UNITED STATES DEPARTMENT OF JUSTICE
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RETHINKING ANTITRUST POLICIES FOR THE NEW ECONOMY

JOEL I. KLEIN
Assistant Attorney General
Antitrust Division
U.S. Department of Justice


May 9, 2000
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I am very pleased to be here today. I want to thank the Haas School
and Dean Tyson for inviting me to address you about a subject that
I've thought and even re-thought about a great deal over the past few
years: the subject of this panel, "Rethinking Antitrust Policies for
the New Economy."

My conclusion is that the core principles of antitrust reflected in
the Sherman Act -- like other fundamental principles embodied in
venerable texts like the Constitution and the Bill of Rights -- should
not be changed in this new era. All of these charters state enduring
rules that can and should be applied in new situations. The Framers of
the Constitution surely could never have imagined electronic
eavesdropping; but the Supreme Court had no trouble ruling that this
form of invasion of privacy was subject to the Fourth Amendment.

Core antitrust principles have served our Nation, our citizens, and
our economy extremely well in the more than a century since the
Sherman Act was passed. And I expect that they will continue to do so
in the 21st Century, during this period of remarkable technological
progress and expansion.

The core principles of antitrust are actually what Adam Smith wrote
about more than two centuries ago: that free and competitive markets
result in maximum economic development, wealth creation, and consumer
welfare, but that markets will not always remain free and competitive
in the absence of effective government oversight. In the end,
antitrust is all about market power -- which every business
understandably wants -- and the limits on how it can be obtained,
preserved, and extended.

The legitimate ways of acquiring and maintaining market power are
essentially the same today as they were a hundred years ago; and the
illegitimate ways are fundamentally the same as well. "Skill,
foresight and industry" is the term that antitrust lawyers use to
summarize the permissible means of acquiring market power. But I don't
have to tell this audience that that simple phrase can capture a broad
range of productive and profitable business activity, activity that
has contributed so much to our Nation's economic strength. And market
power can legally be maintained in the same way, through innovation
and competition in the marketplace.

The illegitimate means of getting and keeping market power have
changed little since Senator Sherman's day as well. I will describe
them in detail in just a bit. They deter innovation and restrict
consumer choice, and they are as illegitimate and illegal today as
they were a hundred years ago.

Two important corollaries follow from all this: First, sound antitrust
policy does not believe that big is bad or that success must be
punished. Quite the contrary -- where success is the result of skill,
foresight and industry, consumer welfare is enhanced. To be sure,
there have been times when antitrust enforcement has appeared to take
a different view. For example, during the 1960's, the Division
sometimes disregarded sound, market-based antitrust analysis in favor
of a big-is-per se-bad philosophy. But that view fell out of fashion
decades ago, and there is little prospect of its revival.

And second, since we believe that free and competitive markets
maximize innovation and consumer welfare, we tend to disfavor
regulation generally and certainly as a way to remedy abuses of market
power. Ongoing regulation is invariably inefficient, both because it
under-deters anticompetitive behavior and because it can be exploited
by opportunistic rivals to hamper procompetitive conduct. Thus, where
possible, we seek structural, market-based solutions to serious
competitive problems, because these solutions mean that consumers, not
government agencies or existing monopolists, will get to chose when
longstanding monopolies yield to innovative technologies and
innovative business models.

In this regard, I've been reading a lot lately about this issue of
regulation versus structural solutions -- as it affects a case of some
interest to me. It's a case that is well known to many of you as well,
I'm sure. It involved complex and wide-ranging antitrust claims,
resulting in a trial that gained lots of attention, followed by a
Justice Department proposal to break-up a major American corporation.

Here's what the Wall Street Journal had to say about the case on its
editorial page:

"While the Justice Department can't promise any consumer benefits
that might result from its suit to break up [the company], it is
sure of one thing: This is the largest antitrust action ever filed.
So much for the mentality of modern-day trustbusters. As long as
they can tackle the biggest of all 'big businesses,' what is the
difference whether the massive expenditure of federal money and
effort is likely to cut anyone's . . . bills?"

"Where is the problem that justifies risking possible damage to the
efficiency of a vital part of the U.S. infrastructure; damage to
the investments of innumerable small investors and pension fund
beneficiaries; possible damage to an important research and
development enterprise? If there is a problem that justifies all
this we can't find it. Maybe it is because we prefer to deal in
economics, rather than politics in such matters."

By now, you may have guessed that this is an editorial about the
Department's monopoly maintenance case against AT&T, a 1974 editorial
as a matter of fact; but if it sounds familiar, it is because the same
charges have been leveled against the Department's lawsuit, and our
proposed remedy, in the Microsoft case.

Then as now, the Department challenged illegal practices by a firm
with monopoly power in a critical market, practices designed to
maintain and extend the monopoly.

Then as now, the Department was criticized for challenging a
technology leader and a critical part of the economic infrastructure.

Then as now, the Department sought a structural remedy because it is
the most effective and efficient means of protecting and preserving
competition.

And then as now, dire predictions were made that structural relief
would kill the goose that laid the golden egg. One of my favorites is
a Forbes Magazine article published the day after the AT&T divestiture
took place: "For the consumer, costs will go up and service down . . .
It's quite alarming, in fact, just how many top executives in the
industry are predicting [this] . . . get used to it; it's going to get
worse."

We now know, of course, that the divestiture in the AT&T case, far
from making things worse, has unleashed unprecedented competition,
innovation and consumer benefit. By separating the local telephone
monopolies from other aspects of the telecommunications business, it
has fostered the growth of the Internet, wireless communications,
broadband services and fiber optics, and other extraordinary
innovations that were unimaginable when the divestiture took place.

And it has also led to substantial competition in telephone services
and significantly lower prices for consumers. Since divestiture,
prices for long distance calls have fallen dramatically, while per
capita use of long distance service has almost tripled -- an
extraordinary output effect by any standard.

We believe that the proposed divestiture in the Microsoft case
similarly would produce substantial innovation and competition in the
software business. The district court found that Microsoft illegally
maintained its operating system monopoly through a broad pattern of
unlawful acts that crushed emerging threats to that monopoly posed by
Netscape's browser, Sun's Java, and other cross-platform middleware
technologies. We need to make sure that new technologies aren't
subject to the same treatment in the future or, even worse, that
innovators decide to avoid such technologies altogether for fear that
they may meet the same fate if things don't change.

The central feature of our proposed remedy is splitting Microsoft into
an operating systems company and an applications company. Unlike the
AT&T case, where line-of-business restrictions remained on the local
telephone companies, here the separated businesses would be entirely
free to compete with each other in all lines of business. Each company
would have the incentive to compete vigorously through developing and
licensing products that compete with the other's core business.

For example, a separate applications company would have the incentive
to develop the best possible office suite, not only for Windows, but
also for other computing platforms like the Apple and Linux operating
systems. Indeed, much like the browser was in 1995, before Microsoft
commenced its illegal campaign, Office has the very real potential to
be a cross-platform middleware threat to the dominance of the Windows
monopoly.

Because Office is an enormously popular product -- with over 100
million copies in use around the world -- its availability on other
operating systems would give those operating systems a real
opportunity to compete against Windows. As these other computing
platforms grow and proliferate, moreover, we would expect the Windows
operating systems business to face real competition for the first
time. And this is only one of several ways in which the proposed split
is likely to facilitate competition. In toto, the result will be
exciting and innovative new products, with more choices and lower
prices for consumers.

Now, there are some who are suggesting that the reorganization will
result in a loss of efficiency currently generated by the coexistence
of the operating system business and the applications business under
one roof. That argument is wrong as a matter of fact, and wrong as a
matter of history as well. It is wrong as a matter of fact, since the
two companies would be free to exchange technical information, as long
as that information was also made available to third parties; and
Microsoft has long claimed that it provided third-party applications
developers all the information about its operating system that those
developers could need to write their applications for Windows. If so,
there should be no real loss of efficiency in the reorganization.

The argument is also wrong as a matter of history. The opponents of
the AT&T remedy made the very same claim, arguing that the divestiture
would imperil the efficiency of the telephone network; and that
argument has surely failed the test of time.

Now, let me move away from this specific example of "the more things
change, the more they stay the same" to the more general point about
antitrust enforcement that I referenced at the beginning of my
remarks. While technology changes, and that of course affects the
particulars of our analysis, antitrust enforcement remains remarkably
constant in its application of the core principles that have proven to
be effective in protecting and preserving competitive markets while
maximizing innovation and assuring low prices for consumers. These
principles, as I noted earlier, have to do with market power and
separating the legitimate, procompetitive ways it is acquired and
preserved, from the illegitimate, anticompetitive ways.

Let me reiterate the fundamental point: businesses want market power
-- i.e., the ability to make more than normal, competitive profits.
It's good for the business, good for its employees, and good for its
shareholders. And a rational, procompetitive system of antitrust laws
must seek to ensure that the way business gets that market power is
good for consumers as well.

To take an obvious example of a good way of acquiring and protecting
market power, one from outside the antitrust arena, though by no means
inconsistent with it, let's look at patent law. Here is an example
where we grant statutory protections that tend to create and protect
market power. That is why drugs cost so much -- absent patent
protection, once a drug is created, it could be duplicated and readily
sold at a small fraction of its patent-protected-price. The rationale
behind patents, and the market power they establish and protect, is
that, in the absence of patent protection and the returns it
generates, no one would spend the money on R&D necessary to develop
the drug in the first place. In short, we create a legally imposed
barrier to entry -- intellectual property (or IP) protection -- in
order to ensure that innovation is encouraged. One can argue, as many
do, whether the period of IP protection is too long or too short to
stimulate a desirable level of overall R&D, but the basic principle
that, absent some IP protection, innovation would be harmed is clearly
correct.

The next point I want to note here is that market power is not a
unitary thing: there is market power and there is market power. Lots
of businesses enjoy at least some market power, but very few enjoy
monopoly power over any significant period of time. Brand loyalty or a
first-mover advantage, for example, may give a business the ability to
charge prices a bit above the competitive level, but in the absence of
stronger barriers to entry than just brand loyalty or a simple
first-mover advantage, the magnitude of these supracompetitive profits
are likely to be quite modest.

This point, in turn, is key to understanding a fundamental market
dynamic that animates antitrust analysis, i.e., the strength of
barriers to entry is ultimately what determines how much market power
a business will be able to sustain and exploit. At the same time, and
somewhat paradoxically, the more a business exploits such power, the
more potential competitors want a piece of the action. In short,
supracompetitive profits, like well-known movie stars, draw a crowd;
businesses, just like the bank robber, Willie Sutton, want to be where
the money is.

And, in fact, as it turns out, because of the powerful incentives of
the marketplace, it's quite rare that we see strong barriers to entry
enduring for long periods of time. That is especially true in the
absence of illegal business practices that augment the natural
barriers that exist, a point that I want to come back to in a moment
because it is at the heart of what antitrust enforcement is all about.
But this view about the strength of entry barriers, at least in
certain critical industries, has not always been widely shared. On the
contrary, there have been quite a few times in our history when entry
barriers to particular markets were thought to be so strong, we
concluded that the market was a so-called "natural monopoly" and that
we had no choice but to regulate it. Indeed, not so long ago, that was
the case with respect to surface and air transportation, telephones,
and energy (and as to the latter two, still is the case to some degree
even today).

But now, with increasing confidence and conviction, we in America (and
much of the world as well) have been won over to the view that, in the
absence of illegal practices, technology will ultimately be able to
erode almost any barrier to entry. Consequently, for several decades
now, we have wisely adopted a national policy that favors deregulation
and market forces instead of regulation.

This is not to suggest that market forces cannot generate strong
barriers to entry. They can, especially in markets characterized by a
so-called positive feed-back loop, either from scale economies or from
what economists call "network effects." What this fancy jargon means
is something we all tend to understand intuitively: in certain
circumstances, nothing succeeds like success. A network effect occurs
when the more a business sells of a particular product or service, the
more people want it because its increasing adoption increases its
value to the next user. A classic example, of course, is the
telephone: the more people on a given network, the more value the
network has to potential users, making it easier to get the next
customer, and so on. Indeed, once a network gets a sufficiently large
number of customers, it becomes almost impossible for a new entrant
without access to the network to successfully challenge its dominance.

Two things I want to emphasize here about these kinds of positive
feedback situations: first, they existed in the old economy, just as
they do in the new. We had an old-economy case against AT&T, for
example, where market power was derived in this fashion. And our
new-economy case against Microsoft relies on this notion as well.

Like the telephone system, the Windows operating system at issue in
the Microsoft case also benefits from a positive feedback loop. People
select an operating system based largely on the number of applications
available to run on that operating system, and people who develop
applications want to develop them for the most popular operating
system, since that is the way to sell the most applications. As a
result, a dominant position in operating systems reinforces itself
because the applications developers write to your operating system and
then more new computer buyers want your operating system because
desirable applications are available to run on it.

The second point to understand about these positive feedback loops is
that there's nothing illegal or even undesirable about them: they are
an outgrowth of market forces and consumer choice and, so far as the
antitrust laws are concerned, businesses which have the skill and
foresight to understand and take advantage of those forces are
entitled to enjoy the fruits of their efforts.

In both AT&T and Microsoft, antitrust enforcement became an issue not
because of the acquisition of market power but because of how that
power was protected and/or expanded. This is a fundamental point to
understanding the future of antitrust enforcement and so, in the time
that remains, I would like to expand on it briefly.

As I have noted, we in America have chosen, wisely in my view, to
reject an effort to regulate all monopolies; instead, we generally put
our faith in the ingenuity of the market -- entrepreneurs and
innovators -- to erode barriers to entry and protect consumer welfare.
But if monopoly power, once had, can be used to protect and extend
itself, our reliance on the market will be frustrated and consumers
will be hurt. Unlike positive-feedback-loops, which are a natural and
inevitable market phenomenon, abuse of market power is anticompetitive
and harmful; it means that a monopoly position has prevented
innovation and entrepreneurship that would strengthen the economy and
increase consumer welfare.

What's interesting in this regard -- and this is why I say that the
new economy is fundamentally no different from the old when it comes
to antitrust enforcement -- is that the anticompetitive techniques
used to protect and extend monopoly power in the new economy are
essentially no different from those used throughout history. Put a bit
differently, while technology changes, human nature, as Adam Smith
taught us long ago, does not. There are, to paraphrase Simon &
Garfunkel, only so many ways to illegally hurt your competitor.

In our business, there are generally about a half-dozen or so of these
techniques and they are used in the new economy in much the same way
that they were used in the old. Let me first mention the basic
techniques and then illustrate their application by referring to cases
involving the new and old economies, mentioning for illustrative
purposes three that are currently in court. The basic techniques --
apart from good old fashioned collusion in which potential competitors
agree not to compete -- typically involve cutting off competitors'
access to important suppliers and markets, inducing rivals not to
compete, using tying to force customers to purchase other products,
and engaging in predatory tactics to raise rivals costs or cut their
revenues without a real business justification. Basically, these are
the time-tested tricks of the monopolist's trade.

Let's take a quick look at several of them. First, there are the
traditional anticompetitive distribution techniques: intimidating or
coercing distributors who need your monopoly product, either
informally or through formal exclusionary contractual arrangements.
These kinds of practices are as old as the antitrust laws themselves
and rest on the sound premise that the use of market power to restrict
distribution of competing products can only injure consumers. That
point is at the heart of our complaint in the Dentsply case, a very
old economy case involving false teeth and exclusive dealing contracts
with dental labs. It was also a key issue in the Microsoft case where
the judge found that Microsoft repeatedly intimidated OEMs who wanted
to distribute competitors's products and used exclusionary contracts
with Internet Access and Content Providers to limit their distribution
of the Netscape browser.

A second common, anticompetitive distributional practice involves
tying two products together -- once again, a violation as old as the
antitrust laws themselves. Tying allows a firm to use its market power
in one product to force consumers to take a second product and thus
often makes it harder for the firm's competitors to distribute their
products. To be sure, a tying case can present complex factual issues
about whether there are one or two products at issue, which in turn
can raise important questions about potential integrative efficiencies
that might result from a "tie." But distributional efficiencies --
i.e., simply putting two products together -- are no defense to tying.
That was true in the 1930s when a unanimous Supreme Court ruled that
IBM's decision to tie calculating cards to its calculator was unlawful
and that was also true under the District court's opinion in Microsoft
involving the tying of Microsoft's browser to its monopoly operating
system.

Since a lot of discussion has focussed on the tying issue in
Microsoft, let me emphasize that ties in the software industry,
especially where, as in our case, the tied product (e.g., browsers)
could undermine the monopoly position of the tying product (e.g.
operating systems) can have particularly strong anticompetitive
effects. In this regard, we need look no further than the remarks of
Microsoft's Chief Operating Officer of Microsoft when he was asked in
1998 how small software companies could compete on products that
Microsoft plans to fold into its operating system. His reply: these
smaller rivals had three possible paths -- they could fight a losing
battle, they could produce a successful product and then sell to
Microsoft or another large company, or they could "not go into
business to begin with because, hey, if you're a betting person, you
know which way it's going to go." It's hard to think of a greater
deterrent to innovation.

The next set of traditional antitrust violations involve what we call
predatory, as distinguished from exclusionary, practices. Here we're
talking about a business incurring expenditures that would be
profitable only if they will defeat a competitor and then allow the
business to recoup the short-term costs of the action through the
long-term preservation of monopoly profits. And here again, these
practices were used in the old economy as well as the new, a point
readily demonstrated by the fact that this issue is at the heart of
our American Airlines case and was key in Microsoft as well.

In the American Airlines case, we charged that, when faced with new
entrants in Dallas, American incurred great expense -- by saturating
the relevant city-to-city markets where the new entrant had started
service (e.g., Dallas/Wichita) and lowering prices substantially -- in
order to drive the new entrant from the market. The essence of the
case is our claim that American would never have engaged in these
practices had it not known that it could eliminate new entrants and
then recoup its short-term losses by enjoying monopoly profits in the
future. As American's CEO said to his colleagues at the time, "if
you're not going to get them out [of the market], then [there is] no
point to diminish [our] profit."

Moving next to the new economy, the facts of the Microsoft case
provide an especially powerful example of this predatory technique.
There, the judge found that Microsoft had spent hundreds of millions
of dollars to develop and distribute Internet Explorer, not just for
Windows but for Internet Access Providers and even for Apple.
Microsoft did this, the court further found, even though it internally
described IE as a "no-revenue product" and knew that, standing on its
own, Microsoft's IE business strategy made no sense. After all, it's
hard to sustain a business plan by paying millions of dollars to
induce others to distribute a no-revenue product, especially one that
cost hundreds of millions to develop. What made this strategy even
more perplexing is that, according to Microsoft's own documents,
"browser market share" -- share of this no-revenue product -- was seen
a "priority number 1" within the corporation.

The reason this otherwise irrational business strategy made sense, of
course, is that, as the district court found, Microsoft was protecting
its monopoly profits in Windows by making sure that Netscape's browser
did not obtain sufficient market share to create a platform that could
ultimately erode Windows' dominance -- a fear that Bill Gates
highlighted at the outset of Microsoft's anticompetitive campaign by
noting that, if Netscape wasn't stopped, its browser would be able to
"commoditize" the operating system.

I could give other examples of anticompetitive practices in the new
economy -- like withholding technical information that competitors
need to compete -- which were also observed in the old economy. But by
now I think you get my basic point: when it comes to antitrust
enforcement, the new, new thing isn't so new after all.

So let me conclude by highlighting two points. First, the focus of
antitrust enforcement tomorrow, as it was yesterday, will remain on
preventing the traditional anticompetitive techniques that businesses
with market power have long used to maintain and extend that power.
And second, given my first point, in the new economy as in the old,
businesses with market power should have little problem in ordering
their affairs in a way that keeps them free from antitrust
difficulties.