Opinion ID: 185418
Heading Depth: 3
Heading Rank: 1

Heading: Market Structure

Text: 31
32 Because the ability of consumers to turn to other suppliers restrains a firm from raising prices above the competitive level, Rothery Storage & Van Co. v. Atlas Van Lines, Inc., 792 F.2d 210, 218 (D.C. Cir. 1986), the relevant market must include all products reasonably interchangeable by consumers for the same purposes. du Pont, 351 U.S. at 395. In this case, the District Court defined the market as the licensing of all Intel-compatible PC operating systems worldwide, finding that there are currently no products--and ... there are not likely to be any in the near future--that a significant percentage of computer users worldwide could substitute for [these operating systems] without incurring substantial costs. Conclusions of Law, at 36. Calling this market definition far too narrow, Appellant's Opening Br. at 84, Microsoft argues that the District Court improperly excluded three types of products: non-Intel compatible operating systems (primarily Apple's Macintosh operating system, Mac OS), operating systems for non-PC devices (such as handheld computers and portal websites), and middleware products, which are not operating systems at all. 33 We begin with Mac OS. Microsoft's argument that Mac OS should have been included in the relevant market suffers from a flaw that infects many of the company's monopoly power claims: the company fails to challenge the District Court's factual findings, or to argue that these findings do not support the court's conclusions. The District Court found that consumers would not switch from Windows to Mac OS in response to a substantial price increase because of the costs of acquiring the new hardware needed to run Mac OS (an Apple computer and peripherals) and compatible software applications, as well as because of the effort involved in learning the new system and transferring files to its format. Findings of Fact p 20. The court also found the Apple system less appealing to consumers because it costs considerably more and supports fewer applications. Id. p 21. Microsoft responds only by saying: the district court's market definition is so narrow that it excludes Apple's Mac OS, which has competed with Windows for years, simply because the Mac OS runs on a different microprocessor. Appellant's Opening Br. at 84. This general, conclusory statement falls far short of what is required to challenge findings as clearly erroneous. Pendleton v. Rumsfeld, 628 F.2d 102, 106 (D.C. Cir. 1980); see also Terry v. Reno, 101 F.3d 1412, 1415 (D.C. Cir. 1996) (holding that claims made but not argued in a brief are waived). Microsoft neither points to evidence contradicting the District Court's findings nor alleges that supporting record evidence is insufficient. And since Microsoft does not argue that even if we accept these findings, they do not support the District Court's conclusion, we have no basis for upsetting the court's decision to exclude Mac OS from the relevant market. 34 Microsoft's challenge to the District Court's exclusion of non-PC based competitors, such as information appliances (handheld devices, etc.) and portal websites that host serverbased software applications, suffers from the same defect: the company fails to challenge the District Court's key factual findings. In particular, the District Court found that because information appliances fall far short of performing all of the functions of a PC, most consumers will buy them only as a supplement to their PCs. Findings of Fact p 23. The District Court also found that portal websites do not presently host enough applications to induce consumers to switch, nor are they likely to do so in the near future. Id. p 27. Again, because Microsoft does not argue that the District Court's findings do not support its conclusion that information appliances and portal websites are outside the relevant market, we adhere to that conclusion. 35 This brings us to Microsoft's main challenge to the District Court's market definition: the exclusion of middleware. Because of the importance of middleware to this case, we pause to explain what it is and how it relates to the issue before us. 36 Operating systems perform many functions, including allocating computer memory and controlling peripherals such as printers and keyboards. See Direct Testimony of Frederick Warren-Boulton p 20, reprinted in 5 J.A. at 3172-73. Operating systems also function as platforms for software applications. They do this by exposing--i.e., making available to software developers--routines or protocols that perform certain widely-used functions. These are known as Application Programming Interfaces, or APIs. See Direct Testimony of James Barksdale p 70, reprinted in 5 J.A. at 2895-96. For example, Windows contains an API that enables users to draw a box on the screen. See Direct Testimony of Michael T. Devlin p 12, reprinted in 5 J.A. at 3525. Software developers wishing to include that function in an application need not duplicate it in their own code. Instead, they can call--i.e., use--the Windows API. See Direct Testimony of James Barksdale p p 70-71, reprinted in 5 J.A. at 2895-97. Windows contains thousands of APIs, controlling everything from data storage to font display. See Direct Testimony of Michael Devlin p 12, reprinted in 5 J.A. at 3525. 37 Every operating system has different APIs. Accordingly, a developer who writes an application for one operating system and wishes to sell the application to users of another must modify, or port, the application to the second operating system. Findings of Fact p 4. This process is both timeconsuming and expensive. Id. p 30. 38 Middleware refers to software products that expose their own APIs. Id. p 28; Direct Testimony of Paul Maritz p p 234-36, reprinted in 6 J.A. at 3727-29. Because of this, a middleware product written for Windows could take over some or all of Windows's valuable platform functions--that is, developers might begin to rely upon APIs exposed by the middleware for basic routines rather than relying upon the API set included in Windows. If middleware were written for multiple operating systems, its impact could be even greater. The more developers could rely upon APIs exposed by such middleware, the less expensive porting to different operating systems would be. Ultimately, if developers could write applications relying exclusively on APIs exposed by middleware, their applications would run on any operating system on which the middleware was also present. See Direct Testimony of Avadis Tevanian, Jr. p 45, reprinted in 5 J.A. at 3113. Netscape Navigator and Java--both at issue in this case--are middleware products written for multiple operating systems. Findings of Fact p 28. 39 Microsoft argues that, because middleware could usurp the operating system's platform function and might eventually take over other operating system functions (for instance, by controlling peripherals), the District Court erred in excluding Navigator and Java from the relevant market. The District Court found, however, that neither Navigator, Java, nor any other middleware product could now, or would soon, expose enough APIs to serve as a platform for popular applications, much less take over all operating system functions. Id. p p 28-29. Again, Microsoft fails to challenge these findings, instead simply asserting middleware's potential as a competitor. Appellant's Opening Br. at 86. The test of reasonable interchangeability, however, required the District Court to consider only substitutes that constrain pricing in the reasonably foreseeable future, and only products that can enter the market in a relatively short time can perform this function. See Rothery, 792 F.2d at 218 (Because the ability of consumers to turn to other suppliers restrains a firm from raising prices above the competitive level, the definition of the 'relevant market' rests on a determination of available substitutes.); see also Findings of Fact p 29 ([I]t would take several years for middleware ... to evolve into a product that can constrain operating system pricing.). Whatever middleware's ultimate potential, the District Court found that consumers could not now abandon their operating systems and switch to middleware in response to a sustained price for Windows above the competative level. Findings of Fact p p 28, 29. Nor is middleware likely to overtake the operating system as the primary platform for software development any time in the near future. Id. 40 Alternatively, Microsoft argues that the District Court should not have excluded middleware from the relevant market because the primary focus of the plaintiffs' 2 charge is on Microsoft's attempts to suppress middleware's threat to its operating system monopoly. According to Microsoft, it is contradict[ory], 2/26/2001 Ct. Appeals Tr. at 20, to define the relevant market to exclude the very competitive threats that gave rise to the action. Appellant's Opening Br. at 84. The purported contradiction lies between plaintiffs' 2 theory, under which Microsoft preserved its monopoly against middleware technologies that threatened to become viable substitutes for Windows, and its theory of the relevant market, under which middleware is not presently a viable substitute for Windows. Because middleware's threat is only nascent, however, no contradiction exists. Nothing in 2 of the Sherman Act limits its prohibition to actions taken against threats that are already well-developed enough to serve as present substitutes. See infra Section II.C. Because market definition is meant to identify products reasonably interchangeable by consumers, du Pont, 351 U.S. at 395, and because middleware is not now interchangeable with Windows, the District Court had good reason for excluding middleware from the relevant market. 41
42 Having thus properly defined the relevant market, the District Court found that Windows accounts for a greater than 95% share. Findings of Fact p 35. The court also found that even if Mac OS were included, Microsoft's share would exceed 80%. Id. Microsoft challenges neither finding, nor does it argue that such a market share is not predominant. Cf. Grinnell, 384 U.S. at 571 (87% is predominant); Eastman Kodak Co. v. Image Technical Servs., Inc., 504 U.S. 451, 481 (1992) (80%); du Pont, 351 U.S. at 379, 391 (75%). 43 Instead, Microsoft claims that even a predominant market share does not by itself indicate monopoly power. Although the existence of [monopoly] power ordinarily may be inferred from the predominant share of the market, Grinnell, 384 U.S. at 571, we agree with Microsoft that because of the possibility of competition from new entrants, see Ball Mem'l Hosp., Inc., 784 F.2d at 1336, looking to current market share alone can be misleading. Hunt-Wesson Foods, Inc. v. Ragu Foods, Inc., 627 F.2d 919, 924 (9th Cir. 1980); see also Ball Mem'l Hosp., Inc., 784 F.2d at 1336 (Market share reflects current sales, but today's sales do not always indicate power over sales and price tomorrow.) In this case, however, the District Court was not misled. Considering the possibility of new rivals, the court focused not only on Microsoft's present market share, but also on the structural barrier that protects the company's future position. Conclusions of Law, at 36. That barrier--the applications barrier to entry--stems from two characteristics of the software market: (1) most consumers prefer operating systems for which a large number of applications have already been written; and (2) most developers prefer to write for operating systems that already have a substantial consumer base. See Findings of Fact p p 30, 36. This chicken-and-egg situation ensures that applications will continue to be written for the already dominant Windows, which in turn ensures that consumers will continue to prefer it over other operating systems. Id. 44 Challenging the existence of the applications barrier to entry, Microsoft observes that software developers do write applications for other operating systems, pointing out that at its peak IBM's OS/2 supported approximately 2,500 applications. Id. p 46. This misses the point. That some developers write applications for other operating systems is not at all inconsistent with the finding that the applications barrier to entry discourages many from writing for these less popular platforms. Indeed, the District Court found that IBM's difficulty in attracting a larger number of software developers to write for its platform seriously impeded OS/2's success. Id. p 46. 45 Microsoft does not dispute that Windows supports many more applications than any other operating system. It argues instead that [i]t defies common sense to suggest that an operating system must support as many applications as Windows does (more than 70,000, according to the District Court, id. p 40) to be competitive. Appellant's Opening Br. at 96. Consumers, Microsoft points out, can only use a very small percentage of these applications. Id. As the District Court explained, however, the applications barrier to entry gives consumers reason to prefer the dominant operating system even if they have no need to use all applications written for it: 46 The consumer wants an operating system that runs not only types of applications that he knows he will want to use, but also those types in which he might develop an interest later. Also, the consumer knows that if he chooses an operating system with enough demand to support multiple applications in each product category, he will be less likely to find himself straitened later by having to use an application whose features disappoint him. Finally, the average user knows that, generally speaking, applications improve through successive versions. He thus wants an operating system for which successive generations of his favorite applications will be released--promptly at that. The fact that a vastly larger number of applications are written for Windows than for other PC operating systems attracts consumers to Windows, because it reassures them that their interests will be met as long as they use Microsoft's product. 47 Findings of Fact p 37. Thus, despite the limited success of its rivals, Microsoft benefits from the applications barrier to entry. 48 Of course, were middleware to succeed, it would erode the applications barrier to entry. Because applications written for multiple operating systems could run on any operating system on which the middleware product was present with little, if any, porting, the operating system market would become competitive. Id. p p 29, 72. But as the District Court found, middleware will not expose a sufficient number of APIs to erode the applications barrier to entry in the foreseeable future. See id. p p 28-29. 49 Microsoft next argues that the applications barrier to entry is not an entry barrier at all, but a reflection of Windows' popularity. It is certainly true that Windows may have gained its initial dominance in the operating system market competitively--through superior foresight or quality. But this case is not about Microsoft's initial acquisition of monopoly power. It is about Microsoft's efforts to maintain this position through means other than competition on the merits. Because the applications barrier to entry protects a dominant operating system irrespective of quality, it gives Microsoft power to stave off even superior new rivals. The barrier is thus a characteristic of the operating system market, not of Microsoft's popularity, or, as asserted by a Microsoft witness, the company's efficiency. See Direct Testimony of Richard Schmalensee p 115, reprinted in 25 J.A. at 16153-14. 50 Finally, Microsoft argues that the District Court should not have considered the applications barrier to entry because it reflects not a cost borne disproportionately by new entrants, but one borne by all participants in the operating system market. According to Microsoft, it had to make major investments to convince software developers to write for its new operating system, and it continues to evangelize the Windows platform today. Whether costs borne by all market participants should be considered entry barriers is the subject of much debate. Compare 2A Areeda & Hovenkamp, Antitrust Law 420c, at 61 (arguing that these costs are entry barriers), and Joe S. Bain, Barriers to New Competition: Their Character and Consequences in Manufacturing Industries 6-7 (1956) (considering these costs entry barriers), with L.A. Land Co. v. Brunswick Corp., 6 F.3d 1422, 1428 (9th Cir. 1993) (evaluating cost based on [t]he disadvantage of new entrants as compared to incumbents), and George Stigler, The Organization of Industry 67 (1968) (excluding these costs). We need not resolve this issue, however, for even under the more narrow definition it is clear that there are barriers. When Microsoft entered the operating system market with MS-DOS and the first version of Windows, it did not confront a dominant rival operating system with as massive an installed base and as vast an existing array of applications as the Windows operating systems have since enjoyed. Findings of Fact p p 6, 7, 43. Moreover, when Microsoft introduced Windows 95 and 98, it was able to bypass the applications barrier to entry that protected the incumbent Windows by including APIs from the earlier version in the new operating systems. See id. p 44. This made porting existing Windows applications to the new version of Windows much less costly than porting them to the operating systems of other entrants who could not freely include APIs from the incumbent Windows with their own.