Commentary: Justice Vs. Microsoft: Why It Has A Case

In taking on Microsoft Corp., federal enforcers are trying to answer a crucial question: Is antitrust relevant in the Digital Age? A loud chorus of critics has come forth with a resounding "no."

These naysayers argue that the Justice Dept. can't apply laws designed to combat 19th century railroad trusts in the era of cyberspace. They worry that the heavy hand of government, as empowered by legislation such as the Sherman Antitrust Act of 1890, could stifle innovation in a rapidly changing industry.

SINGLE STANDARD. But the critics may have been too quick to dismiss the regulators. Instead of basing his attack against Microsoft on outdated economic theories that demonize bigness, Assistant Attorney General Joel I. Klein is relying on a developing body of antitrust thinking that warns that the threat of anticompetitive behavior could be even greater in high technology than in traditional industries. This research on "network externalities" deserves to be taken seriously.

The focus of this new thinking is on network industries, such as telecommunications and computing. These types of businesses depend on single standards so that users' machines can communicate with one another. The value of the network standard increases as more users subscribe. And as the value rises, more users hop on the bandwagon--a phenomenon that led to Windows' dominance as the personal computer's operating-systems standard.

Once a standard becomes dominant, consumers change at their peril. When, for example, an operating system takes the lead, "it attracts further software developers and hardware manufacturers to adopt it, which helps it get further ahead," says W. Brian Arthur, a professor at Sante Fe Institute, a think tank. Arthur calls this phenomenon "increasing returns"--the tendency for a company at the forefront of an industry to gain an even stronger lead. When that happens, he says, it doesn't pay for consumers to switch, even if another system is better or cheaper.

That's not the case in traditional manufacturing. A dominant steelmaker, for example, would have a far more difficult time with the sheer logistics of tying up all distribution and raw materials. If a rival introduces a worthy product, the monopolist's edge will begin to erode. But in the high-tech market, the network features that helped a company gain dominance "may make it more difficult for new entrants to dislodge the market leader," says Carl B. Shapiro, an economics professor at the University of California at Berkeley.

Network theory was conceived a decade ago by a small circle of economists, including Arthur and Shapiro. As the economy continues to shift from a commodity market to an information-based one, the theory is gaining mainstream respectability. A year ago, Federal Trade Commission Chairman Robert Pitofsky devoted much of his seminar on high-tech antitrust to network effects. "This is one of the most important lines of modern research," says William E. Kovacic, a professor at George Mason University School of Law.

The Microsoft case is one of the first ever in which Justice has made use of network theory. Antitrust enforcers' biggest concern is that the computer giant can leverage its "locked-in" customer base to dominate the next generation of technology--for example, the market for Internet browser software. "If I have a steel monopoly, my ability to leverage to autos is not tremendous," says Garth Saloner, a professor at the Stanford University Graduate School of Business. "But if I have an operating system, I can own all kinds of things downstream."

NET CONTROL. Indeed, antitrust enforcers worry there's more at stake than just the browser wars. Merely by determining what consumers see when they click on their computers, Microsoft could conceivably control much of the commerce on the Internet. It already has travel, financial planning, and car-buying services, and it plans to get into real estate information.

That's just the kind of market power that should concern antitrust regulators. While it's true that high-tech industries may be a far cry from the railroad trusts of yore, the "wonderful [thing] about antitrust is that it evolves," says Klein. By using new economic analysis, he is making a legitimate effort to push antitrust law into the next century.

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