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Competition Law in the New Economy Industries: Is the Current Competition Analysis Adequate to Protect Consumers in the New Economy Industries

A thesis submitted to The University of Manchester for the degree of Master of Philosophy in the Faculty of Humanities

2012

Kwangkug Kim

The School of Law

Contents Abstract ....................................................................................................................... 5 Declaration .................................................................................................................. 6 Copyright Statement .................................................................................................. 6 Acknowledgements..................................................................................................... 7 Part I. Introduction .................................................................................................... 8 I. Research Motivation ................................................................................................. 8 II. Research Background: The New Economy Markets and Their Characteristics ... 10 2.1 Definition of New Economy and Competition Policy ..................................... 10 2.2 Characteristics of New Economy Markets ....................................................... 15 2.3 Conflicting Views and Their Limitations ........................................................ 19 III. Research Questions .............................................................................................. 21 IV. Research Methodology ........................................................................................ 23 V. Thesis Structure ..................................................................................................... 25 Part II. Network Effects and Their Impact on Competition in New Economy Markets ..................................................................................................................... 28 I. Introduction............................................................................................................. 28 1.1 Background ...................................................................................................... 29 1.2 Positive and Negative of Network Effects ....................................................... 31 1.3 Competition Policy Implication of Network Effects ....................................... 33 II. Conflicting Approaches of Network Effects ......................................................... 35 2.1 Neo-Structuralist Approach ............................................................................. 35 2.2 Neo-Schumpeterian Approach ......................................................................... 41 III. Case Law .............................................................................................................. 46 3.1 Market Definition in IT Markets ...................................................................... 46 3.1.1 America On-Line/Time Warner ................................................................ 47 3.1.2 WorldCom/Sprint ...................................................................................... 51 3.2 Dominance in IT Markets ................................................................................ 54 3.2.1 Traditional Test ......................................................................................... 56 3.2.2 Neo-Schumpeterian Definition of Dominance.......................................... 57 3.3 Abuse in IT Markets......................................................................................... 60 3.3.1 Safeguarding a Dominant Position ........................................................... 61 3.3.2 Leveraging ................................................................................................ 65 3.4 Objective Necessity: Incentives to Innovate .................................................... 67 IV. Conclusion ........................................................................................................... 70 Part III. Minimisation of Leveraging Effects in Technological Integration ....... 76 I. Introduction............................................................................................................. 77 1.1 Background ...................................................................................................... 77 1.2 Definition and Types of Product Tying and Bundling ..................................... 78 1.3 New Economy and Its Consequences in Product Integration .......................... 81 II. European Legal Approach to Tying ...................................................................... 82 2.1 Forms of Tying ................................................................................................. 83

2.2 European Union Approach to Tying in Case Law ........................................... 86 2.2.1 Dominance ................................................................................................ 87 2.2.2 Two Separate Products.............................................................................. 88 2.2.3 Coercion .................................................................................................... 94 2.2.4 Possibility of Foreclosure.......................................................................... 96 2.2.5 Objective Justifications ............................................................................. 98 III. US Legal Approach to Tying ............................................................................. 100 3.1 Per Se Illegality Approach ............................................................................. 100 3.2 Modified Per Se Approach ............................................................................. 105 3.3 Rule of Reason Approach .............................................................................. 110 IV. Economics of Tying: Reasons to Integrate Software ......................................... 114 4.1 Chicago School Explanations ........................................................................ 114 4.1.1 Price-Discrimination ............................................................................... 114 4.1.2 Risk Bearing ............................................................................................ 115 4.1.3 Quality Control ....................................................................................... 116 4.2 Post-Chicago Anticompetitive Explanations ................................................. 118 4.2.1 Monopoly Leveraging ............................................................................. 118 4.2.2 Preservation of Monopoly ....................................................................... 120 4.3 Post-Chicago Pro-competitive Explanations.................................................. 124 4.3.1 Responding to Diversity of Buyer Valuations ........................................ 125 4.3.2 Stimulating Demand for Complementary Products and Features ........... 126 4.3.3 Generating Revenue from Ancillary Services ........................................ 127 4.4 Evaluation of the Economic Theory on Product Integration ......................... 129 V. Evaluation of Elements Constituting Tying in Judicial Tests of the EU and the US .................................................................................................................................. 129 5.1 Separate Products Test ................................................................................... 130 5.2 Coercion Test ................................................................................................. 137 5.3 Anticompetitive Foreclosure .......................................................................... 143 5.3.1 Foreclosure and the Nature of Bundling ................................................. 143 5.3.2 Anticompetitive Effects: Consumer Detriments ..................................... 155 VI. Framework of Technological Integration in New Economy Markets ............... 162 VII. Remedies in Technological Integration ............................................................ 167 VIII. Conclusion....................................................................................................... 177 Part IV. Interoperability and Compulsory Licensing in Technologically Dynamic Markets ................................................................................................... 180 I. Introduction........................................................................................................... 181 1.1 Background .................................................................................................... 181 1.2 Interfaces between Competition Law and Intellectual Property Rights......... 183 II. European Approach to Refusal to License .......................................................... 187 2.1 Refusals to Supply and Refusal to License .................................................... 188 2.2 The Commission’s Essential Facilities Doctrine ........................................... 194 2.3 Magill TV Guide and the Exceptional Circumstances ................................... 196 2.4 Extension of Exceptional Circumstances/Essential Facilities after Magill.... 200 III. Exceptional Circumstances/Essential Facilities in Information Technology Sector .................................................................................................................................. 206 3.1 Microsoft Case in the EU and Exceptional Circumstances ............................ 206 3.1.1 Commission’s Incentives Balance Test .................................................. 206 3.1.2 EU Courts’ Modification and Extension of Exceptional Circumstances 211

3.2.3 Implications for Future Cases ................................................................. 216 3.2 Microsoft Case in the US ............................................................................... 217 VI. Analysing Elements of Essential Facilities/Exceptional Circumstances ........... 224 4.1 Evolution of Leveraging: Two-Market Theory v. Single-Market Theory ..... 224 4.1.1 Market Foreclosure effects...................................................................... 224 4.1.2 Competitive Relationship ........................................................................ 227 4.2 Exceptional Circumstances ............................................................................ 231 4.2.1 Indispensability ....................................................................................... 231 4.2.2 Risk of Elimination of Effective Competition ........................................ 232 4.2.3 New Product Criterion: Limiting Technological Development .............. 234 4.2.4. Objective Justification and Proportionality............................................ 236 V. Conclusion........................................................................................................... 237 Part V. Conclusion ................................................................................................. 242 I. Summary of Findings ........................................................................................... 242 II. Consideration of Findings ................................................................................... 245 III. Per Se Approach to Article 102 TFEU and Its Consequences in IT Markets.... 248 IV. Implications of Applying the Current European Legal Analysis to IT Markets 251 V. Contribution to the Discussion on the New Economy and Article 102 and its Limitations ............................................................................................................... 255 Bibliogrphy ............................................................................................................. 258

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Abstract This abstract is written by Kwangkug Kim for the thesis of MPhil in Law at The University of Manchester, on 18 April 2012. The thesis title is: ‘Competition Law in the New Economy Industries: Is the Current Competition Analysis Adequate to Protect Consumers in the New Economy Industries.’

This thesis researches current European competition principles in the New Economy industries. New Economy industries have distinct characteristics from traditional ones. One of these characteristics is network effects. This characteristic plays a significant role in determining the type of competition. In such marketplaces, the competition is ‘for the market’, not ‘within the market’, and the market is likely to end up highly concentrated or monopolised. The network effects lead to a tendency for markets to tip towards a single dominant network or technology. Whilst the network effects encourage new undertakings to enter a market, at the same time these allow a dominant firm to leverage its dominance from a primary market to secondary/downstream markets. In particular if a dominant network or technology becomes a de facto standard, its owner has similar characteristics to a natural monopolist because its technology is protected by intellectual property rights (IPRs) and its exclusive exercise is guaranteed by intellectual property law. In such a case, the dominant firm can easily leverage its market power from one market to another; especially, when markets are vertically or horizontally related, the risk of leveraging dominance is dramatically increased. For example, in the computer software market, operating systems are a basic platform in order to develop almost all software. Thus, if a firm has dominance in the operating systems market, it can easily enter into and acquire a market power in applications markets using its protected IPRs and various business strategies such as tying/technological integration. In Microsoft, a milestone case in IT markets, competition authorities had opportunities to deal with undertakings’ two strategies in the New Economy markets. One was technological integration and the other was refusal to license. Whilst technological integration provides increased access to new features or technologies to consumers, IP holders can legally restrict access to its technology or network, due to exclusivity allowed by IP law, through refusal to license. Dominant firms may evict competitors from secondary or complementary markets using these practices. Thus, these practices may make effective competition impossible in the short term and cause harm to consumers in the long term. In IT markets, once an effective competition is restricted, it is difficult or impossible to restore it because of IT characteristics, such as network effects, relatively high switching costs, economies of scale/large installed base, and lock-in. As a result, in such a case, immediate intervention may be needed to maintain effective competition, but at the same time to protect incentives to innovate. Intervention made by European competition authorities into IT markets have so far recognised their unique characteristics and this led to competition rules being applied more flexibly to technological tying and interoperability cases. In other words, more lenient standards have applied to IT markets due to its durable monopoly caused by network effects.

Declaration What portion of the work referred to in the thesis has been submitted in support of an application for another degree or qualification of this or any other university or other institute of learning.

Copyright Statement i.

ii.

iii.

iv.

The author of this thesis (including any appendices and/or schedules to this thesis) owns certain copyright or related rights in it (the “Copyright”) and s/he has given The University of Manchester certain rights to use such Copyright, including for administrative purposes. Copies of this thesis, either in full or in extracts and whether in hard or electronic copy, may be made only in accordance with the Copyright, Designs and Patents Act 1988 (as amended) and regulations issued under it or, where appropriate, in accordance with licensing agreements which the University has from time to time. This page must form part of any such copies made. The ownership of certain Copyright, patents, designs, trademarks and other intellectual property (the “Intellectual Property”) and any reproductions of copyright works in the thesis, for example graphs and tables (“Reproductions”), which may be described in this thesis, may not be owned by the author and may be owned by third parties. Such Intellectual Property and Reproductions cannot and must not be made available for use without the prior written permission of the owner(s) of the relevant Intellectual Property and/or Reproductions. Further information on the conditions under which disclosure, publication and commercialisation of this thesis, the Copyright and any Intellectual Property and/or Reproductions described in it may take place is available in the University IP Policy (see http://documents.manchester.ac.uk/DocuInfo.aspx?DocID=487), in any relevant Thesis restriction declarations deposited in the University Library, The University Library’s regulations (see http://www.manchester.ac.uk/library/aboutus/regulations) and in The University’s policy on Presentation of Theses

Acknowledgements

There are several people to whom I would like to express my gratitude for their support in the process of writing this thesis. Dr. Liza Lovdahl Gormsen, my supervisor, has encouraged and advised me to finish this thesis. Her deeper insights in competition law were precious. A special appreciation goes to my dearest mother, Mrs. Young-Ae Choi, and my family who have been financially and mentally backed me up during the period of study.

Part I. Introduction

I. Research Motivation ................................................................................................. 8 II. Research Background: The New Economy Markets and Their Characteristics ... 10 2.1 Definition of New Economy and Competition Policy ..................................... 10 2.2 Characteristics of the New Economy Markets ................................................. 15 2.3 Conflicting Views and Their Limitations ........................................................ 19 III. Research Questions .............................................................................................. 21 IV. Research Methodology ........................................................................................ 23 V. Thesis Structure ..................................................................................................... 25

I. Research Motivation

Microsoft has been the subject of competition investigations over more than a decade and has become high profile because it has been so long running and because it has polarised opinion on the benefits of pursuing the information technology (IT) software giant. Those who support the litigation express concerns that the dominant personal computer software provider will extend its market power over other software markets, whist those who criticise the litigation assert an absence of evidence of damage to the market and the benefits to consumers of allowing Microsoft to incorporate additional features into its software. Intersecting both positions is a debate regarding the ability of antitrust/competition law to keep up with the IT industry.

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Now the litigation has been finished, however, discussions still continue for evaluating what this case means for the whole IT industry and other innovative markets as well as for competition law itself. It is quite interesting to ask whether decision makers in the EU and the US put more focus on enhancing effective competition generally or on hampering a dominant player in their dealings with Microsoft. Another crucial question is whether, in highly innovative markets, competition authorities can ever craft effective forward-looking remedies that are able to anticipate and reduce future anticompetitive threats. Although, recently, the Court of Justice confirmed that the application of the competition rules could not depend on whether the market concerned had already reached a certain level of maturity,1 the debates surrounding the issues of the New Economy industries, such as technology maturity, still continue. It is also true to say that because New Economy markets have new features, it is important to examine whether the characteristics of IT markets are too new to apply the current competition analysis to these markets. Undertakings in the New Economy industries still use traditional business strategies, such as tying/bundling and refusal to supply, to acquire a market power although these industries have different features from traditional ones. Thus, the research on whether the current competition approaches are adequately dealing with the IT industry which is heavily IP intensive may answer the question about how and how much the current European competition principles may be changed. In addition, it may contribute to future competition policy which will deal with the newer industries.

1

Case C-52/09 Konkurrensverketk v. Teliasonera Sverige AB [2011] 4 Common Market Law Reports 18, paras. 105-108.

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II. Research Background: The New Economy Markets and Their Characteristics

2.1 Definition of New Economy and Competition Policy

“New Economy” is an expression which encompasses high-tech industries such as information technology (IT) including computer software, hardware, Internet-based businesses and associated technologies,

2

biotechnology and aerospace.

3

The

development of the New Economy industries is one of the great economic success stories of this century, with the potential to significantly increase productivity and improve living standards across the economic spectrum. Unlike

traditional

markets,

the

New

Economy

markets’

dynamic

characteristics, such as rapid technology change and the creation of new forms of cooperation and competition, may make traditional competition approaches unworkable. As a result, there have been great debates about whether the existing forms and principles of competition law are effective to deal with regulatory problems in the New Economy industries.4 Like traditional industries, the emergence of one undertaking which has an overwhelmingly dominant position raises important questions for competition in the New Economy markets. The concern for competition policy is not simply that one company has a monopoly in a specific market, but rather that it may be using that monopoly to create barriers to entry in complementary markets and in the

Robert Lind and Paul Muysert, “Innovation and Competition Policy: Challenges for the New Millennium,” European Competition Law Review 24, no. 2 (2003): 87. 3 Alison Jones and Brenda Sufrin, EU Competition Law: Text, Cases, and Materials, 4th ed. (Oxford; New York: Oxford University Press, 2011), 57; However, in this paper, the term of “New Economy” is used to be synonymous with the term of “information technology,” 4 Cosmo Graham, “Introduction,” in Competition, Regulation and the New Economy, ed. Cosmo Graham and Fiona Smith (Oxford; Portland: Hart Publishing, 2004), 1. 2

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monopolised markets themselves. If so, the impact could be to raise prices and stifle innovation. Recently the European Commission (‘the Commission’) has suggested that competition rules are being more stringently applied to the high-tech markets. Former Commissioner Mario Monti stated that “even if the pace of the high-tech sector means that market failures last only for a short time … this does not mean that we should be less concerned.”5 Given the rapid, innovative, immature, and dynamic nature of this sector, this has caused criticism from the business press. For example, The Economist, under the heading “Antitrust Run Amok?”, has expressed huge doubts about whether the more aggressive application of competition law to mergers in this sector is desirable, arguing that the best approach is forbearance. 6 However, this is not only an issue for competition law, but also a general problem for schemes designed to control the Schumpeterian marketplaces.7 In Frederick Brooks’ analysis, the process of high-tech development was described as a tar pit where “… the accumulation of simultaneous and interacting factors brings slower and slower motion. Everyone seems to have been surprised by the stickiness of the problem, and it is hard to discern the nature of it.”8 In many respects the theories and practices of competition law in the New Economy markets are no less a tar pit, particularly compared to the more traditional industries. 9 Competition law applies equally to the New Economy markets as to other markets, but the former imposes some unique challenges for competition authorities due to a Mario Monti, “Competition and Information Technologies” Conference “Barriers in Cyberspace”, Kangaroo Group, Brussels, 18 September, 2000, http://europa.eu/rapid /press Releases Action.do?reference=SPEECH/00/ 315&format=HTML&aged=0&language=EN&guiLanguage=en (accessed 22 February, 2007). 6 “Trust and Antitrust,” The Economist, 7 October, 2000, 21. 7 Graham, supra note 4, 1. 8 Frederick Brooks Jr., The Mythical Man-Month: Essays on Software Engineering, Anniversary ed. (Boston; New York; London: Addison-Wesley, 1995), 4. 9 Willow Sheremata, ““New” Issues in Competition Policy Raised by Information Technology Industries,” Antitrust Bulletin 43, no. 3/4 (Fall-Winter 1998):548. 5

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number of issues that makes competition different from that observed in the traditional manufacturing industries.10 Traditionally, competition policy has been concerned with competition in markets for existing products and services. Admittedly, antitrust analysis often incorporates the conditions for entry into the market of new products and actors, but the economic foundations for competition law can be traced to microeconomic perceptions where price is the main variable of competition and where the ideal market presumes homogeneous products and commonly known and available technologies. The incumbent market participants’ relative market shares of the production and distribution of goods are still the general basis for deciding whether a market practice will lead to a restriction of competition.11 Moreover, anticompetitive effects are typically expressed as the ability to exercise market power by charging prices that exceed those a competitive market would support.12 However, a competition policy focusing too narrowly on market shares and pricing strategies may protect consumer welfare less effectively, getting the trade-off skewed between short-and long term benefits. 13 The incentive for investment and risk, not least in the development of new and improved products and services, as well as the strategies for lowering risks and making research and development (R&D) efforts more efficient, must be acknowledged if markets and competition are to evolve dynamically. This is especially the case for areas where antitrust enforcement interacts with the realm of intellectual property rights. Moreover, current market shares, prices, and profit levels may say little about the true level of competition.

David Balto and Robert Pitofsky, “Antitrust and High-Tech Industries: The New Challenge,” Antitrust Bulletin 43, no. 3/4 (Fall-Winter 1998): 584. 11 Marcus Glader, Innovation Markets and Competition Analysis: EU Competition Law and US Antitrust Law (Cheltenham; Northampton, MA: Edward Elgar, 2006), 7. 12 Ibid. 13 Glader,supra note 11, 7. 10

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Particularly in high-tech markets, dominance and high profits are not necessarily signs of ineffective competition. Rather, such conditions are generally the result of an efficiently and successfully conducted business. In a growing number of industries, competitors with different technologies and resources compete on the basis of product attributes and performance as well as price. 14 Indeed, product performance may be much more important to many customers than price. Declaring that a firm has market power if it can sustain a “significant but non-transitory price increase”15 completely misses the performance dimension of competition. Dynamic characteristics of New Economy markets make competition analysis more complicated. For instance, in assessing market power, potential competition can curb market power, but its implications are more difficult to assess in the dynamic New Economy marketplaces. Contestable market theory demonstrates that potential entrants can make even a monopolist behave as if it faces competition – as long as entrants have access to the same technology and there are no barriers to entry in the form of sunk costs. However, greater dynamism changes the nature of potential competition. Intellectual property rights, trade secrets, and knowhow all combine to make it difficult for potential entrants to possess the same technology as the incumbent. Developing capabilities equivalent to the incumbent’s may involve substantial sunk costs. These factors suggest that potential competition may operate less effectively in dynamic New Economy markets. At the same time, potential competition could be a much more vigorous force in New Economy markets. When innovation and discovery are possible, potential

14

Jerry Ellig, ed. Dynamic Competition and Public Policy: Technology, Innovation, and Antitrust Issues (Cambridge; New York: Cambridge University Press, 2001), 2. 15 Commission Notice on the Definition of the Relevant Market for the Purposes of Community Competition [1997] Official Journal of European Union C372/5, paras. 17, 18.

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entrants can leapfrog an incumbent by offering superior products and services. Sunk costs depreciate more rapidly – and more unpredictably – because of ceaseless changes. Potential competition, in the form of Schumpeterian “creative destruction,” could be much more vigorous in spite of sunk costs. This example illustrates how competition analysis becomes much more complicated in a rapidly advancing economy. Thus, questions arise regarding the manner in which competition policy can incorporate dynamic considerations in its analyses. A recent case on the subject of digital marketplaces involving Microsoft raises a number of fundamental questions relating to contemporary industrial organisation analysis and competition enforcement. These are: does the existence of network effects imply that the market for information technology is different from more traditional markets and requires a different antitrust approach? does constant technological innovation necessarily make information technology markets vulnerable to new entrants and therefore, diminish the need for vigorous antitrust scrutiny? does a dominant firm pose a threat to innovation due to its ability to extend its dominance into secondary and/or complementary markets and deter entry by potential competitors? can antitrust or other forms of government intervention improve or even constructively shape the future of the New Economy marketplaces? and what can governments do, and what should they do, to encourage competition and open access in these rapidly developing markets? The issues which are caused by the high-tech markets’ characteristics are hotly debated between parties that advocate intervention to correct failing markets and remedy anticompetitive behaviours, and those that advocate a laissez-faire approach to self-correcting markets.16

16

Sheremata, supra note 9, 549.

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2.2 Characteristics of New Economy Markets

Although the notion of the New Economy industry sounds vague, there is substantial agreement amongst scholars regarding its distinctive features. One of the most obvious features of New Economy or IT markets is that they are characterised by rapid technological change which leads to the shift of the market structures either through the creation of new markets or the transformation of old ones. The mobile phone market in the UK is a good example. The first two mobile licences were issued in 1985 and the next two were only issued in 1991. 17 From those tiny inceptions the market has dramatically grown both in terms of the services provided by the licensees and the manufacture of mobile phones. This industry is currently evolving through the development of the fourth generation mobile network technology, the so-called Long Term Evolution (LTE) technology. The implication of network effects or network externalities is emphasised in literature on network economics.18 A good example is communication networks such

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Graham, supra note 4, 3. Jeffrey Rohlfs, “A Theory of Interdependent Demand for a Communications Service,” The Bell Journal of Economics and Management Science 5, no. 1 (Spring 1974): 16-37; Joseph Farrell and Garth Saloner, “Standardisation, Compatibility, and Innovation,” The RAND Journal of Economics 16, no. 1 (Spring 1985): 70-83; Michael Katz and Carl Shapiro, “Network Externalities, Competition and Compatibility,” The American Economic Review 75, no. 3 (June 1985): 424-440; Joseph Farrell and Garth Saloner, “Installed Base and Compatibility: Innovation, Product Preannouncement, and Predation,” The American Economic Review 76, no. 5 (December 1986): 940-955; Michael Katz and Carl Shapiro, “Product Compatibility Choice in a Market with Technological Progress,” Oxford Economic Papers 38, no. supplement (November 1986): 146-165; Michael Katz and Carl Shapiro, “Technology Adoption in the Presence of Network Externalities,” The Journal of Political Economy 94, no. 4 (August 1986): 822-841; Michael Katz and Carl Shapiro, “Product Introduction with Network Externalities,” The Journal of Industrial Economics 40, no. 1 (March 1992): 55-83; Joseph Farrell, Carl Shapiro, Richard Nelson, and Roger Noll, “Standard Setting in High-Definition Television,” Brookings Papers of Economic Activity: Microeconomics 1992 (1992): 1-93; Michael Katz and Carl Shapiro, “Systems Competition and Network Effects,” The Journal of Economic Perspectives 8, no. 2 (Spring 1994): 93-115; Stanley Besen and Joseph Farrell, “Chosing How to Compete: Strategies and Tactics in Standardisation,” The Journal of Economic Perspectives 8, no. 2 (Spring 1994): 117-131; Stan Liebowitz and Stephen Margolis, Winner, Loser, and Microsoft: Competition and Antitrust in High Technology (Oakland: The Independent Institute, 1999), 49-115; 18

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as instant messaging services, social network services and telephones services. The effect is that the network becomes more valuable as the number of members who use the same network increases. This is what is known as “network externalities” (direct network effects). There may also be a similar effect in other sectors that do not immediately rely on a physical network. For example, the more people that use compatible computer software the more valuable it becomes because of the ability to swap files and exchange information easily. The popularity of a network may lead to demand-side economies of scale, that is, people value a product or service because it is widely accepted. 19 When combined with the more traditional supply-side economies of scale this creates “positive feedback”, which allows the dominant firms to get stronger and the weak firms to get weaker, potentially leading to a monopoly. 20

As a result, the more complementary goods or applications are produced or written

for the product of a dominant firm (indirect network effects). These network effects lead to a tendency for markets to “tip” towards a single dominant undertaking or technology.21 In markets that tip, competition is “for” the market, not “within” the market, and the market is likely to end up highly concentrated or monopolised. The incentive is, therefore, to gain the upper hand and become a predominant player as early as possible, inevitably leading to particularly vigorous competition at the early stages. Given this incentive, it is common for undertakings to distribute products, such as software, as far as possible. When all firms engage in such tactics with the objective of maximising their market share, it becomes extremely difficult for competition authorities to analyse predatory behaviours using conventional methods. Carl Shapiro and Hal Varian, Information Rules: A Strategic Guide to the Network Economy (Boston: Harvard Business School Press, 1998): 183-184. 19 Carl Shapiro and Hal Varian, Information Rules (Boston, MA: Harvard Business School Press, 1999), 179. 20 Michael Katz and Carl Shapiro, “Antitrust in Software Market,” 22 September 1998, http://faculty.haas.berkeley.edu/shapiro/software.pdf. 21 Lind and Muysert, supra note 2, 89.

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When competition is so high, companies can be expected to use as many tactics available to them to gain the lead. Practices such as tying/bundling, exclusive dealing and refusals to supply critical services or inputs, including interfaces and/or technical information, may be used and can be more effective than usual if they are able to tip the balance in the market at a crucial time. If they can change the competitive situation even temporarily, network effects may make their advantage permanent. Under some conditions these practices can be used by a firm that is dominant in one market and intends to tip the market for a related product in its direction, although its product is inferior to others. A further characteristic is the importance of intellectual property to these developments.

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A huge investment in R&D is necessary to produce new

technologies and ideas are at the centre of these innovations. Intellectual property, therefore, plays a major role in competitive strategies in the New Economy marketplaces and competition policy needs to recognise this. In particular, competition policy issues to do with patenting and licensing intellectual property rights become very important in the highly creative and technologically dynamic industries. These markets tend to have high fixed or sunk costs and low marginal costs.23 They often need to invest a considerable amount of resources to develop their products, either because they must make substantial investments in R&D, or because they must invest in a physical or virtual network to create and deliver the product. Once they make this initial investment, it is inexpensive to manufacture additional units. For example, it does not cost much to produce another copy of Microsoft Office, nor does it cost much to add another subscriber to the Skype network. In 22 23

Graham, supra note 4, 3. Shapiro and Varian, supra note 19, 21-22.

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other words, production in IT markets, especially software markets, exhibits “increasing returns,” which have important implications for market structure. 24 A further implication of an industry with high sunk costs and low marginal costs is that it tends to be concentrated or monopolised because of the high costs of entry. This industry is subject to rapid alteration, but dominated by a few firms or one major player. It is possible that the firm, with a large market share, will exert price discrimination, create entry barriers, and encourage customer loyalty to maximise its profits. The competition authorities have always been highly suspicious of these practices. New Economy markets are often characterised by high levels of technical complexity and the need for complementary products to work together. 25 These characteristics lead to a need for firms to co-operate to ensure that products interoperate. Competition authorities have also traditionally been concerned about cooperation amongst competitors as it may be regarded as collusion. However, in a way, such co-operation over technological standards can ensure that there is competition within a market between different providers of products using the same standard, rather than just competition for the market followed by monopoly or quasimonopoly. In some New Economy markets, competition can take the form of a series of races.26 In the first race, companies invest heavily to develop a product that creates a new category, for example; Apple’s iPad, ARM’s chips for mobile electronic goods, Facebook’s social network services, or Voice over Internet Protocol services like Vibre for iPhone. The winner gains a huge market share or in some cases the whole

24

Shapiro and Varian, supra note 19, 24-29. Lind and Muysert, supra note 2, 90. 26 Christian Ahlborn, “Competition Policy in the New Economy: Is European Competition Law Up to Challenge,” European Competition Law Review 22, no. 5 (2001): 159. 25

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of the market. In subsequent races, companies invest heavily to outstrip the leader by leapfrogging their technology. The pace of high-tech markets has changed radically in a relatively short period of time. From word processors to spreadsheets, instant messaging services, and Internet browsers, in many cases the market leaders have been unable to sustain their positions for any longer than ten years. In other words: “the information economy is populated by temporary, or fragile, monopolies. Hardware and software firms vie for dominance, knowing that today’s leading technology or architecture will, more likely than not, be toppled in relatively short term by an upstart with superior technology.”27 Finally, as with a host of endeavours in which many try but few succeed, the winners are compensated by acquiring enormous profits as long as they stay ahead of their rivals. 28 These “prizes” for the winner serve the same purpose as prizes in professional sports tournaments, i.e., new challengers are attracted to enter the market due to substantial prizes. It serves the interests of society to encourage a lot of entrepreneurs to try to dedicate themselves to technological improvements because the path to successful innovation is fraught with difficulties.

2.3 Conflicting Views and Their Limitations

There are two opposite approaches to the New Economy industries. There are those that focus on economies of scale, network effects, and consumer lock-in, and particularly on the dangers of network effects as a reason to justify competition enforcement29; and those that centre on the dynamic characteristic of these industries,

27

Shapiro and Varian, supra note 19, 173. Ahlborn, supra note 26, 160. 29 Timothy Muris, “Is Heightened Antitrust Scrutiny Appropriate for Software Markets?’ in Competition, Innovation and the Microsoft Monopoly: Antitrust in the Digital Marketplace, Jeffrey 28

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suggesting that any dominance is temporary as markets are contestable.30 The latter group has questioned whether the New Economy industries are especially prone to commit anticompetitive behaviours. These opposing viewpoints are indicative of a more general debate over the role of competition law. On the one hand, the Chicago School argues for a limited role for competition law because markets tend to be competitive, 31 whilst its opponents criticise the Chicago School for being overly optimistic about a market’s ability to rebalance itself, noting that certain market structures are likely to lead to dominance and result in anticompetitive practices.32 The latter view is supported by the “neo-Structuralist” school of thought which favours aggressive antitrust enforcement when anticompetitive structures manifest themselves, 33 whereas the former is advocated by the “neo-Schumpeterian” one which argues that dominance in New Economy markets tends to be temporary and short-lived.34 However, in reality the neo-Schumpeterian argument is difficult to enforce at ground level although it encourages competition authorities to be more flexible. In neo-Structuralist circles there are two arguments; one argues that industry specific regulations are necessary such as telecommunication regulations, while the other argues industry specific regulations are unnecessary provided that the current

Eisenach and Thomas Lenard, eds. (Boston; Dordrecht; London: Kluwer Academic Publisher, 1999), 89-91; Lawrence White, “Microsoft and Browser: Are Antitrust Problems Really New?” in Competition, Innovation and the Microsoft Monopoly: Antitrust in the Digital Marketplace, supra, 137, 139-148. 30 Ronald Cass and Keith Hylton, “Preserving Competition: Economic Analysis, Legal Standards and Microsoft,” George Mason Law Review 8, no. 1 (Fall 1999): 36-37; Robert Levy, “Microsoft and the Broswer Wars,” Conneticut Law Review 31, no. 4 (Summer 1999): 1352-1358. 31 Richard Posner, “The Chicago School of Antitrust Analysis,” University of Pennsylvania Law Review 127 (April 1979): 925-948; Robert Bork, Antitrust Paradox: A Policy at War with Itself (New York: The Free Press, 1993) 32 Philip Areeda and Donald Turner, “Predatory Pricing and Related Practices under Section 2 of the Sherman Act,” Harvard Law Review 88 (February 1975): 697-733. 33 Howard Shelanski and Gregory Sidak, “Antitrust Divestiture in Network Industries,” University of Chicago Law Review 68, no. 1 (2001): 1-99. 34 Philip Weiser, “The Relationship of Antitrust and Regulation in a Deregulation Era,” Antitrust Bulletin 50, no. 4 (Winter 2005): 556-557.

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competition law applies flexibly. The former will produce more regulations and the latter will create legal unpredictability in relation to competition law.

III. Research Questions

One of the fundamental issues surrounding the New Economy is whether the current competition laws are adequate to the task of protecting consumers in an era of “winner-takes-all” market outcomes and Schumpeterian-style competition. To answer this question, the present analysis will be reviewed in terms of how the current competition approaches consider the characteristics of the IT industry. This thesis does not intend to consider all the characteristics of New Economy. Instead, the main focus will be on network effects or network externalities. This characteristic plays a significant role in determining the type of competition and is different from traditional competition as it is defined in New Economy marketplaces. Network effects often act as both a negative factor and a positive factor in IT marketplaces. Network externalities, in particular, allow a dominant undertaking to expand its dominance to complementary or secondary markets by anticompetitive leveraging practices, such as technological tying/bundling or a technical refusal to supply. These effects in turn encourage competition among competitors as well. For instance, in IT markets a tying/bundling practice or technological integration is used to enter a market and to encourage competition, while this practice combined with network effects is also used to raise an entry barrier and strengthen the dominance by a first mover. In addition, in New Economy markets intellectual property makes the outer boundaries of antitrust much more obscure. In other words, it is quite difficult to distinguish between the legal and illegal exercise of intellectual property. The

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exclusive use of company’s IPRs is secured by IP laws but sometimes this may be regarded as the anticompetitive from a competition perspective. Although IT markets are very competitive for obtaining critical mass, these markets may be seen as natural monopolies due to strong economies of scale. Information itself is costly to produce, but cheap to reproduce. The costs of producing the first copy of information good are significant, whilst the costs of producing additional copies are negligible. Due to the natural monopoly characteristics, there are high barriers to entry in the IT markets. Moreover, the network effects where are present in IT markets may fortify the dominant firm’s monopoly position. Since it is very costly to build a network, competitors may not be inclined to invest their resources to enter the monopolist’s market and compete with the monopolist directly. Rather, competitors may try to compete in secondary markets. However, if a dominant undertaking provides only its primary service or product bundled with its secondary applications, or does not want to disclose the interoperability information, effective competition in the secondary markets may be eliminated since the monopolist can easily distribute its applications through operating systems, or competitors may not be able to make their products compatible with the dominant firm’s operating system. In general, this thesis will discuss whether the current European competition analysis is adequate to protect consumers in the New Economy industries, such as IT markets, in its application of Article 102 TFEU. In particular, this thesis will examine the adequacy of the European competition approach to three main issues, i.e. network effects, technological integration, and refusal to license which were central issues in the Microsoft case:

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1. Firstly, It will be asked what network effects are and whether these effects have negative effects on IT markets. And then, it will be questioned whether network effects are adequately dealt with in the current competition analysis, particularly, the process of defining a relevant market in the IT sector. 2. And then, it will be examined how network effects are considered in the analysis of anticompetitive behaviour, such as technological integration, in IT markets. Also, whether the current European competition analysis appropriately deals with technological integration cases in these markets? Or should it be changed? 3. Finally, it will be answered whether the current principles of European competition rules handle refusal to supply cases adequately in the IT sector. In particular, since IT industry is IP intensive, this question will be changed with the following: Under what conditions can the European competition analysis of a refusal to supply extend to IPRs and do these conditions fit to IT markets? And then, it will be asked whether the current European competition doctrine adequately determines the outer boundary between competition law and IPRs in the IT industry.

IV. Research Methodology

It is difficult to discuss competition law without some reference to US antitrust law because of the influence that American lawyers and economists, working with reference to the American legal system, have had on competition law thinking.35 The US was one of the first jurisdictions to adopt a proper modern system of

35

Jones and Sufrin, supra note 3, 19.

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competition.36 The EU competition policy was included in the list of Community activities set out in Article 3 of the Treaty of Rome 37 from the inception of the Community in 1958. EU competition law primarily aimed to serve the imperative of single market integration. It differentiates EU competition law from the US antitrust system. However, there seems to be a general consensus at present amongst economists, competition lawyers, and policy makers in the EU and the US, that competition law should be adopted and applied in pursuance of efficiency and consumer welfare, while there are different views as to how competition law can achieve this.38 Therefore, due to the influence of the US analysis and the similarity of their goals, this thesis will analyse EU cases and regulations compared to the US The primary methodology will be the examination and analysis of primary and secondary documentary materials, such as Section 2 of the Sherman Act, Article 102 of the Treaty on the Functioning of the European Union (TFEU), and the judgements of legal cases in two jurisdictions where similar issues arose in the Microsoft decisions both for operating systems and software applications. The Article 102 TFEU (ex Article 82 EC) sets out:

Any abuse by one or more undertakings of a dominant position within the internal market or in a substantial part of it shall be prohibited as incompatible with the internal market in so far as it may affect trade between Member States. Such abuse may, in particular, consist in: (a) directly or indirectly imposing unfair purchase or selling prices or other unfair trading conditions; (b) limiting production, markets or technical development to the prejudice of consumers;

36

Jones and Sufrin, supra note 3, 19. Now this is an Annex of the Treaty on the Function of the European Union (TFEU). 38 Jones and Sufrin, supra note 3, 18. 37

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(c) applying dissimilar conditions to equivalent transactions with other trading parties, thereby placing them at a competitive disadvantage; (d) making the conclusion of contracts subject to acceptance by the other parties of supplementary obligations which, by their nature or according to commercial usage, have no connection with the subject of such contracts.

The US Congress passed the Sherman Act in 1890.39 It is still in force. Section 2 (Monopolising trade a felony; penalty) which is the counterpart to Article 102 TFEU states:

Every person who shall monopolise or attempt to monopolise, or combine or conspire with any other person or persons, to monopolise any part of the trade or commerce among the several States, or with foreign nations, shall be deemed guilty of a felony…

Article 102 TFEU and Section 2 of the Sherman Act are both concerned with regulating concentrations of power within a market.

V. Thesis Structure

The whole thesis consists of three main topics and each chapter has a definition case analysis - evaluation structure. The second chapter is on network effects, the third chapter deals with technological integration, and finally, the fourth chapter discusses a refusal to license/a compulsory licensing issue. Network effects are sometimes termed demand-side economies of scale. This means that in the presence of network effects it may be efficient to have a single 39

It was supplemented by later statutes, the Clayton Act (1914), the Federal Trade Commission Act (1914), the Robinson-Patman Act (1936), the Celler-Kefauver Act (1950), and the Hart-Scott-Rodino Antitrust Improvement Act 1976.

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provider or many providers of compatible goods. Therefore, the concern is related to the fact that although the market may ultimately tip one way, the identity of the company that comes out on top is not determined by competition but is the result of anticompetitive actions. The presence of network effects could increase the likelihood of the success of a leveraging strategy aimed at foreclosure. However, as leveraging seems only possible under some circumstances, it is important to understand more clearly when this could be the case. Whether the practices may have anticompetitive effects clearly depends on the specifics of a case. Undertakings may be able to leverage their market dominance in a large number of ways depending on the circumstances and facts of a case, including, tying/bundling, rebates, exclusive dealings, full line forcing, and refusal to supply/license critical services or inputs such as interfaces and technical information. However, this thesis will focus on a few broad categories of leveraging practices; tying/bundling and the refusal to supply/license. These were the main issues in the Microsoft case in the EU and the US In the perspectives of access and distribution, these practices have quite opposite characteristics. From the point of view of access, tying/bundling may make it easier for consumers to access certain products or networks. On the other hand, refusal to supply/license may impede the access to some product or facilities. From the point of view of distribution, the former practices enhance the distribution of new products or technologies, but the latter restricts the spill-over of new technologies or goods.

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Both leveraging strategies are common in IT marketplaces and are sometimes used to strengthen network effects and ultimately result in durable natural monopolies in primary and/or secondary markets.

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Part II. Network Effects and Their Impact on Competition in New Economy Markets

I. Introduction............................................................................................................. 28 1.1 Background ...................................................................................................... 29 1.2 Positive and Negative of Network Effects ....................................................... 31 1.3 Competition Policy Implications of Network Effects ...................................... 33 II. Conflicting Approaches of Network Effects ......................................................... 35 2.1 Neo-Structuralist Approach ............................................................................. 35 2.2 Neo-Schumpeterian Approach ......................................................................... 41 III. Case Law .............................................................................................................. 46 3.1 Market Definition in IT Markets ...................................................................... 46 3.1.1 America On-Line/Time Warner ................................................................ 47 3.1.2 WorldCom/Sprint ...................................................................................... 51 3.2 Dominance in IT Markets ................................................................................ 54 3.2.1 The Traditional Test .................................................................................. 56 3.2.2 Neo-Schumpeterian Definition of Dominance.......................................... 57 3.3 Abuse in IT Markets......................................................................................... 60 3.3.1 Safeguarding a Dominant Position ........................................................... 61 3.3.2 Leveraging ................................................................................................ 65 3.4 Objective Necessity: Incentives to Innovate .................................................... 67 IV. Conclusion ........................................................................................................... 70

I. Introduction

Since New Economy markets have distinct features from traditional ones, effective competition in these markets may be harder to maintain than in other markets. As a result of network effects, consumers may face relatively high switching costs and then may easily be locked into the technology of a dominant undertaking. Thus, competitors have to overcome substantial entry barriers in order to effectively compete with the dominant firm. When a dominant technology is a de facto standard, the dominant undertaking may become a quasi-monopolist. 28

In this part, the most important characteristic of the New Economy industries, network effects will be discussed with reference to the impact this feature have on competition in IT markets. It will be argued that the network effects may enhance the incumbent’s dominance after being discussed throughout the competition analysis process.

1.1 Background

Barriers of entry into a market are important in many competition law cases, especially dominance and monopolisation cases, in which the durability of a dominant undertaking’s market power is critical. The potentially decisive impact of network effects is illustrated by the Microsoft case, in which network effects have been much commented on. 40 Network effects exist in any market where the consumption of a product by one consumer has a positive impact on the value of that product’s consumption by another consumer. There are two opposite approaches to network effects in the New Economy industries. One perspective argues that network effects may allow the dominant undertaking to tip a market and to further entrench its dominance, whereas the other claims that network effects may be easily overcome by “creative destruction.” A decisive difference between these two perspectives is whether dominance with strong network effects may endure in the New Economy marketplaces. Competition authorities recognise that network effects could be an entry barrier to competitors. It is true that unlike a network in traditional markets, one in New Economy markets is heavily influenced by fast-moving technologies and consumers will 40

Case T-201/04 Microsoft Corp. v. Commission of the European Communities [2007] European Court Reports II-3601; US v. Microsoft 84 F Supp 2d 9 (DDC 1999) (Findings of Facts), 87 F.Supp. 2d 30 (DDC 2000) (Conclusions of Law).

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immediately benefit due to the increase of network value. However, at the same time consumers will be worse off if they become locked into a specific network or technology against their will, since their choice is severely restricted in the long run. These positive and negative aspects of network effects create great challenges for competition policymakers. Network effects have played a significant part in the litigation against Microsoft previously referred to. Operating systems are characterised by network effects, sometimes called an application barrier to entry. Users want an operating system that will permit them to run all the applications programmes they want to use; developers tend to write applications that they want to use and are for the most popular operating systems. Applications software written for a specific operating system cannot run on a different operating system without extensive and costly modifications or add-ons.41 Microsoft’s high market share has meant that many more applications have been written for its operating system than for any other. 42 This suggests that Microsoft’s market power in operating systems was to some extent further protected by the presence of network effects, possibly raising the question as to why Microsoft needed to act anti-competitively.43 This part will discuss how network effects can influence conditions of entry and will survey the quality of current legal analysis; and whether this analysis is adequate to protect consumers in New Economy markets. In other words, it will be discussed whether network effects are properly examined in the process of current Franklin Fisher and Daniel Rubinfeld, “US v. Microsoft – An Economic Analysis,” Antitrust Bulletin 46, no. 1 (Spring 2001): 15. 42 Ibid., 16. 43 ‘The Commission recognise that network effects may create barriers to entry. A market characterised by network effects tends to tip in the dominant undertaking’s favour, or the dominant undertaking entrenches its position through an installed-base,’ in “Guidance on the Commission’s Enforcement Priorities in Applying Article 82 of the EC Treaty to Abusive Exclusionary Conduct by Dominant Undertakings (hereafter, ‘The Guidance Paper’),” [2009] Official Journal of the European Communities C45/7, paras. 17, 20. 41

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competition analysis. It is crucial to properly deal with network effects because a large “installed base” facilitates market leveraging through exclusionary behaviour, such as tying or refusal to license, and as a result, dominance may be entrenched or become durable, although network effects are in themselves not anticompetitive. It is also important that legal standards should be provided to undertakings for reducing legal uncertainty, encouraging innovation, and ultimately increasing consumer welfare, albeit that the speed of technological development is unpredictable and network effects make competition policy more complex.44

1.2 Positive and Negative Network Effects

In choosing between the Microsoft and Mac operating systems, most consumers gave some thought as to what others were choosing or were likely to choose. In deciding whether to switch to a new operating system (OS) or to remain with their current OS, many users consider the incentives offered by various software companies to switch to the newer operating system. The software companies’ decisions, in turn, depend on their expectations about the number of users who will switch to the newer operating system. There are many products for which the utility that a user derives from the consumption of a product or service increases with the number of other users consuming a product or service.45 There are two possible sources for these positive consumption externalities or network effects:46

Here, ‘consumer welfare increases through lower prices, better quality and a wider choice of new or improved goods and services,’ in The Guidance Paper, supra note 43, para. 5. 45 Michael Katz and Carl Shapiro, “Network Externalities, Competition, and Compatibility,” The American Economic Review 75, no. 3 (June 1985): 424. 46 More general term is ‘demand-side externalities.’ 44

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(1) The consumption externalities may be generated through a direct physical effect of the number of purchasers on the quality of the product. The utility that a consumer derives from purchasing a mobile phone, for example, clearly depends on the number of other consumers that have joined the mobile phone network. These network externalities are present for other communications technologies as well as, including Telex, data networks, and over-the-phone facsimile equipment.47 (Direct Network Effects) (2) There may be indirect effects that give rise to consumption externalities. For example, an agent purchasing a personal computer will be concerned with the number of other agents purchasing similar hardware because the amount and variety of software that will be supplied for use with a given computer will increase exponentially with the number of hardware units that have been sold. This hardware-software paradigm also applies to video games, video players and recorders, PC operating systems, and play stations.48 (Indirect Network Effects)

Although positive network effects will be the main focus in this thesis, there are negative network effects. 49 If, for example, a telephone or computer network becomes overloaded, the effect on an individual subscriber will be negative. Admitting the possibility of a negative network externality causes the set of goods that share such network externalities to expand greatly. It is also the case that road users suffer from a negative network externality because roads are subject to crowding. Although a larger installed base of computer users might lower the price

47

Rohlfs, supra note 18, 16. Katz and Shapiro, supra note 45, 424. 49 Stan Liebowitz and Stephen Margolis, “Should Technology Choice be a Concern Antitrust Policy?” Harvard Journal of Law and Technology, 9 (Summer 1996): 287. 48

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of computer software, there are many commodities, such as housing and fillet steak, where larger networks of consumers appears to increase the price of the product.

1.3 Competition Policy Implication of Network Effects

One important implication for competition policy is that markets with network effects tend to be tippy.50 A network or technology that succeeds in attracting more consumers than its competitors becomes increasingly attractive for other customers who have not yet joined. This reinforces the network’s advantage over the competition. Therefore, these markets tend to tip in favour of one dominant network or technology. This is equivalent to the phenomenon that economists have called “natural monopoly.” 51 For individual customers, it is attractive to stick with the winner because users face switching costs, whereas competing networks may find it difficult to divert a critical mass of customers away from the prevailing network. However, the fact that markets with network externalities are tippy does not necessarily imply that consumers are worse off. 52 On the contrary, by definition, consumers immediately benefit if they all use the same network and can therefore communicate with each other.53 Consumers will only be worse off if, in the long run, they become locked into that network against their will, i.e. they cannot switch to another, presumably more attractive one unless all other users migrate at the same time.54 However, it is very difficult for anyone, let alone competition authorities, to judge in advance whether one network is more efficient or beneficial to consumers 50

Shapiro and Varian, supra note 19. William Shepherd, The Economics of Industrial Organization, 3rd ed. (London: Prentice Hall International, 1990): 210-212. 52 Oxford Economic Research Associates, “Competition and Network Externalities,” Competing Ideas (February 2002): 2. 53 Ibid. 54 Oxford Economic Research Associates, supra note 52, 2. 51

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than other networks. The QWERTY keyboard is a good example to show that market forces do not always result in the most efficient standard (the QWERTY keyboard was designed in the era of typewriters, but PC users are still locked into it). 55 However, studies have shown that even this example is not so clear cut. 56 Furthermore, tippy markets do not inevitably end up in monopoly. In many markets, several networks or technologies can still exist alongside, and compete with each other.57 The application of current competition law analysis, such as market definition, dominance, and competitive effects, becomes less straightforward in markets with network effects. Thus, the following questions can be raised in markets with network effects, such as:

1. If there are several different networks or technology, are these in the same relevant market or is each network/technology a separate market? (Market Definition); 2. During a battle for the new industry standard, are current market shares relevant for assessing dominance, and should prices below cost be allowed? (Dominance);

Some economic theories and legal cases provide some guidance on how competition in these markets should work.

Paul David, “Clio and the Economics of QWERTY,” The American Economic Review 75, no. 2 (May 1985): 332-337. 56 Stan Liebowitz and Stephen Margolis, “The Fable of the Keys,” Journal of Law and Economics 33, no. 1 (April 1990): 1-25. 57 For example, there are several competitors, such as Nintendo’s Wii, Microsoft’s X-Box, and Sony’s PlayStation, to compete in game console market. 55

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II. Conflicting Approaches of Network Effects

2.1 Neo-Structuralist Approach

From a neo-Structuralist perspective, there are three market features which indicate the likelihood of dominance in the New Economy marketplaces; economies of scale, network effects, and consumer lock-in. Many products are characterised by significant economies of scale. Whilst it is very costly to develop new software, once the programme is written, it is virtually costless to reproduce. Marginal costs are almost zero and this leads to a situation where one dominant firm can capture most of the market.58 However, this does not lead to dominance unless the high market shares can be held for a certain period. This is where network effects and consumer lock-in create the risk of dominance. In these markets where network effects exist, there will be a convergence to the most popular network standard. For example, consider the “Voice over Internet Protocol (VoIP)” systems offered by various Internet service providers. There is currently no legal requirement for subscribers to one provider be allowed to send voice or instant messages to subscribers of another. Any provider can keep its VoIP system proprietary. In the absence of interconnection, it is costly for consumers to subscribe to multiple services, and if consumers might find a comparatively beneficial service to purchase it is only the service offering the largest VoIP network externality. 59 However, if enough consumers drift to one VoIP system, then that provider will have a dominant position, because new consumers may wish to enter the network which has the greatest number of users. Similarly, those consumers 58 59

Oz Shy, The Economics of Network Industries (Cambridge: Cambridge University Press, 2001), 5. Shelanski and Sidak, supra note 33, 8.

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using smaller networks will migrate to the larger network where they can communicate with more people. The result is that a proprietary network creates risks of dominance if there is sufficient consumer demand for the services that can be obtained via the network and if other networks are incompatible.60 All these elements are necessary in order to characterise a network effect as potentially anticompetitive.61 Thus, the existence of network effects does not mean that there is or will be dominance. Like in game console networks, in VoIP networks there are still many players with their own proprietary network on the market because there is not sufficient consumer demand for a single network. In contrast, in the first decades of the 20th century, when AT&T was developing the local telephone it refused to connect with independent competitors, albeit there was strong consumer demand for a telephone network that would allow a user to communicate with all other users. AT&T became dominant. 62 Network effects can also evidence themselves in an indirect manner: the owner of a dominant and proprietary network may attract undertakings wishing to sell consumer products that run on the dominant network, thus strengthening the dominance of the network.63 A good example of the competition authorities seeing indirect network effects is the Commission’s 64 analysis of America On-Line’s position in the dial-up Internet access market in the UK.65 AOL had a network of users that navigated through its site. Navigating with AOL was not the same thing as surfing the whole Internet because AOL had created a more limited network of sites Giorgio Monti, “Article 82 and New Economy Markets,” in Competition, Regulation and the New Economy, ed. Cosmo Graham and Fiona Smith (Oxford; Portland: Hart Publishing, 2004), 19. 61 Ibid., 19. 62 United States v. American Telephone & Telegraph Co., 552 F.Supp 131 (D.D.C. 1982). 63 Michael Katz and Carl Shapiro, “System Competition and Network Effects,” The Journal of Economic Perspectives 8, no. 2 (Spring 1994): 97-100. 64 ‘The Commission’ is referred to as ‘the European Commission.’ 65 COMP/M. 1845 AOL/Time Warner, 2001/718/EC Commission Decision of 11 October, 2000 [2001] Official Journal of the European Communities L 268/28. 60

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that could be reached by clicking on its pages. Thus, whilst an AOL customer might feel like they were surfing the World Web Wide, it was in fact a much smaller network that they were surfing. Moreover, because its web design was so appealing many users had difficulties stepping outside the web pages that it supplied. This “stickiness” allowed AOL to enter into lucrative contracts with content providers who wanted presence in its territory. In the view of the Commission, the more content providers’ contracted with AOL, the more people would subscribe. This became a virtual circle where the more consumers it had the more content providers would wish to join its network. This is sometimes called a “snowball effect.” AOL’s dominance would increase dramatically if, for example, it was vertically integrated with a leading music content provider, transforming it into an “on-line store.” 66 Music would attract many new subscribers, because music was one of the most popular and sought after elements of Internet content.67 This approach suggests that an Internet Service Provider (ISP) can consolidate a dominant position either by vertical integration with popular Internet content or by having exclusive access to popular Internet content, without ownership.68 In this circumstance a new entrant has to promise consumers a superior network and superior ancillary content as well. This makes entry more difficult because two markets may have to be concurrently broken into by a new competitor. By providing abundant content, AOL was able to become the dominant ISP, enticing many more Internet subscribers and content providers to drift into its network.69 This analysis assumes that there are certain complementary products that add so much value to the network so as to allow the creation of a dominant

66

Ibid., para 82. COMP/M. 1845 AOL/Time Warner, supra note 65, para. 82. 68 Monti, supra note 60, 21. 69 COMP/M. 1845 AOL/Time Warner, supra note 65. 67

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position. 70 This is a variation on the network effects theory because the network effect is caused by the presence of other compatible properties linked to the network, but the anticompetitive risks are similar: a dominant network owner can behave independently of competitors, who will find it difficult to secure sellers of ancillary products hoping to place them with an Internet Service Provider that has a small number of consumers, and independently of customers wishing to supply goods that run on the existing network because they need the network more than the network needs them.71 While network effects create entry barriers to new competitors and invite more consumers to the dominant network, another phenomenon, i.e. consumer lockin, affects the ability of consumers to look for substitutes. 72 In the absence of interconnection or interoperability among competing networks, switching from the market leader to a rival will entail at least a short-term loss in network benefit.73 This lock-in effect, in turn, makes entry or expansion by rivals more difficult because they cannot attain a critical mass of customers.74 The network is thus said to “tip” to the incumbent, which creates a barrier to entry in the costs to rivals of overcoming the network benefits associated with the incumbent’s product.75 For instance, a consumer will find it too costly to switch Microsoft Windows OS to another because of the need to learn how to use new software and the problems of application programmes compatible with the new software. 76 To overcome these barriers, a firm must have either a sufficiently better product such

70

Monti, supra note 60, 21. Ibid. 72 Max Schanzenbach, “Network Effects and Antitrust Law: Predation, Affirmative Defenses, and the Case of US v. Microsoft,” Stanford Technology Law Review 2002 (2002): para. 26 73 Ibid., para. 28. 74 Schanzenbach , supra note 72, para. 29. 75 Shelanski and Sidak, supra note 33, 9. 76 Monti, supra note 60, 21. 71

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that consumers find it worthwhile to incur switching costs (such as loss in network benefits and retraining costs) or a sufficient cost advantage such that it can compensate consumers for those switching costs through lower prices.77 This makes entry more demanding, and lock-in consumers are at risk of exploitation by the dominant undertaking. 78 Thus, the race to gain and to maintain dominance in a network market might also provide motives to engage in anticompetitive conduct, as the trial court found Microsoft to have done.79 A large network externality can determine the path of technological change in a market in much the same way it can determine market structure. 80 The market leader will set the technological standard even if other technological standards are superior in some economic or technical sense.81 Subsequent innovation in the market, and in markets for complementary products, might thus follow the path set by the technology that first takes a meaningful lead even if that path is not, ex post, seen to be the optimal one.82 Path dependency can also occur for reasons other than network externalities (for example, the costs of learning to use a competing product).83 That is, if switching cost to a new system is low or if it is cheap to use multiple systems, then entry is feasible and the market may support multiple networks of varying sizes.84 Nonetheless the path dependency caused by lock-in can hinder the migration to other networks. Veljanovski argues against the validity of snowball or network effects.85 He focuses especially on the telecommunication industry which is one of the network 77

Shelanski and Sidak, supra note 33, 9. Ibid. 79 Shelanski and Sidak, supra note 33, 9. 80 Ibid. 81 Shelanski and Sidak, supra note 33, 9. 82 Ibid. 83 Shelanski and Sidak, supra note 33, 9. 84 Ibid. 85 Cento Veljanovski, “E.C. Antitrust in the New Economy: Is the European Commission’s View of the Network Economy Right,” European Competition Law Review 22, no. 4 (2001): 116-117. 78

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industries. Firstly he points out that network effects per se do not lead to anticompetitive outcomes.86 In the real world, networks are compatible with many competing networks and seek to achieve universal connectivity through interconnection and roaming arrangements. 87 Moreover, their internalisation by undertakings generates large consumer benefits, so that larger networks are efficient. 88 Network growth is therefore driven by attempts to increase consumer benefits, and to profit from these. But there is no implication in the theory that the increased profits are generated by restricting output as is the case for static monopolies.89 Secondly, snowballing or tipping occurs under restrictive assumptions which require some sort of “bottleneck” in the industry.90 Specifically, a necessary condition for tipping is that competition takes place between incompatible products. In this setting, the consumer makes an all-or-nothing choice which enables the network operator to internalise the network benefits. 91 However, when physical telecommunications networks are compatible and interconnected, the consumer of any one network immediately has access to users on other networks, so that network effects exist for the whole sector, and do not give advantage to any one individual network operator.92 Thirdly, the claim that network effects necessarily lead to monopoly provision requires presupposing that the average marginal external benefit function is positive or increases faster than marginal costs as the installed subscriber base grows to market saturation. 93 It is only in this way that complete monopolisation of the

86

Ibid., 116. Veljanovsk, supra note 85, 116. 88 Ibid. 89 Veljanovsk, supra note 85, 116. 90 Ibid. 91 Veljanovsk, supra note 85, 116. 92 Ibid. 93 Veljanovski, supra note 85, 116. 87

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market would be the competitive outcome. Since no one has measured network effects, this is controversial. Indeed, most economists presume that as market penetration increases, network effects become less significant.94 On the other hand, some of the Commission’s claims drawn from snowballing, such as the claim that new subscriber growth will be captured by larger networks, are easily refuted.95 In the mobile sector smaller and later entrants have gained significant market shares across the world. Further, there is no reason to believe that network effects only lead to snowballing or tipping.96 They are likely to operate symmetrically so that excessive price increases or failure to cater for consumer demand by a large network may cause its “network” to break up quickly in a downward spiral.97 For Internet and mobile telephone markets where the customer’s switching costs are low, this is a real threat. The most striking example in the antitrust field is IBM v. Commission98 in the early 1980s. The Commission alleged that IBM had abused its dominant position in the central processing units (CPUs) market by; failing to supply other manufacturers with interface information needed to make competitive products work with IBM’s System/370, not offering CPUs without main memory capacity included in the price (memory bundling), and not offering CPUs without the basic software included in the price (software bundling). Five years after the case, the alleged dominance of IBM collapsed under a multitude of new products such as PCs, desktops and laptops.

2.2 Neo-Schumpeterian Approach

94

Ibid. Veljanovski, supra note 85, 116. 96 Ibid., 117. 97 Veljanovski, supra note 85, 117. 98 Case 60/81 International Business Machines Corporation v. Commission of the European Communities [1981] European Court Reports I-2639. 95

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In response to concerns about the risks of dominance, some argued that since New Economy markets change at Internet time, competitive advantages are temporary and markets are contestable.

99

Joseph Schumpeter invented the phrase “creative

destruction” to express the idea that the pursuit of market power was a creative and dynamic force that “incessantly revolutionises the economic structure from incessantly destroying the old one, and incessantly creating a new one.”100 Creative destruction means that a firm’s acquisition or possession of market power may be fleeting. In the passage from Schumpeter’s classic discussion on creative destruction, he wrote:

Every piece of business strategy acquires its true significance only against the background of that process and within the situation created by it. It must be seen in its role in the perennial gale of creative

destruction; it cannot be understood

irrespective of it or, in fact, on the hypothesis that there is a perennial lull … The usual theorist’s paper and the usual government commission’s report practically never try to see that behaviour, on the one hand, as a result of a piece of past history and, on the other hand, as an attempt to deal with a situation that is sure to change presently – as an attempt by those firms to keep on their feet, on ground that is slipping away from under them. In other words, the problem that is usually being visualised is how capitalism administers existing structures, whereas the relevant problem is how it creates and destroys them.101

Unless governments impose artificial barriers to market entry, the incumbent will be repeatedly challenged and eventually supplanted by actual or potential competitors. The incentives to contest markets are high: whoever finds the new

99

Michael Cusumano and David Yoffie, Competition on Internet Time: Lessons from Netscape and Its Battle with Microsoft (New York; London; Sydney; Singapore: Simon & Schuster, 2000). 100 Joseph Schumpeter, Capitalism, Socialism and Democracy, revised ed. (London: George Allen & Unwin Ltd, 1947), 83. 101 Schumpeter, supra note 100, 83-84.

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“killer app” will take a large chunk of the market share and the prize is extremely high profits. Many commentators have argued that the network dominance achieved is always temporary.102 Thus, the dynamism of New Economy markets can cancel out dominance. Joseph Schumpeter sets out this vision of competition in the 1940s:

… competition which counts but the competition from new commodity, the new technology, the new source of supply, the new type of organisation (the largest-scale unit of control for instance) - competition which commands a decisive cost or quality advantage and which strikes not at the margins of the profits and the outputs of the existing firms but at their foundations and their very lives.103

If the holder of a network is in persistent fear of being outdone by a new product, that angst will diminish the dominance of the network vis-à-vis its consumers. In addition, the fear of an alternative network evolving will also create incentives for the network owner to cooperate with producers of complementary goods, because the provision of these to its consumers is a way of making the network superior. Therefore, “antitrust authorities need to be cognizant of the selfcorrective nature of dominance” in New Economy markets.104 The consequences of markets being so dynamic also make predatory strategies to exclude competitors more difficult because it may be unclear that undertakings will succeed in fortifying their dominance.105 Furthermore, recoupment of predatory losses is threatened by a paradigm shift.106

David Evans, Albert Nichols, and Richard Schmalensee, “An Analysis of the Government’s Economic Case in US v. Microsoft,” Antitrust Bulletin 46, no. 2 (Summer 2001): 163-251; David Evans, “Antitrust and the New Economy,” ALI-ABA SF 63(September 2000): 41-97. 103 Schumpeter, supra note 100, 84. 104 David Teece and Mary Coleman, “The Meaning of Monopoly: Antitrust Analysis in HighTechnology Industries,” Antitrust Bulletin 43, no. 3/4 (Fall-Winter 1998): 847. 105 Monti, supra note 60, 22. 106 Teece and Coleman, supra note 104, 808. 102

43

The implication of this analysis is that competition laws are largely unnecessary; the monopolies of New Economy markets are fragile and exclusionary tactics are likely to be unsuccessful.

107

Moreover, competition authorities’

intervention may even be counterproductive. If the industry develops at such quick speeds then it is more difficult for competition authorities to impose remedies that improve competition. There is an inevitable regulatory lag between the anticompetitive act and the imposition of a penalty. 108 A situation may have changed by the time the competition authorities are able to intervene. One concern is that heavy-handed regulation will significantly discourage the incentive to invent new technologies or services. This argument applies especially to the obligations of the dominant undertaking to grant access to its “essential facilities” which can work as a tax on innovation.109 Although one must accept that network effects exist, these effects are led by demand and therefore have increased consumer welfare. 110 If so, where is the antitrust problem? Moreover, when considering remedies, how can one be sure that remedies will not lead to a less efficient provision of products or services? On this view, the competition authorities should not attempt to recreate perfectly competitive market structures as these may not be the most efficient in promoting consumer welfare.111 However, according to Robert Pitofsky, while barriers to entry may often be lower in the high-tech sector, partly because successful entry so often depends on

107

Ibid. Teece and Coleman, supra note 104, 809. 109 Monti, supra note 60, 23. 110 Ibid. 111 Ahlborn, supra note 26, 160. 108

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new ideas, those barriers can nevertheless be consequential.

112

The intellectual

property law systems designed to encourage and protect innovation, such as patents and copyrights, can be used as barriers to entry by new competitors.113 A further barrier to entry in New Economy markets involves network effects. A first mover becomes or threatens to become the only supplier of certain products or services because of interoperability. Consumers are more likely to remain with the established network because of their sunk costs, sometimes referred to as “lock-in”, and suppliers of application products will adjust those products to the established network and be reluctant to prepare products for potential challengers. 114 In that event, network dominance itself becomes an insurmountable barrier to entry. Also, New Economy markets are no different than others in the sense that “brand-name recognition” and reputation for reliability can create virtually overwhelming advantages for incumbents.115 Finally, illegal practices under competition law, such as price discrimination, exclusionary contracts, code-sharing, or intimidation tactics can themselves hinder entry by more efficient competitors. 116 As a result of that, undertakings can retain market benefits for decades or even longer.117 One cannot assume that the market will invariably succeed in dissipating entrenched market power in an acceptable time frame or that superior products will supplant inferior products that enjoy first-mover advantages.118 Generally, under a neo-Schumpeterian model, New Economy undertakings with large market shares have little incentive to exploit consumers, because they will

Robert Pitofsky, “Challenges of the New Economy: Issues at the Intersection of Antitrust and Intellectual Property,” Antitrust Law Journal 68 (2001): 916. 113 Ibid. 114 Pitofsky, supra note 112, 916. 115 Ibid. 116 Pitofsky, supra note 112, 916. 117 Microsoft Windows OS is a good example. 118 Pitofsky, supra note 112, 916. 112

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quickly find a substitute, and little incentive to impair rivals, as such tactics will be counterproductive. Thus, dominance is rare in the New Economy markets. Even though there is periodic dominance by one or a few firms, in information technology markets it may be symptomatic of healthy and innovation-based competition and may be subject to displacement, even when goods or services with network externalities are at issue. Therefore, the role of competition policies is questioned: the market may have already cured itself before the remedy is ready. Alternatively, the countermeasure may give undertakings less incentives to develop new products, reducing consumer welfare. Creative destruction implies that competition policies based on static analysis of present market conditions can be misleading and, over time, detrimental to consumers.

III. Case Law

3.1 Market Definition in IT Markets

Market definition focuses on consumer needs and identifies what products can be substitutes if the products concerned become more expensive and if suppliers are able to enter the market quickly.119 According to the Commission’s Notice on Market Definition, the emphasis is upon demand substitution, using empirical and econometric evidence to identify product markets.120 In AOL/Time Warner, the Commission faced the difficulty of determining whether the delivery of on-line music and this emerging mechanism of distribution,

119 120

Monti, supra note 60, 24. Commission Notice on the Definition of the Relevant Market, supra note 15.

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could be considered a relevant product market.

121

In WorldCom/Sprint the

Commission analysed whether top-level Internet Service Providers (ISPs) were distinct from lower-level ISPs. 122 From a neo-Structuralist perspective, the market definitions are plausible in these two cases, whereas a neo-Schumpeterian argued that the AOL/Time Warner decision seemed to employ an unnecessarily narrow market definition for policy reasons, such as the intention to regulate the development of New Economy markets.123

3.1.1 America On-Line/Time Warner

In AOL/Time Warner, the Commission found a market for on-line music, distinct from other sales channels.124 The merged entity would hold 30 to 40 percent of music publishing rights and the general risk identified by the Commission was:

One entity controlling such a sizable music catalogue could exercise substantial market power, by refusing to license its right, or threatening not to license them,

or

imposing

high

or

discriminatory

prices

and

other

unfair

commercial conditions on its customers wishing to acquire such rights (such as Internet retailers offering music downloads and streaming).125

The approach is problematic in two respects. First, it is uncertain whether, from the customers’ point of view, on-line music can be said to be a distinctive market. 126 On the demand side, the Commission pointed out that consumers have

121

COMP/M. 1845 AOL/Time Warner, supra note 65. COMP/M. 1741 MCIWorldCom/Sprint, 2003/790/EC Commission Decision of 28 June, 2000 [2003] Official Journal of the European Communities L 300 /1. 123 Monti, supra note 60, 25. 124 COMP/M. 1845 AOL/Time Warner, supra note 65. 125 Ibid., para. 47. 126 Monti, supra note 60, 25. 122

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immediate access to music.127 However, as most people like to listen to music using a variety of hardware other than their PCs, they will still need to buy portable music players to listen to the music and some blank CDs to burn the music onto. The fact that they can download single tracks is also unconvincing on its own.128 It referred to a physical difference, but said nothing about whether this difference would affect consumer choice.129 That specific hardware was needed to download music from online, but it did not show that on-line music sales were a separate market from off-line sales.130 On the supply side, it is true that the structure of on-line music supply is different for the supplier, but this does not make the two markets separate for the consumer, and it should determine the relevant product market in the consumer perspective. 131 The losses reported by record companies were a sign that pirate copies downloaded on-line had a negative impact on sales of CDs, indicating that the two markets were interconnected rather than separate.132 Lastly, the Commission also noted that the on-line supply of music was an emerging market,133 but it does not necessarily mean that it is a separate one. It is also the case that a virtual shop on the Internet need not be considered so distinct from a physical shop on the high street. For example, in Telefonica/Terra/Amadeus the Commission thought that an on-line travel agency was in the same product market as traditional travel agencies.134 In sum, the first criticism is that the Commission in the AOL/Time Warner case eschews the methodology propounded in the Notice on Market Definition (under which the emphasis should be upon whether consumers, on the basis of econometric 127

COMP/M. 1845 AOL/Time Warner, supra note 65, para. 21. Ibid., 25-26. 129 COMP/M. 1845 AOL/Time Warner, supra note 53, para. 21. 130 Ibid. 131 Monti, supra note 60, 26. 132 Ibid., 26. 133 COMP/M. 1845 AOL/Time Warner, supra note 65, para.21. 134 COMP/M. 1812 Telefonica/Terra/Amadeus, Commission Decision of 18 April, 2000 [2000] Official Journal of the European Communities C 76/5. 128

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evidence, find on-line music supply a separate market) in favour of a general and subjective evaluation based exclusively on product characteristics.135 This approach is particularly unhelpful in New Economy markets because high-tech products are highly differentiated but may still be considered as substitutes. 136 Thus, the traditional approach to market definition does not reflect the manner of competition in the New Economy industries.137 The second criticism is that the Commission’s principal concern does not seem to be that the merger would lead to higher prices for consumers, but that it would impede potential competitors from entering a market.138 There are two ways in which an owner of substantial music content could cause entry foreclosure in the online music market.139 First, if a lot of on-line music is formatted with one proprietary standard, then the owner of that technology can control the development of music player software by not licensing this technology unless the software manufacturers promise not to support other technology. In addition, other music publishers will find it necessary to format their music according to the technical standard of the leading firm, which could act as a gatekeeper. Second, a large music publisher could enter the downstream market and format its music to fit its own music player, thus eliminating other music players’ software.140 The Commission’s definition therefore seems to be policy oriented, because it allows the Commission to find dominance in the market for on-line music and by allowing it to prevent the creation of such dominance, the Commission can protect the development of competing technological 135

Monti, supra note 60, 26. Ibid. 137 Christopher Pleatsikas and David Teece, “New Indicia for Antitrust Analysis in Markets Experiencing Rapid Innovation,” in Dynamic Competition and Public Policy: Technology, Innovation, and Antitrust Issues, ed. Jerry Ellig (Cambridge: Cambridge University Press, 2001), 117-136. 138 Monti, supra note 60, 27. 139 Ibid. 140 The European Commission, 28th Report on Competition Policy, 1998, Available at http://ec.europa.eu/comm/competition/annual_reports/1998 (accessed 12 March, 2007), paras. 96 and 141. 136

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alternatives and prevent the foreclosure of emerging markets. 141 Arguably, the narrow market definition does allow the Commission to regulate the development of technical standards in emerging markets, and also the development of technological convergence in the IT industry.142 Unlike the EU decision on the AOL/Time Warner merger case, the US Federal Communications Commission’s (FCC’s) decision is an example of direct network effects rather indirect network effects. At the time AOL was the largest narrowband ISP and the largest provider of instant messaging (IM) services in the United States and in the world. Time Warner was the second largest provider of cable systems in the United States, offering both TV programming, broadband Internet services, and, to a more limited extent, telephony services. The FCC cleared the merger, subject to additional conditions imposed by the Federal Trade Commission (FTC).143 The FCC’s review mainly focused on the possibility that the proposed merger would enable AOL/Time Warner to dominate the next generation of advanced IMbased applications. All IM-based services require as an essential input the use of a “Names and Presence Database” (NPD) to determine the set of users that is online at any given time. The FCC did not define markets for IM services based on an analysis of consumer’s demand for specific services. Instead, it defined a market for “NPD services,” that is, “interactive communication services which … depend on an NPD for real time communication between and among users.”144 The presence of network effects related to (non-interoperable) NPD was central in the FCC’s assessment of

141

Monti, supra note 60, 27. Ibid. 143 Federal Communications Commission Memorandum Opinion and Order of 11 January, 2011, CS Docket No. 00-30. Available at http://transition.fcc.gov/Bureaus/Cable/Orders/2001/fcc01012.pdf. (accessed 20 February 2009). 144 Federal Communications Commission Memorandum , supra note 143, para. 152. 142

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potential harm from the merger; “Without interoperability, users may choose AOL’s IM simply because it has the largest NPD and not because it offers the best value or is most attractive for some other meritorious reasons.”145 Because AOL controlled the largest NPD in the industry and refused to allow interoperable access to other IM providers, the FCC concluded that AOL was dominant in this market.146 This analysis was strongly criticised because the decision had not proved that refusal to interoperate could only be explained as a dominant firm’s attempt to strengthen its dominance.147 And also AOLs main IM rivals (Microsoft and Yahoo, who jointly had a market share similar to AOL) were also not providing interoperable access to each other and to other IM providers, thus casting doubt on any theory that would essentially equate the refusal to interoperate with (abuse of) dominance.148

3.1.2 WorldCom/Sprint

In mergers of Internet Service Providers (ISPs), the concept of network effects has been deployed to aid the process of market definition.149 For the Internet to work there has to be an infrastructure that allows computers to connect to the World Wide Web. According to US Department of Justice in WorldCom/Sprint, consumers contracted with Internet Service Providers (ISPs) to access the Internet, and ISPs entered into contracts with each other to ensure that their customers could

145

Ibid., para. 175. Federal Communications Commission Memorandum , supra note 143, paras. 158-167. 147 Separate Statement of Commissioner Michael Powell, Federal Communications Commission Memorandum Opinion and Order of 11 January, 2011, CS Docket No. 00-30. Available at http://www.fcc.gov/encyclopedia/major-transaction-decisions (accessed 20 February 2009). 148 Ibid. 149 Monti, supra note 60, 28. 146

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communicate with customers of other ISPs.150 It would be quite expensive and time consuming for an ISP to enter into commercial relations with all other ISPs. So to facilitate the process, the market had evolved into two tiers, i.e. “top-level” and smaller ISPs. Smaller ISPs only needed to contract with one of the top-level ISPs to allow its customers to access all other Internet users.151 The top-level ISPs havd high capacity transmission facilities and “peering” arrangements among themselves whereby they received traffic from other top-level ISPs free of charge. The smaller ISPs entered into so-called “transit” arrangements with one of the top-level ISPs, for which there was a charge, in exchange for which the smaller ISPs could offer their customers universal access to the Internet. Thus, the infrastructure was hierarchical and top-level ISPs were in a separate market. This was supported by the finding that most Internet communications were carried out over top-level networks.152 With this perspective, top-level Internet service provision was a separate market, hence if an undertaking owned all or a sizable share of the top-level ISP market, it held a dominant position. This conclusion was underpinned by the theory of network effects, that is, an Internet consumer will prefer to join an ISP which will guarantee universal connection and if universal connection is only available for the top-level ISPs, then the first tier is a compulsory partner for any ISP and indirectly, for any Internet user. In fact, the Commission concluded that a dominant top-level firm would own a network which could be characterised as an “essential facility.”153 What was crucial to this analysis was the finding that the Internet only worked

150

US vs. WorldCom and Sprint complaint by the Department of Justice, 26 June, 2000, Available at http://www.usdoj.gov/atr/cases/f5000/5051.htm (accessed 12 March, 2007). 151 Ibid., para. 22. 152 WorldCom and Sprint complaint, supra note 150, para. 27. 153 IV/M. 1069 WorlCom/MCI, 1999/287/EC Commission Decision of 8 July, 1998 [1999] Official Journal of the European Communities L 116/1.

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hierarchically,154 and top-tier ISPs acted as gatekeepers of Internet access. However, the question is whether the shape of Internet communications would be changed if the top tier ISPs raises their prices and the US Department of Justice answered this question in a negative way.155 It stated that top-level ISPs had two advantages: a cost advantage because they had peering relationships with other top-level ISPs and therefore, did not need to buy transit in order to provide universal service connection. In addition, lower level ISPs exchanged traffic at inferior public interconnection facilities, whereas the larger ISPs owned private interconnection facilities meaning data transmission was more secure and stable. Consequently, the fewer the number of network connections connecting to a large top-level network, the fewer the crossnetwork connections.156 In addition, even if the lower level ISPs managed to create a sub-network, this would not provide universal access because the customers of the top-level ISP could not be connected unless a transit arrangement was enter into with a top-level ISP.157 Thus, for universal connectivity, contracts with the top-level were needed and no supply substitution is readily available in the ISP market. This analysis of the decisions by the Commission and the US Department of Justice showed that network effects could play a part in defining the relevant product market. However, the response from advocates of dynamic competition was that this analysis was outdated. There had been at least two developments that challenged the identification of top-tier ISPs as a separate market. First, the cost of alternative routing had become cheaper, consequently peering at lower level ISPs was now economical since the new routing standard known as BGP4 was developed. 158 Second, corporate users now resorted to multi-homing, i.e. purchasing connection 154

Monti, supra note 60, 29. WorldCom and Sprint complaint, supra note 150. 156 WorldCom and Sprint complaint, supra note 150, paras. 27-30. 157 Ibid., paras. 75-76. 158 Monti, supra note 60, 30. 155

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from more than one provider.159 The impact of this was that top-tier ISPs were no longer a compulsory partner for much Internet traffic and an economic study had noted that these developments had had the effect of reducing the bargaining advantage of the top-tier ISPs.160 These observations cast some doubt over the value of using network effects to decide market definition. The difficulty is that the approach is unduly static, which is unsuitable in technologically dynamic markets where there is rapid innovation because it will lead to unnecessarily narrow market definitions.161 However, the Commission and US Department of Justice seemed to prefer a neo-Structuralist approach for two reasons. First, it is difficult to take fastmoving innovation into account when determining the relevant product market, since it is uncertain that the outcome of innovation will be marketised. 162 Moreover, this kind of consideration can be considered at the next stage, when assessing dominance, for long-term supply substitutability is considered fully at this stage in the Article 102 TFEU cases.163 The second reason is that if the market definition is policy-driven, then the analysis will eschew all evidence that contradicts the narrow market definition which helps the Commission and US Department of Justice target a market concerned.164

3.2 Dominance in IT Markets

Traditionally, competition policy analysis in Europe has relied heavily on the

159

Ibid. Stanley Besen, Paul Milgrom, Bridger Mitchell, and Padmanabhan Srinagesh, “Advances in Routing Technologies and Internet Peering Agreements,” American Economic Review 91, no. 2 (May, 2001): 292-296. 161 Pleatsikas and Teece, supra note 137, 131. 162 Monti, supra note 60, 31. 163 Commission Notice on the Definition of the Relevant Market, supra note 15, paras. 23-24. 164 Monti, supra note 60, 31. 160

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concept of “dominance.”165 Concrete proof of dominance can only really be found in the pricing structures of monopolies but this evidence may be difficult to capture and in any case may not be the way in which dominance manifests itself. More broadly defined dominance is “a position of economic strength enjoyed by an undertaking which enables it to prevent effective competition from being maintained on the relevant market by giving it the power to behave to an appreciable extent independently of its competitors, customers and ultimately of its consumers.”166 To assess whether a position is dominant, the Commission, following the principles established by the Court of Justice, adopts a two-step approach; first, it defines the relevant market and then it assesses the undertaking’s dominance in the market. 167 In the US an undertaking is dominant if it has a high market share which is protected by barriers to entry.168 This is a structural approach that allows the court to infer dominance from a high market share.169 In New Economy markets the Commission has interpreted network effects as a critical element in the determination of dominance, its abuse and the creation of an essential facility. 170 It has even gone further to suggest that networks which are not dominant are still large enough to lead to snowballing. Competition authorities should be encouraged to intervene in IT markets.171 However, some commentators have argued that it is wrong to focus on network size when evaluating the information technology markets. 172 These are emerging industries in a fluid state buffeted by rapid technological changes and there

165

Article 102 TFEU. Case 27/76 United Brands Company & United Brands Continental BV v. Commission of the European Communities [1978] European Court Reports 207, para. 65. 167 Case 6/72 Europemballage Corporation & Continental Can Company Inc. v. Commission of the European Communities [1973] European Court Reports 215. 168 US v. Aluminum Company of America et al., 148 F.2d 416, 424 (2nd Cir. 1945). 169 US v. Microsoft 253 F 3d 34 (DC Cir. 2001) (en banc). 170 Veljanovski, supra note 85, 117. 171 Veljanovski, supra note 85, 117. 172 Cass and Hylton, supra note 30, 36-37; Levy, supra note 30, 1352-1358. 166

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is a need to make massive and ongoing investment in software and infrastructure.173

3.2.1 Traditional Test

For most products, market share can easily be estimated by looking at sales volume. However, in high-tech markets calculation of market shares may require different measures. For example, in the market for Internet services the Commission used revenue and traffic flows to decide market share.174 Given the high speed of market evolution, the relevance of market share can be questioned. If dominance is weak as the neo-Schumpeterians claim, then the relevance of market share decreases significantly. This is especially the case since competition in the information market is for a market, not within a market, thus making short term monopolies inevitable. However, the market share is not the exclusive measurement of dominance.175 Entry barriers or conditions are also important.176 In the Microsoft case, the barrier to entry was termed an “applications barrier to entry.”177 Consumers wanted to purchase an operating system for which a large number of application programmes were already available and developers of applications preferred to write for an operating system that had a huge consumer base.178 The consequence was that once Microsoft Windows had such a large market share in the OS market, the application developers preferred to write applications for Microsoft Windows. This further cemented its dominance or quasi-monopoly

173

Ibid. IV/M. 1069 WorlCom/MCI, supra note 153, 19-20. 175 Case 85/76 Hoffmann-La Roche & Co. AG v. Commission of the European Communities [1979] European Court Reports 461; Case C-62/86 AKZO Chemie BV v. Commission of the European Communities [1991] European Court Reports I-3359. 176 Ibid. 177 US v. Microsoft 84 F Supp 2d 9 (DDC 1999) (Findings of Facts), 19-24. 178 US v. Microsoft, supra note 177, 19-24. 174

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because applications written for Microsoft Windows were not interoperable with other operating systems.179 This conclusion rests on the theory of indirect network effects, although it is a virtual network where consumers cannot speak to each other, it is nevertheless created by consumer demand.180 Thus, the fact that Microsoft had created network effects through superior marketing and excellent product design does not deny the fact that the network effects placed Microsoft in a dominant position.181 In the Microsoft case the court defined entry barriers as “factors ... that prevent new rivals from timely responding to an increase in price above the competitive level.”182 As in all competition cases, barriers to entry were scrutinised using a short-run analysis.183 This short-run analysis, coupled with a static approach to market definition, has been criticised as inappropriate in IT markets where longrun fears of technological paradigm shifts loom over fragile monopolists. 184 As a result, neo-Schumpeterians have suggested several alternative approaches to analyse dominance.

3.2.2 Neo-Schumpeterian Definition of Dominance

This group has suggested that the traditional test of dominance should be replaced by the following three checks, as this would better reflect the features of the New Economy industries: firstly whether there are competing networks in existence and not just competing products; secondly, to discover the history of innovation in the industry, focusing especially on the rate of innovation; and thirdly, to analyse the

179

Ibid. US v. Microsoft, supra note 177, 19-24. 181 Ibid.. 182 US v. Microsoft, supra note 169. 183 Ibid. 184 Monti, supra note 60, 33. 180

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barriers to innovation rather than barriers to entry. 185 Although high switching costs can raise substantial barriers to competition within or across networks, significant innovation beyond the incumbent standard can make consumers move toward a better and usually cheaper product. 186 Firms with superior technology have little difficulty supplanting an incumbent technology. 187 Compact disc technology that replaced long-playing records is a good example.188 Another example is the VCR standard. While Betamax technology enjoyed a first-mover advantage, VHS successfully challenged that standard because its longer playing time offered the consumer superior technology.189 In the Microsoft case, the US court considered potentially competing networks, but rejected these as unlikely to threaten Microsoft.190 The argument that such potential networks should be included depends on the assumption that entry is fast, but the court found that it would only be in the long run that competing networks could enter. 191 The history of innovation, such as past displacement of market leaders, is not a useful measure because the rate of innovation does not follow any predictable pattern in any industry. 192 Barriers to innovation are useful only insofar as one is able to predict that the new product will displace the incumbent.193 However, it is a fact that Microsoft has been dominant for several product generations and no new products have been able to destroy its dominance for many years. Harvard Law Review Association, “Antitrust and Information Age,” Harvard Law Review 114 (March 2001): 1637. 186 Ibid., 1638. 187 Harvard Law Review Association, supra note 185, 1638. 188 Ibid. 189 Stan Liebowitz and Stephen Margolis, “Network Externality: An Uncommon Tragedy,” The Journal of Economic Perspectives 8, no. 2 (Spring 1994): 147-148. 190 US v. Microsoft, supra note 177. 191 Ibid., 14. 192 Richard Schmalensee, “Antitrust Issues in Schumpeterian Industries,” American Economic Review 90, no. 2 (May 2000): 194. 193 Monti, supra note 60, 34. 185

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Another way of assessing dominance in the New Economy sectors was suggested by Richard Schmalensee at the Microsoft trial.194 In his view, the structural approach was irrelevant in dynamic markets where market boundaries were not well defined. 195 In these markets, it is important to evaluate whether an undertaking’s dominance is fragile, hence market definition and market shares are not as important. 196 Instead, a behavioural approach should be adopted which identifies: first, constraints that limit the ability of firms to behave anti-competitively; and second whether the accused undertaking acts like a firm with monopoly power.197 The examination of constraints considers past, present and future constraints of market power.198 Applying this standard, Microsoft faced competition first from its past behaviour in that consumers who had bought earlier versions of its operating system, such as MS DOS, would have to be persuaded to buy the upgraded version; in the present, higher prices would increase the risks of piracy or lead to some consumers buying other goods, such as LINUX, Mac OS, and Chrome OS; and for the future, Schmalensee identified a number of companies, such as Google and Apple, that were Microsoft’s potential competitors in the long term.199 On this basis, the structure of the market includes Intel compatible operating systems as well as other operating systems for any chip-based devices. On either the structural or behavioural approach, Microsoft lacks monopoly power.

200

In considering

Microsoft’s behaviour, Schmalensee said that its prices were much lower than the monopoly prices. 201 Moreover, in the context of Microsoft’s tactics to exclude 194

Schmalensee, supra note 192, 194. Ibid. 196 Schmalensee, supra note 192, 194. 197 Ibid. 198 Schmalensee, supra note 192, 194. 199 Ibid., 194-195; They are actual competitors while this thesis is being written in mobile OS and non-mobile OS markets. 200 Schmalensee, supra note 192, 194. 201 Ibid., 195. 195

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Netscape, the relevant question is whether Microsoft would be able to recoup the losses of predation in the long run, but a possibility is precluded by the existence of many other potential competitors.202 This approach focuses on long term possibilities that are threats to dominance. Furthermore, the approach does not fit within the methodological approach taken in dominance and monopolisation cases, either under Section 2 of the Sherman Act or Article 102 TFEU, because it confuses the concepts of abuse and dominance.203 Neo-Schumpeterian alternatives share two features which make their adoption unlikely by competition authorities.204 First, they require great faith that the passage of time will correct anticompetitive practices and second, they consider the ability to exploit consumers as a test for anticompetitiveness. The main concern of competition authorities is the unlawful suppression of competitors and thus, a shortrun analysis of the market is more suitable. Consequently, neo-Schumpeterian alternatives are problematic in two respects: they are difficult to put into practice because of speculation about long-term effects and are detrimental to the type of competition culture that exists at present. In addition, the optimal time period in which markets can correct anticompetitive behaviour is unknown. Thus, neoStructuralist approach is and will be applied to cases in the network industries and this will be the best to provide market participants with legal predictability.

3.3 Abuse in IT Markets

The competition authorities worry that a dominant firm displays abusive behaviour towards actual or potential competitors. Traditionally, in the context of the EU this is 202

Schmalensee, supra note 192, 195. Ibid. 204 Schmalensee, supra note 192, 195. 203

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defined as:

The concept of abuse is an objective concept relating to the behaviour of an undertaking in a dominant position which is such as to influence the structure of a market where, as a result of the very presence of the undertaking in question, the degree of competition is weakened and which,

through

recourse

to methods

different from those which condition normal competition in products or services on the basis of the transactions of commercial operators,

has the effect of hindering

the maintenance of the degree of competition still existing in the

market or the

growth of that competition.205

Neo-Schumpeterians argue that it is hard to find how exclusionary tactics, such as safeguarding dominance, refusal to cooperate with competitors, and extension of dominance to new markets, are a problem. 206 As long as these strategies exclude less efficient competitors, consumers do not suffer and more efficient competitors will be able to enter the market because a paradigm shift will transfer power to the new technology developers. However, this view is not accepted by the competition authorities and the courts since they are less interested in improving consumer welfare than in protecting market access for competitors.207 Also when the network effects combine with the costs associated with switching, this will force consumers to lock in specific products or services, meaning potential innovations may be frustrated in the long term.

3.3.1 Safeguarding a Dominant Position

In the Microsoft case, the US courts found the company guilty of exclusionary 205

Case 85/76 Hoffmann-La Roche , supra note 173, para 91. Cass and Hylton, supra note 30, 36-37; Levy, supra note 30, 1352-1358. 207 Ibid. 206

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conduct designed to maintain its monopoly by preventing the distribution of potential competitors’ products. 208 This was achieved by attempting to deter the Netscape browser from gaining a significant portion of the Internet browser market. 209 Microsoft’s reason for blocking the establishment of a competing browser was not so much because it wished to dominate the browser market with Internet Explorer, but because a browser was so-called ‘middleware’, i.e. another means of access to applications. 210 Microsoft achieved its aim by placing its browser on to many consumers’ personal computers and promoting its own browser, Internet Explorer.211 They did this by pre-installing Internet Explorer on personal computers and encouraging Internet access providers to promote their browser.212 The consequence was that Netscape’s market share was significantly decreased in the browser market because of Microsoft’s actions, thereby foreclosing any possibility that Netscape could challenge the operating system quasi-monopoly. 213 The court noted one additional circumstance where attempts by a dominant undertaking to bind purchasers to its products attenuated rapid technological development.214 However, it may be argued that if Netscape’s strategy had been successful everybody would have wanted Netscape in order to access the largest range of applications.215 On this basis, the welfare effects of shifting from “operating system dominance” to “browser dominance” are non-existent because one dominant undertaking simply replaces another. 216 Moreover, it can also be argued that it is more efficient to have an

208

US v. Microsoft, supra note 177, 111-112. Ibid. 210 US v. Microsoft, supra note 177, 111-112. 211 Ibid. 212 US v. Microsoft, supra note 177, 111-112. 213 Ibid. 214 US v. Microsoft, supra note 177, 111-112. 215 Monti, supra note 60, 38. 216 Ibid. 209

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operating system already equipped with a browser.217 Having said this, competition in the IT industry is for the market, not within the market so if Netscape were allowed to compete for the network, this would give incentives to other firms to challenge Netscape’s future dominance. Conceivably a new operating system could be devised that runs applications more efficiently than a browser and then the market would shift back to operating systems. The anticompetitive nature of Microsoft’s tactics was that it tried to protect its dominance in the operating system market by forestalling the emergence of a successful browser and such tactics thwarted innovation by other competitors.218 Microsoft’s licensing practices in the EU during the early 1990s can also been seen as attempts to protect their dominance. 219 Microsoft forced Original Equipment Manufacturers (OEMs) to pay royalties for Windows on every personal computer sold, regardless of whether or not Microsoft software was loaded.220 As many consumers wanted Windows loaded on products, OEMs were obliged to deal with Microsoft, but its licensing conditions discouraged OEMs from installing competing software packages. 221 Microsoft subsequently amended its licensing practices.222 It was argued that it was important to restrict these tactics because they also foreclosed innovation.223 Thus, a neo-Structuralist approach does not deny the dynamism of markets, but is concerned about maintaining dynamism in the market. A neo-Structuralist approach is also seen in the US Court of Appeals’ 217

Monti, supra note 60, 38. Ibid., 39. 219 Monti, supra note 60, 39 220 Willow Sheremata, “Barriers to Innovation: A Monopoly, Network Externalities, and the Speed of Innovation,” Antitrust Bulletin 42, no. 4 (Winter 1997): 942-943. 221 Ibid. 222 European Commission. “Following an Undertaking by Microsoft to Change Its Licensing Practices, the European Commission Suspends Its Action for Breach of the Competition Rules,” IP/94/653, 17 July, 1994. Available at http://europa.eu/rapid/pressReleasesAction.do?reference =IP/94/653&forma t=HTML &aged=1&language=EN&guiLanguage=en (accessed 1 May, 2007). 223 Maurits Dolmans, “Restriction on Innovation: The EU Antitrust Approach,” Antitrust Law Journal 66 (1998): 455-485. 218

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approach.224 The court said that “it would be inimical to the purpose of the Sherman Act to allow monopolists free reign to squash nascent, albeit unproven, competitors at will, particularly in the industries marked by rapid technological advance and frequent paradigm shift.” 225 On this view, the court believed that the dynamic industries needed higher antitrust scrutiny because the better any new innovations were, the greater an incentive there was for an incumbent to eliminate its competitors. 226 Thus, the neo-Structuralist approach adopted by the competition authorities and the courts was designed to facilitate new entry and to protect the potential future innovation rather than relying on innovation to demolish the dominant undertaking.227 Critics of this analysis argue that the line between anticompetitive conduct and aggressive competition policy has been drawn inaccurately. Klein suggested that the better way to test whether Microsoft’s practices were abusive was to examine their effect on consumers and whether the practices were efficient.228 On this analysis it was suggested that both Netscape and Microsoft were able to compete for distribution of their browsers through Internet access providers but that Netscape failed to keep up with Microsoft efforts.229 Moreover, it was noted that Microsoft’s acts merely raised Netscape’s distribution costs but did not make entry overwhelmingly expensive.230 Combined with the fact that consumers benefited from a more advanced product manufactured by Microsoft, the tactics used should not be declared anticompetitive.231 Consequently, the fact that innovation is carried out by 224

US v. Microsoft, supra note 169. Ibid. 226 US v. Microsoft, supra note 169. 227 Monti, supra note 60, 40. 228 Benjamin Klein, “Did Microsoft Engage in Anticompetitive Exclusionary Behaviour?” Antitrust Bulletin 46, no. 1 (2001): 108. 229 Klein, supra note 228. 230 Ibid. 231 Klein, supra note 228. 225

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Microsoft is not of concern to a neo-Schumpeterian, but is of concern to a neoStructuralist.232 Therefore, a neo-Structuralist interpretation of the competition law seems to embrace considerations of distributive justice.233

3.3.2 Leveraging

There is a related strategy, known as “leveraging,” where a dominant undertaking uses “its monopoly power in one market to gain a competitive advantage in another.”234 There are three significant examples of leveraging in the New Economy markets case law. Firstly, the practice of leveraging in Internet markets was noted by the US Department of Justice (USDOJ) where a dominant top-tier ISP was able to enter the market for new internet services and exclude other ISPs, by developing a proprietary protocol for voice over the Internet, which only its subscribers can use.235 This tactic has two anticompetitive effects in two markets. First, it would further undermine the position of other ISPs and drive more consumers to join the dominant firm.236 Second, it would also have an anticompetitive effect in the market for voice transmission over the Internet because there would only be one firm supplying it.237 Secondly, the Commission’s investigation of Microsoft rested on the theory of leveraging as well.238 Microsoft was suspected of refusing to disclose information on its operating system to developers of server software, preventing the possibility of

Franklin Fisher, “Innovation, and Monopoly Leveraging,” in Dynamic Competition and Public Policy, ed. Jerry Ellig (Cambridge; New York: Cambridge University Press, 2001), 156-157. 233 Monti, supra note 60, 40. 234 Berkeley Photo v. Eastman Kodak 603 F 2d 263, 276 (2nd Cir 1979). 235 WorldCom and Sprint complaint, supra note 150. 236 Ibid. 237 WorldCom and Sprint complaint, supra note 150. 238 COMP/C-3/37.792 Microsoft, Commission Decision of 24 March, 2004 [2005] 4 Common Market Law Reports 965. 232

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developing software that works on a computer with Microsoft Windows. 239 The accusation was that Microsoft was attempting to extend its dominance in the server OS market.240 Thirdly, using the concept of “tipping”, the US Department of Justice (DOJ) considered that a dominant top-level ISP could try to drive the customers of competing top-level ISPs away from them by lowering the quality of the services offered to competing ISPs.241 This would make users of lower level ISPs migrate to the top-level ISP, where connectivity was better.242 Top-level ISPs may also raise the price of transit agreements and then lower level ISPs would pass costs on to consumers who would then switch to the top-level ISP who would be offering lower rates.243 As the Commission pointed out, the top-level ISP could pick off competitors one by one and take over the market gradually.244 Regarding the first example, if a company creates a new service which consumers want, it will be inefficient to penalise the provision of that service. 245 Furthermore, the exclusion of others from that market should be seen as the reward that the firm deserves for creating the new service.246 On this basis, the analysis of the US DOJ is flawed because it failed to take innovation into consideration.247 The theory of network effects might suggest that a dominant network holder can very easily become dominant in a relevant market.248 This prevents competition over technological standards. So, although a dominant firm might win the race to produce the next generation product due to network effects, it is not necessarily an 239

Ibid. COMP/C-3/37.792 Microsoft, supra note 238. 241 WorldCom and Sprint complaint, supra note 150, para. 35. 242 Ibid. 243 WorldCom and Sprint complaint, supra note 150, paras. 40-41. 244 IV/M. 1069 WorlCom/MCI, supra note 153, 22-23. 245 Monti, supra note 60, 46. 246 Ibid. 247 Monti, supra note 60, 46. 248 Ibid. 240

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anticompetitive outcome.249 Similarly, the Commission’s evidence against Microsoft does not make it clear whether any damage was caused to Sun Microsystems. 250 In the US, for instance, the Federal Court of Appeals takes the view that leveraging requires an anticompetitive effect in the second market.251 The third scenario also seems to protect competitors rather than competition.252 If the dominant ISP wanted to increase its profits, it would be able to raise the transit charges, thus vertical integration would not raise prices or reduce output any more than transit charges raised by the dominant undertaking.253 In these cases, the neo-Structuralist approach leads to the protection of competitors without any apparent benefit to competition in general as anticompetitive effects are assumed to result from the exclusion of competitors.254 It is doubtful whether there will be many leveraging cases which fall outside the scope of the essential facilities doctrine. 255 To date the competition authorities have preferred to prevent leveraging through merger control and by ensuring that the market structure does not facilitate the extension of dominance.256

3.4 Objective Necessity: Incentives to Innovate

From a neo-Schumpeterian perspective, all imposition of duties to cooperate and all

David Teece and Mary Coleman, “The Meaning of Monopoly: Antitrust Analysis in HighTechnology Industies,” Antitrust Bulletin 43, no. 3/4 (Fall-Winter 1998): 816. 250 Monti, supra note 60, 47. 251 US v. Microsoft, supra note 169. 252 Monti, supra note 60, 47. 253 Herbert Hovenkamp, Federal Antitrust Policy: The Law of Competition and Its Practice (St.Paul MN: West Publishing, 1994), 283-285. 254 Data General v. Grunman Sys Support Corp. 36 F 3d 1147 (1st Cir 1994); Aspen Skiing v. Aspen Highland Skiing 472 US 585 (1985); Eastman Kodak Co. v. Image Technical Services 112 S Ct 2072 (1992). 255 Monti, supra note 60, 47. 256 Monti, supra note 60, 47. 249

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restrictions on business expansion are inappropriate for two reasons.257 First, even if it appears that competition looks suffocated, dominance may be diluted quickly. Second, the imposition of cooperation obligations diminished the incentive to develop new products since undertakings recognise that they will be forced to share the fruits of their investment. The first objection can be countered by considering to what extent cooperation with the dominant firm is necessary. 258 If technical innovations can quickly surmount the entry barrier created by the network effects, then cooperation is unnecessary.259 The second objection, eliminating the incentives to innovate, is that a too extensive obligation to cooperate and a too far-reaching restriction on extending new product markets can act as a tax on innovation and suppress future developments. 260 While intellectual property rights are offered as a reward for innovation, there is the principle that balances the risks and the potential benefits which might accrue to consumers between leaving the dominant undertaking unregulated in order to impede market access and regulated to facilitate market access. The innovation justification requires the decision maker to consider whether the imposition of competition liability or obligation on a dominant undertaking outweighs the foreclosure effects of the anticompetitive conduct.261 In considering whether innovation is reduced, one would have to consider both innovations on the part of the defendant, and also more generally how other undertakings are affected David Evans and Richard Schmalensee, “Be Nice to Your Rivals: How the Government is Selling an Antitrust Case without Consumer Harm in United States v. Microsoft,” and “Consumers Lose If Leading Firms are Smashed for Competing,” in Did Microsoft Harm Consumers: Two Opposing Views, ed. David Evans, Franklin Fisher, Daniel Rubinfeld, and Richard Schmalensee (Washington: AEI-Brookings Joint Centre for Regulatory Studies, 2000): 45-86, 97-132. 258 Monti, supra note 60, 47. 259 Monti, supra note 60, 47. 260 Ibid., 48. 261 The Guidance Paper, supra note 43, paras. 19-22, 86, 87. 257

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by the judgement. There are some cases where the innovation justification has failed, such as Magill. 262 As AG Jacobs observed, copyright protection afforded to the information in Magill was hard to justify “in terms of rewarding or providing an incentive for creative effort.” Here it would be impossible for the defendant to justify a refusal to license to competitors on the basis that it would impede innovation. Marginal cases will be more difficult to resolve as current economic theories have no appropriate suggestions for how to balance the incentives to invest with the costs of abuse of dominance. 263 However, an accurate balance is unnecessary and a qualitative analysis will suffice.264 For example, applying the innovation defence to the Intel scenario, where Intel’s non-participation in Intergraph’s market meant that granting Intergraph access to the secondary markets would not diminish Intel’s economic incentives to develop new products. In fact, by allowing others to develop complementary products, demand for Intel goods should rise due to indirect network effects.265 This kind of approach will be criticised as being too imprecise to be viable, but it is necessary to ensure that competition and innovation are both protected. Furthermore, this approach can be justified on three grounds. First, the lack of a precise cost benefit analysis is not a fatal weakness. For example, while intellectual property rights are designed as an incentive to innovate, the level of protection is not set on a case by case basis but across the board. 266 Second, competition law is applied to maximise competition and innovation by trying to measure the potential effects of imposing liability rather than to draw arbitrary lines to distinguish the 262

Case C-241 to 242/91P Radio Telefis Eireann(RTE) and Independent Television Publications Ltd. (ITP) v. Commission of the European Communities (Magill) [1995] European Court Reports I-743. 263 Richard Brnell, “Appropriability in Antitrust: How Much is Enough?” Antitrust Law Journal 69 (2001): 1-42. 264 Monti, supra note 60, 49. 265 Intergraph Corporation v. Intel Corporation, 241 F. 3d 1353. (Federal Cir. 2001) 266 Richard Posner, Economic Analysis of Law, 5th ed. (New York: Aspen, 1998), 43.

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lawful from the unlawful,267 as is the case in the field of essential facilities. Third, the type of imprecise balancing process is common in legal reasoning. It occurs also in applying the exemption in Article 101(3) TFEU and the efficiency defence in merger cases.268 Through pragmatic decision making a reliable set of precedents will allow for the evolution of imperfect but workable criteria for assessing the consequences of imposing a duty to share on dynamic efficiency.269

IV. Conclusion

The consequence of network effects and lock-in effects is that competition enforcement in network markets becomes complicated. On one hand, if anticompetitive conduct is not detected and stopped early, dominant market share may “tip” in favour of the bad actor. At this point, consumer welfare will be harmed and may not be able to be undone without yet more costs on consumers. On the other hand, distinguishing anticompetitive actions from beneficial competitive conduct can be difficult when firms are competing not just for market share, but for commercial viability and the market itself. For example, aggressive pricing that looks predatory in a conventional market may constitute a rational competitive strategy in a market where one’s future existence depends on early penetration. Thus, network dynamics may raise the risk of both action and inaction by competition authorities. Given the confluence of economic forces, Professor Arrow warned that “a rule of penalising market successes that are not the result of anticompetitive practices

267

Ibid. IV/M. 993 Bertelsmann/Kirch/Premiere, 1999/153/EC Commission Decision of 27 May, 1998 [1999] Official Journal of the European Communities L 53/1. 269 Monti, supra note 60, 40. 268

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will, among other consequences, have the effect of taxing technological improvements and is unlikely to improve welfare in the long run.”270 Two opposite perspectives are still competing. One focuses on three characteristics amongst several attributes of information technology markets, which are economies of scale, network effects, and consumer lock-in, and particularly on the potential dangers of network effects as a reason to justify aggressive competition enforcement; while the other centres on the dynamic characteristic of these industries, suggesting that any dominance is temporary as markets are contestable.271 According to the latter group, the ideal type of competition policy is one of laissez-faire or light touch. These opposed viewpoints are reminiscent of more general debates over the role of competition law. On the one hand the Chicago School argues for a limited role for competition law because markets tend to be competitive, 272 whilst its opponents criticise the Chicago School for being overly optimistic about the market’s abilities to correct itself, noting that certain market structures are likely to lead to dominance and result in anticompetitive practices. The latter view is supported by the “neo-Structuralist” approach which favours aggressive competition enforcement when anticompetitive structures manifest themselves, whereas the former is advocated by the “neo-Schumpeterian” approach which argues that dominance in the information technology markets tend to be temporary and short-lived. However, most competition authorities seem to favour the “neo-Structuralist” approach. 270

Declaration of Kenneth J. Arrow, attached to Memorandum of the United States of America in Support of Motion to Enter Final Judgment and in Opposition to the Positions of I.D.E. Corporation and Amici, United States v Microsoft Corp, Civil Action No 94-1564, 5-6 (D DC filed Jan 18, 1995) (on file with author), 9, Availabel at http://www.justice.gov/atr/cases/f0000/0049.pdf . (accessed 20 February, 2009). 271 Ibid., 268, 17. 272 Richard Posner, “Antitrust in the New Economy,” American Law Institute-American Bar Association Continuing Legal Education SF 63 (14 September 2000): 115-129; Richard Posner, Antitrust Law, 2nd ed. (Chicago; London: University of Chicago Press, 2001).

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Former Commissioner for Competition Mario Monti declares that “even if the pace of the high-tech sector means that market failures last only for a short time, this does not mean that we should be less concerned.”273 Similarly, former Chairman of the Federal Trade Commission, Robert Pitofsky, said that it would be “naïve” to conclude that there is no role for competition law when market power is based on intellectual property; rather competition law is flexible enough to play a role in regulating the Schumpeterian marketplaces.274 In his view, the increasing returns that a dominant firm enjoys, along with lock-in and other network effects can make market power durable. 275 It is, though, still debatable whether this approach is appropriate for the New Economy industries which are competing not “within” the market but “for” the market. It is risky to choose one of two opposite views in analysing the information technology industry. The competition analysis of New Economy markets can be extremely complex. Moreover, there will be significant uncertainty over the future evolution of the New Economy markets. Nonetheless, these factors do not imply that the competition authorities should refrain from intervention until they know all the answers. Markets with large production and demand-side economies of scale are prone to tipping. Dominance may be difficult to be restricted due to network effects in the IT industry. Reducing the dominance will require either the collective consumers’ migration, which incurs substantial switching costs, or an attempt to force open the network, which has its own set of problems. Information technologies create markets that require different economic tools

273

Monti, supra note 5. Robert Pitofsky, “Antitrust and Intellectual Property: Unsolved Issues at the Heart of the New Economy,” Berkeley Technology Law Journal 16 (2001): 536. 275 Federal Trade Commission. “Anticipating the 21st Century: Consumer Protection Policy in the New High-Tech Global Marketplace” May 1996, http://www.ftc.gov /opp/global /report/gc_v2.pdf. (accessed 16 October, 2006), Chap. 9, 3. 274

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to examine the behaviour of undertakings. Economists agree that maintaining competition and promoting innovation is vital, but disagree on how to achieve these; non-enforcement according to neo-Schumpeterians, more aggressive enforcement according to the neo-Structuralists. The competition authorities have preferred the neo-Structuralist approach, and this explains both their preference for narrower market definitions that seek to ensure the proliferation of participants in the dynamically competitive markets, as well as their preference for a structural analysis of dominance. Neo-Schumpeterian concepts are unlikely to gain favours for the following reasons. Firstly, a lot of optimistic speculation about future market developments is required. 276 Secondly, neo-Schumpeterians take a narrower view about the aims of competition law, therefore, the damage that dominant firms can do to other undertakings is irrelevant unless it can be shown that consumer welfare will suffer in the long run as a result of these. However, current competition law is concerned with the elimination of competitors per se, observing that this carries the risk of the dominant firm being alone in its attempt to deter new entrants. Thus, neoSchumpeterian ideas and theories do not fit easily within the current competition law culture and analytical framework of traditional competition law. In addition, antitrust has been analysed by examining the impact on economic incentives to innovate and balancing them against anticompetitive effects. This balance has usually has been accomplished with great consideration towards protecting incentives to innovate. It is important to stress, especially in New Economy markets, that success achieved through legitimate means such as innovation or superior marketing may naturally result in market power or even quasi-monopoly power. The very fact that the New Economy industries is so innovative makes it crucial that success be

276

Monti, supra note 60, 54.

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restricted to success on merits, and that monopoly power be confined to that which results from that success. Even an undertaking that has attained dominance through legitimate means and natural economy effects must not be permitted to retain or extend that power through anticompetitive means. The fact that New Economy markets are dynamic and complex does not imply that these markets are immune from competition law. Rather, it is critical that competition policy should properly reflect the economic features of the New Economy industries within the process of competition liability. Network effects should be closely examined since it may create a durable dominance, rather than a provisional dominance when combined with overwhelming switching costs. In the presence of network effects it may be efficient to have a single provider or many providers of compatible goods. However, the presence of network effects could increase the likelihood of success of leveraging strategies aimed at foreclosure. Hence, the concern is related to the fact that, although the market may ultimately tip, the identity of the undertaking that will win the race is not determined by competition but is the result of anticompetitive behaviours. The analysis of competition in the New Economy industries raises some new issues about the need to apply competition law flexibly. However, this does not mean that current competition analysis paradigms should be abandoned altogether. Recently, case law and competition law do appropriately deal with features, especially network effects, in New Economy markets, although both need to consider positive network effects much more. And the case law showed the current competition analysis has well recognised the risk of durable monopolisation and market leveraging caused by negative network externalities in the New Economy industries.

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Part III. Minimisation of Leveraging Effects in Technological Integration

I. Introduction............................................................................................................. 77 1.1 Background ...................................................................................................... 77 1.2 Definition and Types of Product Tying and Bundling ..................................... 78 1.3 New Economy and Its Consequences in Product Integration .......................... 81 II. European Legal Approach to Tying ...................................................................... 82 2.1 Forms of Tying ................................................................................................. 83 2.2 European Union Approach to Tying in Case Law ........................................... 86 2.2.1 Dominance ................................................................................................ 87 2.2.2 Two Separate Products.............................................................................. 88 2.2.3 Coercion .................................................................................................... 94 2.2.4 Possibility of Foreclosure.......................................................................... 96 2.2.5 Objective Justifications ............................................................................. 98 III. US Legal Approach to Tying ............................................................................. 100 3.1 Per Se Illegality Approach ............................................................................. 100 3.2 Modified Per Se Approach............................................................................. 105 3.3 Rule of Reason Approach .............................................................................. 110 IV. Economics of Tying: Reasons to Integrate Software ......................................... 114 4.1 Chicago School Explanations ........................................................................ 114 4.1.1 Price-Discrimination ............................................................................... 114 4.1.2 Risk Bearing ............................................................................................ 115 4.1.3 Quality Control ....................................................................................... 116 4.2 Post-Chicago Anticompetitive Explanations ................................................. 118 4.2.1 Monopoly Leveraging ............................................................................. 118 4.2.2 Preservation of Monopoly ....................................................................... 120 4.3 Post-Chicago Pro-competitive Explanations.................................................. 124 4.3.1 Responding to Diversity of Buyer Valuations ........................................ 125 4.3.2 Stimulating Demand for Complementary Products and Features ........... 126 4.3.3 Generating Revenue from Ancillary Services ........................................ 127 4.4 Evaluation of the Economic Theory on Product Integration ......................... 129 V. Evaluation of Elements Constituting Tying in Judicial Tests of the EU and the US .................................................................................................................................. 129 5.1 Separate Products Test ................................................................................... 130 5.2 Coercion Test ................................................................................................. 137 5.3 Anticompetitive Foreclosure .......................................................................... 143 5.3.1 Foreclosure and the Nature of Bundling ................................................. 143 5.3.2 Anticompetitive Effects: Consumer Detriments ..................................... 155 VI. Framework of Technological Integration in New Economy Markets ............... 162 VII. Remedies in Technological Integration ............................................................ 167 VIII. Conclusion....................................................................................................... 177

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I. Introduction

1.1 Background

The previous part showed that assessing entry conditions in the presence of network effects is likely to be a complex and highly fact-intensive process. The mere presence of network effects does not imply there are anticompetitive behaviours. However, undertakings with a strong installed base could enhance dominance using network effects. In other words, network effects could work to undermine a competitor’s position more rapidly in the New Economy markets. As soon as it becomes evident that a dominant undertaking’s actions are reducing a competitor’s market share or growth, application developers might be less keen to invest in developing programmes that could run on its product. This suggests that a dominant undertaking’s market power in the New Economy markets characterised by network effects is to some extent further protected by the presence of network effects, raising the question, is a dominant undertaking incentivised to extend its dominance into another market to capture profits or to protect their existing dominance? Undertakings may be able to leverage their market power in a number of ways depending on the circumstances and facts of the case, including bundling/tying and the refusal to supply critical services or inputs such as application programming interfaces or technical information. In the New Economy market, these practices are frequently used because the costs of adding technical features are almost zero and technologies in the IT industry are permitted exclusivity by intellectual property rights. It is also difficult to discern whether product integration is for product improvement or illegal tying.

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Tying/bundling practices can make it easier for consumers to access certain products. On the other hand, these practices can easily transfer the monopoly from primary market to secondary market if there are network effects. New Economy markets have different characteristics from traditional markets and these characteristics may require competition authorities to treat them differently; for example, technological integration differs considerably from traditional tying. The landmark Microsoft case raises the question of whether current competition doctrine on tying arrangements will appropriately treat product integration in the New Economy markets. This part focuses on whether current tying law adequately considers technological tying in the New Economy markets in which intellectual property rights play a crucial role. In most cases, product design is the right of undertakings, and technical integration increases consumer welfare through product improvements. At the same time, technical integration could be used as a tool to eliminate competitors, and as a result reduce consumer welfare through the restriction of consumer choice in the long run.

1.2 Definition and Types of Product Tying and Bundling

Tying occurs when a seller places a condition of sale on a product or service (“the tying product”) on the purchase of a second product or service (“the tied product”). 277 Economists refer to “pure bundling” or “tying” when two different goods are offered only together at a package price. 278 A special form of pure

277

The Guidance Paper, supra note 43, para. 48. Kai-Uwe Khün, Robert Stillman, and Cristina Caffarra, “Economic Theories of Bundling and their Policy Implications in Abuse Cases: An Assessment in Light of the Microsoft Case,” European Competition Journal 1, no. 1 (March 2005). 278

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bundling arises when the two products are linked technically such that it is physically impossible for the consumer to separate them.279 This form of pure bundling is called “technical tying” and involves some form of lasting product design decision.280 Pure bundling or tying is distinguished from “mixed bundling” where a firm offers the product together at a bundled price but also offers the component products individually at stand-alone prices.281 An equivalent form of mixed bundling occurs when a firm quotes stand-alone prices but gives a discount for buying both products. Most

economists

now

would

agree

on

three

fundamentals

of

tying/bundling.282 First, tying is a pervasive practice that, in many instances, gives rise to substantial efficiencies, particularly when it takes the form of product integration.

283

Second, the circumstances in which tying could lead to

anticompetitive effects are very restricted. 284 Third, not only are those conditions hard to verify, but also any attempt to balance efficiency gains against possible anticompetitive effects will prove a complex process. 285 This consensus among economists has policy implications. That is, the recognition of efficiencies as well as possible anticompetitive effects suggests that per se prohibition rules are conceptually inappropriate for the analysis of tying.286 In a competition law context, tying cases often involve the combination of a “monopoly” and a “competitive” product; however, tying is commonly observed even where the supplier in question does not enjoy market power over either element

279

Khün, Stillman, and Caffarra, supra note 278, 88. The Guidance Paper, supra note 43, para 48, footnote 2. 281 Ibid. 282 Christian Ahlborn, David Evans, and Jorge Padilla, “The Antitrust Economics of Tying: A Farewell to Per Se Illegality,” Antitrust Bulletin 49, no.1/2(Spring-Summer 2004): 339. 283 Ibid. 284 Ahlborn, Evans, and Padilla, supra note 282, 339. 285 Ibid. 286 Ahlborn, Evans, and Padilla, supra note 282, 340. 280

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in a bundle.287 For instance, shoes are sold in pairs, hotels sometimes offer breakfast, lunch or dinner included with a room, and there is no such thing as an unbundled car. 288 In the EU and the US competition law regimes, tying could be a per se violation on the following grounds: (1) the inherent unfairness to consumers, in that they are being effectively coerced into accepting a tied product that they do not necessarily desire;289 (2) a firm with considerable market power in the tying market may seek to extend its monopoly power into a second, otherwise competitive, market through the leveraging effects of product tying;290 and (3) tying arrangements create considerable barriers to entry, thereby enhancing the market power of the undertaking engaged in tying, by forcing potential entrants to enter the tied market, if at all, only by entering the tying market at the same time.291 Tying and bundling may be achieved either through technological or contractual links.292 The effects of tying or various types of bundling on competition may be similar and the risk of anticompetitive effects exists, although it appears less strong in the case of mixed bundling where the bundle can also be purchased separately.293 Thus, the real issue in tying or bundling is to identify the circumstances under which the anticompetitive effects of bundling or tying are likely to occur and what criteria should be used in order to come to the conclusion that an unbundling remedy is justified.

Derek Ridyard, “Tying and Bundling: Cause for Complaint,” European Competition Law Review 26, no. 6 (2003): 316. 288 Ahlborn, Evans, and Padilla, supra note 282, 287. 289 Jefferson Parish Hospital Dist. No. 2 et al. v. Hyde, 466 US 2, 12 (1984). 290 David Evans and Michael Salinger, “Why Do Firms Bundle and Tie? Evidence from Competitive Markets and Implications for Tying Law,” Yale Journal on Regulation 22, no. 1 (Winter 2005): 38. 291 The Guidance Paper, supra note 43, paras. 50, 52-58. 292 Ibid., para. 48, footnote 2. 293 Pietro Crocioni, “Leveraging of Market Power in Emerging Markets: A Review of Cases, Literatures, and a Suggested Framework,” Journal of Competition Law & Economics 4, no. 2 (2007): 475. 287

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1.3 New Economy and Its Consequences in Product Integration

The so-called “New Economy” in which technological progress has led to the development of markets that predominantly produce output in the form of intellectual property has created a variety of new questions for competition policy. 294 These unique economic characteristics of the New Economy industries differ from the traditional industries in that they require a novel approach for antitrust in product tying cases. The reason is that traditional antitrust jurisprudence has been aimed at the industries with eventual rising average costs in production, 295 while the New Economy industries are characterised by continuously declining marginal costs in production.296 This is because the product development cycle revolves around initial capital-intensive investment followed by cheap, or virtually free, dissemination.297 Competition policy in traditional markets aims to increase competition in production, 298 whereas in the New Economy markets it may be that the most important form of competition is in establishment.299 It follows that in certain technological markets characterised by network effects, particular attention must be focused on the possibility of incumbent monopolists employing exclusionary practices to frustrate new entry or technological leapfrog. This observation has powerful ramifications for the current focus on product tying, especially technological integration in the IT industry, as such

294

Richard Posner, Antitrust Law, 2nd ed. (Chicago; London: University of Chicago Press, 2001), 246. 295 Ibid., 245. 296 Alan Devlin, “A Neo-Chicago Perspective on the Law of Product Tying,” American Business Law Journal 44, no. 3 (Fall 2007): 561. 297 Posner, supra note 294, 246. 298 Devlin, supra note 296, 561. 299 Ibid.

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practices may be employed for objectionable ends in the high-tech and intellectual property industries laden with externalities in consumption. In the situation where consumers may face significant switching costs in attempting to move from an incumbent firm to a competitor, firms are likely to provide bundled products in order to increase their customer base and to further augment the extent to which its customers are locked in. Therefore, tying arrangements could be employed at a loss by a firm with significant financial resources so as to acquire a market share ahead of a more efficient competitor.300 Additionally, bundling could easily be employed to reinforce the dominant position of an undertaking within a market where the customers face switching costs.301 As a result, tying arrangements must be viewed with additional scrutiny in markets where consumers may become locked in. In particular, tying arrangements within high-tech and IP-based markets must be scrutinised using additional measures to those employed within more traditional contexts due to the technical complexity, rapid innovation, network effects, and considerable switching costs present.302 The competitive effects of a product tie-in within the New Economy markets must be considered with respect to the level of continuing innovation, increased consumer welfare 303 and in terms of consumer choice in the long run.

II. European Legal Approach to Tying 300

Devlin, supra note 296, 561. Ibid. 302 Debra Aron and Steven Wildman, “Economic Theories of Tying and Foreclosure Applied-and not Applied-in Microsoft,” Antitrust ABA 14 (Fall 1999): 48. 303 “Consumer welfare can be equated with consumer surplus (the aggregate measure of the surplus of all consumers),” in Competition Policy: Theory and Practice, Massimo Mota (Cambridge;New York: Cambridge University Press, 2004), 18; However, EU competition law has more diffuse conception of the consumer welfare, viz. “it is concerned with consumer gains in form of lower prices, better quality products, and a wider choice of new or improved goods and services,” in The Guidance Paper, supra note 43, para. 5. 301

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2.1 Forms of Tying

Tying is a common corporate strategy used in many industries and by many undertakings to reduce costs, create production efficiencies, and spread the risk when entering a new market. Tying is specifically mentioned in Article 102(d) TFEU:

…as making the conclusion of contracts subject to acceptance by the other parties of supplementary obligations which, by their nature or according to commercial usage, have no connection with the subject of such contracts.

Although the form of tying referred to in this Article 102(d) only covers contractual tying, a broad range of tying practices has appeared in case law. It includes tying applied as mixed bundling 304 and technological integration. 305 In contractual tying the buyer is forced to take the additional tied product in order to purchase the tying product. Cases demonstrate that it has practically been treated by the Commission and the Courts as illegal per se. 306 However, standards set by contractual tying cases that have been applied fit less well with other forms of tying such as technological integration.

Digital Undertaking, XXVIIth Report on Competition Policy 1997 and Commission Press Release IP/97/868, “The European Commission Accepts an Undertaking from Digital Concerning Its Supply and Pricing Practices in the Field of Computer Maintenance Services,” (Brussels, 10 October 1997). 305 Case T-201/04 Microsoft Corp. surpa note 40. 306 IV/30.787 and 31.488 Eurofix-Bauco v. Hilti, 88/138/EEC Commission Decision of 22 December, 1987 [1988] Official Journal of the European Communities L 65/19, and confirmed in Case T- 30/89 Hilti v. Commission of the European Communities [1991] European Court Reports II-1439 and on appeal C-53/92P Hilti v. Commission of the European Communities [1994] European Court Reports I-667 ; IV/31.043 Tetra Pak II, 92/163/EEC Commission Decision of 24 July, 1991 [1992] Official Journal of the European Communities L 72 /1, confirmed in Case T- 83/91 Tetra Pak International SA v. Commission of the European Communities [1994] European Court Reports II-755 (Tetra Pak II), and on appeal Case C-333/94 Tetra Pak International SA v. Commission of the European [1996] European Court Reports I-5951 (Tetra Pak II). 304

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In principle, there is no coercion of the customer in mixed bundling since the company offers the tying and tied goods in a bundle and separately. However, there may be a financial incentive upon the customer to purchase the bundle rather than the items individually and this can result in exclusionary effects.

307

In Digital

Undertaking, the Commission found Digital dominant in the service market for both the hardware and software of its own products despite the primary market for computer systems being extremely competitive.308 It indicates that the Commission will intervene where exceptional price discounts are given when two goods or services are bought together, but only where the discounts given by the dominant undertaking make it financially unattractive for the customer to purchase separately or go elsewhere, and where the discounts are not proportionate to costs.309 Technological integration is where the tying and tied products have been incorporated into one product, so it is physically difficult for the customer to split the components up.310 In the IBM case, which was a settlement between the Commission and IBM, the issue of technological integration was raised for the first time.311 The Commission used Article 102(d) TFEU as part of the regulatory framework to make IBM agree to discontinue its practice of integrating its memory devices with the Central Processing Units (CPU) and bundling its main memory function with the sale of its System 370 CPU by including the price of its main memory function in the price of its CPU and refusing to supply the CPU individually. In the case of Microsoft, the Commission sought to stop Microsoft from tying its Windows Media Player (WMP) to its Windows operating system (OS). The case raised controversy Digital Undertaking, supra note 304and Commission Press Release IP/97/868, supra note 304. Ibid. 309 Philip Andrews, “Aftermarket Power in the Computer Service Market: The Digital Undertaking,” European Competition Law Review 19, no. 3 (1998): 176-181. 310 Khün, Stillman, and Caffarra, supra note 278, 88. 311 IV/30.849 IBM, 84/233/EEC Commission Decision of 18 April 1984, relating to a Proceeding under Article 85 of the EEC Treaty [1984] Official Journal of the European Communities L 118/24. 307 308

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for various reasons. Firstly, it confirmed that the inflexible list of conditions applied to contractual tying also applies to technological integration despite the Commission acknowledging that the two forms of tying are different, and economists arguing that the latter is not always harmful, even though it can induce pro-competitive effects.312 Secondly, it paralleled the US Microsoft case313 although in the US case the alleged tying was between Microsoft’s OS and its web browser, Internet Explorer (IE).314 While technological integration imposes a risk of foreclosure in the tied product market, the purpose of technological integration may not be purely anticompetitive. In the information technology market it is a tool of innovation and product development commonly applied by firms. From the intellectual property (IP) owners’ view, a strict approach to technological integration will adversely affect their ability to develop IP protected products through technological integration, where only parts of the product are covered by an intellectual property right (IPR) or are covered by different IPR.315 The different types of tying affect the markets and competition differently and thus different levels of pro- and anticompetitive effects. Therefore, it is controversial that the Commission and the EU Courts have chosen to apply only one approach to all different forms of tying. The competition authorities are mainly concerned that where an undertaking holds a dominant position tying will be used as a leveraging device to cause foreclosure a related market, the tied product market, or to protect the tying product market which could result in limiting consumer choice and excluding competition. Other anticompetitive incentives include entry deterrence,

312

COMP/C-3/37.792 Microsoft, supra note 238, para. 841; The Guidance Paper, supra note 43, paras. 47, 52. 313 United States v. Microsoft Corp., 253 F 3d 34, 128 (D.C. Cir. 2001). 314 Steve Anderman and Hedvig Schmidt, EU Competition Law and Intellectual Property Rights: The Regulation of Innovation (Oxford; New York; Oxford University Press, 2011), 129. 315 Ibid., 130.

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price discrimination, reducing competition and gaining a competitive advantage by creating network externalities or through technological integration.316

2.2 European Union Approach to Tying in Case Law

In EU competition law a comparatively small number of cases have reached the Commission and the EU Courts, when compared with other forms of abuse. However, the majority of the tying cases have involved some form of IPR.317 Tying is subject to the completion rules under both Article 101 and 102 TFEU. This means that not only is tying seen as a form of conduct, which can cause severe harm, but it also signifies that both Articles may apply to the same tying conduct or agreement, but on their terms.318 The modernisation of Article 101 TFEU has in recent years created a gap and inconsistencies in the treatment of tying under Article 101 and 102 TFEU respectively. This is because the approach under Article 101 TFEU is more economic and focused on consumer welfare, compared with the more form-based approach applied under Article 102 TFEU.319 The Commission views tying as almost illegal per se under Article 102 TFEU where the following conditions are fulfilled: An undertaking is in a dominant position in the tying market; the customers are coerced into buying the two products together; the tying and tied products are distinct

Barry Nalebuff, “Bundling, Tying, and Portfolio Effects: Part I-Conceptual Issues,” DTI Economics Paper, no. 1, February 2003, available at http://www.dti. gov.uk/ files/file14774.pdf. (accessed 27 February, 2007), 18. 317 IV/30.787 and 31.488 Hilti, supra note 306; IV/31.043 Tetra Pak II, 92/163/EEC Commission Decision of 24 July, 1991 [1992] Official Journal of the European Communities L 72 /1. 318 Anderman and Schmidt, supra note 314, 131. 319 Ekaterina Rousseva, “Modernising by Eradicating How the Commission’s New Approach to Article 81 EC Dispenses with the Need to Apply Article 82 to Vertical Restraints,” Common Market Law Review 42, no. 3 (2005): 589. 316

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products; the tying practice is likely to lead to anticompetitive foreclosure; there is no objective justification or no efficiency.320

2.2.1 Dominance

In all tying cases under Article 102 TFEU, dominance in the market of the tying product has been a prerequisite for the finding of abusive tying. Case law dictates that dominance must be found at least in the tying product market. For example, Tetra Pak was held to have abused its dominant position in the market of machines for packaging by tying the sales of cartons to the sales of their machines; and British Sugar had abused its dominant position in the sugar by tying distribution services to its sales of sugar321 In Hilti, the Commission clarified the importance of dominance in relation to the abuse as:

The ability to carry out its illegal policies stems from its power on the markets for Hilti-compatible cartridges strips and nail guns (where its market position is strongest and the barriers to entry are highest) and aims at reinforcing its dominance on the Hilti-compatible nail market (where it is potentially more vulnerable to new competition).322

In certain cases the Commission has defined the market so narrowly that a finding of dominance was inevitable. 323 Furthermore, the Commission made clear 320

The Guidance Paper, supra note 43, paras. 28, 50; Case 27/76 United Brands, supra note 164, para. 184; Case T- 30/89 Hilti v. Commission of the European Communities [1991] European Court Reports II-1439, paras 102 to 119; Case T- 83/91 Tetra Pak International SA v. Commission of the European Communities [1994] European Court Reports II-755, paras. 136, 207; Case C- 95/04P British Airways v. Commission of the European Communities [2007] European Court Reports I-2331, paras 69, 86; Case T-201/04 Microsoft Corp. supra note 40, paras. 842, 859 to 862, 867, 869. 321 IV/31.043 Tetra Pak II, supra note 317; IV/30.178 Napier Brown v. British Sugar, 88/519/EEC Commission Decision of 18 July, 1988 [1988] Official Journal of the European Communities L 284/41. 322 IV/30.787 and 31.488 Hilti, supra note 306, para. 74. 323 IV/30.787 and 31.488 Hilti, supra note 306.

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that a finding of dominance in the market for consumables (the tied goods) was not necessarily dependent on a finding of dominance in the primary market (the tying goods), as evidenced in the Hilti case:

Even if it were correct as Hilti argues that nail guns form part of a wider market and compete with other fixing methods in general, this would not alter the analysis given above as far as the relevant markets for Hilti-compatible nails and cartridge strips in particular are concerned and Hilti’s dominance thereof. For the independent producers of these consumables the relevant markets on which they compete are those for Hilti-compatible consumables.324

In case law the finding of dominance has also been influenced by the presence of IPR. This was clearly illustrated in both Hilti and Tetra Pak II.325 IPRs have affected the establishment of dominance in two ways: first, indirectly, through the relevant market definition, which is often curtailed along the scope of the IPR326: second, directly, through the assumption that an IPR will inevitable confer some level of market power.327

2.2.2 Two Separate Products

Without the establishment of two separate products there cannot be a tying arrangement. In identifying two products, the question of whether two products are separate is generally assessed on the basis of “commercial usage,”328 and consumer demand.329

324

IV/30.787 and 31.488 Hilti, supra note 306, para. 72. Case T- 30/89 Hilti, supra note 320, para. 93; Case T- 83/91 Tetra Pak, supra note 320, para. 23. 326 Anderman and Schmidt, supra note 314, 136. 327 Ibid. 328 Article 102 TFEU (2) (d). 329 Case T-201/04 Microsoft Corp. supra note 40, paras. 925, 927. 325

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The Commission and the General Court discussed the concept of “commercial usage” in detail in the Tetra Pak II case. Tetra Pak had argued that the tying of machines and cartons did not contravene Article 102 TFEU on the basis that the products were connected by commercial usage. In support, Tetra Pak cited its competitor Elopak, which had stated that the combined sale of machine and cartons was a more efficient way of competing. However, both the Commission330 and the General Court331 held that the products were not linked by commercial usage. The General Court based its view on the fact that there were:

…independent manufacturers who specialise in the manufacture of non-aseptic cartons designed for use in machines manufactured by other concerns and who do not manufacture machinery themselves… approximately 12 per cent of the nonaseptic carton sector was shared in 1985 between three companies manufacturing their own cartons, generally under licence and acting, for machinery, only as distributors.332

The General Court continued, obiter dictum:

Moreover and in any event, even if such a usage were shown to exist, it would not be sufficient to justify recourse to a system of tied sales by an undertaking in a dominant position. Even a usage which is acceptable in a normal situation, on a competitive market, cannot be accepted in the case of a market where competition is already restricted.333

Two important points emerge from the Court’s assessment in Tetra Pak II.334 First, the General Court seems to define “commercial usage” rather narrowly. To establish

330

IV/31.043 Tetra Pak II, supra note 317. Case T- 83/91 Tetra Pak supra note 320. 332 Ibid., para. 82. 333 Case T- 83/91 Tetra Pak supra note 320, para. 137. 334 Ahlborn, Evans, and Padilla, supra note 282, 313. 331

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commercial usage it is not sufficient to show that tied sales are the predominant business practice in the markets in question or comparable markets; as long as some united sales occur in the relevant markets (in the Tetra Pak II case, 12 %335), the criterion of commercial usage is not satisfied. 336 Second, contrary to the express wording in Article 102(d) TFEU, the General Court does not regard absence of commercial usage as a prerequisite for tying; rather, commercial usage seems to be treated similarly to “objective justifications” which may or may not take tying outside the scope of Article 102 TFEU.337 In Microsoft, the General Court described the two separate products assessment as a two-part test: first, an assessment of the product’s nature, physical appearance, and commercial usage; and second, a requirement of consumer demand for the tied product. 338 However, most case law demonstrated that the focus had primarily been on consumer demand and, in particular, evidence of independent manufacturers of the tied product had played a crucial role.339 The lack of focus on the first part of the assessment was due to its closeness to the definition of the relevant product market, an assessment undertaken in all Article 102 TFEU cases.340 The relevant product market definition provides a framework for the establishment of dominance, but case law showed that when two products markets were established under the relevant product market assessment, the finding of two separate products

335

Case T- 83/91 Tetra Pak supra note 320, para. 82. Ahlborn, Evans, and Padilla, supra note 282, 313. 337 Ibid. 338 Case T-201/04 Microsoft Corp. surpa note 40, paras. 925, 927. 339 Case T- 30/89 Hilti, supra note 320, para. 67; Case C-333/94 Tetra Pak International SA v. Commission of the European Communities [1994] European Court Reports I-5951, para. 36; Case T201/04 Microsoft Corp. supra note 40, para. 927. 340 Anderman and Schmidt, supra note 314, 132. 336

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was more or less given.341 Thus, the outcome of a tying case can often already be determined at this stage.342 In the second part of the separate product assessment, consumer demand is applied to identify whether the tied goods are distinct from the tying goods. The test simply asks whether the consumers, given a choice, would purchase the tying and tied product individually. This can manifest itself in whether there are independent manufacturers of the tied product, whether non-dominant undertakings in the markets tend not to tie, especially where the markets are competitive. If so, there is also considered to be a separate consumer demand for the tied goods.343 In Hilti,344 the Commission had responded to a complaint by Eurofix-Bauco that Hilti was tying the sales of its cartridge strips to the sale of its nails. The Commission, applying its policy of a narrow market definition, found that there were three separate markets - nail guns, cartridge strips, and nails. Three facts influenced the Commission’s decision. First, Hilti held a patent on the cartridge strips allowing Hilti legally to exclude competition, and thereby gain market power. 345 Second, Hilti’s market power was further enhanced by its products being technologically advanced, its efficient R&D, and a well-organised distribution system in the nail gun market.346 Third, there were independent nail manufacturers in the market for nails. This was further confirmed by the fact that the nail guns and consumables (nails and cartridge strips) were not purchased together. 347 The Commission found that Hilti was reinforcing the tie-in by a practice of charging excessively high royalties to deter 341

Anderman and Schmidt, supra note 314, 132. Ibid. 343 Anderman and Schmidt, supra note 314, 132. 344 IV/30.787 and 31.488 Hilti, supra note 306, and confirmed in Case T- 30/89 Hilti, supra note 320, and on appeal C-53/92P Hilti v. Commission of the European Communities [1994] European Court Reports I-667. 345 IV/30.787 and 31.488 Hilti, supra note 306, paras. 55, 66. 346 Ibid., para. 67. 347 IV/30.787 and 31.488 Hilti, supra note 306, para. 57. 342

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independent nail manufacturers from obtaining licences for rights in the cartridge strips. It concluded that these practices were abusive because they prevented or limited the entry of independent producers into those markets. The General Court upheld the Commission’s view. In this case, Article 102(d) TFEU was effectively used to prevent Hilti from extending the scope of its exclusive exploitation rights beyond patented product to unpatented products.348 Also, the definition of relevant product markets appears to reinforce that decision because it separated the patented and the unpatented goods into separate markets, and provided the foundation for the findings of dominance.349 A similar approach was taken in Tetra Pak II, the General Court reiterated that independent manufacturers were free to produce and offer consumables intended for use in third party products, as long as these did not infringe IPR. 350 The consequence of this remark is that where goods contain both IP protected and unprotected components, there is a probability that these will be seen as separate products and not as one under Article 102(d) TFEU. This strict definition of a product essentially permits the competition authorities to regulate IPR and ensure that they are not applied to extend the scope of the IPR itself.351 In the Microsoft case, the Commission identified two product markets: the market for the operating system and the market for media players. It based its market definitions on the fact that there were manufacturers of stand-alone media players,352 and barriers to entry into the media player market, such as network effects and IPR.353 In its Guidance Paper, the Commission confirmed the use of the consumer

348

Anderman and Schmidt, supra note 314, 133. Ibid. 350 Case T- 83/91 Tetra Pak supra note 320, paras, 34, 83-84. 351 Anderman and Schmidt, supra note 314, 133. 352 COMP/C-3/37.792 Microsoft, supra note 238, para. 405. 353 Ibid., paras. 418-420. 349

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demand test.354 However, the Guidance Paper does not require that the tying and tied goods are in separate markets, it merely needs to be distinct:355

Two products are distinct if, in the absence of tying or bundling, a substantial number of customers would purchase or would have purchased the tying product without also buying the tied product from the same supplier, thereby allowing standalone production for both the tying and the tied product.356

This statement indicates that where it is still economically viable to produce the tied product individually, the consumer demand requirement is fulfilled. 357 Such an interpretation is in line with the approach taken in the US in Jefferson Parish358 and Eastman Kodak359, where the Supreme Court also demanded that customer demand should be assessed in relation to economic viability.360 However, it does not consider technologically integrated products and the benefits these can generate.361 In contrast, the General Court in Microsoft held that only in the absence of independent demand for the allegedly tied product, can there be no question of separate products and no abusive tying. 362 In other words, the General Court’s standard of proof for technological integration requires all demand for the tied product to have ceased. This is an impossibly high threshold because even though consumer demand dictates a need for an integrated product, the demand for the separate components can continue for a significant period after the integrated product

354

The Guidance Paper, supra note 43, para 185. Ibid., para. 51. 356 The Guidance Paper, supra note 43, para. 51. 357 Anderman and Schmidt, supra note 314, 134. 358 Jefferson Parish Hospital, supra note 289, 21. 359 Eastman Kodak Co. v Image Technical Services, Inc. et al., 504 US 451, 462 (1992). 360 Anderman and Schmidt, supra note 314, 134. 361 Ibid. 362 Case T-201/04 Microsoft Corp. supra note 40, para. 918. 355

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has become available and until the market has fully adapted.363 For example, when PCs originally came onto the market, the consumer had to purchase hardware, software, desktop, screen, keyboard, and mouse separately. Now these are offered in a simple package, although they can be purchased separately as well. The problem with the test is two-fold. First, products can continue to be divided into smaller parts and the question is when is it reasonable to stop the separation. 364 Second, the test does not sufficiently consider product development and innovation, and this is of particular concern to IP holders.365 The US Court of Appeals labelled the test “backward-looking” and thus a “poor proxy” for overall efficiency in the presence of new and innovative integration.366 As part of effective competition, undertakings are expected to develop and improve their products, and one way could be through technological integration. In its Guidance Paper, the Commission has indirectly acknowledged the product development issue, by stating that it will be willing to consider whether the combination of two products into a new, single product may benefit the consumer.367

2.2.3 Coercion

Under the EU competition law, coercion to purchase two products together is a key element in establishing abusive tying.368 Coercion may take many forms. It is clearly shown when the dominant firm makes sales of one product an absolute condition of

363

Anderman and Schmidt, supra note 314, 134. Robert Bork, Antitrust Paradox: A Policy at War with Itself (New York: The Free Press, 1993), 378-379. 365 Anderman and Schmidt, supra note 314, 135. 366 Microsoft Corp., supra note 313, 89. 367 The Guidance Paper, supra note 43, para. 62. 368 Ahlborn, Evans, and Padilla, supra note 282, 313. 364

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another product. 369 This condition may be explicit in an agreement 370 or de facto. 371 However, lesser forms of coercion, such as price incentives or the withdrawal of benefits may also be sufficient, if they are so powerful that customers would not choose to buy products individually.372 Coercion may be contractual as it was in Hilti and Tetrapak; or financial, where the customer is awarded so great a discount that he is left no commercial meaningful choice but to accept the second, the tied goods;373 or by removing certain benefits where customers have used third party products. 374 Finally, through technological integration, coercion may occur due to the fact that the products are physically integrated, and therefore the consumer is left with no choice to purchase the combined product.375 The test applied by the Commission and the EU Courts has been whether the customer is permitted a choice between purchasing the bundle of products or separately.376 In the Microsoft case, the Commission stated that it was inconsequential whether consumers were not forced to purchase or use Windows Media Player (WMP), as long as WMP was automatically obtained, even for free, because alternative suppliers were at a competitive disadvantage. 377 The General Court upheld this, noting that integration of WMP would deter Original Equipment Manufacturers (OEMs) from pre-installing a second media player on the PCs as well

369

Ahlborn, Evans, and Padilla, supra note 282, 313. IV/31.043 Tetra Pak II, supra note 317. 371 IV/30.787 and 31.488 Hilti, supra note 306. 372 Ahlborn, Evans, and Padilla, supra note 282, 313; IV/30.787 and 31.488 Hilti, supra note 306. 373 Digital Undertaking, supra note 304 and Commission Press Release IP/97/868, supra note 304. 374 IV/30.787 and 31.488 Hilti, supra note 306, para. 75. 375 COMP/C-3/37.792 Microsoft, supra note 238. 376 IV/30.787 and 31.488 Hilti, supra note 306, para. 75; Case T- 83/91 Tetra Pak supra note 320, para. 137. 377 COMP/C-3/37.792 Microsoft, supra note 238, paras., 833-834. 370

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as encouraging the consumers to use only the WMP rather than a later downloaded media player, notwithstanding that the latter may be of better quality.378

2.2.4 Possibility of Foreclosure

It is not clear to what extent it has to be demonstrated under the EU competition law that tying leads to anticompetitive effects in a particular case. However, the EU Courts and the Commission seemed to have applied the generally low threshold of the conduct being capable of having, or likely to have, an anticompetitive effect without necessarily excluding all competition from the market.379 According to the British Sugar case, tying did not need to have any actual effects on the tied market.380 British Sugar tied the supply of sugar to the service of delivering the sugar. The Commission did not regard it as necessary to assess whether the delivery of sugar was part of a wider transport market, and whether the tying foreclosed any significant part of such market. The fact that British Sugar had reserved for itself the separate activity of delivering sugar was sufficient as an anticompetitive effect.381 In Microsoft, the Commission engaged in an exceptionally detailed analysis of the anticompetitive effects of Microsoft’s tying and concluded that tying had the potential to risk foreclosure of the media player market in the future. 382 The Commission argued that an extensive analysis was necessary because it was unclear

378

Case T-201/04 Microsoft Corp. supra note 40, paras. 968-971. Case T-219/99 British Airways plc. v. Commission of the European Communities [2003] European Court Reports II-5917, para. 293, and confirmed in Case C-95/04 British Airways plc. v. Commission of the European Communities [2007] European Court Reports I-2331. 380 IV/30.178 Napier Brown v. British Sugar, supra note 321. 381 Ibid., para. 70. 382 COMP/C-3/37.792 Microsoft, supra note 238, paras. 841-954. 379

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whether the tie-in was anticompetitive since consumers could still obtain a third party media player through download.383 However, the General Court did not find the downloading option significant enough to eliminate the risk of foreclosure. 384 Its main concern was the pressure Microsoft put on OEMs to preinstall WMP at Windows which prevented them from offering third party media players to their customers, and resulted in Microsoft being given a competitive advantage not pertinent to the quality of the product and likely to affect related markets.385 Although the General Court confirmed the conclusion of the Commission assessment, it indicated that a less extensive analysis would have brought forth the same result.386 It thereby confirmed the low threshold applied first in British Sugar and held that where there was a reasonable likelihood that the tying arrangement would lead to the lessening of competition so that the maintenance of an effective competition structure would not be ensured in the foreseeable future, the anticompetitive effects requirement was fulfilled.387 The implication of the General Court’s low standard of proof for tying is that once two distinct products have been identified, abuse can be established relatively easily. 388 The Guidance Paper notes that where the tie-in is a lasting one, i.e. technological integration, the risk of anticompetitive foreclosure is considered to be even greater. 389 However, it is unclear whether this will result in an even lower standard of proof for anticompetitive effects, albeit such an interpretation is not unlikely.390

383

COMP/C-3/37.792 Microsoft, supra note 238, para. 841. Case T-201/04 Microsoft Corp. surpa note 40, paras. 1045-1050. 385 Ibid., paras. 1058-1069, 1076. 386 Case T-201/04 Microsoft Corp. surpa note 40, paras. 1058-1059. 387 Ibid., para. 1089. 388 Anderman and Schmidt, supra note 314, 138. 389 The Guidance Paper, supra note 43, para. 53. 390 Anderman and Schmidt, supra note 314, 138. 384

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2.2.5 Objective Justifications

Unlike Article 101 TFEU, Article 102 TFEU does not contain a general exemption clause. However, Article 102(d) TFEU does indicate that the nature of the products or their commercial usage can make it acceptable to sell the products tied together. It is unclear though how the wording of Article 102(d) TFEU should be interpreted. One way could be to see the absence of commercial usage as a prerequisite for seeing tying as abusive.391 An alternative reading would be to see commercial usage and the nature of conduct as a form of objective justification.392 Although the EU Courts and the Commission allowed the defendants to adduce objective justifications for the alleged abusive behaviour, which would then be balanced with the anticompetitive effects of the conduct, so far all undertakings facing a tying as an abuse claim have failed the high standard of proof of objective justifications set by the Commission and the EU Courts.393 The shortage of cases causes difficulty in assessing whether the rejection of the objective justifications is due to insufficient evidence and poor defence by the dominant firm or if the applied threshold is significantly too high for these types of cases.394 Three types of objective justifications have been attempted: public health,395 product safety,396 product quality and cost reduction.397 In Microsoft, in particular, Microsoft attempted to rely on three defences. First, it claimed that having WMP as a default option on the OS reduced time and 391

Ahlborn, Evans, and Padilla, supra note 282, 315-316. Case C-333/94 Tetra Pak, supra note 335, paras. 34-35. 393 Anderman and Schmidt, supra note 314, 139. 394 Ahlborn, Evans, and Padilla, supra note 282, 314. 395 Case C-333/94 Tetra Pak, supra note 335. 396 Case T- 30/89 Hilti, supra note 320. 397 Case T-201/04 Microsoft Corp. supra note 40. 392

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confusion for consumers.398 The Commission rejected this argument, holding that the pre-installed media player did not need to be the WMP.399 Second, Microsoft argued that shipping WMP and OS together reduced transaction costs by saving on maintaining a separate distribution system for the second product, and this reduction in costs was passed on to the consumers.400 Although the Commission accepted the defence as valid, it found that the efficiency gains were insufficient to outweigh the anticompetitive effects. 401 Third, Microsoft argued that Windows and WMP were technologically integrated. This argument was dismissed by the Commission because Microsoft had not demonstrated that the integration was indispensable to achieve the works of application developers.402 On the other hand the General Court seemed to have applied a slightly lower standard of proof.403 It held that Microsoft’s reason for integrating was to ensure a stable and well-defined Windows platform for the benefit of both software developer and Web creators but this was not an acceptable defence as it was the main cause of foreclosure.404 The General Court relied on the fact that the integration of WMP into Windows did not lead to “superior technical product performance.” 405 Microsoft argued that Windows operated faster with WMP integrated, but it never provided clear evidence of this.406 Although the General Court rejected the objective justification for integration of WMP with Windows OS, it provided guidelines as to what can constitute a valid justification for technological integration of products by dominant undertakings,

398

COMP/C-3/37.792 Microsoft, supra note 238, para. 956. Ibid., paras. 956-957. 400 COMP/C-3/37.792 Microsoft, supra note 238, para. 958. 401 Ibid. 402 COMP/C-3/37.792 Microsoft, supra note 238, para. 963. 403 Anderman and Schmidt, supra note 314, 141. 404 Case T-201/04 Microsoft Corp. supra note 40, para. 1146, 1151. 405 Ibid., para. 1159. 406 Case T-201/04 Microsoft Corp. supra note 40, para. 1160. 399

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albeit not very elaborate. 407 It is clear that the firm must demonstrate that technological integration adds some superior technological which is more value than what the consumers could have achieved themselves by merely combining the tying and tied goods together.

III. US Legal Approach to Tying

Although recent economic research provides useful grounds for legal theories of anticompetitive behaviour, that research also provides a rich basis upon which courts could find that consumer benefits might plausibly result from the bundling of software.408 The challenge to legal theories that such economic analysis presents is to formulate a competition rule for software integration that can reconcile existing case law with the unique supply and demand characteristics that influence the nature of competitive rivalry in technologically dynamic markets. 409

3.1 Per Se Illegality Approach

The Harvard Structural School 410 influenced antitrust policy during the 1960s. It developed the Structure-Conduct-Performance paradigm, whereby the structure of

407

Case T-201/04 Microsoft Corp. supra note 40, para. 1159: The General Court noted that the integration of WMP in Windows should create technical efficiencies, in other words it should lead to superior technical product performance. 408 Gregory Sidak, “An Antitrust Rule for Software Integration,” Yale Journal on Regulation 18, no. 1 (Winter 2001): 19. 409 Ibid., 19-20. 410 For more detailed explanations, see Edward Mason, Economic Concentration and the Monopoly Problem (Cambridge, MA; Harvard University Press, 1959); Joe Bain, Barriers to New Competition: Their Charater and Consequences in Manufacturing Industries (Cambridge, MA: Harvard University Press, 1956) and Industrial Organisation, 2nd ed. (New York: John Wiley1968); Carl Turner Kaysen and Donald Turner, Antitrust Policy: An Economic and Legal Analysis (Cambridge, MA: Harvard University Press, 1959); William Kovacic, “The Intellectual DNA of Modern US Competition Law for Dominant Firm Conduct: The Chicago/Harvard Double Helix,” Columbia Business Law Review

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the market determines a firm’s conduct, and that conduct determines market performance, such as profitability, efficiency, technical progress, and growth. 411 Thus, the model sought to establish that certain industry structures lead to certain types of conduct which then lead to certain kinds of economic performance. 412 In particular, highly concentrated industries cause the conduct which leads to poor economic performance, especially reduced output and monopoly price. 413 This conclusion caused a belief that competition law should be concerned with structural remedies, such as divestiture, rather than behavioural remedies.414 It embraced the view that competition law promotes the well-being of small businesses and the basic principles of fairness. 415 The Harvard School Interventionists wanted competition law to promote goals such as guaranteeing free access to markets, providing customers with the widest choice of suppliers, and preventing abuse of economic power.416 Early legal cases in the US, such as Standard Oil417 and Northern Pacific Railway,418 viewed tying arrangements largely as a means of restricting competition with few redeeming features. In the US Steel case, the Court held that tying arrangements generally serve no legitimate business purpose that cannot be achieved in some less restrictive way.419 Given the assumption that tying had no redeeming features, a per se prohibition was an almost inevitable policy conclusion. Any tying 2007, no. 1 (2007): 1-80; Lawrence Sullivan, “Monopolisation: Corporate Strategy, the IBM Cases, and the Transformation of the Law,” Texas Law Review 60, no. 4 (April 1982): 587-647. For Modern Harvard School, see, Areeda and Turner, supra note 32. 411 Jones and Sufrin, supra note 3, 22. 412 Ibid. 413 Jones and Sufrin, supra note 3, 22. 414 Ibid. 415 Devlin, supra note 296, 527; Brown Shoes Co. v. United States, 370 US 294 (1962). 416 Andreas Kirsch and William Weesner, “Can Antitrust Law Control E-Commerce? A Comparative Analysis in Light of US and EU Antitrust Law,” U.C Davis International Law and Policy (2006): 304-305. 417 Standard Oil Co. et al. v. United States, 337 US 293 (1949). 418 Northern Railway Pacific Co. et al. v. United States, 356 US 1 (1958). 419 Fortner Enterprises, Inc. v. United States Steel Corp. et al., 394 US 495, 503 (1969).

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arrangement by a seller with significant market power in the market for the tying product was per se illegal provided the effects of the arrangements in the market of the tied product exceeded a certain de minimis threshold (“a ‘not insubstantial’ amount of commerce”).420 Despite the fact that tying has generally been considered under Section 1 of the Sherman Act, a certain degree of market power by the seller in the market of the tying product has consistently been one of the prerequisites of illegal tying. 421 However, the seller’s market power does not have to amount to monopoly power within the meaning of Section 2 of the Sherman Act.422 According to the Supreme Court, the relevant question was whether a party has “sufficient economic power” with respect to the tying product to appreciably restrain free competition in the market for the tied product. 423 Early Supreme Court cases were concerned with sellers forcing customers to accept unpatented products in order to be able to use a seller’s patent, and the patent rights were deemed to give the seller “sufficient economic market power.”424 In later cases, sufficient economic power was “inferred from the tying product’s desirability to consumers or from uniqueness in its attributes”425 or from the fact that “the seller has some advantage not shared by his competitors.”426 Further, as in Northern Pacific Railway, the mere “existence of a host of tying arrangements in itself” was regarded as “compelling evidence of a firm’s great power” in the absence of other explanations.427

420

Jefferson Parish Hospital, supra note 289, 16; Northern Railway Pacific, supra note 418, 11. Ahlborn, Evans, and Padilla, supra note 282, 292. 422 Ibid., 292, 311. 423 Northern Railway Pacific, supra note 418, 2. 424 International Salt Co., Inc. v. United States, 332 US 392, 395-396 (1947); International Business Machines Corp. v. United States, 298 US 131 (1936). 425 United States v. Loew’s Inc. et al., 371 US 38, 45 (1962). 426 United States Steel Corp. et al. v. Fortner Enterprises, Inc., 429 US 610, 620-621 (1977). 427 Northern Railway Pacific, supra note 418, 8. 421

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Undertakings with significant market power were prohibited from entering into tying arrangements, i.e. to ‘force’ customers to purchase a tied product along with the ‘separate’ tying product. 428 The firms were subject to this prohibition independently of any anticompetitive effects of efficiency gains.429 In the Microsoft case, the Court of Appeals pointed out that “the requirement that a practice involve two separate products before being condemned as an illegal tie started as a purely linguistic requirement: unless products are separate, one cannot be tied to the other.”430 In previous cases,431 the issue of separate products arose but was addressed in an ad hoc manner - on the basis of a wide range of different factors, such as whether the bundled products were generally sold as a unit with fixed proportions,432 whether components were charged separately and whether other players in the industry sold products individually or as a bundle.433 The courts did not develop any systematic standard, nor did their reasoning consider the underlying policy considerations of tying, such as foreclosure and efficiencies. 434 However, establishing separate products is not enough to differentiate illegal tying from legal bundling. A key element of tying is the forced purchase of a second distinct commodity.435 In other words, what distinguishes illegal tying from legal bundling is the sellers’ exploitation of their control over the tying product, forcing the buyer into the purchase of a tied product that the buyer either did not want or might have preferred to purchase

428

Ahlborn, Evans, and Padilla, supra note 282, 293. Ibid. 430 Microsoft Corp., supra note 313. 431 Times-Picayune Publishing Co. et al. v. United States, 345 US 594 (1953); Arlie Mack Moore et al. v. Jas. H. Matthews & Co. et al., 550 F. 2d 1207 (9th Cir. 1977). 432 Arlie Mack Moore, supra note 431, 1215. 433 Times-Picayune Publishing Co, supra note 431, 614. 434 Ahlborn, Evans, and Padilla, supra note 282, 294. 435 Times-Picayune Publishing , supra note 431, 614. 429

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elsewhere on different terms.436 Therefore, where the buyer is given the option to purchase products individually or as a bundle and the option to purchase individual products is economically feasible, no anticompetitive tying occurs. In addition to the previous two factors – sufficient economic power and separate product markets - for a tying arrangement to be illegal under the per se approach, “a not insubstantial amount of interstates commerce” in the tied product had to be affected. 437 The Supreme Court said that the relevant question was “whether a total amount of business substantial enough in terms of dollar volume so as not to be merely de minimis, is foreclosed to competitors by tie-ins.”438 Although the three elements were satisfied, in certain circumstances the US Courts accepted justifications for tying arrangements that would otherwise be considered illegal by the prohibition. 439 During the development period of a new industry, a tying arrangement was held to be justified for a limited period on the basis that selling an integrated system would help in assuring the effective functioning of the complex equipment.440 However, the Supreme Court also held that the protection of goodwill may not serve as a defence for tying the purchase of supplies to a leased machine where such protection can be achieved by less restrictive means, for example, through quality specifications to third parties.441 Under the per se illegality approach, the courts accepted that some form of economic or market power was a necessary condition for harmful tying. In light of their assumption that tying did not have any redeeming features, they did not address

436

Jefferson Parish Hospital, supra note 289, 12. Ibid., 2. 438 Fortner Enterprises, supra note 419, 501. 439 Ahlborn, Evans, and Padilla, supra note 282, 295. 440 Jerrold Electronics Corp. et al. v. United States, 365 US 567 (1961). 441 Ibid. 437

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whether market power was also a sufficient condition,442 nor did they appear to have recognised that tying was a ubiquitous phenomenon among firms with little or no market power and therefore must have served some purpose beyond the suppression of competition.443 Nevertheless, the hostility against tying was largely directed against contractual tying while technological integration frequently escaped the per se prohibition. In ILC Peripherals Leasing v. IBM, IBM’s integration of magnetic discs and a head/disc assembly was not held to amount to an unlawful tying arrangement. 444 Similarly, IBM in the 1970s integrated memory into its CPU platform. IBM was challenged by a peripheral manufacturer. The District Court dismissed the tying claim on the basis that courts were not well-placed to decide on product design decisions.445 The hostile approach toward tying was revised in the Jefferson Parish case, where the Supreme Court accepted that tying could have some merits but struggled to devise a test that distinguished good tying from bad tying.

3.2 Modified Per Se Approach

In the Jefferson Parish case, the majority took an approach that kept per se prohibition but indicated some willingness to recognise efficiency.446 In this case, the Supreme Court recognised that tying may, at least in certain circumstances, be welfare enhancing:

442

Ahlborn, Evans, and Padilla, supra note 282, 295. Ibid. 444 ILC Peripherals Leasing Corp. v. International Business Machines Corp., 448 F. Supp. 228, 233 (N.D. Cal. 1978). 445 Telex Corp. v. International Business Machines Corp., 367 F. Supp. 258 (N.D Okla. 1973). 446 Jefferson Parish Hospital, supra note 289. 443

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Not every refusal to sell two products separately can be said to restrain competition. If each of the products may be purchased separately in a competitive market, one seller’s decision to sell the two in a single package impose no unreasonable restraint on either market, particularly if competing suppliers are free to sell either the entire package or its several parts…. Buyers often find package sales attractive; a seller’s decision to offer such package can merely be an attempt to compete effectively – a conduct that is entirely consistent.447

The Supreme Court focused on the underlying rationale of the rule against tying, namely impairing competition on the merits in the tied market, and approached the definitional questions in relation to the tying criteria, for example, whether two separate products were involved or whether the seller had market power in the tying market, from the position of whether the arrangement may have the type of competitive consequences addressed by the rule.448 In effect, the criteria for illegal tying were used as proxies for anticompetitive harm to provide a safe harbour for some tying arrangements, and to thereby screen out some false positives where noninfringing undertakings are found to have infringed competition rules.449 In determining whether one or two products were involved, the Supreme Court rejected an approach that relied on the functional relationship. Instead, the Court focused on the character of demand for the two products:

In this case, no tying arrangement can exist unless there is a sufficient demand for the purchase of anesthesiological services separate from hospital services to identify a distinct product market in which it is efficient to offer anesthesiological services separately from the hospital services.450

447

Jefferson Parish Hospital, supra note 289, 19. Ibid., 21. 449 Ahlborn, Evans, and Padilla, supra note 282, 297. 450 Jefferson Parish Hospital, supra note 289, 22. 448

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To answer the question of whether there is sufficient demand for the tied product separate from demand for the tying product, the Supreme Court looked at actual market practices for hospitals that did not insist on providing a package including anesthesiological services.451 The use of the tying criteria as proxies for anticompetitive harm also led the Supreme Court to use a definition of economic power that was more focused on the economic concept of market power: “We have condemned tying arrangements where the seller has some special ability – usually called ‘market power’ – to force a purchaser to do something that he would not do in a competitive market.”452 In the Jefferson Parish case, the 30% market share led the Court to conclude that the defendant did not have the requisite market power. 453 It was in this way that the hospital escaped per se illegality. While the Supreme Court in the Jefferson Parish case viewed its separateproduct test as a proxy for anticompetitive harm, the Court of Appeals in the Microsoft case454 pointed out that the separate-product test could also be viewed as a proxy for the net welfare effect of a tying arrangement.455 The reasoning of the Court of Appeals was as follows. Firstly, consumers value choice, “assuming choice is available at zero cost, consumers will prefer it to no choice.” For consumers to relinquish choice and to buy products as a bundle, bundling must provide efficiencies, such as a reduced transaction cost or better performance that will compensate for this reduction in choice. Secondly, the share for consumers buying a bundle rather than individual products gives an indication of the relative strengths of the tying efficiencies compared to the benefits of choice. Where all or almost all consumers 451

Jefferson Parish Hospital, supra note 289, 24. Ibid., 13-14. 453 Jefferson Parish Hospital, supra note 289, 7-8. 454 Microsoft Corp., supra note 313. 455 Ibid. 452

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prefer to buy bundles, there is a strong presumption that the tying efficiencies dominate the consumer choice benefits. Thirdly, it was stressed that “on the supply side, firms without market power will bundle two goods only when cost savings from joint sales outweigh the value consumers place on choice. So bundling by all firms implies strong net efficiencies.”456 The Jefferson Parish case was followed by the Eastman Kodak case457 which dealt with the claim that Kodak had illegally tied the sale of replacement parts for its high-volume photocopier and micrographics equipment (tying product) to the purchase of Kodak’s repair services (tied product). The Supreme Court accepted the possibility of illegal tying even in the absence of market power in the primary market, significantly expanding the scope of illegal tying.458 The modified per se approach under these two cases clearly raised the standard for establishing illegal tying and reduced the risk of false positives. 459 Nevertheless, it remained fundamentally a per se approach.460 It did not assess the impact of the individual tying arrangements in the circumstances of a given case. Moreover, it assumed that on average the anticompetitive harm of tying arrangements is greater than their efficiency gains, at least where the criteria for tying are satisfied.461 As developed in the Jefferson Parish case, the separate-product test acted as a proxy for the effects of tying arrangements on both harm to competitors and consumer welfare. 462 If the separate-product test is not satisfied, i.e. there is no separate demand for the tied product, then this leads to the conclusion that there is no 456

Microsoft Corp., supra note 313, 135. Eastman Kodak, supra note 359. 458 Ibid. 459 Ahlborn, Evans, and Padilla, supra note 282, 300. 460 Ibid. 461 Jefferson Parish Hospital, supra note 289; Eastman Kodak, supra note 359. 462 Ahlborn, Evans, and Padilla, supra note 282, 300. 457

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anticompetitive harm, given that there is no separate market for tied products that could be foreclosed. Moreover, tying is welfare-enhancing. Conversely, if the separate-product test is satisfied, it leads to the conclusion that there could be some anticompetitive harm, and that tying is unlikely to be welfare enhancing. However, whilst a negative result of a separate-product test leads to strong conclusions regarding anticompetitive harm and efficiencies, neither of these is dependent on particular assumptions, a positive result does not lead to any particular conclusion about anticompetitive harm other than that the possibility exists.463 Indeed, the fact that there is separate demand for the tied product, i.e. that customers are willing to purchase the tied product separately, and that some undertakings are offering the tied product separately, only comes to the conclusion that tying is not efficient if both of the two following conditions hold.464 First, the market for the tied product is static and not characterised by innovation. 465 This condition is due to the fact that the separate-product test is backward looking, as the Court of Appeals stated in the Microsoft case:

The direct consumer demand test focused on historic consumer behaviour, and the industry custom test looks at firms that may not have integrated the tying and the tied goods. Both tests compare incomparable – the [tying firm’s] decision to bundle in the presence of integration, on the one hand, and the consumer and competitor calculations in its absence, on the other.466

Thus, the more dynamic the industry, the greater the expected error under the separate-product test.467

463

Ahlborn, Evans, and Padilla, supra note 282, 300. Ibid. 465 Ahlborn, Evans, and Padilla, supra note 282, 301. 466 Microsoft Corp., supra note 313, 140. 467 Ahlborn, Evans, and Padilla, supra note 282, 301. 464

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The second condition is that all undertakings in the market for the tied products have similar characteristics, such as homogeneous cost structure, and they operate in the same circumstances, for instance having an almost identical client base.468 Without this condition it would not be possible to draw any conclusions from the fact that the majority of undertakings in a particular market did or did not bundle certain products, as any difference in strategy could be attributable to differences in characteristics or circumstances.469 In practice, most industries do not satisfy the above conditions. This is particularly true for the information technology industry, which is characterised by a high degree of innovation as well as considerable asymmetry in the characteristics and circumstances of the market players. 470 Therefore, the Microsoft case 471 was predestined to highlight the weakness of the modified per se approach under the Jefferson Parish case due to these underlying assumptions.472

3.3 Rule of Reason Approach

The post-Chicago school adopts Chicago’s central principle that consumer welfare is the sole and relevant consideration, but places less faith in the functioning of the marketplaces. 473 As a result of that, post-Chicago scholars advocate a more interventionist approach, believing that the legal system is capable of correcting distortions more quickly than the market. 474 However, the post-Chicagoan model

468

Ahlborn, Evans, and Padilla, supra note 282, 301. Ibid. 470 Ahlborn, Evans, and Padilla, supra note 282, 301. 471 Microsoft Corp., supra note 313. 472 Ibid. 473 Devlin, supra note 296, 526. 474 Hovenkamp, supra note 253, 267. 469

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does not provide support for a per se prohibition of tying by dominant firms. 475 Instead, their thinking endorses a rule of reason approach. 476 The classic definition of the rule of reason dates back to 1918:

The court must ordinarily consider the facts peculiar to the business to which the restraint is applied; its condition before and after the restraint was imposed; the nature of the restraint and its effect, actual or probable. The history of the restraint, the evil believed to exist, the reason for adopting the particular remedy, the purpose or end sought to be attained, are all relevant facts.477

Therefore, analysis under the rule of reason is effectively open-ended. A full-scale market investigation is necessary and no justifications brought forward by the defendants are excluded a priori. 478 This approach is based on “the renewed recognition of the fact that markets are much more varied and complex.” 479 This corresponds to the increasing refinement of theoretical models and empirical research in industrial economics, which shows that many business practices can in principle have both positive and negative welfare effects.480 The US Department of Justice and 21 States raised a number of antitrust charges against Microsoft, ranging from monopoly leveraging to monopoly 475

Ahlborn, Evans, and Padilla, supra note 282, 328. For more details, David Evans, Jorge Padilla, and Michelo Polo, “Tying in Platform Software : Reason for a Rule-of-Reason Standard in European Competition Law,” World Competition 25, no. 4 (2002): 509-514; Thomas Piraino Jr., “Reconciling the Per Se and Rule of Reason Approaches to Antitrust Analysis,” Southern California Law Review 64 (1991): 685- 739; Ernst Steindoff, “Article 85 and the Rule of Reason,” Common Market Law Review 21 (1984): 639-646; Richard Posner, “The Rule of Reason and the Economic Approach: Reflections on the Sylvania Decision,” University of Chicago Law Review 45, no. 1 (Fall 1977): 1-20; George Stocking, “The Rule of Reason, Workable Competition, and Monopoly,” Yale Law Journal 64, no. 8 (July 1955): 1107-1162; Walter Adams, “The “Rule of Reason”: Workable Competition or Workable Monopoly?” Yale Law Journal 63, no. 3 (January 1954): 348-37 477 Board of Trade of Chicago v. United States, 246 US 231 (1918). 478 Arndt Christiansen and Wolfgang Kerber, “Competition Policy with Optimally Differentiated Rules instead of “Per Se Rules v. Rules of Reason’”” Journal of Competition Law & Economics 2006 (2006): 217. 479 Herbert Hovenkamp, “Post-Chicago Antitrust: A Review and Critique,” Columbia Business Law Review 2001, no. 2 (2001): 268. 480 Christiansen and Kerber, supra note 478, 218. 476

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maintenance and exclusive distribution.481 The plaintiffs also alleged that Microsoft had violated US antitrust law by contractually and technologically bundling Internet Explorer with its Windows operating system.482 The District Court, applying the test under Jefferson Parish, held that the combination of Internet Explorer and Windows met the Jefferson Parish conditions and was therefore illegal.483 However, the Court of Appeals rejected the Jefferson Parish test and concluded that software platforms such as Windows should be subjected to a rule of reason balancing anticompetitive effects and efficiencies.484 In particular, it held that integration of new functionality into platform software was a common practice and that rigid application of per se rules in this litigation may cast a cloud over platform innovation for PCs, network computers and other information appliances.485 According to the Court of Appeals, the Microsoft case was fundamentally different from the previous tying cases addressed by the Supreme Court in at least two respects. This was the first time the tied goods were physically and technologically integrated with the tying goods, and also the first time that it was argued that the tie-in improved the value of the tying product to users and to makers of the complementary goods. 486 As a result of these specific characteristics, the general policy conclusions reached, such as that the efficiencies of tying could be achieved by other less restrictive means, were questionable.487 While the Court of Appeals did not take any view on the validity of the efficiency claims, it came to the conclusion that judicial experience provided little basis for believing that, because of 481

Direct Testimony of Frederick Warren-Boulton, 18 November 1998, United States v. Microsoft Corp., Civil Action Nos. 98-1232 and 98-1233 (TPJ), paras.,19-20, 40-60. 482 Direct Testimony of Franklin Fisher, 5 January 1999, United States v. Microsoft Corp., Civil Action Nos. 98-1232 and 98-1233 (TPJ), paras., 79-81. 483 United States v. Microsoft Corp., 87 F.Supp.2d 30 (D.D.C 2000). 484 Microsoft Corp., supra note 313. 485 Ibid., 159. 486 Microsoft Corp., supra note 313, 144. 487 Ahlborn, Evans, and Padilla, supra note 282, 303.

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the pernicious effect on competition and lack of any redeeming virtue, a software undertaking’s decision to sell multiple functionalities as a package should be conclusively presumed to be unreasonable and therefore illegal without elaborate inquiry as to the precise harm that they have caused or the business excuse for their use.488 In the separate-product test of Jefferson Parish, it operates under the narrow assumption that all competitors are in a similar situation and the markets are static.489 The Court of Appeals argued that the per se rule’s direct consumer demand and direct industry custom inquiries were, as a general matter, backward looking and therefore systematically poor proxies for overall efficiencies in the presence of new and innovative integration.490 It therefore concluded that, in fact, there was merit to Microsoft’s broader argument that Jefferson Parish’s consumer demand test would stifle innovation to the detriment of consumers by preventing undertakings from integrating into their products new functionality previously provided by standalone products, and hence, by definition, subject to separate consumer demand.491 However, Jefferson Parish still represents the general position with respect to US tying cases as the scope of Microsoft was limited by the Court of Appeals to product integration in platform software markets and only then, as a matter of law, in the D.C. Circuit. Thus, it is unclear whether the Microsoft decision can be applied to other tying cases in the IT industry. The criticism of the Court of Appeal concerning the Jefferson Parish test is of a general and universal nature. The rule-of-reason approach may cause legal unpredictability due to its caseby-case consideration, an unpredictability that will be magnified in the fast-moving

488

Microsoft Corp., supra note 313, 144. Ahlborn, Evans, and Padilla, supra note 282, 304. 490 Microsoft Corp., supra note 313, 140. 491 Ibid., 139. 489

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and complex IT industry. Thus, it is necessary for competition authorities to provide the legal predictability as well as to consider the specific characteristics of the IT industry. This suggests that the rule of reason perspective based on the modified per se approach should be the favoured approach in the IT industry.

IV. Economics of Tying: Reasons to Integrate Software

Some of the traditional economic explanations for product tying or bundling are a better fit for the traditional industries than the New Economy industries. 492 The network effects, low marginal costs, and rapid technological change in the New Economy markets create rationales for product integration that are both less familiar and more subtle than the tying or bundling arguments that courts have previously encountered. 493 It is important to establish the range of economic benefits to consumers that may flow from the integration of software products, because those consumer-welfare effects will be the criterion by which courts select the optimal competition rule in this area.494

4.1 Chicago School Explanations

The Chicago School of antitrust analysis produced several economic rationales for why product integration might be pro-competitive or efficiency-enhancing.

4.1.1 Price-Discrimination

492

Sidak, supra note 408, 6. Ibid. 494 The Guidance Paper, supra note 43, para. 5. 493

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The original motivation for product bundling offered by Chicago School economists was price-discrimination.495 The court in the Jefferson Parish case496 recognised that tie-ins between products used in variable proportions may be motivated by the desire to price-discriminate. A tie-in can be used to price-discriminate if: (1) the tying firm possesses market power in the tying product market; (2) the tied and tying products are used in variable proportions and are complementary; and (3) the willingness of consumers to pay for a system depends on, at least to some extent, the number of times they intend to use it.497 The use of tying to bring about price-discrimination is likely to enhance social welfare 498 because it tends to induce the monopolists to increase output to a socially optimal level, which would be obtained under competitive conditions, thus, eliminating the deadweight loss of a single-price monopoly strategy.499 An undertaking that successfully price-discriminates manages to make each consumer pay the most that they are willing to spend for a given product, that is, the consumer’s reservation price.500

4.1.2 Risk Bearing

A strategy of price-discrimination through product bundling may have desirable welfare effects other than the tendency to reduce deadweight loss by increasing

George Stigler, “United States v. Loew’s Inc.: A Note on Block Booking,” Supreme Court Review 1963 (1963): 152-157. 496 Jefferson Parish Hospital Dist. v. Hyde, 466 US 2, 14-15 (1984). 497 Jefferson Parish Hospital, supra note 496, 14-15. 498 “The economic concept of social (or total) welfare is the sum of consumer surplus and producers surplus and that it does not encompass value judgements about how the surplus should be distributed. This does not appear to be the standard or objective used in EU competition law,” in EU Competition Law: Text, Cases, and Materials, 4th ed. Alison Jones and Brenda Sufrin (Oxford; New York: Oxford University Press, 2011), 47. 499 Sidak, supra note 408, 7. 500 Hal Varian, Microeconomic Analysis, 3rd ed. (New York; London: Norton, 1992), 153, 416. 495

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output to the competitive level.501 Because of limited information and risk aversion, consumers might actually favour a pricing strategy for a new product system that would discriminate on the basis of intensity of use.502 For some products, especially brand new ones, a consumer will be uncertain how heavily they will use the product so that ex ante the producer cannot accurately ascertain the price elasticity of demand for the new system, and thus would have trouble identifying a single profitmaximising price. 503 This is especially true for a newly-invented product system since the consumer can only fully evaluate the product’s utility ex post, by actually using the system. This asymmetry of information between producers and consumers is another example of Kenneth Arrow’s general insight that “there is a fundamental paradox in the determination of demand for information; its value for the purchaser is not known until he has the information, but then he has in effect acquired it without cost.” 504 Although it is plausible that a software manufacturer seeks to reduce consumer risk of this sort and that product bundling may facilitate that objective, this result does flow from a strategy of price-discrimination based on metering, as none appears to take place.505

4.1.3 Quality Control

A tie-in can be used to ensure proper performance of a product system, and the usefulness of this quality-control function, which is intended to preclude the consumer’s use of the possibly inferior or incompatible components of other producers, does not depend on whether the tie-in is of a fixed or variable 501

Sidak, supra note 408, 8. Ibid. 503 Sidak, supra note 408, 9. 504 Kenneth J. Arrow, Essay in the Theory of Risk-Bearing (Chicago: Markham, 1971), 152. 505 Sidak, supra note 408, 9. 502

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proportion.506 In the United States v. Jerrold Electronics Corporation case, the court held that service contracts tied to a new antenna system were lawful during the period of the product’s “inception” for quality control. 507 This quality-control function is important when the consumer has a limited understanding of how the system works, and thus might erroneously blame the producer of the system for a malfunction caused by an inferior or incompatible component manufactured by a competitor. 508 In the case of Teleflex Industrial Products, Inc. v. Brunswick Corporation, the court observed:

Although there have been no examples presented by either side of specific incidents of engine failure resulting from the plaintiffs [compatible] instruments malfunctioning, there is ample indication that if and when this may occur, the delineation of responsibility between the plaintiff and defendant regarding who will ultimately bear the liability is far from clear, thus resulting either in customer dissatisfaction, or in the defendant assuming a disproportionate share of the liability, rather than jeopardise its consumer goodwill.509

If the courts are willing to acknowledge the possible value of product bundling when the products are as straightforward as engines and instruments, then this economic rationale in defence of tying should hold with even greater force when the products are software.510 However, for the following reasons, the traditional Chicago School analysis of tying as price-discrimination does not shed light on the technological integration

506

Bork, supra note 364, 379-381. United States v. Jerrold Electronics Corp., 187 F.Supp. 545, 560-561 (E.D. Pa. 1960), aff’d per curiam, 365 US 567 (1961). 508 Jerrold Electronics Corp, supra note 507, 560-561. 509 Teleflex Industrial Products, Inc. v. Brunswick Corporation, 293 F.Supp. 106, 110 (E.D. Pa. 1968). 510 Sidak, supra note 408, 10. 507

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of the New Economy industries. An example of this is Microsoft’s integration of Internet Explorer and Windows Media Player (WMP) into the Windows operating system. Firstly, in the traditional tying case there is a significant incremental cost in adding the tied product to the tying product, and these costs are not reduced substantially as a result of bundling, 511 whereas in the case of software, the incremental costs of adding features or functionalities are low. These low incremental costs can make possible consumer-welfare-enhancing strategies which are not possible for firms that face relatively high incremental costs of product integration. 512 Secondly, the incremental price that Microsoft charged for the integration of Internet Explorer or WMP into Windows operating system was zero.513 So at least in the Microsoft case, it is not the case that product tying enabled the producer to charge supra-competitive prices for the tied good. 514 Thirdly, such bundling does not fit the traditional Chicago School explanation that a tying arrangement facilitates price-discrimination by metering consumer demand. 515 The consumer with a low price elasticity of demand does not purchase multiple Internet Explorer Web browsers or WMPs, nor is their web browser or streaming player priced on the basis of the frequency or intensity of use.516

4.2 Post-Chicago Anticompetitive Explanations

4.2.1 Monopoly Leveraging

511

Direct Testimony of Professor Richard Schmalensee on behalf of Microsoft Corp., 522, United States v. Microsoft Corp., (No. 98-1233) (D.D.C. 1999). 512 Sidak, supra note 408, 8. 513 Ibid. 514 Direct Testimony of Professor Richard Schmalensee, supra note 511. 515 Sidak, supra note 408, 8. 516 Ibid.

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The idea that bundling could extend market power into a second market was largely discredited by the Chicago School.517 In particular, an undertaking with a monopoly in good A gains no advantage by selling good A only as part of a bundle with a competitively supplied good B.518 Because good B is freely available at its marginal cost (as a result of perfect competition), a consumer who buys the bundle would also be willing to buy good A alone at the same profit margin for the monopolist. 519 However, Professor Michael Whinston put forward the Chicago School critique and produced a model showing that this critique of leveraging theory only applies when the tied market is perfectly competitive.520 Whinston’s model shows that tying could be used to deter entry into the tied product market, and thereby monopolise this market if: (1) the selling firm is a monopolist in the tying product market; (2) the tied product market has decreasing average costs over the relevant range of output; and (3) the tied and tying products are used in variable proportions.521 That is, tying commits the monopolist to being more aggressive than the entrant, and this commitment discourages entry.522 In addition, bundling may also give the monopolist a greater incentive to engage in cost-cutting R&D, and thus help to preserve and extend its advantageous position.523 However, Whinston finds that the predicted welfare effects of even that specialised case of tying are ambiguous.524 Since bundling reduces the entrant’s potential profits while mitigating the incumbent’s profit loss if entry occurs,

517

Bork, supra note 364; Posner, supra note 294. Sidak, supra note 408, 10. 519 Ibid., 10. 520 Michael Whinston, “Tying, Foreclosure, and Exclusion,” American Economic Review 80, no. 4 (September 1990): 837-859. 521 Ibid., 854. 522 Whinston, supra note 520, 837-859. 523 Jay Pil Choi and Christodoulos Stefanadis, “Tying, Investment, and the Dynamic Leverage Theory,” RAND Journal of Economics 32, no. 1 (Spring 2001): 52-71. 524 Whinston, supra note 520, 855-856. 518

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it is credible even without any commitment device .525 It is also demonstrated that even if there are no cost savings or value-creating synergies, the incumbent firm still has an incentive to engage in bundling for its entry-deterrence effect.526 A software suite is a good example of this kind of bundling because the marginal costs of producing software are nearly zero. 527 As marginal costs rise, bundling creates inefficiency because some consumers are forced to buy the bundle even though they value the components at below their production costs.528

4.2.2 Preservation of Monopoly

According to Carlton and Waldman, the tying of complementary products can be used to preserve a monopoly position in the market for one of the products. 529,530 Under their work, a monopoly undertaking has an incentive to tie if there is a threat of entry by the alternative producer into the primary market.531 They find tying will preserve monopoly power in the primary market whenever the alternative producer in the tied market faces entry costs, or the demand for the complementary good characterised by network effects. 532 However, both suggest that the competition authorities would have to weigh any potential efficiency from the tying with possible losses. 533 Much of the US government’s economic theory in the 1999 trial of

Barry Nalebuff, “Bundling as an Entry Barrier,” Quarterly Journal of Economics 119. no. 1 (February 2004): 159-187. 526 Ibid., 161. 527 Nalebuff, supra note 525, 162. 528 Ibid. 529 One commentator has dubbed this strategy “dynamic leveraging,” Crocioni, supra note 293, 449; “defensive leveraging,” Robin Feldman, “Defensive Leveraging in Antitrust,” Georgetown Law Journal 87 (1999): 2098-2099. 530 Dennis Carlton and Michael Waldman, “The Strategic Use of Tying to Preserve and Create Market Power in Evolving Industries,” RAND Journal of Economics 33, no. 2 (Summer 2002): 194-220. 531 Ibid. 532 Carlton and Waldman, supra note 530. 533 Ibid., 215. 525

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Microsoft focused on an elaborate version of this theory of anticompetitive tying.534 In this case, one of the economists on behalf of the US government, Sibley, proposed that Microsoft’s actions to put in place contracting restrictions and to distribute the Internet Explorer (IE) browser tied to its Windows operating system (OS) for free were an attempt to preserve its OS monopoly.535 To support his argument, he referred to a monopoly with alleged exclusionary practices in a complementary market that it services, where the general conclusion has been that:

... if the price level in the complement’s market is limited by competitive forces, then in the absence of efficiency justifications ..., the monopolist’s control over the bottleneck input does not give it any profit incentive to restrict or exclude a competitor’s product in the complement’s market. The reason is that control over the bottleneck input allows the monopolist to extract value from consumers no matter whose version of the complementary good the consumer buys. 536

Applied to the Microsoft case, the bottleneck input is Microsoft’s OS and the complementary product is the browser. 537 He explained the competitive threat to Microsoft’s operating system monopoly was led by the competitive browser platform. 538 That is, because the browser can serve as a software applications platform independent of the underlying OS, which means that browsers provide their own application programming interfaces (APIs) for developers, the existence of a competing platform would reduce the applications barrier to entry, especially the installed base entry barrier and the switching costs entry barrier in the Intel534

United States v. Microsoft Corp., 147 F.3d 935 (D.C. Cir. 1998) (No. 98-1233). Declaration of David Sibley, United States v. Microsoft Corp., 147 F.3d 935 (D.C. Cir. 1998) (No. 98-1233), para. 49. 536 Declaration of David Sibley, supra note 535, para. 44. 537 Ibid., para. 45. 538 Declaration of David Sibley, supra note 535, para. 49. 535

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compatible PC operating systems market. 539 Therefore, a new entrant in the OS market would not have to create a substantial installed base of software applications complementary to its OS in its size and use in order to succeed. 540 However, the applications written to the browser platform (perhaps using Sun Microsystems’ Java programming technology) would be accessible to a user using any OS that supported that browser.541 In distributing browsers for free, profits from browsers are usually generated from Internet-related businesses, such as referral fees from Internet access providers (IAPs) and advertising revenues. 542 Professor Sibley proposed that Microsoft had incurred an opportunity cost by foregoing the additional value it could have extracted from consumers, or from original equipment manufacturers (OEMs), IAPs, and Internet content providers (ICPs) that wanted to use Navigator.543 In his proposal, Microsoft was willing to incur that opportunity cost to preserve its alleged OS monopoly: If these restrictions were aimed solely at expanding Microsoft’s profits in Internet-related markets by increasing Internet Explorer (IE) browser usage, it could do better by capturing such profits through the price of its OS, or through selling Internet products tied to the OS (such as desktop space and ISP referral fees).544 At trial, one of the government’s principal critics, Dr. Frederick R. WarrenBoulton, described the basis for the monopoly preservation theory as follows:

Because of the nature of the barriers to entry created by network effects, the most likely long-term threat to Microsoft’s monopoly power does not come directly from other operating systems, but rather from the spread of cross-platform technologies, 539

Declaration of David Sibley, supra note 535, para. 50. Ibid. 541 Declaration of David Sibley, supra note 535, para. 50. 542 Ibid., para. 45. 543 Declaration of David Sibley, supra note 535, para. 48. 544 Ibid., para. 52. 540

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that can serve (like Microsoft’s operating system) as a platform to which application developers write…. Although browsers may never develop into full-fledged operating systems, browsers can serve as a platform to which application developers write. Should application vendors use a browser platform other than the Windows platform, the applications barrier to entry that protects Microsoft’s monopoly could be diminished, and competition in the PC operating system market created.545

In addition Professor Fisher places emphasis on the leveraging theory. He concludes in his direct testimony that:

Microsoft’s conduct has created, preserved, and increased barriers to entry into both the PC operating system market and the Internet browser market and includes tying its browser to the operating system, thereby requiring undertakings to enter successfully the already monopolised operating system market in order to compete successfully with Microsoft in supplying browsers and thus severely hampering Netscape in browser competition.”546

Later, the theory was extended to product integration to preserve the PC operating systems monopoly.547 It was claimed that only in the absence of monopoly power was “bundling … likely to be harmless and…serve legitimate business purposes, because bundling is not a rational anticompetitive strategy for a firm that lacks significant market power.”548 It was contended that Microsoft had an incentive to engage in anticompetitive and unprofitable bundling of its Internet Explorer Web

545

Direct Testimony of Frederick Warren-Boulton, United States v. Microsoft Corp., 147 F.3d 935 (D.C. Cir. 1998) (No. 98-1233), paras. 8-9. 546 Direct Testimony of Franklin Fisher, United States v. Microsoft Corp., 147 F.3d 935 (D.C. Cir. 1998) (No. 98-1233), paras. 22. 547 Franklin Fisher and Daniel Rubinfeld, “United States v. Microsoft: An Economic Analysis,” in Did Microsoft Harm Cinsumers? , ed. David Evans, Franklin Fisher, Daniel Rubinfeld, and Richard L. Schmalensee (Washington D.C.: AEI-Brookings Joint Centre for Regulatory Studies, 2000), 28-29. 548 Ibid.

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browser into the Windows operating system because it had monopoly power over PC operating systems.549

4.3 Post-Chicago Pro-competitive Explanations

The inclusion of Internet-related features in the operating system of a personal computer potentially makes the operating system a better product for Internet service vendors (ISVs) and consumers: adding on various features is ubiquitous in information technology software. Almost all word processor packages have basic spreadsheet components that enable users to perform simple calculations and convert data into various charts and graphics. In these cases, consumers are charged a single price for the product and do not pay extra for particular features of that product, even if earlier versions of that product did not include those features. There are at least three economic reasons why firms in the unquestionably competitive industry bundle features. 550 First, bundling allows the undertaking to respond to the diversity of valuations across software customers; second, bundling stimulates demand for the undertaking’s complementary features and products; and third, bundling generates revenue for the undertaking’s ancillary services.551 In each case, bundling tends to increase demand even if the combination of features included in a product does not improve the performance or quality of the product in a strictly technical sense. Bundling tends to expand output and is therefore pro-competitive.552

549

Fisher and Rubinfeld, supra note 546, 14-15. Steven Davis, Jack MacCrisken, and Kevin Murphy. “Economic Perspective on Software Design: PC Operating Systems and Platform,” August 2001. National Bureau of Economic Research, NBER Working Paper 8411. Available at: http://www.nber.org/papers/w8411.pdf (accessed 27 August, 2009). 551 Sidak, supra note 408, 15. 552 Ibid., 15-16. 550

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4.3.1 Responding to Diversity of Buyer Valuations

Bundling features together increases the number of consumers who will buy a product at a given price. 553 Manufacturers can increase sales by increasing the diversity of buyers to which a product appeals, especially for information goods for which the additional cost to the manufacturer of including and distributing features is low.554 According to Sidak, using newspapers as an example, it can be explained why it makes economic sense for the publisher to include the myriad of sections in The Observer.555 The marginal cost to the newspaper of providing the book review section to someone interested only in the sports section is zero.556 That condition holds regardless of the fact that the Observer Review of Books can exist as a freestanding (unbundled) substitute for the Observer of Book Review. 557 Indeed, the marginal cost to the Observer of stripping the Observer Book Review from the newspaper going to subscribers who read only the sports section would be significant.558 If priced on an avoided-cost basis, the stripped-down Observer would cost more than the fully integrated newspaper.559 Schmalensee explains why this rationale is even more powerful for Microsoft’s bundling of its Windows operating system and Internet Explorer Webbrowsing software:

It is virtually costless to distribute Web-browsing software with the operating system. Although some users may not want to browse the Web or may not want to use the 553

Sidak, supra note 408, 16. Yannis Bakos and Erik Brynjolfsson, “Bundling Information Goods: Pricing, Profits, and Efficiency,” Management Science 45, no. 12 (December 1999): 1613-1630. 555 Sidak, supra note 408, 16. 556 Ibid. 557 Sidak, supra note 408, 16. 558 Ibid. 559 Sidak, supra note 408, 16. 554

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Web-browsing software that is included with the operating system, others will want to browse the Web with the included software. The operating system vendor can therefore increase sales by including Web-browsing software with the operating system. In fact, all major operating system vendors include Web-browsing software with the operating system at no extra charge.560

For example, for a fixed price, Internet Service Providers, such as AOL, provide unlimited access to a wide range of services, including financial market information, weather reports, chat rooms, and e-mail, as well as Internet access. Indeed, AOL and other Internet portals can be regarded as electronic shopping malls that present the consumer with a pre-selected portfolio of services. One would expect Microsoft to integrate additional features into its Windows operating system for the same reason.

4.3.2 Stimulating Demand for Complementary Products and Features

Undertakings also have an incentive to bundle products if they are complements. Suppose that the demand for product B increases if consumers also have product A. If a company produces both products, it has an incentive to lower the price of product A to stimulate sales of product B.561 The company may actually have an incentive to give product A away for free under some conditions. 562 Schmalensee suggests several ways in which demand complementarities give Microsoft incentives to include Internet-related functionality in the Windows operating system. First, demand complementarities may plausibly exist between the operating system and applications software produced by Internet service vendors (ISVs). By including Internet-related functionality in the Windows operating system, Microsoft, in effect, 560

Direct Testimony of Professor Richard Schmalensee, supra note 511, para. 241. Sidak, supra note 408, 17. 562 Richard Schmalensee, “Monopolistic Two-Part Pricing Agreements,” Bell Journal of Economics 12, no. 2 (Autumn 1981): 445-466. 561

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increases the demand for the operating system that runs those applications.563 Second, demand complementarities may plausibly exist between the Windows operating system and applications software produced by Microsoft. By including Internetrelated functionality in the operating system, Microsoft increases the demand for its own applications products that make use of this Internet-related functionality. 564 Third, demand complementarities may plausibly exist between various features within the Windows operating system. The demand for file management and hardware driver features of the operating system may be higher for users who use the Internet. Therefore, by providing Internet-related functionality at no additional cost, Microsoft can increase the demand for the other features of the Windows operating system and thereby increase sales.565

4.3.3 Generating Revenue from Ancillary Services

An undertaking that persuades consumers to use its Web-browsing software can obtain revenue from several different sources. 566 For example, both Netscape and Microsoft sell Internet and intranet server software, Internet commerce applications, and Internet development tools. Similarly, the free distribution of a particular Web browser may enable the firm to generate “revenue streams ‘adjacent’ to the browser itself.”567 The demand for PC operating system software is highly complementary with applications software and Web use and the marginal cost of software production is low, such that pricing these complementary functionalities at zero may be efficient.

563

Direct Testimony of Professor Richard Schmalensee, supra note 560, para. 244. Direct Testimony of Professor Richard Schmalensee, supra note 511, para. 245. 565 Ibid., para. 246. 566 Benjamin Klein, “An Economic Analysis of Microsoft’s Conduct,” Antitrust ABA 14 (Fall 1999): 40. 567 Shapiro and Varian, supra note 48, 294. 564

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Therefore, product integration may be the most efficient means of distribution for the consumer because it “eliminates the time and effort [required] to obtain and install the zero-price item.”568 Schmalensee observed in his 1999 testimony in the Microsoft trial that, during its first two years in business, Netscape earned 27.6 percent of its gross revenues from the sales of such software to undertakings. 569 Because advertising prices rise as more consumers are reached by the advertising and all other factors are held constant, Netscape can earn more advertising revenue from the “free” integration of Navigator into other software products. 570 As a result of these additional revenue sources, the marginal opportunity cost to Microsoft of distributing another copy of Web-browsing software may be negative:

It costs virtually nothing to distribute another copy of the Web-browsing software. But that copy results in nontrivial additional revenue from the sales of ancillary products. It is plausible that the additional revenues exceed the direct cost of distribution, so that the effective cost of distribution of another copy is less than zero (that is, it “pays” rather than “costs” to distribute another copy) …. The “negative marginal cost” of distributing Web-browser software is a further pro-competitive reason for why Microsoft would include such software with its operating system.571

However, Judge Jackson rejected this reasoning when he concluded in April 2000 that Microsoft’s integration of Internet Explorer into Windows 98 constituted attempted monopolisation in violation of Section 2 of the Sherman Act.572

Steve Davis and Kevin Murphy, “A Competitive Perspective on Internet Explorer,” American Economic Review Papers and Proceedings of Ninety-Seventh Annual Meeting of the American Economic Association 90, no. 2 (May 2000): 185. 569 Direct Testimony of Professor Richard Schmalensee , supra note 511, para. 247. 570 Ibid. 571 Direct Testimony of Professor Richard Schmalensee , supra note 511, para. 248. 572 United States v. Microsoft Corp., 87 F. Supp. 2d 30, 38, 44 (D.D.C 2000). 568

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4.4 Evaluation of the Economic Theory on Product Integration

The Chicago School’s influence over competition law has set the consumer welfare573 standard as the benchmark for competition inquiries. The Chicago School approach is aimed at maximising consumer welfare and efficiency. 574 To achieve these goals, Chicagoans look to price theory as the means by which to inform the construction of efficiency and wealth-maximising rules. 575 Therefore, harm to individual competitors and rising market concentration do not raise competition concerns for them.576 Instead, they focus on the question of whether price and quality will be rendered inferior or superior on the basis of the challenged conduct.577 The classic Chicagoan argument is that almost all unilateral business practices do not raise competition concerns, 578 believing that natural market forces provide an appropriate remedy that is superior to the law.579

V. Evaluation of Elements Constituting Tying in Judicial Tests of the EU and the US

The judicial test for tying practices in the European Union follows similar steps to that for tying in the United States.580 There is anticompetitive tying if: (i) the tying and the tied products are two separate (distinct) products; (ii) the undertaking concerned is dominant (or has market power) in the market for the tying product 573

Consumer welfare means total surplus in the Chicago School’s perspective, but in EU competition analysis it means only consumer surplus. 574 Devlin, supra note 296, 526. 575 Ibid. 576 Ball Memorial Hospital, Inc. v. Mutual Hospital Insurance, Inc., 784 F.2d 1325, 1333-1334 (7th Cir. 1986). 577 Alan Meese, “Price Theory and Vertical Restraints: A Misunderstood Relation,” UCLA Law Review 45, no. 1 (October 1997): 152. 578 Richard Posner, “Antitrust in the New Economy,” Antitrust Law Journal 68, no. 3 (2001): 932. 579 Ibid. 580 Nicolas Economides and Ioannis Lianos, “The Elusive Standard on Bundling in Europe and in the United States in the Aftermath of the Microsoft Cases,” Antitrust Law Journal 76 (2009): 518.

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(there is market power in the market for the tying product); (iii) the practice (an agreement or technological integration) does not give customers a choice to obtain the tying product without the tied product (coercion); and (iv) the practice in question forecloses competition (there are anticompetitive effects in the tied market).581 The General Court also accepted in the Microsoft case that the Commission correctly examined the objective justifications of the conduct that were advanced by Microsoft582 and referred to this condition as the fifth step of the analysis.583 The separate/distinct product test fulfils two objectives: first, it is a proxy for efficiency gains, thus excluding from further antitrust assessment practices that have an obvious efficiency justification that benefits consumers; and second, it sets the boundaries of the bundling antitrust category, as opposed to practices involving a single product.584 As for the utility of the coercion requirement, its function is merely to distinguish between different forms of bundling practices, such as technological tying, contractual tying, and mixed bundling (commercial tying).585

5.1 Separate Products Test

The separate products test is the first step of the analysis of anticompetitive tying for the purposes of Articles 101 and 102 TFEU. It is also a requirement in US antitrust law for tying arrangements. This derives from the Jefferson Parish case, one of Section 1 of Sherman Act cases, although case law does not seem to require a separate products test for non-contractual tying under Section 2 of the Sherman Act. 581

Jefferson Parish Hospital, supra note 289; Case T-201/04 Microsoft Corp. supra note 38; The Guidance Paper, supra note 43, paras. 28, 50. 582 Case T-201/04 Microsoft Corp. supra note 40, para. 858. 583 Ibid., para. 869. 584 Economides and Lianos, supra note 580, 519. 585 Ibid.

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The main function of the two distinct products requirement is to serve as a screening device to take into account apparent efficiency gains that follow from the bundling of the two separate products.586 Two items may be considered to be a single product for the purposes of the law of tying when they are subject to certain economies of joint production or distribution that can be achieved only if all customers can be forced to take the entire package.587 In Tetra Pak II, the Court of Justice observed that:

… even where tied sales of two products are in accordance with commercial usage or there is a natural link between the two products in question, such sales may still constitute abuse within the meaning of Article [102 TFEU] unless they are objectively justified.588

This arguably suggests that even if the two items are considered to be a single product for the purposes of tying, it is still possible that Article 102 TFEU will apply if the other conditions of anticompetitive tying are fulfilled. This interpretation finds support in the Microsoft case where the General Court remarked that it is difficult to speak of “commercial usage or practice in an industry that is 95% controlled by Microsoft.”589 The condition of the existence of two separate products will become devoid of purpose if the commercial usage is defined by the practice of a dominant firm in the market.590 Therefore, it seems that if this requirement also applies to the application of Article 102 TFEU in situations of quasi-monopoly position,591 as in the Microsoft case, it is because it fulfils an additional objective other than simply

586

Economides and Lianos, supra note 580, 519. Ibid. 588 Case C-333/94 Tetra Pak, supra note 335, para. 37. 589 Case T-201/04 Microsoft Corp. supra note 40, para. 910. 590 Economides and Lianos, supra note 580, 520. 591 Case C-395/96 Compagnie Maritime Belge Transports SA v. Commission of the European Communities [2000] European Court Reports I-1365, paras. 114-120. 587

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being a screening device for the efficiency of the bundling practice.592 As for the definition of what constitutes a distinct product, the Commission advanced the position in the Microsoft decision that “products are distinct if, in the absence of tying or bundling, from the customers’ perspective, the products are or would be purchased separately.” 593 However, the distinct product test does not necessarily constitute a relevant market test.594 The Guidance Paper relies on direct evidence on the distinctiveness of the products, such as “when given a choice, customers purchase the tying and the tied products separately from different sources of supply.”595 According to the General Court in the Microsoft case, the distinctness of products for the purpose of applying Article 102 TFEU “has to be assessed by reference to customer demand”, and “in the absence of independent demand for the allegedly tied product, there can be no question of separate products and no abusive tying.”596 Nevertheless, in the Microsoft case the Commission did not focus only on customer demand but accorded at least equal importance to the supply side of the tied product’s market:

The distinctness of products for the purposes of an analysis under Article [102 TFEU] therefore has to be assessed with a view to consumer demand. If there is no independent demand for an allegedly “tied” product, then the products at issue are not distinct and a tying charge will be to no avail. The fact that the market provides media players separately is evidence for separate consumer demand for media players, distinguishable from the demand for client PC operating systems. There is, therefore, a separate market for these products. There are vendors who

592

Economides and Lianos, supra note 580, 520. Case T-201/04 Microsoft Corp. supra note 40, para. 910. 594 Economides and Lianos, supra note 580, 520. 595 The Guidance Paper, supra note 43, para. 51. 596 Case T-201/04 Microsoft Corp. supra note 40, para. 917-918. 593

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develop and supply media players on a stand-alone basis, separate from PC operating systems.597

The General Court rejected Microsoft’s argument that the Commission should have examined instead if the tying product was regularly offered without the tied product or whether customers wanted Windows without media functionality. If this were the case, complementary products could not constitute separate products for the purposes of Article 102 TFEU.598 It was the General Court’s view that “[i]t is quite possible that customers will wish to obtain the products together, but from different sources.” 599 The existence of different sources of supply and, in particular, of competing suppliers of the alleged tied product were influential factors in concluding that the products were distinct.600 The General Court followed previous case law of the Court of Justice holding that the presence in the market of independent companies specialising in the manufacture and sale of the tied product constituted serious evidence of the existence of a separate market for that product. 601 The Guidance Paper emphasised again the supply side:

Two products are distinct if, in the absence of tying or bundling, a substantial number of customers would purchase or would have purchased the tying product without also buying the tied product from the same supplier, thereby allowing standalone production for both the tying and the tied product.602

The approach of the General Court makes sense if one considers this element in light

597

COMP/C-3/37.792 Microsoft, supra note 238, paras. 803-804. Case T-201/04 Microsoft Corp. supra note 40, para. 921. 599 Ibid., para. 922. 600 Case T-201/04 Microsoft Corp. supra note 40, para. 932. 601 Case C-333/94 Tetra Pak, supra note 335, para. 36. 602 The Guidance Paper, supra note 43, para. 51. 598

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of the interpretation of the fourth condition in tying - foreclosure of competition.603 The Court of Justice assumed that the foreclosure of competitors in the specific circumstances of this case led to consumer detriment - in the sense that consumers’ choice and innovation were restricted.604 The General Court also noted that IT and communications industries develop rapidly and, over time, separate products might become converged.605 This did not prevent the Court from assessing the existence of distinct products “by reference to the factual and technical situation that existed at the time when ... the impugned conduct became harmful.” 606 The supply-oriented character of the distinct product test is directly related to the emphasis the Courts put on the exclusion of rival suppliers of streaming media players, and it constitutes one of the main points of difference in the interpretation of this test in US antitrust law.607 In US antitrust law, the tying and tied products are separate if “the tying item is commonly sold separately from the tied item in a well functioning market.”608 The test is whether there is sufficient consumer demand in the marketplace to support independent markets despite any efficiencies tying may bring.609 The D.C. Circuit mentioned in the Microsoft case that “perceptible separate demand is inversely proportional to net efficiencies.”610 Separate demand for the tied product indicates that the efficiencies provided by the bundling practice to consumers are limited. However, the existence in the market of independent companies specialising in the manufacture and sale of the tied product does not in itself constitute adequate evidence of a distinct product under US antitrust law.611 Bundling can be efficiency 603

Economides and Lianos, supra note 580, 522. Case C-333/94 Tetra Pak, supra note 335, para. 36. 605 Case T-201/04 Microsoft Corp. supra note 40, para. 913. 606 Ibid., para. 914. 607 Microsoft Corp., supra note 313. 608 Hovenkamp, supra note 253, 415. 609 Microsoft Corp., supra note 313, 87-88. 610 Ibid. 611 Microsoft Corp., supra note 313, 87-88. 604

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enhancing if the tying and the tied products are used in fixed proportions and have no separate utility as the dominant firm has the incentive to tie into the competitive market only if the combination is more efficient.612 By contrast, tying with variable proportions may be a vehicle for price discrimination, and thus lead to a reduction of consumer surplus by profitably extracting consumer surplus from individual buyers.613 This explains why in the US Microsoft case, where Internet Explorer and Windows were used in fixed proportions, the D.C. Circuit found merit in Microsoft’s argument that, in the circumstances of the case, an abstract consumer demand test would stifle innovation to the detriment of consumers by preventing firms from integrating into their products some new functionality that was previously provided by stand-alone products.614 The D.C. Circuit found the Jefferson Parish’s separate products test to be inappropriate:

The per se rule’s direct consumer demand and indirect industry custom inquiries are, as a general matter, backward-looking and therefore systematically poor proxies for overall efficiency in the presence of new and innovative integration. The direct consumer demand test focuses on historic consumer behaviour, likely before integration, and the indirect industry custom test looks at firms that, unlike the defendant, may not have integrated the tying and tied goods. Both tests compare incomparables - the defendant’s decision to bundle in the presence of integration, on the one hand, and consumer and competitor calculations in its absence, on the other …. [b]ecause one cannot be sure beneficial integration will be protected by the other elements of the per se rule, simple application of that rule’s separate-products test may make consumers worse off.615

However, the position of the General Court in the Microsoft case can hardly be

612

Economides and Lianos, supra note 580, 523. Ward S. Bowman, Jr., “Tying Arrangements and the Leverage Problem,” Yale Law Journal 67, no. 1 (November 1957): 20-23. 614 Microsoft Corp., supra note 313, 89. 615 Ibid, 89. 613

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explained by the objective to protect market innovation through product integration. 616 If this were the case, the General Court should have balanced the benefits, from the point of view of the consumers, in having a new integrated product and the costs of the immediate reduction of consumer choice that the bundling of the alleged “distinct products” would have brought. 617 This test could essentially be performed under the step of the analysis of anticompetitive effects (foreclosure of competition). 618 The negative effects on consumers should be balanced against efficiency gains that could be passed on to consumers in the form of new products or those of better quality. 619 The existence of a full “rule of reason test” for technological tying in the United States makes possible the full consideration of these efficiencies without necessarily applying the distinct products test. 620 If the General Court adopted a supply-oriented definition of the distinct product test in the Microsoft case, it is because the main focus of the enquiry was to establish whether competitors could viably (profitably) operate in the tied product market.621 This is relatively easy to prove as the presence in the tied product market of undertakings that offer only the tied product indicates that there is sufficient consumer demand for the tied product without the tying product, and therefore that the two products are distinct.622 There is no point in having a distinct product test if the benefits of the single product for the consumers would in any case be examined in the next step of the analysis under a rule of reason standard.623 Consequently, the General Court assumed that the presence of independent

616

Economides and Lianos, supra note 580, 524. Ibid., 524. 618 The Guidance Paper, supra note 43, paras. 19-22 619 Ibid., para. 30. 620 Economides and Lianos, supra note 580, 524. 621 Ibid. 622 Case T-201/04 Microsoft Corp. supra note 38. 623 Microsoft Corp., supra note 313, 96. 617

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suppliers of the alleged tied product indicated the existence of two distinct products.624 In this sense, the presence of rivals in the tied market constitutes a proxy for potential anticompetitive foreclosure.625 This explains why the General Court did not only focus on identifying an independent consumer demand for the tied product but also looked for evidence that the market included independent companies specialising in the manufacture and sale of the tied product that could have been marginalised or excluded with the tying practice. The distinct product test is therefore intrinsically linked to the General Court’s specific approach in interpreting the requirement of anticompetitive foreclosure.626 This test in EU cases operates as a proxy for anticompetitive effects, whilst the similar test in the US cases indicates the presence of efficiency gains.627

5.2 Coercion Test

It is a common feature in both EU competition law and US antitrust law that bundling of two distinct products does not constitute tying unless there has been an effective limitation of the consumers’ choice or coercion to purchase the products separately.628 The main function of the coercion test is to distinguish between the different forms of bundling, such as by contract, by technological integration, or by financial incentives, and their effects on consumers.629 In EU competition law, there is a tying violation if the undertaking concerned does not give customers a choice to obtain the tying product without the tied 624

Case T-201/04 Microsoft Corp. supra note 38. Economides and Lianos, supra note 580, 525. 626 Ibid. 627 Economides and Lianos, supra note 580, 525. 628 Case T-201/04 Microsoft Corp. supra note 38; Jefferson Parish Hospital, supra note 289, 12-18. 629 Ibid. 625

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product.630 Coercion may arise in several ways. It can result from the refusal of the dominant firm to sell the tying product without the tied one, either as a contractual clause or de facto; from the unavailability of the products separately; from pressure exerted on the customer through the promise of favourable treatment to customers who take both products or threats to those who do not, or from pricing incentives that may be so powerful that no rational customer would choose to buy the products separately.631 In the Microsoft case the General Court took the view that the analysis of whether the dominant undertaking does not give customers a choice to obtain the tying product without the tied product is “merely expressing in different words the concept that bundling assumes that consumers are compelled, directly or indirectly, to accept ‘supplementary obligations,’ such as those referred to in Article 102(d) TFEU.”632 For the General Court, Microsoft had contractually and technically coerced the Original Equipment Manufacturers (OEMs). First, it was not possible for the OEMs to obtain a license on the Windows operating system without Windows Media Player (WMP). Second, it was not technically possible for the OEMs to uninstall WMP. The General Court also noted that coercion of OEMs indirectly restricted the choice of the end consumers.633 Although Microsoft alleged that customers were not required to pay anything extra for WMP, the Court rejected this argument noting that the price of WMP was included in this case in the total price of the Windows client PC operating system. 634 This argument seems paradoxical because the Court had already accepted that the two products were distinct, and it should have therefore

630

Case T-201/04 Microsoft Corp. supra note 38. Hovenkamp, supra note 253, 410-415. 632 Case T-201/04 Microsoft Corp. supra note 40, para. 864. 633 Ibid, para. 965. 634 Case T-201/04 Microsoft Corp. supra note 38. 631

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examined Microsoft’s arguments from that perspective.635 The General Court adopted a broad definition of coercion, stating that “neither Article 102(d) TFEU nor the case law on bundling requires that consumers must be forced to use the tied product or prevented from using the same product supplied by a competitor of the dominant undertaking.”636 The theoretical possibility that consumers were not prevented from installing and using other media players instead of Windows Media Player (WMP) was not sufficient to conclude that there was no coercion as the end consumers had a strong incentive to use WMP.637 The General Court seemed to consider that the alternative offered to consumers to install media players other than WMP should be equivalent with regard to its effectiveness to the pre-installation of media players by the OEMs, which implies a rather strict standard for dominant firms.638 In contrast, the requirement of coercion is not mentioned for tying/bundling practices in the Guidance Paper,639 although it implicitly internalises this condition when it treats technical tying more restrictively than contractual tying, by considering that the risk of anticompetitive foreclosure is expected to be greater in this case.640 Instead, the Commission seems to retain the following four criteria for the application of the bundling test:

(i) The company concerned is dominant in the tying market; (ii) the tying and tied goods are two distinct products; (iii) the tying practice is likely to have a market distorting foreclosure effect; (iv) the tying practice is not justified

635

Economides and Lianos, supra note 580, 529. Case T-201/04 Microsoft Corp. supra note 40, para. 970. 637 Ibid., para. 1042. 638 Economides and Lianos, supra note 580, 530. 639 The Guidance Paper, supra note 43, para. 50. 640 Ibid., para. 53. 636

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objectively or by efficiencies.641

However, the position of the Commission cannot be explained by the case law of the General Court, which does not establish such a distinction between contractual and technical tying. The requirement of coercion is also present in US antitrust law on tying. According to Herbert Hovenkamp:

… this coercion should result from (1) an absolute refusal to sell the tying product without the tied product; (2) a discount, rebate or other financial incentive given to buyers who also take the tied product; (3) technological design that makes it impossible to sell the tying product without the tied product.642

From this it is possible to infer that coercion applies to situations involving commercial tying as well as contractual or technological tying. However, in Cascade Health Solutions, the court distinguished bundled discounts from tying practices by requiring evidence of coercion for tying but not for bundled discounts: “One difference between traditional tying by contract and tying via package discounts is that the traditional tying contract typically forces the buyer to accept both products, as well as the cost savings.” Conversely, the court said that “the package discount gives the buyer the choice of accepting the cost savings by purchasing the package, or foregoing the savings by purchasing the products separately.” The package discount thus does not constrain the buyer’s choice as much as the traditional tying. For that reason, it was stated that: European Commission, “DG Competition Discussion Paper on the Application of Article 82 of the Treaty to Exclusionary Abuses,” December 2005, Brussels, Available at http://ec.europa.eu/compet ition/ antitrust/ art82/discpaper2005.pdf (accessed 12 August, 2009). (Hereafter, ‘Competition Discussion Paper’). 642 Hovenkamp, supra note 253, 410. 641

140

… a variation of the requirement that prices be ‘below cost’ is essential for the plaintiff to establish one particular element of unlawful bundled discountingnamely, that there was actually ‘tying’- that is, that the

purchaser

was

actually

‘coerced’ (in this case by lower prices) into taking the tied-up package.643

When the Ninth Circuit examined the same facts under the tying claim, the court included financial incentives as a form of coercion that could be qualified as unlawful tying, if their effect was to coerce the customers to buy the tying and the tied product.644 Persuasion by financial incentives and coercion have similar effects and the Ninth Circuit was quick to find that PeaceHealth’s practice of giving a larger discount to insurers who dealt with it as an exclusive preferred provider “may have coerced some insurers to purchase primary and secondary services from PeaceHealth rather than from McKenzie.” 645 Indeed, “the fact that a customer would end up paying higher prices to purchase the tied products separately does not necessarily create a fact issue on coercion” and, “additional evidence of economic coercion” is required.646 If coercion can also be established by evidence of economic incentives which have the potential to induce a rational consumer to buy the tying and the tied product together, there is little difference between a tying and a bundled discount claim.647 The Ninth Circuit recognised the problem when it accepted that economic coercion through inducement could be an alternative reason why McKenzie presented its tying claim;

643

Cascade Health Solutions v. PeaceHealth, 515 F.3d 883, 900-901 (9th Cir. 2008). Cascade Health/PeaceHealth, supra note 643, 914. 645 Ibid. 646 Cascade Health/PeaceHealth, supra note 643, 914. 647 Economides and Lianos, supra note 580, 532. 644

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… such a claim might raise the question of whether, to establish the coercion element of a tying claim through a bundled discount, McKenzie must prove that PeaceHealth priced below a relevant measure of its costs. Some commentators would require a plaintiff alleging that a bundled discount amounts to an illegal tie to prove below-cost prices … It is unclear whether the AMC intended its three-part test to apply when a plaintiff alleging an illegal tying arrangement asserts that the defendant’s pricing practices coerced unwanted purchases of the tied product ... The parties have not briefed this issue to us, and the parties did not raise the issue before the district court. We therefore leave it to the district court, if necessary, to decide the issue in the first instance on remand.648

This demonstrates the internal contradiction of the court’s decision. How is it possible to think that coercion distinguishes tying from bundled discounts while considering, at the same time, that bundled discounts may constitute a form of coercion? The Ninth Circuit’s adoption of a different standard for bundled discounts and tying practice is based on unstable grounds, both in terms of law and policy.649 Adopting the modified predatory cost/price standard for bundled discounts would imply the abandonment of the anticompetitive foreclosure test for all exclusionary practices, such as tying and exclusive dealing, in favour of a cost/price predation test or, in other words, of an “as efficient as competitor” test. 650 Although in the Microsoft case the D.C Circuit acknowledged exceptional situations of predatory pricing, it did not apply the predatory pricing test or a modified version of it for the non-price exclusionary practices and bundling. 651 The choice between the two analogies, price predation versus anticompetitive foreclosure, is an issue that is not only linked to the apparent need to build safe harbours for “efficient” pricing

648

Cascade Health/PeaceHealth, supra note 643, 916. Ibid. 650 Economides and Lianos, supra note 580, 533. 651 Microsoft Corp., supra note 313, 96-97. 649

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practices of dominant undertakings but is also related to the theory of competition that underscores the enforcement of Section 2 of the Sherman Act and Article 102 TFEU.652

5.3 Anticompetitive Foreclosure

The competitive assessment of bundling practices requires analysis of the foreclosure of competition in the tying or tied market in both EU and US competition laws. The meaning of the concept of anticompetitive foreclosure has been one of the most controversial issues in antitrust law enforcement, not only for bundling but also for all types of exclusionary practices. An important aspect of this debate has been the definition of a limiting principle for competition law enforcement.653 For bundling practices, the debate over the adequate standard of foreclosure has focused on the following two questions: (i) should the foreclosure effect be presumed from the nature of the bundling practice and/or the existence of a tying market power (dominant position)?; and (ii) in what circumstances does the foreclosure of a competitor from the tied product market harm consumers?654

5.3.1 Foreclosure and the Nature of Bundling

There are two competition law standards, the effect-based approach and the formbased approach, which can be employed to evaluate bundling practices. The former requires an examination of the effects of a practice before concluding that it is anticompetitive, whilst the latter focuses on the nature of the practice before arriving 652

Economides and Lianos, supra note 580, 533-534. Ibid., 533-534. 654 The Guidance Paper, supra note 43, para. 30. 653

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at any conclusion with regard to its anticompetitive effects. 655 A form-based approach is not necessarily incompatible with the analysis of the anticompetitive effects of a practice.656 Nevertheless, instead of analysing the effects of the specific practice within the specific market context (an ex post and concrete analysis), the competition authorities or the judges characterise the practice as falling within an ex ante pre-defined category of practices that are generally deemed, from previous practical experience or because of their opposition to a fundamental aim of competition law, to produce anticompetitive effects (abstract/categorical analysis).657 Both jurisprudence on tying and bundling practices illustrate the evolution of competition standards towards a more effects-based approach although judicial decisions have often developed without much concern for analysing anticompetitive effects.658 . In the Jefferson Parish case, the Supreme Court adopted a modified per se test for contractual tying.659 There was a presumption of anticompetitive effects whenever an undertaking with market power employed bundling practices that had the effect of foreclosing competitors from a significant market share in the tied product market,660 of extracting consumer surplus,661 or of raising barriers to entry in both the tying and the tied markets.662 In the Microsoft case, the D.C. Circuit moved to a rule of reason test for software bundles that required plaintiffs to demonstrate that the benefits of the tying practice were outweighed by the damage to the tied product market.663 This is essentially a cost/benefit analysis test that fully takes into account the efficiency gains to the benefit of consumers and allocates the legal 655

Economides and Lianos, supra note 580, 534. Ibid. 657 Economides and Lianos, supra note 580, 534-535. 658 Ibid., 535. 659 Jefferson Parish Hospital, supra note 289, 12-18. 660 Fortner Enterprises, supra note 419. 661 Jefferson Parish Hospital, supra note 289, 14-15. 662 Eastman Kodak,supra note 359. 663 Microsoft Corp., supra note 313, 95-97. 656

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burden of proof to the plaintiff. The plaintiff “must demonstrate that the anticompetitive harm of the conduct outweighs the pro-competitive benefit.” 664 However, it is on the defending monopolist to “proffer a ‘pro-competitive justification’ for its conduct.”665 The burden then shifts back to the plaintiff to rebut that claim and to prove that “the anticompetitive harm of the conduct outweighs the pro-competitive benefit.”666 This cost/benefit analysis test, and accompanying burden shifting, also applies to bundled discounts. 667 In essence, the anticompetitive foreclosure test in the United States looks to the anticompetitive effects of the practice and concludes that there is anticompetitive foreclosure only when the benefits of a practice do not outweigh its costs, from the point of view of the consumers. The position of EU competition law was initially quite hostile to any form of tying.668 In Hilti and Tetra Pak II, the Commission and the EU Courts applied a quasi-per se test and found that by imposing on their customers numerous obligations that had no link with the purpose of the contracts, the dominant undertakings in question had restricted the market access of their competitors and had deprived consumers of any freedom to make their own choices.669 Consequently, if there were independent producers in the tied product market, it was required that dominant undertakings abstain from any conduct, such as contractual tying or technological integration, which would have the effect of restricting the freedom of these independent producers to compete in the tied market.670 664

Ibid., 59. Microsoft Corp., supra note 313, 59. 666 Ibid., 59. 667 LePage’s Inc. v. 3M, 324 F.3d 141, 163-164 (3rd Cir. 2003). 668 Valentine Korah, An Introductory Guide to EC Competition Law and Practice, 8th ed. (Oxford: Hart Publishing, 2004), 142. 669 IV/30.787 and 31.488 Hilti, supra note 306, para. 75; Case T- 83/91 Tetra Pak supra note 320, para. 140; Case C-333/94 Tetra Pak, supra note 335, para. 36. 670 Economides and Lianos, supra note 580, 536. 665

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Dominant undertakings may argue that there is an objective justification for their conduct. However, older case law has restrictively interpreted this concept, believing that it only has broad non-economic public policy concerns such as safety or health factors related to the dangerous nature of the product in question and does not actually include an efficiency defence.671 The two steps in the abuse control test of Article 102 TFEU are as follows:

Article [102 TFEU] covers practices which are likely to affect the structure of a market where, as a direct result of the presence of the undertaking in question, competition has already been weakened and which, through recourse to methods different from those governing normal competition in products or services based on traders’ performance, have the effect of hindering the maintenance or development of the level of competition still existing in the market.672

As a first step, the abuse test involves assessing whether the conduct is of a type “likely” or “such as” to affect the structure of an otherwise concentrated market and which constitutes a business method “different from those governing normal competition

in

products

or

services

based

on

traders’

performance”

(abstract/categorical analysis) that would initially require the classification of the practice into a specific antitrust category. In the second step, the competition authorities or courts will examine the anticompetitive effects of the specific practice (fact-based analysis). 673 The first prong of this abuse test, abstract/categorical analysis, implies that for certain practices there is a prima facie presumption of anticompetitive effect when the firm has a dominant position.674

Albertina Albors-Llorens, “The Role of Objective Justification and Efficiencies in the Application of Article 82 EC,” Common Market Law Review 44 (2007): 1727-1761. 672 Case 322/81 NV Nederlandishe Banden Indstrie Michelin v. Commission of the European Communities [1983] European Court Reports 3461, para. 70. 673 Giorgio Monti, EC Competiotn Law (Cambridge: Cambridge University Press, 2007), 171. 674 Economides and Lianos, supra note 580, 537. 671

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The case law of the EU Courts is ambiguous as to which practices are presumptively anticompetitive in the abstract/categorical analysis part of the abuse test.675 Certain forms of practices, such as tying, loyalty rebates, predatory prices, and exclusive dealing obligations imposed by dominant firms, are often analysed as being anticompetitive and therefore infringing Article 102 TFEU by their nature and effect.676 It is true that the case law does not always require the examination of the existence of actual anticompetitive effects, as these follow from the qualification of the conduct as being tying, a loyalty rebate, or predatory pricing.677 In other words, it is sufficient to show that the abusive conduct of the undertaking in a dominant position tends to restrict competition or that the conduct is capable of having that effect.678 This classification or characterisation process that precedes the assessment of the anticompetitive effects of the conduct plays an important role.679 However, it is not clear what the Court of Justice meant by “methods different from those governing normal competition in products or services based on traders’ performance.”680 The Guidance Paper, in fact, refers to certain circumstances where it would not be necessary to carry out a detailed assessment before concluding that the conduct in question is likely to result in consumer harm.681 It is true that the Commission considers that the anticompetitive effect will be inferred in this case, as that type of conduct can only raise obstacles to competition without adding any efficiency gain. One could argue, however, that these points made by the Commission do not affect the theoretical possibility of dominant 675

Ibid. Case C-468/06 to C-478/06 Sot. Lélos kai Sia EE v. GlaxoSmithKline AEVE Farmakeftikon Proionton [2008] European Court Reports I-7139, para. 50. 677 Case T-203/01 Macnufacture Française des Pneumatiques Michelin v. Commission of the European Communities [2003] European Court Reports II-4071, para. 239. 678 T-203/01 Michelin, Ibid., para. 239. 679 Economides and Lianos, supra note 580, 538. 680 Ibid. 681 The Guidance Paper, supra note 43, para. 22. 676

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undertakings citing efficiencies, particularly as it remains possible for conduct leading to anticompetitive foreclosure to be justified by the objective necessity defence and efficiencies, before finding the existence of an abuse of a dominant position. 682 The Commission does not explicitly exclude these practices from objective necessity and efficiencies in the Guidance Paper. Although, in practice, it seems unlikely that these supposed efficiencies will be accepted, as they fail to comply at the very least with the first two cumulative conditions of the efficiency defence under EU competition law.683 The Court of Justice implicitly recognised that certain types of conduct, such as a restriction of parallel trade, may create a presumption of negative effects on consumers and therefore shift the burden of proof to the defendant, without it being necessary for the claimant to bring additional evidence on the causal link between the specific conduct and consumer harm.684 Despite the language employed, however, the Court of Justice immediately recognised that this does not amount to an absolute presumption of consumer harm or a per se prohibition. 685 The presumption of anticompetitive effects may still be rebutted by the defendant in limited circumstances. For example, a company must be “in a position to take steps that are reasonable and in proportion to the need to protect its own commercial interests.”686 The first prong of the abuse test, abstract/categorical analysis, does not therefore establish a per se prohibition of certain commercial practices, including tying or bundling.687

682

The Guidance Paper, supra note 43, paras. 83, 84. Ibid., paras. 83, 84. 684 Case C-468/06 to C-478/06 GlaxoSmithKline, supra note 676, paras. 56-57. 685 Ibid., para. 57. 686 Case C-468/06 to C-478/06 GlaxoSmithKline, supra note 676, para. 69. 687 Economides and Lianos, supra note 580, 539. 683

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In theory, many commercial practices may have the effect of excluding competitors from the market or substantially hindering their ability to compete. The test is unworkable without a limiting principle that could provide dominant undertakings with the ability to identify, ex ante, whether their commercial practices could be considered illegal.688 This is where recourse to an effects-based approach makes a difference. In an effects-based approach, the identification of a specific practice as coercive or abnormal should not lead to a presumption of anticompetitive effects and consumer harm.689 It only indicates that the fact finder should examine the existence of consumer harm according to different markers other than purely non-coercive unilateral abuses such as refusals to deal. 690 The latter are subject to a test of indispensability as access is provided only if the resource is considered indispensable for the continuation of the activity of the excluded undertaking, or of a price/cost test measuring the relative efficiency of the excluded or marginalised undertaking as a filter for a more detailed competition law assessment.691 There is no such filter for coercive abuses, as there is a greater likelihood that consumer choice is affected.692 However, this is only the case if there is an identifiable detriment to the consumer, either direct, empirically verified, or indirect, involving a plausible theory of consumer harm that the practice could be contrary to Article 102 TFEU. 693 Identifiable efficiency gains such as lower costs or better quality inputs that are likely to be passed on to the final consumer should mitigate anticompetitive effects. This balancing test or cost/benefit analysis will ensure that practices that could enhance

688

Ibid. 545. Economides and Lianos, supra note 580, 545. 690 Ibid. 691 Economides and Lianos, supra note 580, 545-546. 692 Ibid., 546. 693 Economides and Lianos, supra note 580, 546. 689

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consumer choice in the long run are not prohibited under Article 102 TFEU without a more careful analysis of their effects on the final consumer.694 In the Microsoft case, the Commission, did not base its decision on the traditional theory of tying which advocates a quasi-per se illegality test if the undertaking employing the tying practices holds a dominant position, thus inferring anticompetitive foreclosure from these two elements. Instead it proceeded to the second limb of the abuse test:

There are indeed circumstances relating to the tying of WMP which warrant a closer examination of the effects that tying has on competition in this case. While in classical tying cases, the Commission and the Courts considered the foreclosure effect for competing vendors to be demonstrated by the bundling of a separate product with the dominant product, in the case at issue, users can and do to a certain extent obtain third party media players through the Internet, sometimes for free. There are therefore indeed good reasons not to assume without further analysis that tying WMP constitutes conduct which by its very nature is liable to foreclose competition.695

In the Microsoft case, in relation to technological tying, the Commission thus seemed to apply a structured rule of reason approach by examining the anticompetitive effects of the practice, including the efficiency justifications argued by Microsoft and its incentives to foreclose, before concluding that this conduct infringed Article 102 TFEU. 696 The General Court accepted the position of the Commission, but used language that limited the scope of the structured rule of reason approach in situations of technological tying.697 It stated that:

694

Economides and Lianos, supra note 580, 546. COMP/C-3/37.792 Microsoft, supra note 238, para. 841. 696 COMP/C-3/37.792 Microsoft, supra note 238. 697 Case T-201/04 Microsoft Corp. supra note 38. 695

150

… while it is true that neither [the] provision nor, more generally, Article [102 TFEU] as a whole contains any reference to the anticompetitive effect of bundling, the fact remains that, in principle, conduct will be regarded as abusive only if it is capable of restricting competition.698

The General Court referred to the Michelin case to substantiate this point. This case stood for the proposition that “establishing the anticompetitive object and the anticompetitive effect are one and the same thing.”699 The following paragraph from the Microsoft decision also illustrates the ambivalence of the General Court’s approach with regard to the applicable competition standard for technological tying:

The applicant cannot claim that the Commission relied on a new and highly speculative theory to reach the conclusion that a foreclosure effect exists in the present case. As indicated at recital 841 to the contested decision, the Commission considered that, in light of the specific circumstances of the present case, it could not merely assume, as it normally does in cases of abusive tying, that the tying of a specific product and a dominant product has by its nature a foreclosure effect. The Commission therefore examined more closely the actual effects which the bundling had already had on the streaming media player market and also the way in which that market was likely to evolve.700

It follows that although the General Court did not reject the structured rule of reason approach of the Commission with regard to technical tying, it maintained its previous quasi-per se illegality approach for all other forms of bundling, essentially contractual tying. In sum, in examining the existence of the fourth step of a tying claim, the General Court did not presume that there was foreclosure of competition from the simple fact that a dominant undertaking tied two distinct products. Instead, it found 698

Ibid., para. 867. T-203/01 Michelin, supra note 672, para. 241. 700 Case T-201/04 Microsoft Corp. supra note 40, para. 868. 699

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that one had to determine if the foreclosure of competitors led to anticompetitive effects and if there were objective or efficiency justifications.701 It seems, therefore, that the analysis of objective or efficiency justifications constitutes a necessary complement to the analysis of an anticompetitive foreclosure. 702 This in turn implicitly injects a structured rule of reason approach into the analysis of technological tying. Objective or efficiency justifications raise the issue of who has the burden of proof of the anticompetitive effects and objective justifications, and how much evidence is required.703 The Court explained the position clearly with regard to the issue of the burden of proof:

Although the burden of proof of the existence of the circumstances that constitute an infringement of Article 102 TFEU is borne by the Commission, it is for the dominant undertaking concerned, and not for the Commission, before the end of the administrative procedure, to raise any plea of objective justification and to support it with arguments and evidence. It then falls to the Commission, where it proposes to make a finding of an abuse of a dominant position, to show that the arguments and evidence relied on by the undertaking cannot prevail and, accordingly, that the justification put forward cannot be accepted.704

The General Court seems to distinguish between the legal burden of proof that is borne by the plaintiff and the evidential burden of proof of objective justifications that is borne by the defendant. If the defendant raises these objective justifications, the burden shifts to the plaintiff. The position is not very different from that prevailing in US antitrust law.705 There are, however, important dissimilarities with

701

Case T-201/04 Microsoft Corp. supra note 40, para. 852. The Guidance Paper, supra note 43, paras. 28-31. 703 Economides and Lianos, supra note 580, 550. 704 Case T-201/04 Microsoft Corp. supra note 40, para. 1144. 705 Microsoft Corp., supra note 313, 59. 702

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regard to the standard of proof for objective justification, that is, the amount of evidence required by the defendant to substantiate efficiency gains.706 The Guidance Paper subjects efficiencies justifications to four cumulative requirements:

The dominant undertaking will generally be expected to demonstrate, with a sufficient degree of probability, and on the basis of verifiable evidence, that the following cumulative conditions are fulfilled: - The efficiencies have been, or are likely to be, realised as a result of the conduct. They may, for example, include technical improvements in the quality of goods, or a reduction in the cost of production or distribution; - The conduct is indispensable to the realisation of those efficiencies: there must be no less anticompetitive alternatives to the conduct that are capable of producing the same efficiencies; - The likely efficiencies brought about by the conduct outweigh any likely negative effects on competition and consumer welfare in the affected markets; - The conduct does not eliminate effective competition, by removing all or most existing sources of actual or potential competition.707

According to the Guidance Paper, the dominant undertaking should provide all the evidence in order to objectively justify its alleged conduct, and then the Commission should make an assessment by weighing up anticompetitive effects and efficiencies.708 In practice, it would be very difficult for a dominant undertaking to prove the existence of objective justifications, the control and the conditions for such a defence being at least as restrictive as the conditions of Article 101(3) TFEU.709 In contrast, the standard of proof for anticompetitive foreclosure and consumer harm is particularly low as there is no need to prove the existence of an actual or direct

706

Microsoft Corp., supra note 313. The Guidance Paper, supra note 43, para. 30. 708 Ibid., para. 31. 709 Case C-95/04 British Airways, supra note 379, para. 86. 707

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consumer detriment.710 Thus, there is an important asymmetry between the standard of proof that is required from the plaintiff and the standard of proof required by the defendant, to the benefit of the former.711 This asymmetry of the standard of proof between the plaintiff and the defendant in EU competition law is the principal reason why it is normatively undesirable to adopt a presumption of consumer harm when an undertaking with a dominant position employs tying/bundling practices subject to the assessment of efficiency justifications.712 Relying only on market power and absence of objective justifications may increase the risk of false positives because of the asymmetry of the standard of proof between anticompetitive effects and objective justifications in EU competition law. 713 Hence, because of this specific asymmetry in the standard of proof, the requirement of anticompetitive foreclosure on top of market power and/or a dominant position, may reduce the risk of over-inclusive antitrust standards for tying/bundling practices. 714 This approach will be compatible with the emphasis given by EU competition law to consumer welfare and competition as a process of rivalry rather than on consumer surplus and competition as an efficient outcome, which explains the first prong of the abuse test in Article 102 TFEU.715 The plaintiff should bring evidence that the competitors will be excluded or marginalized as a consequence of the tying/bundling practice. It is true that this requirement will not take into account two of the “power effects” of tying, which are that “tying can profitably allow price discrimination among buyers of the tying product”, and that

710

Ibid., para. 106. Economides and Lianos, supra note 580, 551. 712 Einer Elhauge, “Tying, Bundled Discounts, and the Death of the Single Monopoly Profit Theory,” Harvard Law Review 123 (December, 2009): 442-451. 713 Economides and Lianos, supra note 580, 552. 714 Ibid. 715 Economides and Lianos, supra note 580, 552. 711

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tying can “profitably permit price discrimination across buyers of both products.”716 Since Article 102 TFEU does not prohibit the acquisition or exercise of market power but only its abuse, proof of foreclosure of rivals should form a necessary step of the analysis of tying/bundling or loyalty rebates.717 However, foreclosing on a competitor is not sufficient for inferring consumer harm.718

5.3.2 Anticompetitive Effects: Consumer Detriments

Proving anticompetitive foreclosure requires an analysis of the concrete effects of the practice adopted by the alleged monopolist or dominant undertaking719 although the EU Courts have rejected this. It is therefore necessary to analyse how the specific practice may affect consumers. Merely excluding or foreclosing on competitors is not sufficient to substantiate a claim of anticompetitive foreclosure. The denial of market access to rivals does not in itself constitute evidence of anticompetitive foreclosure, but only a starting point for the analysis of exclusionary abuses.720 Both EU competition law and US antitrust law require a case to show anticompetitive harm that links the exclusion of the competitors to the existence of a consumer detriment or to a negative consumer welfare effect. “Leveraging”, for example, constitutes anticompetitive harm in Europe, although it seems to be controversial in the United States. 721 Anticompetitive leveraging was one of the main theories of harm advanced by the Commission in the Microsoft case.722 The General Court also 716

Elhauge, supra note 712, 404-405. Ibid. 718 Elhauge, supra note 712, 404-405. 719 Guidelines on the Assessment of Non-Horizontal Mergers under the Council Regulation on the Control of Concentrations between Undertakings [2008] Official Journal of European Union C256/6, para. 18. 720 Economides and Lianos, supra note 580, 553. 721 COMP/C-3/37.792 Microsoft, supra note 238. 722 Ibid., para. 982. 717

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relied on the same theory of anticompetitive harm723 and confirmed, on this basis, the substantial fine imposed by the Commission.724 In the US case against Microsoft, Judge Jackson of the D.C. District Court dismissed the separate claim of monopoly leveraging.725 Although the US Supreme Court revived a version of the leverage theory in the Eastman Kodak case,726 it has recently held in the Trinko case where for a leverage claim to succeed there must be a “dangerous probability of success in monopolising a second market.” 727 The existence of market power in an adjacent market does not seem to be a requirement for the application of the leverage theory in the European Union.728 Consequently, the standard of proof for leverage claims is higher in the United States than in Europe.729 The EU and the US approaches also diverge with respect to the analysis of the anticompetitive effects. The Commission claimed in its Microsoft decision that the tying of WMP had not only foreclosed competition in the media player market730 but also had “spill-over effects on competition in related products such as media encoding and management software (often server-side)”, as well as “in client PC operating systems for which media players compatible with quality content are an important application.” 731 The Commission found the following anticompetitive effects:

Microsoft uses Windows as a distribution channel to ensure for itself a significant 723

Case T-201/04 Microsoft Corp. supra note 40, paras. 1344 and 1447. Ibid., para. 1363. 725 United States v. Microsoft Corp., No. CIV.A. 98-1232 (TPJ), 1998 WL 614485 (D.D.C. September 14, 1998). 726 Eastman Kodak, supra note 359. 727 Verizon Communications Inc. v. Law Offices of Curtis V. Trinko, LLP., 540 US 451, 497 (2004). 728 Case T-201/04 Microsoft Corp. supra note 40, para. 599. 729 Economides and Lianos, supra note 580, 554. 730 COMP/C-3/37.792 Microsoft, supra note 238, paras. 835-954. 731 COMP/C-3/37.792 Microsoft, supra note 238, para. 842. 724

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competitive advantage on the media players market; because of the bundling, Microsoft’s competitors are a priori at a disadvantage even if their products are inherently better than Windows Media Player; Microsoft interferes with the normal competitive process which would benefit users by ensuring quicker cycles of innovation as a consequence of unfettered competition on the merits; the bundling increases the content and applications barriers to entry, which protect Windows, and facilitates the erection of such barriers for Windows Media Player; Microsoft shields itself from effective competition from vendors of potentially more efficient media players who could challenge its position, and thus reduces the talent and capital invested in innovation of media players; by means of the bundling, Microsoft may expand its position in adjacent media-related software markets and weaken effective competition, to the detriment of consumers; by means of the bundling, Microsoft sends signals which deter innovation in any technologies in which it might conceivably take an interest and which it might tie with Windows in the future.732

The General Court conducted a limited analysis of the alleged anticompetitive effects. It concluded that “there was a reasonable likelihood that tying Windows and Windows Media Player would lead to a lessening of competition so that the maintenance of an effective competition structure would not be ensured in the foreseeable future.”

733

The General Court used the expression “reasonable

likelihood” of anticompetitive effects, instead of the expression “capable of having” anticompetitive effects, which it had used in previous decisions.734 It also used the expression “actual effects” when it referred to the Commission’s analysis of the anticompetitive effects of bundling. 735 However, the General Court revealed that most of these negative effects on consumers were indirect and emanated from the fact that Microsoft, as compared with its media player competitors, benefited from an “unparalleled advantage with respect to the distribution of its product” that

732

Case T-201/04 Microsoft Corp. supra note 40, para. 1088. Ibid., para. 1089. 734 Case T-219/99 British Airways, supra note 379, para. 293. 735 Case T-201/04 Microsoft Corp. supra note 40, para. 1035. 733

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“inevitably had significant consequences for the structure of competition” on the streaming media player market.736 Specifically, the bundling of Windows and WMP allowed WMP to benefit “from the ubiquity of that operating system on client PCs, which cannot be counterbalanced by the other methods of distributing media players.”737 There was a risk that Windows Media Player would become the de facto standard for the media player market as a result of Microsoft’s leveraging of its quasi-monopoly from the PC operating system market to the media player market. Although the General Court accepted that “standardisation may effectively present certain advantages”, it did not accept that an undertaking in a dominant position could impose that by means of tying.738 The emergence of a de facto standard should be the result of competition between the “intrinsic merits” of the products and depends on the consumers’ choice rather than being due to the arbitrary decision of a dominant undertaking which imposes its own standard.739 Secondly, Microsoft’s bundling practice would have restricted consumers’ access to similar or better quality products than WMP.740 Because of the bundling practice, “consumers have an incentive to use Windows Media Player at the expense of competing media players, notwithstanding that the latter players are of better quality.” 741 The General Court based this finding on the comparative reviews of media players presented by Microsoft during the administrative procedure before the Commission’s decision. These comparative reviews indicated that WMP was of

736

Ibid., para. 1054. Case T-201/04 Microsoft Corp. supra note 40, para. 1036. 738 Ibid., para. 1152. 739 Case T-201/04 Microsoft Corp. supra note 40, paras. 1040 and 1046-1047. 740 Ibid., para. 1356. 741 Case T-201/04 Microsoft Corp. supra note 40, para. 971. 737

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lower quality than some of the other excluded media players, having achieved a lower rank than RealPlayer in more than half of these reviews.742 Thirdly, the ubiquity of WMP as a result of its bundling with Windows was capable of having “an appreciable impact on content providers and software designers” because of the significant “indirect network effects” (“positive feedback loop”) that existed in the WMP market.743 It was thought that the greater the number of users of a given software platform there are, the more will be invested in developing products compatible with that platform, which in turn will reinforce the popularity of that platform with users (Application Barriers).744 There is evidence that content providers and software developers choose the technology for which they develop their own products on the basis of the percentage of consumer installation and use. 745 Because of additional development and administrative costs, the developers are inclined to use only one technology for their products. Encoding streamed content in several formats is expensive and time-consuming, and these costs may not be outweighed by the advantages of increasing the potential reach of content providers and software developers’ products.746 The General Court concluded that the ubiquity of WMP on Windows PCs “secured Microsoft a competitive advantage unrelated to the merits of its products” and erected a barrier to entry to new “contenders”, not only on the media players market but also “on other adjacent markets”, such as “media players on wireless information devices, set-top boxes, digital rights management (DRM) solutions and on-line music delivery.”747 The evolution of the market consistently pointed to “a

742

COMP/C-3/37.792 Microsoft, supra note 238, paras. 949-951. Case T-201/04 Microsoft Corp. supra note 40, paras. 1060-1061. 744 Ibid. 745 Economides and Lianos, supra note 580, 557. 746 Case T-201/04 Microsoft Corp. supra note 40, paras. 1065-1066. 747 Case T-201/04 Microsoft Corp. supra note 40, paras. 1069 and 1076. 743

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trend in favour of usage of [WMP] and Windows Media formats to the detriment of the main competing media players (and media technologies)”, such as RealPlayer and QuickTime Player.748 Furthermore, RealPlayer’s installed base was significantly lower than that of WMP, as it was present on only 60 to 70 percent of home PCs in the United States, while the rate of installation of WMP was 100 percent on Windows client PCs and more than 90 percent on all client PCs, including nonWindows machines.749 Significantly, the General Court does not discuss the existence of direct consumer harm, but it instead seems to infer consumer detriment from the alteration of the competitive structure of the media player market.750 This is in conformity with the approach generally followed by the EU Courts for exclusionary abuses under Article 102 TFEU. 751 The preservation of the competitive process constitutes an important objective of EU competition law. 752 Thus, the Court of Justice and the General Court take a long-term view of consumer detriment, and favour the protection of competitors instead of short-term efficiencies. 753 This approach contrasts with the dominant approach of the US courts that require evidence of at least an increase in prices or a reduction of output in the market.754 The perspective of the EU Courts is that competition is a process of discovering the most efficient solution that benefits consumers, and that restricting competition, in the sense of less rivalry in the market, is presumed to reduce efficiency and be detrimental to consumers in the long term, in particular if the undertaking has an overwhelmingly dominant position. The obvious shortcoming of 748

Ibid., paras. 1078-1081. Case T-201/04 Microsoft Corp. supra note 40, para. 1087. 750 Ibid., para. 1087. 751 Case C-95/04 British Airways, supra note 379, para. 106. 752 Opinion of Advocate General Kokott in Case C-95/04 British Airways, supra note 379, para. 68. 753 Economides and Lianos, supra note 580, 558. 754 Microsoft Corp., supra note 313, 84. 749

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this approach is the absence of clear boundaries for competition law enforcement.755 This approach may also explain why EU competition law considers that anticompetitive effects may result not only from practices that restrict output or increase prices, but also those that restrict more broadly consumer choice or sovereignty.756 However, it is not clear if consumer choice is valued as such, or if it is preserved only when more choice is likely to lead to identifiable consumer benefits, such as better quality products, low prices, and/or additional services.757 The General Court’s Microsoft decision seems to indicate that choice was valued with the purpose of preserving the continuing offer in the market of media players that was at least of similar, if not better, quality than WMP.758 The language used by the General Court seems to indicate that the preservation of consumer choice is linked to the preservation of the competitive structure of the market and the protection of competitors.759 If this interpretation is correct, then there is ultimately little difference between the previous quasi-per se illegality approach for tying and the General Court’s position in Microsoft on technological tying.760 A possible limiting principle to the expansive approach of the General Court with regard to the scope of Article 102 TFEU is the unique character of the Microsoft case. 761 The General Court considered that the ubiquity of Windows granted Microsoft’s WMP an overwhelming distribution advantage, compared to other media players. 762 In other words, the existence of important network effects provided Microsoft with the opportunity to extend its quasi-monopoly to other markets and to

755

Economides and Lianos, supra note 580, 558. The Guidance Paper, supra note 43, para. 19. 757 Economides and Lianos, supra note 580, 559. 758 Case T-201/04 Microsoft Corp. supra note 40, para. 1356. 759 Economides and Lianos, supra note 580, 559. 760 Ibid. 761 Economides and Lianos, supra note 580, 559. 762 Case T-201/04 Microsoft Corp. supra note 38. 756

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exclude even products of equal or superior quality. 763 Without employing the essential facilities terminology, the General Court concluded that it would have been very difficult, or even impossible for other media players to compete on equal terms with WMP without having effective access, meaning without additional costs to the final consumer, to the Windows platform. 764 The protection of the competitive process seems in this case to be intrinsically linked to the concept of consumer sovereignty as consumers’ effective choice would have been limited by Microsoft’s “artificial selection” of media player.765 The emphasis given to the protection of the competitive process is therefore explained by the presumption that the extension of Microsoft’s quasi-monopoly to the media player market would marginalise all existing or potential competition and could therefore lead to consumer harm.766 The assumption is that competition guarantees consumer sovereignty or choice, and, ultimately consumer welfare in the long term, while a monopoly does not.

VI. Framework of Technological Integration in New Economy Markets

In the New Economy markets, it is misguided and potentially harmful to consumer welfare to dwell on the question of whether tying products and tied products are or are not “separate products” for the purposes of tying law, since the very definition of the relevant product may be in a state of continuous change.767 There are two broad difficulties with such inquiry. First, merely to cast the legal analysis in terms of the separateness or cohesiveness of two “products” is to inject an implicit and biased economic assumption that technology in the market in question is static rather than 763

Ibid. Case T-201/04 Microsoft Corp. supra note 38. 765 Ibid. 766 Economides and Lianos, supra note 580, 559. 767 Sidak, supra note 408, 26. 764

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dynamic. 768 Second, the question of separate products has become an intellectual exercise which is required to do all the heavy lifting for a competition standard that otherwise fails to ask the pertinent economic questions that affect consumer welfare.769 This deficiency in the doctrinal intellectual method becomes especially apparent in cases involving technologically dynamic markets, where courts seem to struggle to prevent obvious consumer harm by engaging in increasingly metaphysical inquiries into the integration and separability of products. 770

Therefore, the

competition standard to identify separability of products reflects dynamic and flexible characteristics in the New Economy markets. These should include a technology convergence in these markets as well. In a technologically dynamic market, a more specialised competition analysis of product integration would be required after the four elements of tying in both jurisdictions had been proven. The inherent flexibility, in particular, of software design should be considered. The first additional step must ask whether the market in question is technologically mature or technologically dynamic. 771 If the market is technologically mature, then the traditional four-part test for tying applies.772 In such a market, products are well-defined, both by the consumer demand that they satisfy, and by the production technology through which undertakings supply them. 773 In such a market, as opposed to a technologically dynamic market, it is far more likely that a court can conclude with confidence that the tying product and the tied product are indeed separate products. On the other hand, if the market is technologically dynamic, additional elements are required before an instance of product integration

768

Ibid. Sidak, supra note 408, 26. 770 Ibid. 771 Sidak, supra note 408, 26. 772 Ibid. 773 Sidak, supra note 408, 26. 769

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can be found to be anticompetitive. 774 In such a case, competition exists for the market in a Schumpeterian sense. Consumer welfare will depend to a greater extent on competiveness with respect to non-price variables, such as quality and innovation. 775 Competition for the market can be viewed as a contest to define entirely new demand curves or to push existing demand curves outward with vastly improved combinations of price and performance.776 Jefferson Parish’s analysis of the “character of demand” is incomplete and ambiguous. 777 Consumers and producers are still in the midst of discovering what the “character of demand” is likely to be.778 Any tying rule that ignores this condition of demand uncertainty runs a great risk of harming consumers.779 A second additional step, must ask whether it is plausible that consumers will benefit from the product integration in question.780 Such consumer benefits can come from lower costs, increased demand, or both. 781 Increased demand results from product integration if there is superadditivity of demand across two outputs, when they are produced as an integrated product. 782 The increased demand may result because the product definition has changed as a result of the integration in a manner that produces more satisfaction or utility for consumers.783 Otherwise, it may result because the integration of two goods reduces the cost to the consumer of engaging in additional product assembly or integration. 784 Alternatively, the increased demand may result from some factor that is impossible to predict a priori, but which is

774

Ibid. Schmalensee, supra note 190, 192-196. 776 Sidak, supra note 408, 28. 777 Ibid. 778 Sidak, supra note 408, 28. 779 Ibid.. 780 Sidak, supra note 408, 28. 781 Ibid., 30. 782 Sidak, supra note 408, 30. 783 Sidak, supra note 408, 30. 784 Ibid. 775

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reflected, ultimately and objectively, in consumers’ willingness to pay more. 785 Lower costs result from product integration if there is subadditivity of costs across two outputs.786 Subadditivity of costs is present if an undertaking with a given cost function “has lower costs than would an allocation of output among two or more undertakings using the same cost function.”787 In other words, it is more efficient for the single undertaking to produce two items as an integrated product than it is for multiple undertakings to produce one separately from the other.788 Such efficiencies are also known as economies of scope. The undertaking’s technology is said to exhibit economies of scope when it is less costly for one firm to produce a set of goods jointly than for distinct firms to produce individual goods or subsets of goods separately.789 The analysis of cost subadditivity also implicitly answers the question of who, the producer or the consumer, is the more efficient integrator of individual functionalities.790 Although it may be feasible for the consumer to integrate separate functionalities, the consumer may not be the lower-cost integrator.791 The superior efficiency of the producer depends on economies of scale and scope, as well as learning-by-doing effects that allow the producer’s unit cost of product integration to fall over time with its level of cumulative output.792 Although the government agreed that there was some benefit to Microsoft’s product integration, it seemed to regard such a benefit as insufficient or illegitimate. This was because the integration created a monopoly that impeded competition. This in turn denied consumers access to some alternative market structure in which the government hypothesised that software 785

Sidak, supra note 408, 30. Ibid. 787 Gregory Sidak and Daniel Spulber, Deregulatory Takings and the Regulatory Contract: The Competitive transformation of Network Industries in the United States (Cambridge: Cambridge University Press, 1997), 20. 788 Sidak, supra note 408, 30. 789 Sidak and Spulber, supra note 787, 22. 790 Sidak, supra note 408, 30. 791 Ibid., 30. 792 Sidak, supra note 408, 30. 786

165

would be even more advanced and prices even lower than what Microsoft had actually produced through its integration of software.793 Some may argue that, even though an instance of product integration benefits consumers by achieving subadditive costs, superadditive demand, or both, such integration will preserve a monopoly that the producer possesses over the tying product.794 This concern rests on the theoretical possibility that software integration may tend to preserve a Windows OS monopoly over PC operating systems by discouraging the development of alternative platforms made possible by middleware. Of course, if no reduction in competition in the tying product’s market is discernible, then the inquiry ceases and the tying arrangement is deemed lawful. On the other hand, if a reduction in competition is discernible, then the court’s inquiry advances to the next step, which concerns the ultimate impact of the product integration on consumer welfare.795 The final supplemental element in establishing an unlawful tying arrangement in a technologically dynamic market is a net loss in consumer welfare. 796 This determination requires the court to compare the welfare losses to consumers from reduced competition in the market for the tying product with the welfare gains to consumers from the creation of subadditive costs, superadditive demand, or both.797 A finding of liability follows only if the first amount outweighs the second. Williamson demonstrated the effects on consumer welfare of a merger that restricts output by raising prices and lowers marginal costs by achieving certain productive

793

Ibid. Crocioni, supra note 293, 461. 795 Sidak, supra note 408, 31. 796 Ibid. 797 Sidak, supra note 408, 31. 794

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efficiencies.798 To defend a merger, according to Williamson, the merging parties must demonstrate that the cost savings achieved through greater efficiencies exceed the deadweight loss (the amount above costs that consumers would be willing to pay for the lost output) to consumers.799 The Department of Justice and the Federal Trade Commission have since embraced the Williamsonian welfare trade-off for both vertical and horizontal merger analysis. 800 Also, Robert Bork has stated that Williamson’s insight can be extended to any antitrust analysis.801

VII. Remedies in Technological Integration

Computer software is frequently distributed in two versions; a basic version that may be free and a full-featured version at a cost. The actual software delivered may be identical for both the basic and full-featured versions. An end user upgrades from the basic version by paying a fee and receiving a password to unlock the additional features. The Microsoft antitrust cases emphasise the importance of how access and permission is organised. The tying claim in the US case turned on how Microsoft had organised the relationship, both technical and financial, between Windows OS and Internet Explorer. In the EU case, the focus was on the same questions regarding Windows OS and Windows Media Player (WMP). However, it is argued that the ideas of tying and bundling are too crude to help understand these situations.802 The software with zero marginal cost increments to the good makes tying and bundling Oliver Williamson, “Economies as an Antitrust Defense: The Welfare Tradeoffs,” American Economic Review 58, no. 1 (1968): 21. 799 Ibid., 18-36. 800 Section 4 of 1984 Merger Guidelines, US Department of Justice, Available at http://www.justice.gov/atr/hmerger/11249.htm (accessed 27 August, 2009) 801 Bork, supra note 364, 108. 802 Randal Picker, “Pursuing a Remedy in Microsoft: The Declining Need for Centralised Coordination in a Networked World,” Journal of Institutional and Theoretical Economics 158 (2002): 134. 798

167

particularly elusive.803 It is suggested that presence, visibility, and price should be focused on.804 Presence is about where software is located, whether it comes on the Windows CD, or it is preinstalled by an Original Equipment Manufacturer (OEM).805 In other words, it is the way the software is distributed. Prior to the Internet, Microsoft enjoyed a substantial distributional advantage in being able to incorporate new software into Windows. The existence of the Internet, where software can be downloaded easily, should diminish that advantage. However, the evidence in the EU case suggests that Microsoft still enjoys a powerful distributional advantage over its software competitors.806 Microsoft can easily make software present by just folding new software into Windows.807 Visibility is distinct from presence, i.e. software can be present but invisible.808 Microsoft Word comes with numerous features, but the average user only ever sees a handful.809 Indeed, the current interface of Microsoft Word recognises this and “evolves” to track a customer’s usage patterns by only showing on menus features that a customer uses frequently.810 Software can also be visible but not present.811 Some features in software are listed as being available for use, but in truth they need to be installed on first use, either from a CD or over the network. Finally, price focuses on the question of whether a separate charge is required to use the software.812 Windows is designed as a trademarked product sold for one price. Microsoft does sell what it calls a “personalisation pack” and an “enhancement pack” for Windows operating system, such as “Home” edition and

Randal Picker, “Unbundling Scope-of-Permission Goods: When Should We Invest in Reducing Entry Barriers?” University of Chicago Law Review 72, no. 1 (Winter 2005): 198. 804 Picker, supra note 802, 134. 805 Picker, supra note 803, 198. 806 COMP/C-3/37.792 Microsoft, supra note 238. 807 Ibid. 808 Picker, supra note 803, 199. 809 Ibid. 810 Picker, supra note 803, 199. 811 Ibid. 812 Picker, supra note 803, 199. 803

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“Professional” edition. An end-user cannot buy Windows operating system a la carte and pay a reduced price if, for example, a customer never wants to print anything. The distinction between visibility and presence with regard to Windows Media Player is one of the key lines of separation between the US and EU Microsoft cases.813 In the EU case, Microsoft argued that the US case remedy sufficed as to media players.814 Under the US remedy, OEMs could sell computers without visible access to WMP and could make other media players the default installation. 815 Critically, at least from the EU’s perspective, this meant that the underlying code for WMP would continue to be present on the machines shipped by OEMs.816 The US approach limits the extent to which courts intrude into product design. Although the District Court had proceeded on an analysis of per se liability, the D.C. Circuit had overturned the original finding of liability for tying Internet Explorer to Windows.817 The Court of Appeals had found that Microsoft’s commingling of browser functionality code with operating system code was monopolising conduct that violated Section 2, lacking any efficiency justification. 818 The case for requiring unbundling was particularly true given the presumed cost of requiring Microsoft to redesign Windows, a cost the government plaintiffs had acknowledged when they proposed the original decree to Judge Jackson.819 Further, there was the technical problem of specifying exactly what code constituted “the browser” and how one would specify it in a way that would enable Microsoft to comply with an injunction

813

Ibid. COMP/C-3/37.792 Microsoft, supra note 238, para. 796. 815 State of New York v. Microsoft Corp. 231 F. Supp. 2d 144, 177 (D.D.C. 2002). 816 Ibid., para. 798. 817 Microsoft Corp., supra note 313, 89. 818 Microsoft Corp., supra note 313. 819 Plaintiff’s Memorandum in Support of Proposed Final Judgement, United States v. Microsoft Corp., 97 F.Supp.2d 59 (Nos. 98-1232 & 98-1233), Available at http://www.justice.gov/atr/cases /f219100 /219107.pdf (accessed 28 August, 2009). 814

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that required such code to be removed from Windows without disabling it.820 Thus, Microsoft is free to commingle software codes at will and to reuse chunks of code to provide different functionalities. 821 At the same time, the remedy controls the visibility of pieces of the code.822 This is one approach to software; the user has the right to use the code that is present, but the transaction costs of using it are higher because the code is not visible to the end user.823 By making it possible for computer sellers to reduce the visibility of software functions such as Internet Explorer, the ability of browser competitors to place their software on the desktop may be enhanced.824 In the EU case, the Commission sought to create competition at the computer seller level by requiring Microsoft to create two different versions of Windows, one with WMP and one without (“Windows and Windows-N”). 825 Under the remedy, Microsoft would not be required to charge different prices for the “with” and “without” versions, and Microsoft would be allowed to negotiate with OEMs to have the “with” version installed on desktops. 826 As a consequence of that, Microsoft would have to bargain with OEMs to get WMP on the desktop, just as RealNetworks, Apple, and all of the other media player companies currently bargain to get their software distributed. Notwithstanding the fact that Windows is one of the best possible vehicles for distributing software, Microsoft enjoyed a huge competitive advantage in being able to fold WMP into Windows. When it added software to Windows it could be assured that software would become widely distributed as the

Harry First and Andrew Gavil, “Re-framing Windows: The Durable Meaning of the Microsoft Antitrust Litigation,” Utah Law Review 2006 (2006): 692. 821 Picker, supra note 803, 200. 822 Ibid. 823 Picker, supra note 803, 200. 824 Ibid. 825 COMP/C-3/37.792 Microsoft, supra note 238. 826 Ibid., para. 959. 820

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next version of Windows rolled out, prior to the recent antitrust actions. One measure of this is the distributional deal cut by RealNetworks with Compaq. 827 The Commission characterised that deal as “a revenue sharing model of not insignificant relevance”,828 and RealNetworks’ revenue sharing as an example of “the significant additional cost that tying imposes on Microsoft’s rivals.”829 With WMP already on the system, an OEM will focus on the incremental costs and benefits of adding a second media player. Incremental benefits could arise if the second media player has more features than WMP or taps into music not released in a format supported by WMP. The incremental costs of the second media player are typically extra support and training costs. 830 Without WMP installed, adding RealPlayer would almost certainly be a net positive; with WMP installed, adding RealPlayer may very well be a net negative for the OEM.831 The power to distribute is valuable, and firms routinely get paid for distribution. Therefore, the deal between RealNetworks and Compaq looked much like a standard carriage deal. However, with Windows, Microsoft has its own distribution channel, and Microsoft does not have to strike separate distribution deals. WMP’s presence does make it somewhat more expensive for a media player competitor to enter,832 but it would be a mistake to measure that entry barrier by the size of the observed payments by media player firms to OEMs.833 Pure distribution payments probably represent the lion’s share of those payments, viz. in the Commission’s versioning remedy, the distribution payments suggest that media player software is under-distributed.834 In a

827

COMP/C-3/37.792 Microsoft, supra note 238, para. 856. Ibid. 829 COMP/C-3/37.792 Microsoft, supra note 238, para. 856. 830 Ibid., para. 852. 831 Picker, supra note 803, 204. 832 Ibid., 205. 833 Picker, supra note 803, 205. 834 Ibid. 828

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competitive market, the price of distribution should reflect the marginal cost of distribution.835 If hard disk space is free, the key cost of distribution is the extra support calls that come with having more than one media player installed. If it is right that RealNetworks’ payments to Compaq exceed those costs, then market power is exercised in distributing ‘free’ software such as media players, and that software is under-distributed.836 A second route available to the Commission was a mandatory versioning.837 This is a ‘must-carry’ remedy, meaning that Microsoft would have to distribute one or more media players with Windows if Microsoft wanted to bundle WMP with Windows. The must-carry remedy would directly mitigate the ubiquity advantage that the Commission thought would tip the media platform format war. It would also mitigate the market power that may be being exercised by OEMs in the deals that they strike to distribute software. However, there is the concern about market engineering in the must-carry. In the US Microsoft case, the court held that “the Department of Justice explained its decision not to pursue the States’ proposed Java must-carry provisions: “It is not the proper role of the government to favour one competitor over others, or one potential middleware platform over others.”838 Media player distributors may not just choose media player developers and give them mustcarry rights in perpetuity.839 They must also decide the number of media player slots in Windows and the mechanism to allocate the rights to those slots. This is a way of

835

Picker, supra note 803, 205. Ibid. 837 European Commission Press Release, Commission Gives Microsoft Last Opportunity to Comment Before Concluding Its Antitrust Probe (Europa 6 August, 2003), Available at http://europa.eu.int/ rapid/pressReleasesAction.do? reference=IP/03/1150 (accessed 10 December, 2004). 838 Microsoft Corp., 373 F.3d 1199, 1239-1240. (Nos. 02-7155 and 03-5030) (Decided 30 June, 2004). 839 Picker, supra note 803, 205. 836

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deciding who will get the gains from the slots’ allocation. Certainly, OEMs would be compensated for the extra support costs.840 In the US, under the Telecommunications Act of 1996, a new entry to telecommunication market has sought to create facilities-based competition, that is, competition between telecommunications companies each of which has its own equipment and lines. That has proved hard to do and most of the facilities-based competition that has emerged is intermodal competition, that is, competition between the local telephone incumbent and cable companies and new wireless systems.841 The must-carry remedy is a lower-cost facilities-based competition in the computer software industry as compared with the standards of telecommunications.842 There will be a little extra support costs in having multiple media players installed on a computer. 843 By bundling other media players with Windows, Window Media Player’s competitors would have the same “reach” as WMP. Furthermore the problem of missing Application Programming Interfaces (APIs) would be avoided.844 That means developers would be encouraged to write for various media players. However, the mandatory versioning approach fragments the media player base, making it harder for any developer to rely on a particular API.845 Hence, the mustcarry approach would have to be applied whilst somehow circumventing the fragmentation problem.846

840

Ibid. Douglas Lichtman and Randal Picker, “Entry Policy in Local Telecommunications: Iowa Utilities and Verizon,” Supreme Court Review 2002 (2002): 90-91. 842 Picker, supra note 803, 206. 843 Ibid. 844 Picker, supra note 803, 206. 845 Ibid. 846 Picker, supra note 803, 206. 841

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Another concern is that the must-carry could be regarded as compelled speech.847 In Microsoft’s case, the state and federal antitrust authorities sought to impose on Microsoft an obligation to carry Netscape. That injunction would be analogous to requiring The Times or The Daily Mail, perhaps because of the size of its “installed base” of subscribers, to carry the stories or editorials or advertisements of a less-read newspaper, such as the Manchester Evening News. The mandatory access that the US Department of Justice sought for Netscape’s Internet browser on Microsoft’s Windows platform would directly regulate the content of protected speech. 848 The injunction sought by the Department of Justice against Microsoft would compel Microsoft “to utter the speech of another” by requiring Microsoft to publish

and

advertise

Netscape’s

Internet

browser

on

the

Windows

platform. 849 Indeed, in its complaint against Microsoft, the Department of Justice itself remarked upon “the valuable real estate that the [Windows] desktop screen represents for the provision of software, advertising and promotion.”850 The mustcarry provision of the desired injunction against Microsoft would be “a direct, purposeful regulation of the content of fully protected speech.” 851 The injunction would tell Microsoft what applications it must include on the Windows platform, “even though [Microsoft] would not voluntarily carry such programming and even though its forced inclusion may lead to the exclusion of programming unfavoured by [the government].” 852 Thus, it would not be in accordance with the constitutional

Abbott Lipsky Jr. and Gregory Sidak, “Essential Facilities,” Stanford Law Review 51, no. 5 (May 1999): 1187-1248. 848 Ibid. 849 Lipsky and Sidak, supra note 847, 1242. 850 Complaint, para. 100, in United States v. Microsoft Corp., No. 98-1232 (D.D.C. filed 18 May, 1998). 851 Appellant National Cable Television Association, Inc.’s Brief, Turner Broadcasting Systems Inc. v. Federal Communications Commission, 819 F. Supp. 32, 16 (D.D.C. 1993) (No. 93-44). 852 Ibid. 847

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principles to impose the mandatory carry remedy on Microsoft.853 With respect to competing in the marketplaces, while the cable system may have common carriage aspects, restricted freedom of speech, Microsoft’s Windows does not need, as a prerequisite to conducting business, any license, franchise, certificate of public convenience and necessity; nor does Windows use any government-licensed spectrum or public right of way. 854 Microsoft is not a common carrier, and the injunctions sought by the Department of Justice and the states attorneys general would not have the practical effect of making Microsoft one, as those desired remedies would impose on Microsoft the duty to carry only the Internet browsers of Netscape and at most one other company. Thus, an alternative approach will be needed, since freedom of speech strictly limits the power of government to order Microsoft to open the Windows platform to third parties wishing to disseminate their own messages (browsers or media players) over that medium of expression (Windows). The third route is that Microsoft be required to produce two versions of Windows, viz. one with Windows Media Player completely unbundled, and a second that would include new features yet to be developed, called “Media Player Centre” that would permit consumers to access and download media player software of their choice.855 Although the Commission also required Microsoft to offer an unbundled

853

Lipsky and Sidak, supra note 847, 1244. Ibid., 1246. 855 English Version of the Korea Fair Trade Commissions Microsoft Decision, The Findings of the Microsoft Case (7 December, 2005), 3-4, Available at http://ftc.go.kr/data/hwp/micorsoft_case.pdf (accessed 24 August, 2009); The Koera Fair Trade Commission (KFTC) also investigated Microsoft’s specific practices in Korea: (1) Microsoft’s tying of its Window Media Service to the Window Server operating system, where Microsoft has market dominance; (2) tying WMP to the Windows PC OS, where Microsoft has monopoly power; and (3) tying of its instant messaging programme to the Windows PC OS, where Microsoft has monopoly power. The KFTC concluded that Microsoft had abused its dominant position in violation of the Korean Monopoly Regulation and Fair Trade Act. For remedying these conducts, the KFTC chose a different and more tailored path than the Commission. With respect to bundling of Windows Media Service with Windows Server OS, the KFTC ordered Microsoft to completely unbundle. For tying WMP and instant messaging to Windows PC OS, the 854

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version to provide OEMs and consumers with the option of purchasing Windows without Media Player, it permitted Microsoft to continue marketing its Media Player bundled with its Windows operating system at the same time.856 The remedy to date appears to have been a failure in the sense that there has been little interest in licensing the unbundled version.857 This may be largely due to the fact that there was no requirement that the stripped down version be licensed with more favourable pricing.858 Priced equally, the choice between the bundled and unbundled product is no choice at all and as a consequence of that, Microsoft perpetuates the strategy of raising rivals’ costs to gain access to the desktop.859 These new additions to Windows would “contain links to web-pages that allow consumers to download competing media players, so that competing software can be equally installed into Windows PC operating system.”860 Media Player Centre would function as a portal to the competitive offerings of many suppliers, including Microsoft. 861 Instead of being bound to Microsoft’s offerings, consumers would make their own choices conveniently from the desktop. Although this remedy could be faulted for foisting a choice upon consumers that some might not want, it would directly lower the transaction costs associated with accessing alternative media players and thus neutralise any inherent benefit Microsoft possessed by virtue of its

KFTC took a different approach . Like the Commission, it ordered Microsoft to produce two versions of its PC OS, but instead of requiring an equally priced bundled and unbundled version, it required an unbundled version, for consumers that prefer not to have an instant messenger or a media player, and another version to include “Media Player Centre” and “Messenger Centre,” Thus consumers can download competing media players and instant messengers. 856 COMP/C-3/37.792 Microsoft, supra note 238. 857 First and Gavil, supra note 820, 717. 858 Ibid. 859 First and Gavil, supra note 820, 717. 860 English Version of the Korea Fair Trade Commissions Microsoft Decision, The Findings of the Microsoft Case (7 December, 2005), 3-4, Available at http://ftc.go.kr/data/hwp/micorsoft_case.pdf (accessed 24 August, 2009). 861 First and Gavil, supra note 820, 717.

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monopoly control of the desktop.862 Not content with ignoring the installed base of customers with bundled software, the remedy also called for Microsoft to provide Media Player Centre via CD or Internet updates, so all Windows users would benefit from the newly accessible alternatives. 863 This kind of complete unbundling approach reflects in part the way that the Commission’s approach was not working to reinvigorate competition impaired by Microsoft’s conduct, but it also reflects the fact that neither was the United States’ hands-off approach in the context of browser competition. 864 The complete unbundling approach was similar in spirit but less invasive than the “must-carry” remedy that was originally sought by the US government plaintiffs in the US Microsoft case.865

VIII. Conclusion

Under Article 102 TFEU, EU competition regime views technological integration as almost illegal per se if certain conditions are present. First, there must be two separate products. Second, the undertaking must be dominant in the tying product market. Third, the customer must be coerced into purchasing the two products together. Fourth, the tying must be likely to foreclose effective competition, and finally, there must be no objective justification for technological integration. The US assessment is more or less the same as the EU’s.866 However, their argument remains

862

First and Gavil, supra note 820, 717. English Version of the Korea Fair Trade Commissions Microsoft Decision, The Findings of the Microsoft Case (7 December, 2005), 4, Available at http://ftc.go.kr/data/hwp/micorsoft_case.pdf (accessed 24 August, 2009). 864 First and Gavil, supra note 820, 718. 865 Ibid. 866 Microsoft Corp., supra note 313. 863

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that antitrust enforcement was a crude and slow tool, ill-suited for rapidly changing IT markets.867 In the Microsoft case, the feared foreclosure on the tied market was mainly due to Microsoft’s quasi-monopoly in the operating systems markets and network effects in this market. Many presumed that owing to the fast pace of technological change, the evolution of the software industry would easily outpace antitrust litigation. 868 It was believed that the industry was operating on “Internet Time”, whilst the courts were operating on “Legal Time.” 869 However, since the US Department of Justice brought its Microsoft case in May 1998, for more than a decade Microsoft’s share of the Intel-compatible PC operating system market has remained above ninety percent. Similarly, despite the more recent challenge from Mozilla’s Firefox and Google’s Chrome Internet browsers, Microsoft’s share of the browser market has remained around fifty percent.870 The hailstorm of innovation once predicted by Microsoft’s own witnesses, from the Internet and from Linux, simply has not developed into any serious challenge to Microsoft’s market hegemony in the PC operating system market. More recently, Apple was using its nearmonopoly in the MP3 player market to achieve a monopoly in the music download market by tying Apple’s media gadgets, such as iPod, iPhone, and iPad, with iTunes, its online music store. Technological advances have surely been significant during that time, but from a competition perspective, little of importance has changed.871 Competition policy did move too slowly to protect effective competition. 872 The 867

First and Gavil, supra note 820, 721. Ibid. 869 Cusmo and Yoffie, supra note 99. 870 Netmarketshare, Available at http://www.netmarketshare.com/browser-market-share.aspx?qprid=0 (accessed 21 August, 2011):Total global market share is Microsoft Internet Explorer-52.71%, Firefox21.47%, Chrome-13.49%, Safari-8.10%, Opera-1.65%, Opera Mini-1.25%, Other-1.31% (Data provided by RealTimeStats.com) 871 First and Gavil, supra note 820, 722. 872 Ibid. 868

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nascent competitive threat of Netscape’s Navigator and Sun’s Java was successfully extinguished by Microsoft. Excess caution by competition authorities and courts at that moment, for fear of a ‘false positive’ or Type 1 error, inherently favours the incumbent at the expense of competition.873 An approach more sensitive to both the cost of lost competition and the difficulty of reconstructing it once vanquished would recognise that to some degree “the defendant is made to suffer the uncertain consequences of its own undesirable conduct.”874 Technological integration could have anticompetitive as well as some efficiency justifications in New Economy markets. Because of this, competition authorities are increasingly looking at this practice in technologically dynamic markets on a case-by-case or rule of reason basis.875 However, this type of approach might cause legal uncertainty or unpredictability for market participants. Lacking a definitive standard, courts will not be able to provide consistent outcomes in markets that tend toward monopoly. Thus a more structured standard is needed to make the boundary of legal integration clear, where the reduction in consumer choice is considered to be like the reduction of consumer welfare in the long term. Also it is crucial for competition authorities to recognise that the consumer welfare effects of product integration in technologically mature markets differ considerably for those in technologically dynamic markets. As long as the law of tying arrangements fails to make that distinction, it is as likely to harm consumer welfare in the New Economy as to enhance it.

Andrew Gavil, “Exclusionary Distribution Strategies by Dominant Firms: Striking a Better Balance,” Antitrust Law Journal 72 (2004): 80. 874 Microsoft Corp., supra note 313, 79. 875 European Commission, Competition Discussion Paper, supra note 641; OFT, “Assessment of Conduct – Draft Competition Law Guidelines for Consultation,” 2004, OFT414a. 873

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Part IV. Interoperability and Compulsory Licensing in Technologically Dynamic Markets

I. Introduction........................................................................................................... 181 1.1 Background .................................................................................................... 181 1.2 Interfaces between Competition Law and Intellectual Property Rights......... 183 II. European Approach to Refusal to License .......................................................... 187 2.1 Refusals to Supply and Refusal to License .................................................... 188 2.2 The Commission’s Essential Facilities Doctrine ........................................... 194 2.3 Magill TV Guide and the Exceptional Circumstances ................................... 196 2.4 Extension of Exceptional Circumstances/Essential Facilities after Magill.... 200 III. Exceptional Circumstances/Essential Facilities in Information Technology Sector .................................................................................................................................. 206 3.1 Microsoft Case in the EU and Exceptional Circumstances ............................ 206 3.1.1 Commission’s Incentives Balance Test .................................................. 206 3.1.2 EU Courts’ Modification and Extension of Exceptional Circumstances 211 3.1.2.1 Judgement ........................................................................................ 211 3.1.2.2 Modification and Extension of the Exceptional Circumstances ...... 214 3.2.3 Implications for Future Cases ................................................................. 216 3.2 Microsoft Case in the US ............................................................................... 217 VI. Analysing Elements of Essential Facilities/Exceptional Circumstances ........... 224 4.1 Evolution of Leveraging: Two-Market Theory v. Single-Market Theory ..... 224 4.1.1 Market Foreclosure effects...................................................................... 224 4.1.2 Competitive Relationship ........................................................................ 227 4.2 Exceptional Circumstances ............................................................................ 231 4.2.1 Indispensability ....................................................................................... 231 4.2.2 Risk of Elimination of Effective Competition ........................................ 232 4.2.3 New Product Criterion: Limiting Technological Development .............. 234 4.2.4. Objective Justification and Proportionality............................................ 236 V. Conclusion........................................................................................................... 237

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I. Introduction

1.1 Background

In the previous parts it was shown that strong network effects may facilitate a dominant undertaking to tip the market in its favour by means of anticompetitive leveraging, such as tying, which increases the access of customers to products. Another way of leveraging market power from one product to another complementary product is to hinder interoperability i.e. where a dominant undertaking makes the products of competitors incompatible with its own product i.e. restriction of access. This implies technical refusal to supply. The effects of incompatibility are particularly important in the presence of network externalities. The latter are relevant to market power leveraging if there is a link between primary and complementary products. In other words, by refusing to make a primary product interoperable with secondary and dependent products, the dominant network would gain a competitive advantage and be able to exploit consumers through network effects in a complementary and dependent market. Although Article 102 TFEU may appear to be primarily concerned with exploitative abuses, 876 the Court of Justice has interpreted it to apply to conduct causing damage to competitive structure of markets already weakened by the presence of a dominant undertaking. In other words, it has been interpreted to protect competitors as well as consumers and customers.877 This widened concept of abuse under Article 102 TFEU raises important issues in the context of IPRs. For example, how can it be reconciled with the entitlement of eliminating competition which is an John Lang, “Monopolisation and the Definition of Abuse of a Dominant Position Under Article 86 EEC Treaty,” Common Market Law Review 16, no. 3 (1979): 345-364. 877 Case 322/81 Michelin, supra note 672, para. 70. 876

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inherent part of the grant of the exclusivity of an IPR? Further, to what extent does the concept of normal exploitation of IPRs constitute competition on the merits or on an objective justification? The answers to these questions appear to be shaped by the determination of the EU Courts and the Commission to prove whether an abuse is committed in a primary or a secondary market. In principle, the exclusive exploitation of an IPR is acceptable in the market for a specific product in order to reward inventors for their investments and to encourage innovation although it can lead to a dominant position under competition law. Attempts to extend the method of exclusive exploitation into neighbouring markets or related products could be caught by Article 102 TFEU, as a specific abuse such as a refusal to supply or license in cases where the dominant status precludes alternative sources of supply. In other words, exclusive exploitation could be legitimate competition on the merits in the primary market, but could become abusive in a secondary, complementary market in certain exceptional circumstances because of the leveraging of dominance from one market to the other. Where an IP holder enjoys a de facto monopoly in a product market, and the exploitation of the IPR is used in conjunction with a practice designed to foreclose new entrants or drive out existing competitors in ancillary markets, the EU competition regime is prepared to restrict an IPR if it is contrary to the requirements of Article 102 TFEU. In Magill, it was clear that the exercise of IPRs was within the scope of national law by itself as it offered no defence to complaints of anticompetitive abuse.878 In effect, the Commission is entitled to draw the borderline between IPRs

878

Joined Case C-241/91P and C-242/91P Independent Television Publications Ltd (ITP), and Radio Telefis Eireann (RTE) v. Commission of the European Communities (Magill) [1995] European Court Reports I -743.

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and competition law in its definition of abuse with reference to its definitions of relevant products markets. In several cases the EU competition regime has applied the essential facilities doctrine or exceptional circumstances test to IP licensing. In this part, these cases will be compared with the Microsoft case. It will show that the criteria of Microsoft have been modified and lowered the previous standards for a compulsory licensing. Thus, it will be argued whether these lenient conditions for compulsory licensing have adequately dealt with the information technology (IT) sector where strong network effects, switching costs, and economies of scales cause high entry barriers. Although the Court of Justice ruled that the application of competition rules were not dependent on whether the market concerned was mature or not,879 it does not seem that the specific criteria will uniformly apply to all industries without considering their characteristics. Therefore, it will be concluded that the more modified and relaxed conditions of Microsoft should apply to the IT sector rather the stricter conditions of earlier cases, such as Magill.

1.2 Interfaces between Competition Law and Intellectual Property Rights

With the advent of the New Economy industries, legal cases in the interface between intellectual property rights (IPRs) and competition/antitrust law have increased. In the same way, intellectual property rights have been extended to include new categories of works. These increases of interfaces have arisen from technological advances, as well as the stated need to preserve the ability of owners to take advantage of their investments, and thereby their incentives to innovate for the

879

Case C-52/09 Teliasonera Sverige AB, supra note 1, paras. 105-108.

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benefit of society.880 As intellectual property rights are more strongly and extensively protected, there is increasing concern that intellectual property owners have an unprecedented ability to distort competition in the marketplace. The rationale of the principles and doctrines applicable to the interface between competition law and intellectual law may be difficult to comprehend. This is because such principles reflect different underlying theories. In the field of economics, competition law looks mainly at the short term and promotes practices that tend to drive prices toward increased costs, squeezing excess profits out of the economy.881 In order to achieve this, competition law develops rules that encourage entry and duplication. 882 In general, the more firms offer a product, the more competitive its output and price will be. By contrast, the policy of intellectual property law takes a longer view and encourages innovation by giving people limited periods of exclusive rights, or freedom from copying.883 In at least some situations, the result is that firms earn profits considerably higher than short-run costs, and intellectual property rights have enabled a few firms to earn monopoly profits for very long periods. 884 These different regimes have sometimes been identified to reflect the tension between incentives and competition, or intellectual property and monopoly.885

David Lim, “Beyond Microsoft: Intellectual Property, Peer Production and Law’s Concern with Market Dominance,” Fordham Intellectual Property, Media, and Entertainment Law Journal 18 (Winter 2008): 292. 881 Herbert Hovenkamp, “The Intellectual Property-Antitrust Interface,” University of Iowa Legal Studies Research Paper No. 08-46; Issues in Competition Law, ABA, 2008. Available at SSRN: http://ssrn.com/abstract=1287628. (accessed 18 November, 2008), 1979. 882 Ibid. 883 Hovenkamp, supra note 881, 1979. 884 Ibid. 885 Donald Chisum and Michael Jacobs, Understanding Intellectual Property Law (New York, NY: Matthew Bender, 1992), 1-6. 880

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The exclusive rights have long been regarded as desirable and practical recompense for the innovators, such as inventors and creators. 886 In IP law, the primary driver for reward is the necessity to encourage innovation through incentives, 887 such as granting IPRs. On the contrary, competition law exists to ensure that free market competition facilitates an efficient allocation of resources and prevents the development of monopolistic power.888 Where intellectual property law and competition law overlap, questions are raised as to whether the holder of an exclusive right may use it to completely exclude others or to cause additional insurmountable costs to competitors. The US courts have recognised an inevitable conflict between the two legal regimes:

The conflict between the antitrust and the [IP] laws arises in the methods they embrace that were designed to achieve reciprocal goals. While the antitrust laws proscribe unreasonable restraints of competition, the [IP] laws reward the inventor with a temporary monopoly that insulates him from competitive exploitation of his patented art.889

Without some exclusion, competition by unlicensed borrowers would undermine incentives to invest resources. Yet exclusion introduces deadweight losses and may stifle the productive use of intellectual resources. 890 Thus, IP law has to strike a balance and facilitate both exclusion and effective competition or open access. In competition law, ‘the essential facilities doctrine’ or ‘exceptional circumstances principle’ holds that dominant undertakings may incur anticompetitive 886

Ilkka Rahnasto, Intellectual Property Rights, External Effects, and Antitrust Law: Leveraging IPRs in the Communications Industry (Oxford; New York: Oxford University Press, 2003), 19. 887 Ibid. 888 Lara Glasgow and Alicia Vaz, “Foreword: Beyond Microsoft: Antitrust, Technology, and Intellectual Property,” Berkley Technology Law Journal 16 (Spring 2001): 525. 889 SCM Corp. v. Xerox Corp., 645 F.2d 1195, 1203 (2nd Cir. 1981). 890 Brett Frischmann and Spencer Waller, “Revitalising Essential Facilities,” Antitrust Law Journal 75 (2008): 2.

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liability if they do not provide access to their unique facilities, even to actual or potential competitors, on a ‘fair, reasonable, and non-discriminatory’ (FRAND) basis where sharing/interoperability is feasible and the competitors cannot obtain or create the facility on their own. 891 These essential facilities are often described as infrastructure. While traditional infrastructure includes bridges, highways, ports, electrical power grids, and telephone networks, infrastructure can also include nontraditional items, such as ideas, the Internet, and other assets that are vital inputs to the production of value at later stages of production on a basis disproportionate to their actual use. 892 Sometime these essential facilities require the owners of infrastructure to permit open access. The significant positive externalities that open access produces make such access socially desirable and internalisation through exclusive property rights inefficient.893 However, in the competition field, all debates are abstract until a dominant firm controls such a unique infrastructural asset and unreasonably refuses to grant access to a competitor that needs access in order to compete with the dominant undertaking at some other stages of production. This could include, for example, a long-distance telephone company that requires interconnection to the local phone system;894 a wholesale power company that requires physical interconnection with the local power transmission or distribution system;895 or an application provider that requires interoperability with the operating system.896 When refusal to grant access to infrastructure or essential input is a means of either acquiring or maintaining illegal

891

Image Technology Services Inc., v. Eastman Kodak Co., 125 F2d 1195, 1216 (9th Cir. 1997). Frischmann and Waller, supra note 890, 4. 893 Ibid. 894 MCI Communications Corp. v. American Telephone & Telegraph Co., 708 F.2d 1081 (7th Cir. 1983). 895 Otter Tail Power Co. v. United States, 410 US 366 (1973). 896 Case T-201/04 Microsoft Corp. supra note 38; COMP/C-3/37.792 Microsoft, supra note 238. 892

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dominance, anticompetitive liability should ensue.897 Software firms frequently use copyright law to forestall intra-standard competition, and change their software interfaces to be proprietary in order to preserve competitive advantages. For example, in IBM, the Commission reached a settlement that required the undertaking to provide information on interface changes well in advance. 898 The Commission maintained that IBM’s software changes, made without notice, had stifled competition.899

II. European Approach to Refusal to License

Notwithstanding the fact that the common objectives of intellectual property law and competition law are to promote innovation and enhance consumer welfare,900 competition authorities recognise that in exceptional circumstances IPRs can restrict competition. The unrestrained exercise of these rights may, in exceptional situations, be found to be incompatible with the policy goal of competition rules. In recent years, the most controversial aspect concerns whether and in what circumstances a refusal to license an intellectual property right may constitute an abuse of a dominant position contrary to competition law. In some cases, competition authorities have developed a series of principles to address this question. However, the way in which a refusal to license has become intertwined with the question of essential facilities is a controversial issue. Neither the EU Courts nor the 897

Frischmann and Waller, supra note 890, 4. Commission, “Fourteenth Report on Competition Policy,” 1984, paras. 94-95, Available at http://bookshop.europa.eu/en/fourteenth-report-on-competition-policy-pbCB4184822/ (accessed 12 August, 2009). 899 IV/30.849 IBM, supra note 314. 900 Opinion of Advocate General Gulmann, 1 June, 1994 in Joined Cases C-241/91 P and C-242/91 P, Radio Telefis Eireann and Independent Television Publications Ltd. v. Commission of the European Communities [1995] European Court Reports I-743, footnote 10; Atari Games Corp. v. Nintendo of America, Inc., 897 F.2d 1572 (Fed. Cir. 1990). 898

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Commission has explicitly applied the phrase ‘essential facilities’ to IPRs but in the Magill case, a leading case on IPRs, and the Bronner case901 they showed in which exceptional circumstances undertakings may be required to share facilities that cannot be duplicated by competitors. These exceptional circumstances are similar to the conditions of essential facilities. These cases were subsequently relied upon in the IMS Health case.

2.1 Refusals to Supply and Refusal to License

From an early stage, the Court of Justice was prepared to give strong support to the Commission’s policy of treating a refusal by a dominant undertaking to supply existing, dependent customers as an abuse of a dominant position. In Commercial Solvents,

902

the defendants, an American company, Commercial Solvents

Corporation (CSC), and its Italian subsidiary, Istituto Chemioterapico ItalianoS.p.A (ICI), dominated the market for aminobutanol, a raw material used in the production of another chemical, ethambutol, which was a compound used in producing antituberculosis drugs. The subsidiary also sold and used the finished product within the EU.903 Aminobutanol was an essential material in the production of ethambutol. CSC used to have a patent in the method of production of an element for aminobutanol. The patent had expired, but CSC held a de facto monopoly due to its know-how, and the substantial barriers to entry to the market in the form of high sunk costs and the complexity of the necessary equipment.

901

Jones and Sufrin, supra note 3, 497. Joined Cases 6/73 and 7/73 Istituto Chemioterapico ItalianoS.p.A & Commercial Solvents Corporation v. Commission of the European Communities [1974] European Court Reports 223. 903 Ibid., paras. 6-7, 23. 902

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After a period of supplying the raw material to Laboratorio Chimico Farmaceutico, Giorgio Zoja (Zoja), a company that was active in the downstream market for ethambutol, found alternative suppliers for aminobutalnol due to a price increase for a raw material by CSC/ICI. These alternative supplying undertakings bought the raw materials from CSC for producing paints. Zoja’s supply of cheaper raw materials eventually ran out because CSC forced its buyers in the paint market not to resell the raw materials for pharmaceutical use.904 CSC then announced that it would no longer sell the raw material for anti-tuberculosis drugs and decided to produce the drug itself. When Zoja tried to reorder the raw material from CSC/ICI, it refused to take the order it was following its new commercial strategy. On receiving the complaint from Zoja, the Commission found that there were no other significant sources of, or practical substitutes for, aminobutanol, and concluded that CSC had abused its dominant position under Article 102 TFEU, by refusing to supply aminobutanol (primary market) to a former customer, Zoja. It ordered the resumption of supplies of the raw material. The Court of Justice affirmed the Commission’s decision and held that the dominant firm’s plans to begin producing ethambutol itself did not justify its refusal to continue to supply the raw material to its long-standing customer, even though it would now be a competitor, when the refusal would eliminate the competitor who was one of the principal manufacturer of ethambutol, from the market. On this point, the Court of Justice seemed to be protecting a small market player, rather than allowing competition on merit. 905 Possibly, the successful entrance of the CSC and ICI to the secondary market might increase the consumer

Eleanor Fox, “Monopolization and Dominance in the United States and the European Community: Efficiency, Opportunity, and Fairess,” Notre Dame Lawyer 61 (1986): 994. 905 Liza Gormsen, A Principled Approach to Abuse if Dominance in European Competition Law (Cambridge; New York: Cambridge University Press, 2010), 79. 904

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welfare in the form of more choices while continuing to supply the raw material to Zoja.906 However, it is also likely that the vertical integration of CSC and ICI would have eliminated Zoja from the downstream market if CSC had provided the raw material to ICI at a lower price than to Zoja. The Court of Justice was particularly concerned about the dominant firm’s use of its market power in the dominated market to acquire dominance in the downstream market. The abuse consisted of refusing to supply an existing customer with the aim of reserving raw material for manufacturing its own derivatives.907 In effect, the special responsibility of a dominant undertaking under Article 102 TFEU could be used in the circumstance to restrict its freedom of contract and place limits on its company strategy to vertically integrate. What was less clear in this case were the responsibilities of a dominant firm to a new entrant to such a market.908 Nor was it clear from this case whether and to what extent the obligation of a dominant company not to refuse to supply of a product could be extended to a refusal to license where the dominant undertaking held IPRs, entitling the company to exclusive exploitation. However, one of the important points in this case was that the Commission recognised that the intellectual property could create high barriers to entry.909 The same logic was used in the Télémarketing case where the Court of Justice interpreted Article 102 TFEU in the frame of a preliminary ruling.910 In 1984 the company running Luxembourgian television refused to transmit advertisements

906

Liza Gormsen, surpa note 905, 79. Joined Cases 6/73 and 7/73 Commercial Solvents, supra note 902, paras. 250-251. 908 Anderman and Schmidt, supra note 314, 94. 909 IV/26.911 Zoja/CSC-ICI, 72/457/EEC Commission Decision of 14 December, 1972 [1972] Official Journal of the European Communities L 299/51. 910 Case 311/84 Centre Belge d’Études de Marché – Télémarketing (CBME) v. SA Compagnie Luxembourgeoise de Télédiffusion (CLT) & Information Publicité Benelux (IPB) [1985] European Court Report 3261. 907

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where its agent’s telephone number did not appear, thus excluding Centre Belge, who was engaged in the telemarketing business. The Court of Justice advanced the principle, which it had developed in Commercial Solvents case, to include cases in which not a specific source, but rather a specific service, is a precondition for operating on a downstream market.911 By the time of the IBM case,912 the Commission had begun to formulate a view that in special circumstances an IP-holding undertaking in a dominant position could have a positive obligation both to allow new competition to enter, as well as to ensure that existing competition was not illegitimately lessened in markets in which the company was dominant.913 This obligation to supply was applied more widely than Commercial Solvents since it was applied to all competitors, existing ones and new entrants. However, it was argued that the Commission gave little weight to the right of IBM as the inventor of the mainframe system to prevent competing manufacturers of peripheral applications for the IBM system from enjoying the position of free riders who had not contributed to the costs of researching and developing the system.914 For IP owners, a key feature in the development of the EU Courts’ determination of the entitlement of dominant undertakings to refuse to license under Article 102(b) is the distinction made between primary and secondary markets for the purpose of defining abuses. 915 Undertakings can enjoy the exclusivity of their IPRs in the primary product or technology market in which they are dominant.

911

Case 311/84 Télémarketing , supra note 910, paras. 25-26. Case 60/81 International Business Machines Corporation v. Commission of the European Communities [1981] 3 Common Market Law Reports 635, (Memorex SA intervening). 913 Romano Subito, “The Right to Deal with Whom One Pleases under EEC Competition Law: A Small Contribution to a Necessary Debate,” European Competition Law Review 13, no. 6 (1992): 234244. 914 Anderman and Schmidt, supra note 314, 111. 915 Ibid., 95. 912

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However, in a secondary market or aftermarket where the dominant product or technology is an essential input, the Court of Justice has limited the freedom of exclusive exploitation. This guideline to Article 102 TFEU was introduced in AB Volvo v. Erik Veng (UK) Ltd,916 which was the first case where the Court of Justice recognised a refusal to license an IPR as an abusive conduct under Article 102 TFEU. Volvo held a U.K.registered industrial design right for the front wing panels of its 200 series of automobiles.917 Without Volvo’s authorisation, Veng imported imitations of Volvo’s wing panels in the United Kingdom from other Member States.918 Volvo alleged that the importation and sale of front wing components for Volvo cars infringed U.K.registered industrial design right and refused to license Veng even for a reasonably royalty.919 Veng argued that Volvo was abusing its dominant position on the market for spare parts by refusing to grant Veng a licence for its IP that would enable the company to market car components in the United Kingdom lawfully.920 The Court of Justice held that in the primary market for which Volvo had a monopoly due to its design right, the exclusive right to make or sell would be fully respected since this was the very purpose of the IPR protection. The mere failure to refuse to license IPRs in the primary market did not, in itself, constitute an abuse of dominant position and the reasoning was that:

...the right of the proprietor of a protected design to prevent third parties from manufacturing and selling or importing, without its consent, products incorporating

916

Case 238/87 AB Volvo v. Erik Veng (UK), Ltd. [1988] European Court Reports 6211. Ibid., para. 3. 918 Case 238/87 Volvo/ Veng, supra note 916, para. 3. 919 Ibid., paras. 3-4. 920 Case 238/87 Volvo/ Veng, supra note 916, para. 4. 917

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the design constitutes the very subject-matter of his exclusive right. In the present 921

case no instance of any such conduct has been mentioned by the national court.

It was clear that in the primary market for the product, there was normally no requirement for a dominant company to license competitors to manufacture or sell IP-protected products. On the other hand, the Court of Justice warned that in the secondary market and dependent market for Volvo spare parts, Volvo as the monopolistic supplier of spare parts could not always refuse to supply competitors in the maintenance market. Nor could it raise the price so high as to make supplies of the protected product inaccessible to the secondary market. The concern of Article 102 TFEU was to maintain access and prevent abuse of dominance in one market to foreclose competitors in the secondary market. As the Court of Justice noted in its ruling, the exercise of an exclusive right by IP holder may be prohibited by Article 102 TFEU if it involves certain abusive conduct.922 The Court of Justice gave three examples of such abuse: first, if IPR holder arbitrarily refuses to supply spare parts to an independent repairer; second, if it fixes prices for spare parts at an unfair or excessively high level; third, if it decides no longer to produce spare parts for a particular model though many cars of the model are still in use.923 These three examples in Volvo of additional circumstances for the illegitimate exercise of IPRs under Article 102 TFEU were not meant to be exhaustive. 924 Particularly, in the third example, if the IP holder has refused to license, such conduct would be abusive under Article 102 TFEU, and ultimately susceptible to a remedy of compulsory licence. Similarly, dominant firms which exploit their IPRs by 921

Case 238/87 Volvo/ Veng, supra note 916, paras. 9-10. Ibid., para. 9. 923 Case 238/87 Volvo/ Veng, supra note 916, para. 9. 924 Anderman and Schmidt, supra note 314, 97. 922

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discriminatory licensing, or by demanding unreasonable high royalties would commit an abuse of its dominance despite exercising IPRs allowed under national law. In the Volvo case, the abusive behaviour of the IP owner in the secondary market seemed to consist of leveraging its dominance in the primary market to exclude existing competitors in the secondary market and to deny access to new entrants to that market.925 The Volvo case indicated that in exceptional situations where a dominant undertaking refused to supply with the aim of preventing competition on a secondary market, competition authorities might order compulsory licence or supply of an IP protected good under Article 102 TFEU.

2.2 The Commission’s Essential Facilities Doctrine

In its refusal to deal cases, the Commission had begun to formulate a view based on the reasoning of the Court of Justice in Commercial Solvent and Télémarketing, that the preservation of effective competition required dominant undertakings to offer access to their essential facilities to competitors as well as customers on a FRAND basis. One of the first cases where the doctrine was explicitly mentioned was Sea Container v. Stena Sealink,926 In this case, Sea Container, wishing to introduce a high-speed ferry service form Holyhead to Ireland, demanded access to specific facilities of the port of Holyhead, the only port in the United Kingdom serving Ireland in the market for the transport of passengers and cars on the central corridor

925

Joined Cases 6/73 and 7/73 Commercial Solvents, supra note 902. IV/34.689 Sea Containers v. Stena Sealink, 94/19/EC Commission Decision of 21 December, 1993[1994] Official Journal of the European Communities L 15/8. 926

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route.927 Stena Sealink, the owner and operator of the port of Holyhead, refused to grant access to the extent demanded by Sea Containers.928 In its decision on whether Stena Sealink abused the dominant position in the relevant market, the Commission established the following principle:

An undertaking which occupies a dominant position in the provision of an essential facility and itself uses that facility (i. e. a facility or infrastructure, without access to which competitors cannot provide services to their customers), and which refuses other companies access to that facility without objective justification or grants access to competitors only on terms less favourable than those which it gives its own services, infringes Article [102 TFEU] if the other conditions of that Article are met.

929

The Commission found that Stena Sealink’s refusal was inconsistent with the duties of a firm which enjoyed a dominant position in relation to essential facilities. It had ensured that the principle of access to essential facilities applied to new entrants in the relevant market, particularly where it was offering a new service. Abuse could be defined in terms of a dominant undertaking impeding the development of growth in competition in a market as well as the maintenance of the degree of existing competition in that market.930 The Commission justified its development of the essential facilities doctrine by reference to the judgements of the Court of Justice in Commercial Solvent and Télémarketing. However, Stena Sealink differs from those cases in two respects. First, the Commission’s decision in Stena Sealink appears to suggest that where a company controls essential facilities it is under a stricter duty not to discriminate, stemming

927

IV/34.689 Sea Containers v. Stena Sealink, supra note 926, para. 15. Ibid. 929 IV/34.689 Sea Containers v. Stena Sealink, supra note 926, para. 66. 930 Anderman and Schmidt, supra note 314, 101. 928

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from its dual roles both as an administrator of an infrastructure and an operator on a market utilising that infrastructure.931 For example, in Port of Rødby decision932 the Commission indicated that even if the existing facilities at the port were fully utilised and could not accommodate additional sailings, it would be desirable to introduce competition by providing access to a new entrant. Secondly, there may be additional obligations on undertakings that control essential facilities. In Stena Sealink, for instance, the fact that Stena Sealink had failed to negotiate and consult with its customers as an independent operator contributed to the finding of abuse. The development of essential facilities in the EU competition regime applied to a wide range of commercial sectors: airlines, seaport facilities, railways, telecommunications, and energy. It was not directed solely at IPRs. However, if ownership of IPRs amounted to essential facilities, and unlicensed competitors could not enter into the market, then from the Commission’s view, compulsory licensing of IPRs could be an appropriate remedy.

2.3 Magill TV Guide and the Exceptional Circumstances

The first Commission case to apply the idea of the essential facilities doctrine in the intellectual property area was Magill. 933 In this case, three TV companies, Radio Telefis Eireann (RTE), the British Broadcasting Corporation (BBC), and the Independent Broadcasting Authority (IBA), used their copyright in listings of TV programmes to enjoin Magill from publishing a comprehensive weekly TV guide in 931

Anderman and Schmidt, supra note 314, 101. Port of Rødby, 94/19/EC Commission Decision of 21 December, 1993 [1994] Official Journal of the European Communities L 55/52. 933 IV/31.851 Magill TV Guide v. Independent Television Publications Ltd(ITP), BBC, and Radio Telefis Eireann (RTE), 89/205/EEC Commission Decision of 21 December, 1988 Relating to a Proceeding under Article 86 of the EEC Treaty [1989] Official Journal of the European Communities L 78/43. 932

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Ireland and Northern Ireland. 934 Each of the broadcasters published their own individual weekly programme guide and provided their listings to newspapers for daily publication, but there was no weekly programme guide that combined them.935 The Commission found that the broadcaster’s refusal to provide the copyrighted listings information was an abuse of their dominant position. 936 It reasoned that TV programme listings constitute the essential raw materials for any types of TV guides; 937 that the third party could not supply reliable listings for publishing their own TV guides; 938 and that the ‘factual monopoly’ which the broadcasters held over their own listings was enhanced by the copyright laws in the United Kingdom and/or Ireland.939 On appeal, affirming a judgement of the General Court which upheld the Commission’s decision, on the issue of abuse, the Court of Justice began by emphasising that it was wrong to presuppose that all forms of exercise of copyright which were legitimate under national law could never be reviewed under Article 102 TFEU,940 although it noted that the ownership of intellectual property rights does not necessarily confer dominant position. 941 It admitted that the exclusive right of reproduction was part of the author’s rights, so a refusal to grant a licence, even by an undertaking in a dominant position, could not in itself constitute abuse of a dominant position.942 Nevertheless, it insisted that in exceptional circumstances, the exercise of such an exclusive right by a holder might amount to abusive behaviour.943

934

IV/31.851 Magill , supra note 933, para. 5. Ibid., paras. 14-15. 936 IV/31.851 Magill , supra note 933, para. 23. 937 Ibid., para. 20. 938 IV/31.851 Magill , supra note 933, para. 22. 939 Ibid., para. 22. 940 Joined Case C-241/91P and C-242/91P Magill, supra note 878, para. 48. 941 Ibid., para. 46. 942 Joined Case C-241/91P and C-242/91P Magill, supra note 878, para. 49. 943 Ibid., para. 50. 935

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The Court of Justice upheld the General Court’s finding that exceptional circumstances made a refusal to license TV listings to Magill abusive conduct on the basis of three circumstances. The first circumstance was that there was no actual or potential substitute for a comprehensive weekly guide for which there was a strong potential consumer demand. This meant that the TV broadcasters’ refusal to provide raw information prevented the emergence of a new product which they did not offer. This forced viewers to buy a weekly guide individually from the three TV firms. This was an abuse under Article 102(b), i.e. “limiting production, markets or technical development to the prejudice of consumers.’944 Secondly, the Court of Justice found that there was no objective justification for the refusal, either in the activity of TV broadcasting or in that of publishing TV magazines. This implied that, in the face of a violation of Article 102(b) TFEU, the mere possession of the IPR was not an objective justification for exclusionary behaviour. There must be evidence of other objective justifying factors such as creditworthiness, safety, and public health. Thirdly, TV broadcasters reserved for themselves the secondary market for weekly TV guides by excluding all competition on that market because of their denial of access to the basic information which was indispensable to the publication of such a guide. This was the type of abuse prohibited in Commercial Solvent. On this point, the Court of Justice effectively endorsed the basis of the essential facilities doctrine promoted by the Commission, albeit under certain conditions. One precondition was that the company holding facility in the first market was not merely dominant; it was a quasi-monopoly. Secondly, the facility must be an indispensible input to the secondary market. There was no substitution. Thirdly, the refusal must directly result in maintaining a monopoly for the dominant undertaking on the secondary market.

944

Joined Case C-241/91P and C-242/91P Magill, supra note 878, para. 54.

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The new product test suggests that if an IP holder owns the indispensable component for a new product with actual or potential consumer demand, and (1) that input is a de facto monopoly, i.e. there are no existing or potential alternatives for it; (2) there is no objective justification to prevent the emergence of that new product; (3) which the dominant firm does not offer itself, then the refusal to supply or license the component could be an abuse of the dominance. In such a case, the limiting conditions are cumulative.945 In the same way, if the essential facilities test, the second test of Magill, is to offer a separate test of abuse, there must be a showing of indispensability, a de facto monopoly, and the exclusion of all competition in the secondary market. However, what remains unclear after Magill is when a product will be regarded as an essential input or facility for another product or market as opposed to being simply part of another product. This issue can arise at different stages of production prior to the final product phase in cases of the novel industries. In addition, commentators pointed out the ambiguity inherent in the decision, namely, whether all four of the conditions (indispensability, preventing the appearance of a new product for which there is consumer demand, lack of justification, and elimination of competition in the downstream market) need to be satisfied in a case involving intellectual property rights.946 However, the case provided two lines of guidance to IP holders. First, if an IP owner has a dominant position by virtue of the IPR, its exercise of the IPR is limited by prohibition in Article 102 TFEU. Secondly, if the IP holder has dominance in the form of an essential facility, it will have certain positive duties towards competitors

945

Anderman and Schmidt, supra note 314, 105. Thomas Cotter, “The Essential Facilities Doctrine,” University of Minnesota Law School Legal Studies Research Paper Series, Research Paper No. 08-18, p 8, Available at SSRN: http://ssrn.com/abstract=1125368, (accessed 07 May, 2008); 946

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which may be inconsistent with the full exclusive exploitation of the IPR in a downstream or secondary market. The Court of Justice’s decision in the Magill case did not contain a general essential doctrine. This case set the stage for the view that the refusal to grant access to protected information might be an abuse of dominant position; at least where the information was an essential or indispensable input and the refusal to license it adversely affected competition in some other market. 947 Viewed in this way, the exceptional circumstances test is merely a restatement and application of the essential facilities doctrine.948

2.4 Extension of Exceptional Circumstances/Essential Facilities after Magill

Although the Oscar Bronner 949 case did not actually involve IPRs, the Court of Justice had an opportunity to develop the exceptional circumstances test developed in Magill and its reasoning is important for IP licensing cases. In this case the Court of Justice reinterpreted the Magill case in a non-IPR context. The decision dealt with the access to a distribution service for newspapers in Austria. 950 The company Mediaprint operated the only nationwide home delivery scheme for daily newspapers in Austria and additionally published two newspapers, which had a combined market share of 46.8% of the national daily newspaper market in terms of circulation.951 The company Oscar Bronner, a publisher of a newspaper Harry First, “Microsoft and the Evolution of the Intellectual Property Concept,” Wisconsin Law Review 2006 (2006): 1400. 948 Maurits Dolmans, Robert O’Donoghue, and Paul-John Loewenthal, “Article 82 EC and Intellectual Property: The State of the Law Pending the Judgment in Microsoft v. Commission,” Competition Policy International 3, no. 1 (Spring 2007): 119. 949 Case C-7/97 Oscar Bronner GmbH & Co. KG v. Mediaprint Zeitungs-und Zeitschriftenverlag GmbH & Co. KG. [1998] European Court Reports I -7791. 950 Case C-7/97 Oscar Bronner, supra note 949, para. 8. 951 Ibid, para. 6. 947

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with a small circulation within Austria, argued that the home delivery scheme constituted an essential facility and, hence, Mediaprint’s refusal to distribute its newspaper constituted an abuse of Mediaprint’s dominant position. 952 On referral from the national court, the Court of Justice advised the national court to establish whether there existed a separate market for home delivery of newspapers, or whether other means of distributing newspapers were sufficiently substitutable.953 The Court of Justice assumed a related market to be the newspaper market and held that a refusal to supply or give access to a facility would only be unlawful if (1) it would eliminate all competition on the secondary market; (2) there was no actual or potential alternative; and (3) therefore access to an existing system would be indispensable. In this case, the Court of Justice made an important remark regarding indispensability. It held that the requirement of indispensability could only be met if there were no technical, legal, and economic obstacles capable of making it impossible. 954 It continued: “For such access to be capable of being regarded as indispensible, it would be necessary at the very least to establish … that it is not economically viable to create a second [service] with a [production] comparable to that of…the existing [service].”955 As Bergman notes, these criteria could be interpreted in two ways.956 First, it could mean that the entrant would be unable to establish a competing facility even if it were to capture half of the market. Alternatively, it could mean that the entrant must be unable to establish such a facility even if it were to attract a similar number of customers as the incumbent currently had. The first interpretation can be

952

Case C-7/97 Oscar Bronner, supra note 949, para. 8. Ibid., para. 34. 954 Case C-7/97 Oscar Bronner, supra note 949, para. 44. 955 Ibid., para. 46. 956 Mats Bergamn, “The Role of the Essential Facilities Doctrine,” Antitrust Bulletin 46, no. 2 (Summer 2001): 427. 953

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reformulated as a requirement that at the current size of the market, a symmetric duopoly is not economically viable. The second interpretation potentially sets an even stricter requirement. Assuming that the incumbent was also a monopolist in the related market, the requirement would be that a symmetric duopoly is not economically viable even if the market were to increase to twice its current size. In other words, these criteria seem to mean that the essential facilities doctrine is applicable if a symmetric duopoly with two vertically integrated firms is not economically viable.957 Or they appear to confine the application of the essential facilities doctrine to markets where two or more undertakings would not be economically viable without applying the essential facilities concept.958 Since it was for Oscar Bronner to prove the economic unviability, the criteria of essential facilities seems to be applied more restrictively here than in earlier cases. 959 Although this case did not deal with IPRs, it introduced the exceptional circumstances test to the essential facilities doctrine which originally did not include IPRs.960 In addition, the Court of Justice confirmed Magill by building its ruling in Oscar Bronner upon Magill, clarifying its view on indispensability and the requirements needed for such a claim. In IMS Health, the Court of Justice applied the criteria developed in the earlier cases and clarified the condition that competition on a downstream market must be eliminated. 961 The IMS case concerned competition in the market for providing

pharmaceutical

manufacturers

with

marketing

data

on

retail

Mats Bergamn, “When Should an Incumbent Be Obliged to Share its Infrastructure with an Entrant Under the General Competition Rules?” Journal of Industry, Competition, & Trade 5, no. 1 (March 2005): 8-9. 958 Mats Bergamn, “The Bronner Case- A Turning Point for the Essential Facilities Doctrine,” European Competition Law Review 21, no. 2 (2000): 61-62. 959 Inge Graef, “Tailoring the Essential Facilities Doctrine to the IT Sector: Compulsory Licensing of Intellectual Property Rights After Microsoft,” Cambridge Student Law Review 2011 (2011) : 4. 960 Case C-7/97 Oscar Bronner, supra note 949, para. 41. 961 Ulf Müller and Anselm Rodenhausen, “The Rise and Fall of the Essential Facility Doctrine,” European Competition Law Review 29, no. 5 (2008): 325. 957

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pharmaceutical sales in Germany.962 Pharmaceutical wholesalers collected this data for the various database service companies. 963 The data was then checked and formatted in a brick structure, with each brick constituting a small and useful geographic area related to the number of pharmacies and prescribing physicians.964 IMS Health had been developing brick structures for a number of years and evolved the copyright-protected ‘1860 Brick Structure.’965 This structure divided the German territory into 1860 geographic bricks that were carefully designed to group doctors, patients, and pharmacies so as to allow the reporting of pharmaceutical sales data in a way that was useful for calculating the compensation of pharmaceutical company sales representatives. 966 Pharmaceutical companies adopted this structure as a standard,967 and competitors’ efforts to organise their data with a different brick were unsuccessful in the market.968 In 2000, two companies established in Germany by National Data Corporation Health Information Services GmbH (NDC) and Azyx Deutschland GmbH (Azyx) entered the German market. It soon became apparent to IMS Health that the brick structures used by the data service offerings of these companies infringed IMS Health’s copyright in the 1860 Brick Structure. As a result, IMS Health sued these undertakings for infringement and obtained injunctions against NDC and Azyx from the German courts. 969 When IMS Health refused to

962

COMP D3/38.044 NDC Health GmbH & Co. KG/IMS Health GmbH & Co. OHG, 2003/741/EC Commission Decision of 3 July, 2001 relating to a proceeding under Article 82 of the EC Treaty (Interim Measures) Available at http://ec.europa.eu/competition/antitrust/cases/dec_docs/38044 / 38044_15_5.pdf. (accessed 03 November, 2007), para. 6. 963 Ibid., para. 15. 964 COMP D3/38.044 IMS Health, supra note 962, paras. 15-19. 965 Ibid., para. 22. 966 COMP D3/38.044 IMS Health, supra note 962, paras. 24-26. 967 Ibid., paras. 22-23 968 COMP D3/38.044 IMS Health, supra note 962, para. 20. 969 Ibid., para. 29.

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grant NDC a licence to use the brick structure, NDC complained to the Commission.970 NDC presented the case as an essential facilities case, and the Commission treated it as such.971 Although recognising that the EU Courts had not yet explicitly referred to the essential facilities doctrine, the Commission decided that intellectual property could be a facility and that a refusal to license could be an abuse of a dominant position under Article 102 TFEU.972 This required finding that the refusal of access would eliminate all competition in the relevant market and that the facility was indispensable for carrying out the business, in the sense that there were no actual or potential substitutes. 973 The Commission assumed that IMS Health’s copyright was valid974 because copyright holders normally have the right to refuse to license.975 Nevertheless, the Commission found that the 1860 Brick Structure was an indispensable input for producing the data services involved and that IMS Health’s refusal to license would exclude all competition in a dependent market that was not otherwise objectively justified.976 In the meantime, the German court requested a preliminary ruling from the Court of Justice. It confirmed that all three main conditions of Magill’s exceptional circumstances test had to apply. They were cumulative, i.e. that in order for a refusal to license new entrants to a market dependent upon an indispensible IP protected input to be abusive, the refusal must meet three conditions: (1) the undertaking that “requested the licence intends to offer, on the market for the supply of the data in question, new products or services not offered by the owner of the intellectual 970

COMP D3/38.044 IMS Health, supra note 962, paras. 5-6. Ibid., paras. 63-71. 972 COMP D3/38.044 IMS Health, supra note 962, paras. 64-70. 973 Ibid., para. 70. 974 COMP D3/38.044 IMS Health, supra note 962, para. 36. 975 Ibid., para. 167. 976 COMP D3/38.044 IMS Health, supra note 962, paras. 169, 185 971

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property right and for which there is a potential consumer demand”; (2) “the refusal is not justified by objective considerations”; and (3) the refusal reserves to the IPR owner the secondary market by excluding all competition on that market.977 In drawing boundaries on the exceptional circumstances, the Court of Justice considered the Magill criteria not ‘necessary’ conditions but ‘sufficient’ conditions for finding an abuse.978 That proposition would seem to follow from the purpose of Article 102(b) TFEU which in principle prohibits as abusive, behaviour by dominant firms which limits technical development of markets to the detriment of consumers.979 Limiting technical development is a wider concept than the particular factual circumstances and conditions of the Magill case. Hence, both the language of Article 102(b) TFEU and the Court of Justice in IMS Health provide good grounds for concluding that other types of abuse can also fall within the category of exceptional circumstances.980 Both the General Court and the Court of Justice in IMS Health had emphasised an investment theory of IPRs stressing the entitlement that an IPR holder has to the rewards that flow from its investments in innovation, rather than taking an incentives theory of IPRs, which stresses that IPRs are given only to the extent necessary for the societal purpose of encouraging innovation.981 The requirement of exceptional circumstances appeared to indicate that a holder of IPRs would have fairly wide latitude, even if not complete freedom, to refuse to license its protected information.982

977

COMP D3/38.044 IMS Health, supra note 962, para. 52. Case C-418/01 IMS Health GmbH & Co. OHG v. NDC Health GmbH & Co. KG. [2004] European Court Reports I -5039, para. 18. 979 Anderman and Schmidt, supra note 314, 109. 980 Ibid. 981 First, supra note 947, 1403. 982 Ibid., 1403-1404. 978

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The IMS Health interpretation of the exceptional circumstances test base on Volvo and Magill could be seen as offering a reconciliation between competition law and IPRs based on their mutual interest in innovation by stressing that the exceptional circumstances for a compulsory licence for new entrants to a market is limited to cases of new products or follow-up innovation.983 The refusal to license in such a situation would clearly be a case of limiting technical development under Article 102(b) TFEU.

III. Exceptional Circumstances/Essential Facilities in Information Technology Sector

3.1 Microsoft Case in the EU and Exceptional Circumstances

3.1.1 Commission’s Incentives Balance Test

In February 1998, Sun Microsystems lodged a complaint before the Commission accusing Microsoft of breaching competition rules by denying access to essential information on its Windows client PC operating system. Six years later, the Commission concluded its investigation by finding Microsoft guilty.984 According to the Commission, Microsoft had infringed Article 102 TFEU by refusing to supply Sun Microsystems and other rivals with relevant interface information, that is, software codes underlying interoperability between non-Microsoft workgroup server operating systems and Windows client PC operating systems. 985 The Commission followed two lines of argument in demonstrating that the refusal to supply was abusive. Firstly, it attempted to establish that information on an interface was an 983

Anderman and Schmidt, supra note 314, 109. COMP/C-3/37.792 Microsoft, supra note 238. 985 Ibid. 984

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essential facility.986 Secondly, it advocated that Microsoft’s behaviour in refusing to supply reflected a leveraging and foreclosure conduct.987 To remedy the abuse the Commission ordered Microsoft to give access to specifications of interface protocols.988 This obligation, however, would not and did not include disclosure of the source code that Microsoft used to implement the protocols. 989 Microsoft’s disclosures had to be made on reasonable and non-discriminatory terms in a timely manner.990 If users decided to use the disclosed specifications in workgroup server operating system products, Microsoft’s royalty rates could not reflect the strategic value to Microsoft of those protocols.991 In other words, Microsoft could not charge monopoly rates.992 This remedy of compulsory disclosure of interface information was reminiscent of the remedy in the IBM undertaking of 1984.993 It was noteworthy that the remedy of compulsory disclosure was not restricted to a specific complainant but appeared to be aimed at all participants in the workgroup server market.994 There was little doubt that Microsoft satisfied the threshold of a test of a monopoly which was an indispensible input to a secondary market. If a dominant undertaking with a monopoly on an IP-protected product which is an indispensable input chose to compete on its merits, it would have to continue to license the relevant interface information to its competitors and compete directly in the secondary market on the basis of quality and price. For a dominant firm with a quasi-monopoly which is an indispensable input to other products to be allowed to use its power in any other way would have a chilling effect on innovation by competitors in the dependent 986

COMP/C-3/37.792 Microsoft, supra note 238, para. 1064. Ibid., paras. 1063-1065. 988 COMP/C-3/37.792 Microsoft, supra note 238, paras. 998-1004. 989 Ibid., para. 999. 990 COMP/C-3/37.792 Microsoft, supra note 238, para. 1007. 991 Ibid., para. 1008. 992 First, supra note 947, 1397. 993 IBM Undertaking, XIVth Report on Competition Policy 1984 (Commission, 1984), paras. 94-95. 994 Anderman and Schmidt, supra note 314, 112. 987

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market and limit technical development in that market. Without access to interface information, competitors in a workgroup server market would be gradually deprived of their opportunity to develop severs with new or added functionality that Microsoft did not offer to the consumer. In addition, by initially opting for an open system as a strategy to grow and achieve dominance, the owner of an IP-protected technology standard has created an expectation that it will continue to share interface information. In such cases, Article 102(b) TFEU can be infringed when a company like Microsoft with industrial standards limits technical development by refusing to continue to license interface information, and thereby prevents competitors on related markets from developing their interoperable systems. If Microsoft had initially opted for a closed system, the circumstances might have been different because the firm would have achieved its dominance on the basis of originally integrated products and it would normally have been entitled to continue to compete on the basis.995 Microsoft argued that the information required by Sun Microsystems was protected by IPRs and such a protection justified its refusal to license.996 However, the Commission pointed out that the pure presence of intellectual property rights was not sufficient to justify the refusal to license. 997 In order to assess whether Microsoft’s arguments regarding its incentives to innovate outweighed the negative effects on technical development to the prejudice of consumers, the Commission applied the Incentives Balance Test.998 In this test, the effects of the refusal on the innovative behaviour of the firms in the relevant market were determined and weighed against the effects of a compulsory license on the innovative conduct. Thus,

995

Anderman and Schmidt, supra note 314, 114. COMP/C-3/37.792 Microsoft, supra note 238, para. 709. 997 Ibid., para. 712. 998 COMP/C-3/37.792 Microsoft, supra note 238, para. 712. 996

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the commission concluded that a compulsory license could be appropriate when the negative effects of a license on the dominant firm’s incentives to innovate were balanced against the positive effects on the innovative climate in the whole market.999 In the application of the test, the Commission focused on Microsoft’s fear that it would be cloned as soon as it disclosed its interface information. In the opinion of the Commission, Microsoft’s competitors were disadvantaged regarding the quality of the implementation of the relevant specifications in comparison to Microsoft’s own product. Furthermore, Microsoft would have a time advantage compared to its competitors as it would disclose the specifications only when it already had a working implementation. Thus, to compete with Microsoft, the other software undertakings would have to offer an additional service to the customers to convince them to buy their products instead of those of Microsoft. The interoperability of their products with Windows OS would not in itself be enough to be successful on the market. However, there was no reasonable explanation for Microsoft’s fear of being cloned.1000 Furthermore, concentrating on the accusation of cloning implies restricting innovation on interoperability and the underlying specifications. 1001 The Commission stressed that it was important to consider “Microsoft’s incentives to innovate its products as a whole, not only in the design of its products’ interfaces.”1002 Above all, it was necessary to compare the effects on innovation of a compulsory license with a situation in which Microsoft maintained its refusal to supply. If Microsoft continued with its abusive behaviour, competition could be eliminated and this would have negative effects on Microsoft’s innovative

999

COMP/C-3/37.792 Microsoft, supra note 238, para. 783. Ibid., paras. 721-722. 1001 COMP/C-3/37.792 Microsoft, supra note 238, para. 723. 1002 Ibid., para. 724. 1000

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conduct. If, by contrast, Microsoft were obliged to disclose its interface information, its workgroup server operating systems would have to compete with the implementations of other firms. Thus, consumers would no longer be locked-in to Microsoft’s products. Consequently, Microsoft would have more incentives to innovate in order to keep and, even better, to extend the numbers of its consumers.1003 Therefore, after examining the circumstances of the Microsoft case and applying the Incentives Balance Test, the Commission came to the conclusion that in the short term a compulsory license would have negative effects on Microsoft’s incentives to innovate. However, these negative effects on Microsoft were outweighed by the positive impact on the innovative behaviour of its competitors.1004 Moreover, in the long run, this would also strengthen Microsoft’s incentives to innovate as it needed to defend its leading position in the market against its competitors. Thus, the Commission concluded, the positive effects of the disclosure on innovation incentives would outweigh the negative effects on Microsoft’s incentives to innovate. As a result of this, the Commission rejected that Microsoft’s refusal to supply the interface information was objectively justified.1005 Both the Commission and Microsoft accepted that interoperability was a question of degree, and that various software products in a system interoperate when they are able to exchange information and mutually use it once exchanged.1006 Apart from this point, the opinions of both parties diverged. Microsoft claimed that if it was forced to license its communications protocols as the Commission envisaged, the end result would not be competition, but instead, the development of ‘clones’ of

1003

COMP/C-3/37.792 Microsoft, supra note 238, para. 725. Ibid., paras. 693-700. 1005 COMP/C-3/37.792 Microsoft, supra note 238, para. 783. 1006 Case T-201/04 Microsoft Corp. supra note 40, para. 158. 1004

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Microsoft workgroup servers with perfect substitutability (or ‘plug replaceability’) for a Windows-based server operating system.1007 Microsoft conceded that there was a minimum level of interoperability with Windows PC OS that was required for effective competition, but it said that this level was not difficult to achieve, technically (i.e. by using reverse engineering).

3.1.2 EU Courts’ Modification and Extension of Exceptional Circumstances

3.1.2.1 Judgement

Upholding the Commission’s decision, the General Court highlighted the fact that disclosure of information which is necessary for interoperability is quite usual in this industry and that so far no claims had occurred regarding its negative effects on innovation.1008 In reverse engineering, also, it pointed out that this method does not constitute ‘viable substitute’ for disclosure of the interoperability information at issue.1009 Regarding the individual examination steps, the General Court agreed with the Commission’s assessment of the facts. For its analysis, the General Court retained the four following criteria developed in the Magill and IMS Health cases which had to be fulfilled cumulatively: indispensability, elimination of competition, new product, and objective justification.1010 Taking the indispensability criterion, Microsoft rejected the opinion of the Commission that the interface information was indispensable to compete in the

1007

Case T-201/04 Microsoft Corp. supra note 40, para. 121. Ibid., para. 702. 1009 Case T-201/04 Microsoft Corp. supra note 40, para. 362. 1010 Ibid., para. 332-333. 1008

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market. 1011 According to Microsoft, at least five other ways existed to ensure the interoperability of working group server operating systems which were already used by suppliers of competing systems. Even though these methods did not ensure perfect substitutability to the required interface information, they were sufficient to ensure effective competition. 1012 However, the General Court agreed with the Commission that it was necessary that the competitor’s operating systems provided a comparable interoperability to Windows domain architecture like Microsoft’s own products. 1013 Furthermore, the General Court found that due to the very narrow linkages between the Windows client PC and the workgroup server operating systems, Microsoft had established a de facto standard for working group computing.1014 Therefore, the Commission was correct in its appraisal that the full provision of the interface information had to be warranted. According to the General Court, the arguments put forward by Microsoft that the Commission’s assessment was wrong had not been convincing.1015 Concerning the requisite of ‘elimination of competition’, Microsoft had argued that the refusal to license would not eliminate all competition in the secondary market. It complained that even the Commission had only mentioned the mere risk of elimination of competition in the market. It was observed that there were still other competitors on the market for workgroup server operating systems. 1016 Pointing out that it was not in line with Article 102 TFEU to wait until the elimination of competition had been realised, the General Court rejected this plea. The existence of competitors in some niches would not be sufficient to maintain

1011

Case T-201/04 Microsoft Corp. supra note 40, para. 337. Ibid., para. 345. 1013 Case T-201/04 Microsoft Corp. supra note 40, para. 374. 1014 Ibid., para. 392. 1015 Case T-201/04 Microsoft Corp. supra note 40, paras. 378-381, 388-391. 1016 Ibid., paras. 374-442. 1012

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effective competition. As the market was characterised by significant network effects, the Commission was correct in intervening before competition was eliminated.1017 Furthermore, Microsoft challenged the development of a new product depending on the interoperability information. Accordingly, the Commission failed to identify a new product which would be developed on the basis of this information. Moreover, the Commission could not prove that there was a consumer demand for this product. Microsoft suspected that its products would be copied.1018 However, the General Court emphasised that Article 102(b) TFEU prohibited abusive conduct which limited production, markets or technological developments to the prejudice of consumers.1019 Following this line, the previous decision in Magill and IMS Health had indeed emphasised the requirement of a new product. But this criterion has to be seen in the light of consumer interests. That is, the new product condition in the above-mentioned cases was an indicator as to whether the prevention of competition in a secondary market was to the prejudice of the consumers. But as Article 102(b) TFEU states, it is not only the prevention of markets and products that may constitute a prejudice to consumers but also the limitation of technological development. Thus, the decisive criterion in this context was whether consumer welfare had been reduced.1020 In the Microsoft case, due to the lack of interoperability, consumers are locked into Windows products and thus, competitors cannot successfully offer their own innovative products. Hence, the General Court explained that due to these circumstances the resultant effect was similar to the prevention of a new product.1021 Contrary to Microsoft’s plea in which Microsoft blamed the Commission for using a new and legally unfounded test to analyse the objective justification, the 1017

Case T-201/04 Microsoft Corp. supra note 40, paras. 561-563. Ibid., paras. 621-625. 1019 Case T-201/04 Microsoft Corp. supra note 40, para. 643. 1020 Ibid., paras. 645-655. 1021 Case T-201/04 Microsoft Corp. supra note 40, parsa. 655-665. 1018

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General Court argued that Microsoft had misread the decision of the Commission which was not based on Balancing Test.1022 In fact, the Commission showed that there was no evidence for its objective justification to refuse licensing. According to the General Court, the Commission, firstly, established that the exceptional circumstances defined by the Court of Justice in the cases of Magill and IMS Health were present. Secondly, it proceeded to analyse the arguments put forward by Microsoft. The Commission assessed whether the justifications put forward by Microsoft outweighed the exceptional circumstances which establish the infringement of competition.1023

3.1.2.2 Modification and Extension of the Exceptional Circumstances

Upon appeal by Microsoft, the General Court gave its judgement modifying and extending the exceptional circumstances established in the Magill 1024 and IMS Health1025 judgements. In both cases, the Court of Justice maintained that where an IPR was involved, it was necessary to show that there must be exceptional circumstances present before Article 102 TFEU could be used to override the free exercise of an IPR. The exceptional circumstances established in these two cases consisted of three cumulative conditions. The first condition was that the undertaking requesting a compulsory licence must offer a new product for which there was potential or demonstrable consumer demand. Secondly, the Commission needed to show that the refusal to license would lead to an elimination of all competition on the

1022

Case T-201/04 Microsoft Corp. supra note 40, parsas. 704-710. Ibid., para. 709. 1024 Joined Case C-241/91P and C-242/91P Magill, supra note 878. 1025 Case C-418/01 IMS Health, supra note 978. 1023

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secondary market. Thirdly, it had to be shown that the dominant firm had no objective justification for a refusal to license. Microsoft argued that there should be a strict test based on the new product rule set out in IMS Health.1026 However, this argument was not convincing since the Court of Justice held in IMS Health that the facts of Magill were sufficient to meet the exceptional circumstances test, implying that other categories of exceptional circumstance could exist.1027 Microsoft also insisted that competitors would clone Windows server OS instead of providing a new product and thus, the consumers would not be harmed by its refusal to share interface information. The Commission successfully argued that competitors could use the interface information to develop the advanced feature of their own products1028 and encourage innovation competition.1029 Therefore, it argued that the refusal to continue to supply interface information hampered follow-on innovation. In its argument on appeal, the Commission refined the new product test by arguing that the new product was defined to add to substantial features arising from competitors’ own research efforts. It reiterated that IMS Health had not established an exhaustive list of exceptional circumstances. It also added the point that the framework for analysing the test of refusal to license was provided by Article 102(b) TFEU which states that it is an abuse to limit technical development to the prejudice of consumers. It continued that the refusal to share the indispensible interface information became a block of interoperability in the IT sector and an obstacle to

1026

Case T-201/04 Microsoft Corp. supra note 40, para. 301. Case C-418/01 IMS Health, supra note 978, para. 107. 1028 Case T-201/04 Microsoft Corp. supra note 40, para. 695. 1029 Ibid., para. 725. 1027

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follow-on innovation in the secondary market. This is what makes this situation different from IMS Health and Magill type cases.1030 The General Court upheld most of the Commission’s arguments. It emphasised that the new product test must be considered under Article 102(b) TFEU.1031 It concluded that the Magill and IMS Health new product rule could not be the only parameter which determined whether a refusal to license an IPR was capable of causing prejudice to consumers within the meaning of Article 102(b) TFEU.1032 The General Court went on to find that the refusal to supply interoperability information would prevent competitors from developing the advanced features of their products and thus caused prejudice to consumers.1033

3.2.3 Implications for Future Cases

It is clear that after Microsoft, the exceptional circumstances test has wider parameters than the new product principle in Magill. Now the only issue is how wide the parameters are. Probably the parameters are not as wide as is suggested by a literal reading of Microsoft judgement1034 which stated that:

Article [102 TFEU] covers not only those practices which may prejudice consumers directly but also those that which indirectly prejudice them by impairing an effective competitive structure.1035

1030

Case T-201/04 Microsoft Corp. supra note 40, para. 305. Ibid., para. 644. 1032 Case T-201/04 Microsoft Corp. supra note 40, para. 647. 1033 Ibid., paras. 651-656. 1034 Anderman and Schmidt, supra note 314, 117. 1035 Case T-201/04 Microsoft Corp. supra note 40, para. 664. 1031

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It should be noted that, first of all, the exceptional circumstances test established by the EU Courts presupposes that the IP-protected product in the primary market must be both a monopoly and an indispensible input in the secondary market. Secondly, the conduct of the IP holder must create a risk of eliminating effective competition in the secondary market. After Microsoft, the crucial test of exceptional circumstances is to discern how the new product test has been redefined.1036 In this case two factors seem to be influential. The test was to ensure that the demonstrable plural sources of innovation should be continued and these sources were also demonstrably satisfying consumer needs which were not satisfied by a dominant undertaking. The category of exceptional circumstances when applied to new entrants will continue to require that the new entrant offers a new product, however, that is defined by the case law. Following Microsoft, it can be assumed that where an incumbent has already been dealing with undertakings operating in a dependent secondary market and the competitor in the secondary market already has advanced features in its own product and requires access to the interface information in order to viably continue to develop this advanced feature, Article 102(b) TFEU will apply.

3.2 Microsoft Case in the US

The antitrust action against Microsoft was an attempt by the US Department of Justice to mandate interoperability between a platform owner and applications developers.1037 The US Department of Justice challenged a number of Microsoft’s

1036

Anderman and Schmidt, supra note 314, 117. United States v. Microsoft Corp., 84 F.Supp.2d 9 (D.D.C. Findings 1999) (Findings of Facts); United States v. Microsoft Corp., 87 F.Supp.2d 30 (D.D.C. 2000) (Conclusions of Law); Microsoft Corp., supra note 313. 1037

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actions as part of an effort to maintain its monopoly in the market for desktop computing operating systems.1038 In particular, it claimed that Microsoft sought to exclude Netscape’s Navigator browser as well as Sun’s Java technology in order to prevent them from serving as middleware that would affect Microsoft’s operating system and displace Microsoft’s monopoly power. Middleware was important to the plaintiffs’ case because of its relationship to one of the most critical barriers to entry into the operating system market,1039 the existence of a substantial number of applications programmes that work with Windows operating system.1040 This large array of programmes had become an entry barrier because consumers were reluctant to buy an operating system for which there were few applications and software developers were reluctant to write applications for operating systems for which there were few users.1041 This kept consumers and developers attached to Windows. The middleware focused on in the litigation, however, was ‘cross-platform’, that is, it would be capable of running with any operating system, not just Microsoft’s Windows OS. 1042 It indicated that if applications developers could write software to interoperate with such middleware, rather than with Windows, the applications barrier to entry into the operating system market might be lowered or eliminated.1043 At the liability stage of the plaintiff’s case against Microsoft, Microsoft refused to share protected information in a way that might have harmed competition, i.e. a four-month delay in 1995 in releasing the specifications for a so-called

1038

United States v. Microsoft Corp., 84 F.Supp.2d 9 (D.D.C. Findings 1999) (Findings of Facts); United States v. Microsoft Corp., 87 F.Supp.2d 30 (D.D.C. 2000) (Conclusions of Law); Microsoft Corp., supra note 313. 1039 United States v. Microsoft Corp., 84 F.Supp.2d 9, 28 (Civil Action Nos. 98-1232 & 98-1233). 1040 Ibid., 19-20. 1041 Microsoft Corp. (Findings of Facts), supra note 1037, 20. 1042 Ibid., 28-30 and 34-38. 1043 Microsoft Corp. (Findings of Facts), supra note 1037, 28-30 and 34-38.

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application programming interface (API) to Netscape. 1044 In 2001, the litigants agreed on a settlement which was finally approved by the US Appeals Court in 2004. This agreement obliged Microsoft to share, in certain circumstances, the APIs and related documentation used by Microsoft middleware to interoperate with Windows (mandatory disclosure). 1045 The access to this interface would enable software companies to establish a full technical compatibility of their software applications with the Windows operating system. 1046 Furthermore, Microsoft was required to license, on reasonable and non-discriminatory terms, communications protocols installed on a personal computer and used to interoperate with a Microsoft server operating system (compulsory licensing).1047 The reason for requiring the disclosure of APIs is that if middleware were to be a competitive threat to Windows, it would have to be able to work with Windows as well as with other operating systems, that is, it could not be cross-platform unless it worked on the dominant platform as well as on others in the future.1048 Requiring disclosure of APIs helps ensure this interoperability, making relief justifiable although the required disclosure was not clearly directed towards a specific finding of liability, but instead, was aimed at eliminating the effects of illegal conduct.1049 Disclosure of communications protocols between Windows and Microsoft server operating systems could also be justified. The theory was that servers might be the new middleware, in the sense that future applications might run on servers rather than on personal computers. 1050 Server operating systems thus might become a platform that would challenge Microsoft’s dominance in the desktop operating 1044

United States v. Microsoft Corp., 84 F.Supp.2d 9, 33 (D.D.C. Findings 1999). Microsoft Corp., supra note 313 1046 Ibid. 1047 United States v. Microsoft Corp., 2002-2 Trade. Cas. (CCH) P73, 860, at 95, 110. 1048 United States v. Microsoft Corp., 231 F.Supp.2d 144, 186-187 (D.D.C. 2002). 1049 Ibid., 189. 1050 New York v. Microsoft Corp., 224 F.Supp.2d 76, 172-173 (D.D.C. 2002). 1045

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systems market, but only if servers were able to communicate with the desktops.1051 Such communication requires knowledge of the protocols that Microsoft builds into Windows OS.1052 In applying a traditional manufacturing industry-type duty to deal theory to the technologically dynamic markets of the New Economy, the Microsoft case suggests that a platform monopolist must exercise special care in terms of the type of cooperation, or lack thereof, it offers to competitors.1053 In the Microsoft case, both the District Court and the Court of Appeals concluded that inter alia the strong network externalities inherent in operating systems meant that any rival operating system would find it extraordinarily difficult to displace Microsoft’s dominance and encourage application developers to create software programmes to run on a platform other than Windows OS.1054 In holding a platform monopolist liable under the antitrust law, the D.C. Circuit concluded that Microsoft engaged in exclusionary conduct by pressuring developers to use Microsoft’s own non-compatible version of a Java Virtual Machine (JVM), deceiving them about its lack of compatibility with Sun’s JVM, and pressuring Intel not to support Sun’s JVM.1055 In so doing, the Court found that a rival had no duty to make a competing platform compatible, particularly in this case where Microsoft’s product worked more effectively on Windows than Sun’s JVM. Nevertheless, the use of anticompetitive tactics to gain an advantage violated the antitrust law. 1056 Moreover, where a firm engages in a practice designed to

1051

Microsoft Corp., supra note 1048, 189. Ibid., 189-190. 1053 Philip Weiser, “Regulating Interoperability: Lessons from AT&T, Microsoft, and Beyond,” Antitrust Law Journal 76 (2009): 280. 1054 Microsoft Corp., supra note 313, 55-56. 1055 Ibid., 74-77. 1056 Microsoft Corp., supra note 313, 74. 1052

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disadvantage a rival, and cannot justify that practice on efficiency grounds, it infringes Section 2 of the Sherman Act.1057 Since the purpose of the final decree was to achieve a high degree of interoperability of Microsoft software, the result might be that non-Microsoft software could result in operating in a way that would be functionally interchangeable with Microsoft’s products. In other words, the compulsory disclosures would have permitted competitors to offer clones of Microsoft’s software, specifically of Windows operating system.1058 Judge Kollar-Kotelly recognised that cloning a programme’s functionality is not the same as copying a programme’s code. 1059 Indeed, the District Court acknowledged that not all information in the software industry is protected by intellectual property law1060 and even stated, albeit without any specific legal analysis, that the mandatory disclosure provisions would allow Microsoft’s competitors to clone many features of Microsoft’s software without violating intellectual property laws. 1061 Nevertheless, the District Court referred to the proposed compulsory licensing provision as an intellectual property ‘grab’ by Microsoft’s competitors. 1062 Intellectual property law gives its holders some very specific and bounded rights to exclude others from using the holder’s property, 1063 but there is no clear examination in Judge Kollar-Kotelly’s opinion regarding whether Microsoft protects its APIs or communications protocols through copyright, patent, trade secret, or even trademark, or the extent to which intellectual property laws might provide no protection at all to the information.1064

1057

Weiser, supra note 1053, 281. Microsoft Corp., supra note 1048, 228. 1059 Ibid. 1060 Microsoft Corp., supra note 1048, 229. 1061 Ibid. 1062 Microsoft Corp., supra note 1048, 229. 1063 Microsoft Corp., supra note 483, 40. 1064 First, supra note 947, 1389. 1058

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In general, the protection of intellectual property rights encourages innovation by rewarding the innovator’s investment in creating something new, while making the innovation available to the public. 1065 The fact that the Court allowed Microsoft’s products to be cloned was a contradiction of the terms of IPRs; Microsoft was to be denied the returns from its investment in innovation and to be effectively divested of its IP value.1066 There needs to be some legal protection for intellectual property without which intellectual products could be freely appropriated by others, at low or no cost. The real questions are, however, how much protection is necessary and what the costs of that protection might be.1067 For example, a fuller calculation of the effects of compulsory disclosure on Microsoft’s incentives to innovate would also have considered the stimulus to innovation that competition might provide; the competition that would be increased by making it easier for other software to interoperate with Windows; and, indeed, the competition that would come from permitting other software to mimic its functionality.1068 In this respect, the final decree’s mandatory disclosures, and compulsory licensing of any intellectual property rights necessary to secure interoperability would seem to raise a direct conflict between antitrust law and intellectual property law. The most obviously regulatory aspect of the decree entered by Judge KollarKotelly was the requirement that the compulsory protocol licenses be offered on reasonable and non-discriminatory terms. 1069 Essential facilities or public utilities traditionally have been required to provide service to all who ask, without discrimination, and to offer services at fair and reasonable rates. 1070 These

1065

First, supra note 947, 1390. Microsoft Corp., supra note 1050, 176. 1067 First, supra note 947, 1390. 1068 Ibid.,. 1069 United States v. Microsoft Corp., 2002-2 Trade. Cas. (CCH) P73, 860, at 95, 110. 1070 First, supra note 947, 1391. 1066

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obligations have been overseen by regulatory agencies, but the Microsoft decree gave the District Court this review function.1071 The decree also required the court to supervise the quality of Microsoft’s compliance with the protocol-disclosure requirement, with the assistance of an outside technical committee. 1072 In fact, supervision of this disclosure requirement has proved to be a substantial regulatory burden, as the adequacy of Microsoft’s protocol documentation has been a constant point of contention between the parties, leading the District Court to require periodic reporting and hearings in an effort to force Microsoft to perform adequately.1073 Although antitrust authorities generally avoid such regulatory decrees, preferring remedies that restore competition and then permit the market to do its work, the regulatory direction of the final decree can be seen as consistent with the economic and institutional assumptions that the IP-related product can be the essential facilities.1074 As an economic issue, Windows OS, an intellectual property product, is now seen as a twenty-first century natural monopoly, with economies of scale on the supply side (subject to declining average costs because of near-zero short-run marginal costs) and economies of consumption on the demand side (the network effects arising from its ubiquity). 1075 By the end of the case, since the government plaintiffs appeared to fear fragmentation of the platform more than a continuation of Microsoft’s monopoly, the decree left Microsoft in its monopoly position but imposed on it at least some of the duties traditionally imposed on a

1071

United States v. Microsoft Corp., 231 F.Supp.2d 144, 100-202 (D.D.C. 2002). United States v. Microsoft Corp., 2002-2 Trade. Cas. (CCH) P73, 860, at 95, 113. 1073 United States v. Microsoft Corp., 2002-2 Trade. Cas. (CCH) (Civil Action No. 98-1232 (CKK)); United States v. Microsoft Corp., 2006-2 Trade. Cas. (CCH) P75, 418 (D.D.C. 2006) (modified decree). 1074 First, supra note 947, 1393. 1075 United States v. Microsoft Corp., 87 F.Supp.2d 30, 40 (D.D.C. 2000) (Civil Action Nos. 98-1232 (TPJ) & 98-1233 (TPJ), Declaration of Kenneth J. Arrow, 5-6; John F. Duffy, “The Marginal Cost Controversy in Intellectual Property,” University of Chicago Law Review 71 (2004): 39-40. 1072

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regulated monopoly, including the duty to deal on reasonable, non-discriminatory terms, instead of as a restructured Microsoft (subject to competitive markets).1076 In conclusion, it is noteworthy that the Supreme Court used legal terms such as ‘monopolisation’ in Section 2 of the Sherman Act,1077 although the approach taken in the remedial phase seemed to deal with essential facilities in the Microsoft case; an undertaking which possesses dominance in a primary market, i.e. the market for Intel-compatible PC operating system, and tries to control a downstream market, i.e. the market for Internet browsers. 1078 In fact, the D.C. Circuit Court of Appeals pointed out the essential function of the API for the downstream market for personal computer application software.1079 This judicial practice of focusing on the specific misconduct rather than determining whether the requirements of a certain doctrine are fulfilled is in accordance with the former decisions of the US Supreme Court.1080

VI. Analysing Elements of Essential Facilities/Exceptional Circumstances

4.1 Evolution of Leveraging: Two-Market Theory v. Single-Market Theory

4.1.1 Market Foreclosure effects

The principle of Commercial Solvent is based on a situation where there are two vertically different markets, upstream market A and downstream market B: the undertaking which is dominant in market A may not, by withholding supply of

1076

United States v. Microsoft Corp., Civil Action No. 98-1232 (CKK) (D.D.C. 9 February 2005) (Statement of Counsel for the Department of Justice), Transcript of Hearing, 17. 1077 United States v. Microsoft Corp., 345 F.3d 49 (2004). 1078 First, supra note 947, 1376-1394. 1079 Microsoft Corp., supra note 1075. 1080 Muller and Rodenhausen, supra note 961, 327.

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product A, extend its market share in market B, in which it is also present. This was the factual setting of most cases decided under the Commercial Solvent paradigm. However, in a few cases the Commission and the EU Courts have imposed a duty to supply on a dominant undertaking in market A, in order to enhance competition in market B, despite the fact that this undertaking is not present in the derivative market. Especially, in the Magill case, access to TV listings was ordered because no product was being offered in market B (weekly comprehensive TV guides), despite there being demand for such a product. Thus, it is clear that not all essential facilities cases fit the Commercial Solvents case which needed to leverage market power from an upstream or primary market to a downstream or secondary market.

1081

Market foreclosure, rather than market leveraging, may provide

underlying justification for the application of the essential facilities doctrine in the EU.1082 Similarly, in the Oscar Bronner case, the Court of Justice expressly deferred to the national court on the issue of whether home delivery schemes for newspapers constituted a service market. 1083 However, the evidence showed not only that Mediaprint, the newspaper publisher in question, introduced and maintained a home delivery system for its own use,1084 but also that there was no “access market” in the home delivery system created by Mediaprint for the purposes of this case, in that it had never licensed access to it, as such, to any newspaper publisher.1085 These facts demonstrated that the Court of Justice in the Oscar Bronner case did not consider the

Frank Fine, “NDC/IMS: A Logical Application of Essential Facilities Doctrine,” European Competition Law Review 23, no.9 (2002): 458. 1082 Ibid. 1083 Case C-7/97 Oscar Bronner, supra note 949, para. 34. 1084 Opinion of Advocate General Jacobs, in Case C-7/97 Oscar Bronner, supra note 949, para. 70. 1085 Case C-7/97 Oscar Bronner, supra note 949, para. 9. 1081

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absence of two markets an impediment to the application of Article 102 TFEU, provided that the other elements were satisfied.1086 Moreover, even if there were a market in home delivery systems for newspapers, the Court of Justice in the Oscar Bronner case was not concerned with any leveraging by Mediaprint from that market to the market in newspaper publishing. Rather, the Court of Justice assumed for the purposes of the case that Mediaprint held a dominant position in the Austrian market for daily newspapers even before Bronner sought access to its home delivery system. 1087 The Court of Justice’s concern was therefore not with leveraging from that system to a market already dominated by Mediaprint, but rather, with whether Bronner was being denied access to a facility, which might have been necessary for the distribution of newspapers “with a circulation comparable to that of the daily newspapers distributed by [Mediaprint’s] scheme.”1088 In other words, the Court of Justice was concerned about potential market foreclosure by Mediaprint, rather than leveraging from one market in which it exercised power to a secondary market in which such power was absent.1089 The Court of Justice’s real concern was whether Mediaprint, the dominant newspaper publisher in Austria, in refusing access to its home delivery system, enabled it to obtain, or maintain, a “genuine stranglehold” on the Austrian newspaper market.1090 The situations in the cases of Magill and Oscar Bronner were, therefore, devoid of market leveraging because there was only one true market which was relevant in both cases, and the effect of the relief sought, if indispensability of access were demonstrated, was to prevent market foreclosure rather than market

1086

Fine, supra note 1081, 459. Case C-7/97 Oscar Bronner, supra note 949, para. 16. 1088 Ibid., para. 46. 1089 Fine, supra note 1081, 459. 1090 Opinion of Advocate General Jacobs, in Case C-7/97 Oscar Bronner, supra note 949, para. 65. 1087

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leveraging.1091 Finally, the Commission in the IMS case for the first time explicitly rejected the need to prove the existence of two markets in an essential facilities case.1092

4.1.2 Competitive Relationship

The Seventh Circuit’s decision in the MCI Communications case contains the most frequently cited list of elements of an essential facilities claim:

(1) control of the essential facility by a monopolist; (2) a competitor’s inability practically or reasonably to duplicate the essential facility; (3) the denial of the use of the facility to a competitor; and (4) the feasibility of providing the facility. 1093

Most importantly, the Seventh Circuit explicitly relied upon the leveraging theory that permitted the owner of the essential facility to monopolise or restrict competition in a related but distinct market:

A monopolist’s control of an essential facility (sometimes called a ‘bottleneck’) can extend monopoly power from one stage of production to another, and from one market into another. Thus, the antitrust laws have imposed on firms controlling an essential facility the obligation to make the facility available on non-discriminatory terms.1094

The MCI court’s incorporation of a vertical element into its essential facilities analysis, i.e., AT&T’s use of its monopoly in local telephony to exclude MCI from

1091

Fine, supra note 1081, 459. COMP D3/38.044 IMS Health, supra note 962, paras. 183-184. 1093 MCI Communications Corp. supra note 894. 1094 Ibid., 1132. 1092

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the market for long-distance telephone services, is echoed by numerous appellate decisions. For example, according to the Second and Seventh Circuits:

The policy behind prohibiting denial of an essential facility to a competitor, at least in part, is to prevent a monopolist in a given market (here, bodybuilding magazines) from using its power to inhibit competition in another market (here, nutritional supplements for bodybuilders).”1095 “The point of the essential facilities doctrine is that a potential market entrant should not be forced simultaneously to enter a second market, with its own large capital requirements.

1096

Professor Hovenkamp’s treatise described the role of the vertical relationship in the essential facility doctrine as follows:

It should be clear that the essential facility doctrine concerns vertical integration-in particular, the duty of a vertically integrated monopolist to share some input in a vertically related market, which we call market #1, with someone operating in an upstream or downstream market, which we shall call market #2. If the facility is truly “essential.” then the #1 monopoly facility also establishes a #2 monopoly … Understanding the “vertical” nature of essential facility claims helps to focus the analysis: the essential facility claim is about the duty to deal of a monopolist who is able to supply an input for itself in a fashion that is so superior to anything else available that others cannot succeed unless they can access this firm’s input as well.1097

As a matter of antitrust jurisprudence and policy, this two-market analytical approach is set by the underlying notion of legitimate market power found in Section 2 of the precedents of the Sherman Act: market power acquired “as a consequence of a superior product, business acumen, or historic accident” does not offend the antitrust 1095

Twin Labs, Inc. v. Weider Health & Fitness, 900 F.2d 566, 568 (2nd Cir. 1990). Fishman v. Estate of Wirtz, 807 F.2d 520, 540 (7th Cir. 1986). 1097 Herbert Hovenkamp, “Unilateral Refusals to Deal, Vertical Integration, and the Essential Facility Doctrine,” 1 July, 2008. University of Iowa Legal Studies Research Paper No. 08-31, p. 1. Available at SSRN: http://ssrn.com/abstract=1144675. (accessed 20 April, 2010). 1096

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law.1098 Thus, there is no basis under the essential facilities or any other doctrine for compelling the sharing of legitimately acquired advantages which are absent from exclusionary abusive conduct in or affecting an adjacent market.

1099

This

fundamental principle is not limited to intellectual property.1100 Antitrust law does not, for example, require a manufacturer who achieves economies of scale that cannot be matched by its rivals to share its more efficient plant.1101 However, the Tenth Circuit’s opinion in Aspen Skiing clearly deviated from the two-market logic of the essential facilities doctrine.1102 In that opinion, the Tenth Circuit explicitly held that vertical integration into two markets was not necessary to an essential facilities case.1103 In other words, there is no requirement that a plaintiff alleging anticompetitive denial of access to an essential facility should demonstrate the existence of two separate relevant product markets.1104 Instead, according to the Tenth Circuit in Aspen Skiing, parties making essential facilities claims may simultaneously be customers and competitors of the alleged monopolists in a single market. 1105 As some cases suggest, 1106 the essential facilities doctrine does not require a plaintiff to neatly order the relevant levels of production into two separate relevant product markets. It is sufficient to prove that the parties compete, or would compete if the plaintiff were permitted access to the defendant’s asset, in the same market. This is not to say that the essential facilities doctrine does not apply where two vertically-related markets are involved. Obviously, it captures such situations as 1098

United States v. Grinnell Corp., 384 US 563, 571 (1966). Paul Marquardt and Mark Leddy, “The Essential Facilities and Intellectual Property Right: A Response to Pitofsky, Patterson, and Hooks,” Antitrust Law Journal 70 (2003): 852. 1100 Ibid. 1101 Marquardt and Leddy, supra note 1099, 852. 1102 Aspen Highlands Skiing Corporation v. Aspen Skiing Company, 738 F.2d 1509 (10th Cir. 1984). 1103 Ibid., 1518, footnote 11. 1104 Robert Pitofsky, Donna Patterson, and Jonathan Hooks, “The Essential Facilities Doctrine Under US Antitrust Law,” Antitrust Law Journal 70 (2002): 458. 1105 Ibid. 1106 Sunshine Cellular v. Vanguard Cellular Systems, Inc.,810 F.Supp. 486 (S.D.N.Y. 1992); Delaware & Hudson Railway Co. v. Consolidated Rail Corp., 738 F.2d 1509 (10th Cir. 1984). 1099

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well. 1107 The courts require only that the plaintiff prove that the facility is indispensable for competition in a relevant product market, is controlled by a monopolist who could practically make access available, and is not capable of duplication.1108 The aim of the policy is simply to ensure competition in the market where the two parties could compete but for the refusal to provide access to the essential asset; any characterisation of the essential facility would be superfluous and artificial.1109 Thus, the vital issue in applying the essential facilities doctrine is whether the plaintiff has a competitive relationship with the alleged monopolist in the relevant product, not what the relationship is between the plaintiff and the defendant with respect to the asset alleged to be “essential.” 1110 In other words, the competitive relationship between the parties, not the relationship between the essential facility and the relevant market, is the criterion of liability under the essential facilities doctrine.1111 However, the Supreme Court in Aspen Skiing case expressly declined to reach the essential facilities reasoning relied upon by the Court of Appeals.1112 The Supreme Court’s opinion clearly distinguished between a refusal to enter into a new cooperative arrangement and a sudden change in market practice by the dominant firm that seemed squarely aimed at eliminating its lone, remaining competitor:

The monopolist did not merely reject a novel offer to participate in a cooperative venture that had been proposed by a competitor. Rather, the monopolist elected to 1107

American Telephone & Telegrph Co. v. North American Industries, Inc., 772 F.Supp. 777 (S.D.N.Y. 1991); Advanced Health-Care Services, Inc. v. Radford Community Hospital, 910 F.2d 139 (4th Cir. 1990); Twin Labs, Inc. v. Weider Health & Fitness, 900 F.2d 566 (2nd Cir. 1990). 1108 MCI Communications Corp. supra note 894. 1109 Pitofsky, Patterson, and Hooks, supra note 1104, 460. 1110 Ibid., 461. 1111 Pitofsky, Patterson, and Hooks, supra note 1104, 461. 1112 Aspen Skiing Company v. Aspen Highlands Skiing Corporation, 472 US 585, 611 fn. 44 (1985).

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make an important change in a pattern of distribution that had originated in a competitive market and had persisted for several years.1113

Although in its decision the Supreme Court distanced itself from the reasoning of the lower court, the opinion of the Tenth Circuit in Aspen Skiing can mark the first step on a new path for the essential facilities doctrine, the duty to license for obtaining interoperability.1114 In particular, the one-market theory can provide justification in a situation where a competitor intends to produce goods or services of a different nature, which answer specific consumer requirements not satisfied by existing goods or services.1115

4.2 Exceptional Circumstances

4.2.1 Indispensability

Indispensability implies that the input or information in question is essential for the exercise of a viable activity on the market for which access is sought.1116 The test is whether the creation of substitute inputs or information is impossible or extremely difficult. In other words, whether there are technical, legal or economic obstacles capable of making it impossible or at least unreasonably difficult to create alternatives, or to create them within a reasonable timeframe.1117 Thus, it must be shown that the cost of duplicating the allegedly essential facility constitutes a barrier 1113

Aspen Skiing, supra note 1112, 603. Marquardt and Leddy, supra note 1099, 855. 1115 Case IMS Health, supra note 976, Opiniion of Advocate General Tizzano, para. 62. Available at http://curia.europa.eu/jurisp/cgi-bin/form-.pl?lang=en (accessed 20 April, 2008). 1116 Case T-504/93 Tierce Ladbroke SA v. Commission of the European Communities. [1997] European Court Reports II -923,para. 130. 1117 Case C-418/01 IMS Health, supra note 978, para. 28; Case T-374/43 European Night Service v. Commission of the European Communities. [1998] European Court Reports II -3141,para. 209, footnote 34. 1114

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to entry such that there are no viable alternatives to the dominant firm’s input,1118 or the cost of such alternatives is “prohibitively expensive and would not make any commercial sense.1119 In the case of intellectual property rights, similar considerations apply. Due to the legal restrictions, the test is whether competitors can turn to any workable alternative technology of the right in question in such a way that they can remain effective competitors without the supply. 1120 The Commission’s Discussion Paper states that the indispensability requirement “would likely be met where the technology has become the standard or where interoperability with the right holder’s IPR protected product is necessary for a company to enter or remain on the product market.” 1121 This is the case for any interoperability information that may be protected by intellectual property rights in regard to products that have become de facto standards or where interoperability is necessary to compete in the market.1122 Indispensability is not required for an abuse not involving a (constructive) refusal to license a rival, where a compulsory license may be an appropriate remedy, but where dominance in addition to some other abusive behaviour may be enough for the application of Article 102 TFEU.1123

4.2.2 Risk of Elimination of Effective Competition

The refusal to share the indispensable input must entail the elimination or substantial reduction of competition to the detriment of consumers in both the short and the long 1118

Case T-374/43 European Night Service, supra note 1117, para. 227. COMP/37.685 GVG/FS, 2004/33/EC Commission Decision of 27 August, 2003[2004] Official Journal of the European Communities L 11/17, paras. 109, 120, and 148. 1120 Dolmans, O’Donoghue, and Loewenthal, supra note 948, 128. 1121 European Commission, Competition Discussion Paper, supra note 641. 1122 Dolmans, O’Donoghue, and Loewenthal, supra note 948, 128. 1123 Ibid., 129. 1119

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term. 1124 This condition is the corollary of the condition that the dominant firm’s input is indispensable for competition. If the input is not indispensable, the refusal to share would not have substantial effects on competition.1125 Conversely, if an input is essential for competition, it would, ultimately, allow the undertaking or undertakings that own or control it to exclude all competition on the relevant downstream market in which the input is used.1126 The Commission has explained this underlying policy rationale for imposing a duty to deal in the following terms:

The duty to provide access to a facility arises if the effect of the refusal to supply on competition is objectively serious enough: if without access there is, in practice, an insuperable barrier to entry for competitors of the dominant company, or if without access competitors would be subject to a serious, permanent and inescapable competitive handicap …1127

However, there should be no requirement to show that the rival who wishes to have access to the information is already excluded from the market before the refusal to supply can be found to risk substantially eliminating competition. 1128 Rather, the Commission said that the relevant legal test is not whether each and every competitor has irreversibly exited, but whether there is some present basis for identifying a “serious risk of foreclosing competition and stifling innovation.” 1129 This makes sense, since, otherwise, competition authorities and courts would have to stand idly by and wait for actual exclusion and anticompetitive effects to materialise before they could act, even where the long-term harm caused by exclusion would be serious

1124

Opinion of Advocate General Jacobs, in Case C-7/97 Oscar Bronner, supra note 949, para. 61. Dolmans, O’Donoghue, and Loewenthal, supra note 948, 129. 1126 Ibid. 1127 Organisation for Economic Cooperation and Development, “The Essential Facility Concept,” (1996): 94, Available at http://www.oecd.org/dataoecd/34/20/1920021.pdf (accessed 19 April, 2011). 1128 European Commission, Competition Discussion Paper, supra note 641. 1129 COMP/C-3/37.792 Microsoft, supra note 238, para. 842. 1125

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or even irreversible owing to very high barriers to re-entry.1130 Moreover, in a case of ‘monopoly maintenance’ the anticompetitive effect is not the mere exclusion of competitors, but harm caused to consumers from the continuation of a substantial degree of market power and reduction of product diversity.1131 In addition, the mere presence of a competitor does not mean that no elimination of competition has occurred.1132 Especially in markets where significant investments are required to compete through innovation, effective competition does not mean the mere presence of one or more niche rivals. It implies a meaningful process of competition whereby firms have an effective opportunity to compete on merits based on price, quality, and innovation.1133

4.2.3 New Product Criterion: Limiting Technological Development

There is no requirement that the refusal must always prevent the emergence of a product that has not existed before in any form. The situation where consumers are deprived of a specific new product for which they have present and unsatisfied demand, as occurred in the Magill case, is one example of a limitation of innovation to the prejudice of consumers.1134 The General Court indicated that the new-product test could justify imposition of a duty to deal under Article 102 TFEU, but that other criteria could also justify such a duty. 1135 This was confirmed again in the IMS Health case, where the new-product criterion was mentioned as merely one of several sufficient conditions, thereby suggesting, implicitly but clearly, that this

1130

Dolmans, O’Donoghue, and Loewenthal, supra note 948, 130. COMP/C-3/37.792 Microsoft, supra note 238. 1132 European Commission, Competition Discussion Paper, supra note 641. 1133 Dolmans, O’Donoghue, and Loewenthal, supra note 948, 130. 1134 Joined Case C-241/91P and C-242/91P Magill, supra note 878. 1135 Case T-504/93 Tierce Ladbroke, supra note 1116, para. 131. 1131

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criterion (together with the other elements) is sufficient but not necessary.1136 The new-product test applied in the IMS Health case must be understood as a proxy to identify conduct that stifles innovation and reduces consumer welfare, or that “limit[s] production ... or technical development to the prejudice of consumers” within the meaning of Article 102(b) TFEU.1137 This thinking appears to underpin the following statement:

A refusal to licence an IPR protected technology which is indispensable as a basis for follow-on innovation by competitors may be abusive even if the licence is not sought to directly incorporate the technology in clearly identifiable new goods and services. The refusal of licensing an IPR protected technology should not impair consumers’ ability to benefit from innovation brought about by the dominant undertaking’s competitors.1138

In the Magill case the Court of Justice required proof of unsatisfied consumer demand and not merely the prospect of future innovation, and assessed the relevant market in which the follow-on innovation would compete. 1139 Consumers can be harmed in many ways other than the narrow case of suppression of existing new products.1140 One example of consumer harm is where rival software vendors lack access on equal terms to essential interoperability information and cannot offer products which are even better, more functional or more innovative and which have full interoperability with a virtual monopoly standard.1141 Interoperability is a policy goal designed to provide users with the freedom to combine ‘best-of-breed’

1136

Case C-418/01 IMS Health, supra note 978. François Lévêque, “Innovation, Leveraging and Essential Facilities: Interoperability Licensing in the EU Microsoft Case,” World Competition 28, no. 1 (2005):71-91. 1138 European Commission, Competition Discussion Paper, supra note 641. 1139 Joined Case C-241/91P and C-242/91P Magill, supra note 878. 1140 Dolmans, O’Donoghue, and Loewenthal, supra note 948, 132. 1141 Ibid., 132 1137

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components of a system or network in any way they wish.1142 The non-disclosure of essential information in such a case not only deprives users of that freedom, but it is also an artificial handicap to rivals’ products that otherwise could evolve in innovative ways, creating product diversity, or could directly or indirectly foster innovation that challenges the dominant firm’s monopoly.

1143

Restriction of

innovation and lack of interoperability can prejudice consumers even if there are no new products yet, but incentives and opportunity to innovate are stifled to such an extent that rivals who in the past have shown a propensity to innovate are being cut out of the market.1144 There is unsatisfied consumer demand for third-party products with full interoperability with Windows and Office. There is substantial consumer prejudice, in particular, where the rivals’ activities could directly or indirectly foster innovation that challenges the dominant firm’s monopoly; or rivals’ products themselves can be expected to evolve in innovative ways, creating product diversity.1145 In these cases, there will be little scope for innovation, except, possibly, innovation coming from Microsoft, and even Microsoft’s incentives are reduced in the absence of pressure from rivals. 1146 Thus, the scope for competitive harm in cases of denial of interoperability is far greater than in any previous case that involved only one new type of product.1147

4.2.4. Objective Justification and Proportionality

1142

Dolmans, O’Donoghue, and Loewenthal, supra note 948, 132. Ibid., 132. 1144 Dolmans, O’Donoghue, and Loewenthal, supra note 948, 133. 1145 Ibid. 1146 Dolmans, O’Donoghue, and Loewenthal, supra note 948, 133. 1147 Ibid. 1143

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Objective and proportionate efficiencies or other justifications can safeguard behaviours from liability.1148 The elements to be proven for an objective justification analysis under Article 102 TFEU are four-fold. Firstly, the refusal seeks to attain a legitimate goal. The range of acceptable justifications for a refusal to deal will vary from case to case depending on the facts. In the case of IPRs the desire to recover past R&D expenses and to underpin investments in future innovation may be provided as a legitimate goal. In the second place, the conduct is effective, in that it is reasonably capable of achieving that legitimate goal; the objective must not be a theoretical or a subterfuge for exclusionary intent. Thirdly, the conduct is necessary to achieve the pro-competitive goal. If this is convincingly alleged, the plaintiff must show that there are less restrictive and effective alternatives. Fourthly, the use of the intellectual property right is proportionate in light of the pro-competitive goal and the anticompetitive effect, called the balance-of-interest test. This test should focus on the essential function of IPRs, that is, to foster innovation. If the IPR is used in a way that reduces overall innovation, the balance of interest should arguably fall in favour of compulsory licensing.1149 An inquiry of this kind is similar to the rule-of-reason analysis applied in the Section 2 offence of the Sherman Act.

V. Conclusion

Although the objectives of competition law and intellectual property policy are complementary in that both seek to create a set of incentives to encourage an innovative, and vigorously competitive marketplace that enhances efficiency and improves consumer welfare, there appears to be a tension between competition law 1148

Joined Case C-241/91P and C-242/91P Magill, supra note 878; Case C-7/97 Oscar Bronner, supra note 949; Case 311/84 Télémarketing, supra note 910. 1149 Dolmans, O’Donoghue, and Loewenthal, supra note 948, 134.

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and IP law in practice because IPRs are characterised as exclusive and anticompetitive with regard to competition for and within the market. In the case of conflicts, arguably competition law ought to take supremacy since the dominance in the IT industry can be durable due to network effects, switching costs, and economies of scale. This relationship of competition law as a second measure of the exercise of IPRs was reinforced by Microsoft. However, there should be limitations and the exceptional circumstances test, or the essential facilities doctrine may delimit boundaries between effective competition and IPRs. Indeed IPRs should not be regarded as protecting their owners from competition; rather, IP rights should be seen as encouraging undertakings to engage in effective competition. Whilst the conditions of compulsory licensing have not changed, their application and interpretation by the EU Courts have.

The different factual

circumstances of legal cases have required that the exceptional circumstances test or the essential facilities be differently applied in each case. In New Economy markets characterised by network effects, switching costs, and lock-in, IPRs over a de facto standard cause substantial entry barriers in the primary market. As a result right holders are provided with the dominant power to control the degree of competition through the use of interface information in secondary and complementary markets. Thus, effective competition in IT markets may be harder to achieve than in other markets. In such a situation, the scope of the exceptional circumstances or the essential facilities should be more widely interpreted. In addition, it is necessary to relax the conditions of the exceptional circumstances test in IT markets. This was exactly what the General Court did in the Microsoft case.

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In Magill and IMS Health, the EU Courts followed the previous judgments by developing the exceptional circumstances test or the essential facilities. However, despite that the General Court in Microsoft referred to the previous IP licensing cases in its adjudication, its interpretation considerably departed from the structured conditions applied in the earlier cases. Although the General Court did not directly explain the reasons for doing so, its statements in the case implied that it recognised the exceptional characteristics of the relevant market. Thus, it can be argued that the General Court lowered the standards to impose the compulsory licensing in the Microsoft case owing to its special market situation. However, the EU did not relax the scope of the exceptional circumstances and lower the standard to impose the compulsory licence in general. The higher standards of Magill and IMS Health may still be applied to relevant markets with no substantial entry barriers. Thus, it is suggested that a Microsoft-type standard may apply only to the specific markets with strong network effects and enormous switching costs in order to protect innovation and effective competition. When considering the possible compulsory licensing of IPRs for innovation and effective competition, there are clear dangers if the competition authorities and the courts intervene rashly, as this can unjustly share the fruits of the innovation and reduce the incentive to innovate in the future. There is also a risk in failing to intervene in cases where there truly is a market failure, both because this will allow the holder of the IPRs to reap additional profits from the market failure, and because it will reduce or eliminate the incentive for further innovation in the downstream market.1150

Christopher Stothers, “IMS Health and Its Implication for Compulsory Licensing in Europe,” European Intellectual Property Review 26, no. 10 (2004): 470. 1150

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IPRs themselves do not create an economic monopoly that can be defended in all circumstances and at all costs. Therefore, interference with any intellectual property should be limited and proportionate and should not materially affect its wider incentives for innovation.1151 This is not to say that abusive and exclusionary conduct does not occur in IT markets, particularly when the presence of network effects, lock-ins, and barriers to entry make market self-correction difficult. However, abuse in the IT industry must be assessed by the damage which it causes to new market entrants who may replace the incumbent monopolist. There should be an internal balance between exclusivity and access within IPRs and the possibility of an external restriction set by the competition law. In other words, IPRs should be carefully examined so that the conflict between competition and intellectual property is minimised. Further, the economics of intellectual property and IP products should be carefully understood in each case so that the impact of anticompetitive liability on those rights and on the incentives provided by intellectual property can be properly assessed. Finally, the benefits provided by the competitors that want access to IP should be appreciated, particularly for the ability of such undertakings to stimulate innovation. Competition law does not correct the exercise of IPRs, but only corrects the market situation which has been caused by IPRs. In other words, competition rules apply when IPRs are used as a tool of abuse or as a means of impeding effective competition. 1152 It is noteworthy that in general the exercise of IPRs will distort effective competition for a limited time, but in certain circumstances a dominant firm’s monopoly over products or services may lead to the permanent elimination of

1151

Dolmans, O’Donoghue, and Loewenthal, supra note 948, 136. Case 85/76 Hoffmann-La Roche , supra note 173, para. 6; Case 262/81 Coditel v. Ciné Vog Films [1982] European Court Reports 3381, para. 14. 1152

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effective competition in the relevant market.1153 In such a situation, the possibility of permanent distortion of competition in a whole market may exceed the degree of restriction inherent in IPRs. It is impossible to establish a single principle that can be uniformly applied to all industries, since each industry has its own specific characteristics. The imposition of a compulsory licence may have different effects on innovation and competition in each market. Therefore, the interpretation of the conditions of the exceptional circumstances test should be adapted to the specific sector. That is what the current EU competition regime has done.

1153

The Opinion of Advocate General Jacobs in Case C-7/97 Oscar Bronner, supra note 949, para. 64.

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Part V. Conclusion

I. Summary of Findings .........................................................................................................242 II. Consideration of Findings .................................................................................................245 III. Per Se Approach to Article 102 TFEU and Its Consequences in IT Markets..................248 IV. Implications of Applying the Current European Legal Analysis to IT Markets..............251 V. Contribution to the Discussion on the New Economy and Article 102 and its Limitations .............................................................................................................................255

I. Summary of Findings

This thesis discusses whether the current European competition principles are adequate to protect consumers in the New Economy industries, such as IT markets, in their application of Article 102 TFEU. The aim of the research question was to establish the adequacy of the Commission’s approach based on the European consumer welfare definition when reviewing exclusionary or exploitative abuses under Article 102 TFEU and to provide legal predictability to undertakings in the information technology market. In order to answer the research question, the thesis has examined the approaches behind network effects and the theories and legal doctrine behind significant tying and interoperability cases in the EU and the US. It has assessed the legal principles which have been shaped by early jurisprudence where tying arrangements and interoperability were found. Finally it has scrutinised how these

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formulas fit with the current Commission approach to IT markets in the context of broader consumer welfare. Based on these considerations, this thesis has found:

1. Network effects, which are a crucial feature of the New Economy industries, increase the legal complexity of a case and make the previous competition analysis changed; 2. in IT markets, network externalities, switching costs, economies of scale, and lock-in cause substantial entry barriers, which have similar effects to natural monopolies; 3. neo-Schumpeterians regard network effects as an incentive to enter the market, whilst neo-Structuralists regard network effects as an entry barrier because switching costs combined with network effects lock consumers into a specific product or service; 4. neo-Schumpeterians prefer a laissez-faire policy because rapid innovation can easily replace a dominant incumbent within a relatively short period. On the other hand, neo-Structuralists prefer a policy of intervention because there may be a risk of a durable monopoly resulting from strong network effects, relatively high switching costs, economies of scale, and lock-in; 5. the case law analysis has showed that the competition authorities have considered that the presence of network effects in primary markets increases the likelihood of the success of a leveraging strategy aimed at foreclosure and the elimination of effective competition in secondary/downstream markets; 6. technological integration in the New Economy markets are used as a tool to leverage a dominant undertaking’s market power in primary markets to secondary markets as well as to protect its dominance in the primary market;

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7. the EU competition authorities generally take a structured rule of reason approach to technological integration; 8. the definition of consumer welfare is broader in the EU regime than in the US regime, as consumer choice and the quality of the product are included; 9. technological integration can be regarded as an anticompetitive behaviour whilst it can be justified by efficiency gains, such as the increase of compatibility and access for consumers. However, the EU competition authorities have been very reluctant to entertain such arguments; 10. the current framework of tying is adequate to the New Economy market, although technological maturity and its characteristics should be considered within the European consumer welfare analysis; 13. unlike tying which facilitates access to a product or service, refusal to supply/license restricts access to a product or service and can be a means of anticompetitive leveraging; 14. the current analysis of a compulsory licensing under the exceptional circumstances test/essential facilities is adequate for interoperability cases since the provision of interoperability increases consumer choice. 15. the judgement of the General Court in Microsoft drew attention to the fact that the language and the purpose of Article 102(b) TFEU provide the guidance to define the outer limits of competition rules in the IT sector. 16. a Magill-type test and a Microsoft-type test can be applied to IP-related cases, and a Microsoft-type test which has the more relaxed standards should be applied to the IT sector.

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These findings are important when assessing whether the current European competition analysis is adequate for protecting consumers in the New Economy industries in its application of Article 102 TFEU and to evaluate the adequacy of the Commission’s decision to embrace a broad definition of consumer welfare. Based on the findings, this thesis has demonstrated that there seemed to be no critical conflicts between the New Economy markets and current EU competition analysis. It has concluded that there were no fundamental defects in the current EU competition analysis. However, current competition analysis needs to be more flexible when considering market behaviour in the New Economy industries. In addition, the Guidance Paper should clarify which one is more important between the better product quality justification and product differentiation defence, also known as consumer choice. Cases implied that product differentiation takes priority over better product quality.

II. Consideration of Findings

With regard to the legal complexities produced by specific characteristics in IT markets, this thesis has considered two conflicting schools of thought – neoSchumpeterianism and neo-Structuralism. The former argued that the fact that markets with network effects are tipping towards a dominant technology or product does not necessarily imply that consumers are worse off. On the contrary, by definition consumers immediately benefit if they all use the same network and can therefore communicate each other. However, consumers will be worse off if they become locked into that network in the long term. Several cases in the New

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Economy industries indicated that in that situation an incumbent’s dominance can be durable and cannot be overcome by other superior products or services. In most cases the Commission was influenced by neo-Structuralist theory, embracing a broad consumer welfare definition. Thus, it seems to protect market access for competitors as well as consumers. The Guidance Paper states:

Consumers benefit from competition through lower prices, better quality and a wider choice of new or improved goods and services.1154

The Commission has applied a broad definition of consumer welfare to several cases in the information technology market. As a result of that, the Commission took a structured rule of reason analysis, and applied more leniently the competition principles to IT markets. This analysis is more suitable for fast-moving markets due to the difficulties in predicting technology path. In addition, the concept of an optimal time period in which markets can cure anticompetitive conducts and restore effective competition in these markets is unknown. The presence of network effects, relatively high switching costs, economies of scale, and lock-in could increase the likelihood of the success of anticompetitive leveraging strategies, such as technological integration or refusal to license, aimed at foreclosure. Part III and IV showed that when network externalities, switching costs, and lock-in are present, a dominant undertaking in a primary market could monopolise a secondary or complementary market more quickly. Therefore, it is justified that EU Courts have relaxed the competition principles and have expanded the scope of the exceptional circumstances to IT markets.

1154

The Guidance Paper, supra note 43, para. 5.

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In terms of the broad consumer welfare, competition law may restrict the excise of IPRs if it is exclusionary or exploitative. At the juncture of IP law and competition law, there have been fierce debates about whether a holder of IPRs may use them to completely exclude others or cause additional insurmountable costs to competitors. Without exclusivities, competition by unlicensed borrowers could undermine incentives to invest resources in the first place. Yet exclusion introduces deadweight losses and may stifle productive use of intellectual resources. In the end, intellectual property law is required to strike a balance and create a semi-common arrangement, i.e. a complex mix of private rights and commons designed to facilitate both exclusion and competition. Notwithstanding the fact that the common objectives of intellectual property law and competition law are to promote innovation and enhance consumer welfare, competition authorities have recognised that in exceptional circumstances IPRs can restrict effective competition. The unrestrained exercise of IPRs may, in these exceptional circumstances, be found to be incompatible with the policy goal of competition rules. In recent years, the most controversial aspect of this concerns whether and in what circumstances a refusal to license an intellectual property right may constitute an abuse of a dominant position contrary to competition law. Whether a refusal to license has become intertwined with the question of essential facilities is hotly disputed. In the case law analysis, neither the Commission nor the EU Courts had applied the phrase ‘essential facilities’ to IPRs. However, the leading case on IPRs, the Magill case, featured significantly in the Bronner case, which in exceptional circumstances requires dominant undertakings to share facilities

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that cannot be duplicated by competitors. 1155 And in turn, the Bronner case was relied upon in the intellectual property case IMS Health.1156 In the analysis of both tying and refusal to license case law, the Commission has confirmed that the cases in the New Economy industries may be examined in terms of increasing consumer welfare including consumer choice, improved quality, and better products/services.

III. Per Se Approach to Article 102 TFEU and Its Consequences in IT Markets

The strategic use of IPRs in the IT markets has been a challenge to the competition authorities in enforcing Article 102 TFEU. Although the current competition analysis recognises the positive nature of IPRs in competition, the treatment of IPRs is different depending upon the stages of analysis of anticompetitive behaviour. In the relevant market definition and the dominance assessment, IPRs are assessed in the extent of the restriction of competition in the form of entry barriers. At this stage, innovative features of IPRs can contribute to enhancing dominance. Although the Commission no longer assumes that IPRs are automatically related to the dominance, its methodology considers the possibility that IPRs can be related to an asset that enjoys dominance in a market. On the other hand, in defining abuse, innovative features are considered as pro-competitive ones within the logic of competition rules. The concept of abuse under Article 102 TFEU relies on per se rules due to the influence of the EU Courts. The logic of the EU competition law is to protect effective competition. The first result of this logic is that the Commission follows the form-based or the weak effect approach, although it has recently argued that the 1155 1156

Case C-7/97 Oscar Bronner, supra note 949. Jones and Sufrin, supra note 3, 497.

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Commission intends to take a more effects-based approach to the interpretation of Article 102 TFEU.1157 It has stated that it will not take the effects-based approach in cases where behaviour seriously restricts competition because of the need to prioritise existing effective competition as the best guarantee of productive and innovative efficiencies in the long run.1158 Moreover, the effects-based approach has been called into question by the General Court in Microsoft, and the Court of Justice made it clear that it preferred a form-based approach to Article 102 TFEU.1159 The Court of Justice reiterated in British Airways that behaviour to which objective abusive intention could be attributed created a plausible risk of the harm of elimination of effective competition.1160 The second consequence of an approach based on per se rules is that the EU Courts have tended to confine innovative efficiencies arguments to the category of objective justification rather than allow efficiency gains to offset current harms in a more balanced way.1161 This approach reduces the scope of arguments based on the dynamic efficiency defence. In Microsoft, the defendant asserted that it would have less incentive to innovate technology if it would be required to license its IPR to competitors. The Commission attempted to contend this argument by a balancing test. That is, it balanced the negative effect of a compulsory licensing on Microsoft’s incentives to innovate against the counter-argument that the compulsory licensing would increase innovative efficiency for the industry as a whole because interoperability would maintain plural sources of innovation. However, the General Court made it clear that what was called for was not a balancing exercise of the two theories of innovation but a more legally structured assessment of Microsoft’s 1157

The Guidance Paper, supra note 43, para. 19. The Discussion Paper, supra note 641, para. 91. 1159 Case C- 95/04P British Airways, supra note 321. 1160 Ibid. 1161 Case T-201/04 Microsoft Corp. supra note 38. 1158

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assertions, holding that Microsoft’s innovation defence could only be raised under the heading of objective justification as an integral part of the proof of abuse.1162 This suggests that the test of abuse gives a priority to real effective competition in the short term and ignores less easily provable assertions about dynamic efficiencies in the long term. Therefore, the innovation defence will be negated if behaviour deprives consumers of a new product or creates a risk of elimination of effective competition in IT markets. There is no sign of judicial acceptance in the EU of an approach that treats pro-competitive and anticompetitive arguments equally in a balancing test and moves toward the rule of reason analysis that US antitrust has applied. The third consequence of a form-based approach seems to be that if the conduct of IP owners has reached the stage of offending the competition law, it will attract competition remedies rather than IP remedies, such as decompilation/reverse engineering. The use of a more effects-based approach to the enforcement of Article 102 TFEU is designed to help avoid Type 1 errors, i.e., errors where non-infringing undertakings are found to have infringed competition rules. However, the EU courts would appear to be affirming that the avoidance of Type 2 errors, i.e., errors where infringing undertakings are found not to have infringed competition rules, is of greater concern than the reduction of Type 1 errors. Insofar as this continues to be the case, Article 102 TFEU will apply as a relatively robust limit to abuses of dominance and ensure that compliance with the competition rules will be taken more seriously.

1162

Case T-201/04 Microsoft Corp. supra note 40, para. 659.

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IV. Implications of Applying the Current European Legal Analysis to IT Markets

The effects of leveraging can be more pronounced when there are network effects, switching costs, and lock-in in the market. Network effects can be either direct or indirect. The former refers to products whose value to each individual increases when the number of users increases, while the latter arises when the value of a network increases with the number of providers of complementary services or applications over the network. In IT markets where there are strong network effects with relatively high switching costs, anticompetitive leveraging may allow a dominant undertaking to tip the market in its favour in a way that is difficult to reverse. In practical terms, this means that, unless deterred, anticompetitive behaviour may result in consumer harm not only more quickly than in other cases, but also at a greater scale. The costs of failing to intervene, or intervening too late, may be considerable. In IT markets where innovation is particularly important, consumers may place a higher value on receiving new or better products/services than the price of these products/services. In these markets, most of the value to consumers is created by maintaining the undertaking’s incentive to innovate. These benefits may not be immediate, but may only emerge in the relatively long term. When leveraging takes place in such markets, intervention by competition authorities often means imposing remedies that may, on the one hand, alter, distort, or reduce, and on the other hand, eliminate the incentives to innovate. In these cases, the risks and costs of intervening, when the authorities should not (Type 1 error), could be more serious than in other cases (Type 2 error).

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Thus, the key message is that by their own nature, in IT markets, the probability of committing errors is greater. Undertakings with substantial market power often have the ability to engage in behaviour that can have anticompetitive effects and sometimes they also have the incentive to do so. In other words, it is possible that an undertaking with market power in one market may have an incentive and the ability to leverage this market power into other markets. These could be vertically or horizontally related markets that have certain links either on the demand side or on the supply side. Leveraging of market power may not be solely aimed at extending market power from a primary/upstream market to a secondary/downstream one, but also could be about protecting a dominance enjoyed in a primary/upstream market from entry threats. It might wish to prevent the emergence of strong competitors in the downstream or related market who could in the future enter the upstream markets or vertically integrate backwards into a primary market. In the US Microsoft case, the allegation centred on Microsoft’s alleged anticompetitive actions to eliminate competition in Internet browsers and restrain the availability of the cross-platform Java technology thus protecting its current and future dominance of its Windows OS in PC operating systems market. Microsoft recognised the possibility that its dominance in PC operating systems could be eroded by these developments and engaged in a number of actions to weaken the position of rivals’ Internet browsers by:

• integrating its browser to its operating system; • giving its browser, Internet Explorer (IE) away for free or paying OEMs to take it; 252

• excluding browser competitors from the most efficient distribution channels; • requiring OEMs not to remove or substitute IE; and • imposing agreements on online services, ISPs, and Internet Content Providers requiring them to pass over or boycott Netscape, its rival Internet browser

Microsoft’s concern was due to the fact that Netscape’s Internet browser was capable of supporting applications that were ‘operating-system-independent.’ Microsoft also allegedly attempted to contain the cross-platform threat from Java by gradually polluting Java designed to lure software developers into writing Java programmes, which would not run except with Windows. In the EU, only some of the concerns were related to leveraging. The Commission concluded that Microsoft abused its dominant position in PC operating systems by leveraging it into the workgroup server operating system market, by refusing to provide interoperability information and, in the media player market, by bundling its own media player (Windows Media Player) and PC operating systems to stave off the threat by an independent provider, Real Player. The contested abuse in the workgroup server operating system market was Microsoft’s alleged refusal to license information about the APIs, which would allow workgroup servers running competing operating systems to interact with client PCs and workgroup servers running Microsoft’s Windows 2000 operating systems. In its rejection of the “one monopoly profit” theory advanced by Microsoft in the contested tying case, the Commission noted that the theory does not apply when the goal of foreclosure is to raise barriers to entry that would defend the original 253

monopoly by creating another one for the complementary product. In the context of streaming media player bundling, the Commission also noted that dominance of the media player market can also become a barrier to entry in the PC operating systems market, both because the Windows Media Player’s API could be extended into a complete (possibly Java-based) general purpose platform1163 and because “not being able to guarantee consumers the availability of a complementary media player which supports (the most) popular application programmes and content makes entry and business in the PC operating system market harder and less likely to be successful.”1164 Technological integration is likely to enhance consumer welfare when it reduces distribution costs, lowers the cost of ensuring compatibility, and enhances accountability in the case of product malfunction. The refusal to license may be necessary to protect intellectual property and provide a competitive response. Both technological integration and refusal to license have ambiguous effects when they are employed. However, it is clear that they are anticompetitive when they aim at monopolising the competitive segment or at protecting the monopoly segment.1165 The fact that monopoly leveraging can be assisted by innovation may require it to consider the trade-off between inefficiencies caused by leveraging and the possible gains that may result from a greater incentive to innovate if doing so brings the ability to leverage monopoly power. It is dubious whether any innovation should have the power to restrain the beneficial effects of competition and allow for anticompetitive inefficiencies to gain hold. Moreover, it is very important not to lose sight of the fact that permitting a

1163

COMP/C-3/37.792 Microsoft, supra note 238, para. 972. Ibid., para. 973. 1165 Jean Tirole, “The Analysis of Tying Cases: A Primer,” Competition Policy International 1, no. 1 (Spring 2005): 3. 1164

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dominant undertaking to leverage its monopoly through innovation may increase the dominant undertakings’ incentive to innovate, but at the same time may impair or prevent innovation by competitors. Given all the findings in this thesis, it is hard to see any merit in a competition exemption permitting monopoly leveraging even if done through innovation. There can certainly be innovations that necessarily involve the extension of dominance and these perhaps cannot be realised in any other way that is less restrictive of competition and can bring consumers benefit. These innovations should be allowed following the principle of competition and broad consumer welfare. However, innovations that do not meet such a standard should not be encouraged.

V. Contribution to the Discussion on the New Economy and Article 102 and its Limitations

While competition law should protect effective competition and increase consumer welfare, the Commission has been criticised for protecting competitors rather than competition itself. It has been suggested that the adoption of a more structured rule of reason approach should consider industry characteristics or technological maturity.1166 Thus, Article 102 TFEU would ensure that the provision was enforced to consistently protect effective competition and consumers in the long term. To obtain these, the Commission has suggested that the main objective of Article 102 TFEU when assessing exclusionary abuses should be broad consumer welfare which includes lower prices, better quality, and a wider choice of new or improved goods

1166

See Sub-chapter VI of Part III.

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and services.1167 That suggestion enshrines more than consumer surplus and seems to ignore a short-term economic efficiency in the Article 102 TFEU jurisprudence of the New Economy industries where the product differentiation or consumer choice has been interpreted by the Commission and EU Courts as a means to protect consumer welfare. There appears to be a tension between the current European competition regime and the New Economy industries. However, it is not serious enough to completely change the current competition principles in the way that Schumpeterians argue. Rather, in general competition policy this seems to have had a positive impact on dynamic competition in the New Economy markets by protecting effective competition and defending consumers within the terms of broad consumer welfare. Competition in the New Economy industries and the current European competition policy generally work as an effective tool to promote innovation and to ultimately protect consumers. However, it would be a mistake to completely ignore the fact that the New Economy industries are characterised by dynamic competition, where the threats to existing products comes from new products. Over-reliance on market share should be avoided where New Economy markets are concerned. Instead, it is necessary to put more focus on the durability of dominance and easy access to the market. The fact that this was a fast-growing market could not preclude application of the competition rules. However, it should be understood that the New Economy markets have to be looked at from a dynamic perspective by assessing potential as well as actual effective competition.

1167

The Guidance Paper, supra note 43, para. 5.

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It is noteworthy that it is impossible to establish a single principle that can be applied to all industry sectors in an identical manner, because each sector has different characteristics and these have different effects on competition and innovation process. The New Economy markets will continue to be an issue in the current European competition regime and future developments cannot be perfectly predicted. It is also unlikely that all the characteristics of the New Economy industries can ever be considered. Thus, this thesis, in much the same way as the Commission, has attempted to provide a minimum level of legal clarity for these industries.

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3. Theses and Dissertations Jeon, Min-Cheol. “A Study on “the Essential Facility Doctrine” under the Antitrust Law.” MPhil diss., Yonsei University (Seoul, South Korea), 2003. Kim, Gun-Sic. “The Application of Monopoly Regulation and Fair Trade Act in the Digital Economy.” MPhil diss., Dong-A University (Pusan, South Korea), 2004. Lee, Yong-Woo. “A Study on the Restriction on the Use of the Intellectual Property Right by the Monopoly Regulation & Fair Trade Law.” PhD diss., Konkuk University (Seoul, South Korea), 2003. Park, Sun-Ha. “The Role of Antitrust Law in the New Economy.” MPhil diss., Chungbuk University (CheongJu, South Korea), 2006.

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