I usually find Krugman at least provocative.
But how about this? Definitely not his best effort.
Enjoy!
Victor
Soft Microeconomics
The squishy case against
you-know-who.
By Paul Krugman
(posted Thursday, April 23)
I wrote this piece in
WordPerfect, not Word, mainly
because Word's equation editor is
awful (are you listening, Mr.
Myhrvold?), and I may as well use
the same software for plain English
articles and professional
gobbledygook. I surf with Netscape
Navigator and check e-mail in
Eudora. So, I am not a fan of
Microsoft's products. Moreover, for
reasons explained below, it is in the
public interest to have Bill Gates
always running a bit scared of the
Justice Department. Nonetheless, the
more anti-MS propaganda I read, the
more pro-MS I get. There is a case
against Microsoft, but it is not the one
you hear, and I would hate to see
crude misunderstandings posing as
sophisticated analysis prevail.
Probably the first thing one ought to say
is that the public has no interest in helping Bill
Gates' rivals for their own sake. It's easy to
think of the people who run software
companies other than Microsoft as underdogs
fighting Big Bad Bill. But those "little" guys
are no more in need of extra money than
Gates is, and if allowing him to get an extra
billion at Larry Ellison's--or even Marc
Andreesen's--expense is good for the rest of
us, so be it. Those of us who do not get paid
in software stock options should not allow
ourselves to become pawns, either way, in
struggles among those who do.
So what is the public interest?
he case for leaving Microsoft alone does
not rest on some naive faith in the
perfection of free markets. Software is an
industry characterized by powerful increasing
returns in both production and consumption:
The more units Netscape ships, the lower its
per unit cost; the more copies of Navigator in
use, the more attractive it is to the typical
user. These increasing returns make the kind
of atomistic, "perfect" competition that
prevails in the market for, say, wheat
impossible in the market for browsers or word
processors. Necessarily, each type of product
will in the end be produced by only a few
companies, perhaps only one.
But how does this concentration of
production take place? One of the depressing
things about public discussion of the
Microsoft case, even among supposedly
well-informed people, is that much of it has
come to be dominated by a basically primitive
view about what increasing returns do to
markets--namely, that they convey monopoly
power purely randomly, on whoever happens
to be in the right place at the right time--and
that this "path dependence" allows clearly
inferior technologies to become "locked in."
Now path dependence has its place--but when
applied to the Microsoft case it misses the
point. After all, high-technology companies
are themselves quite aware of increasing
returns, and their strategies--above all the
prices they charge when they are trying to
establish themselves in a market--are very
much affected by that awareness.
onsider, for example, one particular form
of increasing returns: The so-called
"learning curve," which says the more units of
something you have already produced, the
lower the cost of producing the next one. You
might think this means that whoever gets into
a market first will simply have a snowballing
advantage. But as Stanford's Michael Spence
pointed out in a classic, 20-year-old paper on
this subject, profit-maximizing companies that
know they face a learning curve will compete
fiercely to move down it more rapidly, selling
cheaply in the early stages of a product cycle
(and therefore losing money) in the hope of
making the money back later.
The same logic applies to increasing
returns on the demand side: As a
manufacturer, if I know that a typical
customer's choice of browser depends both
on the price and on the number of other
people using that browser, I will initially make
my own browser cheap--maybe even free--so
as to build market share. In either case I must
incur initial losses that are, in effect, part of
the price of entry into the market--an add-on
to the cost of developing a product in the first
place. And because nobody will want to pay
this entry fee without a reasonable hope of
earning it back, only a few companies will
enter a market subject to strong increasing
returns. The point is that the eventual
domination of an industry by a few
companies--and a high rate of profit on sales
for these companies in the later stages of the
cycle--doesn't happen because these
companies just happened to get a head start.
On the contrary, it is precisely because it isn't
purely a matter of luck--because everyone
competes so fiercely on prices in an effort to
get some of those nice increasing returns--that
only a few dare enter.
f course, there is also an element of luck.
It's not true that whoever gets a head start
always dominates the market--if a company
has a small head start but offers a clearly
inferior product or has clearly higher costs,
rivals can and will overtake it. But nobody
can be sure just what an as-yet undeveloped
product will cost to produce, or how it will go
over with consumers. Thus, competition in a
market characterized by increasing returns
is--as it must be--a sort of demolition derby in
which only some of those who enter cross the
finish line. Those who do make it across the
finish line will typically make big profits. But
this profitability is necessary to the enterprise.
Who will enter a demolition derby without the
incentive of a prize?
So this is the case for leaving Microsoft
alone: High-tech competition is, necessarily, a
competition that ends up being won by a
handful of players. Those who make vast
fortunes may not always be the most
deserving--but so what? For the rest of us,
what matters is not who wins or loses, but
how they play the game. And if they know or
suspect that too much success will be
punished--that anyone who does too well will
become a target of envy-driven litigation--they
will have that much less incentive to play
hard.
ow there is, of course, also a case against
Microsoft. Never mind the crude
complaint that it is too big, or too profitable,
or that nerdy types tend to dislike its products.
The real concern is that because Microsoft's
victory in an earlier derby happens to have
given it control over a particularly strategic
part of the industry--because it supplies
operating systems--it is in a position to
squeeze out rival suppliers of other software.
And that is a real concern: If Microsoft had,
for example, written Windows 95 in a way
that made it hard or even impossible for me to
use WordPerfect, the Justice Department
would have been absolutely justified in calling
out the arsonists.
But the fact is that MS has been very
careful not to use its undoubted power to
practice any crude, obvious version of what is
known in the trade as "vertical foreclosure."
WordPerfect and Netscape work just fine on
my Windows-based machine. This restraint
may partly reflect Microsoft's market
strategy--after all, Microsoft beat Apple partly
because Apple did practice vertical
foreclosure, and as a result inhibited the
development of complementary software
(although the main problem was Apple's
persistent belief, despite all the evidence to the
contrary, that everyone would be willing to
pay a premium price for a niftier machine).
For sure, however, Microsoft has mainly been
restrained by the knowledge that any crude
use of its power would indeed land it in court.
nd yet, despite all that restraint, Microsoft
is in court anyway. Any nontechnologist
ventures into the browser wars at his peril, but
here is how I understand it: After initially
missing the significance of the Internet,
Microsoft has gone to the other extreme,
designing Windows 95 so that it uses an
Internetlike metaphor for everything. It makes
sense, then, for a browser that can find both
internal and external documents to be an
integral part of the system--unless, that is, you
regard browsers and operating systems as still
basically different things, and view Microsoft
as practicing vertical foreclosure under the
guise of product enhancement. Well,
maybe--but it's a pretty subtle point.
Microsoft isn't preventing anyone from using
Netscape or charging Netscape for the right of
access; it's providing Internet Explorer free,
but then that would be normal practice in this
kind of industry even if IE wasn't allegedly an
integral part of Windows 95. You can argue
that Microsoft has stepped across the line on
this one--but surely by only a few inches.
Here's what worries me: Given the
subtlety of the real issues here, what is the
chance that this stuff will be decided on its
merits? When you hear that despite the fact
that he has economists who know better, the
Justice Department's Joel Klein apparently
either believes or chooses to claim that this
case is about path dependence, you start to
wonder. And when you hear that the
anti-Microsoft side has retained the services
of that economic and technology expert Bob
Dole, you start to despair.
Links
An article in the Feb. 25 Wall Street Journal
("QWERTY Spells a Saga of Market
Economics") is a good example of the
mistaken view that path dependence is the
core of the case against Microsoft. Nicholas
Economides, who really understands these
things, took the Wall Street Journal to task in
a letter that it, of course, did not print. His
useful site also contains a good, slightly
anti-MS discussion of the vertical foreclosure
issue on browsers as well as a set of links to
just about everything relevant to the case. |
