Microsoft economist grilled at trial

The software giant's economic expert is asked how he reconciles his view that the company doesn't have a monopoly with his earlier writings.

Feb. 6, 2002 5:02 a.m. PT

4 min read

WASHINGTON--Microsoft's economic expert, testifying at the company's antitrust trial under way here, was asked how he reconciles his view that the software company doesn't have a monopoly with his earlier writings that support the theory of the government's case.

"It was 16 years ago--my immediate reaction is 'What could I have been thinking?'" Richard Schmalensee replied when asked about his Harvard Law Review article that said persistent excess profits are a "good indication" that a company has power to control market forces.

Economists for the Justice Department and 19 states suing Microsoft have said that the profits earned by the world's largest software company are evidence it has a monopoly on computer operating systems.

The government must establish that Microsoft's Windows operating system gives the company a monopoly in order to persuade U.S. District Judge Thomas Penfield Jackson that the company illegally uses its market power to defend its dominant position.

Schmalensee, Microsoft's lead defense witness, testified that the company faces "potentially serious competition" from many companies and technologies, and therefore is not a monopolist.

Schmalensee, dean of the Sloan School of Management at the Massachusetts Institute of Technology, said Apple Computer's new iMac computers, Sun Microsystems' Java computer language, and the emergent Linux operating system all threaten Windows. Microsoft's operating system runs more than 90 percent of the world's personal computers.

Market Power
Schmalensee told lead government attorney David Boies that he had not determined whether Microsoft had earned the kind of excessive profits that are the mark of a monopolist. The economist said exploitation of market power was not the only way for a company to net such sums.

"I couldn't disentangle or separate any possible market power from simply being lucky or skillful for coming up with a terrific profit," he said.

The economist said someone who struck oil could earn excessive profits without being a monopolist.

Schmalensee's 1982 article, though, said "persistent excess profits provide a good indication of long-run power?. They show clearly that there is some impediment to effective imitation of the firm in question."

When Boies confronted him with that paragraph, Schmalensee said it "does not, the way it sits, provide a good indication of my present views."

Schmalensee also was asked if he still believed that evidence of competitors conspiring to fix prices or divide markets indicate that they have market power.

"Market power, yes. Monopoly power, no," Schmalensee said.

He added that price-fixing or market-division was "perhaps" evidence a company has a monopoly.

Executives of Intel, Apple, and Netscape Communications have testified that Microsoft asked them to stay out of particular businesses. Microsoft denies charges by Netscape chief executive James Barksdale and other software executives that it sought to illegally divide markets.

New competitors
Beyond an analysis of excess profits, one test for determining whether a company is a monopolist is whether new competitors can enter the market.

Schmalensee acknowledged for the second time in two days on the stand that "there has not been anyone who has been able to displace Microsoft."

Schmalensee has testified that Microsoft faces threats not only from emerging Internet technologies, but also new operating systems. Linux, which is marketed by Red Hat Software and Caldera, is one such product. The economist said BeOs, sold by Be, is another operating system getting attention from computer makers, with Intel providing financial backing for the software.

Boies, though, questioned whether these companies really had entered the marketplace. The lawyer pointed to a 1987 law-review article in which Schmalensee wrote there was a difference between "toe-hold entry that never gets any bigger and real entry" into a market.

Schmalensee couldn't identify any instance in which the competitive threats to Microsoft affected the company's profits.

Self Defense
The government's case included accusations that Microsoft integrated its Internet Explorer Web browser into Windows to crush competition from Netscape's rival Navigator browser and to protect Windows.

A survey taken by Microsoft found 85 percent of software programmers wanted Explorer and Windows melded, but the government today attacked the company's motives for commissioning the poll (See related story).

The MIT economist defended his reliance on the survey in court.

Boies showed Schmalensee a February 15, 1988, memo written by Microsoft executive Nathan Myhrvold that said the survey had to be completed in time for Microsoft CEO Bill Gates to quote its results during Senate testimony.

"We should keep this VERY quiet before the testimony because we do not want Barksdale or others preparing a counterattack," Mhryvold wrote. "Bill should lead with this in his testimony, then we run the big full-page ads the next day."

Schmalensee said he may have known the purpose of the survey when it was commissioned. He defended its inclusion in his prepared testimony.

"It is a random sample" by a market research firm, he said. "The purpose is not relevant."

Microsoft shares fell 2.0625 to close at 141.75 today.