The economics of networks implies that a product or a technology
becomes more valuable to each new user the more widespread its use
Both consumers and producers benefit from the ease of a single
Frequently, a "tipping point" is reached when - as with Microsoft
Windows - a single standard becomes so dominant that it is in more
or less everyone's interest to use it.
Such standardisation can be benign, as with the universality of
the VCR format in videos which provides a common platform for
viewers and media companies alike.
But when the network technology is owned by a single company, as
with Windows, the benefits of standardisation have to be traded off
against the potential for that company to exploit its monopoly
Network effects are not new: literal networks like railway tracks
or gas pipelines, in which competition is virtually impossible, have
long been subject to heavy regulation or nationalisation.
But for regulators, the Microsoft situation is complicated
further by the fact that in dynamic, fast-moving markets like
computer technology, monopolists may use their market power in
A traditional monopolist in a market with a mature technology is
often easy to spot: it will gain a large share of the market, try to
stop other companies entering and then raise prices to maximise
Critics of Microsoft, by contrast, object to too low
prices - such as the cheap or free "bundled" or "tied" related
products such as browsers and media players - which they say aim to
protect the long-run monopoly profits in the operating system that
While some economists believe regulators should err on the side
of giving companies free rein, on the grounds that even tech
monopolists face incentives to continue innovating rapidly, some
think the extraordinary power of tech standards means that
regulators should err on the side of restraining companies.
Or, one side is frightened of killing the goose that lays the
golden eggs, the other of letting the fox run riot in the hen
Some economists argue that the threat of predatory pricing could
kill markets not yet born and technologies not yet invented. Future
Googles and Adobes might not bother developing innovative new
products if they fear being undercut by Microsoft aiming to protect
its near-monopoly in operating systems.
"Normally there is a first-mover advantage in these tech markets
but Microsoft may have a second-mover advantage which has the effect
of stifling innovation," says Jay Pil Choi, an economist at Michigan
Defenders of Microsoft say that no monopoly can be safe for long
in the fast- moving tech field, and that the waves of "creative
destruction" posited by Joseph Schumpeter, the Austrian economist of
the mid-20th century, are an ever-present challenge.
Nicholas Economides, an academic at New York University's Stern
School of Business, thinks that courts and regulators have
interpreted the economic arguments to take an overly aggressive
"The argument that network effects can result in anti-competitive
behaviour has been understood," he says. "But the argument that
network effects can lead to Schumpeterian competition where a
dominant firm is suddenly overthrown by another has not."
And in practice, a tech company undertaking predatory pricing to
deter future competition can look remarkably like one using
aggressive but legitimate "penetration pricing" against its current
competitors to win the battle to become the industry standard.
Simple rules like preventing companies pricing below the marginal
cost of their production will confuse the two.
So far, courts have reached only tentative and ad hoc conclusions
about the economics.
With masterly understatement, the appeals court in the US
Microsoft case concluded: "There is no consensus among commentators
on the question of whether, and to what extent, current
monopolisation doctrine should be amended to account for competition
in technologically dynamic markets characterised by network
The court set aside the lower court's decision that tying Windows
to other Microsoft products violated antitrust law - also part of
the European Commission's case - but warned against extrapolating a
general rule from this decision.
The European appeals courts will have the chance to build on the
scant case law that exists. But they are highly unlikely to be able
to set rules that definitively settle the extraordinarily complex
questions of regulating dynamic network industries.