Old bottle for new wine?

Pratap Ravindran

THE roll-out of Windows XP by Microsoft on October 25 is expected to revive debate in diverse fora about the compatibility of US anti-trust policy and laws with emergent information technologies.

According to reliable media reports, some State attorneys general in the US, encouraged by the appeals court ruling that Microsoft did, in fact, violate the Sherman Anti-trust Act by bundling its Internet Explorer browser with its operating system (OS), are now preparing to level the charge that its Windows XP will result in the company occupying larger areas of prime real estate in cyberspace.

The basis for this charge? The bundling of MSN Messenger, Microsoft's Passport authentication technology and a new Windows Media Player that burns CDs and plays DVDs, streaming video and Internet music with Windows XP which, in terms of ubiquity, is expected to rival Windows 95.

Over 30 companies, including Apple Computer, Adobe Systems, Corel, Intervideo, Netopia, RealNetworks and Symantec, fear that they will wind up as roadkill on the information highway if Microsoft is allowed to incorporate these features in Windows XP.

While their stand-alone products are indubitably superior to the features bundled with Windows XP, these companies fear that the average buyer will just buy or go along with the Microsoft product to save themselves the bother of picking up third-party offerings.

Microsoft has been characteristically laconic in its dismissal of these concerns. It has maintained that it is simply trying to improve its products in a fiercely competitive market so that it continues to deliver value to its customers. And, just in case people thought that it wasn't serious about what it was saying, Microsoft has announced the withdrawal of Sun Microsystem's Java technology from Windows XP. This means that Web applications that run on Java won't work on XP without the installation of additional software.

Who is wearing the white hat in this particular showdown on main street? It's very, very difficult to tell.

The official version is that Microsoft is wearing a black hat here because, when customers opt for bundling because it gives them immediate gratification and ease-of-use, they are basically stifling competition and, thereby, ensuring higher prices down the line.

But life isn't that simple.

In order to understand why it isn't (at least, in this particular case), we'll have to get a hang of the basics of the so-called New Economy and the ways in which it works differently from the so-called Old Economy.

But before we get into that, it might be worth the while to check out the history of anti-trust doctrine per se which, as we shall see, wasn't all that simple either.

The roots of anti-trust doctrine lie in the need to protect and help consumers. However, historically, the evidence has been that the doctrine and the laws embodying it have been used to hinder efficient corporations that have increased output and lowered prices. Cynics argue that this has happened because the doctrine was never a pro-consumer one at any point of time and that it was formulated in order to protect some firms from the efficiency of other firms. In order to buttress their position, they cite the fact that virtually every anti-trust action has involved two or more firms and hardly ever consumers and firms.

Others, less cynical in their orientation, have been inclined to the view that the anti-trust doctrine and the attempts to put it into practice have not worked because those involved -- economists, regulators and so on -- have not been able to define clearly certain basic concepts such as competition and entry barriers. For instance, does the lowering of prices by a firm constitute competition or an attempt to monopolise the market? And then again, does heavy expenditure incurred by a firm on research and development, advertising and so on enhance entry barriers, thereby stifling competition and hurting the interests of the consumers?

Backing up a little, we find that micro-economic theory, from roughly the 1940s to the 1960s, was pretty much based on what economists refer to as the perfectly competitive equilibrium model which embodied the assumption that competitively structured markets tended towards equilibrium in which price, marginal cost and minimum average cost were all equal and in which consumer interests were, thereby, protected optimally. It followed that if firms advertised or if they achieved economies of scale that other firms could not or if they achieved a level of market share which allowed them to control prices, they were working against the interests of the consumers.

Inevitably, such firms were viewed then as candidates for prosecution under anti-trust laws.

In the 1970s and 1980s, however, the Chicago School economists trashed this theory and demonstrated that the correlation presumed to have existed between market concentration and profit didn't hold good in all cases. At about the same time, Austrian economists put forward the argument that real world divergences from perfect competition do not necessarily mean market failure or, for that matter, justify anti-trust action. They went on to say that products should be differentiated if the market itself was differentiated, that firms should advertise if adequate information was not available to consumers and that lower costs achieved by firms through innovation must be allowed to wipe out less innovative firms. And then, as a clincher, they pointed out that people were getting dominant firms mixed up with monopolistic entities.....

And now for anti-trust policy in the context of the New Economy. Let's assume for the moment that anti-trust policy and laws are entirely unambiguous -- and then figure out why people say that they create a whole bunch of problems when hooked up to emergent information technologies.

The anti-trust doctrine was developed in the context of smokestack economies characterised by multi-firm, multi-plant production of physical goods such as cars and steel and cement and cigarettes and so on. In as much as this production was undertaken on a multi-firm, multi-plant basis, the economies of scale were limited at the plant and firm-levels. Inevitably, average costs rose with output. Further, smokestack economy enterprises required high capital investment and were characterised by stable market shares, relatively slow innovation and extended entry/exit cycles. New Economy firms are, in a manner of speaking, the mirror image of these enterprises. They enjoy much higher economies of scale and, consequently, the total average costs of their products fall across output. They require less capital investment, run on extremely high levels of innovation and have accelerated entry/exit cycles. Most significantly, they benefit from economies of scale in consumption owing to what is referred to as network externalities.

New Economy companies are different from Old Economy outfits in another extremely important respect: their principal output is intellectual property. Intellectual property has a unique feature -- it has extremely high fixed costs relative to marginal costs. That is, it'll cost you a bomb to create intellectual property but, once you've created it, the cost of making additional copies is very low. In fact, in the case of software, it is so low that it might as well be zero. That's just great for consumers, right? Wrong. The problem here is that intellectual property has to be given very high levels of protection under law. If this is not forthcoming, everybody will jump on board for a free ride and innovators may not be able to recover even the cost of their innovations.

And so, we have a situation in which protection will actually increase production -- even while deflecting demand to more expensive substitutes.

There goes the very basis of the anti-trust doctrine....

Regulators are aware of all this. Thus, Robert Pitofsky, Chairman of the US Federal Trade Commission, addressing a recent conference on anti-trust, technology and intellectual property held at the Berkeley Centre for Law and Technology (University of California), said that ``it is unduly simplistic to assert that intellectual property is like all other forms of property'' but added that ``it is also unduly simplistic to conclude, as some have urged, that because of differences, anti-trust enforcement has little or no role to play when it comes to market power based on intellectual property.''