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               Creative Insecurity 
               The complicated truth behind the rise of Microsoft 

               By Virginia I. Postrel 

               Back in 1983, Forbes ran an article called "If they're so smart,
               why aren't they rich?" It was about how inventors rarely reap
               big financial rewards from their creations, and it started like
               this:

               "Here are some names you are not likely ever to see in The
               Forbes Four Hundred [list of the richest Americans]: Franklin
               Lim. Gary Kildall. Bill Gates...."

               Oops.

               The world's richest man wasn't always so. During the last
               round of high-tech excitement--the personal-computer boom of
               the early 1980s (which was followed by a traumatic
               shakeout)--Gates looked like a smart programming geek whose
               business savvy was dwarfed by the marketing whizzes at
               Apple: "Their Apple Corp.," wrote the anonymous Forbes
               author, "has been among the most successful at packaging a
               product that sells and then selling it at an attractive price."

               Therein lies a tale. As the Justice Department and a half-dozen
               state attorneys general push forward antitrust actions against
               Microsoft, it's worth considering how the company got where it
               is and what that suggests about the strengths and limitations of
               markets.

               There are two main fables told about Microsoft: It has become
               the dominant, standard-setting software company, and made
               Gates a multibillionaire, because a) it makes wonderful
               products and expresses all that is good about a capitalist
               system or b) it cheats. Both fables turn up especially strongly in
               statements by people who lack deep knowledge of the
               industry, and each serves the interests of an industry faction.

               The truth, however, is more complicated. Considered without
               regard to price, ubiquity, or compatibility with inexpensive
               hardware, many Microsoft products are mediocre at best. I am
               happily writing this article using an obsolete Macintosh
               operating system and WordPerfect, both of which I find
               superior to even the latest versions of Windows and Word.
               Great products did not make Microsoft number one.
               Good-enough products did.

               That uncomfortable truth offends moralists on both sides of the
               Microsoft debate. The company's fans (and its spin doctors)
               want to tell a simple tale about virtue triumphant--with virtue
               defined, Atlas Shrugged-style, not only as astute business
               decision making and fierce competition but also as engineering
               excellence. Its critics use the same definition. If the products are
               less than great, they suggest, the only way to explain the
               company's success is through some sort of sleaze. Or,
               alternatively, through the innate flaws of the market.

               So what really happened? How did Microsoft end up ruling PC
               operating systems and, through them, software in general?

               At the risk of simplifying a complex story (if only by reducing
               it to two players), the bottom line is this: Apple acted--and
               continues to act--like a smug, self-righteous monopolist.
               Microsoft acted--and continues to act--like a scrambling,
               sometimes vicious competitor.

               That pattern shows up most clearly in pricing strategies.
               Microsoft's approach, throughout its history, has been to charge
               low prices and sell an enormous amount of software. True to
               form, the company is currently in trouble with the Justice
               Department for charging too little--nothing--for its Internet
               Explorer, by including it in Windows. (The technical legal
               dispute is over whether Explorer is a "feature" of Windows, as
               Microsoft maintains, or a separate product that is an illegal
               "tie-in" and thus violates a consent decree Microsoft signed in
               1995.)

               The low-price strategy makes sense on two levels: First, it
               approximates marginal-cost pricing, since software, once
               written, costs very little for each additional copy. Anything
               above that incremental cost, however small, is profit. Second,
               and more significantly in this case, lower prices mean more
               customers. And the more people who use a particular kind of
               software, the more desirable it is for others to use it too.
               Although translators help, switching formats is messy and
               inconvenient. This "network externality" is particularly
               important for operating systems and Internet browser formats,
               since software developers and Web site designers have to pick
               a standard for which to optimize their products.

               As Gates toldWall Street Journal reporter Jim Carlton in an
               interview for Carlton's new book Apple: The Inside Story of
               Intrigue, Egomania, and Business Blunders, "Momentum
               creates momentum. If you have volume, then people write
               apps. If people write apps, you have momentum."

               But if you think you already have a monopoly, you don't
               worry about momentum. While Apple executives theoretically
               knew they had competition, they acted as though they didn't.
               Back in 1983 Apple may have been "selling [its computers] at
               an attractive price." But the coming of the IBM clones made
               Apple's prices look downright hideous. In the face of
               ever-stronger competition, the company insisted on pricing the
               Macintosh to maintain at least 50 percent profit margins; its
               "50-50-50 rule" told managers to keep margins up to maintain
               the stock price.

               Customers who paid their own personal money for Macs might
               be able to justify the high price simply because the computers
               were fun and easy to use. But business managers who paid
               Apple prices for any but the most specialized applications,
               notably graphics-intensive work, were either fiscally
               irresponsible or just plain dumb. Apple's pricing strategy
               handed the vast business market to computers running
               Microsoft operating systems, first DOS, then Windows.

               Microsoft, of course, doesn't sell computers. It's in the software
               business. You can get its operating system (and run its
               applications) on all sorts of different machines, whose
               manufacturers compete intensely. That competition drives
               down consumer costs, even as machine features get better all
               the time.

               Apple didn't want that sort of competition. It not only kept its
               own prices high but refused to license its software to any other
               computer maker. That meant even fewer people used its
               operating system, which further dampened its momentum.
               Apple, in fact, acted like the ultimate "tie-in" monopolist. You
               not only couldn't buy parts of its software separately; you
               couldn't buy them at all without forking over thousands for an
               Apple-made machine. And Apple has never been particularly
               good at manufacturing.

               After the company tepidly began licensing a couple of years
               ago, Mac clone makers did what Apple had feared: They cut
               into its revenue. But they also expanded the market, and they
               made the fastest computers ever to carry the Mac operating
               system. They gave Apple money for its software, even as they
               bore the costs of manufacturing and distributing their
               machines. And they gave consumers more choice, more
               alternatives to Windows. If I were an antitrust regulator
               looking for conspiracies, I'd be wondering just how
               coincidental it was that Microsoft invested $150 million in
               Apple just about the time Steve Jobs announced that the
               company was ending the clone program.

               Such explanations aren't necessary, however. Apple screwed
               Mac lovers all by itself. Far from the marketing whizzes of 1983
               conventional wisdom, its executives were enamored with the
               cult of the machine, too hung up on the beauty of their product
               to understand that consumers actually cared about many other
               things: price, plenty of software, and compatibility with other
               systems. Quality is not one-dimensional.

               Apple's arrogance left computer users with less choice than
               they might have had--or, perhaps, with more. After all, if Apple
               had slashed prices early on and taken the business market
               seriously from the start, it could well have ended up in a
               Microsoft-like position, but without having to share its market
               with clones. Microsoft would then have been mostly an
               applications company, selling Excel and Word to Mac users,
               and we'd be hearing about the evil, anticompetitive actions of
               Steve Jobs.

               That seems unlikely, however, and the reason is revealing.
               Apple's all-in-one-box strategy was inherently brittle. It offered
               too many margins of error and too few margins of adjustment.

               The same company wrote the software and made the machines.
               So if the computers caught on fire, as they sometimes did, or
               the manufacturing plants couldn't keep up with Christmas
               demand, there was no alternative outlet for the Mac operating
               system. Software sales dropped too. No competitive sales force
               could go after business users while Jobs and company were
               chasing public schools. All new ideas had to come from within
               the same closed system. (For a discussion of related issues, see
               my Forbes ASAP article "Resilience vs. Anticipation". While
               Apple is based in Silicon Valley, its self-sufficiency strategy
               more closely resembles those of the minicomputer companies
               based around Boston.)

               Microsoft's partner-dependent system proved far more resilient
               as the industry changed. The company didn't have to do
               everything itself, and it could reap the benefits of innovations
               by others, whether in manufacturing, assembly, distribution, or
               applications software. Instead of the best minds of a single
               company, it enlisted the best minds of hundreds. And while
               Microsoft depended on its partners to build the market, in time
               they came to depend on Microsoft. The irony is that by making
               alliances and competing furiously--by not acting like a
               monopolist--Microsoft wound up reaping the benefits of a
               near-monopoly on its operating system.

               It is emphatically not true that "when you buy a computer, you
               already are without any choice as to the operating system," as
               Microsoft critic Audrie Krause said on Crossfire. Both
               REASON's production department and I personally will be
               buying new Macs in the next few months. Translation software
               makes it relatively easy to go from one operating system to
               another. Nowadays, it's possible to function reasonably well
               with an operating system that controls only 5 percent of the
               new-computer market.

               The great fear of Microsoft's critics is that the company will
               wind up controlling everything, foisting mediocre-to-poor
               products on an unwilling public at ever-higher prices. It's
               impossible to disprove that hypothetical scenario. But history,
               and Microsoft's own intense paranoia, cast doubt on it. Just
               when its quasi-monopoly looks secure, something
               new--Netscape's Web browsers, Sun Microsystems' Java
               programming language--pops up and makes Microsoft
               scramble to maintain its position. So far its resilience has
               served it well, but the critics' scary scenario relies on more than
               successful scrambling. It requires absolute security, no future
               challengers. And that looks unlikely.

               Consider the smoking gun memo cited by Assistant Attorney
               General Joel Klein at the press conference announcing the
               Justice Department suit. An internal Microsoft document, it
               told marketing managers to "Worry about the browser share as
               much as Bill Gates does, because we will lose the Internet
               platform battle if we do not have a significant user-installed
               base. The industry would simply ignore our standards. At
               your level, that is at the manager level, if you let customers
               deploy Netscape Navigator, you lose the leadership on the
               desktop."

               I will leave it to the attorneys to divine what it means not to "let
               customers deploy Netscape Navigator," but one thing is clear:
               This is not a company that thinks like a monopoly. It is always
               running scared. There's always the possibility that something
               new could come along and destroy its franchise.

               Microsoft didn't get where it is by creating perfect products. It
               benefited as much from its competitors' mistakes as from its
               own considerable acumen. And it isn't shy about leaning on
               suppliers and intermediate customers, such as computer
               makers, to get its way. In the eyes of its critics, its success is
               therefore proof that something is amiss in the marketplace.

               But the market doesn't promise perfection, only a
               trial-and-error process of discovery and improvement. The
               fallible human beings who create products make mistakes.
               They let their egos and preconceptions blind them to what
               people really want. Or they just don't know enough, or adjust
               fast enough, to produce the right goods at the right time. That
               some of Microsoft's strongest current competitors--Sun and
               Oracle--are gripped by an anti-PC ideology, when customers
               love the independence and flexibility of personal computers,
               does not bode well for them.

               What is striking about the story of Microsoft is how adaptable
               the company has been. Gates's original vision of "a computer
               on every desk and in every home, running Microsoft software"
               didn't specify what sort of software or who would make the
               computers. It was an open-ended, flexible idea that built a
               resilient company.

               What Microsoft has delivered is pretty much what most people
               want: a way to use computers easily, for many different
               purposes. Its software isn't always elegant, but that's the
               criterion of programming elites, not everyday users. And
               though Microsoft is clearly the big kid on the block, it has
               enabled, and encouraged, lots of other software developers.
               Microsoft accounts for a mere 4 percent of industry revenue. As
               Eamonn Sullivan of PC Week notes, "A lot of companies are
               making a lot of money on the ubiquity of Windows, providing
               users with a lot of choice where they want it--on their desktops.
               That isn't the expected result of a monopoly."

               From 1969 to 1982, the Justice Department carried on a similar
               trust-busting crusade against IBM, which had behaved in many
               ways just like Microsoft. (An earlier antitrust action against
               IBM had been settled by a consent decree in 1956.) Millions of
               dollars were transferred from the taxpayers and stockholders to
               lawyers and expert witnesses. Enormous amounts of brain
               power were dissipated. Having to monitor every action for
               possible legal ramifications further constipated IBM's
               already-centralized culture.

               The suit was a complete waste. Whatever quasi-monopoly IBM
               had was broken not by government enforcers but by obscure
               innovators, working on computer visions neither IBM nor the
               Justice Department's legions of lawyers had imagined. Big Blue
               is still big, though it's smaller than it once was. But nobody
               thinks it could control the world. The world, it seems, is
               beyond that sort of control.