The Microsoft "Sequester"

Here is  a definition of “sequester” that isn’t the real definition but what we now talk about. A sequester is a situation where a party (or parties) agree to a horribly painful and costly course of action to themselves in the event that they do not take a certain action. For the US Congress, the painful action was, well, a sequester, while the action was failure to come to a budget agreement.

By this new definition Microsoft have fallen prey to the consequences of a “sequester.” Several years ago Microsoft agreed to allow a “choice screen” for its Windows users in Europe to select their default browser. It came to this agreement with the European Commission. The “choice screen” was the action and the sequester were penalties that related to the number of users and length of time for non-compliance. Microsoft was supposed to offer the screen until 2014 but between 2011 and 2012 a coding error meant that Windows 7 SP1 did not contain the screen. The error was not changed for 14 months. As a result of this, yesterday, Microsoft was fined $738m by the European Commission. The sequester was on.

Now I don’t normally comment on issues related to companies I consult for — in this case Microsoft. However, I have not been involved in this matter and I have past writings expressing support for features like a “choice screen” so I have decided to enter the fray this time around (one my own and not with any consultation or discussion with Microsoft). This sequester is a very poor application of competition policy and may well have far reaching implications that harm the ability to engage in agreements to reduce the exercise of market power in the future.

First, this is a situation where the fine imposed as way out of proportion with the magnitude and harm caused by any legal infringement. When the EU took Intel to court for years of antitrust violations that harmed the microprocessor market, the eventual fine was roughly double what Microsoft just paid. However, the potential harm caused by that exercise of monopoly power on welfare and consumer surplus was far greater. By contrast, with perhaps 28 million computers affected, if the fine was commensurate with the harm, the harm would have to be about $26 per computer. Browser choice is important but simplifying it surely doesn’t amount to that much.

Moreover, on the issue of harm, those who follow tech blogging know, the minute some change or issue arises bloggers are on to it right away. Instagram or Apple’s licensing terms are scrutinised in every update. But for 14 months, no one appeared to notice Microsoft’s error. This was high profile and a sensitive issue and from what I can tell, it went by unnoticed. That suggests the harm wasn’t there.

This case is not unique in this regard. Last year, the Australian Competition and Consumer Commission fined Apple several million dollars for the 4G labelling on the new iPad. Apple had behaved very well with regard this issue but the ACCC chose to make an example of them anyway. Fortunately, Apple did not react by shying away from Australia but with that liability risk they or others might have.

Second, you might say, why should harm matter? We want to make sure Microsoft complies and a big fine should get their attention. That argument is sound and that is one way of reading all this. The fine was there, Microsoft didn’t organise themselves to make sure they weren’t liable and now they should suffer.

But the counter to that is that we may not want them to engage in that organisation. For a large company like Microsoft, with changes being rolled out usually to improve things for consumers, it is possible to miss something. They also have probably organised themselves to react to user issues rather than check off all of them. That is not an unreasonable way to go. What this type of agreement means is that companies like Microsoft will have to organise themselves to minimise the risks of missteps like this. It is not clear that that will be less costly than the harm that might emerge for some periods of accidental non-compliance.

Third, but related to this, is the incentive for Microsoft and others to enter into these agreements. Settlements can be good in that competition authorities can often insist on structural and behavioural changes that are outside the strict purview of antitrust laws but are much better than the remedies that might be court imposed. Also, in technologically dynamic industries, such settlements can be reached sooner than a litigation outcome.

Faced with liability risk like this, companies will take their chances with the courts. That will gum up the competition enforcement business. This would be a great outcome for lawyers and, ahem, economic consultants, but it is terrible for consumers and firms alike. This isn’t just hypothetical. From the NYT:

The fine comes as Mr. Almunia’s office is negotiating with Google to try to resolve the commission’s concerns about the way it runs its Internet search service and its advertising business.

Mr. Almunia said Wednesday that attempts to reach a deal with Google were continuing and were unrelated to the decision taken against Microsoft. But he made it clear that the substantial fine was meant to serve as a warning to others.

If Google eventually settles, it “will have to exert extra care to not give the impression that it is deviating from the commitments that such a settlement will entail” to avoid a similarly high fine, Mario Mariniello, a research fellow at Bruegel in Brussels and a former antitrust official, wrote in a blog post.

I’m not so sure Google should settle for a sequester. It may severely harm how it experiments with change and innovation. If there is one thing that we have learned in the last few weeks about them, it is surprisingly easy for people to shoot themselves in the foot.