Full opinion text
OPINION SCHNACKE, District Judge. I. Plaintiff, Transamerica Computer Company, Inc. (“Transamerica”), has alleged that certain activities of Defendant, International Business Machines Corporation (“IBM”), violated Section 2 of the Sherman Act which forbids the monopolization or attempted monopolization of any part of trade or commerce. An appreciation of the nature of the computer industry and the parties’ respective roles is helpful to an understanding of, and indispensable to an evaluation of, that conduct. Computers, like the punched card accounting equipment that preceded them, depend upon the capabilities of the electronic circuits. Because of the laws of physics involved, an electronic circuit, if properly designed, is capable of performing both arithmetic and logical functions. For instance, it is possible to design a circuit that will add two numbers together (an arithmetic function), and another circuit that will compare the result of the addition to a third number and choose between various alternatives on the basis of that comparison (a logical function). The sequence of arithmetic and logical functions that are to be performed is known as a program. With punched card accounting equipment, programs were “hard-wired”, that is, the sequence of functions to be performed by the arithmetic and logical circuits was predetermined, and could only be altered by actually switching wires around within the machine. In 1951, in response to the needs of the Bureau of the Census, Sperry Rand Corporation introduced the first stored-program computer, the Univac 1. This first computer differed from its predecessors in that it was possible easily to alter the program that determined the sequence of functions to be performed. No longer was it necessary to “hard-wire” the program; the sequence of functions desired could now be indicated to the computer through “softer” and more flexible means. A program could be punched into a series of cards and the content of those cards could then be read into the computer. The computer would turn to this data read in from the cards for instructions as to what arithmetic and logical functions it was to perform, and in what sequence. A program could be altered simply by altering a punched card, and new programs could be carried out merely by causing the machine to read in a different set of punched cards. IBM offered its first electronic computer in 1953. That machine, like those offered by competitors, utilized vacuum tubes to perform the electronic circuit functions. Before long, this first generation of computers was outmoded by a second-generation whose transistorized circuits performed more economically and more reliably. In 1964, IBM announcéd a series of machines, the System/360; these were the first of the third generation computers. The 360s not only employed improved components (integrated circuits replace transistors), they also relied upon a single general design or architecture for a broad spectrum of machines. That meant that one computer was capable of efficiently performing both scientific and commercial tasks, and, perhaps most important, it meant that customers who outgrew their smaller machines could “migrate” to larger machines without the need to change their existing programs; the whole 360 family of computers was program-compatible to an unprecedented degree. As a result, System/360 was a tremendous commercial success. In 1970 IBM announced its 370 system, a further significant improvement, and superior to the 360 system. The new 370 system involved improved central processing units as well as new and improved peripherals. All of the acts Transamerica claims caused it damage were related to the introduction of the 370 system. IBM is a supplier of computer systems, supplying all, or nearly all of the user’s computing needs. It offers a wide range of services and products, both software and hardware. The hardware of a computing system consists of a central processing unit (“CPU”), which houses the arithmetic and logical electronic circuits, and a variety of peripheral gear. The functions of peripherals include: storing data for later access by the CPU; feeding data into the CPU (input); and accepting data from the CPU (output). A machine capable of reading data on punched cards and transferring that data to the CPU is considered an input peripheral, while a printer attached to the CPU functions as an output peripheral. Some peripherals perform all three functions. Disk drives and tape drives are examples of peripherals capable of storing data, inputting data, and outputting data. Data is stored on disks and is “randomly” accessed very rapidly by an access arm with the capability of reading or writing data. The access arm can be made to move to a particular track on the disk where the data is to be read or written. Tape drives are used for reading and writing data sequentially. Random access of data on tape reels is impractical because it is so time consuming. The tape and disk drives which attached to System/360 CPUs were a lucrative part of IBM’s business, so lucrative in fact, that they attracted competition. In the late 1960’s, several companies began marketing copies of IBM’s tapes, disks and printers, which were “plug-compatible” with IBM CPUs. A user could simply unplug the IBM peripheral, substitute the cheaper copy, and plug it into the IBM CPU. The companies providing this new competition became known in the industry as plug-compatible manufacturers (“PCMs”). The PCMs enjoyed a tremendous success. They were offering equivalent or better performance at a substantial discount. But in order to sustain their growth the PCMs needed funds. Most computer systems were leased rather than sold. This meant that the PCMs were unable to realize a quick return on their capital investment; much of their capital was tied up in ownership of leased machines, an investment that would not be recouped for years. The PCMs needed money to finance the manufacture of machines to meet a growing demand as well as to pay for the engineering costs of developing new products. They sought financing from a variety of sources: the sale of equity and debt securities; bank loans; the use of leasing companies; and more complex arrangements. Transamerica Computer Company, Inc., was incorporated in late 1967 as a wholly-owned subsidiary of Transamerica Corporation, a large non-bank financial conglomerate with wholly-owned subsidiaries in the insurance, auto rental, motion picture and other businesses. The parent was well financed, with nearly unlimited credit, and desired a “window to the computer industry.” Transamerica made a number of ventures into computer related financing. The transactions central to this case are Transamerica’s purchase of millions of dollars worth of on-lease tapes and disks from two PCMs, Marshall Industries (“Marshall”) and Telex Corporation (“Telex”). These manufacturers leased their equipment to end users. After it was on lease, the equipment was “sold” to Transamerica under an arrangement by which the manufacturers were obligated to- collect the rents, to service and maintain the equipment, and to remarket it as leases expired. Unlike some leasing companies which buy equipment, find users, collect rentals, etc., Transamerica had no function except to supply capital. In many cases the end users were unaware of Transamerica’s ownership of their equipment, and, indeed, at various times there was considerable doubt as to whether specific equipment, was owned by Transamerica or the manufacturer. The arrangements also contemplated that, after Transamerica had been reimbursed some agreed amount, further rental revenues would be shared between it and the manufacturer. There were two important reasons for this structuring of what was basically a financing arrangement. First, Transamerica expected that, as “owner” of the equipment, it would be permitted to take, for the substantial benefit of its parent, the investment tax credit then available under the tax laws. And, second, the manufacturers hoped to treat the transfers of title to Transamerica as sales, thus increasing their current profit picture, and aiding them in sales of their corporate stock. Neither of these benefits would have resulted if Transamerica had simply lent money to the manufacturer. Telex and Marshall were but two of the companies which were successful in displacing IBM peripheral equipment by offering it at prices well below those IBM was charging. IBM responded to the PCM competition by offering certain of its own products at substantially reduced prices, and by offering its peripherals for lease on longer and better terms than it had previously. In addition, new CPUs were introduced that were incompatible with the PCMs’ existing peripherals. These actions, and others described- herein, are those that Transamerica contends were the means by which IBM monopolized and attempted to monopolize in violation of Section 2. Following a seven month trial, a jury was unable to reach a unanimous verdict on any of the issues presented. The parties, before commencement of the trial, foresaw that possibility, and, stipulated that the case would be submitted to the Court for decision in the event of jury disagreement. (It might be well for the courts or Congress to consider whether such an arrangement might be compelled by the trial judge in advance of trial. No one case should be allowed to monopolize the court’s time indefinitely to the exclusion of the rights of other litigants. If, after one long jury trial, it becomes apparent that further jury trials would be inordinately time consuming, without any realistic expectation that the issues would be resolved, the matter should be resolved otherwise. The best method would seem to be by decision of the trial judge on the evidence presented at the jury trial.) This Court, having heard and fully reviewed all of the evidence, has made the findings of fact and come to the conclusions of law that are incorporated in this opinion. II. In order to establish that IBM monopolized in violation of Section 2 of the Sherman Act, plaintiff must prove: 1) that the defendant was in possession of monopoly power in a relevant market; and either 2) that the defendant has willfully acquired or maintained that power; or 3) that the defendant used its monopoly power, whether lawfully or unlawfully acquired, to foreclose competition, to gain a competitive advantage, or to destroy a competitor. The first essential inquiry must be whether IBM possessed monopoly power; whether it had the power to control prices in, or to exclude competition from some relevant market during the years here in question, 1969 to 1973. III. In general, two types of evidence are relevant to an appraisal of defendant’s ability to control price or exclude competition. The first category can be broadly labelled “market structure,” and encompasses evidence that is relevant to an estimation of the nature and significance of constraints on defendant’s power. The second category, “market performance” relates to a comparison between the actual past functioning of the market and the manner in which monopolized or competitive markets are predicted to function. A. Market Structure Economic theory teaches that a monopolist, because it is in a position to control price by varying the quantity of goods it produces and sells, will be able to sell its goods at a price higher than would prevail were the market competitive. As a result it will earn supra-normal profits. In competitive markets, two forces are at work which inhibit the ability of a firm to charge more than the competitive price level and earn more than a normal profit. First, if a producer raises its price above the price for competing goods, then customer demand for the higher-priced article will fall off in favor of cheaper alternatives, and the producer will be forced to lower its price again. Second, even if the producer were able to charge relatively more for its product for a time, the resultant supra-normal profits would lure new competitors into the market, and the additional supply of competing goods that they offer to customers would cause prices and profits to return to competitive levels. If that first force (“demand substitutability”) and that second force (“supply substitutability”) are sufficient checks upon defendant’s power to control price, then the market is effectively competitive. If not, defendant is a monopolist. An inquiry into demand substitutability calls for a definition of the relevant market and measurement of defendant’s share of that market. The relevant market is comprised of defendant’s product, products that are fungible, and of those products which the customer would consider to be reasonable alternatives. If a small increase in the price of product A will cause customers to shift their allegiance to product B, then the cross-elasticity of demand is high, the products are reasonable alternatives, and they belong in the same relevant market. The geographic aspects of the relevant market must also be considered. Thus, if small changes in the price of a product in one location will cause customers to turn to alternatives available in another location, then the quantity of reasonably alternative products supplied at both locations should be considered as part of the relevant market. The relevant geographic market is the area of effective competition within which the seller operates and to which the purchaser can practically turn for supplies. With the relevant market defined, the defendant’s share of that market can be measured. A relatively small market share would lead to the inference that monopoly power was not present since the ready availability of substitutes would defeat attempts to use that power. The larger defendant’s market share, the stronger is the inference that competitors would be unable to effectively check exercises of monopoly power. The distribution of the share of the market not supplied by defendant is also telling. Defendant’s share is more likely to indicate monopoly power if the rest of the market is widely distributed among many small competing suppliers than it would be if the size of competitors and the market share held by them approached defendant’s size and share. Under some circumstances it may be proper to apply the concept of supply substitutability to the definition and measurement of the relevant market and to include within the market any suppliers which might readily and easily enter by producing a reasonably acceptable alternative product. The greater the barriers faced by a new entrant, the more probable it is that control of a particular market share would enable defendant to exercise monopoly power. Anything that tends to inhibit firms from readily and easily entering the marketplace can be analyzed as an entry barrier. Thus, the capital an entrant would have to invest is a factor, as are the employee skill levels required for a firm to be successful. Product differentiation, product loyalty, or any customer disinclination to accept the product from different suppliers are hurdles the new entrant may have to overcome. And, the existence of economies of scale or a dwindling market demand would make entry difficult. Within a market, as defined by demand cross-elasticity considerations, economically significant submarkets may exist. Submarkets are zones of .actual or potential competition that are sufficiently distinct from the larger market that one firm could exercise the power to control price or the power to exclude competition within them. Practical aids in identification of such zones of competition include industry or public recognition of the submarket as a separate economic entity the product’s peculiar characteristics and uses, unique production facilities, distinct customers, distinct prices, sensitivity to price changes, and specialized vendors. If these indicia indicate a submarket exists, market structure and market performance should be examined to determine whether defendant is in possession of monopoly power. B. Market Performance Evidence of the actual operation of the market or submarket can also provide valuable clues as to the existence of monopoly power. If defendant has, in the past, successfully controlled price or excluded competition, that is direct and convincing evidence that it had the power to do so. Less direct evidence can also be persuasive. Many courts have examined defendant’s profit record on the theory that persistent excess profits are inconsistent with the competitive model and attributable to the possession of monopoly power. Monopoly is also expected to result in technological stagnation. Without a competitive spur, the monopolist is thought not to have any incentive to innovate. Thus, the rate of technological progress in the industry is relevant. In a competitive industry firms are expected to be “price takers.” That is, they will be unable to affect price by variations in the quantity of goods they offer for sale. Where it appears defendant was a “price maker,” able to choose among a range of. price options in order to achieve its profit goals, or able to disregard cost and set price according to utility to the consumer (functional pricing), it may indicate monopoly power., Market history, in terms of entry and growth of new firms or exit of failed firms, and whether concentration is increasing or decreasing are additional factors that can indicate whether the competitive process is functioning properly or not. Transamerica asserts that IBM had monopoly power in three markets: 1. The manufacture and placement of general purpose electronic digital computer systems (“systems market”); 2. The manufacture and placement of tape drives and their controllers plug-compatible to IBM CPUs (“tape market”); and 3. The manufacture and placement of disk drives and their controllers plug-compatible to IBM CPUs (“disk market”). C. The General Purpose Systems Market Computer systems are the functioning combination of hardware (CPUs and peripherals) and software that a user may employ to satisfy data processing requirements. Transamerica draws a distinction between general purpose systems and special purpose systems. Special purpose systems are those that are designed for .and dedicated to specialized applications. For instance, a special purpose computer system might be utilized to control a manufacturing or a chemical process. General purpose systems, on the other hand, are those that are capable of easily and economically being adapted to a variety of data processing applications. A general purpose computer system might be used to process a company’s payroll, to update its books of account, or to allow its engineers to solve complex mathematical problems while sitting at a remote terminal. Some (but not all) general purpose systems are capable of performing all these tasks concurrently. By definition, all general purpose systems allow the user to switch easily from one task to another. This Court accepts the view that the market for general purpose computer systems should be analyzed separately from the market for special purpose computer systems. The systems sold to satisfy these different needs are not readily interchangeable and different suppliers specialize in each of the markets. Transamerica’s definition of the systems market is, however, too narrow. Only suppliers of complete systems are included, suppliers of parts of systems are ignored. Firms which offer the user parts of systems have become a major competitive force in the computer industry, and, because they significantly constrain IBM’s power to control the price of the systems it sells, a market definition that ignores them- is incorrect. At one time the only option a general purpose systems user had was to choose between suppliers of complete systems. If an IBM user was dissatisfied with IBM’s peripheral equipment or with IBM’s software, the only recourse was to remove the entire IBM system as a unit, and replace it with an entire system from another manufacturer. Since that time, literally thousands of companies have entered the systems market, not as suppliers of entire systems, but rather as specialists providing users with replacements for parts of their computer systems. IBM did not charge the user one price for an entire computer system, rather they priced each component of their systems individually. That meant that companies which focused on replacing parts of a system could offer the user a better price on that part and the user was still free to acquire the rest of the system from IBM. The PCMs are perhaps the best example of such specialists. Some PCMs got their start by copying IBM’s tape drives and offering them to IBM’s systems customers. Other PCMs specialized in replacing IBM’s disk subsystems with their own versions. Still others recognized a competitive opportunity in supplying printers for use on IBM’s systems, and some PCMs competed with IBM for sales of the electronic memories attached to IBM CPUs. Entry barriers proved remarkably low, and the PCMs proliferated. Today, a user could replace practically every part of an IBM system with hardware from a PCM. The same is true for software. Software firms offer programs to users of IBM systems that are reasonable alternatives to the programs available from IBM. And the entry barriers faced by an entrepreneur with a software package to sell are truly insignificant. A market definition should “recognize competition where, in fact, competition exists”, and should include all significant competition even though that competition differs in form or nature. Transamerica’s systems market definition fails this fundamental test. By assuming that only manufacturers offering complete systems compete with IBM, Transamerica ignores the fact that IBM systems users had other reasonable alternatives; they could, replace parts of their IBM systems. In many ways, partial replacement was a more significant constraining force than total replacement. Customers found partial replacement attractive because it did not involve a scrapping of the user’s investment in programming and personnel skills, and it allowed users to reduce data processing costs without abandoning entirely the security of the IBM fold. Partial replacement of parts of IBM systems was a significant constraining force on IBM’s market power during the 1969-1973 time period. Billions of dollars worth of equipment was being replaced piecemeal by IBM systems users. A market definition that ignores this cannot be accepted. Some minicomputers (minis), small, relatively inexpensive computer systems should also have been included in Transamerica’s general purpose systems market definition. Transamerica included the smaller IBM systems, but excluded the thousands of minis that were directly competitive with those small IBM systems. That exclusion would have had more validity in the past. When they were first introduced minis were limited, or at least thought to be limited to special purpose applications. But things changed. By May, 1970, Computerworld, a widely read industry newspaper, recognized that the “. . . new minicomputers and microcomputers showed drastic changes in design that make them truly general purpose . . . . For the first time, they offer a reasonable alternative to ‘full-sized’ systems.” Advertisements by minicomputer manufacturers emphasized that theme, and apparently users got the message. In August of 1972, Computerworld reported: “They [minis] are being used as true general purpose computers, running a range of applications such as order entry, sales analysis, payables, receivables, general ledger, inventory control, payroll, price ticket printing and credit authorization . . During the relevant time period minis were being sold as reasonable alternatives to the smaller general purpose systems offered by IBM. When connected together, several minis were a reasonable alternative to the acquisition of larger systems. And minis, whether used as data collection devices, intelligent terminals, pre-processors, or stand-alone systems, could ease the workload of larger general purpose systems, thereby providing the user with a viable alternative to the acquisition of a more powerful system. The competition minis provided was significant, and their exclusion from the systems market definition was incorrect. IBM also faced other constraints not contemplated by Transamerica’s systems market definition. Service bureaus buy computing systems and make them available to others by renting out time on them or doing work on them for the benefit of end-users. Time-sharing companies make their computers available to many users who access them concurrently via remote terminals. In both cases, users may turn to such companies during peak periods, or for the specialized services they offer. Leasing companies are financial intermediaries; they buy computer systems, or parts of computer systems, from manufacturers and lease them to users. Service bureaus, time-sharing companies and leasing companies all provide significant competition for IBM. However, their exclusion from the market definition is analytically correct. These companies all buy computers from systems manufacturers, add some financial or technical services, then turn around and offer the computers to the end user. Their basic product is computing power. Their basic raw material is a computer system. Since they all must buy equipment from manufacturers, if one manufacturer has the power to control price at the time of the initial sale, it has the power to indirectly control the price at which the computer re-enters the market with the added services. Where it is possible that a defendant might indirectly control the price at which goods reenter the market, that alternative source of goods should be excluded from the market definition. But the nature and the volume of the business done by service bureaus, time-sharing companies, and leasing companies need not be totally ignored. Although exclusion from market definition is called for, the constraints these companies provide decrease the likelihood that defendant’s market share reflects monopoly power. This Court agrees with Transamerica’s contention that the concept of supply substitutability does not affect the systems market definition since there has been no evidence that any firms are in a position to readily shift their production facilities into the manufacture of general purpose systems, and also agrees that the United States constitutes the relevant geographic market. Transamerica has made no effort to measure IBM’s share of the market as this Court would define it, i. e., including minicomputer manufacturers, software suppliers, and PCMs as competitors. Nonetheless, the evidence of IBM’s market share, in the market as defined by Transamerica, will be examined for whatever light it might shed on the issue of IBM’s market power. The most common measurement of market shares is a comparison of the competitors’ annual sales. Here, Transamerica, however, has used what is called the “installed base” method. Included in each company’s installed base for any year are all computer systems ever leased or sold by that company which are still in use in that year. Those systems, no matter how old they are, are valued at their original purchase price or their current purchase price, whichever is higher. Transamerica insists that this method is appropriate because the general purpose computer systems market is predominantly a lease market. Any measurement that failed to recognize past activity, they argue, would ignore the substantial revenues IBM enjoys from machines leased and shipped in the past and ignore the substantial hold IBM has on those customers due to software lock-in. The computer industry is characterized by cyclical development or “generations” of computer equipment. These cycles can be expected to produce sharp fluctuations in one company’s share of annual shipments, and the tendency of the installed base method to smooth out these swings is another advantage claimed for it. Installed base is a method traditionally employed by the computer industry, including at one time IBM itself, and this too is a reason advanced for its adoption here. IBM counters that installed base reflects more history than current market power. IBM is right. IBM has been successful in the computer field almost since the industry’s inception. Thus, inclusion of all IBM machines still in use distorts their share. The successes of newer companies (such as the PCMs) are camouflaged by the large installed bases of more established manufacturers. The installed base method credits IBM with purchased machines from which it no longer enjoys any revenue, and even with machines that have come back into the market to compete against it. Machines sold in an earlier year to leasing companies, time-sharing companies, service bureaus, and used machines are all attributed to IBM’s market share in later years. Transamerica insists this is proper because IBM, as the original manufacturer, indirectly controls the prices at which such machines and services can be offered. While such reasoning supports an exclusion of this competition from market definition, it does not warrant an attribution of the value of their capital equipment to the manufacturer’s market share except in the year of the initial sale. The lease nature of the business is an insufficient reason for abandoning an annualized approach. By 1973, less than half of IBM’s general purpose systems were leased. And if software lock-in, or any other factor, persuades users not to switch vendors, then the future successes that installed base would predict will ultimately be reflected in annual shipment data. One of Transamerica’s industry market share experts, recognizing the infirmities of installed base, recently discontinued his use of that method. It is not necessary to discard all of Transamerica’s data because the installed base measurement method is unacceptable. Annual shipments can be approximated from the installed base figures in evidence by subtracting one year’s installed base from the following year’s. This will yield a figure for net shipments. Net shipments appear to be a more desirable indicator then gross shipments because many computers are shipped to users who return their older machines to the manufacturer. Cyclical fluctuations can be accounted for by averaging the share figures for several years. In some of its data Transamerica has included the value of equipment placed by the PCMs as part of IBM’s share. This is clearly incorrect, and Transamerica has offered no convincing rationale for it. It would be possible to rehabilitate this data by extracting from IBM’s share the value of disks and tapes supplied by PCMs. However, the value of PCM supplied printers, electronic memories, and other gear cannot be separated out, providing still another reason for viewing the resulting figures cautiously. IBM’s share of net shipments (less all PCM products) has been calculated to be: 65.4 percent; 67.9 percent; 51.4 percent; 56.4 percent; 56.5 percent; 30.6 percent; and 64.4 percent, for the years 1969 through 1975 respectively. Over the entire seven-year period IBM shipped 57.4 percent of all general purpose systems (net). The next largest share was shipped by the PCMs as a group with 14 percent over the seven years. Burroughs was the second largest manufacturer of systems with 7.7 percent, followed by Univac with 4.9 percent, and Honeywell with 4.6 percent. Even in a properly defined market these market share statistics would not be overwhelming. Other ' courts have doubted whether sixty percent of a market would be enough. But while a finding of monopoly power is not foreclosed by IBM’s share if the setting is conducive to the exercise of such power and if other indicators confirm its presence, such a finding is certainly not compelled by these market shares. The distribution of the remainder of the market serves to enhance IBM’s power. No single manufacturer approaches the success IBM enjoys. However, their shares are growing while IBM’s is shrinking. IBM’s share tends generally downward, indicating that monopoly power is not present, or, if present, that the monopolist’s grip is weakening. Consistent supra-normal profits may be attributable to an ability to control price. Here IBM’s profits have been very substantial. Its after-tax return on equity during the 1964 to 1973 period was consistently 30 to 70 percent above the Fortune 500 median, while its after-tax return on sales doubled and sometimes tripled the industrial giants’ median. But the inference that a defendant that enjoys healthy profits only does so because of an unhealthy market structure is not a strong one. Good management, superior efficiency and differences in accounting provide explanations that are just as plausible, and none of those explanations is inconsistent with an effectively competitive market. One thing excessive profits can be expected to result in is increased entry by firms hungry to participate in the rich rewards. Transamerica says that this has not occurred because the entry barriers faced by potential entrants are insurmountable. It is true that enormous barriers are faced by firms wishing to enter this market as suppliers of complete computer systems. Between $500 million and $1 billion in capital would be required; a national network of sales and maintenance offices staffed with highly skilled personnel is imperative; the entrant would have to fund research and development projects; a broad product line must be offered; and customer loyalty due to software lock-in would have to be overcome. Because such a large commitment would be involved for entry as a systems supplier, it is not surprising to find that there has been no new entry on that basis since the early 1960’s. The flaw in Transamerica’s entry barrier analysis is a consequence of its market definition error. Competition and entry in this market does not occur on only a full-system basis. Entry could, and did occur where companies recognized profitable opportunities in less inclusive offerings. Storage Technology Corporation, one of the most successful PCMs, was started by a bright engineer with $225,000 in equity capital, and experienced phenomenal growth. It was not alone. In 1970, International Data Corporation, (IDC) a company specializing in statistical studies of the computer industry, reported: “Just 15 years ago, the number of companies in the infant industry could be counted on the fingers of one hand; today well over 4,000 companies produce computers, related equipment and supplies, or offer data processing and programming services.” IDC thought there had been “an explosive proliferation of options for the computer user.” In 1971, Transamerica, in a presentation to its parent Board of Directors, agreed, saying: “The frequency of entry into the data processing industry is quite high compared with any other industry, and there are usually at any one time, more competitors than anyone would really like to have.” The new entrants were growing. From 1967 to 1975 the value of PCM equipment attached to IBM systems increased from $15.8 million to $2.6 billion. In the same period, leasing companies jumped from holding 8.3 percent of the IBM CPUs to 26.7 percent. And the market as a whole was growing; most of IBM’s full-systems competitors participated in that growth. Digital Equipment Corporation, (DEC) for example, was founded in 1957 with DEC initial capitalization of $70,000. By 1977 it had computer related revenues of $1.1 billion. One commentator has referred to IBM’s systems competitors as the “billion dollar dwarfs.” This is not the story of a stagnant, dominated industry. There is no doubt that the pace of technological progress in the computer industry is extraordinary. Commentators are fond of saying that had the auto industry kept the same pace over the last 30 years, a Rolls-Royce would cost $2.50 today and would have an EPA gas rating of 2,000,000 miles per gallon. There is some evidence that IBM sought to maximize profits by choosing a price for its products from a range of alternative prices. But that is not necessarily inconsistent with an effectively competitive market. The range of price options available to IBM was never so broad that it could set a price without regard to competitors' prices. And, in most cases, the range was only theoretical, because competitive pressures, not IBM preference, dictated which price had to be adopted. This market was not monopolized. IBM did not control prices, it reacted to the prices set by others. IBM’s market share (if the market had been properly defined) was below 57 percent and falling. Entry was easy for anyone with a good idea and the courage to exploit it, and new entrants, along with the old, grew and prospered. This Court finds that Transamerica has failed to prove that IBM had monopoly power in the general purpose systems market. Nonetheless, Transamerica’s other contentions will be considered on the assumption that IBM did have such monopoly power. D. Tape and Disk Markets The hardware of a computing system was previously described as consisting of a CPU and peripherals. Further refinement of that over-simplification is necessary for an understanding of the peripherals markets alleged to be relevant. Certain control functions must be performed if peripheral gear is to function properly. The access arm of a disk drive, for example, must be positioned over the proper track before data can be read from, or written onto that track. These control functions can be performed by the arithmetic and logical circuits of the CPU, in which case the control function is said to be “integrated” into the CPU. But when the CPU is tied up with control functions, it is not free to perform more sophisticated tasks, and so an alternative design was incorporated into the architecture of System/360. Most of the peripherals attachable to System/360 CPUs were not integrated. The control functions were performed by two independent “boxes” or machines with arithmetic and logical circuits: channels and control units. A limited number of channels could be attached to most System/360 CPUs. Channels funnel data into the CPUs’ main electronic memory, and take from the memory data that is to be written onto any of the peripheral devices that may attach to the channel, and send it to its destination. Channels perform control functions common to a variety of peripheral gear. It is possible to attach a number of control units to each channel on the system, and the peripheral devices attach to the control unit. Control units perform the control functions that are required by the specific type of peripheral that attaches to it. Thus, one type of tape drive, expecting specific control functions to be performed, only attaches to a specific type of control unit. Other types of tape drives require a different control unit, and the same is true of disks. But various types of control units can be attached to the same channel. PCMs typically supplied a combined package of disks and disk control units attachable to, or “plug-compatible” with, IBM channels. This meant that the user could remove the IBM control unit and disk combination (known as a “subsystem”), plug in the PCMs’ replacements and the computing system would continue to function with very little inconvenience. That was so because the PCMs had duplicated the “interface” between the IBM channel and the IBM disk control units. An interface has both physical aspects (in terms of the number of wires' involved and their arrangement in a connector), and protocol aspects (what a given pulse sequence on a particular wire is understood to indicate by the machine receiving the pulse). Unlike PCM disk suppliers who provide subsystems, PCM tape suppliers concentrated initially on tape drives and generally did not sell tape control units. Thus, the interface that they duplicated was the interface between IBM tapes and IBM control units. Although many computer manufacturers designed their systems with this CPU-channel-control unit-peripheral hierarchy of control functions, no other systems were designed so that the interface between the channel and control unit (disks) or the interface between the control unit and peripheral device (tapes) was precisely the same as the corresponding IBM interface. Thus, tape drives and disk drive-control unit combinations developed for use on IBM’s System/360 could not, without some interface modifications, be plugged into another computer manufacturer’s system, and vice versa. The two peripherals markets alleged by Transamerica consist of tape drives and tape control units, and disk drives and disk control units that can be plugged into IBM CPUs without any modifications, i. e., that are plug-compatible. These peripherals markets will be examined together. Both markets, if they can be so described, became economically significant in the late 1960’s, when PCMs began duplicating the peripherals that would attach to IBM’s computers. Prior to that time some of the PCMs supplied peripherals to IBM’s general purpose systems competitors, who then incorporated them into the systems they offered. When the systems competitors took to manufacturing their own peripherals, the PCMs turned their attention to marketing peripheral replacements to IBM users. Having already accepted a definition of a systems market that encompasses all the economic activity on the peripherals front, perhaps “submarket” would be the proper term to apply here. In any event, the Brown Shoe submarket indicia can provide valuable clues as to whether plug-compatible tapes and control units and plug-compatible disks and control units are sufficiently distinct that they could be monopolized. Industry recognition of the peripherals markets as separate economic entities could hardly be more evident. IBM studied the “tape market” and “disk market” separately and referred to them repeatedly by those or similar appellations. Others in the industry, including witnesses called by both sides, referred to and treated the tape and disk markets as separate economic entities. The peculiar uses and characteristics of the products involved have already been spoken of. Because the interfaces between IBM CPUs and control units and between IBM control units and peripherals were unique, the tapes or disks described as plug-compatible to IBM CPUs could only be used with those CPUs. Users with systems provided by other manufacturers could not use them at all, and IBM users could use nothing else. Thus, customers for plug-compatible tapes and disks were readily identifiable and distinct. The production facilities for tapes were different from the production facilities for disks, and both were different from the production facilities for other components of the system. IBM’s main disk facilities were in California; its main tape facilities in Colorado; and its CPUs were manufactured elsewhere. However, the production facilities of independents and systems manufacturers producing non-IBM-plug-compatible tapes and disks were probably not so different from the facilities for the corresponding plug-compatible peripherals. This is so because the tapes and disks were similar in almost all respects save for the unique interface electronics. Prices were distinct. In setting its prices IBM was less influenced by the prices of non-plug-compatible tapes and disks than by the PCMs’ prices. Users were price sensitive. Lower prices for equivalent or superior performance was the PCMs’ selling point. With it they managed to attract millions of dollars worth of business away from IBM. Finally, the PCMs were specialized. Peripherals were their major activity. Many supplied only plug-compatible tapes or only plug-compatible disks. Those that supplied both, made the combination only after experiencing an initial success with the one device or the other. The Brown Shoe sub-market criteria indicate that the peripherals markets are capable of being dominated, and the markets should be examined further. IBM attacks these markets as narrow for three reasons: (1) they ignore the interchangeability between tapes and disks; (2) they fail to include as potential suppliers either the systems manufacturers who make their own peripherals, or the independents who manufacture peripherals for them; and (3) they fail to account for the constraint of systems competition on peripheral price discretion. IBM's first argument, that tapes and disks are interchangeable, is without merit. In configuring a system, users have several alternatives. Various types of media are available to store and access data. Principal among these are tapes, disks and electronic memory. In that order, data is accessed by the CPU with increasing rapidity, but also with increasing cost. Electronic memory is so expensive that it is only used as a temporary storage area for data. Data is read into the electronic memory (from a tape or disk perhaps) where the CPU can readily access and work with it, then written from electronic memory onto another medium for more permanent storage. Electronic memory is not really a peripheral, rather more a part of the CPU itself, and is not a reasonable alternative to either tape or disk. For some applications a disk must be used. Where the CPU must access data frequently, but not necessarily in a serial fashion, a disk is indispensable; tapes are not an alternative regardless of the price differential. Applications where many users access a central computer through remote terminals (such as an airline reservations system) are only feasible if the data for them is kept on disk (or other direct access device). This is so because every data record on a disk pack can be reached within a fraction of a second by a lightning-quick access arm. To reach a particular record on a tape, the tape reel must be spun until the proper spot is reached. It might take as long as one minute to reach a particular data record, ages by comparison with disk speeds. However, if the records on a tape reel are sorted so that the CPU can access them seriatim, then the time required to access records in a tápe file is quite acceptable. So, tapes are typically used only for data which can be accessed serially, and only disks are used when data must be accessed randomly. Still, there is some overlap. For some serial data files either a tape or disk can be used. Because the cost of storing data on disks is much greater than the cost of tape storage, only with relatively short files would the user consider tape and disk to be alternatives. Most system users employ both disks and tapes. Indications are that the incidence of actual substitution between tape and disk is not high. Neither IBM nor the PCMs considered tape prices when pricing disks or vice versa. IBM’s Financial Procedures Manual calls for calculation of the impact on existing products’ profits caused by introduction of a new product. If tapes and disks were reasonable alternatives, one would expect that a new tape would impact the profitability of old disk products and that new disk devices would impact the profits of existing tape products. Yet only rarely were such impact calculations made. The manual also calls for competing products to be identified. Tapes were not so identified when disks were introduced, nor were disks, when tapes were introduced. The head of IBM’s Computer Division testified that slight variations in the price of disks would not affect the demand for tapes; that variations of 40, 50 or 100 percent in price would be required. That is not the high degree of price cross-elasticity that is required if two products are to be considered reasonable substitutes and placed in the same market. IBM’s second argument for a broader market definition, supply substitutability, calls for the inclusion of firms with a high cross-elasticity of production. This contention would require a finding that producers are capable of quickly and easily entering the market to produce alternatives. That finding cannot be made. Producers of non-plug-compatible peripherals would have to change the interfaces in their devices to cope with IBM’s CPUs. Interface changes would cost hundreds of thousands, if not millions of dollars, and might require a year to carry out. Under these circumstances it would be improper to include this potential competition in the peripherals market definition. IBM’s third attack, emphasizing the influence of systems competition, has merit. The cost of peripherals accounts for 50 to 70 percent of the total cost of a typically configured general purpose computer system. Efforts made at controlling price in the peripherals submarkets would be felt by systems market competitors because control of peripheral prices translates indirectly into control of systems prices. If the systems market were effectively competitive, one would expect that the pressures exerted by that competition would be sufficient to defeat attempts to wield monopoly power in a peripheral submarket. Thus, the existence of monopoly power in a peripherals market must be predicated upon a finding of monopoly power in the systems market. Transamerica’s expert economist agreed. He testified that by definition IBM could not have monopoly power in the peripherals market if it did not have monopoly power in the systems market. This Court’s conclusion that IBM lacked systems market monopoly power is thus fatal to Transamerica’s peripheral markets claims. Nonetheless, this inquiry will proceed under the assumption that IBM had a systems monopoly. As with the systems market, Transamerica combined a narrow définition of the peripherals market with a distorting share measurement technique, the installed base. Installed base measurement makes even less sense here than it did in the systems market. For many years, IBM faced absolutely no competition for the tapes and disks that attached to its CPUs. As a re-suit, it built a tremendous installed base of those peripherals. Even if the PCMs had won every sale from 1968 onward, many years would have to pass before the installed base figures would show PCM competition was significant. And the software lock-in argument rings hollow here. By definition, every product in these markets is plug-compatible; none of the competitors enjoys any advantages traceable to software lock-in. Transamerica’s mistaken failure to recognize systems competition in its market definition invalidates its share measurement data. However, the net shipments of peripherals in the market, as Transamerica has defined it, can be calculated in the same manner as net shipments were calculated for the systems market. The installed base at the end of one year is subtracted from the installed base at the end of the following year to indicate net shipments over that year. Thus, the 1969 net shipment figures were calculated by subtracting the 1968 year end installed base from the 1969 year end installed base. Years prior to 1969 are ignored. Before that time PCM competition was insignificant and IBM’s net shipments were almost 100 percent of all net shipments of tapes and disks that hooked onto its CPUs. The following two tables show the total net shipments of peripherals (drives and control units) for the years 1969 through 1975 as derived from the installed base data. IBM’s share appears both in dollars and as a percentage of total. That portion not attributable to IBM was divided amongst the PCMs. Dollar figures are shown in terms of thousands of dollars of monthly rental value. TAPE MARKET 1969 1970 1971 1972 1973 1974 1975 1969-75 Totals 5760 737 519 -19 1443 4144 2569 15155 IBM 4547 105 -587 -470 544 2409 1618 8167 IBM% 78.9% 14.3% * * 37.7% 58.1% 63% 53.8% DISK MARKET 1969 1970 1971 1972 1973 1974 1975 1969-75 Total 7838 15594 627 5204 10376 21738 16772 78158 IBM 7248 13423 -3095 3809 7155 18409 13240 60237 IBM% 92.5% 86.1% * 73.1% 69% 84.7% 78.9% 77.1% * —Loss It would be difficult to conclude that a company possessed monopoly power in a market where its net shipments were negative at the very time it allegedly used or maintained that power. That is the case here. In 1971, IBM was losing ground to its PCM competitors. That was a relatively lean year for everyone, but more so for IBM than for its competitors. The PCMs were increasing ' their customer base at IBM’s expense. . Even the aggregate numbers are unconvincing. IBM’s mere 53.8 percent of the tape market suggests monopoly power is not present. The 77.1 percent figure in the disk market would support a monopoly finding, but the significance of this market share is diminished by the realization that IBM had 100 percent of the market only a few years before, and the failure of the market definition to account for systems competition means these numbers must be viewed circumspectly. These share figures are also inflated by Transamerica’s inclusion into the market of products which the PCMs never duplicated, and areas of the country where PCMs chose not to compete. Entry barriers around these markets are extraordinarily low. The market definition excluded potential suppliers (such as systems competitors and their independent peripherals sources) because they were incapable of quickly and easily supplying substitute products. But the hurdles those potential suppliers must clear are far lower than those new systems market entrants face. Firms already producing peripherals have the production facilities, the trained staffs, and the research and development expertise needed; all that remains for them is to study the IBM interface and duplicate it. Two of the most prominent systems competitors, Univac and CDC, have done just that. Both manufacture peripherals for their own computer systems, and also manufacture IBM plug-compatible peripherals that compete in the markets at issue here. And many PCMs market their wares to other systems manufacturers as well as to IBM end-users. While the cost, in time and money, of developing an interface is sufficient to exclude systems manufacturers and independents from the market definition, it does not provide a formidable entry barrier around the market as defined. The entry barriers faced by completely new entrants into the peripherals market have already been discussed in relation to the systems market. Those barriers are low, as is demonstrated by the history of entry into peripherals manufacture. PCMs, attracted by IBM’s high profits on its peripherals, stormed these markets and flooded them with cheaper copies of the IBM gear. IBM, unable to maintain its relatively high price, was forced to react with lower prices and improved products. This picture is consistent with the dynamics of an effectively competitive market, not a monopolized one. This Court will not be misled by the share figures propounded by Transamerica. Those calculations ignore the significant constraint .of systems competition, and measure the markets as an aggregation of all peripherals in use, when there is no reason for doing so. Accurate share figures cannot be determined from this record, but the data which can be rescued indicates that IBM did not have market control, and that its share was not dominant. Entry barriers are low, and entry has been easy, frequent, and successful. Even if a systems monopoly were not a prerequisite to peripheral market control, or even if IBM had a systems monopoly, this Court would find, as it does here, that Transamerica has failed to prove that IBM had monopoly power in either the tape or the disk market. IV. PRICING CONDUCT A defendant not in possession of monopoly power may nonetheless incur antitrust liability by attempting to monopolize. Transamerica alleged that IBM attempted to monopolize by its pricing conduct, by its design conduct, and by its long-term leases. IBM’s conduct will be examined first under the assumption that IBM did possess monopoly power. Following that, the conduct that would have violated the monopolization provision of Section 2 will be re-examined to determine whether, in light of the absence of monopoly power, an attempt to monopolize has been proved. IBM responded to the lower prices and increased successes of the PCMs by offering some of its own products at substantially reduced prices. Transamerica claims that those prices were predatory and violated the antitrust laws. The concept that prices can be used as a means of acquiring or maintaining monopoly power is not new; it has long been recognized that financially powerful firms might coerce or destroy their rivals by pricing at unremunerative levels. Attempts to distinguish between predatory pricing and legal price behavior, by comparing defendant’s costs with its prices, are new.. In an article published in 1975, Professors Areeda and Turner suggested that pricing conduct should be conclusively presumed legal if price levels exceeded either defendant’s average variable cost or defendant’s short-run marginal cost. Reaction to the Areeda and Turner proposal has been mixed. Courts have embraced it; academicians have criticized and rejected it. An understanding of the relationship between these cost measures is critical to an appreciation of the effect that imposition of the Areeda and Turner rule would have. All three kinds of cost (average cost, average variable cost, and marginal cost) will at first decline, then later increase as a firm’s output is expanded. Average cost (which includes both fixed and variable costs) will always be greater than average variable cost (which only includes variable costs). At low output levels, marginal cost will be less than both of the other cost measures. As output is increased, marginal cost will rise until at some point it will be greater than average variable cost (but less than average cost). If output is increased still further, marginal cost will increase to the point that it exceeds both average cost and average variable cost. A monopolist has the power to control market price by varying the quantity of goods it offers for sale. As that quantity is varied, the monopolists’ marginal, average variable, and average cost will also vary. If market demand would permit it, the monopolist would have the following options: 1) setting a market price in excess of both average cost and marginal cost; 2) setting a market price below average cost but greater than marginal cost; or 3) setting a market price below both average cost and marginal cost. Areeda and Turner would conclusively presume the monopolist’s conduct legal if it exercised option 1) or option 2), and would conclusively presume conduct illegal only if option 3) was chosen. IBM argues that the Areeda and Turner rule is the law of the Ninth Circuit and is binding upon this Court. Transamerica maintains that prior cases are distinguishable, and that a monopolists’ pricing is illegal if it sets a market price below the point at which it would maximize profits if the purpose and effects of that action are to unnecessarily exclude competition. Neither standard is appropriate in this case. If a monopolist, in response to actual or threatened entry into a previously controlled market, reduces prices below its full cost, there are strong implications of conduct that unreasonably restricts competition. Therefore, and for reasons hereinafter stated, the IBM conduct will be judged against a “full cost” standard. A. Predatory Pricing Case Law. In 1976, the Ninth Circuit Court of Appeals, in Hanson v. Shell Oil Co. (“Hanson ”), held that a plaintiff’s failure to show that a defendant’s prices were below its marginal or average variable costs was a failure a