AEI-Brookings Joint Center Policy Matters 05-35

Antitrust a la carte. Ronald A. Cass. December 2005. 

South Korea's Fair Trade Commission last week handed down a decision that should send a shiver down our collective spines. The commission ordered Microsoft to stop selling its popular Windows operating system in Korea, at least in its present form. In place of the current system, or any future system of Microsoft's design, the company is commanded to offer modified versions that strip out its Instant Messenger and Media Player and allow other companies' media players to be inserted in place of Microsoft's.

Korea is following the path marked out by antitrust authorities in the U.S. and the EU. At the insistent urging of Microsoft rivals, authorities in each of these jurisdictions spent countless man-years and millions of dollars (or euros or won) in misguided efforts to manage competition. In each case, regulators claimed to know which parts of a product package are essential and which are dispensable. They assert the right to decide what components consumers should be able to purchase as parts of a pre-assembled bundle and which components must be offered separately. Obviously, bad ideas travel well. If regulators routinely followed this path, they would arrogate authority of a breadth that Soviet commissars would have envied. If each of the world's competition authorities took this turn, the result would be global economic gridlock.

Early on, antitrust regulators opined that a business could frustrate competition by tying a product it enjoyed monopoly power over to a second product that otherwise would be purchased in a competitive market. On this view, a firm that is dominant in one product line could simply decide to extend its dominance to another product line by linking the two. A manufacturer of automobiles who had dominance in that market could also dominate, say, the market for car radios or car DVD players simply by insisting that anyone wanting to purchase a car also purchase its radio or DVD player.

This assumption was wrong. Firms almost never can dominate the second market sufficiently to alter the price of the second good. Further, a monopolist always has limited power to extract extra money from customers. Using that power to force purchases of a second product comes at the expense of earning extra money in the monopoly product. If you can earn more money from sales of cars, why not just raise the price of the car.

"Tying" or "bundling" products is a nearly universal practice, even for firms with no dominance over either product. Shoes are sold with laces even though laces are sold separately. Law firms bundle their partners' services with their associates' services. The practice is even more widespread if defined to include physical, not just contractual, connections between things that could be sold separately. Cars are sold with radios, heaters and seats, and tires. All used to be sold separately; many still are.

Bundling is ubiquitous because it's efficient. Most consumers want radios, DVD players, etc., in their cars. They don't want the trouble of separately finding the items they want, purchasing them, installing them, and making sure they work properly. It's better -- except for the few who intensely prefer a different combination of features -- for the manufacturer to sell a pre-packaged combination. That's also why nearly everyone buys clothes "off the rack" -- already cut, sewn, styled, with buttons and other touches pre-selected. You can have a custom-made suit -- just the cut, fit, cloth and buttons you want -- at a higher price. The ready-made suit-maker isn't trying to gain dominance in another market by forcing you to buy his buttons. It's just cheaper and easier to do business that way.

In rare cases, bundling doesn't promote efficiency. Early tying cases probably were examples of firms trying to exploit a monopoly -- not by extending it to another product, but by using a complementary product (ink, punch cards) to distinguish among buyers based on how much they value the base product (mimeo machines, computers). Those who buy more ink or more punch cards presumably would be willing to pay more for the mimeo or computer. Tying the complementary good allows the producer to extract some of that extra value. Newer theories, depending on very peculiar assumptions, posit that tying can harm competition. Yet, while competition hurts individual businesses, consumers almost never suffer from a firm's decision to bundle products together. In reality, bundling doesn't hurt competition.

That brings us to Microsoft, the phenomenally successful software firm whose operating system is the world's standard -- and the favorite target for competition police everywhere. Years ago, Microsoft combined its more cumbersome, less user-friendly DOS program with an optical interface program to create Windows. It has been adding features, reducing the burden on users, and expanding what its operating system does ever since. Consumers have approved that approach to product evolution. Rivals have cried foul. Regulators have answered the call.

U.S. courts threw out most of the case brought against Microsoft by antitrust regulators because they recognized that bundling generally does benefit consumers and because they also realized the limits of judicial competence. How can courts say which parts of a complex product, like a computer operating system, should be left intact and which "broken out" so that they can be purchased separately? Unlike shoe laces -- easily removed for separate sale -- software components are not simple modules that can be unplugged. Anyone who has used a computer should understand the problems that arise when code from one application doesn't mesh perfectly with another. That's why software companies spend so much time to make certain that they know exactly what instructions are in and out and how they fit. This isn't a job regulators or judges are equipped to do.

Bad as tying law is in most nations, ours included, Korea's decision portends an even worse development: dueling directives. Korea was only the most recent nation to address how the Windows system should be configured. The U.S. and EU addressed the same issue and came to different conclusions. The EU decision imposed more onerous requirements on Microsoft than the U.S. did, requiring greater intrusion into the design of its products. Korea went beyond the EU decision, not only requiring an alternative product but barring sale of the current product designed for consumers, and adding more restrictions to future sales.

We live in a global market. If each nation asserts the right to dictate the composition of products sold there, producers will need different products for every nation. Suppose, in addition to the EU and Korea, that Japan, India, China and Brazil regulate products like Windows, each requiring different features. The efficiency of global production will not be totally eliminated, but it would be very significantly eroded. Obviously, each nation has the right to protect the health and safety of its citizens. That goes with the notion of sovereignty. But antitrust laws don't deal with those issues. Competition drives prices down, encourages efficient production and distribution, and spurs innovation as a means to get ahead of the crowd. Yet competition authorities largely protect businesses from competition by more efficient firms. With U.S. companies among the world leaders in efficiency, other nations' competition authorities increasingly are used to handicap U.S. businesses. The biggest losers are consumers abroad, but our firms and our workers are hurt as well.

Even business leaders who have a real stake in global efficiency often take a cavalier attitude to other companies' problems. They shouldn't. This is not a time to ask Microsoft to handle its own problem. This is the time to stand up for principles: for open markets, for property rights, for consumers and for our workers. U.S. authorities should make clear to Korea that they have taken a turn that will hurt the global economy and Korea along with it. Products aren't all that is bundled in a global economy. International relationships also have many related facets. We should not treat this one as easily detached, like a shoelace. Some ties should bind.

Ronald Cass is Chairman of the Center for the Rule of Law, was vice-chairman of the U.S. International Trade Commission and is dean emeritus of Boston University School of Law.

This article appeared in The Wall Street Journal December 16, 2005.