Computers Today, August, 1998 Computer Business

August 1998 COMPUTER BUSINESS

Leave Microsoft Alone, Please

In a rapidly changing technological landscape, the next threat to market-leader Microsoft may come from some technology brewing somewhere that can change the entire structure of the industry

By Atanu Mukherjee

Late May, the US Government sued Microsoft for anti-competitive practices and predatory pricing for tying Internet Explorer with it's Windows operating system (OS). This raises important policy considerations about the nature of competition and the dynamics of monopoly power in industries undergoing rapid and sustained technological change. It is unfortunate that the suit is motivated largely by competitors and politicians who enjoy Microsoft bashing, and not by market realities and economics.

Moving Up the Value Chain
It has long been known that some industries exhibit a characteristic called network externalities wherein the value of a product increases as more users start using it because new users raise the benefits to others. Telephone networks are a case in point. As the number of people owning telephone connections increase, more people can communicate; the value of the telephone network increases exponentially. Similarly, the VHS system for videotapes became the dominant system since when more people started using VHS, the availability of movies on VHS increased. This led to even more programming using VHS, leading to even greater user adoption. Ultimately, VHS displaced Sony's Betamax as the standard.

Similarly, Microsoft's Windows and related products have become the de facto standard because of their ability to increase the benefits to users as more users start using it. No wonder Microsoft has 90 percent of the desktop operating system marketshare. Such apparently monopolistic markeshares attract the wrath of the competitors and government antitrust attention. This usually results in calls for regulation due to the stifling of competition and innovation while promoting inefficient standards and monopolies.

This argument is plain wrong.

Is Windows Inefficient?
Let's take the inefficient standards line of argument. It sounds something like this: Apple's operating system is much more efficient, Netscape's browser is really cool and Microsoft killed Apple and is now killing Netscape. This has led to Windows being the de facto but inefficient standard. This is like the now defunct Betamax videotape argument. Economists have shown that there is no support for the claim that the Betamax standard was a more efficient standard than VHS. Similarly, it has been shown that there is no compelling evidence that Apple's OS is more efficient than Windows or for that matter that Wintel PCs are less efficient than Macs.

Further, if the Windows standard were indeed inefficient, in a rapidly changing technology industry, superior products from other companies would appear at a far lower price and take customers away from Windows. None of that is happening. On the contrary, tying Explorer with Windows further simplifies user interaction with the PC and the Internet at a price-point which clearly benefits the consumer.

The second compelling argument against Microsoft is that as a monopoly it exercises excessive market power. It is true the nature of some software businesses is such that the company, which controls the standards, can have natural inclination for monopoly power. Monopoly power in the traditional sense should lead to monopoly price increases on its OS and Internet Explorer. However, leveraging its power hardly describes Microsoft's actions. The browser is free and the price point of its OS has been stable for a long time. Some pathbreaking work done at the University of Chicago and at the Massachusetts Institute of Technology explain this apparent anomaly and shed light on why the traditional theory of monopolies does not apply to some high-technology industries with network externalities.

Traditionally, it was argued that lack of competition leads to monopolies, which exercise excessive market power, resulting in increased prices for the consumer. This is still largely true in what we call "processing" industries: industries like steel, oil, cars, etc., which have much lesser rates of technical change and are largely dependent upon physical resources. However, in an industry with rapid technical change, like the software industry, the likelihood of entrepreneurs developing revolutionary technology to leapfrog the dominant players is very high. This almost happened to Microsoft in 1994 when it initially refrained from adopting Internet technology. For instance, if Netscape's browser became the standard for user interface, then the control of the applications would be dictated by the browser and not the operating system. The operating system still matters but now the market control gradually shifts to Netscape. Microsoft realised this and consequently made the browser and the Internet as a cornerstone of its future strategy.

In a rapidly changing technological landscape, the next threat to Microsoft may come from some technology brewing somewhere that can change the entire structure of the industry. What matters then is not competition itself, but the threat of competition which forces seeming monopolies like Microsoft to continuously innovate and reduce prices. This is the antithesis of monopolies. Here is a so-called monopoly with 90 percent of the OS market and with over $200 billion in market capitalisation, paranoid about the next new change which might usurp its position. It therefore has no choice but to continuously innovate and reduce prices. That is some monopoly!

Busting the Trustbusters
Microsoft's competitors, notably Netscape and Sun Microsystems, have frequently accused Microsoft of predatory behaviour by giving its browser away free. The argument for predatory pricing is based on the premise that once Microsoft eliminates the competition it will raise the prices to monopoly levels. In a highly competitive environment where the threat of competition is high, predatory pricing cannot succeed. For instance, if Microsoft's zero price browser strategy results in the demise of Netscape, Microsoft cannot afford to jack up the price of its Internet Explorer to, let's say, $500 per licence. Here is why--by jacking up the price, Microsoft will signal to the market of a highly profitable opportunity. As entry costs to re-enter into a browser market are relatively low, it will attract renewed competition. A new company like an Apache (Apache is one of the lesser known developers of browsers and Web server software) enters the market with a superior browser, at let's say, $50 per licence. To retain market share, Microsoft may again have to give the Internet Explorer browser away free. If Microsoft anticipates this competitive behaviour, it has no incentive to jack the prices back up in the first place. Thus predatory pricing in such markets rarely leads to monopoly profits. On the contrary, in a dynamic market with rapidly changing technology, even if there are attempts by firms to drive each other out of business, the price of the product rarely goes up and may well be termed as pro-competitive. It is the consumer who reaps the benefits of reduced prices.

It is high time that the trustbusters realise the economics and market realities of the rapidly changing high-technology industry. The US government will do a disservice to the global consumers if it insists on intervening in this industry. It is also unfortunate that companies like Sun and Netscape, who apparently espouse the virtue of openness and competition, orchestrated the government's entry into a dynamic industry for regulatory forbearance, instead of allowing the market to determine the winners. History has shown that competitors, which develop superior products and technologies, are far better protectors of consumers than government officials who dance to the tunes of political motivations and incentives. The most sensible antitrust action that the Justice Department can initiate is to just leave Microsoft alone!

(Atanu Mukherjee is involved in advanced research at MIT's Laboratory for Computer Science and the Sloan School of Management.)

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