September 2, 2013
Microsoft's Dilemma
Microsoft's Dilemma—Posner
I do not think the puzzling conjunction of Microsoft's rising profits and declining stock price reflect investor pessimism about its principal products—the Windows operating system, the Office Suite (Word, Power Point, and Excel), and servers for large users. There will continue to be a heavy worldwide demand for them. The laptop and desk computer are not going away; they will continue to be indispensable in enterprises of all sort, public and private, individual and corporate, all over the world. And there is no compelling objective reason why Microsoft should lag in improving these products sufficiently to maintain its market share.
No reason, and yet the decline in its stock price suggests that investors are dubious. The problem is not that Microsoft has failed to achieve success in the hot new areas of mobile devices and of search, but that the failure strikes many investors as symptomatic of a more general problem, identified by organization economists such as Clayton Christensen of Harvard. And that is the difficulty that large, established, successful enterprises have in adapting to rapid changes in their markets. The number of large successful computer companies that have failed or (like Hewlett Packard) are struggling is quite markable. The list includes (among the better known) Atari, Burroughs, Compaq, Control Data, Data General, DEC, NBI, Netscape, Prime Computer, Remington Rand, Sperry, and Wang.
What makes the computer industry so unstable from a producer standpoint is not only or even mainly the rapidity of technological change, which characterizes a number of other industries as well, but the rapidity with which a start-up can become a major producer because start-up costs in software and other computer-related business innovations are so cheap. Teenagers attuned more sharply to emerging tastes than adults, let alone middle-aged business leaders, can become formidable competitors of established businesses, seemingly in minutes. Smart teenagers become proficient in computer programming, are instinctively knowledgeable about the tastes and need of their contemporaries, and are able to raise the modest amount of money necessary to demonstrate the feasibility of their innovations.
What makes the young computer entrepreneurs so formidable is that established firms, especially successful established firms, such as Microsoft, which made Bill Gates the wealthiest person in the world, cannot adapt rapidly to market changes in the computer-Internet-social media world. It's a bird in the hand, two birds in the bush, problem. Microsoft is very successful with a certain type of product, namely software designed to meet the work needs of professionals and businesspersons. Microsoft's corporate culture, organization, leadership, and personnel are all optimized to improving, producing, marketing, price, and servicing that type of product. It a huge organization. It has 100,000 employees. What is it to do with them, who are the successful core of its successful business, if it tries to transform itself an Apple, a Google, a Facebook? Erect a new business beside it—a start-up staffed by brilliant unruly college drop-outs? Can one see a Bill Gates type or a Steve Jobs type as Microsoft employee number 100,001? What kind of fit would that kimd of employee make with the company's existing staff?
Large firms are organized hierarchically; it is the only way top management can exercise effective control. New ideas move slowly up a ladder of successively more senior supervisors. Because they are senior, older, experienced, they resist change, espcially change that may diminish their value to the company, or provoke turf battles with other divisions of the firm. They suffer from bureaucracy.
Yet the problem of adaptation to change is not limited to large companies. Small companies are nimbler, but also more fragile, and so equally or more reluctant to cannibalize themselves in order to move into a more promising business. It is start-ups that are most likely to embrace new, disruptive technologies—they have little to lose.
The tendency in economics is to think of corporate costs in opportunity-cost terms. A forgone opportunity is a cost measured by the profit that the opportunity would have yielded. Failure to exploit a promising business opportunity is like failing to pick up a $10 bill that you see lying in the gutter. But the individuals who make up a large organization tend not to think in opportunity-cost terms. They are not worker ants. They are individuals with their own utility functions. And one of the arguments in their utility functions is risk aversion. They weight a loss more heavily than an equivalent gain. They'd rather go with the office consensus, even if they think it wrong, because if everyone is wrong no one is blamed, than go out on a limb. Not all business people are risk averse. Entrepreneurs are not. But middle managers in large, established, successful firms are risk. They are doing well. They don't want to rock the boat. Bureaucracy and the bureaucratic mentality are not limited to government agencies.
It would take a remarkable person to change Microsoft's business culture. Investors apparently think it unlikely that CEO Ballmer will be succeeded by such a person. And apparently they fear that Microsoft's established products, profitable as they are, might someday soon be subject to the same wave of creative destruction that has challenged so many computer companies and destroyed not a few of them.
Dynamic Competition and Anti Trust Policy-Becker
The recent surprise resignation of Microsoft's chief executive, Steve Ballmer, only made official what has long been obvious; namely, that Microsoft is in decline, and is no longer the great and dominating company it once was. Microsoft's rapid decline may be inevitable in industries with rapid technological change, which should influence anti-trust policy in the United States and other countries concerned about monopolies.
Microsoft's Windows has been by far the dominant operating system for personal computers during the past 3 decades, as it was installed in some years in more than 95% of all personal computers, and is still installed in over 90% of all computers worldwide. What economists call "network economies" gave Windows a major advantage over Apple's operating system and that of potential entrants. Since computers have to communicate with each other, it has been advantageous to buy a computer with Windows when most other computers also used Windows.
Microsoft had monopoly power as measured not only by its dominant share of all computer operating systems, but also by the very large profits it continues to make year after year. These profits led to an elevated price of Microsoft's stock- it has since fallen significantly- and to enormous wealth not only for Bill Gates, but also for many other employees of the company. Microsoft attracted topnotch employees, and was generally considered the leading company in the world.
Complaints by competitors against so-called unfair tactics by Microsoft attracted the attention of the Department of Justices. It began an anti trust case against Microsoft that accused the company of abusing its monopoly power. This resulted in an expensive and bruising battle between the company and the government, including the attorney generals of many state governments. The final settlement did not force many changes in what Microsoft did, but the case may have distracted Microsoft's leaders from the goal of continuing to innovate in the computer industry.
We will probably never know if the lawsuit damaged Microsoft's subsequent performance, but forces were gathering even prior to the lawsuit that greatly undermined Microsoft's dominance. The growth of the Internet was a major force, and was itself sparked by major network economies. Gathering information from, and communicating via email through, the Internet became the primary interest of many consumers, and did not require word processing and other tools at the heart of Windows. Microsoft's Explorer system that provided access to the Internet rapidly declined in importance.
Apple soon became the most important innovator in the high tech industry, with its iphone, iPod and IPad. Smart phones and Tablets provided easy access to the Internet, and simple communication among users through email, texting, Facebook, and Twitter without the need to own a computer, and certainly without having to rely on Microsoft. This company tried to compete with its own tablets and other Internet devices, but it could never regain the attractive products it had when first introducing Windows. Perhaps a reluctance to "cannibalize" the market for its computer software made Microsoft drag its feet in getting into new products that allowed direct access to the Internet. In any case, Ballmer and other Microsoft leaders downplayed the importance of smart phones and other such Internet devices.
Google is in turn replacing Apple as innovation leader in the industry, with its dominance of the market for gathering information from the Internet, its Android operating system for smart phones, its driverless car, and Google glasses. This process whereby new entrants erode over time the market position of dominant companies is part of "dynamic competition", as opposed to the static competition discuss in economic textbooks. The large profits made by dominant companies encourage entry of new competitors who try to appropriate some of those profits for themselves. These new entrants may not be able to compete effectively by offering the same products and services as dominant firms do because these firms benefit from network economies and other advantages of scale. Instead, they innovate with different products that take away some of the market held by dominant firms. Unlike Microsoft, Apple did not mind, and probably enjoyed, cannibalizing Microsoft's market.
Anti trust policy should recognize that dynamic competition is often a powerful force when static competition is weak. The big policy question then is whether it is worthwhile to bring expensive and time consuming anti trust cases against still innovating firms that have considerable profits and monopoly power, given the significant probability that new competitors will before long greatly erode this power through different products? I believe the answer to that is no, and that policy should often rely on dynamic competition, even when that allows dominant firms only temporarily to enjoy economic power.