Stakes High In Software Showdown Attempts To Restrain Microsoft Could Stifle Innovation, Slow Down Economic Growth

Tuesday’s dramatic hearing before the Senate Judiciary Committee highlighted the great paradox of the software industry: Though dominated by Microsoft Corp. and its near-monopoly, the industry still manages to enjoy falling prices, high levels of innovation, and legions of freshly-minted millionaires.

Sorting through that paradox has now become a cottage industry in Washington. At stake are the prices consumers will pay for software and the choices they’ll face for one of the staples of modern life, the Internet. Moreover, as committee chairman Orin Hatch put it Tuesday, the government’s approach to regulating its leading high-tech company will have a profound impact on the pace of innovation and the vibrancy of the American economy.

To hear it from Microsoft Chairman William Gates, the old fears about the evils of monopoly simply don’t apply in the new knowledge-based economy, where “no company owns the factory for ideas.”

Gates described his own success as a model for those who would topple him from industry leadership. Just as he challenged IBM’s dominance of the computer industry when he was a 19-year-old college student with a new set of code, Microsoft’s competitors can break its grip on the industry if they deliver better products and lower prices.

In fact, Gates refused Tuesday even to concede that Microsoft has a monopoly, despite the fact that its Windows operating system for personal computers has well over 90 percent of the market. In his view, there simply can’t be a monopoly in an industry where products become obsolete every two or three years - giving competitors a new shot at knocking off the dominant firm.

“We create a product, it becomes popular, then it has no demand,” Gates testified Tuesday. The only constancy, he said, has been the “ingenuity of Microsoft engineers.”

Gates’ competitors - as well as antitrust officials at the Justice Department - would dispute the claim that ingenuity alone accounts for Microsoft’s amazing success. Today’s software industry, they argue, exhibits a natural tendency toward monopoly - just like the railroad and telephone industries of an earlier era.

As in those industries, the up-front costs of developing the original product or network are so enormous that the company that first gains dominance gains an overwhelming competitive advantage - allowing it to cut prices and gain an even larger market share.

And as with railroads and telephones, there are benefits to software customers in having a standard product that’s relatively reliable and widely used.

Gates also tried to dismiss the monopoly issue by noting that, despite the supposed dearth of competition, Microsoft continues to lower prices even as it spends lavishly to improve and expand its product line - $2.6 billion in research and development last year.

But economists point out that such behavior may be in Microsoft’s self interest.

After all, the aim of any business owner is to maximize profits, not prices. And if, by lowering prices, Microsoft can hasten the day when there is a computer on every desktop and a Microsoft interface on every TV screen, Microsoft will be better off.

So why should government care whether Gates is a monopolist, if economic logic pushes him to innovate and cut prices?

The answer, according to economists and antitrust lawyers, is that there might be much more innovation and even lower prices if Microsoft were less dominant and there were more companies competing in the software market.

Microsoft has benefited consumers, for example, by adding a free Internet browser to its Windows software. But if that package helped drive competitors such as Netscape, America On-Line and Novell out of business, would consumers really gain in the long run?

The Justice Department must now try to answer such speculative questions as it considers whether to go to court to prevent Microsoft from using its operating system monopoly to gain other monopolies in related products and services.

Even if Justice decided to file a broad antitrust suit, it must address the thornier question of what it will ask the court to do to restrain a great company without destroying it.