The European Microsoft Case: The Economics of Network Effects, Interoperability, and Tying
Tokyo, Japan
10 October 2007
Hosted By: the Fair Trade Centre
In a seminar at the Fair Trade Centre, Tokyo, NERA Director Dr. Mark Williams, who leads NERA's European Competition Policy group in London and Brussels, discussed the European Microsoft case. He set out a conceptual framework for the European Commission's analysis on both the server interoperability issue as well as the tying/bundling of the Windows Media Player.
In relation to interoperability, Dr. Williams set out the economic theory of network effects, under which the size of a company's customer base is itself a material factor in its attractiveness to customers. In so-called two-sided markets (or multi-sided markets) these network effects take an indirect (or market-mediated) form, where the existence of a large community of users stimulates an increase in supply of complementary goods, which in turn benefits the users.
In the absence of interoperability between different systems, network effects operate at the level of a single system or platform. Network effects can give rise to a "tipping point," beyond which substantially all customers migrate to a single supplier. Accordingly, there are some rationales in economic theory for promoting interoperability, especially given the efficiency benefits of a larger interoperative customer base. However, Dr. Williams also noted that under certain conditions the intensity of competition between rival suppliers to build market share may be intensified by the absence of interoperability, and hence that mandating interoperability is not unambiguously pro-competitive, especially in nascent markets.
In the context of the server market, the European Commission was persuaded that the lack of interoperability discouraged customers from buying servers from Microsoft's competitors, and that interoperability -- and the compulsory licensing of the necessary intellectual property rights -- was necessary. Yet, it is not obvious that the conclusions drawn in the Microsoft case would apply in all markets characterized by network effects. One factor that might be relevant is whether successive "generations" of products compete from a blank slate, or whether, by contrast, the incumbent in one generation is able to leverage that advantage into the next generation product. This in turn may depend on inter-generation compatibility issues.
Dr. Williams noted that network effects, issues of interoperability, and tipping can feature in a wide variety of industries, and that generically similar analysis could potentially be applied to dominant firms in those markets. However, a finding such as that in the Microsoft case would not necessarily arise in a high proportion of cases.
In relation to the second limb of the Microsoft case, i.e., the allegation that Microsoft had abused its dominant position by bundling Windows Media Player with the Windows operating system, Dr. Williams noted that, although there are some coherent mechanisms that lead to anticompetitive effects, the theory of tying and bundling has long been controversial. This controversy extends to the Microsoft case, particularly in view of the negligible effect of the remedy: as part of the original 2004 decision Microsoft was instructed to offer a version of Windows without Media Player -- yet, demand for that unbundled product, albeit one sold at no discount, was negligible. This empirical evidence thus raised questions about the practical plausibility of the Commission's posited exclusion mechanism.
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