SYNOPSIS: What to do about a Natural Bully?

When the members of the appeals court were writing up their ruling on Microsoft, did an animated paper clip pop up on their screen, bat its eyelashes and say: "You seem to be writing a legal opinion. Would you like some help?"

Actually, we could all use some help here: the Microsoft case is fundamentally difficult. How do you deal with a monopoly when the monopoly is "natural," when it would exist even in the absence of foul play? For even if Microsoft had been utterly scrupulous in its conduct (which it wasn't), the force of "network externalities" — the incentives to use the same system that everyone else is using — would have given it a monopoly in the operating-system market.

In the past, Microsoft's lawyers have made the ludicrous claim that the company isn't a monopoly. But the appeals court, while rebuking Judge Thomas Penfield Jackson for talking out of turn, firmly upheld his ruling that what looks and quacks like a monopoly is, sure enough, a monopoly. Nonetheless, it threw out his proposed remedy.

To sort through the issues, imagine that a new use is found for the Internet — say, a way to transmit smells (leading to the discovery that most of the content out there stinks, but never mind). Several companies introduce software, so-called "sniffers," that allow users to find and download smell files in the ".snf" format. Meanwhile, however, Microsoft introduces its own competing proprietary file format, ".sml." What rules should be applied to Microsoft in this competition?

At one extreme, Microsoft could be free to do whatever it wants — including introducing a new operating system in which Windows Media Sniffer works, but the products of rival companies, like AOL's RealSniffer, do not. If Microsoft were not a monopolist, if it were one of many competing companies offering operating systems, this would be legal. But it isn't legal given Microsoft's monopoly position, which creates a special obligation to provide market openings for competing software applications.

At the other extreme, Microsoft could be banned from offering its own sniffer, or forced to divest itself of its sniffer division if it already had one. This was in effect the remedy demanded by Judge Jackson, who ruled that Microsoft must be split into an operating-system company and an applications company. That is the part of his ruling that has been overturned — and with good reason: standard economic analysis suggests that while such a "vertical" breakup of Microsoft would increase competition, it would do so at considerable cost to consumers. So to prevent Microsoft from offering a sniffer would be a case of cutting off our nose to spite our face.

Somewhere between these extremes is where the line must now be drawn. And the key question is what Microsoft can and can't do in terms of "bundling" — offering sniffers, or other software, as a part of the operating system.

As I understand the court's ruling, Microsoft probably could now get away with including a free sniffer as part of the operating system. What it could not get away with is including a free sniffer that only reads .sml files, thereby giving its proprietary file format a tremendous advantage — and probably giving its sniffer, which is designed for that format, a big advantage too.

Now for the bad news. Even as this case was working its way through the courts, Bill Gates and Steve Ballmer were still up to their old tricks. The next Microsoft operating system, Windows XP, contains Windows Media Player, which — unlike AOL's RealPlayer — apparently will play music and video in Microsoft's proprietary formats but not in those of competitors. Now I have generally felt that Microsoft gets a worse rap than it deserves, and I criticized Judge Jackson's breakup plan from the start. But this looks like sheer arrogance — the sort of arrogance that got Microsoft in trouble in the first place.

That arrogance is what drove Judge Jackson over the edge. He concluded that Mr. Gates and his friends could not be trusted, that they would always try to find a way around any court order that limited their conduct, and that the only way to enforce good behavior was a drastic "structural" remedy. It's now up to Microsoft to prove that he was wrong. Otherwise, we'll see them back in court — and the next judge will keep his mouth shut but carry a big stick.

Originally published in The New York Times, 7.1.01