Monopoly Bundling in Cyberspace: How Many Products Does Microsoft Sell?

Abstract:     
The United States charged Microsoft with tying its internet browser to its operating system (OS). This claim, of course, depended upon the government's assertion that Microsoft's browser and OS were separate products that can be tied together. Under current law, two items are deemed distinct products if there is a separate demand for each item, that is, if some sellers of the tying product offer purchasers the option of selecting the source of the tied item.

This essay examines the assertion, apparently endorsed by the D.C. Circuit when interpreting a consent decree, that Microsoft is sold a single product that combines browser and OS functionality, despite the seeming existence of a separate demand for browsers and operating systems. The essay argues that the separate demand standard, a product of the applied price theory tradition of industrial organization, is unduly biased in favor of certain efficiencies, i.e., those realized by all market participants. Efficiencies not universally realized, therefore, are judged, if at all, under the harsh standards applicable to the assertion of business justifications for otherwise invalid tying arrangements.

The shortcomings of the separate demand test, however, do not justify the approach suggested by the D.C. Circuit. Under that approach, proof that an innovative combination creates benefits establishes that the combination is a single product, even if there is a separate demand for the two items. Such an approach, it is argued, is unduly generous, immunizing, as it does, even anticompetitive arrangements simply because they generate some benefits. Traditional Rule of Reason treatment, it is asserted, is preferable, and can be conducted without hampering innovation.

Keywords: Microsoft, tying, separate products, price theory, transaction costs

JEL Classifications: D21, D23, K21, L12, L41

Accepted Paper Series