The New Republic


   Does Microsoft understand America?
   The Gates of Power

   By Robert J. Samuelson
   Issue Date: 04.23.01
   Post Date: 04.17.01



   World War 3.0: Microsoft and Its Enemies
   by Ken Auletta
   (Random House, 436 pp., $27.95)

   Pride Before the Fall: The Trials of Bill Gates and the End of the
   Microsoft Era
   by John Heilemann
   (HarperCollins, 246 pp., $25)

   Trust on Trial: How the Microsoft Case Is Reframing the Rules of
   Competition
   by Richard B. McKenzie
   (Perseus, 281 pp., $26)

   I.

   As allegory, few companies today rival Microsoft. But as allegory
for
   what? Since the late 1980s, Microsoft and its co-founder Bill Gates
   have come to symbolize, to admirers and to detractors, the best and
   the worst of American business. For its admirers, it represents a
zest
   for new technology and a beneficial marriage of self-enrichment and
   social improvement. For its detractors, it embodies ambition that
has
   evolved into ruthlessness, and an almost pathological pursuit of
   economic and technological power. These conflicting versions of
   Microsoft crystallized in the antitrust suit brought by the Justice
   Department and twenty states in May 1998.

   This may well be the most important antitrust suit since the
   government's breakup of Standard Oil in 1911. If U.S. District Judge
   Thomas Penfield Jackson is upheld on appeal, the division of
Microsoft
   into two companies would re-shape competition in the computer
   industry, though just how is unclear. The ruling would also warn
other
   companies that the acquisition of market power (hardly anyone denies
   that Microsoft has market power) imposes obligations of
   self-restraint. Otherwise they may be sued by the government, egged
on
   by rival companies. But again, the consequences of this murky
   self-restraint remain unclear. In the broadest sense, the Microsoft
   case poses the question of whether government can constructively
   police competition in new technologies.

   By and large, Americans favor competition. We regard it as a check
on
   excessive economic, social, and political power. We believe that
   economic competition advances social well-being by promoting
   efficiency and encouraging innovation. The antitrust laws, first
   enacted with the Sherman Anti-Trust Act in 1890, reflect these
values.
   These laws prohibit the worst abuses of monopoly and market power.
   Companies cannot collude to fix prices or to restrict supply.
Mergers
   that would let the surviving company control an industry are
generally
   rejected. Approved mergers that increase market power often come
with
   conditions--the sale of certain properties or businesses--intended
to
   dilute that power.

   All these restrictions aim to enhance Adam Smith's classic ideal of
   competition. His "perfect competition" presumes thoroughly informed
   consumers, so that buyers will choose the lowest-priced and
   best-performing products. Similarly, perfect competition requires
many
   producers, so that none has sufficient market power to limit supply
   and to raise prices. (Wheat farmers are the customary textbook
   example.) In theory, perfect competition maximizes consumer welfare.
   The lowest possible prices prevail. Efficient companies (which can
   sell at these prices and still earn a profit) drive out less
efficient
   rivals. Although the economy creates few perfect markets, such
markets
   are regarded as an ideal worth pursuing. The antitrust laws arose
when
   the emergence of immense industrial enterprises (in steel, sugar,
and
   oil, among others) offended popular sensibilities and seemed to
   insulate these organizations from market discipline.

   But there is another model of competition, and it paints a much
   different picture of economic and social progress. It comes from
   Joseph Schumpeter, who coined the evocative phrase "creative
   destruction." Schumpeter's notion of competition pits technologies,
   production processes, and business methods against each other. The
   superior displaces the inferior. Steel replaces wood; cars replace
   buggies; limited liability corporations replace partnerships. It is
   this process, rather than intense competition among producers of
   similar products, that creates true progress. Innovations of this
   sort, Schumpeter thought, might spawn gigantic companies that
dominate
   their industries.

   Sheer size, however, does not guarantee perpetual success. By its
   nature, creative destruction is unpredictable. Yesterday's victor
can
   become tomorrow's victim. A company's physical investments, learned
   habits, and institutional complacency may blind it to new
technologies
   or business methods. There are many famous examples. Xerox offered
its
   copier technology to many large companies, but none was interested.
   The idea behind Federal Express--an overnight package service at
   premium prices--was dismissed as silly. Wedded to what is familiar,
   onceinvincible firms may wither. The antitrust laws originally aimed
   to preserve competition as idealized by Adam Smith. Can they now
   preserve and promote Schumpeter's competition? The Microsoft case
   suggests that they cannot.

   II.

   The trial demonstrated one thing beyond all doubt: that you would
not
   want to compete against Microsoft. Every business aspires to what
   Microsoft attained in the 1990s, a virtual monopoly over a product
for
   which demand was exploding. From 1990 to 2000, worldwide
   personal-computer shipments rose from twenty-two million annually to
   roughly ninety million. Microsoft's Windows operating system is
   installed on about ninety percent of these machines.
(Operating-system
   software gives the computer instructions so that it can read other
   programs--application software--that perform specific tasks, such as
   word processing.) Even better for Microsoft, the extra cost (or the
   "marginal" cost) of installing another copy of Windows on another
   personal computer is almost zero. The major costs are writing,
   testing, and marketing the program. Once these costs are covered,
   additional sales are almost pure profit.

   With these marginal costs so low, and with demand so high,
Microsoft's
   growth and profit margins have been spectacular. Founded in 1975,
the
   company "went public" by selling its shares to general investors in
   1986. In 1985, sales totaled $140 million and profits $24 million.
In
   2000, Microsoft had sales of almost $23 billion and profits of $9.4
   billion. The profits came after $3.8 billion was devoted to research
   and development spending, which is money essentially targeted
against
   actual and potential competitors. Since Microsoft pays no dividends,
   it has huge cash reserves that are invested in short-term government
   and corporate securities. In mid-2000, these reserves were about $24
   billion.

   Besides being fabulously well-financed, Microsoft is ferociously
   combative. It is one thing to challenge a large, wealthy firm that
is
   complacent--say, General Motors twenty-five years ago. It is quite
   another to challenge a large, wealthy firm obsessed with
obliterating
   any threat--say, Microsoft. The company's character reflects Bill
   Gates's personality. He is a genuine geek who was hooked on software
   as a teenager in Seattle in the early 1970s. But what always
   distinguished Gates from the other geeks was his taste for business.
   Geek culture long romanticized free software as an entitlement to
   promote computer use; but not Gates. In 1976, he wrote an "Open
Letter
   to Hobbyists" in a computer newsletter that (according to John
   Heilemann) "asserted for the first time that software, like
hardware,
   was a valuable commodity--it was intellectual property, and as such
   its creators deserved to be compensated."

   Heilemann covered the Microsoft trial for Wired magazine, and Ken
   Auletta covered it for The New Yorker. Their books about the trial
   agree that Gates's compulsive competitiveness pervades Microsoft.
   Gates simply does not like to lose. Usually even-tempered, he is
   sometimes given to legendary outbursts. "Why are you trying to screw
   me?" he once yelled at cable-television magnate John Malone when
they
   had a business dispute. Another time he vowed to "destroy" Sun
   Microsystems, a rival. Auletta describes Microsoft as a "tough,
   competitive, passionate place." At the trial, one executive
   characterized the company's culture as taking "extreme positions to
   push ourselves." As much as anything else, Microsoft's corporate
   culture was on trial, and it was convicted.

   [INLINE]

   he language of the Sherman Anti-Trust Act is so broad that if
   interpreted literally, it would prohibit most agreements among
   companies. Section 1 declares "every contract, combination in the
form
   of trust or otherwise" that is "in restraint of trade" to be
illegal.
   Section 2 makes it a felony for anyone to "monopolize, or attempt to
   monopolize ...any part" of trade or commerce. Since many companies
try
   (secretly or not) to monopolize something, thousands of executives
   could easily violate Section 2. Over the years, courts have narrowed
   the law's sweep. Contrary to the language, companies can attain a
   monopoly (at least in theory) as long as they do it legally. If
   everyone buys your mousetrap because it is cheaper and better than
   anyone else's mousetrap, good for you. What is illegal is to use the
   power of monopoly to maintain your dominant position by destroying
   competitors. This was Microsoft's sin, the government alleged.

   As Auletta and Heilemann show, the trial seemed to prove Microsoft's
   guilt. Above all, its executives--led by Gates--acted as if they
were
   guilty. They were evasive, defensive, and sometimes obnoxious. Their
   statements were often contradicted by the evidence of their own
e-mail
   messages. Gates turned out to be the government's best witness. In a
   videotape of his deposition that was shown repeatedly at the trial,
he
   denied knowledge of matters discussed in his e-mails. He jousted
   repeatedly with David Boies, the government's lead trial attorney.
   Here is one revealing exchange (quoted by Auletta), after Gates is
   asked whether he is "concerned" about a new competitor.

     Gates: I don't know what you mean, "concerned"?

     Boies: What is it about the word concerned you don't understand?

     Gates: I'm not sure what you mean by it....

     Boies: Is the term concerned a term you're familiar with in the
     English language?

     Gates: Yes.

     Boies: Does it have a meaning you're familiar with?

     Gates: Yes.

     Boies: Using the term concerned consistent with the normal
     meaning....

   Gates and other Microsoft executives seemed to deny the obvious:
that
   they pulled out all the stops to beat competitors. The centerpiece
of
   the government's case was Microsoft's effort to overtake Netscape's
   Internet browser. A browser is a software program that serves as a
   translator. It takes the data on a website and converts it into text
   and images. Before browsers, the Internet--which is simply a
   high-speed data communications network--served mainly as an exchange
   of research files and papers for scientists, academics, and computer
   buffs. Without browsers, the Internet would not be a mass medium.

   Microsoft was slow to recognize the Internet's significance. By
1995,
   Gates realized his error. In a memo to his staff in May titled "The
   Internet Tidal Wave," he said that "the Internet is the most
important
   single development to come along since the IBM PC was introduced in
   1981." Worse for Microsoft, the Internet might erode its domination
of
   desktop computers. Application software (for creating documents and
   spreadsheets, doing taxes, handling investments, and so on) could be
   distributed by the Internet and made compatible with the browser.
   Then, as now, these programs were mainly compatible with Windows,
   meaning that anyone who wanted to use them had to have Windows. The
   threat was that desktop computers might operate easily without
   Windows. Bye-bye Microsoft? Well, maybe.

   Gates and his company responded with a focused fury. They were
   determined not to let Netscape's browser, Navigator, dominate the
   Internet the way Windows dominated the desktop. Microsoft had its
own
   browser, called Internet Explorer; but within the company there was
   much pessimism about its prospects. "I don't understand how IE
   [Internet Explorer] is going to win," James Allchin, a senior
   executive, e-mailed a colleague in December 1996. "Let's [suppose]
IE
   is just as good as Navigator.... Who wins? The one with 80 percent
   market share." As it turned out, the pessimism was misplaced. Five
   years later, Microsoft's Explorer has roughly 80 percent of the
   market. What happened?

   There are three ways to distribute a browser to customers: it can be
   preinstalled on the computer; it can be distributed by Internet
   service providers (ISPs)-- companies like American Online--that
   provide connections to the Internet; or it can be installed by the
   computer user, who downloads it from the Internet or copies it from
a
   cd-rom. Microsoft tried, largely successfully, to deny the first two
   channels to Netscape; and by improving Explorer, it made the last
   channel virtually irrelevant.

   For starters, Microsoft made Explorer free in early 1995 by
including
   it as part of Windows. This soon stopped Netscape from charging for
   its browser (which had cost between $39 and $49) and cut off the
   company's main source of revenue. Microsoft insisted that
   manufacturers of personal computers (companies such as Compaq,
   Hewlett-Packard, and IBM, called "original equipment manufacturers,"
   or OEMs) offer Windows with the pre-installed Explorer. When Compaq,
   then the world's largest PC maker, decided to feature Navigator over
   Explorer on some computers, Microsoft objected. It maintained that
   this would violate the terms of its license for Windows. It then
   threatened to withdraw the license, a move that could have put
Compaq
   out of business. Compaq backed down.

   There were other ways to promote Explorer. In 1996, America Online,
   the largest ISP, decided to offer Explorer to its customers. In
   return, AOL was included in a preferential "folder" for ISPs on
   Windows. In 1997, Microsoft settled a series of disputes with Apple
   and agreed to invest $150 million in the financially strapped
company,
   and one condition of the settlement was that Apple feature Explorer,
   not Navigator, on its computers. Finally, some OEMs got price
   discounts on Windows to promote Explorer. For a student of monopoly,
   all this looks incriminating. First you give away the product,
forcing
   the competitor to do likewise; then you pressure your (dependent)
   customers to smother the rival's product; finally, you bribe your
   customers to favor your product a bit more.

   Judge Jackson adopted the government's "facts" and legal theories
   almost in their entirety. Microsoft had alternative explanations for
   what happened: AOL was said to have adopted Explorer because it had
   better technical features than Navigator. But Jackson was so
offended
   by Microsoft's witnesses that he didn't give much weight to these
   stories. We know this because Jackson has told us. Although he once
   advised judges not to talk to the press, the judge flagrantly
violated
   his own dictum. After his rulings, he gave numerous interviews, and
   while the trial proceeded he spoke extensively with Auletta on the
   condition that nothing could be used until after the trial was over.
   "Truth be told," Jackson said, "a lot of Microsoft's witnesses were
   not credible."

   As tales of the trial, both Auletta's and Heilemann's accounts are
   splendid, extensively reported, and well written. I prefer
Heilemann's
   account for several reasons. For a start, it is about half the
length
   of Auletta's tome; Auletta seems to have dumped everything in his
   notebook onto the printed page. And Heilemann shows in convincing
   detail--not available in Auletta's account--that the government's
   antitrust suit was actively promoted by Netscape. The company's
   attorneys assembled evidence and (along with other Microsoft rivals)
   aggressively lobbied the Department of Justice to sue. According to
   Heilemann, the lobbying was critical in persuading Joel Klein, then
   assistant attorney general for antitrust, to file. For better or
   worse, legal action now plays an important role in economic
   competition.

   But finally both these books are disappointing. Sooner or later,
   almost all reporters cover a story that they think is so dramatic
and
   so significant that its narrative cries out to be told in exhaustive
   and enthralling detail. United States of America v. Microsoft
   Corporation struck Auletta and Heilemann as just such a story. They
   were wrong. It isn't. The human drama is muted: Boies, Gates, Klein,
   and Jackson just aren't that interesting. The case is significant,
to
   be sure; but its significance lies in the very issues of economic
and
   social power that, by hewing so closely to the court proceeding,
   neither Auletta nor Heilemann engages directly. In this sense, they
   miss the story.

   III.

   Presumably, the antitrust laws exist to advance some larger public
   interest. The trouble with the government's case is that it never
   demonstrated that Microsoft harmed this larger public interest. It
   never demonstrated, in particular, that the brutal competition made
   consumers worse off. Traditional economic theory holds that a
   monopolist uses its market power to raise prices and to suppress
   innovation. Competitive markets would lower prices and increase
   innovation. But this is a hard case to make against Microsoft.

   Microsoft sells Windows for pre-installation by computer makers
   (Compaq, Dell, IBM, and other OEMs) for about $50 to $60 per copy.
The
   retail price of Windows 98 (cited by Jackson) was $89. These levels
   are hardly oppressive. On a typical personal computer sold in the
late
   1990s, they might represent 2.5 percent to 10 percent of the final
   price to the consumer, as the economist Richard McKenzie notes in
   Trust on Trial. McKenzie visited a local computer store in November
   1999 and found the retail prices of OS-2 (an IBM operating system)
to
   be $110 and the price for Apple's Macintosh operating-system
software
   to be $85. Suppose that there were four or five major competing PC
   operating systems. Would all or any of the prices be much lower than
   the price for today's Windows? This seems unlikely.

   As for suppressing innovation, Microsoft's power to do so was
limited.
   Having belatedly recognized the Internet's significance, and also
its
   threat, Microsoft did not try (as it might have) to frustrate the
   Internet's expansion. Quite the opposite. By bundling Explorer with
   Windows, Microsoft made it easier for computer users (many of whom
   were undoubtedly technophobic) to use the Internet. The intense
   competition between Netscape's browser and Microsoft's browser
   probably hastened public acceptance of the Internet. At the trial,
   James Barksdale, Netscape's former chief executive, testified that
   Microsoft's capture of the browser market would harm innovation
   because there would be no pressure to improve the technology. His
   prediction may one day be vindicated, but it has not been yet.

   One reason Microsoft won the browser war is that it ultimately
created
   a better product. By late 1996, Jackson found, users could not tell
   the difference between Explorer and Navigator. By fall 1997,
   Explorer's quality was rated equal or superior to Navigator's by
many
   technical reviewers. Although Netscape could still distribute its
   product over the Internet or as a CD sent through the mail, computer
   users had less reason to adopt it. Despite its present market
   dominance, Microsoft still issues new versions of Explorer.
Similarly,
   Netscape, which is now owned by America Online, continues to improve
   Navigator. Comparing the latest versions of both, Walt Mossberg, the
   computer columnist for The Wall Street Journal, concluded that
   Navigator causes a PC to crash more often than Explorer. "I can't
see
   any real reason for satisfied Internet Explorer users to switch to
   Netscape 6.0," he wrote, "unless they wish to make an anti-Microsoft
   statement."

   In his decision, Jackson claimed that consumers had suffered harm
from
   Microsoft's power. But this is a mere assertion, with little
   supporting evidence. Worse, Jackson did not consider any possible
good
   that might flow from Microsoft's domination. Microsoft created an
   almost universal standard for PCs. This had huge practical benefits.
   It meant that computer users, having learned one system, would not
   have to learn another. They could move from job to job without being
   re-trained on new computers. They could transfer disks from office
PCs
   to home PCs, from desktop PCs to laptop PCs. The standard meant that
   application software (for writing, games, tax preparation, inventory
   control, and other tasks) could conveniently be written for a single
   operating system. This expanded the availability of software.
Perhaps
   seventy thousand programs can run on Windows, compared with twelve
   thousand for Macintosh, Jackson found.

   Economists call this process a "network effect." The larger a
network,
   the more useful it is. If only two people have fax machines, they
are
   not very useful. If sixty million people have fax machines, they are
   quite useful. Ditto for telephones, e-mail, or software. If many
   people use a software program, the price can be lower. Microsoft
   spawned a vast worldwide network of people using computers with
   Windows. This was not pre-ordained. In the late 1980s, Apple's
   Macintosh was widely regarded as easier to use than PCs with
Microsoft
   software. But Apple's business model was different. It decided to
   maximize profits by owning as much of the final product as possible.
   It made and sold computers. It wrote the operating software for
   Macintosh. It did not license the software to others.

   By contrast, Microsoft's approach was (perhaps of necessity)
   different. In 1981, IBM selected Microsoft's ms-dos software to run
   its first personal computer, which used Intel computer chips. In a
   massive blunder, IBM chose to license the software rather than to
buy
   it. Microsoft kept ownership and licensed it to any company that
   wanted to make PCs based on the IBM-Intel-Microsoft model. The
result
   was a new industry of personal-computer makers, led by Compaq, Dell,
   and Gateway, among others. Competition was fierce. Companies adopted
   new methods of manufacturing, marketing, and distribution. PC prices
   declined, especially compared to Apple's. Application software
   expanded.

   As McKenzie shows in great detail, Microsoft consistently sought to
   expand and to enhance the network by keeping prices low and adding
new
   software features. It was this business model, not Apple's
restrictive
   rival, that accelerated the rise of a mass market for personal
   computers. There is a certain irony that Microsoft's model, which
   created more opportunities for hardware companies and other software
   firms, is now under antitrust assault.

   IV.

   The paradox, then, is that Microsoft seems to possess and to
exercise
   monopoly power, but not to enjoy the presumed benefits of higher
   prices and less innovation. How can this be? The most important
reason
   is the nature of Microsoft's market.

   Almost all products and services experience a period of explosive
   growth--from the point when the product is unknown--before reaching
   maturity. During the explosive phase, prices usually drop sharply.
   Companies discover lower-cost methods of production. Lower costs in
   turn expand the market, and higher sales decrease unit costs. At
   maturity--at market saturation, when the product has achieved
   widespread acceptance--companies must survive on the sluggish growth
   of population increases, replacement purchases, or repeat business.
If
   your car wears out, you buy a new one. If you like a new restaurant,
   you go back.

   For personal computers, the 1980s and the 1990s were the period of
   explosive growth. The expectation was that, like Henry Ford and the
   Model T, profits would come more from volume than from price. Gates
   was very much of this mind. Companies (such as Apple) that pinned
   their success more on pricing power belatedly discovered that this
   strategy was short-sighted and self-defeating. The point is simple.
   Even if Microsoft possesses monopoly power, this was the wrong time
to
   attain to the archetypal consequence of monopoly: higher prices.
Gates
   simply didn't believe that gouging made business sense.

   There was also something else that frustrated Microsoft's monopoly
   power. Again, companies in mature markets can depend on a steady
   replacement demand. Your car will wear out. It will need
maintenance.
   At some point, its high maintenance costs will persuade you to trade
   it in. If car companies offer flashy new designs, you may buy a new
   model before your old one becomes a clunker. Many services also have
   steady demand: you constantly need to renew health insurance, or to
go
   to the cleaners. But this predictable demand does not apply to
   personal computers. They have few moving parts, so they do not wear
   out quickly. In this respect, they are more like televisions than
like
   cars. And unlike dry cleaning or insurance, many of the services
   provided by PCs do not require repeat purchases.

   The upshot is that the PC industry--the chip-makers, the software
   companies, the OEMs--needs to make customers discard their old PCs
   (which are still perfectly good) and buy new ones. The obvious
   solution is to make new models that do more things, and that do them
   faster and more cheaply. Corporate customers get greater performance
   for less price: an inventorycontrol system that works more swiftly,
   provides more information, and costs less to operate. Individuals
get
   simpler, more reliable, more versatile, and "cooler" machines.
   Marketing and innovation blend. The point, again, is simple:
   Microsoft--and everyone else in the PC industry--has a big stake in
   innovation. Otherwise sales will stagnate.

   And high-tech companies hate stagnation. They are obsessed with
   growth. Without the prospect of rapid growth, investors will not
   envisage huge future sales and profits that rationalize--perhaps
   foolishly--high stock-market valuations and price-earnings (or PE)
   ratios. Companies need high stock prices and high PE ratios to lure
   new employees with stock options, to raise new money by selling more
   stock, or to buy other companies with their shares. (A PE ratio is
the
   relation between a firm's stock price and its profits, expressed as
   earnings per share. Historically, stocks have had a PE ratio of
   fourteen; but many high-tech firms have recently had PEs in the
   hundreds or even the thousands.) Microsoft shared the obsession with
   the stock market. Indeed, Microsoft helped to create it. Thousands
of
   its employees have stock options.

   [INLINE]

   ut if microsoft's markets prevented it from being a textbook
   monopolist, the same markets conditioned it to act like a bully. No
   book better defines the mentality of today's high-technology
   industries than Only the Paranoid Survive, by Andrew Grove, the
   chairman of Intel. Published in 1996, Grove's book portrayed
business
   success as fragile and constantly threatened. If you don't worry
about
   everything, you may soon not have to worry about anything. And you
   should worry most about "strategic inflection points": basic
business
   changes that might propel your firm to new heights or consign it to
   oblivion.

   Grove argued that these strategic inflection points occur in most
   industries. The advent of Wal-Mart and other superstores obliterated
   many local stores, regional chains, and old-line discount stores.
Yet
   the upheavals seem more common in industries dominated by
   technological change. Personal computers threatened traditional
   computer firms. Many foundered, and Digital Equipment Corporation,
   once the second largest computermaker, did not survive. Grove's
theme
   has now become dogma in the high-tech world. "My job is to delegate
   paranoia," Steve Case, the chairman of America Online-Time Warner,
   told Auletta. Gates has written that "sometimes I think my most
   important job as CEO is to listen for bad news."

   More than anyone, Gates personifies management by paranoia. He lives
   in a harsh world of threats and opportunities. This helps to explain
   both Microsoft's success and the loathing that it inspires. When
Gates
   pursues another company's business, he does not go after a little of
   it or most of it. He goes after all of it. It's eat or be eaten.
   Interestingly, some of Netscape's top officers had the same idea.
They
   bragged that they could topple Microsoft. As Auletta and Heilemann
   observe, Microsoft could have plausibly argued at trial that its
   attacks on Netscape were simply a response in kind: they tried to
kill
   us, so we tried to kill them. Instead, Gates and Co. pretended
   unconvincingly that they were not especially bothered by the
Netscape
   threat. Gates probably saw Netscape's challenge as a potential
   strategic inflection point--a struggle that, if lost, might lead to
   ruin.

   He may have been right. But he may also have misjudged the true
   strategic inflection point confronting Microsoft. In the early
1990s,
   Microsoft ceased being an ordinary company and became a company that
   had to watch its relationship with the government. When companies
   attain a certain critical mass of size and power, the government
   inevitably becomes a lightning rod for complaints and
   discontents--from competitors, customers, and the public. Microsoft
   simply joined the likes of General Motors. The complaints may or may
   not be justified; but any company concerned with its own well-being
   will try to anticipate them and, if possible, to defuse them. And
   surely, once they occur, it will take them seriously.

   Gates and his associate Steven Ballmer failed to make this
transition.
   They had ample warning: in 1994, the government and Microsoft had
   reached an antitrust consent decree involving practices that the
   Justice Department regarded as anti-competitive. Afterwards Gates
and
   Ballmer treated the consent decree contemptuously. They did nothing
to
   moderate Microsoft's hyper-competitive behavior. Would it really
have
   been crippling to allow Compaq and other computer makers to offer
   Navigator as the preferred browser, if some customers wanted
   Navigator?

   Explaining Microsoft's take-no-prisoners attitude, Auletta and
   Heilemann contend that Gates and Ballmer were determined to avoid
the
   fate of IBM, which lost its dominance of the computer industry
   arguably because the company became bureaucratic and fearful of
   antitrust suits. "The minute we start worrying about antitrust, we
   become IBM," Gates once remarked, according to Heilemann. There may
   have been other reasons. Perhaps Gates and Ballmer were too
parochial:
   so immersed in business that they could not see anything else.
   Whatever the explanation, the lapse represented a real failure of
   corporate management, and it opened up Microsoft to a government
   action that more astute executives might have avoided.

   Regardless of how the antitrust case concludes--Microsoft might win
   reversal of some or all of Jackson's rulings--it has cost Microsoft
   dearly. On this, Auletta and Heilemann also agree. There has been a
   huge drain on the time and the energy of top executives; some of
them
   have left. It has tainted the company's image, probably irreparably,
   an image that had been (except among some disgruntled techies and
   corporate rivals) immensely favorable. Microsoft was once everyone's
   example of America's entrepreneurial genius at work.

   The financial costs have also been substantial: one official told
   Auletta that the trial expenses could total $100 million. But if
   Microsoft ultimately loses, there might be damages (perhaps in the
   billions) from private lawsuits. Some see Microsoft as a victim of
the
   government's excesses, but it is a victim also of its own.

   V.

   Today's antitrust laws cannot deal easily with the likes of
Microsoft.
   These laws were crafted to enhance Adam Smith's competition, and
they
   founder on Joseph Schumpeter's competition. Smith's competition
   assumes that the more competitors, the merrier. It assumes that
   sellers peddle similar products or services. Schumpeter's
competition
   is a struggle between the old and the new. The number of sellers
does
   not really matter. Much competition in the computer world is of the
   Schumpeterian type, and the intellectual foundation of today's
   antitrust laws lacks a coherent basis for distinguishing between
   socially desirable behavior and socially destructive behavior. This
is
   why the Microsoft case is so confusing. Microsoft seems to have
   behaved badly without hurting anyone, except its rivals.

   The most damning commentary on the government's case came from its
   chief economic witness, Franklin Fisher of the Massachusetts
Institute
   of Technology. Asked whether consumers were being victimized by
   Microsoft, he said: "On balance, I would think the answer was no, up
   to this point." The government wants Microsoft broken into two
   competing firms on the basis of hypothetical harm. One company would
   own Windows; the other would own all of Microsoft's other activities
   (the browsers and application software). Competing against each
other,
   the companies would (supposedly) create rival operating systems and
   applications. There have been countless other imagined outcomes,
from
   two complementary monopolies to a chaos of competing operating
   systems.

   As sensible policy, the proposed breakup seems a stretch. Yet Fisher
   and economist Daniel Rubinfeld (formerly the anti-trust division's
   chief economist) argue that this is precisely what the antitrust
laws
   allow. "Antitrust law does not require proof of such [consumer]
harm,"
   they write in Did Microsoft Harm Consumers?, a recent publication of
   the American Enterprise Institute. "The law merely requires harm to
   competitors on the general presumption that such harm, in turn,
leads
   to harm to consumers." Here is the crux of the issue. Everyone
agrees
   that competition is good, but hardly anyone faces the hard question
of
   what constitutes competition. The loose language of antitrust laws
   gives courts much leeway in defining permissible behavior.

   The government's argument against Microsoft, if accepted, could
   transform antitrust laws into legal weapons deployed by companies
   against their rivals and disconnected from any larger public
interest.
   Any company that achieves market dominance might face suits from
   disgruntled competitors, alleging antitrust violations. Consumer
harm
   would be assumed, even if it could not be found. The antitrust laws
   could evolve into an official sanction against striving and success.
   Boorish and bullying behavior would be criminalized.

   This would be undesirable. The boundless ambition of people such as
   Gates helps to perpetuate America's vitality. As often as not, the
   creators of great enterprises are driven, single-minded,
unreasonable,
   passionate, highly competitive, relentless, self-righteous, and
   egocentric. They are not always likable. They see business as a
   merciless struggle. "This is rat-eat-rat, dog-eat-dog. I'll kill
'em,
   and I'm going to kill 'em before they kill me," Ray Kroc, the
founder
   of the McDonald's chain, once said. Gates belongs to this class.
They
   may or may not be good neighbors, friends, or parents; but their
   obsessiveness fosters new ideas and industries. Their success ought
to
   be curbed and penalized only if it becomes abusive to the larger
   society.

   But what if there is no way of assessing abuse? Microsoft's power,
and
   the resentment that it inspires, lies in the network. Most personal
   computers use Windows. This creates huge benefits of
standardization,
   while also conferring on Microsoft immense economic and
technological
   power. Many of Microsoft's customers and competitors naturally
regard
   it as a despot, benevolent or otherwise. Everyone that depends on
   Windows is vulnerable to Microsoft's next whim. Given the network's
   importance, the interesting thing about the Microsoft trial is how
   little attention was paid to it.

   In some ways, this was understandable. The government could not
focus
   on it without inviting a cost-benefit calculation of the network's
   value; and this might have gone in Microsoft's favor. But Microsoft
   could not raise the network's value in its defense, because its
   position as the network leader looks like a "natural monopoly"--and
   past natural monopolies (such as the telephone company and the
   electric utilities) have been regulated by the government to prevent
   abuses of their pricing power. Microsoft did not want to justify
   government supervision of its operations. The perverse result was
that
   the central questions posed by the Micro-soft antitrust case were
   virtually ignored. How can society deal with the network? Should
   society deal with the network?

   Just because the Justice Department's case against Microsoft is weak
   does not mean there is no case. The great fear inspired by Microsoft
   is that it will use its huge profits from Windows to extend its
   reach--its monopoly--into related markets. It will incorporate more
   and more new software into Windows, just as it incorporated the
   browser. And it will overwhelm competitors in many software markets.
   This has already happened in popular applications (word processors,
   spreadsheets). It may now be happening for software for servers--the
   computers that manage networks of other computers. A decade ago,
   Microsoft's share of this market was negligible; today it is rising
   rapidly.

   To its critics, Microsoft is the grim reaper. Wherever it ventures,
   its rivals ultimately die. This specter is plausible. I have argued
   that so far this process has mostly benefited the public. The
   conquests involved mostly competitive (or superior) products at
   competitive prices. But this may not always be true. Microsoft's
   intensely competitive behavior reflects the youth of the personal
   computer industry and all its derivatives, including the Internet.
   Once the industry matures, things could change. Microsoft might
   compensate for slower growth by raising prices. At least in the
short
   run, it faces few restraints. And so many computer users, both
   companies and individuals, may be locked into Microsoft's technology
   that the costs of changing it would be prohibitive. Technology could
   become rigid, if not frozen. What will curb Microsoft's power then?

   [INLINE]

   here are answers, but none of them is entirely satisfactory. Judge
   Jackson ruled that Microsoft's market consists of desktop computers
   with Intel-like chips. In this market, Microsoft enjoys a
   near-monopoly. But what if the true market is much broader: the
   delivery and the display of digital information? Then Microsoft's
   position is much weaker. In many areas, its ambitions remain
   unfulfilled. Its online Internet service (MSN) lags far behind
   AOL-Time Warner. Palm Pilot dominates the hand-held computer market,
   not devices using Microsoft software. Similarly, Microsoft has
   struggled to be a major player in writing software for wireless
   devices. Threats from alternate technologies, existing and not yet
   existing, may check Microsoft's power and complacency.
Interestingly,
   Schumpeter seemed to embrace this view. His sort of competition, he
   wrote, acts before it assumes a concrete form and only is "an
   ever-present threat. It disciplines before it attacks."

   What also restrains Microsoft is its reputation for ruthlessness. As
a
   software company, it needs partners, such as hardware companies (the
   makers of computers, wireless devices, or other "boxes"). The very
   characteristics that make Microsoft an attractive partner--its
wealth,
   prominence, market power, and drive--also scare possible partners.
   Dependence on Microsoft may seem like a death wish. Auletta relates
a
   telling story of Gates meeting with the heads of major
   cable-television companies. He was trying to persuade them to adopt
   Microsoft's software for set-top boxes that would provide television
   access to the Internet and interactive television. Gates wanted a
fee
   for each box and fifty percent of any revenues from interactive
   transactions or Internet advertising. According to Auletta, the
   cable-television chiefs were stunned by Gates's proposal. A fee was
   reasonable. A cut of their revenues was not reasonable. He wanted
   control of their business. Brian Roberts, the head of Comcast--a
   company in which Microsoft had an 11.5 percent ownership
stake--broke
   the silence: "Bill, let me be the first to express our reaction: no
   fucking way."

   Microsoft's rise has been so stunning that it naturally casts itself
   as a morality tale: "Small Company Becomes Amazing Success but Is
   Undone by Its Own Power and Wealth." Once upon a time, Heilemann
   writes, "interviewing Bill Gates was one of the great pleasures in
   journalism." He was unlike most corporate CEOs or major politicians,
   who are "polite and pleasant to the point of inanity ... and [who]
   ooze false sincerity and exude excess optimism." Gates, by contrast,
   was candid, engaging, offensive, and profane. But when Heilemann
   visited Gates in early 1999, he found someone who is "guarded,
distant
   and defensive." He had been ground down by the consequences of his
own
   success.

   This story no doubt contains much truth. But the larger story is one
   of ignorance. As a society, we have yet to reconcile old laws with
new
   technologies and new industries. Economists, legal scholars,
business
   leaders, and politicians need to develop a consensus, or at least
some
   rudimentary understanding, about how, if at all, to police
   Schumpeter's competition. Right now there is only a huge black hole
of
   knowledge. Sooner or later the Microsoft case will be resolved. It
   might be settled by the company and the government; or the courts
may
   determine Microsoft's fate. But the unsettling fact is that nobody
can
   possibly know the consequences of curbing Microsoft's power or of
   leaving it alone. One way or another, we will all be driving in the
   dark.

   ROBERT J. SAMUELSON writes a column for Newsweek and The Washington
   Post Writers Group. He is the author, most recently, of Untruth: Why
   the Conventional Wisdom Is (Almost Always) Wrong (Random House).


   RELATED LINKS
   TNR Online's Books and Arts Newsletter
   Free news, links, and special features. E-mailed weekly.
   Slamming Gates
   Is Microsoft-bashing good for you?.
   the new republic Unsweet Smell of Success
   Jackson Lears on how Bill Gates makes J.P. Morgan look good.
   Software Baron
   Richard Wolffe on what's at stake in the Microsoft trial.
   Copyright 2001, The New Republic


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