Practical application of industrial economics: Antitrust Law November 24, 2008 By Kinga Guzdek

Practical application of IO by Kinga Guzdek 2 United States The Sherman Antitrust Act (1890) Section 1. applies to agreements among competitors Section 2. applies to firms with monopoly power

Practical application of IO by Kinga Guzdek 3 United States Section 1: Prohibition of all restraints of trade Every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce among the several States, or with foreign nations, is declared to be illegal.

Practical application of IO by Kinga Guzdek 4 United States Section 2. Prohibition of monopolization Every person who shall monopolize, or attempt to monopolize, or combine or conspire with any other person or persons, to monopolize any part of the trade or commerce among the several States, or with foreign nations, shall be deemed guilty of a felony (…).

Practical application of IO by Kinga Guzdek 5 European Union Treaty establishing the European Community Article 81: Prohibition of restrictions of competition Article 82: Prohibition of abuse of a monopoly power

Practical application of IO by Kinga Guzdek 6 European Union Article 81 Prohibition of restrictions of competition All agreements between undertakings, decisions by associations of undertakings and concerted practices which may affect trade between Member States and which have as their object or effect the prevention, restriction or distortion of competition within the common market shall be prohibited (…).

Practical application of IO by Kinga Guzdek 7 European Union Article 82 Prohibition of an abuse of a dominant market position Any abuse by one or more undertakings of a dominant position within the common market or in a substantial part of it shall be prohibited as incompatible with the common market in so far as it may affect trade between Member States.

Practical application of IO by Kinga Guzdek 8 Comparizon The U.S. and European provisions are similar They aim at protecting competition held to be a market structure resulting in the most efficient allocation of resources. Law wants to preserve market freedom of companies. It doesn‘t define what desired business behavior is. It allows for an intervention only when companies engage in practices leading to inefficiency from the viewpoint of whole society (not individual market participants)

Practical application of IO by Kinga Guzdek 9 Practical example: MS case Let‘s look at the practical application of antitrust in MS case. We‘ll focus on the question of monopoly power of MS. The relevant provisions are:  § 2 Sherman Act  Art. 82 EC Both dealing with conduct of a company having significant market power

Practical application of IO by Kinga Guzdek 10 § 2 Sherman Act Application of § 2 consists of three steps: 1) Define the relevant market 2) Define the market power of the company in the relevant market 3) Decide if the company engaged in a wrongful act

Practical application of IO by Kinga Guzdek 11 European Union – Art. 82 EC Art. 82 EC also requires three steps: 1) Define the relevant market 2) Define the market power of the company – does it have a dominant position? 3) Does it abuse its dominant position?

Practical application of IO by Kinga Guzdek 12 Step one: definition of a relevant market Why do we need it?  Allows us to determine the market power of a company by analyzing competitive constraints faced by it  Allows us to determine the effects of its behaviour on competition by clarifying who the competitors are

Practical application of IO by Kinga Guzdek 13 Traditional ways of defining a product market To what extent can a company raise prices without losing market demand?  Small but Significant Non-transitory Increase in Price (SSNIP) test  Additional market data

Practical application of IO by Kinga Guzdek 14 SSNIP test = can a company raise prices 5-10% without consumers switching to other products? If yes: the other products don‘t belong to the same market (no competitve constraints) If no: the other products belong to the same market (the company faces competition)

Practical application of IO by Kinga Guzdek 15 Application of the test If there are two products - car A and car B and the manufacturer of A raises prices by 5-10% and  Consumers switch to car B => A faces competition from B, B belongs to the same market as A  Consumers still buy A => B doesn‘t compete with A and thus doesn‘t belong to the same market

Practical application of IO by Kinga Guzdek 16 Other market factors (1) Reasonable interchangeability for the demand and supply side  similarity of performed function(s)  product and price differentiation  quality restraints

Practical application of IO by Kinga Guzdek 17 Other market factors (2) Practical indicia:  industry or public recognition of the product market as a separate entity  product’s peculiar characteristics and uses  unique production facilities  distinct customers  distinct prices  sensitivity to price changes  specialized vendors

Practical application of IO by Kinga Guzdek 18 Microsoft case U.S.A.: Did Microsoft want to exclude the competing internet browser Netscape from the market? Did it violate Sec. 2 of the Sherman Act?

Practical application of IO by Kinga Guzdek 19 Microsoft case EU: Did Microsoft want to exclude competition with Windows Media Player from the market? Did it violate Article 82 EC?

Practical application of IO by Kinga Guzdek 20 What is the relevant market? PC operating system – internet browser Should they be viewed as one product or two products? Do they belong to one or two markets?

Practical application of IO by Kinga Guzdek 21 What is the relevant market? What do you think:  did Microsoft try to push Netscape out of the market to maintain its monopoly on the market for operating systems (restriction of competition on the same market)?  or MS wanted to leverage its monopoly power on the market for internet browsers (restriction of competition on a secondary market using the market strength from the primary market)?

Practical application of IO by Kinga Guzdek 22 What is the relevant market? How does the SSNIP test apply in MS? Note: Internet browser and operating system are in a vertical relationship (they don‘t compete with each other)

Practical application of IO by Kinga Guzdek 23 Microsoft case – U.S.A. By raising the price of IE, was MS at risk of  Losing some buyers of the PC operating system?  or would only lose users of IE?

Practical application of IO by Kinga Guzdek 24 Microsoft case – U.S.A. Would a loss in demand for IE threaten MS’s market position on the market for PC operating systems?  If yes – the monopolization claim was rightly decided, MS violated § 2 of the Sherman Act.  If no – the momopolization claim was unfounded, no violation of § 2 of the Sherman Act. How important was/is an internet browser for a buyer of a PC? Does it account for a substantial share of the price of the PC?

Practical application of IO by Kinga Guzdek 25 Microsoft case – U.S.A. The ruling: It was assumed that Internet Explorer and PC operating system constitute one product/belong to the same market Because Netscape‘s Internet browser was capable of supporting applications that were independent of the operating system.

Practical application of IO by Kinga Guzdek 26 Microsoft case – U.S.A. Assuming the court was right in finding that browsers and operating systems are one product can you think of any circumstances under which it is profitable for a firm with a mopoly power on the market for operating systems to exclude competition among internet browsers?

Practical application of IO by Kinga Guzdek 27 Microsoft case – U.S.A. In other words: Would it be profitable for MS to exclude any competition on the market for browsers? Would MS be able to reap monopoly profits there?

Practical application of IO by Kinga Guzdek 28 Microsoft case – U.S.A. § 2 Sherman Act test in MS:  IE and PC operating system constitute one product market (PC operating systems);  MS has a monopoly power on market for PC operating systems;  It engaged in wrongful exclusionary conduct. Violating § 2 Sherman Act.

Practical application of IO by Kinga Guzdek 29 Microsoft case – U.S.A. What would happen if the court found that IE is a separate (independent) market form the market for PC operating systems market?

Practical application of IO by Kinga Guzdek 30 Microsoft case – U.S.A. Probably no monopoly power on the side of MS! No charge with violation of § 2 Sherman Act Possible liability for tying.

Practical application of IO by Kinga Guzdek 31 Wrongful conduct Microsoft’s business practices that gave rise to antitrust concerns: the way in which it integrated IE into Windows; its various dealings with Original Equipment Manufacturers (“OEMs”), Internet Access Providers (“IAPs”), Internet Content Providers (“ICPs”), Independent Software Vendors (“ISVs”), and Apple Computer; its efforts to contain and to subvert Java technologies; and its course of conduct as a whole.

Practical application of IO by Kinga Guzdek 32 Wrongful conduct Integration of IE and Windows Microsoft made the IE software code an irremovable part of Windows. Issued to Original Equipment Manufacturers MS prohibited the OEMs to: (1) removing any desktop icons, folders, or “Start” menu entries; (2) altering the initial boot sequence; and (3) otherwise altering the appearance of the Windows desktop.

Practical application of IO by Kinga Guzdek 33 Wrongful conduct Agreements with Internet Access Providers MS licensed IE to hundreds of IAPs for no charge. Then, Microsoft extended valuable promotional treatment to the ten most important IAPs in exchange for their commitment to promote and distribute IE and to exile Navigator from the desktop. Finally, in exchange for efforts to upgrade existing subscribers to client software that came bundled with IE instead of Navigator, Microsoft granted rebates-and in some cases made outright payments-to those same IAPs. Dealings with Internet Content Providers, Independent Software Vendors, and Apple Computer MS granted ICPs and ISVs free licenses to bundle IE with their offerings, and by exchanging other valuable inducements for their agreement to distribute, promote and rely on IE rather than Navigator.

Practical application of IO by Kinga Guzdek 34 Microsoft case – EU Abuse of the dominant position consisted i.e. in the EU in exclusionary conduct towards competitors of Windows Media Player by offering it for free together with the PC operating system.

Practical application of IO by Kinga Guzdek 35 Microsoft case – EU Do operating systems and media players belong to the same or different product markets?

Practical application of IO by Kinga Guzdek 36 Microsoft case – EU It was assumed that there are 2 markets – one for operating systems and one for media players And Microsoft was trying to leverage its market power from the market where it had a monopoly (operating systems) to the market where it didn‘t have a monopoly (media players).

Practical application of IO by Kinga Guzdek 37 Thank you for your attention.