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Capitol Comment

    Capitol Comment 217 - Microsoft and Monopoly

    12/14/1998

    Over the past year, Microsoft has made headlines across the country, and not just for its new and innovative products. The software giant has been the target of an antitrust case by the Department of Justice (DOJ). The government claims that Microsoft is acting anti-competitively by using its operating system, Windows, as leverage to dominate the market for Internet browsers. Before intervening in one of the most dynamic sectors of the economy, the DOJ must demonstrate that Microsoft is a monopolist rather than a successful company in a fiercely competitive market.

    Over the past year, Microsoft has made headlines across the country, and not just for its new and innovative products. The software giant has been the target of an antitrust case by the Department of Justice (DOJ). The government claims that Microsoft is acting anti-competitively by using its operating system, Windows, as leverage to dominate the market for Internet browsers. Before intervening in one of the most dynamic sectors of the economy, the DOJ must demonstrate that Microsoft is a monopolist rather than a successful company in a fiercely competitive market. Yet, computer prices are falling and customer benefits are increasing, so just what is Microsoft’s crime?

    Could this be just another case of a company going to Washington to get what it wants through government intervention rather than the marketplace?

    Microsoft does have an 80 percent market share for operating systems. And in redesigning its operating system, Microsoft included its browser, Internet Explorer, as a key component of the computer user’s desktop operating system. Microsoft does not charge consumers for Internet Explorer; it is fully integrated with its operating system. The DOJ views this as a "tie-in" sale that threatens other browser companies, particularly Netscape. As a remedy to what it sees as Microsoft’s anti-competitive behavior and exclusionary business practices, the DOJ would like to have Microsoft offer its browser as a separate item. Alternatively, Microsoft must include the icon for Netscape’s browser along with its own as part of the desktop screen that computer users view when they first boot up.1

    Simply, because Microsoft has an 80 percent market share, this does not mean the company is behaving like a monopolist. Acting like a monopolist means raising prices to gain monopoly profits, and this can only be done when barriers to entry eliminate the threat of competition. In the computer industry, there are numerous alternatives to the Windows operating system, including Apple’s Macintosh, IBM’s AIX, Sun’s Solaris and even the popular freeware Linux. In an open market, virtually any software company must be viewed as a potential competitor. Without a true barrier to entry, Microsoft is hard-pressed to exercise any market power. In fact, because there are no barriers to entry, Microsoft’s market share may be better viewed by the fact that the firm is an aggressive competitor -- not a monopolist -- that has gained its market share by providing consumers what they want at affordable prices. This is borne out by the fact that the price of Windows has actually fallen and will fall even further if the courts do not interfere with the company’s efforts to add an Internet browser to the operating system without raising the price.2

    The new monopoly theory. Recent critics claim that a "network effect" creates monopoly power for Microsoft, even without barriers to entry. That is, the more people who use a product such as Windows, the more valuable and dominant it becomes, and the more difficult it becomes to change. Think of the phone system. The more people with telephones, the more worthwhile it is to have a phone. If a network effect exists (and it is not clear to what degree it does), it would explain why Microsoft is keeping its prices low. Namely, the company knows that signing people up today at low prices will offer the opportunity to collect higher prices from more people down the road. But this argument assumes that in the future, all competitors to Microsoft will be gone, so it can safely raise prices to exploit its monopoly position. In a market that is as dynamic as the computer industry, real and potential competitors do exist, and to assume that they will be successfully driven from the market at some point in the future is a high-risk strategy that today’s investors would not be willing to bear.

    Going down the wrong path? Building on the network effect, critics also claim that the dominance of one product can make it difficult for new products to enter the market, even if they are superior. Path dependency, as this line of thinking is called, has been used to explain failed technologies that were allegedly superior to products that ultimately won out in the marketplace. Two famous cases are the QWERTY keyboard (the standard keyboard in use today) and VHS videotape. Both of these were said to be inferior to alternative products. But research into the QWERTY keyboard found no evidence to suggest alternative keyboards were superior, and VHS videotapes won out over Betamax because VHS tapes are long enough to record movies.3 In the marketplace, products survive because they meet consumer demand. Otherwise, entrepreneurs with better products can fill the void. New technologies and better products constantly replace outdated products, even when vast infrastructures are involved. The nation has moved from barge transport to rail transport, from horses to automobiles, and from vinyl records to compact discs. In short, path dependency arguments do not offer an accurate description of a dynamic economy.

    Politics over markets. Computer hardware and software are swiftly growing parts of the American economy, marked by fast-paced technological innovation and intense competition. Microsoft has evolved into an aggressive leader in this industry. It is telling that the Department of Justice is seeking a larger market share for a specific Internet browser -- Netscape -- as part of the remedy it is seeking against Microsoft. Netscape, with 50 percent of the browser market, is a billion dollar giant in an industry that includes a number of other browsers as well. Could this be just another case of a company going to Washington to get what it wants through government intervention rather than the marketplace?

    1U.S. v. Microsoft, Complaint, Civil Action No. 98-1232, May 18, 1998.

    2See Richard B. McKenzie and William F. Shughart II, "Is Microsoft a Monopolist?" The Independent Review, vol. II, no. 2, (Fall 1998).

    3See Stan Liebowitz and Stephen E. Margolis, "Policy and Path Dependence: From QWERTY to Windows 95," Regulation, 1995, no. 3, pp. 33-41.