Microsoft, the EU fine, and a browser ballot no one missed

Editors' note: This is a guest column by Geoffrey Manne and Berin Szoka. See below for their bios.

If a tree fell in the forest, and no one noticed... the European Commission would impose a staggering fine -- and then congratulate itself for protecting consumers from falling trees. That's essentially what just happened: the Commission fined Microsoft $732 million for failing to show its "browser ballot" when users installed one of its Windows 7 updates.

In 2009, the Commission settled charges that Microsoft had monopolized the EU browser market -- even as Internet Explorer's market share was plummeting -- by accepting Microsoft's commitment to show a browser ballot in the Windows setup process. Because of a technical glitch, the Service Pack 1 update for Windows 7 (released in February 2011) omitted the software necessary to display the ballot. Apparently, it took a year and a half for anyone to inform the Commission about this supposedly vital tool -- whose absence should have been obvious to anyone who cared. The Commission then notified Microsoft, which apologized for the glitch and promptly remedied it. The Commission says that between February 2011 and July 2012, roughly 15 million Europeans who purchased new PCs running SP1 weren't shown the browser ballot screen when setting up their new computers. Yesterday, the Commission responded with its $732 million fine.

The Commission still insists the browser ballot was essential to promote competition, noting that "84 million browsers were downloaded through it" (prior to Service Pack 1). But the actual data show no change in the long-term trend lines. Internet Explorer's EU market share fell from 60 percent five years ago to 24 percent today. Internet Explorer was losing ground to Mozilla's Firefox and Google's Chrome before the ballot was imposed, and has continued to do so steadily -- including during the 14 months at issue. The same data belie Mozilla's claim that it lost 9 million Firefox installs and appreciable market share as a result of the glitch. Firefox has continued to lose market share since before the glitch -- not to IE but to Chrome, which now leads the EU market with 35 percent.

Clearly, Europeans were never as helpless as the Commission presumed. They were aware of increasingly popular alternatives to IE and could easily find them simply by searching online. Only in Europe is "search, click, download, and install" thought to be beyond the comprehension or ability of ordinary users.

The Commission could have accepted that the browser ballot was a solution in search of a problem, that Microsoft's error here was an honest one, and that Microsoft addressed it immediately -- and quietly dropped the matter, perhaps with a small fine. The EC accepted Microsoft's explanation, presumably after a careful investigation, yet it still insists the heavy fine is necessary to deter future violations. Why? Such penalties are of limited value in deterring honest mistakes. Microsoft did all any reasonable regulator could have asked: It endeavored to comply with the law, and, when it discovered its compliance was incomplete, it immediately corrected the mistake. At most, the error had a trivial effect. So why impose such a staggering fine -- seven months later?

In 2004 the EU fined Microsoft about $800 million for an actual violation of its competition laws. Yet, without a finding that Microsoft actually violated EU antitrust laws in the browser market, the Commission has now fined Microsoft almost as much for its inadvertent and quickly remedied noncompliance with a voluntary commitment. The Commission's claim that the fine takes into account the gravity of the infringement and the mitigating circumstances rings hollow. Indeed, the fine (1 percent of Microsoft's 2012 global revenue) looks reasonable only compared to the EU's maximum possible fine of 10 percent of global annual turnover. But that's an arbitrary baseline, not keyed to an assessment of proper deterrence or punishment. Indeed, 10 percent is supposed to be a ceiling for extreme cases. Deviating from that means only that the EC exercised some restraint, not that the actual fine makes any sense.

Some fine could well be necessary to deter unintentional violations of legal commitments -- if only to ensure that companies like Microsoft take the right amount of care in executing their obligations. But there is a real danger of overdeterrence. It doesn't serve anyone for Microsoft to expend excessive resources protecting against even the most trivial mistakes when the company could be investing in real product improvements or new innovations -- especially now that Internet Explorer has fallen to No. 3 in the EU browser market.

However far behind IE has fallen, focusing on the browser market makes less and less sense. The original concern about Microsoft's alleged monopolization of the browser market was that the browser would be "middleware" for other content and services -- which the browser-maker could control. That paradigm has, in some ways, indeed come true with the rise of cloud-based services run inside the browser. But it may also have peaked, as such services are increasingly run in apps. That's clearly true in the mobile environment, where the apps store and the OS are the real "middleware" -- not the browser. The same trend seems to be starting with desktops and laptops, too, especially as touch screens increase the usability advantage of apps over browser-based services. Indeed, the lines between mobile devices, laptops, and desktops are quickly blurring. Microsoft has bet the company on making Windows 8 and Windows Phone successful apps platforms -- but lags far behind Apple and Google, just as it does in the cloud computing market (think Skydrive versus Google Docs).

The Commission needs to recognize that the world is changing faster than it -- or any "ballot" -- can keep up. The role of antitrust should be to ensure that companies don't use market power to block their rivals' offerings for purely anticompetitive reasons and in ways that clearly harm consumers. That may well mean regulators should pay more attention to the apps and cloud markets, but it doesn't mean they should try to preserve outdated paradigms for how we consume content or use services like maps, e-mail, calendars, docs or... who knows what?

The Commission might argue the deterrent effect of yesterday's fine lies precisely in those emerging markets, but whatever that deterrence might be, it has to be weighed against two costs. First is that the money Microsoft spent on this settlement could have funded work on the new technologies consumers actually want -- say, a thousand engineers for five years at $146,400 per year. Second, and ironically, by holding companies to a standard of strict liability for voluntary settlements with heavy fines, the Commission actually deters companies from settling antitrust cases in the future. That means Microsoft and other companies will spend a lot more time, money, and attention on antitrust litigation in the future, rather than on innovating. Such litigation, and the threat of it, is particularly wasteful if it deters abuses that technological change would have mooted anyway.

Such trade-offs are unavoidable and increasingly hard to balance as the paradigms, technologies, and "dominant" players of the future become less and less predictable. The Commission would do well to trust in that change, and in the users it empowers, rather than trying to freeze the paradigm of the day into a nice, tidy ballot. Real-world competition is far too messy for that -- and it's a good thing, too.