PREDATORY AND EXCLUSIONARY INNOVATION

8/4/2019 PREDATORY AND EXCLUSIONARY INNOVATION

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Working draft

7 August 2005

PREDATORYANDEXCLUSIONARYINNOVATION: WHICHLEGALSTANDARDFORSOFTWARE

INTEGRATIONINTHECONTEXTOFTHE COMPETITIONV INTELLECTUAL PROPERTYRIGHTS

CLASH?

Maria Lill Montagnani

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

Abstract

This paper aims to address two questions: first, how to identify the

legal standard that courts use to assess a specific behavior (software

integration) commonly adopted by firms possessing IPRs. Second, whether

this standard enables us, on the one hand, to draw a line between predatory

and competitive innovation, and, on the other, to strike a balance between:

the market leaders freedom to innovate and the public interest towards the

persistence of competitive markets.

The research consists of an examination of the main hardware and

software integration cases in the US and the EU, from which a standard

echoing the predatory innovation doctrine principles and increasingly aware

of network effects and high-tech market features emerges. The conclusion is

thus that, as long as IPRs work as incentives to innovate, a system of rivalry

is to be maintained. However, when exploitation of IPRs by rightholders

becomes a means to limit competition in the market (in that it enables toprevent both competitors and rightholders further innovation); then IPRs

loose the function of innovation incentives and remedies are to be

undertaken in order to maintain competition effective in the market.

1 INTRODUCTION

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Innovation has historically been deemed a competition driver and,

therefore, rewarded through the granting of IPRs (1). However, in high-tech

markets innovation may be twofold. On the one hand, it promotes

competition and deserves reward, such as IPRs; on the other hand, it may

be a means to prevent competition due to the high-tech market specific

features, such as network, spill over, consumer lock in and winner-takes-all

effects (2).

The twofold nature of innovation in high-tech markets has been

theorized by those scholars asserting the predatory innovation doctrine,

under which innovation in network markets can be a means to predation

and, as such, can violate competition law (3).

Distinguishing good from bad innovation is not an easy task,

since the high-tech market specific features are counterbalanced by high-

tech market operators ownership and exploitation of IPRs, granted as a

result of their innovative efforts and entitling rightholders to act freely.

Both these aspects (market features and IPRs) emerge when dealing

with a specific behavior adopted in the software market: software

integration.

First, the software market is a classic example of network market in

that one product or standard tends towards dominance. In this context, the

1 IPRs are granted to foster innovation since they are an (economic) reward for creative andinventive works. Granting an exclusive right is considered an incentive to further creationand invention, and it benefits society in terms of culture, science, and economy. Such aprocess invention-IPRs- incentives to further innovate, thus, benefits competition itself bydeveloping new products and markets and suites the Schumpeterian perspective, underwhich innovation is competitive when it promotes the technological progress necessary to

produce more and better quality goods. With this regard, the market process appearssegmented in (i) introduction of a product innovation into a market; (ii) increase ofinnovators revenues; (iii) imitation of that product innovation by competitors; (iv)introduction of the imitated product into the market by competitors; and (v) decrease ofinnovators revenues [FREDERIC M. SCHERER, INDUSTRIAL MARKET STRUCTUREAND ECONOMIC PERFORMANCE 350(Rand McNally College 1970). See also JOHN M. CLARK, COMPETITION AS A DYNAMIC PROCESS 178-270(Brooking Institution 1961)]. Through the above mentioned process, technological andeconomic progress develops. However, innovators will be likely to aim at making phase (ii) asmuch longer as they can in order to postpone phases ( iv) and (v), and IPRs appear to beuseful means to stretch phase (ii) and block or slow down the innovation circle.2 ILKA RHANASTO, INTELLECTUAL PROPERTY RIGHTS, EXTERNAL EFFECTS AND ANTITRUST LAW 183 passim (OxfordUniversity Press 2003).3 Janusz A. Ordover & Robert D. Willig, An economic Definition of Predation: Pricing and

Product Innovation, 91 YALE L. J. 8 (1981). Contra J. Gregory Sidak, Debunking PredatoryInnovation, 83 COLUM. L. REV. 1121 (1983).

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utility that a user derives from the consumption of a good increases with the

number of other users consuming that good. Thus, once one product or

standard achieves wide acceptance, it becomes entrenched (4). At the same

time, such entrenchment may be temporary because innovation may alter

the field altogether (5). At least the latter is deemed to be the mechanism to

keep the software market (and, generally speaking, the high-tech markets)

competitive (6). Recent cases, such as the European Microsoft case,

however, seem to demonstrate that network effects and IPRs tend to

strengthen the innovators position.

Second, software programs are protected by copyright and this

protection has been progressively extended from source code to other

elements (7), not least communication interfaces. Besides, patents are

granted for software programs showing technical effects which further

expand these products protection (8).

Software integration can thus exemplify the issue in exam: innovative

behaviors adopted by IP rightholders generating both pro- and anti-

competitive effects. When adopted by a firm leading a forehead market

(such as the operating system market), software integration may be capable

of hampering competition in an aftermarket (such as the server or browser

markets). In this case, innovation can be considered predatory, and

predation can be challenged. On the other hand, software market operators

are rewarded for their innovation through the granting of IPRs that, in turn,

are supposed to provide an incentive to further innovate. However, in this

market and in certain circumstances, IPRs are unlikely to offer an incentive

to innovate, but, rather, a means to limit further innovation and

developments.

4 This mechanism has been defined competition for the field, instead of in the field, byHarold Demsetz, Why regulate utilities?, 11 J.L. & ECON. 55, 57 n.7 (1968).5 JOSEPH. A. SCHUMPETER, CAPITALISM, SOCIALISMAND DEMOCRACY 81-90 (Allen & Unwin 1943).6 Herbert Hovenkamp, Post-Chicago Antitrust: A Review and Critique, 2001 COLUM. BUS. L. REV.257, 332.7 For a complete overview of software protection under the US copyright law see MARK A.LEMLEYETAL., SOFTWAREAND INTERNET LAW (Aspen Law and Business 2nd ed. 2003). For a comparativeapproach, see ADRIAN STERLING, WORLD COPYRIGHT LAW (Sweet & Maxwell 2nd ed. 2003).8

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

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For these reasons software integration cases appear to be an ideal

scenario for finding the legal standard to distinguish good from

predatory innovation in network markets. And, too, the predatory

innovation doctrine principles constantly emerging in hardware and

software integration cases appear to be a good means towards achieving

this goal.

Hence, the aim of this paper is to find the legal standard used by case

law to assess software integration and to verify: first, whether predatory

innovation principles have therein been applied; and, second, whether this

application enables the courts to strike a balance between actors freedom

to innovate and public interest towards competitive markets. Besides, this

assessment is to be carried bearing in mind that in the software market

freedom to innovate is granted through the IPR ownership, which brings in

the clash between Competition law and Intellectual Property law.

The rest of part I will provide a definition of predatory innovation and

the terminology used herein. Part II will survey the early software and

hardware integration cases (IBM cases) since they are the early cases where

the predatory innovation principles underpinned the allegations. Part III will

survey the early software integration cases: Microsoft II and Caldera v.

Microsoft and the blurring of monopolization and tying offenses. Part IV will

address whether predatory innovation principles were applied in Microsoft III

and IV. And, finally, part V will try to work out a system to assess software

integration and, more broadly, innovative conducts generating both anti-

and pro-competitive effects in the light of predatory innovation doctrine

principles. With regard to the software market, this assessment can not becarried without considering the presence of IPRs enabling the innovator to

justify his behaviors. Innovation being counterbalanced by IPRs, software

integration needs to be addressed and inserted within the context of the

clash between Competition law and Intellectual Property law.

1.1 Predatory and exclusionary innovation in the

hardware and software markets

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Predation is that conduct which has the purpose and the effect of

advancing the actors competitive position, not by improving the actors

market performance, but by threatening to injure or actually injuring

potential competitors, as to drive and keep them out of the market, or force

them to compete less effectively (9). Such predatory behaviors can center

on prices (predatory pricing) or other elements, such as innovation,

research and development, advertising, and product designs (non-pricing

predatory practices) (10). In both cases a key element to raise competition

concerns is the actor being a monopolist or possessing a dominant position.

The focus is herein on those behaviors centered on innovation. This

competition driver may generate both anti- and pro-competitive effects so

as to raise the question as to when innovation stops being beneficial and

starts being detrimental.

The question becomes even more relevant in network markets, such

as software and hardware markets, for several reasons. First, lock-in,

network, winner-takes-all and similar effects together with low marginal

costs can amplify innovations anticompetitive effects (11). Second, in such

markets the actors positions is strengthened by IPRs either rewarding

rightholders for their previous innovative efforts or protecting their

freedom to further innovate. Although changing design or updating

(upgrading) of patented or copyrighted products are rightholders choices

as well as bundling two different products however, exploitation of IPRs

may higher barriers to entry.

Therefore, with regard to the software and hardware markets, the

question to pose is as to whether markets features and IPRs are to be taken

9 LAURENCE A. SULLIVAN, HANDBOOKOFTHE LAWOF ANTITRUST 108 (West 1977).10 HERBERT HOVENKAMP, FEDERAL ANTITRUST POLICY. THE LAWOF COMPETITIONANDITS PRACTICE 289 (West end ed.1999). Non-prices behaviours centered on innovation consist in: (i) manipulation of leadingfirms main technology in order to make it incompatible with competitors accessories andleverage secondary markets (so called technological or implicit - tying); (ii) constantupdating of leading firms main technology to raise competitors costs to regain compatibility(technological manipulation or design change); (iii) vapourware (on the latter practice, seeRobert Prentice, Vaporware: Imaginary High-Tech Products and Real Antitrust Liability in aPost-Chicago World, 57 OHIO ST. L. J. 1163 (1996). For a categorization of behaviours falling inthe predatory practices, see also Carlos Acuna-Quiroga, Predatory Innovation: A StepBeyond? (Understanding High-technology Markets), 15 INTL REV. OF L. COMPUTERS & TECHNOLOGY 7,8-9 (2001).11

John Temple Lang, European Community Antitrust Law: Innovation Markets and HighTechnology Industries, in INTERNATIONAL ANTITRUST LAWAND POLICY 519 (Bender 1996).

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into account in assessing when innovation stops being beneficial and starts

being detrimental. In other words, assuming that the innovations

exclusionary effects outweigh pro-competitive effects, is this boundary to be

struck according to market features and actors ownership and current or

potential exploitation of IPRs?

According to those scholars formulating the predatory innovation

doctrine, a different assessment is needed for monopolists operating in

network markets due to market power possibility of being entrenched by

innovation (12).

Both the United States and European courts have been wary of these

principles granting a different treatment to the incumbents innovation

when aiming to prevent competition in network markets. This does not

mean that courts have always been consistent in assessing behaviors

dealing with innovation, and a progressive change appears to have taken

place.

While, in the early cases, innovative behaviors at that time

hardware integrations were implicitlyper se lawful, in that an assessment

involved technical evaluations was deemed difficult to undertake and falling

outside courts competence; predatory innovation doctrine principles appear

to underpin the recent decisions involving software integrations. As markets

have changed (integration in the hardware market has been progressively

replaced by integration in the software market), courts approach has

changed either, and allegations grounded on predatory innovation principles

have progressively been accepted.

A premise is however necessary in order to clarify the wording

predatory innovation. Although this term originates from the antitrust law

doctrine stating the principles we deal with, however, in this work a slightly

different wording is adopted. Predatory innovation is used to indicate that

12 Ordover & Willig, supra note 3, at 8. In details, the Authors doctrine can be applied tovertical integration, such as the software integration in question, by a three-prong test: 1.Analysis of the likelihood and the sources of monopoly profits from exclusion; 2. Profitsacrifice; 3. Recoupment of the forgone profits. See also Laurence J. White, Microsoft and

Browsers: Are the Antitrust Problems Really New?, New York University, Center for Law andBusiness, Working Paper No. 98-018 www.ssrn.com/abstract=164499 (March 1998).

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conduct falsely innovative but exclusively aimed to drive and keep

competitors out of the market; whereas exclusionary innovation is

adopted to indicate that conduct whose effects on competition can be both

detrimental and beneficial at the same time, regardless of the actors

purpose.

A survey of cases dealing with, firstly, hardware and, secondly,

software integration can show how predatory innovation doctrine principles

have progressively emerged and, with them, the assessment of market

features and exploitation of IPRs. This survey may also provide a means to

assess software integration by eliciting the legal standard applied. Since in

the case-law predatory innovation doctrines principles are often melted

with the tying doctrine principles, a few remarks on this point are necessary.

1.2 Hardware and software integration: technological tying

between monopolization (or abuse of dominant position)

and tying

Hardware and software integration can fall under different provisions:

monopolization (section 2 US Sherman Act) or abuse of dominant positions

(art. 82 EC Treaty); and, tying (section 1 US Sherman Act and art. 82 (d) EC

Treaty). In the U.S., besides these provisions, an allegedly exclusionary

innovation conduct may also be challenged as an attempt of monopolization

(section 2 US Sherman Act). Although an attempt of monopolization claim

was accepted in the predatory innovation leading case Bard v. M3 System

(13

) this offense has little relevance in the hardware and software

13 157 F.3d 1340 (Fed. Circ. 1998).

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integration cases (14) (15). For this reason, it will not be dealt with in this

paper (16).

Monopolization (or abuse of dominant position) on the one hand, and

tying on the other hand, are rather differently assessed under the US and

the EU competition laws. These differences are worth pointing out as they

affect the legal standard to be applied.

In the US, two different legal standards can be applied depending on

whether an integration is being challenged under sec 2 or sec 1 of the

Sherman Act: the Grinnel standard andper se illegality rule, respectively.

As to the former, monopolization offense has two elements deriving

from the Grinnell case: (i) the possession of market power in the relevant

market and (ii) the willful maintenance of that power as distinguished from

growth or developments as a consequence of a superior product, business

acumen, or historic accident (17).

As to the latter, tying has traditionally been assessed the following

way: whenever four conditions are considered present (namely: (i) two

separate products; (ii) market power in the tying product market; (iii) no

consumer choice to obtain the tied product separately from the tying

product; and, finally, (iv) foreclosure of competition in the tying market), the

tying practice is deemed illegal per se (18) no matter the efficiencies the

tying could generate for consumers. However, since the legal standard to

evaluate tying in high-tech markets needs to balance the efficiencies a tying

can generates with the anti-competitive effects it can yield, a rule of reason

assessment is progressively emerging (19).

14 Herbert Hovenkamp, The Monopolisation Offense, 61 OHIO ST. L. J. 1035, 1046 (2000),stresses that, as long as its product is complement of competitors products, a non dominant

firm is unlikely to design change or integrate in that there is no incentive to limitcompatibility. Rather, a non dominant firm has incentive to maximize its profits bymaximising its compatibility. Hence, an attempt of monopolisation by a non dominant firm isless likely to happen than a monopolisation offense.15 The attempt of monopolizations three element test, deriving from Swift & Co. v. UnitedStates [196 U.S. 375, 396 (1905)], are: (i) specific intent to control prices or destroycompetition in some part of commerce; (ii) predatory or anticompetitive conduct directed toaccomplishing the unlawful purpose; and (iii) a dangerous probability of success.16 For an analysis of Bard v. M3System see Herbert supra note 6, at 327-332.17 United States v. Grinnell Corp. 384 U.S. 563, 570-571 (1996).18 For a discussion of tying arrangement assessment see HOVENKAMP, FEDERAL ANTITRUST POLICY,supra note 18, at 392.19

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

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Conversely, in the EU, tying is a species of the abuse of dominant

position genus, thereby sharing the same rule of reason approach applied to

behaviors falling under art. 82 EC Treaty. This tying assessment is thus

focused on four elements (the same elements the US tying assessment is

grounded on). Their presence, however, does not determine a tying per se

illegality, because a balance has always been deemed necessary to be

undertaken between pro- and anti-competitive effects.

As long as the US and the EU apply two different rules in assessing

tying, hardware and software integration assessments will be different.

However, because of the current trend in the US towards the adoption of a

rule of reason approach, differences between the US and the EU systems

are progressively being blurred. It is still worth bearing in mind, though, that

these differences did affect the early cases and, even now, parties try to

make claims or a defense under one or the other category according to the

results that they are pursuing.

2 EARLY LEGAL STANDARDS FOR EXCLUSIONARY INNOVATION IN THE HARDWARE AND

SOFTWAREMARKETS: THE IBM CASES

In the late 70s and beginning 80s the first relevant claims underlying

predatory innovation doctrine took place in the hardware market and

involved IBM, challenged of using innovation to monopolize and attempt at

monopolizing, in violation of section 2 of the Sherman Act.

Even the early cases show concern over the twofold nature ofinnovation: as triggering competition and, at the same time, harming

competition. However, courts awareness that the markets at hand

presented specific features capable of altering the competition mechanism

did not modify the very conservative approach adopted in assessing IBMs

behaviors under the monopolization legal standard. Therefore, that

Illegality, 49 ANTITRUST BULL. 287 (2004). See also David S. Evans, A. Jorge Padilla and Michele

Polo, Tying in Platform Software: Reasons for a Rule-of-Reason Standard in EuropeanCompetition Law, 25 WORLD COMPETITION 509 (2002).

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approach did not take into consideration market features and IPRs as means

to raise barriers to entry (20).

2.1 IBM hardware integration cases

At the time that IBM cases took place, computers were rather

different from now. What we now call a computer was a minicomputer,

while computers occupied an entire room or office, where the central unit

machine and its accessories not only printers but also memories and tape

drives and the like were located. Conversely, software was not that

important and was often given free to customers buying a central unit.

In this context, IBM was manufacturing both central unit machines

and its peripherals. However, accessories were also manufactured by IBM

competitors, and, although not being original, they were IBM compatible as

well. IBM then started to integrate these accessories (peripherals) or to

change the design of interfaces between the main frame machine and

peripherals, thereby making the competitors accessories incompatible with

its main frame machines.

By doing this IBM was innovating. We would probably not have the

machines we have now if IBM had been prevented from doing it. However,

this same innovative behavior was alleged to limit competition in the

accessories markets since precluding the compatibility of competitors

peripherals, thereby forcing them to move to another product or seek

compatibility again.

20As to IPRs in the hardware and software markets, it is to bear in mind that copyright on

software was introduced in the 1980 in the US and later in EU [on this point, see MananderGrewal, Copyright protection for computer software, 18(8) E.I.P.R. 454 (1996)]; while the suigeneris rights on microchip is slightly more recent, at least in the US [ see Jay A. Erstling, TheSemiconductor Chip Protection Act and Its Impact on the International Protection of ChipDesign, 15 RUTGERS COMPUTER & TECH. L.J. 303 (1989)]. Therefore, in the earlier IBM cases, morerelevance was given to trade secret law, since IBM, after having integrated accessories, usedto refuse to disclose the new interfaces by claiming a secret on them. The courts, however,tended to affirm the principle that trade secret, even though granted as an incentive toinvent, should not prevent competitors reverse engineering [as an example of the

mentioned conduct and courts reasoning, cf. ILC Pheripherals Leasing Corp. v. IBM, 458F.Supp. 423, 437 (N. D. Cal. 1978).

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No claim brought against IBM was accepted by the American Courts,

though. Its interesting to examine the outcomes because every case adds a

bit more information on the courts reasoning.

2.1.1 IBMs behaviors

More specifically, IBMs challenged practices were: (i) design changes

for the interfaces between central processing units and certain peripherals,

such as tape drive (21); (ii) integration of disk functions, such as disk

controller (22) and disk driver (23), into the central processing unit; (iii)

behaviors not directly related to innovation rather to contracts,

advertisements and prices.

The practices were challenged under the section 2 of the Sherman

Act stating unlawful for a firm to monopolize (monopolization offense) and

to attempt at monopolizing (attempt of monopolization offense) (24).

2.1.2 The courts decisions

The courts reasoning on exclusionary innovation conducts have in

common the adoption of a generalized standard applicable to all types of

behaviors adopted by monopolists regardless of the relevant market

features and IPRs.

Although all the decisions rejected the predatory innovation claims,

they still present a slightly different approach to the issue which is worth

pointing out.While the early decisions state that innovation was always good;

the later ones started out by refusing to admit that innovation could both

harm and benefit competition, but ended up by affirming that, from a

21 Transamerica Computer Company Inc. v. IBM, 698 F.2d 1377, 1382 (9th Cir. 1983).22 California Computer Products Inc. v. IBM, 613 F.2d 727, 743-744 (9th Cir. 1979).23 ILC Peripherals Leasing Corp. v. IBM, 458 F.Supp. 423, at 438-439.24 For a complete overview and analysis of the IBM case, see also Lawrence A. Sullivan,Monopolization: Corporate Strategy, the IBM Cases, and the Transformation of the Law, 60

TEX L. REV. 587 (1982); Robert E. Barkus, Innovation Competition: BeyondTelex v. IBM, STAN. L.REV. 285 (1975-1976).

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theoretical point of view, innovation could unreasonably restrict

competition, and, thereby, violate the Sherman Act sec. 2. On the other

hand, however, a product improvementcould never be restrained, even

when its effect would severely injure competitors (25).

The point, therefore, was and, partially, still is to figure out when a

product improvement was occurred. Even on this issue the courts

reasoning was still theoretical. A balance between the level of superiority

and the effects on competition was invoked but never explained. An

improvement was deemed to possibly harm competition whenever that

level of product superiority was, with respect to the former product, not

compensated for by the harm done to competition.

In the IBM cases, the courts never moved from theory to practice

since the challenged integrations did always constitute an improvement,

and, before than that, IBM was deemed not to have market power. In other

words, time was unlikely to be ripe for accepting an exclusionary innovation

claim since network effects were not that worrisome and IPRs on hardware

products were hardly considered.

2.2 IBM software integration cases

The last case involving IBM took place, rather than in the hardware

market, in the software market; and dealt with IBMs having integrated a

proprietary software in its operating system (26). Such a behavior was

alleged to harm competition in the software market since it could have

driven out all the software manufacturers competing with IBM.

2.2.1 The IBMs behaviors

IBMs challenged behavior was the tying of an application software

program and the operating system. This software had two functions:

transferring data between the computer disk into the operating system, and

loading for the first time IBMs operating system (27).

25 In re IBM Peripheral EDP Devices Antitrust Litig. Transamerica Computer Co. Inc. v. IBM,481 F.Supp. 965, 1004 (N. D. Cal. 1979) (emphasis added).26 Innovation Data Processing Inc. v. IBM, 585 F. Supp. 1470, 1472-1473 (N. J. Dist. Ct. 1984).

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A little background information is necessary to understand the case

facts and the outcome. At that time IBM was marketing two different

versions of its operating system: the former had integrated the software

performing the above mentioned functions; the latter had kept it unbundled.

However, even in the case of the integrated software, it could have been

used to upload the operating system and, after that, removed without

paying fees within thirty days (28).

Since an IBM competitor was manufacturing a software program

performing the same functions of the software IBM had integrated in its

operating system it challenged IBMs integration claiming that it

constitutes tying under sec. 1 of the U.S. Sherman Act. This integration was

thus alleged as being illegalper se (29).

2.2.2 The courts decision

Although at that time, and under the American antitrust law, tying

assessment was quite strict, in this case the court decision stated that the

integration was lawful since the users were not coerced into buying the

integrated version of IBMs operating system. And, even when they bought

it, they were still free to unbundle it.

The courts reasoning expressly grounded on (i) the presence of these

two different versions of IBMs operating system; and (ii) the possibility of

either licensing the software without the operating system (in the

segmented version), or removing it from the integrated version whenever

the customer wanted (and without paying any fee if removed within thirty27 Of some interest, even for the following, is the definition of operating system that the courtgave in Innovation v. IBM (id. at 1472): An operating system is a set of computerprograms which guide and control the basic function of a computer. These operating systemprograms also provide the necessary link between the physical hardware and the variousapplications programs software, designed to perform specific tasks, such as accounting,world-processing, payroll or even video games.28Id., at 1474.

29Differently from the current legal standard for tying (see supra p. 6 and note 18), at that

time, the elements of the test to affirm a tying illegal per se were: (i) an agreement to by aparty to sell the tied product provided that the tying one is bought; (ii) market power in thetying product market; (iii) harm of competition in the term of not insubstantial amount of

interstate commerce affection(Id., at 1475), since the coercion was implicit in the concept ofleverage (while in the later standard it will be explicitly required).

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days from the hardware purchase). Given this context, the coercion

implicit in the concept of leverage, and, at that time, not explicitly required

was not deemed present, and the tied product as such was always

remaining a possibility of licensing.

2.3 The European perspective on IBMs behaviors

In the late 90s there was a European IBM case as well (30), and it

never reached the courts since it was settled through the Commissions

intervention.

In Europe, IBM was selling a series of hardware and software products

designed to complement one another. And, like in the US, IBM was

horizontally integrated, whereas its competitors each sold some, but not all,

of the same range of products, for use with IBM products. At a certain point

IBM started (i) selling its main frame machines coupled with main memory

and basic software; (ii) refusing to sell certain proprietary software to users

of non-IBM main frame machines; and, finally, (iii) advertising new products

long before the technical details and interfaces were disclosed. By doing

this, IBM was challenged for tying its products and, thereby, preventing the

compatibility of competitors products.

The Commission stated that IBMs behaviors were creating, firstly, an

artificial advantage for itself by (i) delaying disclosure of interface

information on its new products while taking orders for them; and by (ii)

denying the competitors an opportunity to adapt their products to IBMproducts. Secondly, IBMs behaviors were creating a disadvantage for its

competitors by refusing to supply software to users of non-IBM machines.

Finally, IBMs behavior was tying-in because software or memory could only

be purchased with the mainframe machine.

Although the Commission never elaborated the legal reasoning

behind its Statement of Objection, IBMs behaviors would likely have been

30

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

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fallen under art. 86 (now art. 82) of the EC Treaty because it placed

competitors at a competitive disadvantage (31); a settlement was duly

reached when IBM undertook to disclose the interface information, and to

supply the software to users of non-IBM machines.

Even though it not involved a technological tying like the American

IBM cases, the European IBM case was worth mentioning so as to have a

complete overview of what was happening in both the EU and the US

systems with regard to hardware and software integration.

2.4 Summation

IBM cases are a good starting point on the issue of hardware and

software integration for several reasons.

Firstly, they show the development of the courts reasoning and the

increasing awareness of the anti-competitive effects that innovation can

generate in the high-tech markets.

Secondly, a progressive openness towards economics appears to

progressively emerge due the more in-depth knowledge of high-tech market

specific features.

Thirdly, the courts seem to be consistent in keeping technological

tying separate from traditional tie-in practices. Such separateness makes a

relevant difference on the standard to apply in assessing the challenged

behavior lawfulness (32

). In this context, however, it is to stress the changingapproach in the tying assessment. Even though, when tie-in claims are

raised to challenge software integration, decisions on these allegations are

to be adopted under the tying standard, instead of the monopolization one;

in Innovation Data Processing v IBM, the court expressly stated that as a

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

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

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general rule we hold that the development in introduction of a system of

technologically interrelated products is not sufficient alone to establish a per

se unlawful tying arrangement even if the new products are incompatible

with the products then offered by the competition and effective use of any

one of the new products necessitates purchase of some or all of the others

(33).

3 MICROSOFT II AND CALDERA V MICROSOFT: LEGAL STANDARDS FOR EXCLUSIONARY

INNOVATION INTHESOFTWAREMARKET

The early integration cases involving subjects other than IBM are

Microsoft II and Caldera v. Microsoft. The former needs to be analysed since

some scholars believe it to be the leading case in assessing software

integration (34), and since it tells us what the courts thought level of

superiority was. The latter is to be examined since it gives an interpretation

of level of superiority different from the one given in Microsoft II.

3.1 Microsoft II (35): a leading case for software integration

conduct?

Microsoft II involved the practices adopted by Microsoft in marketing

the operating system (OS) Windows 95 in the primary market of original

equipment manufacturers (OEMs); and the proper interpretation of a 1994

consent decree.

In the following some background information is provided to

understand the differences between this case and the subsequent Microsoftcases, and the affirmation that Microsoft II is the leading case to assess

software integration.

3.1.2. Microsofts behaviors

33 Innovation Data Processing Inc. v. IBM, 585 F. Supp. at 1476 [quoting Foremost Pro Color v.Easterman Kodak Inc., 703 F. 2d 534, 542-543 (9th Cir. 1983)].34 J. Gregory Sidak,An Antitrust Rule for Software Integration, 18 YALE J. ON REG. 1, 34 (2001).35 United States v Microsoft Corp., 147 F.3d 935 (D.C. Cir. 1998).

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Before Windows 95 was released, Microsoft used to manufacture DOS

and graphical user interfaces separately. The former being the central

nervous system of the computer, controlling the computers interaction with

peripherals such as keyboard and printers (36); the latter being the

technology by which the operator performs functions not by typing at the

keyboard but by clicks of his mouse (37).

DOS products and graphical user interfaces were not directly offered

to end users, rather, they were marketed through OEMs. The latter were in

charge of making computers; installing operating systems and other

software that they licensed from vendors such as Microsoft; and selling the

packages to end users either individual consumers or businesses. In this

context, it is to point out that Microsofts graphical interfaces were

compatible with DOS manufactured by Microsofts competitors.

Complaints were lodged with both the U.S. Department of Justice and

the European Commission vis--vis Microsofts tying its DOS to its graphical

user interfaces so as to limit the latters being used with non-original DOS

products. In detail, Microsoft was accused of creating economic incentives

for OEMs to preinstall Microsoft interfaces and Microsoft DOS, thereby

influencing OEMs choices in the DOS market, and preventing competitors

DOS being installed and marketed in this market.

In 1994 the U.S. Department of Justice filed a complaint against

Microsoft, claiming that its license agreements with OEMs and software

developers contained anticompetitive terms aiming to unlawfully maintain

its monopoly in the OS market. The complaint was accompanied by a

proposed consent decree intended to regulate those practices andnegotiated amongst Microsoft, the Department and the Commission. In this

context, an anti-tying provision was included whereby Microsoft was

prohibited from entering into any licensing agreement on its products so as

to leave OEMs free to license, use, and distribute any non-Microsoft

products. At the same time, the same consent decree stated out that this

36Id., at 938.37Id., at 938.

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provision in and of itself should not be construed to prohibit Microsoft from

developing integrated products.

After the consent decree was signed by the parties (38) thus pre-

empting a trial on the merits Microsoft released Windows 95 with

integrated graphical user interfaces without raising competition concerns

and the new version of its browser Internet Explorer 3.0 which, on the

opposite, raised competition concerns as to the above mentioned consent

decrees violations.

The concerns over both Internet Explorer 3.0 and its subsequent

updated versions integration into the OS centered on Microsoft requiring the

OEMs to shortly shift to the latest service release for Windows, as soon as it

was publicly released. The OEMs had to do this by installing the OS copies to

be distributed to end-users. The question thus arose as to whether such an

obligation was infringing the consent decree.

3.1.2. The Courts decisions

In 1997 the anti-tying agreement condition was alleged to have been

infringed by the Microsoft integration, and an injunction was sought by the

Department of Justice. Although Jackson J. deemed the 1994 consent decree

decision to be too vague to be enforceable, he granted an injunction due to

the high probability of Microsofts behavior constituting monopolization

under Section 2 of the Sherman Act. Integration was thus not deemed to

infringe the consent decree, but to constitute a monopolization offense.

However, in 1998 the Court of Appeal for the District of Columbia

Circuit reversed the injunction and gave the interpretation on the consent

decrees anti-tying provision that the Court of First Instance had not

provided. In this respect, the Court of Appeal stressed the difference

between a combination offered by the manufacturer (integrated products)

and a combination created by the purchaser through OEMs from separate

products. In other words, Microsoft integrations (even though installed by

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

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OEMs) differed from installations by OEMs, which were based on purchasers

requests, but had often been conditioned by Microsofts license agreements.

Although in both cases OEMs were installing OSs and software together, in

the former Microsoft had innovated and installation was grounded on that

in the latter Microsoft had not innovated and it was just seeking to impose

a tie on OEMs in order to sell more products. In the Court of Appeals

opinion, since integration is the creation of the design that knits together

two separate products, it had to occur at Microsofts level, in that OEMs

cannot do it. Once two products had been integrated, OEMs could just install

what Microsoft had given them according to Microsofts instructions.

The Court of Appeal, thus, deemed that the consent decrees anti-

tying provision could not limit Microsofts freedom to innovate, and

innovation was not a net plus but merely a question of whether there is a

plausible claim that it brings some advantages (39). Therefore, as long as

consumers gain advantages from the integrated versions of the OS, there is

no room for competition concerns and no need to bring in IPRs to strengthen

Microsofts position.

To sum up, the software integration rule underpinning Microsoft IIs

decision is somewhere in the middle between predatory innovation and

tying principles, tilting more towards the latter.

Although software integration itself is more likely to be included in a

predatory innovation behavior and judged under the section 2 Sherman Act

standard, the Court of Appeal expressly rejected the idea of both

technological tying and balance between integrated product synergies

and distinct market evidence. Rather, it applied a plausible consumerbenefit rule deriving from antitrust law principles and deemed

Microsofts practice lawful since the software integration was producing a

plausible benefit.

However, this interpretation was given in the context of an alleged

infringement of a consent decrees provision, and, in a subsequent decision,

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

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the same court remarked the analysis provided had not been sufficiently in-

depth (40) (41).

3.2 Caldera v Microsoft (42): a comparison between two

different texts

The same reasoning as in the Microsoft II case underlay the courts

decision in rejecting Calderas claim against Microsofts having integrated

DOS and Windows in a single product: Windows 95.

Although the reasoning and outcome were the same, a relevant

difference between Caldera v Microsoft and Microsoft II cases lies in the

interpretation of level of superiority, and, therefore, in the criterion

adopted to make a balance between product superiority and anti-

competitive effects.

3.2.1. Microsofts behavior

In Microsoft v Caldera, Microsoft was challenged vis--vis

technological tying since it integrated MS-DOS and Windows 3.0 in a new

and innovative product: Windows 95 OS (an early version of the Windows

operating system as we know it). By doing this, Microsoft took two functions

belonging to two different products and combined them into one new and

innovative product, thus limiting competition in the DOS market. IBMs

competitors could not have effected the same combination because, while

IBM was horizontally integrated, they were only producing DOS products.

IBMs integration, therefore, was to drive them out of the market.

3.2.2. The Courts decision

40 United States v. Microsoft Corp., 253 F.3d 34, 92 (D.C. Cir. 2001).41

Basically, the consent decrees anti-tying provision was related to a contractual tyingMicrosoft had previously undertaken. Therefore, having Microsoft adopted a technologicaltying, the court deemed it not to infringe that anti-contractual-tying provision. Moreover, bytechnologically integrating, Microsoft was innovating. And, asking Microsoft not to innovatewould have meant limiting its freedom and harming innovation.42 Caldera Inc. v. Microsoft Corp., 72 F. Supp. 2d 1295 (Utah Dist. Ct. 1999).

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In Caldera v Microsoft the courts reasoning relied on the same

concepts emerging in Microsoft II, specifically the idea that technological

innovation is an important defense in defending antitrust allegation (43).

Even though the court rejected Calderas antitrust claim, it recognized,

however, that product innovation can be stifled if companies are allowed to

dampen competition by unlawfully tying products together and escape

antitrust liability by simply claiming a plausible technological advance

(44). The court did not apply Microsoft II cases plausible advantage claim,

rather, it required a valid, not insignificant, technological improvement has

been achieved by the integration (45). A rejection of the previous standard

is clear when the court stated that the technological improvements must

have demonstrated efficiencies. This is more than just a plausible claim

that brings some advantage (46).

However, since this Microsofts integration was highly innovative, it

represented a net plus compared with the prior art. Therefore, Microsofts

behavior was deemed lawful even in the light of the standard adopted.

3.3 Summation

Although outcomes were the same, these two decisions differ widely

in defining how those integrations were deemed innovative and what was

meant for level of superiority.

The Microsoft II court affirmed that no a net plus was needed, but,

rather, a plausible claim that integration will bring some advantages.

Therefore, a product is superior every time its latest version generates a

plausible advantage. That is, it is superior whenever it is better in somerespect. This plausible advantage, thus, is what has to be weighed against

the effects on competition in the market. In this context, consideration of

market features such as network effects and IPRs as amplifier of the anti-

competitive effects of innovation, is almost negligible, in that a complex

analysis was unlikely due to the limited scope of the courts decision in

43Id., at 1323.44Id., at 1324.45Id., at 1325.46Id., at 1325.

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Microsoft II. In fact, even though Microsoft II is supposed to be the leading

case in assessing software integration, this decision stopped at an

interpretation of a consent decrees anti-tying provision, and did not seem

to have provided a possible legal standard for software integration.

In Caldera v Microsoft case, instead, the court rejected the plausible

advantage claim. Rather, it stated that a valid, not insignificant,

technological improvement was to be effected by the integration of two

products. This difference in the definition of level of superiority is quite

relevant since it affect the competition balance. In the plausible advantage

claim standard the balance is tilted towards the pro-competitive effects

that the integration can generate; instead, the net plus standard appears

to be more aware of all the factors affecting the competition balance.

This balance is the central point of the later cases. In particular, what

emerges in these cases is the progressive relevance of market features in

striking a balance between anti- and pro-competitive effects of software

integration, and, in the latest case, the increasing consideration of IPRs and

the need for a regulated exploitation of them.

4 RECENT SOFTWARE INTEGRATION CASES: A NEW LEGAL STANDARD FOR TECHNOLOGICAL

TYING?

Since the IBM cases, integration has been a common practice in both

the hardware and software markets. With specific regard to the latter the

software market leading firms, such as Microsoft, have constantlyintegrated applicative software programs into operating systems to innovate

and improve their products. This behavior has not always raised competitive

concerns (not every integration has been challenged). However, recent

integration practices have been challenged in the US and the EU courts in

order to address their anti-competitive effects. In these cases, the outcomes

have not always been consistent with the earlier legal standards applied in

the IBM, Microsoft II and Caldera v Microsoft cases, while a more economic-

oriented standard seems to have progressively emerged.

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The recent cases all involving Microsoft as the software market

leader present common features absent in the previous ones: the

assessment of IPRs and network effects in the relevant markets, whose

potential anti-competitive effects appear to be increasingly acknowledged.

4.1 Microsoft III (47)

Microsoft III involved the integration of a new version of Microsofts

Internet Explorer (IE) browser in the Windows 98 OS. Although Microsofts

challenged behaviors in Microsoft III were substantially similar to those of

the Microsoft II case, both outcome and reasoning are remarkably different.

4.1.1 Microsofts behaviors

Among the several challenged behaviors, such as withholding crucial

technical information, predatory prices, contractual restrictions on OEMs in

order to affect distribution channels, and so forth, the software integration

at issue was IE integration in the Windows 98 OS. The integration was

further protected by contractual provision at the distribution level so as to

prevent the purchase of OSs and browsers separately.

To end-users this did not constitutes a burden since it did not really

affect Windows 98s purchase price. However, it mattered to Microsoft

competitors. In particular, Netscape and Sun Microsystems found the

integration a means of (i) preventing their products namely, Netscape web

browser and Java class libraries from competing with the Microsoft

products in the OS and browser markets; (ii) preventing them from enteringthe OS market; and (iii) driving them out of the browser market.

Specifically, Microsofts behaviors were challenged for (i)

monopolization; (ii) attempt of monopolization; and (iii) tying. While all the

complaints were accepted by Jackson J. (48) who even required Microsoft to

submit a proposed plan of divestiture in order to split the company into an

47 United States v. Microsoft Corp., 253 F.3d 34 (D.C. Cir. 2001).48 United States v. Microsoft Corp., 87 F.Supp.2d 30 (D.D.C. 2000).

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OS business and an applicative software business (49) the Court al Appeal

upheld the sole monopolization offense.

4.1.2 The Courts decisions

Before entering the merits of Microsoft III and in order to understand

both the District and Appeal Courts reasoning (as well as the reasoning in

Microsoft IV), some technical information is to be mentioned.

OSs and software programs interact through Application Program

Interfaces (APIs) which also enable software developers to write programs

compatible with an OS. However, OSs are not the only software programs

exposing APIs. Other non-OS programs do the same, among them: Netscape

and Sun Mycrosystem products. Programs like this are called middleware

since they rely on an OS and its APIs, but, at the same time, they expose

their APIs to software developers.

While the Microsoft III controversy was taking place, no middleware

exposed enough APIs to offer a full range of applications. Users still needed

to rely on an OS. However, a middleware such as Netscape would have been

capable once program developers had written enough middleware

applications to satisfy all user needs. Had this happened, users might have

chosen less expensive middleware compatible applications rather than OS

direct compatible applications. For this reason, Jackson J. stated that: The

growth of middleware-based applications could lower the costs to users of

choosing a non-Intel-compatible PC operating system like the MAC OS (50).

Both District and Appeals courts grounded their analysis on the

above technological background. However, the only complaint that theCourt of Appeal upheld was the monopolization offense; while the attempt

of monopolization in the browser market was reversed; and the tying

remanded to a lower court.

49 United States v. Microsoft Corp., 97 F.Supp.2d 59 (D.D.C 200).50 United States v. Microsoft Corp., 83 F.Supp.2d 9, 18 (D.D.C. 1999).

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As to the monopolization offense, the Court of Appeals upholding of

Jackson J.s opinion was grounded on the application of the Grinnell test (51).

Microsoft was deemed to possess monopoly power in the relevant market

and to adopt an anti-competitive behavior in order to maintain its position.

The existing monopoly power was derived not only from Microsofts

market share, but also from the OS market structure. In this regard, entry

barriers were deemed to increase Microsofts market power so as to make

entry to the market difficult. It is worth pointing out that the Court of

Appeals structural approach considered software market features only with

respect to their network effects and their capacity to raise barriers to entry.

The recognition that the network effects raised barriers to entry constituted

a step toward a more complex standard in dealing with software and

network markets.

Microsofts anticompetitive behavior derived from the exclusionary

practices it engaged in so as to maintain its monopoly by preventing the

effective distribution and use of products that might threaten it. In detail,

these practices were: (i) the way in which it integrated IE in Windows 98; ( ii)

its various dealings with OEMs and IAPs; (iii) its efforts to contain and to

subvert Java technologies; and (iv) its course of conduct as a whole.

A relevant point here is the test that the Court of Appeal used to

assess whether the IE integration was an exclusionary practice. Did the

Court of Appeal consider the software market features and Microsofts

owning IPRs? Or, rather, did it apply the standard that the courts had

applied in the IBM cases?

The test applied consisted in balancing the pro- and anti-competitive

integration effects. Once the anticompetitive effects i.e. the competitionharm were deemed present; a lack of pro-competitive justification for the

integration, or, alternatively, the anticompetitive effects outweighing pro-

competitive effects, was to be proved to establish an exclusionary practice.

Although, in principle, the Court of Appeal was skeptical about an

integration having anti-competitive effects since integrations were still

considered mainly pro-competitive in this case, even the second instance

court showed concern for the way the integration could affect the

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

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emergence of products alternative to Microsoft OS (i.e. middleware). Since

IE was bundled into the OS code, it was deemed to prevent OEMs from pre-

installing other browser programs, thereby reducing rivals usage share and

developers interest in rivals APIs as an alternative to the API set exposed

by the Microsoft OS. In other words, both Courts appear to be aware of the

integrations refraining middleware potential competition to OSs.

In this context, Microsoft provided a general justification about

substantial benefits to customers and developers which the Court of Appeal

did not deem sufficient to overturn the monopolization offense. It is here

worth noting that software and network market features appear be relevant

to the Court of Appeal decision since it asserted that judicial deference to

product innovation () does not mean that a monopolists product design

decisions are per se lawful (52) in such markets. This was stated by the

Court of Appeal as to say that not only a net plus was needed in order to

the pro-competitive integration effects outweighing the anti-competitive

ones, but also that behaviors of monopolists lawfulness is to be more

carefully considered according to the relevant market in exam.

As to the attempt of monopolization, the Court of Appeal overturned

Jackson J.s decision because of a pervasive flaw: the same behavior (IE

integration in Windows 98) had been challenged for both monopolization in

the OS market and attempt of monopolization in the browser market.

However, the events that formed the basis for the monopolization offense

could show additional liability to Microsofts behavior, but not prove an

attempt of monopolization (53). Therefore, relying on the monopolization

liability, attempt of monopolization standards were not proved as to the

relevant market and the barriers to entry.

As to the tying, the facts underlying the monopolization offense were

deemed to partially overlap this allegations facts as well, with particular

regard to the way in which Microsoft had integrated IE. In particular: (i)

Microsofts refusal to allow OEMs to uninstall IE or remove it from Windows

desktop; (ii) IE entry removal from the Add/Remove Programs utility in

52 United States v. Microsoft Corp., 253 F.3d at 65.53Id., at 80.

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Windows 98; (iii) IEs overriding consumers choice as to the browser; and

(iv) the predatory prices allegation.

While Jackson J. applied the per se illegality rule and condemned

Microsoft practices with regard to the IE tying (54), the Court of Appeal

remanded the decision to the District court. It called for: (i) the application

of a rule of reason, instead of a per se illegality rule, and (ii) a

reconsideration of the remedies. In the meantime, the parties reached a

consent decree whose alleged violation was the starting point of Microsoft

IV thereby preventing the lower court decision from being adopted. The

Court of Appeals reasoning on tying is relevant in that it explains the

rationale for a rule of reason application through the analysis of: (a)

dynamic market features; (b) the test to adopt in these markets; and (c) the

relationship between monopolization and tying offense when they rely on

the same facts.

Firstly, the Court stressed that, in dynamic markets, integration is

more likely to bring innovation and benefits for consumers (even though a

strong consumer demand for the tied product is present). Therefore, an in-

depth analysis of the integration effects needs to be developed in order not

to stunt innovation. When two products are prima facie separate, this

analysis is not necessary and a per se illegality rule can be

straightforwardly applied. Software and hardware integrations being in

question, a more cautious approach is to be adopted so as not to stifle

welfare-enhancing innovation.

Secondly, the Court recalled the four elements necessary to allege

tying conduct, namely: (i) the tying and the tied goods are two separate

products; (ii) the defendant has market power in the tying product market;

(iii) the defendant affords consumers no choice but to purchase the tiedproduct from it; and (iv) the tying arrangement forecloses a substantial

volume of commerce.

54In the first instance decision, even though Microsoft invested financial and labor resources

to develop a browser as efficient as Netscape was, the court was aware that users would nothave easily switched to IE unless Microsoft employed other devises to induce users to use itsbrowser instead of Netscape. Therefore, in addition to improve its browsers quality, Microsoftstarted giving away its browser for free and in many cases even coupled with other valuablethings (at substantial costs) in exchange for their commitment to distribute and promote IE.At the same time Microsoft sought to exclude Navigator from important distribution channelssuch as the OEMs and IAPs (Internet Access Providers). Thus, Microsoft required OEMs to pre-

install IE, and IAPs to bundle IE with their own proprietary software so that subscribers would,by default, use that browser whenever they connected to the web.

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In particular, the Court focused on the separate-product-enquiry test

because of the difficulties it presents in itself and in the software market. In

fact, the two items being complements (one is useless without the other)

does not make them a single product, rather, the tying anticompetitive

effects on the consumer demand are still relevant and need to be

considered. At the same time, even when there are distinct consumer

demands for each individual component, efficiencies from the tying could be

expected. For this reason the consumer-demand test needs to be assessed

under a rule of reason aiming at a comparative in-balance of separate

demands for the tied product, on the one hand, and welfare efficiencies, on

the other hand (55). This is even truer in the software market, where

assessing such a balance with regard to the current asset may jeopardize

innovation if the benefit-consumer demand comparison is only focused on

the historic consumer behavior so as to ignore integration potential

efficiencies (56).

Finally, the Court stated that, even though a more accurate approach

was needed when dealing with tying in the software market, the integration

at hand did not show these high efficiencies when evaluated under the

monopolization offense (57). However, this lack of demonstration not being

sufficient to apply a per se illegality rule, the assessment was to be

remanded to a lower court for further analysis.

4.1.3 The Final Judgments remedies for the monopolization offense

Unfortunately the lower court never entered into the merits of the

remanded points since the parties signed a consent decree (58) which put an

end to the proceeding and imposed many obligations on Microsoft, amongstwhich is worth recalling: (i) the disclosure of the new APIs in use between OS

and browser (59), and (ii) the compulsory licenses of Microsofts IPRs to

enable licensees (i.e. OEMs) to promote non-Microsoft middleware (60).

55 Jefferson Parish Hosp. Dist. No. 2 v. Hyde, 466 U.S. 2, 12-18 (1984).56 United States v. Microsoft, 253 F.3d at 89.57Id., at 89.58 United States v. Microsoft Corp., 231 F.Supp.2d 144 (D.D.C.2002).59Id., at E.60Id., at I.

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As to the former, although protected under copyright and trade secret

laws, the new API disclosure was deemed necessary so as to enable

software developers to create new browser versions competitive with the

new IE version.

As to the latter, Microsofts past behaviors had showed how IPRs

could be a means to refrain OEMs from promoting non-Microsoft products.

Therefore, compulsory licenses could be a viable solution to this.

It is worth pointing out that the IPR issue emerges only at this stage

and not at the stage of the competition balance. In principle, IPR ownership

itself does not amplify the anti-competitive effects of an incumbent

behavior, such as Microsoft. Rather, it is the way in which IPRs are exploited

that can possibly harm competition. Therefore, IPRs consideration seems to

emerge whenever their ownership and exploitation are claimed as a means

to limit courts intervention.

4.2 Microsoft IV (61)

Microsoft IV involved the integration of other middleware Windows

Media Player (WMP) in a new version of Microsoft OS. The starting point for

Microsoft IV is the above mentioned consent decree, as implemented in

Kollar-Kotelly J.s final judgment (62), and its alleged violation. Although the

Microsoft III and IV decisions are often compared, and the Microsoft IV

decision is deemed stricter than the Microsoft III one (63), they do not appear

to involve identical practices, rather, to address different aspects of a

similar behavior. In other words, we could say that the reasoning underlined

the Microsoft IV decision starts where the reasoning of the Microsoft III

decision left off.

4.2.1 Microsofts behaviors

61 Commission Decision of 24.03.2004, relating to a proceeding under Article 82 of the EC Treaty (Case COMP/C-3/37.792 Microsoft), C(2004)9 final (Brussels 21.4.200) (unofficialpublication).62 United States v. Microsoft Corp., 231 F.Supp.2d 144.63

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

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Microsoft was challenged for abuse of dominant position under art. 82

of the EC Treaty with regard to both the OS and work group server markets.

As to the latter, Microsoft refused to comply with the disclosure obligation.

Whereas, with regard to the media player market, in 1999 Microsoft started

to integrate Windows Media Player into Windows OS and, since 1999, it

persisted in bundling it in all subsequent versions (64). This practice, alleged

to constitute tying under art. 82(d) of the EC Treaty, and to harm

competition in the OS market, falls under the software integration category,

and therefore it needs to be dealt with.

4.2.2 The European Commissions decision

WMP integration was addressed under art. 82(d) prohibiting the

making contract conclusions subject to acceptance by the other parties of

supplementary obligations, which, by their nature or according to

commercial usage, are not connected to the subject of such contracts.

The following elements are to be present in order to claim an art.

82(d) violation: (i) dominance in the tying market; (ii) product separateness;

(iii) no consumer choices in obtaining the tied product separately from the

tying one; and (iv) foreclosure of competition.

As to Microsofts dominance in the OS market, the proof of it was

deemed reached not only by Microsofts market share, but also by the fact

that Microsoft did not dispute it in appeal (65).

As to the products distinctness, the Commission assessed it through

the consumer demand test. The presence of consumers demand for mediaplayer on its own, independently of the OS, was deemed to prove they were

distinct products and they were so perceived by consumers (66).

The Commission (as well as the Court of Appeal in Microsoft III)

recognized that a test should not focus on historic consumer behavior

64 Integrations of WMP previous versions were not challenged in that it was in the 1999 thatWMP reached both the functions of streaming over the Internet and local playback of content.Instead WMP previous versions could just perform local playback (see, Commission Decisionof 24.03.2004 at 819).65 Case T-201/04, Microsoft Corp. v Commission, 4 C.M.L.R. 5, 397 (Ct. First Instance 2005).66 Commission Decision of 24.03.2004 at 807.

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which, considering consumers behavior at that moment, may ignore the

efficiency benefits deriving from new product integration (67). In the case at

hand, even after years of Microsofts integrating WMP in its OSs, there was

still significant demand for alternative players (68). This showed that

consumer behavior had not changed despite constant integrations.

It is worth pointing out that the WMP versions Microsoft integrated

before 1999 did not present the current WMP functionalities since they just

offered local playback functionality; while the WMP under discussion offered

both streaming over the Internet and local playback functionalities. The

Commission stressed the competitive advantage that the integration of the

last WMP version was giving to Microsoft, regardless of whether the two

were distinct products or not.

A different position was maintained by the Court of Appeal in

Microsoft III and the Commission in Microsoft IV on the question of consumer

choices being prevented by the integration.

In Microsoft III, this condition appears to be satisfied whenever a

consumer has the choice to uninstall the middleware (in that case IE) and

launch alternative middleware programs. What Microsoft could not do was

to prevent consumers (and OEMs) from doing this by removing such a

functionality and the add/remove tool from the desktop, or select its own

middleware as the default program. The unlawfulness of such behavior was,

thus, stated in Kollar-Kotelly J.s consent decree.

In Microsoft IV, instead, the Commission asserted that complying with

that consent decrees provisions as to the uninstall choice did not fully

restore consumers choices as to whether to acquire WMP without the OS.

This was because the Microsoft III decision did not deal in-depth with thetying allegation (it only considered the monopolization offense) (69).

Therefore, integration itself still affected consumers choices, even though

67Id., at 808.68 This argument appears to be in contrast whit what previously recalled (supra n. 55) toassert that Microsoft behaviour challenged started in 1999 as at that time WMP could offer afull array of functions. Consumers demand for alternative player, at the time in whichMicrosoft integrated a WMP not performing streaming functionality, is not likely to indicatethat this test does not have an historic perspective. The WMP after which integrationconsumers demand for alternative products remained is rather different from the WMPintegrated in 1999. The former did not offer streaming functionality, while the latter does.69 Commission Decision of 24.03.2004 at 828.

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the tied product did not affect the tying products price and did not coerce

consumers to use it. Insofar as consumers were likely to use the tied

product, there would be competition foreclosure in the Commissions

decision, the most relevant element of the tying allegation.

Consequently, as to the competition foreclosure the Commission

deemed it not only to be a matter of consumer choices but also of

producers access to the market. Even when consumer choices might not be

completely stifled, effects on the tied product market might be such as to

eliminate potential competition in that market, thereby making consumer

choices impossible because of the absence of alternative products (70). For

this reason, art. 82 EC of the Treaty was deemed applicable even when

Microsofts behaviors affected consumer choices only indirectly by

affecting access to the market and behaviors of stakeholders, such as OEMs,

content providers, and software developers.

As to OEMs, WMP bundling into WOS was deemed to limit their

incentives to bundle an additional media player for two main reasons: first,

an additional player would use up hard-drive capacity to offer essentially

similar functionalities; second, users would be unlikely to pay higher prices

to have an additional player when they could have one at the standard price

(71).

As to content providers, in the presence of a widely disseminated

media player, such as WMP, they were deemed to encode their content for

access by end-users through the most widespread technology in order to

maximize the potential reach of their own products. Moreover, the more

content available for a given media player, the higher the consumer

demand for this media player would be. Network effects were, thus,considered to play a significant role in content providers choice of

technology (72).

As to software developers, being WMP a program for which

applications are being developed, the same above mentioned mechanism

was deemed likely to occur. The more a platform, such as WPM, spread, the

70Id., at 835.71Id., at 849.72Id., at 883.

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more incentives software developers would have to write for it. The

presence of WMP APIs in every PC carrying WOS was thus deemed to make

software developers to write applications for it (73) (74).

The Commission recognized, however, that tying can generate

efficiencies but, in the case at hand, these efficiencies were deemed to have

been reached even without the integration. Neither the fact that the

transactions costs of tying outweighed its anticompetitive effects (75), nor

the fact that the tying benefited software developers by exhibiting WMP APIs

in all PCs, were deemed generating sufficient efficiencies (76). Such a result

could have been reached only through showing net efficiencies (77).

Again, the Commission seemed to apply the net plus standard

established in the Caldera v Microsoft case, as did the Court of Appeal in

Microsoft III.

4.2.3. The Commissions remedies to tying

With regard to the WMP integration, the main remedy adopted was

the obligation to offer to OEMs two WOS versions: one with WMP unbundled

and one with WMP bundled.

At the same time, Microsoft was not allowed to: (i) hinder the APIs in

use between WOS and WMP or select preferential APIs, thereby privileging

compatibility with Microsoft programs; (ii) give favorable treatment to WMP

on WOS (i.e. providing a link for an easier download); (iii) affect or otherwise

condition OEMs freedom to choose WOS without WMP; (iv) otherwise tie

Microsofts application to WOS.

4.3 Summation

73 Id., at 892.74

Id., at 897. In reason of this integration, thus, WMP was deemed to be as ubiquitous asWOS was no matter it could be uninstalled in compliance with the U.S. consent decree (orbetter final judgment) since its binary code would still be pre-installed together with the OSon every PC. Moreover, spill-over effects were deemed to possibly alter other marketsstructure, such as media player on wireless devices, on set-top boxes or DRM solutions andon line music delivery (so called complementary business areas).75Id., at 956.76Id., at 962.77Id., at 969.

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Although both Microsoft III and IV involved middleware integrations,

the decisions appear to assess different aspects of this behavior, and, with

regard to the legal issues discussed, the Microsoft IV decision seems to

complete Microsoft III.

As to similarities, even though the integrations were evaluated under

different provisions belonging to different systems in Microsoft III, IE

integration was assessed only under the monopolization offense, while a

definitive assessment under the tying offense was not provided; in Microsoft

IV, instead, WMP integration was assessed under tying offense (thereby

falling in the overall category of abuse of dominant position) the reasoning

followed by the Commission and Court of Appeal seems similar. A common

standard, too, appears to be adopted to assess the integrations in question.

However, this standard can be identified as mutual only between

monopolization offense, on the one hand, and tying as a subset of the abuse

offense, on the other hand, in that the standard used to assess IE

integration as a tie-in in the US system was never expressly formulated (the

remanded decision was not issued due to the settlement amongst the

parties) (78).

In both decisions, market power and exclusionary practices form the

test for the section 2 of the Sherman Act and art. 82(d) of the EC Treaty

violations; the focus is on the balance between anti- and pro-competitive

integration effects; and the level of superiority required tends more toward

the net plus benefit criteria than the plausible advantage claim (79).

Moreover, in both cases, a thoroughly examination of network effects shows

the outcomes of monopolization and abuse similar. In this context, networkeffect consideration severely amplified the threat to current and potential

competition in the OS market that middleware integration can generate, to

the extent that both IE and WMP integrations were deemed to enable

Microsoft to possibly prevent any non-Microsoft middleware from efficiently

competing with WOSs. In fact, a middleware program can be compatible

78 It is however known that that a rule of reason approach was called for by the Court ofAppeal which rejected theper se illegality rule applied by the District Court (United States v.Microsoft Corp., 253 F.3d at 81).79See supra paragraphs 3.1 and 3.2.

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with every OS, thereby providing incentives to write middleware-compatible

applications instead of specific OS compatible applications. Even though, at

the time WMP and IE were integrated, neither player nor browser exposed

such a high number of APIs to effectively compete as a platform, both Court

of Appeal and Commission believed that this might occur in the future.

Therefore, preventing the development of browser- or player-compatible

applications not only yielded anti-competitive effects in the browser and

media player markets, and the above categories of stakeholders operating

there, but also prevented potential general platform substitutes from being

developed in the future.

In spite of the similarities, it is important to bear in mind that

Microsoft IV starts where Microsoft III ends and it completes the analysis

started therein.

Even though, in both cases, the behavior in question was defined as

software or better middleware integration, this behavior can be split (or

at least it seems to have been split in Microsoft III decision) (80) into

technological integration (or technological tying) and contractual tying (the

latter appearing to be a means to strengthen the former in both American

and European cases). Thus technological tying was the focus of the

assessment carried out in Microsoft III, and, in this respect, the behavior was

evaluated under the monopolization offense (the tying not having been

assessed but remanded). In Microsoft IV, instead, since the technological

tying complied with the consent decree as to disclosure obligations (i.e. the

new APIs in use between WOS and WMP were disclosed) (81), the assessment

dealt more broadly with other non-technological components of that tying

80

The distinction between technological and contractual tying is quite evident HOVENKAMP,FEDERAL ANTITRUST POLICY, supra n. 303, where the Author stresses that the most obviousdifference between the 2 tying () and the traditional 1 or Clayton Act 3 offenses consistsin the lack of any agreement requirement in the former. Monopolization is a unilateralpractice. So when a dominant firm unilaterally imposes tying () under circumstances wherea qualifying agreement cannot be proven, the practice may still constitute an antitrustviolation. To be more precise, in Microsoft III the Court of Appeal identified four behaviors:two of them namely, preventing OEMs to uninstall or remove IE from WOS desktop; anddesigning WOS so as to withheld from consumers the ability to remove IE by use of theAdd/Remove Programs utility in Windows constituting technological tying, thereby assessedthrough the monopolization offense test; and the remaining two namely, Microsoftsrequiring WOS licensees to license IE as a bundle at a single price; and Microsofts designingWOS so as to override the users choice of default web browser in certain circumstances constituting tying and needing for a rule of reason analysis by the remanded court. On the

difference between technological and contractual tie-ins, see also David S. Evans, A. JorgePadilla and Michele Polo, supra note 19, at 509.

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practice that is contractual tying (those same practices remanded to the

lower court in Microsoft III and never assessed due to the settlement).

The different approach adopted within the European framework can

be justified by: (i) use of same provision (and common standard) to assess

both technological and contractual tying i.e. art 82 of the EC Treaty (82);

and (ii) no need to assess the technological integration of WMP since the

consent decrees obligations were complied with. The European decision can

thus be deemed a logical complement to the US one, in that it assessed

those aspects not covered in the US case because of the settlement.

In the analysis of the US and the EU decisions on Microsoft

integrations, other issues come up, however, different from those emerging

in the strict comparison of those decisions. These issues, related to the

coherence of the assessment of software integration behaviors, need to be

examined herein.

Firstly, the question arises as to whether to maintain the distinction

at least in the US system between tie-in and monopolization (under which

technological tying should rationally fall), since tying (whether contractual

or technological) can be considered as one possible mechanism of

predation (83). In the US, maintaining the distinction causes different

standards to be used to assess predatory behaviors: monopolization, on the

one hand, and tying, on the other hand (the latter also giving rise to wide

debate on the tying being per se legal or illegal or needing a rule of reason

approach). Whereas, in the EU, the abuse offense test is common for both

81 The obligation of disclosure, deduced form United States v. Microsoft Corp., 231 F.Supp.2dat E, was complied with by Microsoft when it integrated WMP (Commission Decision of24.03.2004 at 315).82 It is here worth recalling that, in the US system, technological tying falls under themonopolization offense i.e. section 2 of the Sherman Act; whereas, in the EU system,technological tying falls under the abuse provision, contractual tying being a subset of it. Forthis reason, in the European decision the difference between technological tying andcontractual tying does not emerge, both behaviors falling under the same provision.83 Jean Tirole, The Analysis of Tying Cases: A Primer, 1 COMPETITION POL. INTL 1,2 (2005). TheAuthor expressly asserts that Like many other corporate strategies that make onesproducts attractive to consumers, tying has the potential of hurting competitors, andtherefore is just one in a range of strategies that can be employed to prey on them.

Competition policy therefore should analyze tying cases through the more general lens ofpredation test.

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contractual and technological tie-ins. This distinction, likely to lead to

different outcomes, depending on the system under which a tying is

assessed (84), does not even consider that tie-ins (whether contractual or

technological) may be a perfect legitimate strategy, even for dominant or

monopolistic firms; it is only the extent that they turned into predatory tools

that they became a concern (85). Therefore, whenever these behaviors turn

out to be means to predation, they need to be asse

PREDATORY AND EXCLUSIONARY INNOVATION

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