Digital Equipment Corporation; Analysis to Aid Public Comment

FEDERAL TRADE COMMISSION

[File No. 981-0040]

Digital Equipment Corporation; Analysis to Aid Public Comment

AGENCY: Federal Trade Commission.

ACTION: Proposed Consent Agreement.

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SUMMARY: The consent agreement in this matter settles alleged

violations of federal law prohibiting unfair or deceptive acts or

practices of unfair methods of competition. The attached Analysis to

Aid Public Comment describes both the allegations in the draft

complaint that accompanies the consent agreement and the terms of the

consent order--embodied in the consent agreement--that would settle

these allegations.

DATES: Comments must be received on or before July 6, 1998.

ADDRESSES: Comments should be directed to: FTC/Office of the Secretary,

Room 159, 6th St. and Pa. Ave., N.W., Washington, D.C. 20580.

FOR FURTHER INFORMATION CONTACT: William Baer or Willard Tom, FTC/H-

374, Washington, D.C. 20580 (202) 326-2932 or 326-2786.

SUPPLEMENTARY INFORMATION: Pursuant to Section 6(f) of the Federal

Trade Commission Act, 38 Stat. 721, 15 U.S.C. 46 and Section 2.34 of

the Commission's Rules of Practice (16 CFR 2.34), notice is hereby

given that the above-captioned consent agreement containing a consent

order to cease and desist, having been filed with and accepted, subject

to final approval, by the Commission, has been placed on the public

record for a period of sixty (60) days. The following Analysis to Aid

Public Comment describes the terms of the consent agreement, and the

allegations in the complaint. An electronic copy of the full text of

the consent agreement package can be obtained from the FTC Home Page

(for April 23, 1998), on the World Wide Web, at ``http://www.ftc.gov/

os/actions97.htm.'' A paper copy can be obtained from the FTC Public

Reference Room, Room H-130, Sixth Street and Pennsylvania Avenue, N.W.,

Washington, D.C. 20580, either in person or by calling (202) 326-3627.

Public comment is invited. Such comments or views will be considered by

the Commission and will be available for inspection and copying at its

principal office in accordance with Section 4.9(b)(6)(ii) of the

Commission's Rules of Practice (16 CFR 4.9(b)(6)(ii)).

Analysis To Aid Public Comment

I. Introduction

The Federal Trade Commission (``Commission'') has accepted from

Digital Equipment Corporation (``Digital'') an Agreement Containing

Consent Order (``Proposed Consent Order''). The Proposed Consent Order

is designed to remedy anticompetitive effects likely to occur in three

product markets as a result of the acquisition by Intel Corporation

(``Intel'') of certain assets of Digital. The Order requires that

Digital License its Alpha microprocessor technology to two Commission-

approved companies to ensure that there are independent suppliers and

developers of Alpha. The Order ensures that Intel will not have

exclusive control over the technology, and that Alpha will remain

competitive.

II. Description of the Parties and the Transaction

Digital is a Massachusetts corporation headquartered in Maryland,

Massachusetts, with sales of approximately $13 billion and net income

of over $140 million for the fiscal year ended June 28, 1997. Digital

manufactures and sells computer systems, and develops, manufactures,

and sells microprocessors based on its proprietary 64-bit \1\ Alpha

architecture.

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\1\ The number of bits generally correlates with the amount of

data that a microprocessor can process during one clock cycle.

Intel's current Pentium microprocessors have a 32-bit architecture

(known as IA-32), while Digital's alpha chip has a 64-bit

architecture.

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The Alpha microprocessor is widely regarded as among the highest

performing general purpose microprocessors available and is the only

non-Intel microprocessor architecture that can run the Windows NT

operating system in ``native'' mode.\2\ Digital is the largest consumer

of Alpha chips, which it uses in its computer systems.

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\2\ Windows and Windows NT are operating systems. Operating

systems are a type of software that acts as an intermediary between

applications software and the microprocessor. An operating system

runs in ``native'' mode when it is specifically written to interact

optimally with the particular microprocessor architecture.

Microsoft, the developer of Windows NT, today supports only two

microprocessor architectures--Intel's and Digital's--to run Windows

NT in native mode. Other microprocessor architectures today must use

translation software in order to run Windows NT, significantly

reducing performance and speed.

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Intel Corporation (``Intel''), a Delaware corporation

headquartered in Santa Clara, California, is the world's leading

semiconductor manufacturer. Intel reported 1996 sales of approximately

$20.8 billion and net income of more than $5 billion. Intel supplies a

broad

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line of semiconductor devices used as computer system components,

including x86-compatible microprocessors \3\ such as the Pentium line,

which are used primarily in conjunction with Microsoft's Windows and

Windows NT operating systems. Intel has been working with other

companies to develop a 64-bit microprocessor (currently known by the

project name Merced) with a new 64-hit architecture (known as IA-64),

which is intended to extend Intel's current x86 architecture and

compete with Digital's Alpha architecture.

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\3\``X-86 architecture'' generally refers to the original line

of Intel microprocessor products for personal computers and includes

successive generations such as the 8096, 286, 386, 486 and the

Pentium family of chips.

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The proposed transaction resolves three pending lawsuits between

Digital and Intel relating to microprocessor intellectual property and

technology rights. Digital initiated that litigation in May 1997,

claiming the Intel infringed ten Digital patents by making and selling

Intel Pentium chips. Intel countersued, claiming, among other things,

that Digital is infringing nine Intel patents by making and selling

Alpha microprocessors.

On October 26, 1997, the parties agreed to settle the litigation

and grant each other broad patent cross-licenses. Intel would also buy

Digital's microprocessor production facilities (such a facility is

known in industry parlance as a ``fab'') for net book value

(approximately $650 million). In addition, Intel agreed to produce

Alpha microprocessors for supply exclusively to Digital. Digital agreed

to endorse publicly these IA-64 architecture and design some Digital

computer systems based on Intel 64-bit microprocessors. Digital will

retain the intellectual property rights and design assets for Alpha,

including the design engineers who conduct research and development for

the Alpha architecture.

III. Competitive Concerns

A. Relevant Markets

The draft Complaint alleges three relevant markets: (1) The

manufacture and sale of high-performance, general-purpose

microprocessors that are capable of running the Windows NT operating

system in native mode; (2) the manufacture and sale of all general-

purpose microprocessors and (3) the design and development of future

generations of high performance, general-purpose microprocessors.

The Complaint alleges that microprocessors designed to run the

Windows NT Operating system and its complementary application programs

constitute a relevant antitrust product market. The demand for

microprocessors is determined indirectly by the demand for operating

systems, which is determined in part by the software applications that

run on those systems. Applications are designed for specific operating

systems; operating systems can optimally run application programs only

when the operating system is written for the microprocessor

architecture (so that the microprocessor runs native on that operating

(system). Consumers cannot readily switch between computer systems that

use different microprocessor architectures, because in most cases such

a switch also requires changing the operating system and application

programs, an expensive proposition and one that may not yield the same

level of functionality enjoyed by consumers on their former systems.

Windows NT is currently written in two versions, so that only the

Alpha microprocessor and the Intel-based microprocessors can run it in

native mode.\4\ Windows NT will also be compatible with Merced, Intel's

64-bit chip, which will not be commercially available until 1999. Thus,

consumers using software optimized for use with Windows NT must choose

between Intel-based and Alpha-based systems. Thus, if the price of

Alpha and high-end Intel microprocessors were to increase by 5 percent,

consumers using Windows NT would not readily switch to computer systems

built with alternative microprocessors.

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\4\ See fn. 2.

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The Complaint also alleges that a second relevant product market

includes all general-purpose microprocessors, a category that includes

devices based on the Intel and Alpha architectures, as well as

microprocessors based on other rival architectures such as those

developed by Hewlett-Packard (PA-RISC), Sun Microsystems (SPARC), IBM

(PowerPC), and Silicon Graphics (MIPS). Because only Alpha and Intel

microprocessors can optimally run Windows NT, however, these two

microprocessors are the closest substitutes in this broader,

differentiated product market.

Finally, the Complaint alleges that the transaction will reduce

competition in the innovation market for the design of microprocessors.

Intel and Digital are two of a very few competitors developing next-

generation, high-performance microprocessors. Computer makers choose

microprocessors based, in part, on the ``roadmap'' provided by each

microprocessor manufacturer--that is, the manufacturer's projection of

future expected increases in performance and functionality for

successive generations of microprocessors based on the same

architecture. Roadmaps therefore provide an essential element of

microprocessor competition. Intel and Digital compete for sales to

computer manufacturers, based on their roadmaps, and they use each

other's roadmaps as benchmarks for developing next-generation products

to leapfrog the performance of the rival company's chips.

B. Barriers to Entry

The Complaint alleges there are significant barriers to entry in

the market, including incurring large sunk costs to build a fab and

design a microprocessor, overcoming the network externalities and

Intel's installed base, obtaining Microsoft support to obtain Windows

NT-compatibility, building a reputation as a reliable microprocessor

manufacturer and innovator.

Building a new microprocessor facility requires the expenditure of

substantial fixed and sunk costs and takes many years. A new entrant

must also design the microprocessor, an expensive and lengthy process.

Most important, a successful entrant would need to convince

computer system manufacturers to design their systems around the new

microprocessor. Entrants, however, face a significant ``Catch-22'' in

this endeavor because of ``network externalities.'' Externalities exist

where consumers place more value on a particular technology

(microprocessor, operating system, peripherals, applications, etc.)

that is more widely adopted than other technologies. Software

developers and computer system manufacturers are unwilling to support a

new microprocessor technology unless they first see that it enjoys

consumer interest. Because of these network externalities and

reputational effects, however, consumers are unwilling to switch to a

new microprocessor technology unless they first see that it has

compatible operating systems, software, and peripherals. In this

environment, consumer and industry expectations about the degree to

which a manufacturer will be able to get network externalities and

reputational effects working for it in the near future are critical.

The importance of these expectations is illustrated by Intel's

recent marketing efforts on behalf of the Merced, its new 64-bit

microprocessor. Even though

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Merced has yet to be tested and will not be available for more than a

year, Intel has already successfully obtained commitments from a large

share of the software vendors and computer system manufacturers to

write software and build computers for it.

C. Competitive Effects

Intel has market power in both relevant microprocessor product

markets. Intel accounts for nearly 90 percent of dollar sales and

nearly 85 percent of unit sales of microprocessors for Windows NT and

for nearly 90 percent of dollar sales and 80 percent of unit sales of

general-purpose microprocessors. No firm other than Intel accounts for

more than 4 percent of dollar sales of microprocessors or for more than

10 percent of unit sales of microprocessors. Finally, the competitive

significance of other high-performance microprocessors--such as

Hewlett-Packard's PA-RISC, Sun Microsystems' SPARC, PowerPC from the

Motorola/IBM/Apple venture, and Silicon Graphics' MIPS

microprocessors--has been declining.

The transaction also threatens to increase concentration

significantly in the relevant innovation market. Digital and Intel are

two of the most significant innovation competitors in the design and

development of high-performance microprocessors. Even with its

comparatively small share of the relevant markets, the Alpha

architecture (because of Alpha's superior processing performance)

represents the most significant threat to Intel's continued market

dominance. Intel's documents refer repeatedly to the competitive threat

posed by Alpha, which is acknowledged by many as possibly the best

performing and fastest microprocessor in the world. Innovation and

actual competition between the two companies is likely to increase in

the future because of the growing popularity of Microsoft's Windows NT

operating system, which currently supports only Digital's Alpha and

Intel's advanced microprocessors. As the demand for and functionality

of Windows NT grow, the competition between the Alpha and Intel

architecture is likely to intensify.

On these facts, it is clear that an acquisition of Digital by Intel

would substantially lessen competition. Although the transaction at

issue here does not involve an outright acquisition of Alpha

technology, it nevertheless threatens competition in the relevant

markets. Under the terms of the settlement, Intel will acquire

Digital's Alpha fabrication plant (known as Fab 6) and will produce

Alpha chips for Digital. Digital will retain its Alpha intellectual

property and design team and is, therefore, only receiving ``foundry''

services (that is, a supply agreement where one company manufactures

the product for another) from Intel. The parties will also end the

patent litigation and sign a patent cross-license agreement.

The proposed transaction has positive implications for the future

of Digital's Alpha systems. The supply agreement frees Digital from

operating a plant that it was not able to utilize efficiently. Because

Intel manufactures a vast line of semiconductor products, it can

utilize the plant more efficiently than Digital. As a result, overall

manufacturing costs will go down and, under the Digital-Intel

agreement, those cost reductions will be passed on to Digital. Under

the agreement, Digital will also be able to bring the next generation

of Alphas--based on an improved .18 micron process technology--to

market earlier than it would have absent the transaction.

Digital's move to this ``fabless'' business model of operation is

not unprecedented. Other successful companies--like Sun Microsystems,

Inc. and Silicon Graphics--have designed high performance

microprocessors while relying on third-party foundries for

manufacturing. None of the other fabless microprocessor companies,

however, placed manufacturing in the hands of such a dominant

competitor.

Because of this unique characteristic, the proposed transaction

creates the opportunity for Intel to slow down or otherwise impair the

supply of Alpha microprocessors, harming competition in the relevant

markets. In particular, the transaction presents a risk that Intel will

not provide the necessary level of coordination between the design and

manufacturing processes, and that Intel may take other steps to reduce

quality and slow the supply of Alpha microprocessors to Digital. Every

foundry arrangement requires design engineers and manufacturing process

engineers to coordinate their efforts. The development of a

microprocessor involves conforming that design to the process

technology and vice-versa. The Digital-Intel settlement separates these

functions and provides no incentive for Intel to ``tweak'' its own

processes to conform to Digital's products.

Furthermore, the transaction as proposed threatens the continued

viability of Digital's sales of Alpha to the ``merchant market.'' \5\

As part of this transaction, Digital is selling off most of its

semiconductor business to Intel and thus will have no economic need for

a marketing staff, which includes people who market Alpha to other

computer system manufacturers. Without a marketing staff to service and

pursue the merchant market, the loss of competition would be

significant.\6\ Computer system manufacturers using Alpha

microprocessors have pioneered the opening of new market segment for

Alpha-based systems, such as media graphics. With the expected growth

of Windows NT, Alpha and Intel should go head-to-head in competition in

these market segments for these systems. The uncertainty created by the

proposed transaction, had it not been addressed by the proposed

consent, could have reduced competition between Intel and Alpha

processors, resulting in higher prices, reduced consumer choice, and

lower rates of innovation.

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\5\ Merchant market means sales of separate microprocessor chips

to computer system manufacturers, who then use them as a component

in their own computer systems.

\6\ As explained more fully below, as part of this consent

agreement, Digital will be licensing Alpha to Samsung, a company

that plans to sell the Alpha chip in the merchant market through a

U.S. subsidiary.

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The Complaint concludes that, unless remedied, the transaction is

likely to create uncertainty regarding the future competitive viability

of Alpha, thereby maintaining and enhancing Intel's market power, which

could result in increased prices and reduced quality and innovation in

each of the relevant markets for the following reasons: (1) By making

it less likely that Digital would maintain the sales force to continue

``merchant market'' sales of Alpha microprocessors and other products

to other computer system manufacturers, it would reduce competition

between Intel and Digital for such sales; and (2) putting Digital's

supply of Alpha solely in the hands of Intel would give Intel the

opportunity to delay production of Alpha microprocessors, impede the

development of new generations of Alpha microprocessors, and otherwise

undermine the competitiveness of Alpha. In these ways, according to the

Complaint, the consummation of the proposed transaction, without any

changes, would violate Section 5 of the Federal Trade Commission Act,

as amended, 15 U.S.C. 45, and Section 7 of the Clayton Act, as amended,

15 U.S.C. 18.

IV. The Proposed Consent Order

The Commission has entered into an agreement containing a Proposed

Consent Order with Digital in settlement of the draft Complaint. The

Proposed Consent Order is designed to preserve Alpha's future viability

by ensuring alternative sources for production,

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marketing, and development of Alpha products. The Proposed Consent

Order requires Digital to enter into or to continue certain licensing

arrangements and alliances with Advanced Micro Devices, Inc. (``AMD''),

Samsung Electronics Co., Ltd. (``Samsung''), or some other Commission-

approved licensee, and to be begin the process of certifying

International Business Machines, Inc. (``IBM''), or some other

Commission-approved company, to become an Alpha foundry. The purpose of

these provisions is to establish two licensees and another foundry as

providers and developers of Alpha devices, independent of Intel.

The Proposed Consent Order binds Digital to comply with the terms

of agreements it already has entered into with Samsung. Under those

agreements, Samsung will obtain an architectural license and technical

support. Furthermore, Digital will grant to Samsung a non-exclusive

AlphaPowered trademark license and the assistance and support necessary

to enable Samsung to enter rapidly and expand the merchant market

segment for Alpha products.\7\ Under the current version of the

Samsung-Digital agreement, Samsung will be creating a U.S. subsidiary,

to be known as the Alpha Volume Company, that plans to market Alpha

chips to the merchant market segment. Furthermore, Digital has

committed to purchase substantial volumes of its Alpha products needs

at a competitive price from Samsung, thus reducing its reliance on

Intel.

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\7\ The Proposed Consent Order also includes provisions for an

``Interim Trustee'' (i.e., an auditor) and a licensing trustee. The

Interim Trustee provision assures early assessment and monitoring of

Digital's agreements with the licensees and continuing monitoring

and reporting to the Commission of how the provisions are working.

The licensing trustee provision is triggered if the parties to a

licensing agreement fail to agree within the requisite time.

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The Proposed Consent Order also requires Digital to enter into a

broad license with AMD, or a Commission-approved licensee, that

includes a license to the Alpha architecture and software tools that

enable AMD to develop microprocessors compatible with the Alpha

architecture. Digital must provide technical and engineering support

until AMD is capable of independently developing and producing products

based on the Alpha architecture, but in no event for more than two

years.

The licenses with AMD and Samsung (or two other Commission-approved

companies) are architectural licenses, meaning that the license is to

the Alpha architecture, as defined by convention in Digital's official

reference manual. Under such license, the licensee is free to create

its own implementations and derivative works--that is, to design

original chips around the architecture--with the one caveat that it

maintain backward compatibility with the existing Alpha

architecture.\8\ In this way, a licensee will have every incentive to

develop the merchant market aggressively because it will have the

ability to create Alpha-derivative innovations that can give it

profitable ``design wins''--that is, agreements with computer system

manufacturers by which the computer system manufacturers will design a

computer line around the licensee's chip. These architectural licenses

also provide assurance to customers who commit to the Alpha

architecture because the licenses provide independent sources of supply

and innovation for these microprocessors.

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\8\ An architectural integrity provision in the Order preserves

backward compatibility for existing applications written to exploit

the architecture, and to make designing easier for applications

developers that have not yet ported applications to Alpha. If

Digital fails to innovate and improve the performance of the Alpha

architecture, however, the Order allows AMD to modify the base

architecture without Digital approval.

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The Proposed Consent Order also requires Digital to enter into an

agreement, subject to Commission approval, with IBM or some other

Commission-approved company to evaluate that company as a potential

foundry for Alpha parts and to inform that foundry partner of the steps

necessary to become a qualified supplier of Alpha products. Submission

of that agreement is required within six months of Commission approval

of the Proposed Consent Order. Alternatively, the Proposed Consent

Order permits Digital to demonstrate why such an agreement is

unnecessary.

Samsung is a leading supplier of DRAM technology, is considered to

have excellent manufacturing quality, and will receive marketing

assistance from Digital. Samsung is already in the merchant market and

the Order should empower Sumsung to further its marketing efforts in

this important segment. AMD is the leading challenger to Intel for x86-

compatible microprocessors and already a major merchant market

supplier, with excellent design capabilities. Though AMD does not yet

produce Alpha chips, it should have every ability to do so. AMD is a

major supplier of microprocessors and should have significant

incentives to develop an Alpha-based business because it does not

otherwise have a 64-bit architecture capable of challenging the

upcoming Intel IA-64 architecture. IBM is an established high-

performance microprocessor foundry, likely to be capable of producing

Alpha products. All three of these companies, or other licensees, help

to ensure adequate and independent supplies of Alpha microprocessors.

V. Opportunity for Public Comment

The Proposed Consent Order has been placed on the public record for

sixty (60) days for receipt of comments by interested persons about

both the appropriateness of the relief provided herein as well as the

suitability of Samsung, AMD, and IBM as licensees who can ensure

alternative sources for the manufacture, marketing, and development of

Alpha products. Comments received during this period will become part

of the public record. After sixty days, the Commission will again

review the Proposed Consent Order and the comments received and will

decide whether it should withdraw from the Proposed Consent Order or

make it final.

By accepting the Proposed Consent Order subject to final approval,

the Commission anticipates that the competitive problems alleged in the

Complaint will be resolved. The purpose of this analysis is to invite

public comment on the Proposed Consent Order, including the proposed

licenses and alliances, to help the Commission determine whether to

make final the Proposed Consent Order contained in the agreement. This

analysis is not intended to constitute an official interpretation of

the Proposed Consent Order, nor is it intended to modify the terms of

the Proposed Consent Order in any way.

By direction of the Commission.

Donald S. Clark,

Secretary.

[FR Doc. 98-11798 Filed 5-1-98; 8:45 am]

BILLING CODE 6750-01-M