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Microsoft licensing fees under fire in court

An economist hired by the government testifies that the software giant has hurt consumers by keeping prices for its operating systems above market levels.

WASHINGTON--Microsoft has hurt consumers by keeping prices for its operating systems above market levels, an economist hired by the government testified today as the ongoing antitrust trial under way here wrapped up its fifth week.

The seventh witness to take the stand, Frederick Warren-Boulton backed up his claim with an internal Microsoft email discussing pricing strategies the company considered using with computer sellers as PCs for the first time dropped below the $1,000 price level.

"While we have increased our prices over the last ten years, other component prices have come down and continue to come down," Microsoft senior vice president Joachim Kempin wrote in the December 1997 email to chief executive Bill Gates. Kempin, who is in charge of the software giant's sales to original equipment manufacturers or OEMs, was referring to the chips and other hardware that go into PCs.

Cuts in prices, Kempin added, "will make us a much higher[-priced] component of their system than ever before."

In an interesting side note revealed in the email, Kempin floated the possibility that Microsoft might adopt a "limited time" license for Windows, which users would have to occasionally update. Such an arrangement would be a radical departure from the licensing model Microsoft has used for the past 15 years, which grants users the right to use a product forever.

In written testimony, Warren-Boulton, the chief economist under the Reagan administration's antitrust division and now an economist with the Washington-based firm Microeconomic Consulting Research & Associates, claimed that Microsoft's market power meets the legal threshold of a monopoly. What's more, the economist asserted, Microsoft has hurt consumers by keeping prices above competitive levels and by using its dominance to thwart potential competitors.

The Justice Department (DOJ) and 20 states, which filed suit in May, claim Microsoft's actions are part of a broad pattern of practices that violate antitrust laws. Microsoft denies it has a monopoly or that it has violated any laws.

Warren-Boulton pointed to another section of Kempin's email that discussed the possibility that Compaq Computer might pay Microsoft $750 million in licensing fees. The prices were so high, Kempin said, that he worried the world's largest OEM might band together with other PC sellers to create an alternative to Windows.

"Our high prices could get a single OEM (Compaq might pay us $750 million next year) or a coalition to fund a competing effort (say in India)," Kempin wrote. Still, Kempin doubted such an effort would succeed. "The investments in training, infrastructure, and applications in Windows computing are huge and will create a lot of inertia."

Warren-Boulton offered the last sentence as proof that even Microsoft recognizes the significant barriers that potential competitors face in entering the operating system market.

In court today, Microsoft attorney Michael Lacovara challenged Warren-Boulton's testimony that Microsoft has monopoly power. The lawyer also disputed that Microsoft raised prices for licensing its operating system, but the economist refused to back down.

"Do you know what the competitive price of Windows 98 is?" Lacovara asked.

"Significantly lower than what it is," Warren-Boulton answered. Responding to another question, he claimed that Microsoft has "a great deal of discretion in choosing prices, and the prices they have chosen are a lot higher than they would be at a competitive level."

Lacovara also pointed to the meteoric rise of Linux, an "open source" operating system developed by a loose confederation of programmers over the Internet, as proof that Microsoft does not a monopoly on operating systems. Linux recently received strong corporate support when Netscape Communications and Intel announced they were backing Redhat, a company that supports the product. Other companies, such as Oracle, Sybase, and Informix, also have backed Linux technology.

Asked if Linux will limit Microsoft's ability to raise prices in coming years, Warren-Boulton said no, noting that financial markets remain bullish on Microsoft's long-term prospects.

"If you really believe personally that this product is severely going to constrain Microsoft's operating profits, run--don't walk--to your nearest broker and short [sell] Microsoft's stock," Warren-Boulton said.

One of the several ideas Kempin floated in his email to Gates to adapt the company's strategy to the lower costs of PCs was the possibility of licensing Windows for a limited time frame and charging an annual fee.

"This is the best thing long-term, but it might disrupt end user operations and could require end user registration," Kempin wrote. He added that such a plan, if implemented, could not happen until 2001 because it would require that significant infrastructure be put in place. "We need to be a champion for this now, if we want to do this," Kempin wrote.

Another interesting side note revealed in Kempin's email was Microsoft's fear that Intel might leverage its power in the microchip business to create an operating system that would compete with Windows. Under such a plan, Kempin wrote, Intel would work with Compaq, Netscape, or Sun Microsystems to work on the project. "If they decide to sell the OS for $1 and the [central processing unit or CPU] for $200, they will get the OEMs on their side," he told Gates.

"Our reaction could be to buy Nsemi or AMD or both and own the CPU and the [software] business," he continued, referring to National Semiconductor and Advanced Micro Devices. "We would sell [software] at $100 and CPUs at [$1 above] costs."

Microsoft is expected to continue its cross-examination of Warren-Boulton when trial resumes on Monday. Lacovara said in court he expected the cross-examination to last for another "several days."