lies in the architecture of the network. The
technical capabilities of the network controlled by the proprietor can be configured and operated
to disadvantage competitors. The proprietary network owner can seriously impair the ability of
competitors to deliver service by restricting their ability to interconnect efficiently and deploy or
utilize key technologies that dictate the quality of service. Forcing independent ISPs to connect
to the proprietary network or operate in inefficient or ineffective ways, or giving affiliated ISPs
preferential location and interconnection, can result in substantial discrimination. Similarly,
forcing CLECs to make digital to analog to digital conversions to implement cross connects
raises costs. The result is a sharp increase in the cost of doing business or degradation of the
quality of service.
ISPs have identified a range of ways the dominant telephone companies impede their
ability to interconnect in an efficient manner. Refusing to peer with other ISPs and causing
congestion by “deliberately overloading their DSL connections by providing them with
2002); “Comments of the New Mexico Information Professionals Association of America,” In the Matter of Review of
Regulatory Requirements for Incumbent LEC Broadband Telecommunications Services, Federal Communications Commission,
CC Docket No. 01-337, March 1, 2002 (hereafter NMIPA, 2002); “Comments of Cox Communications, Inc.,” In the matter of
Appropriate Framework for Broadband Access to the Internet Over Wireline Facilities, Universal Service Obligations of
Broadband Providers, Computer III Remand Proceedings: Bell Operating Company Provision of Enhanced Services; 1998
Biennial Regulatory Review – Review of Computer II and ONA Safeguards and Requirements, Federal Communications
Commission, CC Docket NO. 02-33, 95-20, 98-10, May 3, 2002 (Hereafter Cox, 2002); “Comments of BrandX.,” In the matter
of Appropriate Framework for Broadband Access to the Internet Over Wireline Facilities, Universal Service Obligations of
Broadband Providers, Computer III Remand Proceedings: Bell Operating Company Provision of Enhanced Services; 1998
Biennial Regulatory Review – Review of Computer II and ONA Safeguards and Requirements, Federal Communications
Commission, CC Docket NO. 02-33, 95-20, 98-10, May 3, 2002 (Hereafter BrandX, 2002); “Comments of the New Hampshire
ISP Association,” In the matter of Appropriate Framework for Broadband Access to the Internet Over Wireline Facilities,
Universal Service Obligations of Broadband Providers, Computer III Remand Proceedings: Bell Operating Company Provision
of Enhanced Services; 1998 Biennial Regulatory Review – Review of Computer II and ONA Safeguards and Requirements,
Federal Communications Commission, CC Docket NO. 02-33, 95-20, 98-10, May 3, 2002 (Hereafter NHISP, 2002); “Comments
of Ruby Ranch Cooperative Association,” In the matter of Appropriate Framework for Broadband Access to the Internet Over
Wireline Facilities, Universal Service Obligations of Broadband Providers, Computer III Remand Proceedings: Bell Operating
Company Provision of Enhanced Services; 1998 Biennial Regulatory Review – Review of Computer II and ONA Safeguards and
Requirements, Federal Communications Commission, CC Docket NO. 02-33, 95-20, 98-10, May 3, 2002 (Hereafter Ruby Ranch,
2002; “Comments of Earthlink, Inc.,” In the matter of Appropriate Framework for Broadband Access to the Internet Over
Wireline Facilities, Universal Service Obligations of Broadband Providers, Computer III Remand Proceedings: Bell Operating
Company Provision of Enhanced Services; 1998 Biennial Regulatory Review – Review of Computer II and ONA Safeguards and
Requirements, Federal Communications Commission, CC Docket NO. 02-33, 95-20, 98-10, May 3, 2002 (Hereafter Earhtlink,
2002); “Comments of U.S. LEC Corp.,” In the matter of Appropriate Framework for Broadband Access to the Internet Over
Wireline Facilities, Universal Service Obligations of Broadband Providers, Computer III Remand Proceedings: Bell Operating
Company Provision of Enhanced Services; 1998 Biennial Regulatory Review – Review of Computer II and ONA Safeguards and
Requirements, Federal Communications Commission, CC Docket NO. 02-33, 95-20, 98-10, May 3, 2002 (Hereafter US LEC,
2002); “Comments of Big Planet, Inc.,” In the matter of Appropriate Framework for Broadband Access to the Internet Over
Wireline Facilities, Universal Service Obligations of Broadband Providers, Computer III Remand Proceedings: Bell Operating
Company Provision of Enhanced Services; 1998 Biennial Regulatory Review – Review of Computer II and ONA Safeguards and
Requirements, Federal Communications Commission, CC Docket NO. 02-33, 95-20, 98-10, May 3, 2002 (Hereafter Big Planet,
2002); “Joint Comments of Cbeyond and Nuvox,” In the Matter of Review of Regulatory Requirements for Incumbent LEC
Broadband Telecommunications Services, Federal Communications Commission, CC Docket No. 01-337, March 1, 2002
(hereafter CBeyond, 2002).
154 Tauzin Dingell.
32
insufficient bandwidth from the phone company’s central offices to the Internet” 155 create a
roadblock that forces ISPs to enter into expensive transport arrangements for traffic.156 Refusing
to guarantee quality of service to unaffiliated ISPs and imposition of speed limits157 has the
effect of restricting the products they can offer.158 The network owners then add insult to injury
by forcing ISPs to buy bundles of redundant services,159 preventing competitors from cross
connecting to one another,160 restricting calling scopes for connection to ISPs,161 and refusing to
offer a basic service arrangement or direct connection to the network.162 The effect is to
undermine competition and restrict service offerings.163
CLECs have also identified a host of practical barriers to entry thrown up by incumbent
local telephone companies including “blocking required access to equipment, illegally stealing
customers… stalling hook-ups…multiple and unnecessarily erroneous bills to alienate or confuse
their customers… false advertising, price gouging, randomly cutting off service and other
bullying tactics.”164 The most critical architectural decisions are to impose network
configurations that prevent competition for the core monopoly service, voice.165 This bundling
of competitive and noncompetitive services,166 places competitors at a disadvantage. Ironically,
Cox complains that it is being discriminated against when incumbent telephone monopolists
bundle voice and data.167 Independent ISPs have pointed out that their ability to offer voice is
being frustrated by architectural decisions, which of course denies them the ability to offer the
voice/data bundle.168 Moreover, incumbents are reserving the right to offer additional services,
like video, over lines for which independent ISPs are the Internet access service provider.169
Telephone companies also leverage their control over the network into an abuse of the
affiliate relationship. The use of corporate resources including logos and joint advertising has
been a constant source of cross-subsidy.170 Assets have been transferred to the advantage of the
affiliated ISP, including customer accounts, CPNI, bottleneck facilities and collocation space.171
Employees, senior management and boards of directors have been co-mingled, facilitating the
cross-subsidization and anti-competitive advantage given to affiliates.172
Vaughn-Nichols, Steven J., “DSL Spells Trouble for Many ISPs,” Smart Reseller, February 24, 1999.
Onramp, pp. 16-17.
157 ITAA, p. 11; DirecTV, p. 8-10.
158 Onramp, pp. 5-6.; NMIPA, p. 5.
159 TISPA, p. 18.
160 IURC, p. 14; Utah ISP, pp. 8,9; ISPC, p. 7; IAC, p. 9; AOL, pp. 6,8; AdHoc, p. 26; ITAA< pp. 13, 15.
161
TISPA, p. 27.
162 TISPA, p. 33.
163 Onramp, p. 14.
164 Keith Epstein, “Cheating or Competing?”, Washington Techway, February 4, 2002, p. 28. See also Utah ISP, p.6;
MNDPS, p. 9; ISPC, p. 6; IAC, p. 9; Rythms, pp. 2,3; AOL, pp. 6, 8; ITAA, p. iv. Minnesota, p. 9.
165 ITAA, pp. 10-11; CISPA, 2001a, pp. 27-28.
166 TISPA, p. 17.
167 Cox, p. 6.
168 IURC, p. 5; TXPUC, p. 14; NYDPS, p. 7; Utah ISP, p. 13, 15; ISPC, p. 11; IAC, p. 9; AdHoc, p. 27; ITAA, p. 16.
169 CISPA, Reply, p. 7.
170 FTC, pp. 5,7; IURC, p. 10, TXPUC, p. 2; MNDPS, p. 3; Utah ISP, p. 16, AdHoc, p. 24; ITAA, pp. 899.
171 TXPUC, pp. 4,8; MNDPS, p. 16; IAC, p. 13; AdHoc, p. 22; ITAA, pp. 12,13.
172 FTC, p. 6; IURC, p. 16; TXPUC, p. 5; IAC, p. 9; AdHoc, pp. 23; ITAA, p. 15.
155
156
33
Even after the service is “generally” available, it appears that the incumbent delivers
wholesale services to its affiliate more quickly than it is made available to competitors.173 The
telephone companies manipulate the availability of capacity, denying unaffiliated ISPs access to
their DSLAMs or CLECs access to their central office space.174 Competitors and regulators
maintain that incumbents have been guilty of unfairly steering customers to affiliates at the
expense of competitors.175 The affiliates get the preferential first spot in the list of options, and
this gives them a huge advantage.176 Joint marketing is a concern,177 with suggestions that
incumbents may offer only one option. Slamming has also been a constant problem.178 The
detailed control of the network confers an immense information advantage on the system
operator. The potential for competitive abuse of information is substantial.179 Independent ISPs
note that the affiliated ISP has been given access to network information in advance, thereby
being assured of preferential access to capacity.180
Controlling a bottleneck, network owners have placed prices and conditions on
independent content providers that undermine their ability to compete.181 Minimum terms and
volume discounts, which are not imposed on the affiliated ISP or are cross-subsidized by the
parent company, place independent ISPs at a disadvantage.182
The local phone companies price squeeze on competitors is paramount.183 The first
concern is with very high prices charged for access to the network. This leaves little margin for
the competitors to operate their business. The price squeeze may appear to be nondiscriminatory, if the network owners charge its own affiliate the same high price. Since the
network owner pockets the profit, it does not care that it is “losing money” on the retail product.
It is implicitly cross-subsidizing the affiliated ISP. Unaffiliated ISPs do not have the source of
cross-subsidy and go out of business. Once they are gone, the incumbent can raise prices, which
is exactly what happened in 2001.
The price squeeze on unaffiliated ISPs is similar in the DSL and the cable modem worlds.
The price for access to the network is far above costs and leaves little margin for the unaffiliated
ISP.184 The margins between the wholesale price ISPs are forced to pay and the retail price
affiliated ISPs charge is as small as $1 on the telephone network.185 For cable networks, the
margins are as low as $5. In other words, independent ISPs are forced to look at margins in the
173
Epstein, pp. 29-30.
TISPA, pp. 22, 23, 31; CISPA, 2001a, pp. 10-14; DirectTV, p. 8.
175 MNDPS, pp. 10, 11; Utah ISP, pp. 10, 11; ISPC, p. 9; IAC, p. 9; AOL, pp. 6,8.
176 IgLou, Questionable Marketing Practices.
177 FTC, p. 11; IURC, p. 10; MNDPS, pp. 8, 10; NYDPS, p. 7; Utah ISP, p. 10; ISPC, p. 7; IAC, p. 11; AOL, pp. 6, 8;
ITAA, pp. 6, 15.
178 IgLou, How BellSouth is Using the Internet to Rebuild its Monopoly.
179.
CISCO, Streaming Media, p. 9; M.J. Richter, Everything’s Coming Up Convergence, Telephony, June 28, 1999, at
30 (quoting Rich Aroian, vice president of marketing and strategic alliances, Saville Systems).
180 TISPA, p. 22; CISPA, 2001a, pp-21-22, 31-32; New Edge, p. 6; NMIPA, p. 6.; TXPUC, p. 3, MNDPS, p. 3; Utah
ISP, pp. 9,1 6; ISPC, p. 11; IAC, p. 9; AdHoc, p. 27, ITAA, p. 16.
181. Seth Schiesel, “Start-Up Leads Phone Cause in Battle for Internet Access,” N.Y. Times, May 17, 1999, at C-4.
182 IgLou, “ADSL Tariff and Deployment.
183 IURC, p. 8; ISPC, p. 11; AOL, pp. 6, 8; AdHoc, p. 21.
184 Onramp, p. 3.
185 TISPA, p. 21, New Edge, p. 6; Brand X, p. 2, DirectTV, p. 8; CIX, P. 8.
174
34
single digits and never much above 20 percent. Cable and telephone company margins for these
services are well in excess of 40 percent.186
CONSUMER HARM
With ISPs excluded from the cable network, cable owners have been free to pursue an
aggressive strategy to leverage their market power. Over the course of technology deployment,
prices have risen moderately, quite the opposite of what one would expect from a digital
technology seeking to increase penetration. Tom Hazlett has characterized the situation as
follows:187
Cable operators possess substantial market power in subscription video
markets. Moreover, they use this leverage to restrict output in broadband access.
This is not profitable in a narrow financial calculus, but is rational due to strategic
considerations…
One of the key elements underlying this ability to avoid competition is a sharp
segmentation of the market by technology. Business and residential markets are segmented and
concentration is higher within each segment (see Exhibit 9). Cable dominates the residential
high-speed Internet market, with a 65 percent market share for all “broadband” services.
However, it has a 75 percent market share for the advanced services residential market. Digital
Subscriber Line service (DSL), the telephone industry’s high-speed offering, dominates the nonresidential market with an 90 percent market share.
For advanced telecommunications service, a substantial part of the residential customer
class and virtually all of the business customer class there is no intermodal competition.188 The
majority of customers in this country have only one technology available for advanced
telecommunications services – either a cable wire or a telephone wire. Wireless technologies are
simply not an economic option today for advanced telecommunications, and there is great
uncertainty about whether they ever will be.189
For basic telecommunications services, the situation is about the same. Facilities-based
competition remains in its infancy. Where competitors have deployed facilities, they remain
dependent on the use of large parts of the incumbent’s network to deliver service. Wireless is
not a substitute for basic telecommunications service, or for a bundle of basic and advanced
telecommunications services.
186 Telephone companies achieve the margin difference by offering high volume ISPs massive volume discounts that
aggregate business across state lines, without any cost justification for such a discount (see TISPA, p. 37; MPIPA, p. 5; ITAA, p.
21; DirectTV, p. 9, CSIPA, p. 16.
187 Hazlett and Bittlingmayer, 2001, pp. 3… 4.
188 Jason B. Bazinet, The Cable Industry (J.P. Morgan Securities, Inc., November 2, 2001); Industry Analysis Division,
High-Speed Services for Internet Access: Subscribership as of June 30, 2001 (Common Carrier Bureau, Federal Communications
Commission, February 2002), Tables 1-4.
189 Mohney, Doug. 2002. “The Train Wreck Mess of Consumer Satellite Broadband.” ISP World. April 24;
Baumgartner, Jeff. 2002. “Not all Systems ‘Go’ for Satellite Broadband.” Communications Engineering and Design. April.
35
Looking carefully at specific product and geographic markets reveals little competitive
overlap of different facilities.190 It has been apparent from the beginning of high-speed service
that technological differences give different facilities an edge in different customer and
geographic markets.191
Businesses are disinclined to use cable.
Cable modem service presents serious security and reliability issues that, while
present for residential users, are of far greater concern when used to support
business applications… In addition, service quality for cable modem service not
equivalent to ILEC standards… Additionally cable modem transmission speeds
are not consistent, due to the “shared platform” architecture… Finally, cable
modem platforms do not offer business customers a sufficient level of security.192
DSL, as deployed is ill suited to multimedia video applications. For the next generation
telephone network technologies “most experts agree that the VDSL business case isn’t for
everyone and won’t realize its full revenue potential for decades.”193
Low-density areas are not prime candidates for wired technologies,194 but wireless is not
here yet as a technology.
Regarding “substitutability,” wireless and satellite broadband capabilities are
currently limited and suffer from geographic and climatic limitations. A customer
seeking stable access still will choose a broadband capability supported over
wires. Moreover, satellite and wireless broadband access is generally far more
expensive than DSL. Second, cable modem access has sufficient drawbacks
depending on a customer’s needs. If a customer seeks a more secure connections
or is a business that generally does not have cable access, cable is not a substitute,
even if the ILEC maintains a price higher than what would h e existed if CLEC’s
continued to be viable competitors…
“Initial Comments of the California ISP Association, Inc.,” Further Notice of Proposed Rulemaking in the matter of
the Computer III Remand Proceedings: Bell Operating Company Provision of Enhanced Services; 1998 Biennial Regulatory
Review – Review of Computer II and ONA Safeguards and Requirements, Federal Communications Commission, CC Docket
NO. 95-20, 98-10, DA 01-620, April 16, 2001 (hereafter CISPA, 2001a), p. 7. ); “Comments of DirecTV Broadband, Inc,” In the
matter of Appropriate Framework for Broadband Access to the Internet Over Wireline Facilities, Universal Service Obligations
of Broadband Providers, Computer III Remand Proceedings: Bell Operating Company Provision of Enhanced Services; 1998
Biennial Regulatory Review – Review of Computer II and ONA Safeguards and Requirements, Federal Communications
Commission, CC Docket NO. 02-33, 95-20, 98-10, May 3, 2002, p. 5; “Comments of Cbeyond, et al.,” In the matter of
Appropriate Framework for Broadband Access to the Internet Over Wireline Facilities, Universal Service Obligations of
Broadband Providers, Computer III Remand Proceedings: Bell Operating Company Provision of Enhanced Services; 1998
Biennial Regulatory Review – Review of Computer II and ONA Safeguards and Requirements, Federal Communications
Commission, CC Docket NO. 02-33, 95-20, 98-10, May 3, 2002 (Hereafter Cbeyond, et al, 2002), pp. 27-28.
191 Bits, pp. 21, 152-154.
192 Ad Hoc, pp. 18-19.
193 Kuhl, Craig, “Writing the Business Case for VDSL,” CED, April 2000.Extensive documentation of the technology
difference is provided in Cooper, Mark, Transforming the Information Superhighway into a Private Toll Road (Consumer
Federation of America, October 1999).
194 Bits, p. 21.
190
36
Best-case scenario in many situations would approximate a duopoly with one
dominant ILEC and one dominant cable providers. We have seen the results.
As the number of competitive DSL providers has diminished, the prices charged
by ILECs and cable companies for high-speed access has increased. For example,
when SBC raised its residential rtes to approximately $50, cable modem providers
raised theirs to $45. It is the price leadership mentality leading to higher prices
that has lessened the number of consumers that have purchased broadband
connections. And, there is no reason to expect that to change without a vibrant
CLEC industry competing and scrapping for customers.195
Cable operators devoted less than two percent of the capacity of their systems to cable
modem service. They could easily expand that if they so desired. This gives them an immense
advantage over telephone companies.
Cable companies have strategically priced their digital services and have achieved a
much higher take rate of digital TV than high speed Internet. This becomes quite apparent to any
consumer who tries to buy the service in the marketplace (see Exhibit 10). If a consumer adds a
digital tier, the charge would be an additional $14 (on average). If a consumer requests cable
modem service, but not cable TV service, the charge will be $10 for the use of the basic cable
facilities, and an additional $40 for the cable company’s chosen ISP to provide an Internet
connection. For the vast majority of cable subscribers, if they want to keep their ISP, they will
have to pay an additional charge. For the dominant narrowband ISP, the change is $15. The
total would be $65. In order to lower the price, the consumer must bear a burden – subscribe to
cable or give up the ISP that was chosen in the competitive world of the Internet. Even the $40
price is high compared to digital video services. The service is not being priced to penetrate.
The difference in price is striking and there appears to be no cost justification. Indeed, a
Morgan Stanley Dean Witter analysis entitled Digital Decade found that the incremental capital
costs for digital cable were higher than high-speed Internet added to a cable upgrade. In their
report entitled Broadband! Bernstein/McKinsey reached the same conclusion. The example
given in the National Research Council report entitled Broadband: Bringing Home the Bits,196
which appears to be for a new overbuild, fiber system, suggests that the capital costs would be
equal in both.
This pricing scheme implicitly suggests that the basic network costs $10 (the incremental
charge for stand alone high-speed service). It implicitly suggests that the digital upgrade costs
are about $10 (the charge for the digital tier). Pure transmission should be about $20. Other
evidence suggests that customer care, billing and incremental facility costs for Internet service
providers are in the range of $10-$15 dollars. These costs include real services, like customer
service (billing and customer care), customer acquisition, and deployment of their own facilities
(like points of presence, local caching, and centralized computing). AOL charges $15 (recently
up from $10) to get their service as a buy through on the cable systems from which they have
been excluded. Limited use narrowband Internet plans are available at $10 per month, which
195
IPC, p. 3.
196
37
suggests this is the basic cost per customer. Indeed, AOL was a profitable, narrowband company
at $20 per month for full service customers. This is exactly what Bernstein/McKinsey concluded
in Broadband!
Cable operators have recently suggested that digital service costs are not much lower than
that. Comcast, which prices digital services at $15 claimed that its margin is 80 percent.197
Cable operators put cable modem service at a 50 percent profit margin.198 Cable operators report
this cost is in the range of $7 to $8.199 Digital service also generates some advertising revenue
and significant pay per view revenues. Thus, if total revenues per subscriber are in the range of
$20 to $25 per month, operating costs would be in the range of $4 to $5. With identical capital
costs and similar operating costs on digital video and high-speed Internet, the difference in price
of $15 versus. $40, is wholly unjustified. Even when Excite@Home was the ISP, Comcast was
pricing access at $30, twice the level of digital with no operating costs.
The price tag that the cable operators have put on cable modem service is driven by the
raw exercise of market power. Bill Gates’ suggestion that this service should be priced at $30
may be too generous, if only facility costs are included. In any event, this service is being
dramatically overpriced. The implication is that cable operators are extracting massive
monopoly rents.
The price increases of 2001 confirm the willingness of cable operators to forego sales to
increase profits.200 This led to a re-thinking on Wall Street as “long term pricing pressures may
turn out to be pricing power.”201 With costs falling202 and demand lagging in the midst of a
recession, both cable operators and telephone companies raised prices. Cable companies
imposed a severe interruption of service on their customers, which, in a highly competitive
market, would have been suicidal.203 They have refused to respond to telephone company
pricing moves. The financial analysis provided by Bernstein/McKinsey showed a three year
break-even and an after tax rate of profit of 23% before recent price increase. The price increase
would push that figure up to 36 percent and shorten the payback. The cable operators have
carried the lessons of market power in the MVPD market into the high-speed Internet market.
They pick-up the high value early adopters by being first and bundling. Keeping prices high
creates a high rate of profit. They get the benefit of having the best customers locked-in to their
technology.
The telephone network presents two pricing problems. Telephone companies sell highspeed Internet service (DSL) and wholesale facilities to local telephone competitors.
197
Stern, 2002.
198
199
Brown, 2001,
“Excite@Home’s 35 percent cut of subscriber fees to operate the service equaled roughly #13 to $14
monthly per subscriber. In contrast, Burke said Comcast could run the service for $7 to $8 per month.
200 Spangler, 2002; Braunstein, 2001;Boyd, 2001;Spring, 2001; Ames, 2002.
201 “Cable Industry Comment,” Banc of America Securities, May 7, 2001; Ames, Sam, “Study: Broadband Fees
Climbed in 2001,” Yahoo News, January 18, 2002.
202 Onramp, p. 3.citing CFO Stephenson.
203 Spangler, Todd, “Crossing the Broadband Divide,” PC Magazine, February 12, 2002 (noting pricing and service
quality problems); Banc of America; Plosinka and Coffield.
38
On the DSL side, telephone companies have maintained high prices. One incident that
drives home the failure of the rivalry between telephone and cable companies to discipline
anticompetitive behaviors is the slow down decision by the telephone companies. As the
Chairman of the Illinois Commerce Commission put it:
The ICC ruling requires the company to allow its competitors meaningful access
to their network at reasonable prices…
In a carefully worded letter to members of Congress last month, Whitacare [CEO
of SBC] harshly criticized the ICC decision and said that SBC Ameritech has
“been forced to halt indefinitely further deployment and activation of new DSL
facilities in Illinois…
As we all know, the competitiveness of a market easily can be measured by one
player’s ability to control the supply of a good. Whitacre’s statement is clear:
SBC Ameritech controls the market so completely that it can determine if more
than a million consumers in Illinois will have access to broadband services…
Whitacre wants to extend his monopoly over the local telephone network to highspeed Internet access. Maybe that is why SBC was able to reduce service and
increase the price for DSL service by 25 percent last month.204
As the quote suggests, more than statements indicate a competitive problem. While the
CEO was complaining to policy makers, the CFO was touting the high profitability and bright
prospects for DSL service.
"SBC: DSL highly profitable
CFO Stephenson: 40% EBIDTA margins, low investment needed
The debate is over: DSL makes money. "Once we get to scale, DSL is very
profitable, just like our other services. We've reached that volume in California
and are approaching it in SWB territory as well. We cut our costs by 30% in
2001,and expect them to drop another 25-30% in 2002." CSFB calculates
Deutsche gets payback in two years on DSL, while Korea Telecom is at 35%
EBIDTA and rising. (I don't like EBIDTA numbers, but that's all I can get.)
Stephenson also said capex has dramatically dropped since early in 200 1. (That
was the Pronto halt, among other things) DSL Prime has reported equipment costs
dropping fiercely, to between $150 & $250 per subscriber. I just got some
backbone costs from Band-X; 45 meg of high quality transit is now $8,000 per
month, half the price of a year ago. That's enough for 1,000-2,500 DSL consumer
circuits. SBC, like other volume buyers, is presumably paying much less, or $2-4
per month per user.205
Harvill, Terry, S. “ICC Commissioner Blasts SBC,” Chicago Sun Times, April 23, 2001; see also, Young, Shawn,
et. al., “How Effort to Open Local Phone Markets Helped the Baby Bells,” Wall Street Journal, February 11, 2002.
205 Cited in Onramp, p. 3.
204
39
The incumbents had just executed a classic price squeeze on ISPs. They had dropped
prices at retail for about a year and waited until the independent ISPs had gone under. As a
result many competitive residential DSL providers have either gone bankrupt, sold out or ended
the DSL portion of their business, leaving consumers in many U.S. regions as single choice for
DSL service: the local phone company. The competitive fallout opened the door for price
hikes.206 Telephone companies continue to impose long installation times and service
interruptions on DSL customers of their competitors.207
More recently, the telephone companies have announced discounted rates, but a close
look at the rates reveals the continuing disconnection in competition. On a megabyte basis, the
discounted services are about three times as expensive as the cable offering.
Exhibit 9 suggests why the pricing abuse has persisted across the various services that are
said to be converging in the digital communications platforms. Each of the platforms is dominant
in a specific product/market.
ECONOMIC HARM: ELIMINATING INTERNET SERVICE PROVIDERS
Although the primary impact of a bearer service flows from the broad range of activity it
supports, a case can be made that even at the core of the directly related industries the value of
open networks is clear. Open communications networks and unrestricted service development,
particularly in the delivery of digital products opened the door to the growth of a whole new
industry -- Internet service providers208 – that played a key role in the successful
commercialization of the Internet.
Similarly, after the FCC required carriers to offer unbundled transmission services
to information service providers under tariff, many new providers entered the
information service industry and developed innovative new service offerings,
which in turn facilitated the explosive growth of internet services. With access to
unbundled transmission service, information service providers concentrated on
development of new services – like online communities or burglar, fire or theft
protection – while being assured of a means to deliver these services to their
206 Ploskina, Brian and Dana Coffield, “Regional Bells Ringing Up Higher DSL Rates,” Interactive Week, February 18,
2001; Braunstein, Yale, Market Power and Price Increases in the DSL Market (July 2001).
207 Ashton, Doug, “The Future of Telecommunications Investment,” Columbia Institute for Tele-Information, March 3,
2001 (noting lack of new services), Tim Horan, “Communications Services: Industry Restructuring,” Columbia Institute for TeleInformation, March 3, 2001 (noting lack of competitors and lack of services), Bits, p. 15, 58, (noting service quality and lack of a
killer application).
208 Lemley & Lessig, supra note 26, at 943-44.
One should not think of ISPs as providing a fixed and immutable set of services. Right now, ISPs typically
provide customer support as well as an Internet protocol (IP) address that channels the customer’s data.
Competition among ISPs focuses on access speed and content.
. . .The benefits of this competition in the Internet’s history should not be underestimated. The ISP market has
historically been extraordinarily competitive. This competition has driven providers to expand capacity and to
lower prices. Also, it has driven providers to give highly effective customer support. This extraordinary
build-out of capacity has not been encouraged through the promise of monopoly protection. Rather, the
competitive market has provided a sufficient incentive, and the market has responded.
Id.
40
customers. Unbundled wholesale transmission capacity proved to be a critical
building block for the development of the entire information services industry.209
Online service providers numbered about 400 to 500 in the late 1980s when the
commercialization began. That number grew to between 7,000 and 8,000 service providers in
the late 1990s. Buying wholesale telecommunications service from telephone companies and
selling basic Internet access combined with a variety of additional services to the public, they
translated the complex technologies that had to be combined to use the Internet into a mass
market service. Once the Internet was commercialized, they rapidly covered the country with
dial-up access and translated a series of innovations into products and services that were
accessible and useful to the public. Some of the underlying innovations that the ISPs adapted and
popularized had been around for a while like the Internet protocol itself, e-mail, file transfer and
sharing, and bulletin boards. Some of the innovations were very recent, like the web, the
browser, instant messaging and streaming. Thousands of ISPs tailoring services to customer
needs supported the rapid spread of Internet subscription and use.
Interestingly, a close look at the data suggests that there is a real sense in which the
Internet, delivering access to the World Wide Web rendered accessible by the development of
web browsers, became the killer application for the PC (see Exhibit 11). Although the PC had
enjoyed success prior to commercialization of the Internet, it was only after the advent of the
business of selling Internet access service to the public that PC sales exploded. PC prices played
a role as well, but it can be argued that the demand stimulation created by the killer application
laid the groundwork for the price reductions. The initial PC price reduction of the mid-1980s
sustained the moderate growth of the PC for about a decade. In the mid-1990s PC prices were
stable, as Internet use escalated. In the late 1990s, PC prices came down, although the sharp
increase in demand came first. Thus, in an important way, the application that triggered demand
contributed to the cycle of economies of scale that is so important in the computer industry.
The closing of the Internet produces a very different picture of the ISP sector (see Exhibit
12). In contrast to the commercial Internet, which witnessed a steady flow of innovations and
the growth of a large customer service sector that stimulated the adoption of Internet service by a
majority of households. The broadband Internet is a wasteland. The body of potential
innovators and customer care providers has shrunk. Throughout the history of the commercial
narrowband Internet, the number of service providers was never less than 10 per 100,000
customers. At present, and for most of the commercial history of the industry, there have been
15 or more ISPs per 100,000 subscribers. On the high-speed Internet there are now less than 2
ISPs per 100,000 customers. For cable modem service there is less than 1 Internet service
provider per 100,000 customers. For DSL service, there are fewer than and 2.5 ISPs per 100,000
customers. Viewed on a market size basis, the impact is even starker (see Exhibit 13).
At a minimum, ISPs provided customer care, extend service throughout the country,
adapt applications to customer needs, etc. They are like the mechanics and gas stations in the
automobile industry. There are now just too few of ISPs on the broadband Internet. Innovation
was stimulated by this environment. A small number of entities dominating the sale of high209 Steven A. Augustino, “The Cable Open Access Debate: The Case for A Wholesale Market, George Mason Law
Review, 8 (2000), p. 663.
41
speed Internet access and dictating the nature of use is the antithesis of the environment in which
the narrowband Internet was borne and enjoyed such rapid growth. Changing the environment
changes the nature of activity. One thing we never heard about the narrowband Internet was a
complaint about the slowness of innovation. High-speed service is into its sixth year without a
major innovation to drive adoption. Complaints about high and rising prices for high-speed
Internet have come earlier and louder than they did for narrowband service. Having failed to
develop appealing applications and choosing to increase prices with a low level of penetration
has raised concerns about the rate of adoption of the new high-speed Internet service.
ECONOMIC HARM: SLOWING COMPETITIVE LOCAL EXCHANGE CARRIERS
The idea behind the 1996 Act was to decentralize investment decisions and stimulate
investment through competition, or what has been called the Competitive Stimulus Hypothesis.
ILEC investment will be encouraged both to meet the growth in ILEC retail
demand and to serve the growing demand for wholesale services CLECs. If
access to UNEs encourages CLECs that would not otherwise exist to form, their
non-UNE investments also constitute a net increase attributable to unbundling.210
Entrants invest where they believe they have an advantage. ILECs respond, sometimes to
defend market share or lower their costs, sometimes to provide wholesale inputs for new
entrants, and sometimes to innovate more quickly in the competitive environment.
In essence, the heightened threat of loss of business to rivals impels the ILEC
facing competition to lower prices, to produce more, to improve quality and range
of services, to innovates, and to invest more in order to accomplish these goals.
The result is that incentives for investment and production of output are greater
under the pressures of a competitive environment, and predictably, the firms
invest more.211
Nor is price the only dimension along which increased competition will benefit
consumers. As they compete, both ILECs and CLECS will have the incentive to
use quality of service improvements and innovation as competitive tools to
protect their own market share and to lure customers away from their rivals.
Because most of these improvements must be embodied in network infrastructure,
competition provides an added spur to increased investment.212
Thus the key to understanding the behaviors of the incumbents and the CLECs is to
recognize that the incumbents approach the advent of competition as monopolists.
Natural human inertia, the uncertainty of a competitive world, the temptations of
its market power and its privileged relationship with regulators may all combine
to motivate it to minimize the amount of adjustment by attempting to thwart
competition. Because incumbents dominate their markets and essentially serve all
210
Robert D. Willig, et al., Stimulating Investment and the Telecommunications Act of 1996, at 7.
Id., at 6.
212 Id at 7.
211
42
consumers and businesses, they naturally see entrant as firms that attempt to
duplicate their own business in a zero-sum world, where competition means they
must suffer loss.213
The pricing challenge in the voice telecommunications sector was not to prevent
monopolists from abusing their market power, it was to root out legal monopoly rates in a
ubiquitous monopoly network. Because the purpose of the Telecommunications Act was to
replace a ubiquitous, century old monopoly with competition, the interconnection and carriage
obligations went well beyond traditional common carriage. Federal regulators adopted a
forward-looking economic cost model for pricing the piece parts of the network and the Supreme
Court upheld the methodology.
In fact, consumer advocates and others argue that, as applied, the methodology is too
friendly to the incumbents. NASUCA points out that its estimate of costs is inflated because of
certain assumptions imposed by the FCC on the TELRIC methodology.214 Others argue that as
applied, TELRIC “has been modified in practice to allow price increases that compensate the
seller for a portion of retail margins.”215 The joint provision of basic and advanced products on
one network is only part of the cost problem. Other have pointed out that “due to inefficiencies
of its legacy structure, it is likely that there would continue to be rents under TELRIC to the
extent that TELRIC uses incumbent costs as ILECS are currently organized.” The legacy of the
mandated, vertically integrated monopoly affects the cost structure of the industry and the
regulatory oversight of costs leading to the conclusion that “the existing vertical structure of
incumbents is characterized by likely inefficiencies.”216
Not only is the underlying cost structure inefficient, but the allocations of costs is
strategic. Regulated monopoly incumbents “typically manage the upstream operating (network)
as a cost-based entity supplying the profit maximizing downstream entity (retail).” Given the
flexibility “costs will clearly depend on the nature of regulation that may continue to exist in the
market as well as the strategic behavior of the firms which seek to maximize their profits subject
to regulatory constraints and the behavior of rival firms.”217 This strategic allocation of costs is
part and parcel of the regulatory process, but it takes on an even more critical role with the
introduction of competition. 218 The there is also the problem of monopoly profits
Increasing the wholesale price of network elements would undermine competition,
entrant would have to deploy redundant facilities. The first victim would be innovation in
marketing and customer care. Defenders of the incumbents discount and disregard the benefits
of innovation that entrants bring. The most obvious examples, on which the consumer benefit
213 Alain Bourdeau de Fontenay, Why Inefficient Incumbents Can Prevail in the Marketplace OverMore Efficient
Entrant: An Analysis of Economies of Scale and Scope, Transaction Costs and the Misuse of Data, 46 (2003).
214 Gabel, David, Robert Loube, Michael Travieso, “Comments of the National Association of State Utility Consumer
Advocates (NASUCA),” In the Matter of Cost Review Proceeding for Residential and Single Line Business Subscriber Line
Charge (SLC) Caps, Access Charge Reform, Price Cap Performance Review for Local Exchange Carriers, Federal –State Joint
Board on Universal Service, CC Docket Nos. 96-262, 94-1, 96-45, January 24, 2002, p. 25
215 Beard, Ford and Klein, p. 8.
216 De Fontenay, at 58-59.
217 Id. at 24.
218 Id. at 42.
43
calculations rest, are the customer oriented and marketing strategies of the new entrants. This is
the same role that ISPs played in the development of the Internet.
These authors, like all the authors who argue in favor of asymmetrical regulation
between facilities and services-based competition, essentially ignore the value
added a competitor contributes through steps such as definition, marketing, sales,
and support of commercialized services, all dimensions around which competitors
seek to compete and innovate….
In the case of UNE-P, for example, competition is keen in pricing, brandings,
markets, customer service, etc… [T]hose activities constitute real competition that
results in true economic efficiency.219
Although the marketing innovation of the new entrants is most obvious, they have also
made substantial contributions to the production side of the industry. They have driven
innovation in operating support and back office systems, rights of way and collocation, and the
provisioning and use of fiber.
Entrants innovated in almost every dimension of the business from use of rightsof-way, to becoming early adopters of net technology. Entrants innovated at the
OSS/BSS level by working closely with new vendors that were developing
modular off-the-shelf elements that would support a plug-and-play strategy.
While incumbents were selling their real estate because of the miniaturization of
equipment and complaining that there was not enough space for collocation,
entrepreneurs created the telehouse, where myriad service providers could
collocate and interconnect efficiently. Fiber became commercialized under a
growing diversity of formats – dark or lit, by strands or lambda. While ADSL
had been developed by Bellcore in the late 1980’s, as it was the CLECs who were
the first to push for its large-scale deployment. In all, entrants brought a new
standard of innovation and efficiency to the marketplace.220
One of the lessons from the recent competitive era is that new entrants and
competitors can be quite ingenious and innovative in tackling the challenges that
they face. One of the most impressive innovations was the use of old pipelines to
create a national backbone fiber network… More generally entrants have been
very successful in addressing the right-or-way problem where they were at an
enormous disadvantage.221
IV. PUBLIC POLICY IMPLICATIONS
Current communications network policy has gotten both the Communications Act and the
antitrust principles wrong. Lessig argued in a number of proceedings involving access to
broadband facilities that we would be better off if communications policy took care of the
219
Id. at 27.
Id. at 57.
221 (p. 39)
220
44
problem, rather than antitrust. In fact, if we look back on the history of network industries, they
were frequently the target of both regulatory policy and antitrust actions. There are two reasons
for this, I think. First, market power in network industries has always been very potent. Second,
the goals of the two strands of public policy are not identical. There is growing evidence that the
digital communications platform will not be open without vigorous public policies and it will not
thrive as a closed platform. Our understanding of how to use antitrust and communications law
to achieve that goal must evolve as the nature of the underlying economic structure does but the
goal should never change.
BUILDING INFRASTRUCTURE
My primary argument rests on the large positive externalities that flow from open
communications networks. Such benefits are typically hard to measure. They require a
leap of faith, but five centuries of commitment to the development of infrastructure
should have created a strong basis for the belief in these investments. The point that
public policy has missed is that these externalities were paid for through public policy.
The public bought the infrastructure, directly or indirectly.
When the National Research Council revisited the issue of the deployment of the
broadband Internet, it discovered the obvious – you cannot build infrastructure on a three-year
payback. Adopting the financial analysis of merchants, it conducted an analysis of the
economics of building Internet infrastructure under conditions of competition. It used a threeyear payback period and found that investment was subject to the tyranny of the take rate.
Markets simply would not provide financial returns to meet the demands of investors, unless one
firm captured virtually all of the customers and services.
The NRC should not have been surprised by this finding, as none of the ubiquitous
national networks of our continental economy was deployed under these circumstances.
Railroads were massively subsidized by land grants. Highways have been built by public funds.
Telephones and cable were shielded by exclusive franchises. Risk capital is simply too
expensive to finance such networks.
We are willing to pay for these networks, as long as they are available to all on a
nondiscriminatory basis and support highly complex and interconnected activities of our
postindustrial economy222 because adequate and open infrastructure creates great fluidity and
opportunities (positive externalities) in an information-based economy that individuals and
businesses cannot capture directly through private actions. Economists fret about a free-rider
problem when people use a network without accounting for every jot and twiddle of costs, but it
is just as likely that the network can be creating shared user-benefits.
222
Traditional economic discussions identify public goods and public infrastructure driven primarily by
externalities (see for example John Taylor, Chapter 15, Economics (Boston: Houghton Mifflin, 1998) but the discussion
inevitably leads to consideration of regulation of natural monopolies wherein public policy seeks to impose socially responsible
behavior on private firms (see id., Chapter 16; Viscusi, W. Kip, John M. Vernon, and Joseph E. Harrington, Jr., Chapters 11-14,
Economics of Regulation and Antitrust (Cambridge, Mass.: MIT Press, 2001).
45
PROMOTING COMPETITION
The behavior of the lower level monopolists undercuts the claims of a new economy in
one important respect. If the new economy provides such powerful forces for natural monopoly,
why are these dominant entities forced to resort to so many unnatural anticompetitive tactics
some from straight out of the old economy, others variations on old practices, and some largely
from the new economy? The strategies adopted by dominant players at the start of the digital
information age are not all that different from the strategies adopted by the Robber Barons at the
start of the second industrial age. They sought to control the economy of the twentieth century
by controlling the railroads and oil pipelines that carried the most important products of that age
– heavy industrial inputs and output. The dominant firms in the digital communications platform
are seeking to control the economy of the digital information age by imposing a proprietary,
closed network on the essential functionalities of the new economy – controlling the flow of the
most important inputs and outputs of the information age – bits.
The remarkable array of anticompetitive weapons that owners have at the lower layers of
the platform flows from its network nature. Higher levels of the platform are completely
dependent on the lower levels for their existence. Without an obligation to treat applications and
content suppliers fairly, the incentive to innovate will be squelched. The dynamic innovation of
decentralized development is replaced by the centralized decision making of gatekeepers.
Some argue that we should go back to the mid-19th century, before the antitrust laws and
communications policy required non-discriminatory interconnection or carriage. I take the
opposite view. I believe that the twentieth century came to be known as the American century
precisely because antitrust and public interest regulation promoted infrastructure that is open,
accessible, and adequate and supports innovations and discourse.
46
EXHIBIT 1: INTERNET AS A BEARER SERVICE
Source: National Research Council,
47
EXHIBIT 2: LAYERS OF THE COMMUNICATIONS PLATFORMS AND
CHARACTERISTICS THAT RAISE SPECIAL MARKET POWER CONCERNS
PLATFORM LAYERS
MARKET POWER
CONCERNS
CONTENT/INFORMATION
TIPPING & LOCK-IN
Network Effects
Extreme Economies
of scale and scope
APPLICATIONS
APPLICATIONS BARRIER
TO ENTRY
Installed base
Switching costs
CODE
Interconnection standards,
Communications protocols,
Operating systems
PHYSICAL
Display Devices, Switch
Transmission medium
VERTICAL LEVERAGE
Incompatabilities
Impairment
Desupporting
VERTICAL LEVERAGE
Foreclosure
Refusal to Interconnect
Refusal to Interoperate
48
EXHIBIT 3: THE MICROSOFT BUSINESS MODEL AND ITS IMPACT ON CONSUMERS
MARKET STRUCTURE AND CORPORATE CONDUCT:
CHARACTERISTICS OF THE ANTICOMPETITIVE BUSINESS MODEL
MARKET PERFORMANCE:
CONSUMER HARM
UNDER THE TABLE
Abrogation of Contracts
Intimidation
Market Division
Patent Infringement
Reverse Bounty
Predation
CONTRACT PROVISIONS
Preferential Location
Exclusive Deals
Quality Impairment
Resource Denial
Secret Prices
Indirect Sales
LEVERAGING MONOPOLY
TO PREVENT COMPETITION
OS Tying
Incompatibility
Disabling
Desupporting
Imitation
COST SAVINGS
Volume
Capacity Utilization
Low Sales/Services
BARRIERS TO ENTRY
Installed Base
Positive Network Effects
RETARDING INNOVATION
Chilling Effect on Investment
Delaying and Preventing Products
DENIAL OF CONSUMER CHOICE
Denying and Delaying Products
Denying User-Friendly Configurations
Inconvenient Distribution of
Non-Microsoft
Thwarting Responses to Demand
DEGRADATION OF QUALITY
Impairing Functionality of Microsoft
Reducing Availability of Product
Impairing Functionality of
Non-Microsoft Products
INCREASING CONSUMER COST
Transaction Cost
Monopolistic Pricing,
Short and Long-Term
Raising Hardware Cost
ABUSIVE PRICING
Bundling Hidden Price
Upgrade Policy
Excess Functionality
Overcharges
Cross-subsidy from OS
EXCESS PROFITS
1
EXHIBIT 4: EXAMPLES OF ABUSIVE MICROSOFT BUSINESS PRACTICES
ELEMENTS OF THE
MICROSOFT BUSINESS MODEL
UNDER THE TABLE
ABROGATION OF CONTRACTS
INTIMIDATION
MARKET DIVISION
PATENT INFRINGEMENT
REVERSE BOUNTY
PREDATION
CONTRACT PROVISIONS
PREFERRED DESKTOP LOCATION
EXCLUSIVE DEALS
QUALITY IMPAIRMENT
RESOURCE DENIAL
SECRET PRICE
BUNDLING, OS TYING
COMMERCE
INCOMPATIBILITY/INTEGRATION
DISABLING
DESUPPORTING
IN PUBLIC
IMITATION
PREANNOUNCEMENT
INDIRECT SALES
TRADE PRESS ACCOUNTS
OF ANTICOMPETITIVE
PRACTICES
DESKTOP
DR-DOS, INTUIT
DOS
FINDINGS OF FACT
UPHELD ON APPEAL
INTEL, APPLE
NAV, INTEL, REAL,
APPLE
STAC, APPLE, 3D, GO,
DOS
DOS, DESKTOP
NAV
NAV
DR-DOS, DESKTOP
DR-DOS,
DR-DOS,
DR-DOS, E-COMM
DESKTOP, E-COMM
NAV, WIN95
NAV, DESKTOP
NAV, JV
NAV
NAV
NAV, DESKTOP, E-
DESKTOP, HP NEWWAVE
DR-DOS,
DR-DOS, E-COMMERCE
NAV
NAV
NAV
DR-DOS, APPLE
DR-DOS,
NAV
NAV, DESKTOP
OS,
DESKTOP = covers the individual programs as well as the suites including Lotus, Corel, Novell, WordPerfect,
Borland and IBM Smartsuite; DR-DOS = Novell’s DR-DOS; E-COMMERCE = covers the range of transaction
involving commercial transactions on the Internet; NAV = Netscape Navigator; JV=JAVA;
Wallace James and Jim Erickson, 1992, Hard Drive (Harper’s, New York); “Mine, All Mine,” Time, June 5, 1995;
Kaplan, Jerry, 1995, Startup (); “Gleick, James, “Making Microsoft Safe for Capitalism,” Antitrust Law and
Economic Review, 1996; Sheremata, Willow A., “Barriers to Innovation: A Monopoly, Network Externalities, and
the Speed of Innovation,” Antitrust Bulletin, 1997; Akin, Alan, July 16, 1997, Microsoft and 3D Graphics: A Case
Study;; Wallace, John, Overdrive (John Wiley: New York, 1997); “Windows 98 Disables Microsoft Competitors’
Software,” CNET, July 4, 1998; Edstrom, Jennifer and Marlin Eller, 1998, Barbarians Led by Bill Gates (Henry
Holt and Company, New York); Rohm, Wendy Goldman, 1998, The Microsoft File: The Secret Case Against Bill
Gates (Random House: New York); The World According to Microsoft,” PC Week Online, June 8, 1998;
1
EXHIBIT 5: IDENTIFYING MONOPOLY OVERCHARGES PRICE
$40
$50
|
|
|
|
|
|
|
|
|
|
MONOPOLY
PERIOD
COMPETITIVE
PERIOD
$19
HISTORIC
TREND
1981
1990
$50+
|
|
|
|
|
|
|
|
|
OVERCHARGES
BASED ON
CURRENT CASE
|
|
|
|
|
|
|
|
|
|
|
|
|
1996
1998
2
EXHIBIT 6: NON-PRICE HARMS OF THE MICROSOFT MONOPOLY
FINDINGS OF FACT
CONCLUSIONS
(Paragraph No.)
OF LAW
(Page No.)
DENIAL OF CONSUMER CHOICE
Force New Versions in New PC
57, 66
Upgrade Raises Hardware Cost
57,66
Excess Functionality
173-174,210-216
Deny Consumer Needs
210-216, 247, 410
Delaying Release of Products
167-168
Deny or Delay Non-Microsoft
90-91,93
Thwart Responses to Demand
225-229
6
6
6,11,32
11
11
10,11
11,14
RETARDING INNOVATION
Chilling Effect on Investment,
Developer Time and Money
Resource Denial
Delay or Prevent Development
Netscape’s Navigator
IBM’s OS2/Smartsuite
Sun’s JAVA
Real Networks
Apple’s Quicktime
Intel’s Native Signaling
Undermining Compatibility
31
10,18,19
22
10
18
10
10
6
6,18,19
379, 397,412
240,357,379,396-406
411, 132,395-396
81-88,408-410
116-118,125-130
397-403
111-114
104-110
94-103
390-396, 407
DEGRADATION OF QUALITY
Impair MS Functionality
173, 174
Reducing the Availability
407
Quality Impairment
90-92,128-129,160,
171-172, 330,339-340
Incompatibility/Integration
129,387-396,404-406
Disabling
160,170-172
11
18,19
6,10,11,17,32
18,19
11,31,32
3
EXHIBIT 7: ANTICOMPETITIVE ELEMENTS OF THE CABLE INDUSTRY
VIDEO/COMMUNICATIONS PLATFORM
VIDEO
DATA
Discriminatory Carriage Terrestrial
Exclusion
Exclusionary/ Discriminatory
Carriage
Preference for Affiliated
Applications
Control of
Functionality
Streaming
Uploading
Bit stripping
Policy-based Routing
Closed OS
DOCSIS, discrimination
Monopoly
85% share
Monopoly
65-75% share
Set Top Box Closed
Cable Modem Closed
4
i
Pi
on
H
om
t
e
N
Tw
IP
k
Ad
C
dr
om
es
m
s
er
ci
al
U
se
Ba
nd
Se
w
rv
id
R
er
th
es
O
el
ve
l in
ru
g/
Sp
se
IS
am
P
/C
Se
on
rv
su
ci
e
m
er
Fr
au
d
H
ac
ki
U
ng
nl
aw
Im
fu
lU
m
or
se
al
Pu
rp
os
e
d
En
W
iF
VP
N
% OF AGREEMENTS
EXHIBIT 8: RESTRICTIVE CONDITIONS IN HIGH SPEED INTERNET CONSUMERS CONTRACTS
100
90
80
70
60
50
40
30
20
10
0
CABLE MODEM
DSL
5
EXHIBIT 9:
MARKET SHARES OF INTERMODAL COMPETITORS WITH
MISMATCHED TECHNOLOGIES
MARKET
_________________________________
RESIDENTIAL/
BUSINESS/
LOW VOLUME
HIGH VOLUME
SERVICE
TECHNOLOGY
VIDEO
HYBRID FIBER
(cable)
COPPER
(DSL)
WIRELESS
(satellite)
80
NA
0
NA
20
NA
HYBRID FIBER
(cable)
COPPER
(DSL)
WIRELESS
(cellular)
1
0
95
95
4
5
HYBRID FIBER
(cable)
COPPER
(DSL)
WIRELESS
(cellular)
0
0
0
0
100
100
75
0
20
95
5
5
BASIC VOICE
MOBILE VOICE
ADVANCED DATA HYBRID FIBER
(cable modem)
COPPER
(DSL)
WIRELESS
(satellite/cellular)
6
EXHIBIT 10: STRATEGIC PRICING OF CABLE MODEM SERVICE
70
60
COST OF
INDEPENDENT ISP
MONTHLY COST
50
NO CABLE FEE
40
30
20
10
MONTHLY SERVICE FEE
0
DIGITAL TV
HSPD INTERNET
Source: Web site visits.
7
EXHIBIT 11:
THE INTERNET AND THE WEB WERE THE ‘KILLER APPS’ FOR THE PC
60
P[ERCENT OF HOUSEHOLD
50
40
30
20
10
WEB BROWSER
0
1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002
PC
INTERNET
Source: Source: Subscriber counts: Carey, John, “The First Hundred Feet for Households: Consumer Adoption
Patterns,” in Deborah Hurley and James H. Keller (Eds.), The First Hundred Feet (Cambridge: MIT Press, 1999);
National Telecommunications Information Administration, A Nation Online (U.S. Department of Commerce, 2002).
Early ISP counts are discussed in Mark Cooper, Expanding the Information Age for the 1990s: A Pragmatic
Consumer View (Consumer Federation of America, American Association of Retired Persons, January 11, 1990),
see also Janet Abbate, Inventing the Internet (Cambridge:MIT Press, 1999) and Matos, F., Information Service
Report (Washington, D.C.: National Telecommunications Information Administration, August 1988), p. x. More
recent numbers are from the Bureau of Labor Statistics; 2001b.Since the mid-1990s, annual counts of ISPs have
been published in Network World.
8
EXHIBIT 12: DENSITY OF INTERNET SERVICE PROVIDERS
BY YEAR
18
ISPS PER 100,000 SUBSCRIBERS
16
14
12
10
8
6
4
2
0
1996
1997
1998
DIAL-UP
1999
CABLE MODEM
2000
2001
2002
DSL-OTHER
Source: Source: Subscriber counts: Carey, John, “The First Hundred Feet for Households: Consumer Adoption
Patterns,” in Deborah Hurley and James H. Keller (Eds.), The First Hundred Feet (Cambridge: MIT Press, 1999);
National Telecommunications Information Administration, A Nation Online (U.S. Department of Commerce, 2002).
Early ISP counts are discussed in Mark Cooper, Expanding the Information Age for the 1990s: A Pragmatic
Consumer View (Consumer Federation of America, American Association of Retired Persons, January 11, 1990),
see also Janet Abbate, Inventing the Internet (Cambridge:MIT Press, 1999) and Matos, F., Information Service
Report (Washington, D.C.: National Telecommunications Information Administration, August 1988), p. x. More
recent numbers are from the Bureau of Labor Statistics; 2001b.Since the mid-1990s, annual counts of ISPs have
been published in Network World.
9
EXHIBIT 13: DENSITY OF INTERNET SERVICE PROVIDERS
BY MARKET SIZE
Sources: See Exhib
Source: Source: Subscriber counts: Carey, John, “The First Hundred Feet for Households: Consumer Adoption
Patterns,” in Deborah Hurley and James H. Keller (Eds.), The First Hundred Feet (Cambridge: MIT Press, 1999);
National Telecommunications Information Administration, A Nation Online (U.S. Department of Commerce, 2002).
Early ISP counts are discussed in Mark Cooper, Expanding the Information Age for the 1990s: A Pragmatic
Consumer View (Consumer Federation of America, American Association of Retired Persons, January 11, 1990),
see also Janet Abbate, Inventing the Internet (Cambridge:MIT Press, 1999) and Matos, F., Information Service
Report (Washington, D.C.: National Telecommunications Information Administration, August 1988), p. x. More
recent numbers are from the Bureau of Labor Statistics; 2001b.Since the mid-1990s, annual counts of ISPs have
been published in Network World.
1