MICROSOFT'S BILLION-DOLLAR CALIFORNIA CONSUMER SETTLEMENT:
Coupons for Plaintiffs, Cash for Lawyers, A Cheap Solution For Microsoft

By AARON EDLIN

Tuesday, Jan. 21, 2003

Since then, however, "follow on" private actions seeking to capitalize on the proof of monopolization have loomed. In the California consumer suits, for example, a $1.1 billion settlement was just announced.

The big catch, however, is that the settlement is for coupons, not cash - a practice that has become common in many large class action suits. While the plaintiffs' lawyers plan to ask the court to award their legal fees in cash, they seem to believe that coupons, not cash, are good enough for the plaintiffs they represent.

Are they? Probably not. A cash settlement would serve the dual purposes of compensating California consumers and deterring Microsoft and other potential monopolies from future wrongdoing. This coupon settlement, however, does relatively little on either front: much of what Microsoft pays will wind up in the hands of other vendors, not California consumers; and much of what California consumers receive will be paid by out-of-state consumers, and not by Microsoft. Thus, Superior Court Judge Paul Alvarado should seriously consider refusing to approve the settlement.

A Hypothetical Shows Why Coupon Settlements Aren't As Good As Cash Ones

To understand the problems with a coupon settlement, imagine that each injured buyer receives a $10 discount coupon that can be used only to buy Microsoft products. Each buyer then turns in her coupon to Microsoft when she buys the next version of the operating system, and feels as if she saved $10.

But the savings could be illusory. Microsoft might simply raise its "sticker" price by $10; thereby charge the same "net" price after the coupon; and have paid the consumer $0 - effectively paying nothing in settlement. If all Microsoft customers had the coupons, this is exactly what Microsoft would do.

Microsoft's incentives will differ somewhat because the settlement is California-only, and the company may need to charge the same price nationwide (for two reasons: first, customers could otherwise buy over the Internet from outside California if prices were cheaper there; and second, the earlier settlement requires a degree of price uniformity and transparency). As a result, Microsoft may want to stick with a price closer to the original sticker price, which was calculated to maximize its nationwide profits absent the settlement.

Microsoft's incentive, however, still won't be to stick to the original sticker price. Perhaps it will raise the price $3, instead of $10 - to try to get back some of its coupon from California customers, while still offering a price that is relatively attractive nationwide.

And that will hurt everyone: California customers promised a $10 coupon will effectively get only a $7 coupon, and other customers will have to pay $3 more than they otherwise would have. Because California customers get only $7, the compensation goal will be compromised.

The Problem Is Not Solved by Allowing Coupons to Be Used With Other Vendors

Fortunately, the problem with the California settlement is not quite as obvious as in the hypothetical. That is because the lawyers have wisely ensured that the coupons can be used for computer software or hardware other than Microsoft's.

Does that make the $10 coupon really equivalent to a $10 cash settlement? The answer is still no.

Remember that Microsoft has a monopoly of operating systems and a huge fraction of Office Suites. As a result, many customers will choose to use their coupon with Microsoft after all.

Some customers will of course use the coupon to buy hardware from competitors. But Microsoft still wins: Increased demand for computer hardware (whether from coupons or other factors) tends to increase demand for Microsoft's software.

No matter how you look at it, this settlement comes much cheaper for Microsoft than the $1.1 billion headlines suggest. Likewise, California customers will get less than suggested. Again, suppose customers buy from competitors, and recall the analysis above. Coupons make it possible for vendors to raise prices. And that applies not only to Microsoft, but to other vendors as well. A price increase by other vendors means that Microsoft, in effect, ends up paying them - not their customers.

Suppose a competitor raises prices $3 because of the $10 coupon. When Microsoft pays off the coupon, in effect $3 goes to the competitor, and only $7 to the consumer. And while readers may appreciate the irony of Microsoft having to pay the very competitors it probably injured, the point of this settlement is to benefit not them, but the consumer plaintiffs. (Competitors can sue on their own if they want).

In sum, as a Californian, and as one of the millions of members of this plaintiff class, I would much rather have cash than coupons, for all the reasons given above. Moreover, I would much rather that others have cash too, so that I don't have to pay higher software prices inflated by the demand of other coupon holders. People's everyday intuition that scrip is not "real money" is, in this case, precisely correct.

Why the Judge Shouldn't Approve the Coupon Settlement

But what if the judge thinks that the class will benefit adequately, but that non-Californians, and not Microsoft, will be paying the price? That would be a reasonable position to take: In our hypothetical, Californians get at least around $7 each, and non-Californians pay an extra $3 each.

That puts the judge in a more difficult place, since his job is mainly to ensure that the settlement adequately benefits the class. Judges are given this task because at times, class action attorneys have the incentive to settle earlier than is precisely in their clients' interests; and widely-spread class plaintiffs, who may individually have a limited stake in the litigation, have less incentive to police their lawyers than other plaintiffs do.

If he confines himself to that limited role, the judge may well feel he ought to approve the settlement. But he could also reject it as against public policy - or, indeed, on the ground that it is illegal, since it is anti-competitive.

Sound far-fetched? It's not. Consider that the effect of the settlement, if approved, will probably be to raise prices to non-Californians. Consider also that this effect will result from an agreement between Microsoft and the plaintiff's lawyers, acting on the class's behalf. Then consider that the essence of an antitrust claim is an agreement with predictable anti-competitive effect.

Finally, the judge has yet another option - suggested by professor Christopher Leslie. He could require that the lawyers, too, take their fees in coupons (which they would be permitted to resell if they chose, since lawyers and even law firms create only so much demand for hardware and software). I doubt the lawyers would be any happier with the coupons than you or I would.

Such creative judging might solve some of the problems with this settlement, and might also lead to more traditional cash settlements in future cases.


Aaron Edlin is a professor of economics and law at UC Berkeley, where he has taught since 1993. He worked for the Clinton Administration as a Senior Economist at the Council of Economic Advisers, covering industrial organization, regulation and antitrust in 1997-98, and has been a visiting professor and research scholar at Columbia, Stanford, and Yale law schools. He received his A.B. from Princeton and his Ph.D. and J.D. from Stanford.

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