The most important test of antitrust regulation in the digital age was the Justice
Department’s landmark antitrust suit against Microsoft. The Microsoft case fea-
tured network externalities and the control of standards. Recall from Chapter 3
that network externalities exist when users obtain greater value with a larger
network of other connected customers. As a result, there is a strong tendency
for one dominant standard to emerge to the exclusion of others. With over 90
percent of the PC market, Windows established itself as the dominant stan-
dard. Furthermore, because switching costs are so high, we would expect the
dominant standard to persist over time. In short, the economic preconditions
were in place to support Microsoft’s dominant market position.
But despite its market dominance, Microsoft was not immune from the
forces of competition. In the mid-1990s, the most important threats to Microsoft
were posed by Sun Microsystems’ Java language and by Netscape’s Internet
browser. Java offered a universal, open-source platform for running software
applications. Java would run on any number of operating systems: Windows, but
also Unix, Linux, Mac OS or whatever new technology came along. Widespread
use of Java could have effectively sapped the monopoly power Microsoft derived
from control of the Windows standard. With Java, any other operating system
(working with Java) could compete with Windows on equal terms. Similarly,
Netscape’s browser, because it could operate as an intermediary between the
operating system and applications (particularly Internet applications), posed
its own challenge. If the browser succeeded in becoming a standard, Microsoft
would find its market power diluted by the countervailing strength of Netscape.
Microsoft argued that it faced strong competition and that its strategy of
integrating more and more functions into its operating system met this com-
petition by delivering maximum value to consumers. The company’s oppo-
nents argued that Microsoft undertook these actions to limit new competition
and prohibit future entry, not by producing a better product at a lower price,
but by forcing users of Windows not to use Java or Netscape. Microsoft delib-
erately chose to bundle its own browser, Internet Explorer, with Windows, giv-
ing Explorer prominence on the desktop and hoping to discourage the
separate use of Netscape’s Navigator browser. In its dealings with PC makers,
chip makers, and software developers, the company took calculated actions to
prevent the distribution and adoption of new rival technologies. For example,
Microsoft warned PC manufacturers that if they did not favor Internet
Explorer, they would lose their Windows licenses. Similarly, it required PC mak-
ers to install and prominently display Internet Explorer (notwithstanding the
makers’ and consumers’ preference for Netscape Navigator). By threatening to
turn to rival chip maker Advanced Micro Devices, Microsoft prevented Intel
from joining with Sun to improve the performance of Java on Intel’s chips.
Finally, Microsoft’s leverage extended to software applications developers. Any
developer doing business with the company (and receiving advanced infor-
mation about new versions of Windows) was contractually required to use
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