Letter to Larry

Baldwin Louie — Mon, 03 Jul 2000 15:00:00 -0700

In the June 12 issue of The Standard, a friend and former colleague, Harvard Law Professor Lawrence Lessig, asked Bill Gates whether his opposition to the breakup of Microsoft (MSFT) was based on any principle. Gates can speak for himself. Nevertheless, because I believe in the benefits of what economists call "comparative advantage," I'd prefer to keep Mr. Gates focused on making software and allow me, a part-time economist, to deal with Professor Lessig.

Lessig makes two central points. First, he claims that Gates' assertion of a right to innovate is not sufficient to oppose the government's antitrust remedy - at least not if Microsoft's innovations reduce consumer choice by cementing the power of Windows against potential rivals. Second, Lessig argues that breaking Microsoft into Ops and Apps companies would only level the competitive playing field. If non-Microsoft developers have to deal with Windows on arms-length terms, why shouldn't the developers inside Microsoft meet the same standard?

Lessig knows a lot about this case. He served as a special master for U.S. District Court Judge Thomas Penfield Jackson for a period and later was asked by the judge to submit a "friend of the court" brief on the liability issue. But to believe that the two questions he poses go to the crux of the matter is to reveal how little Lessig - and the court - understand about the economics of software.

Microsoft's tormentors view the software industry through the same lens as any other industry subject to antitrust laws. And there is, after all, a long tradition of breaking up firms that appear to dominate industries by possessing large market share - Standard Oil and the Tobacco Trust, for instance. But making software is different than refining oil or making cigarettes: Computer software operates on a network, the value of which increases as the network expands, both in terms of the number of interacting applications and the number of users. That is why the business-as-usual approach of Lessig and the court - identify monopoly, see monopoly expanding, break up monopoly - puts software consumers at considerable risk.

Judge Jackson concluded that it is predatory for Microsoft to include Internet Explorer in Windows and to not charge extra for the added browser code. But he misses the point: Gates believes that Microsoft's success, as well as the public interest, turns on the creation of the broadest possible expansion of the network built around Windows.

Lessig offers an impassioned plea for equity among applications writers. But he ignores basic economics - this time the old-economy economics of "vertical integration."

If Bethlehem Steel (BS) digs its own coal to make coke to make steel, or if it builds a plant to turn steel ingots into sheet metal, we assume the company thinks it can save money or time, or deliver a better product through integration. We don't assume it aims to become a monopolist. By the same token, it makes little sense to assume that Microsoft's goal as an integrated maker of Windows and Windows applications is to monopolize either part of the software business. Indeed, in light of the fact that Microsoft spends hundreds of millions of dollars a year on nurturing independent software developers, one might well assume the opposite.

The proposed Microsoft breakup would not be the first vertical dissolution. Decades ago, the Justice Department forced the major movie studios to sell off movie theaters. There is not a single soul who believes consumers benefited.

Regrettably, Professor Lessig's recommendations approach would have the same effect. If the Microsoft breakup is affirmed, the harm to consumers from putting both the network and the no-muss, no-fuss integration of applications software with Windows at risk could be substantial.

George L. Priest teaches law and economics at Yale Law School and is a consultant to Microsoft.

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Letter to Larry