Microsoft’s competitors argue that the company’s ‘bundling’ practices – in
which, for example, an internet browser is tied into its Windows operating
system – locks customers into a single monolithic program and hence stifles
innovation in the industry. Microsoft, in response, contends that the real threat
to innovation would come from government intervention to stop it from
bundling products. Who is right?
Maybe both of them, according to Professor Jay Pil Choi, writing in the
January 2004 issue of the Economic Journal. His research indicates that the
kind of bundling practised by Microsoft can serve as a strategic mechanism
for the bundling firm to commit itself to more aggressive R&D in the bundled
goods market. But at the same time, this commitment has the strategic effect
of dulling the R&D incentives of rival firms.
In the recent US antitrust case against Microsoft, it was alleged that
Microsoft’s decision to integrate its internet browser, Internet Explorer, with its
operating system software, Windows 95, allows Microsoft to leverage its
monopoly power in the operating system market into the browser market.
The European Commission is also concerned with the way Microsoft
produces and sells its Windows operating system, notably in relation to its
Media Player software. Microsoft’s rivals, led by AOL Time Warner, have
alleged that incorporating Media Player as a standard feature of Windows
gives the software an unfair advantage over rival programs such as Real
Networks’ Real Player.
What distinguishes the Microsoft case from previous antitrust cases about
bundling is that the focus is predominantly on the effects of bundling on
innovation. Though the parties involved do not agree on much, all
acknowledge that innovation is a key issue in this debate.
Joel Klein, for example – the former US Assistant Attorney General, who was
in charge of the US Justice Department’s antitrust division – stated that the
mission of the antitrust authorities in the Microsoft case was to ‘create
circumstances in which the right innovation signals are given.’
In light of this, it is unfortunate that most existing studies of the impact of
bundling arrangements focus mainly on ‘static’ price competition and thus
miss an important channel through which bundling can affect competition.
Recognising the central role that innovation plays in these industries,
Professor Choi argues that the focus of antitrust enforcement should be rather
in ensuring that there is a competitive market for innovation and that basing
antitrust policy narrowly on pricing practices can result in misguided antitrust
enforcement. His research provides a framework through which the effects of
bundling on R&D incentives – and its wider social welfare implications – can
be analysed.
Choi shows that bundling can tilt the playing field in favour of the bundling firm
in the R&D market. Tying products together means that competitors don’t
have a fair chance to reach consumers. This market ‘foreclosure’ translates
into reduced R&D incentives for the rival firms whereas the increased market
share for the bundling firm implies that it will engage in more aggressive R&D
investment. As a result, bundling has the potential to drive better products and
services out of the market.
Even though Choi’s analysis suggests that the effects of bundling on social
welfare are unambiguously negative, he also points out the possibility that
bundling enhances welfare by serving as a mechanism to co-ordinate and
eliminate duplicative R&D activities if R&D outcomes are uncertain and
products are less differentiated.
Choi thus cautions that the uncertainty concerning the welfare effects of
bundling makes it difficult to apply a simple legal standard in antitrust cases
involving bundling practices.
ENDS
Notes for Editors: ‘Tying and Innovation: A Dynamic Analysis of Tying
Arrangements’ by Jay Pil Choi is published in the January 2004 issue of the
Economic Journal.
Jay Pil Choi is Professor of Economics at Michigan State University, 101
Marshall Hall, East Lansing, Michigan 48824-1038 (website:
http://www.msu.edu/~choijay).
For Further Information: contact Jay Pil Choi on +1-517-353-7281 (email:
choijay@msu.edu); or RES Media Consultant Romesh Vaitilingam on 0117-
983-9770 or 07768-661095 (email: romesh@compuserve.com).