Trust on Trial.(Review)

How the Microsoft Case Is Reframing the Rules of Competition

By Richard B. McKenzie

Richard B. McKenzie, an economist and Walter B. Gerken Professor of Enterprise and Society in the Graduate School of Management at the University of California, Irvine, has written a fascinating book evaluating the antitrust case (United States v. Microsoft Corporation, civil action no. 98-1232) that may heavily influence the future of U.S. competition policy toward the nation's economic engine of growth, the information technology industry. In his book, McKenzie takes a critical view of what the nation's antitrust laws are supposed to protect: namely, competition and consumer welfare, not competitors. Because all firms exhibit varying degrees of market power, the important question to McKenzie is whether Microsoft has acted like a monopolist. Has Bill Gates eliminated competitors and consumer choice, restricted the supply of software products, and raised consumer prices to monopoly levels? If the answer is no then what is the basis for this lawsuit?

According to McKenzie, the U.S. Department of Justice believes that Microsoft has monopoly power. It is alleged that the Redmond, Washington-based software giant's dominance in the Windows operating system market is protected by high entry barriers in the form of certain economies of scale and network effects, which reinforce one another. "Economies of scale" mean that production costs per unit drop as volume increases (dramatically evident in software manufacturing). "Network effects" means that as more consumers purchase a product requiring standardized protocols for interaction, the more difficult it is for a competitor to enter the market with a new product that is incompatible with what the majority of consumers are now using. Thus, "switching costs"--the expense the consumer would incur to embrace the new product--would be prohibitively high.

McKenzie admits that by 1997, Microsoft controlled 95 percent of the Intel-compatible operating system market with its Windows product. This is what Justice Department lawyers refer to as a "choke point" on "entry points into cyberspace." Yet there are alternative operating systems available for consumers to use, such as IBM OS/2 and UNIX. In fact, McKenzie counted 19 viable producers of operating systems in the marketplace. Also noticeably absent from the Justice Department's case is any mention of the Linux operating system. Linux's share of the server operating system grew from less than 7 percent in 1997 to more than 17 percent by the end of 1998, at the expense of Microsoft's Windows NT's market share. Red Hat is also offering a price-competitive desktop version of Linux to the retail consumer market.

McKenzie points out that, while controlling over 90 percent of the PC operating system market over the last decade, Microsoft has not restricted the production of Windows. It did increase the price of new versions in 1995. Yet research has revealed that Microsoft has competitively maintained and even slightly increased its market share, with the average real "street" price of Windows dropping from $225 in 1990 to $106 in 1998. Moreover, between 1990 and 2000, Microsoft released six technologically enhanced versions of Windows to consumers.

The Justice Department's position is that Microsoft does not have to worry about raising its prices because of a lack of viable competitors ...