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       E.      Microsoft's conduct has caused, and will continue to cause, substantial and far-
               reaching consumer harm

       404.  Microsoft's predatory and anticompetitive course of conduct to blunt the browser

to impede other middleware platforms, and to extend its control over standards has caused, and will

continue to cause, substantial and far-reaching harm to consumers.

               1.      Microsoft's maintenance of its operating system monopoly has
                       deprived, and will continue to deprive, consumers of the benefits of
                       greater competition in operating systems.

       405.  As detailed above, Microsoft's conduct eliminated the possibility that browsers could

lead to a paradigm shift that would erode the applications barrier to entry and dissipate

monopoly power.  Microsoft also hindered other middleware threats, including Java and NSP.

Microsoft's maintenance of its operating system monopoly has thus harmed consumers by denying them

the prospect of the substantial consumer benefits that the success of these threats might bring.

                       a.         Microsoft has deprived consumers of the possible development
                                  of greater choice in operating systems

               405.1.  The fuller development of cross-platform applications, whether running on

browsers, the Java runtime environment, or other middleware, could have increased competition and

innovation in operating systems and resulted in substantial consumer benefits.

               i.      Steven McGeady testified: "If Netscape managed to get into a position where
                       they were a credible threat to Microsoft. . . . that would not only directly
                       benefit to the marketplace, but it would goad Microsoft in increased
                       competition" and provide more opportunities for other vendors to bring
                       applications to market more quickly.   Consumers would benefit by more
                       choice and by a faster rate of innovation.  McGeady, 11/9/98pm, at 62:19 -
                       63:16.

               ii.     Caldera concluded, based on a Harvard Business School case study:


                                                  856



                       "Rivalry within the Desktop OS industry is brutal to the point of
                       existence of Microsoft in the Desktop market has, to this time, prevented any

in operating system might bring and have been directly harmed by the strategies Microsoft employed

its scheme to eliminate potential rivals.

                        357.5.2.  Most important, Microsoft will continue to have the power and

incentive to distort the pace and direction of innovation in ways that protect its monopoly power

than serving the interests of consumers.

        A.      Microsoft's campaign to blunt the browser threat further entrenched
                Microsoft's operating system monopoly

        358.  Microsoft has maintained its operating system monopoly by blunting the browser threat

the applications barrier to entry.  By gaining a substantial position in browsers and weakening

Microsoft has ensured that non-Microsoft browsers do not threaten Microsoft's control over the APIs

to which developers write, the source of the principle barrier to entry that protects Microsoft's

monopoly position.

                1.      Microsoft could maintain its operating system monopoly without
                        monopolizing the browser market because, by gaining merely a
                        substantial share of browsers (and denying a large share to rivals), it
                        was able significantly to reduce the likelihood that its monopoly power
                        would be eroded

        359.  Crippling the browser threat to its monopoly did not require Microsoft to monopolize

browser market; rather, Microsoft could defeat that threat merely by ensuring that no single rival

obtained (or maintained) a sufficient share of the browser market to develop into an alternative

platform.

                359.1.  As explained, non-Microsoft browsers threaten Microsoft's operating system

monopoly because they expose APIs to which developers could write operating system-independent


                                                710



applications.

                   i.      See supra Part III.B.1., ¶¶ 53.2, 53.3.

VII.  Through its predatory and anticompetitive conduct, Microsoft has maintained its
        operating system monopoly, dangerously threatened monopolization of the browser
        market, and inflicted substantial and far-reaching consumer harm

        357.  Microsoft has achieved its anticompetitive objectives and, in doing so, has

likely will continue to inflict, substantial and enduring harm on competition and consumers.

                357.1.  By gaining a substantial share of the browser market and weakening rivals,

Microsoft has blunted the browser theat to the applications barrier to entry and thereby maintained

operating system monopoly.  See infra Part VII.A.; ¶¶ 358-387.

                357.2.  Microsoft's course of conduct also dangerously threatened monopolization of

the browser market.  See infra Part VII.A.5.b.(2); ¶¶ 376-384.

                357.3.   AOL's acquisition of Netscape will not undo the harm to competition wrought

by Microsoft.  In the wake of Microsoft's predatory and anticompetitive campaign, AOL will neither

resurrect the browser threat nor seek to erode the applications barrier to entry in other ways. 

Part VII.C.1.; ¶¶ 393-396.

                357.4.  Microsoft further entrenched its operating system monopoly by enhancing its

control over standards, in particular network-based standards, and by gaining a reputation as a

predator, which is likely to deter other threats to the applications barrier to entry.  See infra

VII.D.; ¶¶ 397-403.

                357.5.  Microsoft's campaign to maintain and extend its operating system monopoly

has caused, and will continue to cause, substantial and far-reaching consumer harm.  See infra Part

VII.E.; ¶¶ 404-410.

                        357.5.1.  Consumers have been deprived of the benefits increased competition

                                                  709



in operating system might bring and have been directly harmed by the strategies Microsoft employed

its scheme to eliminate potential rivals.

attack on Sun (and probably Oracle). . . . Between ourselves and our partners, we can certainly hurt

their (certainly Sun's) revenue base. . . . We need to get Intel to help us.  Today, they are not."

months later, Eric Engstrom, a Microsoft executive with responsibility for multimedia development,

wrote to his superiors that one of Microsoft's goals was getting "Intel to stop helping Sun create

Multimedia APIs, especially ones that run well (ie native implementations) on Windows."  Engstrom

proposed achieving this goal by offering Intel the following deal:  Microsoft would incorporate

Windows API set any multimedia interfaces that Intel agreed to not help Sun incorporate into the

class libraries.  Engstrom's efforts apparently bore fruit, for he testified at trial that Intel's

subsequently stopped helping Sun to develop class libraries that offered cutting-edge multimedia

support.

        D.      The Effect of Microsoft's Efforts to Prevent Java from Diminishing the
                Applications Barrier to Entry

        407. Had Microsoft not been committed to protecting and enhancing the applications barrier

to entry, it might still have developed a high-performance JVM and enabled Java developers to call

upon Windows APIs.  Absent this commitment, though, Microsoft would not have taken efforts to

maximize the difficulty of porting Java applications written to its implementation and to

the ability of developers to write Java applications that would run in both Microsoft's version of

Windows runtime environment and versions complying with Sun's standards.  Nor would Microsoft

have endeavored to limit Navigator's usage share, to induce ISVs to neither use nor distribute non-

Microsoft Java technologies, and to impede the expansion of the Java class libraries, had it not

determined to discourage developers from writing applications that would be easy to port between


                                                  201



Windows and other platforms.  Microsoft's dedication to the goal of protecting the applications

to entry is highlighted by the fact that its efforts to create incompatibility between its JVM and

        H.      The Success of Microsoft's Effort to Maximize Internet Explorer's Usage
                Share at Navigator's Expense

        358. Microsoft's efforts to maximize Internet Explorer's share of browser usage at

Navigator's expense have done just that.  The period since 1996 has witnessed a large increase in

usage of Microsoft's browsing technologies and a concomitant decline in Navigator's share.  This

reversal of fortune might not have occurred had Microsoft not improved the quality of Internet

Explorer, and some part of the reversal is undoubtedly attributable to Microsoft's decision to

Internet Explorer with Windows at no additional charge.  The relative shares would not have changed

nearly as much as they did, however, had Microsoft not devoted its monopoly power and monopoly

profits to precisely that end.

                1.      The Change in the Usage Shares of Internet Explorer and Navigator

        359. A developer of network-centric applications wants as many consumers as possible to

acquire and use its products.  It knows that only consumers running a browser that exposes the

requisite APIs will be able to use network-centric applications that rely on those APIs.  So in

whether to concentrate its development work on APIs exposed by Netscape's Web browsing software

or Microsoft's, one of the questions a developer will ask is how much Navigator is being used in

relation to Internet Explorer.  Dividing the total usage of each browser product by the total usage

browsing software (i.e., usage of the installed base) answers this question, for it reveals the

of total usage accounted for by each product.  The relative attractiveness to developers of

and Internet Explorer thus depends to a large extent on their relative shares of all browser usage.




                                                177



       360. According to estimates that Microsoft executives cited to support their testimony in

trial, and those on which Microsoft relied in the course of its business planning, the shares of

       D.      Microsoft entered into anticompetitive and exclusionary agreements with OLSs
               and ISPs

       212.  As part of its campaign to maintain its operating system monopoly, Microsoft entered

exclusionary agreements with the most important Internet Service Providers (ISPs) and Online

(OLSs).

               212.1.   ISPs and OLSs comprise one of the two most important channels for obtaining

and retaining browser market share.  See infra Part V.D.1.; ¶ 213.

               212.2.   Microsoft thus determined that gaining preferential treatment for Internet

Explorer through ISPs and OLSs, and excluding rivals, was vital to winning the browser war.  See

Part V.D.1.; ¶ 213.3.

               212.3.   Microsoft entered into exclusionary agreements with the most important ISPs

and OLSs.  See infra Part V.D.2.; ¶¶ 214-223.

                         212.3.1.   Microsoft believed that, given a free choice, users would choose

non-Microsoft browsers.  Microsoft's agreements thus not only required preferred distribution and

promotion of Internet Explorer, but also prohibited in most circumstances the distribution and

promotion of browser rivals.

                         212.3.2.    To induce ISPs and OLSs to agree to the exclusionary terms,

Microsoft offered them a large payment; for the most part, that payment took the form of barter,

consisting of, among other valuable consideration, access to and distribution through Windows.

               212.4.     The exclusionary terms in Microsoft's ISP and OLS agreements lack any

procompetitive purpose and can be explained only as part of a predatory strategy to maintain


                                                 463



Microsoft's operating system monopoly.  See infra Part V.D.4.c.(5); ¶ 256.

       C.      Microsoft imposed a variety of other anticompetitive restraints on the OEM
               channel in order to impede rivals such as Netscape

               1.        Microsoft imposed exclusionary restrictions on OEMs' ability to modify
                         the Windows desktop and start-up sequence

       175.  In addition to its tying arrangement, Microsoft forced OEMs to agree to restrictions on

their ability to modify the Windows desktop and start-up sequence.  As with its tying arrangement,

Microsoft's OEM desktop and start-up restrictions raised rivals costs, harmed consumers, and cannot

be explained except as part of Microsoft's effort to blunt the threat to its operating system

posed by non-Microsoft browsers.

                         a.      Microsoft imposed the "Windows Experience" restrictions in
                                 response to, and in order to stop, OEMs' featuring Netscape
                                 Navigator more prominently than Internet Explorer.

       176.  When Microsoft first released Windows 95, OEMs customized the Windows 95 desktop

and start-up sequence in various ways designed to meet consumer demand; and they did so with

Microsoft's tacit or express consent.

               176.1.  OEMs operate in a competitive environment; to thrive, OEMs must supply

what their customers demand, differentiate their products, minimize their support costs, and offer

that are easy to use.

               i.        Professor Fisher explained: "OEM's are, in some sense, the representatives
                         the consumer for certain purposes.  They are in competition with each
                         They gain if they deliver what end users actually want.  They wouldn't care
                         about the restrictions on them if they didn't think that it mattered in
                         dealings with consumers."  Fisher, 6/2/99am, at 22:1-6.

               ii.       Dr. Warren-Boulton testified:  "As Microsoft has acknowledged, OEMs are in
                         the business of satisfying their customers.  They are exceedingly unlikely
                         market a product that does not meet consumer demand."  Warren-Boulton Dir.

                                                   385



                       ¶ 160.

               iii.    Garry Norris testified that IBM sought to "differentiate PC's that were

       B.      Microsoft tied its Internet Explorer browser to Windows 95 and Windows 98 in
               order to impede browser rivals such as Netscape, and for no legitimate purpose

       93.  A central part of Microsoft's predatory campaign to prevent Netscape's browser from

developing into a platform that could erode the applications barrier to entry was Microsoft's tying

Internet Explorer browser to Windows 95 and Windows 98 and its refusal to offer, or to permit OEMs

to offer, an unbundled option.

               93.1.  Internet browsers and personal computer operating systems are separate

products.  Consumers view browsers and operating systems as separate products and demand one

without the other.  In response to that separate demand, Microsoft and other software firms have

it efficient to promote and distribute browsers and operating systems separately.  See infra Part

¶¶ 96-119.

               93.2.  Despite the existence of this separate demand for browsers and operating

systems, Microsoft tied its browser to its Windows operating system, and refused to offer an

option, for the purpose of hindering the development of Netscape and other browsers.  See infra Part

V.B.2; ¶¶ 120-149.

                       93.2.1.  Microsoft tied Internet Explorer 1 and 2 to Windows 95 by requiring

OEMs to obtain Internet Explorer in order to obtain Windows 95 and prohibited OEMs from removing

Internet Explorer.

                       93.2.2.  Subsequently, fearing that its merely contractual tie was not

eliminate the threat that Netscape's browser posed to its operating system monopoly, Microsoft

changed its product design in Internet Explorer 3 and 4 to commingle browser and operating system


                                                229



code.  Still, recognizing the desire of users to have the Windows 95 operating system without

Explorer, Microsoft designed and advertised an easy means for users to remove the browser.

                                           TABLE OF CONTENTS


                                                           Volume 1



I.      Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

II.     Microsoft Possesses Monopoly Power Over Operating Systems . . . . . . . . . . . . . . . . 8

        A.        Microsoft's monopoly power is established by direct evidence of its existence
                  and exercise . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

        B.        Microsoft's monopoly power is also demonstrated by a structural analysis 20

        C.        Microsoft's ability to control the price of Windows evidences its monopoly
                  power . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

        D.        Dean Schmalensee's contrary analysis is unreliable . . . . . . . . . . . . . . .

III.    Alternative Platform-Level Technologies, Especially Internet Browsers and Java,
        Threaten Microsoft's Operating System Monopoly . . . . . . . . . . . . . . . . . . . . . .

        A.        Middleware technologies have the potential to reduce the applications barrier
                  to entry and facilitate operating system competition  . . . . . . . . . . . . . .

        B.        The widespread use of non-Microsoft Internet browsers threatened to erode
                  the applications barrier to entry and Microsoft's monopoly power . . . . . . 127

        C.        Cross-Platform Java also presented a middleware threat to Microsoft's
                  operating system monopoly . . . . . . . . . . . . . . . . . . . . . . . . . . . .

        D.        The threats to Microsoft's monopoly posed by Internet browsers and Java are
                  mutually reinforcing, and they could be essential to the emergence of other
                  platform-level threats to Microsoft's operating system monopoly . . . . . . . 147

IV.     Microsoft Attempted To Enter Market-Division Agreements To Eliminate Platform-
        Level Software That Threatened Its Operating System Monopoly . . . . . . . . . . . . 151


                                                                 i



       A.       Microsoft tried to eliminate the browser threat by proposing a naked market-
                division agreement to Netscape . . . . . . . . . . . . . . . . . . . . . . . . . .

       C.      Other Middleware Threats

       78.      Although they have been the most prominent, Netscape's Navigator and Sun's

Java implementation are not the only manifestations of middleware that Microsoft has perceived

as having the potential to weaken the applications barrier to entry.  Starting in 1994, Microsoft

exhibited considerable concern over the software product Notes, distributed first by Lotus and

then by IBM.  Microsoft worried about Notes for several reasons:  It presented a graphical

interface that was common across multiple operating systems; it also exposed a set of APIs to

developers; and, like Navigator, it served as a distribution vehicle for Sun's Java runtime

environment.  Then in 1995, Microsoft reacted with alarm to Intel's Native Signal Processing

software, which interacted with the microprocessor independently of the operating system and

exposed APIs directly to developers of multimedia content.  Finally, in 1997 Microsoft noted the

dangers of Apple's and RealNetworks' multimedia playback technologies, which ran on several

platforms (including the Mac OS and Windows) and similarly exposed APIs to content

developers.  Microsoft feared all of these technologies because they facilitated the development

of user-oriented software that would be indifferent to the identity of the underlying operating

system.



V.         MICROSOFT'S RESPONSE TO THE BROWSER THREAT

       A.       Microsoft's Attempt to Dissuade Netscape from Developing Navigator as a
                Platform

       79.      Microsoft's first response to the threat posed by Navigator was an effort to

persuade Netscape to structure its business such that the company would not distribute platform-


                                                 40

       B.      Microsoft's proposal of market-division agreements to eliminate other
               potentially threatening middleware confirms the anticompetitive character of its
               course of conduct against the browser

               1.      Microsoft similarly attempted to divide markets with Apple

       73.  Microsoft made other efforts to divide markets with platform-level competitors.  Those

efforts establish a pattern and practice of attempts to eliminate competition by agreement with

       74.  Microsoft sought to divide markets with Apple for the purpose of eliminating competing

platform-level technology.

                       a.        Apple's QuickTime multimedia software, like the browser, is
                                 platform-level software that Microsoft viewed as a potential
                                 threat to its operating system monopoly

       75.  Apple Computer's QuickTime is its software architecture for the creation, editing,

publishing, and playback of multimedia content (e.g., audio, video, graphics, and 3D) on the

and Windows operating systems.  QuickTime is cross-platform; developers using QuickTime

technology can create multimedia content that will run on QuickTime implementations for both

Windows and Macintosh.

       i.      Tevanian Dir. ¶¶ 47, 50-51, 54, 57-59, 67-68; Tevanian, 11/5/99am, at 27:1-7;
               11/4/99am, at 45:3 - 46:6  (testifying concerning QuickTime's API and cross platform
               capabilities).

       76.  Apple, through QuickTime, competes against Microsoft, among other firms, in providing

multimedia functionality to Windows users.

       i.      Tevanian testified that QuickTime competes with Microsoft's multimedia technologies,
               including Microsoft's multimedia APIs (DirectX) and media player (Windows Media
               Player).  Tevanian Dir. ¶¶ 69-70.  See generally Tevanian ¶¶ 57, 60-65.

       ii.     Eric Engstrom, Microsoft's former general manager for multimedia, acknowledged that

                                                193



               Apple competes to varying degrees with Microsoft in trying to convince developers to
               target their respective multimedia APIs, codecs and file formats suitable for their
               respective players.  Engstrom, 2/23/99pm, at 35:24 - 36:10, 79:4 - 84:6  See also

IV.    Microsoft Attempted To Enter Market-Division Agreements To Eliminate Platform-
       Level Software That Threatened Its Operating System Monopoly

       A.      Microsoft tried to eliminate the browser threat by proposing a naked market-
               division agreement to Netscape

       63.  Microsoft initially tried to eliminate the threat non-Microsoft browsers posed to the

applications barrier to entry by attempting to bribe, and later threatening, Netscape into giving

core Window 95 web-browsing business.   Had Netscape accepted Microsoft's market-division

proposal, Microsoft would have succeeded in killing the browser threat in its infancy and likely

have acquired a monopoly over browsers.

               1.      Microsoft first unsuccessfully sought to purchase or license Netscape's
                       browser software code

       64.  Before it fully recognized the threat that Internet browsers posed to its operating

monopoly, Microsoft unsuccessfully sought to purchase or license the software code for Netscape's

Navigator browser.

               64.1.  When Microsoft decided that it wanted to offer its own Internet browser

in late 1994, it opened discussions to license browser software code with several companies,

Netscape.

               i.      Microsoft's Thomas Reardon "contacted Netscape in the early fall of 1994 and
                       explained his desire to explore whether Netscape would be willing to consider
                       some sort of licensing arrangement for the first version of its web browsing
                       software."  Rosen Dir. ¶13 (citing Reardon Dep., 9/9/98, at 153-54, 224).

               64.2.  Netscape representatives rejected Microsoft's proposal.

               i.      Barksdale testified that Netscape did not want to sell their software "at the
                       price they [Microsoft] offered.  They offered a flat fee of a couple of
                       dollars to take us out of the game.  And that would have killed our product

                                                152



                       their space."  Barksdale, 10/21/98am, at 28:6-10; Barksdale Dir. ¶ 96 ("those
                       discussions did not prove fruitful because Netscape was not interested in
                       Microsoft's proposal, which was to purchase the Navigator code for what

IV.    Microsoft Attempted To Enter Market-Division Agreements To Eliminate Platform-
       Level Software That Threatened Its Operating System Monopoly

       A.      Microsoft tried to eliminate the browser threat by proposing a naked market-
               division agreement to Netscape

       63.  Microsoft initially tried to eliminate the threat non-Microsoft browsers posed to the

applications barrier to entry by attempting to bribe, and later threatening, Netscape into giving

core Window 95 web-browsing business.   Had Netscape accepted Microsoft's market-division

proposal, Microsoft would have succeeded in killing the browser threat in its infancy and likely

have acquired a monopoly over browsers.

               1.      Microsoft first unsuccessfully sought to purchase or license Netscape's
                       browser software code

       64.  Before it fully recognized the threat that Internet browsers posed to its operating

monopoly, Microsoft unsuccessfully sought to purchase or license the software code for Netscape's

Navigator browser.

               64.1.  When Microsoft decided that it wanted to offer its own Internet browser

in late 1994, it opened discussions to license browser software code with several companies,

Netscape.

               i.      Microsoft's Thomas Reardon "contacted Netscape in the early fall of 1994 and
                       explained his desire to explore whether Netscape would be willing to consider
                       some sort of licensing arrangement for the first version of its web browsing
                       software."  Rosen Dir. ¶13 (citing Reardon Dep., 9/9/98, at 153-54, 224).

               64.2.  Netscape representatives rejected Microsoft's proposal.

               i.      Barksdale testified that Netscape did not want to sell their software "at the
                       price they [Microsoft] offered.  They offered a flat fee of a couple of
                       dollars to take us out of the game.  And that would have killed our product

                                                152

       I.      Microsoft's Actions Toward Other Firms

       67.     Microsoft's monopoly power is also evidenced by the fact that, over the course of

several years, Microsoft took actions that could only have been advantageous if they operated to

reinforce monopoly power.  These actions are described below.



IV.    THE MIDDLEWARE THREATS

       68.     Middleware technologies, as previously noted, have the potential to weaken the

applications barrier to entry.  Microsoft was apprehensive that the APIs exposed by middleware

technologies would attract so much developer interest, and would become so numerous and

varied, that there would arise a substantial and growing number of full-featured applications that

relied largely, or even wholly, on middleware APIs.  The applications relying largely on

middleware APIs would potentially be relatively easy to port from one operating system to

another.  The applications relying exclusively on middleware APIs would run, as written, on any

operating system hosting the requisite middleware.  So the more popular middleware became and

the more APIs it exposed, the more the positive feedback loop that sustains the applications

barrier to entry would dissipate.  Microsoft was concerned with middleware as a category of

software; each type of middleware contributed to the threat posed by the entire category.  At the

same time, Microsoft focused its antipathy on two incarnations of middleware that, working

together, had the potential to weaken the applications barrier severely without the assistance of

any other middleware.  These were Netscape's Web browser and Sun's implementation of the

Java technologies.



                                                35

could arise to depreciate the value of selling PC operating systems; however, the fact that these

new paradigms already exist in embryonic or primitive form does not prevent Microsoft from

enjoying monopoly power today.  For while consumers might one day turn to network

computers, or Linux, or a combination of middleware and some other operating system, as an

alternative to Windows, the fact remains that they are not doing so today.  Nor are consumers

likely to do so in appreciable numbers any time in the next few years.  Unless and until that day

arrives, no significant percentage of consumers will be able to abandon Windows without

incurring substantial costs.  Microsoft can therefore set the price of Windows substantially higher

than that which would be charged in a competitive market - or impose other burdens on

consumers - without losing so much business as to make the action unprofitable.   If Microsoft

exerted its power solely to raise price, the day when users could turn away from Windows

without incurring substantial costs would still be several years distant.  Moreover, Microsoft

could keep its prices high for a significant period of time and still lower them in time to meet the

threat of a new paradigm.  Alternatively, Microsoft could delay the arrival of a new paradigm on

the scene by expending surplus monopoly power in ways other than the maintenance of high

prices.

           G.     Significance of Microsoft's Innovation

           61.    The fact that Microsoft invests heavily in research and development does not

evidence a lack of monopoly power.  Indeed, Microsoft has incentives to innovate aggressively

despite its monopoly power.  First, if there are innovations that will make Intel-compatible PC

systems attractive to more consumers, and those consumers less sensitive to the price of

Windows, the innovations will translate into increased profits for Microsoft.  Second, although


                                                  31

In 1998, all major OEMs agreed to this restriction.  Naturally, it is hard to sell a pirated copy of

Windows to a consumer who has already received a legal copy included in the price of his new

PC system.  Thus, Microsoft is able to effectively contain, if not extinguish, the illegal secondary

market for its operating-system products.  So even though Microsoft is more concerned about

piracy than it is about other firms' operating system products, the company's pricing is not

substantially constrained by the need to reduce the incentives for consumers to acquire their

copies of Windows illegally.

       F.      Price Restraint Posed by Long-Term Threats

       59.     The software industry in general is characterized by dynamic, vigorous

competition.  In many cases, one of the early entrants into a new software category quickly

captures a lion's share of the sales, while other products in the category are either driven out

altogether or relegated to niche positions.  What eventually displaces the leader is often not

competition from another product within the same software category, but rather a technological

advance that renders the boundaries defining the category obsolete.  These events, in which

categories are redefined and leaders are superseded in the process, are spoken of as "inflection

points."

       60.     The exponential growth of the Internet represents an inflection point born of

complementary technological advances in the computer and telecommunications industries.  The

rise of the Internet in turn has fueled the growth of server-based computing, middleware, and

open-source software development.  Working together, these nascent paradigms could oust the

PC operating system from its position as the primary platform for applications development and

the main interface between users and their computers.  Microsoft recognizes that new paradigms


                                                 30

       D.      Price Restraint Posed by Microsoft's Installed Base

       57.     Software never expires, so consumers who already have a version of Windows

with which they are content and who are not shopping for a new PC system are somewhat

reluctant to incur the cost of upgrading to a new version of Windows.  Fortunately for Microsoft,

the pace of innovation in PC hardware is rapid, and the price of that hardware has declined

steadily in recent years.  As a result, existing PC users buy new PC systems relatively frequently,

and OEMs still attract at a healthy rate buyers who have never owned a computer.  The license

for one of Microsoft's operating system products prohibits the user from transferring the

operating system to another machine, so there is no legal secondary market in Microsoft

operating systems.  This means that any consumer who buys a new Intel-compatible PC and

wants Windows must buy a new copy of the operating system.  Microsoft takes pains to ensure

that the versions of its operating system that OEMs pre-install on new PC systems are the most

current.  It does this, in part, by increasing the price to OEMs of older versions of Windows when

the newer versions are released.  Since Microsoft can sell so many copies of each new operating

system through the sales of new PC systems, the average price it sets for those systems is little

affected by the fact that older versions of Windows never wear out.

       E.      Price Restraint Posed by Piracy

       58.     Although there is no legal secondary market for Microsoft's PC operating

systems, there is a thriving illegal one.  Software pirates illegally copy software products such as

Windows, selling each copy for a fraction of the vendor's usual price.  One of the ways Microsoft

combats piracy is by advising OEMs that they will be charged a higher price for Windows unless

they drastically limit the number of PCs that they sell without an operating system pre-installed.

                                                  29



In 1998, all major OEMs agreed to this restriction.  Naturally, it is hard to sell a pirated copy of

       D.      The threats to Microsoft's monopoly posed by Internet browsers and Java are
               mutually reinforcing, and they could be essential to the emergence of other
               platform-level threats to Microsoft's operating system monopoly

       60.   The competitive threats posed by non-Microsoft Internet browsers and cross-platform

Java are, to a significant degree, interdependent.

               60.1.  Dissemination of Java virtual machines and Java runtime environments not

controlled by Microsoft hinges in significant measure on the widespread distribution of

Internet browsers.

                       60.1.1.  Industry witnesses recognize that Internet browsers are the

distribution vehicle for Java Virtual Machines and JREs and that, because Microsoft distributes

own (as will be discussed below, non-cross-platform) implementation of the JRE with its browser,

Netscape Navigator was the principal distribution vehicle for cross-platform Java.

                       i.      IBM's John Soyring testified that Netscape has been a significant
                               distributor of Java virtual machines: "Netscape is a very high-volume
                               distribution vehicle for Java virtual machines on operating systems
                               than OS/2."  Soyring, 11/18/98am, at 89:8-12; see also Soyring Dir.
                               ¶¶ 28 ("The reason this relates to browsers is that Netscape
                               has been the prime distribution vehicle for Sun's Java technology
                               Internet Explorer contains the Microsoft version of Java.").

                       ii.     Barksdale testified that "the widespread distribution of Netscape
                               Navigator facilitated widespread distribution of the Java programming
                               language developed at Sun Microsystems."  Barksdale Dir. ¶ 15; see
                               also Sasaki Dep. (played 12/16/98pm), at 31:6-8; 32:8-11.

                       60.1.2.  Microsoft, both  in contemporaneous documents and through its

witnesses at trial, recognized that Internet browsers are essential to distribute JVMs and Java

libraries and, in particular, that Netscape was the principal distribution vehicle for a


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runtime environment.

                        i.         Muglia acknowledged at trial that Netscape has been "one of the

       C.      Microsoft's ability to control the price of Windows evidences its monopoly
               power

       33.  Microsoft's monopoly power is also evidenced by its ability to control the price of its

operating systems.

       i.      Professor Fisher testified that a firm's "substantial ability to vary, and, indeed,
               price "without fearing that its customers will turn elsewhere" can be evidence
               power.  Fisher, 6/1/99am, at 11:14 - 12:17.

               1.       Microsoft does not consider rival operating systems in pricing Windows
                        95 or Windows 98

       34.  Microsoft does not consider competitors in setting the price for Windows 98, and

Microsoft does not fear that increasing the price of Windows will cause its customers to turn

       i.      See supra Part II.A.; ¶ 15.1.5.

               2.       Microsoft raised the prices of obsolete versions of Windows

       35.  Microsoft's substantial pricing discretion is also demonstrated by its ability to

royalty for older versions of Windows, versions that Microsoft characterized as "obsolete,"

the release of new versions.

                        a.          Microsoft increased the Windows 95 price when it