Microsoft’s Business Strategy: Innovation or Predatory Behaviour? 2000 words

Microsoft’s Business Strategy: Innovation or Predatory Behaviour?

 

  1. Introduction

 

In the 1990s and early 2000s, Microsoft Corporation dedicated itself to consolidating its position as the world’s number one software leader. In the process, the company took a number of actions that attracted the attention of US and European regulators. The US Department of Justice and the European Commission accused Microsoft of deliberately engaging in anti-competitive practices and displaying predatory behaviour. Both the US and European court cases eventually found Microsoft guilty of illegal actions. The prominence of the court actions has caused a heated debate between economists on the worth of Microsoft’s strategy. On one hand, the anti-Microsoft economists argued that Microsoft’s actions were predatory and intent only on destroying its competition (e.g. Netscape). On the other hand, pro-Microsoft economists, including Microsoft itself, argued that the company’s position was simply the result of its outstanding innovation and IT development. This essay analyses the economic arguments behind Microsoft’s court cases, paying particular attention to the issue of whether Microsoft’s business strategy was dedicated to predatory action or to innovation.

 

  1. Brief Background: the US and European Court Cases

 

In 1995, Microsoft began to market an internet browsing software, Internet Explorer, together with the Windows operating system. Microsoft’s gesture came after the introduction of Netscape’s browser Navigator on the market in 1994. At the time of Microsoft’s entry into the browsing market, Navigator was available for a fee for everyone except educational and non-profit institutions (Economides 2001). However, when Microsoft began to market Internet Explorer as an alternative browser, the company decided to include it in the Windows OS at no extra charge – thus, effectively, undermining its main competition and, at a stroke, destroying the general market for ‘non-free’ browsing software.

 

Microsoft had been under US government scrutiny since 1991. The first government inquiry had concluded with the decision that Microsoft must not force its customers to purchase other Microsoft products together with its operating system. However, the government’s decision explicitly allowed Microsoft to integrate new features within its OS (Gilbert & Katz 2001). Predictably, Microsoft took the position that the IE was not a product, but a feature integrated in the OS. The government did not agree, and in 1998 sued Microsoft for illegal practices. In 2000, the court found Microsoft guilty of anti-competitive practices and ordered it broken up into two separate units. Microsoft appealed this decision, and eventually, in 2001, the ruling settled on a lower antitrust penalty (Gilbert & Katz 2001).

 

The E.U. Court Case

In 1997, the European Commission began to investigate Microsoft’s integration of the Windows Media Player into the Windows OS. In 2003, the EU’s inquiry concluded that Microsoft must distribute versions of Windows without the Media Player. When Microsoft failed to comply, E.U. placed a fine of €497 million on them in 2004. Microsoft paid the fine and unbundled the Media Player on a version of Windows XP, but did not release all information for competition software as requested. In response, the EU fined Microsoft an additional € 280.5 million.

 

Microsoft appealed both decisions of the EU. However, in 2007, Microsoft lost its appeal against the European Commission (BBC 2007). Consequently, the company agreed to provide interoperability information only against a fee. In 2008, the E.U. fined Microsoft an additional €899 million for failure to comply with the 2004 decision (Montalbano 2008).

 

  1. The Anti-Microsoft Economic Arguments

 

The US government’s economists prosecuting the antitrust case analysed Microsoft’s position in the Intel-based PC market and determined that Microsoft held more than 90 percent of it, establishing a virtual monopoly (Gilbert & Katz 2001). However, the position of a monopoly is not prosecutable under US law; instead, the accusations focused on the possible practice of monopolisation (i.e. preserving that monopoly against entry threats) (Bresnahan 2001, Economides 2001). As a business strategy, monopolisation can manifest itself through illegal predatory behaviour, defined as an exclusive intent of eliminating one or more competitors (Ordover and Willig 1981). Areeda and Turner (1975) argue that predatory conduct occurs if a firm prices below its average variable cost of production. After a thorough analysis, the US government’s assessment concluded that Microsoft’s actions were, indeed, predatory toward Netscape, and that the zero-cost approach toward the Internet Explorer would eventually be compensated by increasing Windows prices (U.S. v. Microsoft 1998, para. 75-102).

 

In Bresnahan’s (2001) description, Microsoft management became worried about the rise of the internet, and considered that this posed a fundamental threat to the Windows operating system. Microsoft reasoned that internet users would not be interested in a complex OS such as Microsoft’s, but instead seek stripped-down, cheap versions. In this, Microsoft identified Netscape as the most likely company to build such an OS and decided to undermine the company at all costs. This is why they focused on destroying the popularity of the Netscape browser, even at a loss – or, rather, short term loss – to their own company (Bresnahan 2001, pp. 13-15).

 

Bresnahan (2001) further addresses the issue of the impact of Microsoft’s practices on innovation on the market. Innovation is defined as “a part of the research and development process which seeks to introduce new products or technical processes that eventually render the existing range of products and processes obsolete” (Lipczynski & Wilson p. 208). As Griliches (1992) and Jones and Williams (1998) have pointed out, innovation typically provides a greater social benefit than the costs of investment into it, and as such it is highly desirable.

 

According to Bresnahan (2001), an IT platform is constructed through divided technical leadership (DTL), the decentralised actions of several companies. For instance, IBM (computer), Microsoft (OS), Intel (CPU), Netware (networking OS), WordPerfect and Lotus contributed to the divided technological leadership of the PC platform. Although the necessity of building an OS platform forces these companies to cooperate, the system also maintains them in competition. Bresnahan (2001) divides an IT platform in several layers and shows that DTL competition when (1) firms in one layer cause epochal change in another layer and (2) there is rivalry at layer boundaries, particularly in regards to extension capability. This competition then leads to a form of Schumpeterian disruptive innovation. According to this theory, the technology market tends to self-regulate itself through “creative destruction” – spurts of innovation that shake the system (Rose 2002). However, according to Bresnahan (2001), the monopolisation of a market by Microsoft or Intel causes the inhibition of Schumpeterian innovation. Hence, the reduction or elimination of monopoly in technology is necessary to stimulate creative innovation.

 

The anti-Microsoft advocates generally take the position that innovation depends on competition. For instance, Evans et al (2005) argued that competition had a positive impact on browser creation. Similarly, the EU Commission made the argument on behalf of a direct relationship between competition and innovation, arguing that “on balance, the possible negative impact of an order to supply on Microsoft’s incentives to innovate is outweighed by its positive impact on the level of innovation of the whole industry (including Microsoft)” (Page & Lopatka 2007, p. 81).

 

  1. The Pro-Microsoft Economic Arguments

 

In comparison to the anti-Microsoft position, other economists have argued that Microsoft’s actions of bundling IE or Windows Media was the result of innovation and research & development (R&D). According to this argument, Microsoft embarked on a business strategy that encouraged innovation.  As a clear example of this, advocates of Microsoft have pointed out that the inclusion of the IE browser in the Windows package has triggered a quasi-revolution in the browser market, forcing everyone to give out the software for free. Thus, before the advent of the IE, Netscape controlled web browsing as a quasi-monopolist, charging users $40-50 for the software (Economides 2001, p. 24-25).  However, Microsoft’s innovative strategy allowed the company to provide the Internet Explorer free of charge. Eventually, in order to survive, Netscape was forced to give its browser away for free as well. According to Economides (2001), Microsoft’s actions caused an estimated benefit of $4 to $5 billion to American consumers – in the short term, at least; long term effects may well be negative.

 

Against those that argued that Microsoft’s zero-price strategy was only meant to bankrupt its competition, and was not in fact sustained by R&D and innovation, Microsoft advocates pointed out that there is no evidence of rising Microsoft prices since the 1990s (Economides 2001). In fact, according to Microsoft’s economist, Richard Schmalensee, in a monopoly position Microsoft would have charged 16 times more for its OS (Reddy et al 1999). Instead, these economists suggested that Microsoft’s technology allowed smooth integration of the IE browser (Davis & Murphy 2001). The bundling methodology allowed Microsoft such major efficiencies that the marginal cost of the software became close to, or actually, zero.

 

In this line of argument, Microsoft’s advantage centres on the concept of ‘network effects’. According to this idea, product demand is directly linked with the number of auxiliary goods and services that the product has (Gilbert & Katz 2001). In IT, this principle translates into the fact that the acceptance of an IT product – an operating system, for instance – depends on the amount of other applications that the product supports. On the other hand, ‘network effects’ have the downside that programmers are not really interested in or, in fact, capable of writing new applications for an operating system unless the demand for the product is large Gilbert & Katz 2001, Bresnahan 2001). Page and Lopatka (2007) found that network effects had a large impact on the web browser software (Internet Explorer), as well as the Windows Media Player.

 

Network effects often have the result of creating quasi-monopolies in the IT market, as the dominating OS company draws within its orbit creative programmers and uses economies of scale to produce lower-priced products (Economides 2001). Hence, the economic efficiency of the OS market can be tied in with monopolistic positions (Economides and Flyer 1998). The pro-Microsoft economists have argued that monopolies in the technology market are natural and contribute to both consumer and producer well-being (Economides 1996). Rather than eliminating innovation, Microsoft’s quasi-monopoly encouraged it within its framework. Indeed, an analysis by Lerner (2001) confirmed that Microsoft’s position did not hinder innovation, as claimed by anti-Microsoft theorists.

 

 

  1. Consequences of Microsoft’s Strategy

 

Microsoft succeeded in the short run to establish Internet Explorer as the most popular browser in the market (Bresnahan 2001). However, in the long run, IE’s supremacy came to be challenged by other browsers. The most successful of these has been Firefox, which, by July 2009, had earned almost 30% market share in the browser market (Mills 2009).  Moreover, the search engine Google emerged as a new serious contender to Microsoft’s OS supremacy. By 2005, Google was described as the new Netscape (Vise & Malseed 2005). Google has created a successful OS for mobile phones, Android, and launched a browser called Google Chrome. Recently, it has announced that it will put out a new open source OS also called Google Chrome (Singel 2009).

 

In its turn, Microsoft has recently introduced a new search engine, Bing, which hopes to thwart the domination of Google. The new version of the OS, Windows 7, has been addressed in autumn 2009 (Singel 2009). Even if Microsoft has been overshadowed by Google and other internet-based companies in recent years, it is also true that it is still the biggest company in the IT software business, and its financial power allows it to invest large amounts into innovation, and also to take on any competition using its huge wealth and influence.

 

  1. Conclusions

 

The Microsoft anti-trust cases in the US and EU have focused on Microsoft’s business strategy and its economics case. The anti-Microsoft economists have emphasised that Microsoft was guilty of anti-competitive behaviour. According to this point of view, Microsoft involved itself in predatory actions meant to cripple the competition at any cost. These economists generally also take the view that monopolies are undesirable for social benefit, as they inhibit innovation. By comparison, pro-Microsoft economists argued that Microsoft’s bundling of IE and Windows Media is a result of intensive innovation, and results from large network effects. Furthermore, this argument states that technological monopoly is desirable in some cases, as it brings net social benefits. This essay has examined the ‘pro and con’ points of view, and the consequences of Microsoft’s position in the market.

References

 

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