Creative Insecurity

The complicated truth behind the rise of Microsoft

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...."


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.

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