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To: Reginald Middleton who wrote (21602)	11/20/1998 11:02:00 AM
From: Gerald R. Lampton	Read Replies (2) \| Respond to of 24154

I agree there are some parts of Boulton's report that seem kind of weak, like where he talks about the company's stock price being evidence of monopoly power: Microsoft's monopoly power in operating systems has translated into extraordinarily high net profit margins that have been increasing over time.38 Even more telling is Microsoft's extraordinarily high market capitalization. With a price/earnings ratio more than double the S&P 500 average, the financial markets are signaling very optimistic investor expectations regarding Microsoft's future growth in earnings. I mean, Amazon.com has a P/E in the triple digits, but no one is accusing them of being a monopolist, or claiming that Barns&Noble.com faces high barriers to entry into that market. Then there is the one paragraph that talks about Microsoft's "use" of monopoly power as being proof that it has it: Microsoft has engaged in conduct that it could not profitably pursue unless it possessed monopoly power. For instance, when one OEM removed the IE icon from the Windows 95 desktop, Microsoft responded by threatening to terminate that OEMs' Windows 95 license. The OEM capitulated to Microsoft's demands.35 It is plain it did so because, as OEMs universally explain, a Windows license is essential to remaining competitive in the OEM market.36 This capitulation is itself evidence of Microsoft's monopoly power. This comes very close to saying that, because Microsoft engages in conduct that would be predatory if it were a monopolist the fact that it engages in such conduct proves it is a monopolist. I assume, though, that DOJ can come up with more than this one example. I also assume the Microsoft lawyers will be all over poor Boulton as to all the alternative causes for this and whatever other instances of "unprofitable" behavior he can come up with. There are also all the usual arguments about sunk costs which we have talked about before. I assume he will be cross-examined extensively about the ways to mitigate or recoup those sunk costs, things like using net-based unpaid development teams, as Netscape and Linux do, selling the operating system, and reusing the code, which, if properly designed, should be designed as components that can be used in other programs. These won't help the first entrant, but they should help entrants two through infinity. I have no doubt, too, that they will cross-examine him extensively about the literature he relied on to develop his network effects and lock-in barrier to entry theories, asking, among other things what he thinks of things like the the Liebowitz & Margolis article I linked to earlier, setting themselves up to be able to say down the road through the mouths of their own witnesses that all the studies he relied on are flawed. It is also interesting that he uses the merger guidelines developed for the Clayton Act in this Sherman Act case. He says it makes no difference, a statement I am sure he will be able to defend, but the Clayton Act does use tighter standards on market share and other things than does the Sherman Act. What surprises me about this is that, for anyone familiar with network effects/increasing returns literature, there are really no surprises here. This really is a network effects case.