Free Minds & Free Markets

Antitrust's Greatest Hits

The foolish precedents behind the Microsoft case

New developments in the antitrust face-off between Microsoft and the U.S. Department of Justice keep on coming. On August 17, Bill Gates' company failed in its efforts to delay any more action in the case until the Supreme Court decides whether to consider Microsoft's request to dismiss the suit. That was bad news for the company, since the next major step would be to decide what "remedies" will be imposed. Then, on September 6, the DOJ announced that it would no longer seek a breakup of the company -- and, more surprisingly, that it would drop its claim that Microsoft had illegally "bundled" separate programs. But the other charges remain, and it is clear that Microsoft's enemies will surely urge the court to impose every possible restriction on the company's ability to adapt to changing conditions -- particularly the diminishing importance of the personal computer and the growth of Web-based computing.

It has been six years since Microsoft introduced Windows 95, the operating system that, by "bundling" itself with a Web browser, prompted the government's first antitrust suit against the company in 1997. Put another way, six years have gone by without Microsoft suffering any penalty for its supposed misconduct -- unless, of course, you count the expenses and negative publicity it has incurred fighting the Justice Department. When Windows 95 debuted, Microsoft's critics and competitors made many predictions of the unpleasant things that would happen if the company kept doing business without new restraints. It's past time to see whether those predictions have come true.

It is also past time to take an even longer historical perspective: to look at the government's earlier adventures in antitrust and see how they compare with the Microsoft case. The results are very telling -- not just with regard to Microsoft, but to antitrust law in general. Indeed, when one looks closely at the ground-breaking government actions taken against Standard Oil, the Aluminum Company of America, and AT&T, it becomes clear that something other than preventing harm to consumers -- the stated goal of federal antitrust legislation -- is the motivating force behind applying the law. Misinterpretation of these cases lies behind the claim that Microsoft, unless punished, crippled, or otherwise injured, will achieve a "chokehold on the Internet" or somehow undermine the entire computer industry.

What follows is a medley of what might be called antitrust's greatest hits and an analysis of how the lessons of history are being misapplied to the Microsoft case.

The Oil Standard

From 1906 to 1911, antitrust authorities prosecuted Standard Oil, a case that culminated with John D. Rockefeller's company being forcibly broken up into several smaller businesses. The Microsoft wars have often been compared to the Standard Oil case, and the analogy is apt -- though not in the way it is usually intended.

Like Microsoft, Standard Oil was pilloried for practices considered legitimate when used by other companies. Since Standard Oil was such a high-volume customer, railroads gave it special discounts in exchange for planning shipments in ways that enabled railroads to use their lines and railcars most efficiently. Standard Oil's competitors complained bitterly about these discounts (called "rebates"), which the railroads kept secret from other oil companies.

Also like Microsoft, Standard Oil may have harmed its competitors, but it helped its consumers. Rockefeller's chemists developed 300 different byproducts from oil and created production and distribution processes far more efficient than those of other companies, allowing it to underprice them and to buy many of them out.

Standard Oil began in 1870, when kerosene cost 30 cents a gallon. By 1897, Rockefeller's scientists and managers had driven the price to under 6 cents per gallon, and many of his less-efficient competitors were out of business -- including companies whose inferior grades of kerosene were prone to explosion and whose dangerous wares had depressed the demand for the product. Standard Oil did the same for petroleum: In a single decade, from 1880 to 1890, Rockefeller's consolidations helped drive petroleum prices down 61 percent while increasing output 393 percent. He eventually built Standard Oil of New Jersey into a trust composed of 18 companies operating under a single board of directors.

Standard Oil used resources with legendary efficiency, introducing many new labor-saving devices to its factories and locating sophisticated facilities at key points in its distribution system. Yet Rockefeller paid wages well above the market level, believing that high wages and good working conditions would save money in the long run by averting strikes and by encouraging loyalty among employees. Before Standard Oil revolutionized oil derivatives by lowering prices and improving quality, the high prices and limited supplies of whale oil and candles prevented all but the wealthy from being able to work or entertain after dark. Thanks to Standard Oil, families could illuminate their homes for just one cent per hour. And he saved the whales.

The federal government filed suit against Standard Oil in 1906 for violating the Sherman Antitrust Act, and in 1909, the company was found guilty; the Supreme Court affirmed the finding in 1911. Standard Oil, claimed the courts, evinced an "intent and purpose to exclude others" -- demonstrated, ironically, by its many mergers, acquisitions, and business alliances. No one brought forward evidence of consumer harm, and the government never showed that Standard's specific actions, as opposed to its alleged intent, were illegal.

For several decades following the verdict, economists and legal scholars viewed the Standard Oil case as a classic example of "predatory pricing" -- a monopolist's attempt to underprice its competitors out of the market so it could raise its prices later. In fact, just as the threat of new entry into the operating system, browser, and applications markets has kept Microsoft from ever exercising its supposed "monopoly power," so did new sources of competition keep Standard Oil from raising its prices. Neither the federal district court nor the U.S. Supreme Court found that Standard Oil's practices made kerosene prices higher than they otherwise would have been. If Microsoft Windows actually were a monopoly (that is, essential for anyone who wants to use a computer), the proper price would be about $900 a copy. Microsoft doesn't price this high because it knows that if it does, consumers will flock to Linux and Macintosh, and other companies would enter the operating system business, with products much cheaper than $900.

There's one more important parallel between the Standard Oil and Microsoft cases: Technological change made the Standard Oil decision obsolete by the time it was resolved. Of course, the Microsoft case hasn't resolved itself yet, but as we'll see, changing technologies are changing market conditions in the software world as well.

The oil business was opening fields in states such as Kan-sas, Oklahoma, Louisiana, California, and especially Texas, where Rockefeller had failed to invest. All those fields were far away from the Ohio/Pennsylvania/New Jersey corridor that was the base of Standard Oil's power. Also, the national kerosene market had declined, as home lighting shifted from kerosene lamps to coal-generated electricity and as fuel oil replaced coal and wood as the major fuel for home heating. In 1899, kerosene had accounted for 58 percent of all refined petroleum sales, and fuel oil for 15 percent. By 1914, kerosene had plunged to 25 percent, and fuel oil had risen to 48 percent.

Rockefeller was slow to switch from kerosene to gasoline, and with only 11 percent of the nation's oil production in 1911, Standard Oil could never hope to dominate the new market. Throughout the energy business, new technologies and new efficiencies were creating new and stronger competitors from industries previously distinct from the oil industry. Those competitors were far more powerful than the kerosene companies Rockefeller had defeated decades before.

Some observers have noted that in the years after Standard Oil was broken into smaller regional companies, the stock prices of those smaller companies rose, leading to speculation that breaking up Microsoft might have a similar positive effect on the total value of Microsoft stock. This is a misreading. Nearly all oil companies' stock went up in that period, not because of the breakup but because of rising demand and technological breakthroughs. Nor did the breakup have any discernible impact on oil production or oil prices.

The government's victory against Standard Oil had a long-term effect on the oil industry that is seldom discussed by those who see parallels with the Microsoft case. Only six years after losing the antitrust case, Standard Oil dramatically changed its attitude toward Washington, moving from hostility or avoidance to a very warm embrace. Company chief A.C. Bedford served as chairman of the War Services Committee, an agency created to mobilize the nation's supplies of gasoline and diesel fuel for military use during World War I. After the war, federal control never retreated, transforming what economist Dominick Armentano has called "a virtual textbook example of a free and competitive market" into "what had previously been unobtainable: a governmentally sanctioned cartel in oil." The legacies of this transformation include higher prices for consumers and the "energy crisis" of the 1970s. Deregulation in the 1980s finally restored some measure of competition to the industry.

The Standard Oil case teaches some important lessons about competition, innovation, and antitrust law. We see the difficulty antitrust has dealing with highly innovative companies. We witness the vagueness of antitrust law, which allows prosecution on the basis of alleged intent rather than specific actions. And we see how the Standard Oil case ultimately failed to benefit consumers or investors. Instead, it laid the groundwork for collusion between industry and government, bringing about many of the very ills the "progressive" proponents of antitrust said they were fighting.

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