Network Drama. - Brief Article - Review - book review

Reason, April, 2000 by Steven R. Postrel

Winners, Losers, and Microsoft: Competition and Antitrust in High Technology, by Stan J. Liebowitz and Stephen E. Margolis, Oakland, Calif.: The Independent Institute, 288 pages, $29.95

Any truthful history of the intersection between scholarship and public policy must resemble a tragicomedy. Usually, the scholars and their government disciples present the comic spectacle, while the public gets to play out the tragedy (see, for example, the misuse of systems analysis in the Vietnam War), although sometimes there is enough tragedy to go around, as in the fate of geneticists under Stalin. Good ideas, such as school choice, move tortuously through a hostile political process, while bad ideas, such as treating statistical representativeness as the sine qua non of nondiscrimination, are enshrined in law and practice.

Or look at the Justice Department's antitrust suit against Microsoft. The government complains that Microsoft has a monopoly on personal computer operating systems, a monopoly which it has abused to stifle innovation and to maintain its dominant position. The intellectual roots of these arguments are hard to disentangle. In many respects, they seem no different from the sort of predation and bundling complaints to which market leaders such as IBM have been subjected in the past.

But underlying the government's willingness to sue and vilify Microsoft is a belief that its current dominance is in some sense undeserved, that its products have succeeded through a combination of luck and deviousness, not because they gave buyers a better combination of attributes and price. This belief, or at least suspicion, has received considerable nourishment from an economic theory that burst into scholarly prominence in the mid-1980s. According to this theory, markets for high-technology products, where issues of technical compatibility matter a great deal to users, are particularly subject to the risk of choosing the wrong product from a set of mutually incompatible rivals.

Stan J. Liebowitz and Stephen E. Margolis' Winners, Losers, and Microsoft: Competition and Antitrust in High Technology is an all-out attack on the intellectual and empirical basis for this claim, with particular application to Microsoft's role in the software market. In a nutshell, Liebowitz, a professor of managerial economics at the University of Texas at Dallas, and Margolis, a professor of economics at North Carolina State, say that while it is logically possible for markets to pick inferior products, there should be a strong theoretical presumption that it doesn't happen; that often-cited examples of the phenomenon fall apart upon closer examination; and that a detailed study of the PC applications market shows that Microsoft has achieved dominance when and only when its products were rated superior by third-party observers. These conclusions position the authors as the leading academic defenders of Microsoft, a role in which they are almost certainly more effective than the company's paid experts.

The basic idea behind the claim that markets may get it wrong--that buyers may find themselves purchasing products that they themselves perceive as inferior to alternatives--is fairly simple: For some kinds of products, the value of the product to the user increases with the number of other people who own a compatible version. Such "network effects" are easiest to see with a product like the telephone, where no one would buy the service unless there were someone else to talk to. But they may also be important for products like computer operating systems, whose users may want to share files, answer each other's questions, and have access to a wide array of complementary products such as applications software.

So the comparative value of two incompatible products for a particular user depends both on what the user thinks about the intrinsic attributes of the two products compared to their prices and on how big the user expects the network size of each product to be. It is logically possible for those comparisons to point in opposite directions (i.e., the product that looks like it offers better quality for the money is expected to have a smaller network) and for all users to rationally choose the product that is intrinsically inferior but expected to be more popular. The problem is one of coordination among the users; if everyone thinks that a given product is going to be the winner, even if they're all unhappy about it, that product can indeed become the winner.

But why would people expect an intrinsically inferior product-price combination to win? Here is where a second idea, "path dependence," comes in. Path dependence means that history matters; in this case, if the inferior product gets out on the market first, or acquires a sizable user base first, then it may get a leg up on its superior rival that "locks in" its dominance.

The archetypal example, cited by nearly all adherents of the lock-in hypothesis, is the standard typewriter keyboard, whose QWERTY layout is supposedly vastly inferior to alternatives that were developed later. In a famous 1985 article in The American Economic Review; Stanford University economist Paul David argued that the Dvorak alternative keyboard had been proven to be superior to QWERTY, that the gains from switching keyboards were large, but that the ubiquity of the QWERTY format deterred people from learning the Dvorak format. Liebowitz and Margolis' convincing refutation of these claims, first published in 1990 in the Journal of Law and Economics, is reprinted in Winners, Losers, and Microsoft.