Opinion ID: 185418
Heading Depth: 2
Heading Rank: 2

Heading: Per Se Analysis Inappropriate for this Case.

Text: 209 We now address directly the larger question as we see it: whether standard per se analysis should be applied off the shelf to evaluate the defendant's tying arrangement, one which involves software that serves as a platform for thirdparty applications. There is no doubt that [i]t is far too late in the history of our antitrust jurisprudence to question the proposition that certain tying arrangements pose an unacceptable risk of stifling competition and therefore are unreasonable 'per se.'  Jefferson Parish, 466 U.S. at 9 (emphasis added). But there are strong reasons to doubt that the integration of additional software functionality into an OS falls among these arrangements. Applying per se analysis to such an amalgamation creates undue risks of error and of deterring welfare-enhancing innovation. 210 The Supreme Court has warned that  '[i]t is only after considerable experience with certain business relationships that courts classify them as per se violations....'  Broad. Music, 441 U.S. at 9 (quoting Topco Assocs., 405 U.S. at 60708); accord Cont'l T.V., Inc. v. GTE Sylvania Inc., 433 U.S. 36, 47-59 (1977); White Motor Co. v. United States, 372 U.S. 253, 263 (1963); Jerrold Elecs., 187 F. Supp. at 555-58, 56061; see also Frank H. Easterbrook, Allocating Antitrust Decisionmaking Tasks, 76 Geo. L.J. 305, 308 (1987). Yet the sort of tying arrangement attacked here is unlike any the Supreme Court has considered. The early Supreme Court cases on tying dealt with arrangements whereby the sale or lease of a patented product was conditioned on the purchase of certain unpatented products from the patentee. See Motion Picture Patents, 243 U.S. 502 (1917); United Shoe Mach., 258 U.S. 451 (1922); IBM Corp. v. United States, 298 U.S. 131 (1936); Int'l Salt, 332 U.S. 392 (1947). Later Supreme Court tying cases did not involve market power derived from patents, but continued to involve contractual ties. See Times-Picayune, 345 U.S. 594 (1953) (defendant newspaper conditioned the purchase of ads in its evening edition on the purchase of ads in its morning edition); N. Pac. Ry., 356 U.S. 1 (1958) (defendant railroad leased land only on the condition that products manufactured on the land be shipped on its railways); United States v. Loew's Inc., 371 U.S. 38 (1962) (defendant distributor of copyrighted feature films conditioned the sale of desired films on the purchase of undesired films); U.S. Steel Corp. v. Fortner Enters., Inc., 429 U.S. 610 (1977) (Fortner II) (defendant steel company conditioned access to low interest loans on the purchase of the defendant's prefabricated homes); Jefferson Parish, 466 U.S. 2 (1984) (defendant hospital conditioned use of its operating rooms on the purchase of anesthesiological services from a medical group associated with the hospital); Eastman Kodak, 504 U.S. 451 (1992) (defendant photocopying machine manufacturer conditioned the sale of replacement parts for its machines on the use of the defendant's repair services). 211 In none of these cases was the tied good physically and technologically integrated with the tying good. Nor did the defendants ever argue that their tie improved the value of the tying product to users and to makers of complementary goods. In those cases where the defendant claimed that use of the tied good made the tying good more valuable to users, the Court ruled that the same result could be achieved via quality standards for substitutes of the tied good. See, e.g., Int'l Salt, 332 U.S. at 397-98; IBM, 298 U.S. at 138-40. Here Microsoft argues that IE and Windows are an integrated physical product and that the bundling of IE APIs with Windows makes the latter a better applications platform for third-party software. It is unclear how the benefits from IE APIs could be achieved by quality standards for different browser manufacturers. We do not pass judgment on Microsoft's claims regarding the benefits from integration of its APIs. We merely note that these and other novel, purported efficiencies suggest that judicial experience provides little basis for believing that, because of their pernicious effect on competition and lack of any redeeming virtue, a software firm's decisions to sell multiple functionalities as a package should be conclusively presumed to be unreasonable and therefore illegal without elaborate inquiry as to the precise harm they have caused or the business excuse for their use. N. Pac. Ry., 356 U.S. at 5 (emphasis added). 212 Nor have we found much insight into software integration among the decisions of lower federal courts. Most tying cases in the computer industry involve bundling with hardware. See, e.g., Digital Equip. Corp. v. Uniq Digital Techs., Inc., 73 F.3d 756, 761 (7th Cir. 1996) (Easterbrook, J.) (rejecting with little discussion the notion that bundling of OS with a computer is a tie of two separate products); Datagate, Inc. v. Hewlett-Packard Co., 941 F.2d 864, 870 (9th Cir. 1991) (holding that plaintiff's allegation that defendant conditioned its software on purchase of its hardware was sufficient to survive summary judgment); Digidyne Corp. v. Data Gen. Corp., 734 F.2d 1336, 1341-47 (9th Cir. 1984) (holding that defendant's conditioning the sale of its OS on the purchase of its CPU constitutes a per se tying violation); Cal. Computer Prods., 613 F.2d at 743-44 (holding that defendant's integration into its CPU of a disk controller designed for its own disk drives was a useful innovation and not an impermissible attempt to monopolize); ILC Peripherals Leasing Corp. v. IBM Corp., 448 F. Supp. 228, 233 (N.D. Cal. 1978) (finding that defendant's integration of magnetic disks and a head/disk assembly was not an unlawful tie), aff'd per curiam sub. nom. Memorex Corp. v. IBM Corp., 636 F.2d 1188 (9th Cir. 1980); see also Transamerica Computer Co. v. IBM Corp., 698 F.2d 1377, 1382-83 (9th Cir. 1983) (finding lawful defendant's design changes that rendered plaintiff peripheral maker's tape drives incompatible with the defendant's CPU). The hardware case that most resembles the present one is Telex Corp. v. IBM Corp., 367 F. Supp. 258 (N.D. Okla. 1973), rev'd on other grounds, 510 F.2d 894 (10th Cir. 1975). Just as Microsoft integrated web browsing into its OS, IBM in the 1970s integrated memory into its CPUs, a hardware platform. A peripheral manufacturer alleged a tying violation, but the District Court dismissed the claim because it thought it inappropriate to enmesh the courts in product design decisions. Id. at 347. The court's discussion of the tying claim was brief and did not dwell on the effects of the integration on competition or efficiencies. Nor did the court consider whether per se analysis of the alleged tie was wise. 213 We have found four antitrust cases involving arrangements in which a software program is tied to the purchase of a software platform--two district court cases and two appellate court cases, including one from this court. The first case, Innovation Data Processing, Inc. v. IBM Corp., 585 F. Supp. 1470 (D.N.J. 1984), involved an allegation that IBM bundled with its OS a utility used to transfer data from a tape drive to a computer's disk drive. Although the court mentioned the efficiencies achieved by bundling, it ultimately dismissed the per se tying claim because IBM sold a discounted version of the OS without the utility. Id. at 1475-76. The second case, A.I. Root Co. v. Computer/Dynamics, Inc., 806 F.2d 673 (6th Cir. 1986), was brought by a business customer who claimed that an OS manufacturer illegally conditioned the sale of its OS on the purchase of other software applications. The court quickly disposed of the case on the ground that defendant Computer/Dynamics had no market power. Id. at 675-77. There was no mention of the efficiencies from the tie. The third case, Caldera, Inc. v. Microsoft Corp., 72 F. Supp. 2d 1295 (D. Utah 1999), involved a complaint that the technological integration of MS-DOS and Windows 3.1 into Windows 95 constituted a per se tying violation. The court formulated the single product issue in terms of whether the tie constituted a technological improvement, ultimately concluding that Microsoft was not entitled to summary judgment on that issue. Id. at 1322-28. 214 The software case that bears the greatest resemblance to that at bar is, not surprisingly, Microsoft II, 147 F.3d 935, where we examined the bundling of IE with Windows 95. But the issue there was whether the bundle constituted an integrated product as the term was used in a 1994 consent decree between the Department of Justice and Microsoft. Id. at 939. We did not consider whether Microsoft's bundling should be condemned as per se illegal. We certainly did not make any finding that bundling IE with Windows had no purpose except stifling of competition, White Motor, 372 U.S. at 263, an important consideration in defining the scope of any of antitrust law's per se rules, see Cont'l T.V., 433 U.S. at 57-59. While we believed our interpretation of the term integrated product was consistent with the test for separate products under tying law, we made clear that the antitrust question is of course distinct. Microsoft II, 147 F.3d at 950 n.14. We even cautioned that our conclusion that IE and Windows 95 were integrated was subject to reexamination on a more complete record. Id. at 952. To the extent that the decision completely disclaimed judicial capacity to evaluate high-tech product design, id., it cannot be said to conform to prevailing antitrust doctrine (as opposed to resolution of the decree-interpretation issue then before us). In any case, mere review of asserted breaches of a consent decree hardly constitutes enough experience to warrant application of per se analysis. See Broad. Music, 441 U.S. at 10-16 (refusing to apply per se analysis to defendant's blanket licenses even though those licenses had been thoroughly 215 investigated by the Department of Justice and were the subject of a consent decree that had been reviewed by numerous courts). 216 While the paucity of cases examining software bundling suggests a high risk that per se analysis may produce inaccurate results, the nature of the platform software market affirmatively suggests that per se rules might stunt valuable innovation. We have in mind two reasons. 217 First, as we explained in the previous section, the separateproducts test is a poor proxy for net efficiency from newly integrated products. Under per se analysis the first firm to merge previously distinct functionalities (e.g., the inclusion of starter motors in automobiles) or to eliminate entirely the need for a second function (e.g., the invention of the stainresistant carpet) risks being condemned as having tied two separate products because at the moment of integration there will appear to be a robust distinct market for the tied product. See 10 Areeda et al., Antitrust Law p 1746, at 224. Rule of reason analysis, however, affords the first mover an opportunity to demonstrate that an efficiency gain from its tie adequately offsets any distortion of consumer choice. See Grappone, Inc. v. Subaru of New England, Inc., 858 F.2d 792, 799 (1st Cir. 1988) (Breyer, J.); see also Town Sound & Custom Tops, Inc. v. Chrysler Motor Corp., 959 F.2d 468, 482 (3d Cir. 1992); Kaiser Aluminum & Chem. Sales, Inc. v. Avondale Shipyards, Inc., 677 F.2d 1045, 1048-49 n.5 (5th Cir. 1982). 218 The failure of the separate-products test to screen out certain cases of productive integration is particularly troubling in platform software markets such as that in which the defendant competes. Not only is integration common in such markets, but it is common among firms without market power. We have already reviewed evidence that nearly all competitive OS vendors also bundle browsers. Moreover, plaintiffs do not dispute that OS vendors can and do incorporate basic internet plumbing and other useful functionality into their OSs. See Direct Testimony of Richard Schmalensee p 508, reprinted in 7 J.A. at 4462-64 (disk defragmentation, memory management, peer-to-peer networking or file sharing); 11/19/98 am Tr. at 82-83 (trial testimony of Frederick Warren-Boulton), reprinted in 10 J.A. at 6427-28 (TCP/IP stacks). Firms without market power have no incentive to package different pieces of software together unless there are efficiency gains from doing so. The ubiquity of bundling in competitive platform software markets should give courts reason to pause before condemning such behavior in less competitive markets. 219 Second, because of the pervasively innovative character of platform software markets, tying in such markets may produce efficiencies that courts have not previously encountered and thus the Supreme Court had not factored into the per se rule as originally conceived. For example, the bundling of a browser with OSs enables an independent software developer to count on the presence of the browser's APIs, if any, on consumers' machines and thus to omit them from its own package. See Direct Testimony of Richard Schmalensee p p 230-31, 234, reprinted in 7 J.A. at 4309-11, 4312; Direct Testimony of Michael Devlin p p 12-21, reprinted in 5 J.A. at 3525-29; see also Findings of Fact p 2. It is true that software developers can bundle the browser APIs they need with their own products, see id. p 193, but that may force consumers to pay twice for the same API if it is bundled with two different software programs. It is also true that OEMs can include APIs with the computers they sell, id., but diffusion of uniform APIs by that route may be inferior. First, many OEMs serve special subsets of Windows consumers, such as home or corporate or academic users. If just one of these OEMs decides not to bundle an API because it does not benefit enough of its clients, ISVs that use that API might have to bundle it with every copy of their program. Second, there may be a substantial lag before all OEMs bundle the same set of APIs--a lag inevitably aggravated by the first phenomenon. In a field where programs change very rapidly, delays in the spread of a necessary element (here, the APIs) may be very costly. Of course, these arguments may not justify Microsoft's decision to bundle APIs in this case, particularly because Microsoft did not merely bundle with Windows the APIs from IE, but an entire browser application (sometimes even without APIs, see id.). A justification for bundling a component of software may not be one for bundling the entire software package, especially given the malleability of software code. See id. p p 162-63; 12/9/98 am Tr. at 17 (trial testimony of David Farber); 1/6/99 am Tr. at 6-7 (trial testimony of Franklin Fisher), reprinted in 11 J.A. at 7192-93; Direct Testimony of Joachim Kempin p 286, reprinted in 6 J.A. at 3749. Furthermore, the interest in efficient API diffusion obviously supplies a far stronger justification for simple price-bundling than for Microsoft's contractual or technological bars to subsequent removal of functionality. But our qualms about redefining the boundaries of a defendant's product and the possibility of consumer gains from simplifying the work of applications developers makes us question any hard and fast approach to tying in OS software markets. 220 There may also be a number of efficiencies that, although very real, have been ignored in the calculations underlying the adoption of a per se rule for tying. We fear that these efficiencies are common in technologically dynamic markets where product development is especially unlikely to follow an easily foreseen linear pattern. Take the following example from ILC Peripherals, 448 F. Supp. 228, a case concerning the evolution of disk drives for computers. When IBM first introduced such drives in 1956, it sold an integrated product that contained magnetic disks and disk heads that read and wrote data onto disks. Id. at 231. Consumers of the drives demanded two functions--to store data and to access it all at once. In the first few years consumers' demand for storage increased rapidly, outpacing the evolution of magnetic disk technology. To satisfy that demand IBM made it possible for consumers to remove the magnetic disks from drives, even though that meant consumers would not have access to data on disks removed from the drive. This componentization enabled makers of computer peripherals to sell consumers removable disks. Id. at 231-32. Over time, however, the technology of magnetic disks caught up with demand for capacity, so that consumers needed few removable disks to store all their data. At this point IBM reintegrated disks into their drives, enabling consumers to once again have immediate access to all their data without a sacrifice in capacity. Id. A manufacturer of removable disks sued. But the District Court found the tie justified because it satisfied consumer demand for immediate access to all data, and ruled that disks and disk heads were one product. Id. at 233. A court hewing more closely to the truncated analysis contemplated by Northern Pacific Railway would perhaps have overlooked these consumer benefits. 221 These arguments all point to one conclusion: we cannot comfortably say that bundling in platform software markets has so little redeeming virtue, N. Pac. Ry., 356 U.S. at 5, and that there would be so very little loss to society from its ban, that an inquiry into its costs in the individual case [can be] considered [ ] unnecessary. Jefferson Parish, 466 U.S. at 33-34 (O'Connor, J., concurring). We do not have enough empirical evidence regarding the effect of Microsoft's practice on the amount of consumer surplus created or consumer choice foreclosed by the integration of added functionality into platform software to exercise sensible judgment regarding that entire class of behavior. (For some issues we have no data.) We need to know more than we do about the actual impact of these arrangements on competition to decide whether they ... should be classified as per se violations of the Sherman Act. White Motor, 372 U.S. at 263. Until then, we will heed the wisdom that easy labels do not always supply ready answers, Broad. Music, 441 U.S. at 8, and vacate the District Court's finding of per se tying liability under Sherman Act 1. We remand the case for evaluation of Microsoft's tying arrangements under the rule of reason. See Pullman-Standard v. Swint, 456 U.S. 273, 292 (1982) ([W]here findings are infirm because of an erroneous view of the law, a remand is the proper course unless the record permits only one resolution of the factual issue.). That rule more freely permits consideration of the benefits of bundling in software markets, particularly those for OSs, and a balancing of these benefits against the costs to consumers whose ability to make direct price/quality tradeoffs in the tied market may have been impaired. See Jefferson Parish, 466 U.S. at 25 nn.41-42 (noting that per se rule does not broadly permit consideration of procompetitive justifications); id. at 34-35 (O'Connor, J., concurring); N. Pac. Ry., 356 U.S. at 5. 222 Our judgment regarding the comparative merits of the per se rule and the rule of reason is confined to the tying arrangement before us, where the tying product is software whose major purpose is to serve as a platform for third-party applications and the tied product is complementary software functionality. While our reasoning may at times appear to have broader force, we do not have the confidence to speak to facts outside the record, which contains scant discussion of software integration generally. Microsoft's primary justification for bundling IE APIs is that their inclusion with Windows increases the value of third-party software (and Windows) to consumers. See Appellant's Opening Br. at 41-43. Because this claim applies with distinct force when the tying product is platform software, we have no present basis for finding the per se rule inapplicable to software markets generally. Nor should we be interpreted as setting a precedent for switching to the rule of reason every time a court identifies an efficiency justification for a tying arrangement. Our reading of the record suggests merely that integration of new functionality into platform software is a common practice and that wooden application of per se rules in this litigation may cast a cloud over platform innovation in the market for PCs, network computers and information appliances.