Is Microsoft a Monopoly?
Preliminary version
April 4, 2000
Steven Cuellar
Department of Economics
San Jose State University
San Jose, CA. 95129
Phone: (408) 924-5408
E-mail: SCuellar@email.sjsu.edu
Presented at the
Department of Economics Seminar
San Jose State University
San Jose CA. 95129
April 7 th 2000
Is Microsoft a Monopoly?
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This would occur in the case natural monopoly in which economies of scale result in a single firm producing at a lower cost than a large number of smaller competitive firms.
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Since the beginning of the antitrust trial against Microsoft there has been a great deal of commentary and analysis concerning the market position, pricing and strategic behavior of
Microsoft. The courts Finding of Fact and the recent Conclusions of Law have intensified the interest in the case and resulted in even more analysis and questioning of the courts findings. This paper adds to the current list of Monday morning quarterbacks questioning among other issues:
Whether or not Microsoft is a monopoly? Did they violate the antitrust laws? Have they harmed consumers? If the answer to previous questions is in the affirmative, then what remedies should be enacted? The purpose of this paper is to address the first and perhaps the most contentious question of whether or not Microsoft is a monopoly. Although most people have a general understanding of what a monopoly is, to eliminate any ambiguity it is helpful to establish a precise definition of monopoly. A generally accepted definition describes a monopoly as:
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A market composed of a single or dominant firm,
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That sells a good with no close substitutes,
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In a market with barriers to entry.
Thus, to be considered a monopoly a firm must satisfy all three criteria. It should be noted that even if a firm is determined to be a monopoly it is neither illegal nor pernicious in any sense.
It is an economic distinction devoid of any value judgement. Although the term monopoly may elicit a negative response in the minds of many, these reactions are very much misplaced. Indeed, monopolies are not necessarily harmful to consumer, and in many circumstances they can lead to outcomes more beneficial to consumers than competitive markets.
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Thus, the distinction of monopoly is not, as many perceive, necessarily damning.
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More accurately, De Beers is a cartel. However, the purpose of a cartel is to coordinate behavior among firms and act as a monopoly.
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The criteria used to define the relevant market are explained below.
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Nevertheless, the purpose of this paper is not to discuss the merits or limitations of monopoly, rather, the purpose of this paper is to objectively determine whether Microsoft fits the definition of monopoly given above. The paper proceeds with an examination of each component of the above definition and then discusses the ramifications of possessing monopoly power.
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A Market Composed of a Single or Dominant Firm
Monopoly literally means one firm. However, finding a market composed of a single firm is nearly impossible. Consequently, virtually no firm could be considered a monopoly. A more reasonable definition of a monopoly would include a market dominated by a single firm. For example, the De Beers company of South Africa, which controls 80% of the worlds diamond supply, is often used as a textbook example of a monopoly.
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OPEC is another example of a cartel that controls a large portion of the worlds oil supply and is therefore considered to wield monopoly power. Obviously, unless a market is very narrowly defined, a monopoly need not be a market composed of a single firm.
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We can also look to how the courts have defined monopoly.
Most antitrust enforcement today is based on the Sherman Antitrust Act of 1890 which makes “restraint of trade” and “monopolization” illegal, and the Clayton Act of 1914 which delineates specific behavior as illegal which tends to “substantially lessen competition or tend to create a monopoly.” Unfortunately, monopoly is defined in neither the Sherman nor Clayton
Acts. As an indication of monopoly, the courts often look at the share of a market a firm holds.
This is often referred to as the market share test. An indication of monopoly power is said to
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The second component of the relevant market is the geographic market. For products that are sold nationwide, the geographic boundaries of the market encompass the entire United
States. If a producer and its competitors sell only in a limited area, the geographic market is limited to that area. For our concerns, the relevant geographic market is the United States.
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Delong 1998.
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exist if a firm’s share of the relevant market is more than 70%. Consequently, how the relevant market is defined becomes critical in determining whether or not a firm is a monopoly.
The determination of the relevant market consists to two criteria: The relevant product or output market and the relevant geographic market.
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The relevant product market includes all products produced by different firms that have identical attributes. In addition, the relevant market includes products that are not identical but may be used as substitutes for one another.
For example, consider the 1956 case in which Dupont was judged to hold a monopoly in the cellophane market. Dupont controlled 100% of the cellophane market. However, although
Dupont controlled 100% of the cellophane market, it controlled only 20% of the “flexible packing materials” market which was also defined to include wax paper and aluminum foil. Because the courts determined the relevant market to be the “flexible packing materials” market, they ruled that Dupont did not constitute a monopoly.
As would be expected, defining the relevant market has become a primary concern in the
Microsoft case. Microsoft has argued that the relevant market is the “software market”, in which
Microsoft’s sales makes up only 5% of total dollar sales.
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Furthermore, Microsoft has even contended that the relevant market should be expanded to include the entire computer market
(hardware and software). In this case, Microsoft’s share of the relevant market would fall to even less than 5%. If, however, the relevant market is defined as the “operating systems” market, then
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U.S. v. Microsoft,
Findings of Fact
.
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The rule of reason was first enunciated in the 1911 antitrust cases against Standard Oil and American Tobacco. In the Standard Oil case, the court ruled that Standard Oil’s behavior in acquiring its monopoly power was illegal not being a monopoly per se.
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Microsoft’s Windows operating system makes up a much larger share of the market. Yet, even considering only operating systems, there is dissension as to how the market is defined. By most definitions, Microsoft is seen as holding between 80% and 90% or above of the personal computer operating systems market. In the current antitrust case against Microsoft, the court has defined the relevant market to be operating systems for, “single user personal computers with intel based processors.”
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Given the courts definition, Microsoft’s share of the relevant market is approximately 95%. This definition, however, is not without controversy since it excludes Apple computers, which run on Motorola processors, and makes up approximately 10% of personal computer sales. The courts definition also excludes network systems such as Sun Microsystems which produces expensive servers that are commonly used as work stations.
Although the definition of the relevant market and market share or dominance is important, a large market share or market dominance alone is not illegal. For example, in the
1920 case against U.S. Steel, the courts applied the so called “rule of reason” and determined that although U.S. Steel clearly possessed monopoly power, they controlled nearly 75% of the domestic iron and steal industry, they had not resorted to illegal acts to gain their monopoly position nor did they abuse their monopoly power.
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Hence, the “rule of reason” makes clear that market dominance or “size alone is not an offense” and that not all monopolies are illegal per se.
Only those monopolies that resort to illegal acts against competition to gain or maintain monopoly power are illegal.
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In particular, it is alleged that Microsoft used its monopoly power to artificially construct barriers to entry. The formal charges against Microsoft will be examined more fully later. 5
It is important to note at this time that Microsoft is not being charged with being an illegal monopoly. Nor is Microsoft being charged with gaining its market dominance or monopoly power illegally. Microsoft is being charged with abusing it monopoly power.
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Thus, how
Microsoft gained its monopoly position is irrelevant to the question of whether or not Microsoft is a monopoly. Unfortunately, because much of the literature addressing the question as to whether or not Microsoft is a monopoly focuses on how Microsoft acquired its dominance, I feel it necessary to address this particular question.
Although there are several explanations as to how Microsoft acquired it dominance in the operating systems market, I will concentrate on three specific explanations: A technical explanation, a strategic explanation and an admittedly simplistic explanation. These explanations are neither collectively exhaustive nor mutually exclusive.
The first deals with several interrelated concepts: Network externalities, first mover advantage and path dependency. It is argued that operating systems exhibit network externalities.
Network externalities can be direct and or indirect. A direct network externality occurs if the value of a good increases as more people use the good. Operating systems are said to exhibit direct network externalities because the value of an operating system, measured in terms of compatibility with others using the same operating system, increases as more people use a common operating system. For example, the sharing of files generally requires each user to use a common or at least compatible operating systems. The more people using a common operating system, the more people with whom I can share files.
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In addition a network externality can be indirect if the value of a good X increases as more of a complementary good Y is sold. Likewise, the value of good Y increases the more of good X is sold. As a result, there is an indirect effect on the value of good X through Y referred to as a positive feedback loop. Operating systems are said to exhibit indirect network externalities in that the value of an operating system increases the more software applications are available for that operating system. Similarly, the value of a software application increases the more people have an operating system that runs the application.
As a result of the existence of network externalities, both direct and indirect, consumers will prefer a common operating system that runs a wide variety of applications. Consequently, if an operating systems maker can be the first (i.e., first mover advantage) to reach a “critical mass” of users, consumers will chose that operating system over others thus directing the “path” of consumer demand. One explanation for Microsoft’s dominance of the operating systems market is that MS-DOS and subsequently Windows gained first mover advantage in reaching a critical mass of users which then lead to the dominance of Microsoft in the operating systems market.
A second explanation as to how Microsoft gained it dominance in the operating systems market is not unrelated to the first. In particular, it relates to Apples pricing blunders in marketing its own operating system. In the early years of personal computers when Apple and IBM were competing for dominance, Apple chose to maintain strict control over the licensing and distribution of its computers and operating systems. IBM, on the other hand, allowed others to copy or “clone” its personal computer configuration which lead to greater competition and lower prices for IBM and IBM compatible systems than for Apple’s systems. The lower prices for IBM based systems which used Microsoft’s operating system, allowed IBM to reach the critical mass
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first and hence become the dominant operating system.
A third explanation, again not unrelated to the previous two and one that Microsoft itself would argue, asserts that Microsoft has a dominant position in the operating systems market because Windows is simply better than other operating systems. That is, consumers have chosen to use Microsoft operating systems over others because it is a better product at a lower price.
As mentioned above, these are only three explanations out of many that have been posited, and these explanations are not mutually exclusive. In fact, taken together they provide a fairly complete view of how Microsoft acquired its dominance in the operating systems market. Note that Microsoft’s behavior in all three explanations is totally benign. In fact, actions by Microsoft played no role in the existence of network externalities in operating systems or in IBM’s choice to allow others to copy its personal computer configuration. Of the three explanations provided, the only action for which Microsoft is responsible, is producing a superior product. An action for which Microsoft is praised and not the action for which it is prosecuted. One factor that does run through all three explanations is that consumers freely chose Microsoft’s products over other products. Again, the fact that consumers viewed Microsoft’s operating system as superior and freely chose Windows over inferior products is laudable and is the desired result of the workings of a free market. That is, mutually beneficial trade in which consumers have gained and Microsoft has gained.
The important point to be made by the brief discussion of how Microsoft became a dominant firm is not that consumers freely chose Microsoft. Consumers always freely choose which products to consume. It is consumers who choose diamonds over other possible substitute goods and it is thus consumers who give De Beers its monopoly power. The important point is
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that just because consumers freely chose Microsoft’s products over others does not mean that
Microsoft is not a monopoly. Monopoly does not presuppose force upon consumers.
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Are there Substitutes to Microsoft’s Windows?
The second part of the definition above posits that a monopoly operates in a market with no close substitutes. The availability of a substitute good, however, is dependant on the definition of the relevant market. Consequently, as with the definition of the relevant market, the availability of a “close” substitute is a term open to a great deal of interpretation. To some extant, there are substitutes for all goods. How “close” a substitute one good is for another, however, is determined by consumers. As previously noted the De Beers company of South Africa is often used as an example of a monopoly because it controls 80% of the worlds diamond supply.
However, there are substitutes for diamonds. There is cubic zirconium, an artificial diamond. In fact, most consumers cannot distinguish between a real diamond and a cubic zirconium.
Furthermore, if the relevant market is defined as precious gems, then there are emeralds, rubies, and sapphires. Consumers, however, choose not to view cubic zirconium as a very good substitute for diamonds and instead prefer to chose diamonds over cubic zirconium and the other precious gems for purely personal reasons. For example tradition, sentiment or peer pressure.
The important point is that it is consumers who choose what is and is not a substitute for a good and it is thus consumers that give firms their monopoly power.
Similarly with operating systems. There are substitutes for Microsoft’s Windows. For example, Linux, Free BSD, which runs Yahoo, OS2 Warp which was developed by IBM, BeOS
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Recall that the court defined the relevant market to be, “single user personal computers with intel based processors.” In addition to excluding Apples Mac operating system, it excludes other operating systems such as Sun Microsystems, Solaris, that also runs on Intel based computers. Solaris is not included in the governments definition of the market because it is usually used to run business networks systems.
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4.0, and others are substitutes for Windows.
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However, most consumers do not view Linux,
BeOS or the other fringe operating systems as a “close” substitute to Windows for a variety of reasons. These include the availability of software applications, ease of use, compatibility with other users or simply, as Microsoft would argue, because Windows is “better” than other operating systems. Regardless of the reason, most consumers choose not to view the present alternatives as close substitutes for Windows.
Even including Apples Mac OS, the second most widely used personal computer operating system, in the definition of the relevant market, substitutability is not enhanced.
Consider the transactions costs associated with switching from Windows to the Mac operating system. First you would have to purchase a whole new computer system i.e., the hardware along with the new operating system. This alone would cost somewhere near $1,500. Then you would have to purchase all new versions of your software that runs on the Mac Operating System: word processor, spread sheet, games, reference software and any number of a variety of software programs. Depending on how many programs you use, this could cost you thousands of dollars.
In addition to the financial cost of switching operating systems, you would have to spend a considerable amount of time learning how to use a new operating system and how to use familiar programs running on a new operating system. That is, of course, assuming you can find versions of all the software applications you normally use that run on the Mac operating system. The problem of finding software applications becomes considerably more difficult as you move from
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Barriers to potential entrants are examined in the next section.
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A zero profit long run equilibrium will occur in perfectly competitive markets and imperfectly competitive or differentiated product markets.
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During the Microsoft trial, the government referred to a 1982 article by MIT’s Richard
L. Schmalensee, who is currently Microsoft’s economic expert witness, in which Dr. Schmalansee indicates that persistently high profits indicate barriers to entry by rivals.
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the Mac Operating System to fringe operating systems such as Linux and BeOS.
In market economies, consumers determine what is and is not a substitute for a good and in the case of operating systems consumers have made that determination. Regardless of whether consumers freely choose Microsoft over other products or that there are no close substitutes to
Windows because Microsoft produces a far superior operating system, consumers do not perceive other operating systems as close substitutes for Windows. That is not to say that there will never be a close substitute for Windows. Technology moves fast and Microsoft’s Windows may be displaced by an existing operating system or a future operating system.
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Then again maybe not.
No one knows what will happen in the future, and we should not base our analysis on what may or may not happen in the future. What we can do is analyze the facts as they currently exist.
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Are There Barriers to Entry ?
The final criteria in meeting the definition of a monopoly is barriers to entry. Barriers to entry are important to the continuance of a successful monopoly. Microeconomic theory argues that if a firm produces a successful product and is profitable, it will inevitably attract other firms seeking to replicate those profits. If rival firms are allowed to enter the market, profits will only be short lived as competition among the firms will compete away economic profits. Thus for a firm to successfully earn positive economic profits in the long run, barriers to entry must exist.
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,
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Consider for example the internet. There is virtually no value to purchasing access to the internet if you are the only member. However, as more people access the internet, the value measured number to contacts that can be made increases significantly. With n people on the
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Microsoft’s “persistent high profits” it is alleged are indicative of barriers to entry. Specifically, it is argued that there are three types of barriers to entry to the operating systems market. Two natural barriers to entry and an artificial barrier.
First, it is argued that there are economies of scale in the production of operating systems.
That is, although there are high fixed costs associated with the research, development and marketing of operating systems, the long run per unit cost of producing operating systems decreases as more units are produced. Consequently, the per unit and marginal cost of producing copies of Windows is low, and subsequently the cost to consumers is low. The low per unit cost is good for consumers but the high fixed costs are prohibitive for potential rivals. Again it is important to note that there is nothing illegal in the actions of Microsoft and that consumers benefit from the low prices resulting from the economies of scale in production.
Second, it is argued that there are economies of scale in the consumption of operating systems. Economies of scale in consumption are the result of the aforementioned mentioned network externalities associated with operating systems. Recall that, operating systems exhibit network externalities if the value of an operating system increases as more people use it. By no means are network externalities new. The rail road network, telephone networks, credit card and
ATM networks, fax machines, modems and the internet all exhibit network externalities. That is the value of these goods increases as their use increases. The value of being connected to the internet is low if you are the only one on the internet. However, as more and more people use the internet, the value to internet users increases.
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It is argued that operating systems exhibit a direct internet, there are n(n-1) potential exchanges among members. However, each new entrant to the network provides a direct externality to all other entrants by adding 2n potential new exchanges.
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network externality in that as more and more people use a single operating system, consumers benefit in terms of uniformity and compatibility with other users.
In addition, operating systems are said to exhibit indirect network externalities. Again, recall that an indirect network externality exists when the value of a primary good increases as more of a complementary good is sold. Likewise, the value of a complementary good increases the more of a primary good is sold. Thus, there is an indirect effect on the value of the primary good through the complementary good referred to as a positive feedback loop. A current example of an indirect network externality is the inter-dependence between VCR’s and the complementary good video rental stores. The value of a VCR increases with the availability of the complementary good pre-recorded movies. Also, the value or success of a video rental store depends on the number of people who own VCR’s. In this case, the demand for video tapes depends on the number of VCR’s and the demand for VCR’s depends on the number and availability of movies on video tape.
Operating systems possess an indirect network externality in that the value of an operating system increases the more that complementary software applications are written for that operating system. Also, the value of a software application increases the more people who use a single operating system that runs the software and by extension the greater the number of potential purchasers of that software.
The Applications Barriers to Entry a.k.a. “ The Chicken and Egg Problem”
Economies of scale in production and economies of scale in consumption, in particular the
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The applications barrier to entry is also central to the current antitrust trial.
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existence of an indirect network externality, work together to create what is referred to as the applications barriers to entry. The applications barriers to entry is used to explain why there is very little competition for Microsoft’s Windows and why it is unlikely that competing operating systems will be developed in the near future.
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The logic behind the applications barrier to entry is as follows: Because of the high fixed costs of developing an operating system, developers of new operating system’s need to reach a large number of consumers to recoup costs. In addition, consumers prefer to purchase an operating system for which there are a large number of applications available to run on the operating system. However, because re-writing software to a variety of operating systems is expensive, software vendors will only write applications for operating systems that are used by a large number of people. Since there is no guarantee that a new operating system will be successful, software vendors will be reluctant to write software that will run on a new operating system. Consequently, because few applications will be available for a new operating system, demand for a new operating system will be low and thus operating system developers will be reluctant to invest in the development and marketing of new operating systems. In short, the applications barrier represents a “vicious circle” in which an operating system will only be successful if there are a large number of applications available. A large number of applications will only be written for an operating system that is used by a large number of people.
A large number of people will use an operating system only if there are a lot of applications available for it to run. etc.
Finally, there is an artificial or government granted barrier to entry. Specifically,
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Microsoft’s copyright to its Windows operating system legally restricts others from reproducing its operating system. Government granted patents reward inventors by giving them the exclusive right to sell their product for twenty years. However, patents are only as valuable as the underlying product they protect and Microsoft’s Windows has proven to be extremely valuable.
Consequently, Microsoft enforces its patent to Windows by closely guarding the underlying source code for the Windows operating system. Again, it is important to note that protecting its source code is Microsoft’s legal right and is not an action for which Microsoft should be condemned. Microsoft developed a product which consumers find highly valuable and patents are designed to reward developers like Microsoft and many others who invest in the research and development of new products.
Recall that the applications barriers to entry is a natural barrier resulting from the combined effects of economies of scale in production and the network externality associated with operating system’s and is not the result of any action by Microsoft. Thus, Microsoft is not responsible for the existence of the applications barrier to entry. In addition, enforcing its copyright on Windows is fully within Microsoft’s legal right. Thus, Microsoft is not liable for the existence of barriers to entry into the operating systems market. The relevant point, however, is that there are barriers to entry into the market for operating systems.
To this point, I have addressed the question of whether Microsoft is a monopoly. I now turn to the question of, if they are a monopoly, “so what?” That is, what are the ramifications of
Microsoft being a monopoly? A firm with monopoly power will generally act to restrict quantity below the competitive level in order to raise price and thus earn positive economic profits. The question now is then, does Microsoft restrict output and charge a price above the competitive
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level?
Does Microsoft Restrict Output?
Microsoft restricts the output of Windows by maintaining its copyright to Windows and closely guarding the technical (i.e., source) code underlying the operating system. This however is perfectly legal and within Microsoft’s rights as a copyright holder. Copyright laws were intended to reward research, development and innovation by granting the holders of copyrights the monopoly rights to their inventions. In this sense, Microsoft behaves like any other copyright holders. Some would argue, however, that how can Microsoft be restricting output when you can go to any computer store and find a copies of Windows 98 sitting on the shelves? Or how can
Microsoft be restricting output when I can go on to the internet and order a copy of Windows form any one of a number of sellers? Again, return to the diamond market for clarification. As noted above, the De Beers corporation is often seen has being a monopoly in the diamond market.
As a monopoly, De Beers closely regulates and restricts the quantity of diamonds on the world market at any one time so as to maintain a profit maximizing price and quantity. Yet, I can go to any jewelry store or I can go on the internet and buy a diamond. Alternatively, look at OPEC and the market for oil. Recently, OPEC has greatly reduced the quantity the oil supplied to the world oil markets, yet I can go to any corner gas station and purchase gasoline. Restricting output does not necessitate a shortage. Shortages are generally the result of government price controls. A monopolist on the other hand will only restrict output below the perfectly competitive level so they can charge a price above the competitive level and thus earn profits above the competitive rate. As was noted above, the intent of patents is to give patent holders a monopoly on their inventions. 15
The wholesale price to computer manufacturers is approximately $49.
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Findings of Fact
, page 32.
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In general a firm can set the price of their output at any level they want. However, it is consumers who will determine whether or not to purchase the output of a firm. In competitive markets consumers will not purchase output from a firm that charges above the market determined level.
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Does Microsoft Raise the Price of its Operating System Above the Competitive Level?
In perfectly competitive industries, price is determined in the market by the interaction of a large number suppliers and demanders. Each firm, lacking price setting power, takes the market price as given. Competitive pressure drives the market price of output to the marginal cost of production. So the question is, does Microsoft charge a price above the marginal cost of production for Windows?
It is often argued that the marginal cost of producing an additional unit of Windows is close to zero. However, this does not generally include support and other incremental costs associated with selling additional units. Thus we can conclude that the marginal cost of selling additional units is greater than zero. The current retail price of Windows is $89.
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Is $89 above the competitive price? Instead of estimating what the “competitive” price of Windows may be, we can turn to what Microsoft itself has said. In an internal study conducted by Microsoft in
1997, Microsoft concluded that they could have charged $49 per unit for an upgrade to Windows
98, but identified $89 as the revenue maximizing price.
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That is, Microsoft was able to effectively set price at a level that would earn them long run economic profits.
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Again, it is important to note that Microsoft is not being accused of “price gouging” or of charging too high a price for Windows. The internal study is simply indicative of price setting or
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See for example, Reddy, Evans and Nichols,
Why Does Microsoft Charge so Little for
Windows?
A copy of which is available on Microsoft’s web site.
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For example, if the marginal cost of producing a good is one dollar, doubling the price would only result in a price of two dollars.
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monopoly power by Microsoft. Furthermore it is also important to note that all firms that operate in markets with differentiated products have some degree of pricing power and thus some degree of monopoly power. What distinguishes Microsoft, however, is that they operate in a market with no close substitutes and barriers to entry and thus have been able to earn positive economic profits consistently over the last decade.
A further question often arises concerning Microsoft’s pricing policy. If Microsoft is the dominant firm of the operating systems market with no close substitutes and barriers to entry and if Microsoft restricts output and charges a price above the competitive level then why do they charge so little for Windows? That is, $89 per copy of windows does not seem outrageously high. Some have even argued that if Microsoft was a monopoly, they could charge a price as high as $2,000 per copy of Windows.
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There are several explanations for the apparent “low” price of
Windows.
To begin with, a monopoly cannot charge “any” price it wants. A monopoly charges the maximum price consumers are willing to pay. The extent to which a monopoly charges a “high” price is its ability to charge a price above the marginal cost of production. As noted above, the marginal cost of producing software is fairly low, so that even if Microsoft prices above marginal cost this may not result in a price deemed high by consumers.
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In addition, it is also argued that a monopolist may choose keep price and thus profits
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Princeton’s William J. Baumol theory of contestable markets.
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relatively low in order to keep out potential entrants.
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In the theory of contestable markets, potential entry of firms into markets that are not perfectly competitive may bring about results close to that of perfectly competitive markets. As long as there is free or costless entry into a market, above normal profit will induce firms to temporarily enter the market in a “hit and run” fashion and compete away profits. Thus, in contestable markets the mere presence of potential competition will force existing firms to behave competitively. It is argued that although Microsoft faces little pressure from actual competitors in the market for operating systems, they do face a threat from potential competitors. Thus, the decision to keep the price of Windows low may deter entry by would be competitors and thus maximize long term profits.
Also, although there may be few legal competitors, Microsoft does faces competition from illegally pirated software. Prices significantly above marginal cost create an opportunity for arbitrager to produce copies above marginal cost but below Microsoft’s retail price.
Another argument raised in Microsoft’s defense is the contention that because a monopolist does not face competitive pressures, they do not engage in product innovation. As evidence that Microsoft is not a monopolist, is Microsoft’s 1997 research budget of nearly three billion dollars. Clearly Microsoft has engaged in rigorous and consistent product development and thus cannot be considered a monopolist. However, others argue that monopolists, like competitive firms are profit maximizers and will engage in innovation and product development if it leads to greater profits. The late Austrian economist Joseph Schumpeter argued that the profits associated with monopoly power provide a source of funds available to monopolistic firms for research and development that competitive firms do not have at their disposal. As evidence of
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this view is Du Pont, AT&T and IBM all of which are large firms with dominant positions that vigorously engage in research and development. Microsoft can also be added to this list.
Conclusion
To be considered a monopoly, the three criteria presented at the beginning of paper must be met:
Market dominance, lack of close substitutes and barriers to entry. Clearly, Microsoft is the dominant firm in the operating systems industry. Regardless of how Microsoft gained its dominance consumers conclusively choose to use Windows over other operating systems.
The degree to which there are “close” substitutes to Windows is apparent by its dominance. Because consumers view Windows as far superior to other operating systems, those
“fringe” operating systems are not seen as close substitutes to Microsoft’s Windows. And it is the view of consumers that is of primary importance. Producers of rival products invariably believe that their products are superior. However, it is consumers who decide which products best meet their needs.
Barriers to entry exist in the form of economies of scale in production, economies of scale in consumption and the enforcement of copyright laws. The fact that these are legal and consistent with profit maximizing behavior of any firm does not invalidate their existence.
Satisfying all three conditions presented provides overwhelming evidence to affirm that
Microsoft is a monopoly.