Trampling on the theory of path dependence

[Matthew Gaylor]

http://news.ft.com/ft/gx.cgi/ftc?pagename=View&c=Article&cid=FT3OPVMLY 
JC&live=true


Tuesday Mar 6 2001 [FT.com] Financial Times

Trampling on the theory of path dependence
Microsoft's judges may decide that consumer approval rather than 
illegal tactics led to the company's power
Published: March 5 2001 19:49GMT | Last Updated: March 5 2001 20:07GMT

[amity schlaes]

Microsoft looks as if it may evade the dismemberment ordered in the 
finding sent up by Judge Thomas Penfield Jackson. Not only have 
federal appeals court judges shown some sympathy for the company's 
case, but the Bush administration may also revise antitrust policy 
and offer it a settlement. Microsoft stock's recent rise reflects 
these new prospects.

But what about the underlying theory that convinced Judge Jackson 
that Microsoft needed dismantling in the first place? He leaned 
repeatedly towards an economic idea known as path dependence.

The position that the appeals court or the Justice Department take on 
this issue will do much to determine Microsoft's fate. Path 
dependence is also a key part of modern monopoly theory generally, so 
has a bearing on other antitrust cases.

So what precisely is it? Path dependence says that a company may gain 
an overwhelming advantage in a market if it manages to establish an 
industry standard before anyone else. That standard then becomes so 
powerful that it becomes a barrier to better challengers. The 
company, in short, creates an impregnable monopoly.

The textbook example here has long been the qwerty keyboard. Its 
critics argue that it is less efficient than other key arrangements. 
Their position is that it has dominated for a century merely because 
one of the first manufacturers of the manual typewriter, E. 
Remington, adopted it early on, ensuring that it would become the 
standard. Path dependence emphasises, sometimes close to exclusively, 
the competitor as victim. Consumers are part of path dependence 
theory too - but only indirectly; they lose because the competitor 
does.

Bunkum, say two professors of economics, Stan J. Liebowitz of the 
University of Texas at Dallas and Stephen E. Margolis of North 
Carolina State.* Markets are meritocracies where good products win, 
be they mouse traps or operating systems. An item's success is due 
more to its quality than to any industrial predation.

Start with the qwerty keyboard. The professors argue that qwerty was 
hardly the competition-free gladiator that received wisdom makes out. 
It turns out that there were 51 rivals to Remington's qwerty at the 
outset. Remington's qwerty prevailed not because of market share 
alone but also because qwerty typists won at much-publicised typing 
contests.

Then there is the showcase argument against qwerty: DSK, a keyboard 
arrangement patented in 1936 by ergonomics expert August Dvorak. 
Dvorak tested DSK in Chicago schools and found data indicating its 
superiority. In the second world war, DSK was pitted against qwerty 
at the US Navy. Recruits who had once performed at a measly 32 words 
a minute speeded up to a masterly 56. Yet the old qwerty standard 
still prevailed.

Messrs Liebowitz and Margolis have unearthed evidence to show that 
DSK's superiority is something of a fable. For one thing, as it turns 
out, the co-author of the landmark Navy study was Dvorak himself. And 
later studies failed to replicate the pro-Dvorak evidence.

Another supposed paradigm of path dependence is the famous Beta-VHS 
war. Sony's Beta, the argument runs, was a good product. But through 
sheer market aggression, RCA, the US distributors of VHS, managed to 
make VHS the US standard and so obtained an enduring monopoly.

But this, the professors note, is an incomplete account. While the 
technology of the two products was identical, Sony took a fateful 
step in crafting its cassettes. It believed portability would be the 
most attractive feature for the cassette. It made its product smaller 
- but with a playing time of only one hour, in contrast to VHS, which 
could handle full-length films. Filmgoers, as it turned out, became 
big video customers. VHS won.

In the Microsoft case, the company's advantage is Windows' 
superiority and not Microsoft's scheming. Messrs Liebowitz and 
Margolis criticise Judge Jackson's view that Microsoft did social 
damage by bundling its browser, Internet Explorer, in the Windows 
package. This may have hurt Netscape, a competitor, as the latter 
loudly claimed. But there is little evidence that it hurt the 
consumer, at least not in the long run.

The authors offer a telling example from an older industry giant, car 
manufacture. In the old days, US carmakers sold vehicles without the 
rustproofing necessary in bitter climates. Cautious buyers then took 
their new purchases to rustproofing specialists for treatment. Later, 
carmakers incorporated rustproofing into their own product.

This may have hurt America's big rustproofing company, Ziebart. It 
even disrupted car owner habits temporarily. But car owners in the 
long run were not unhappy to receive a road-ready product. Or, as the 
authors put it, "a rule that compels a look at consumer perception as 
though frozen in time will be harmful".

Given the failings of path dependence, why its prevalence as a way of 
looking at the world? Messrs Margolis and Liebowitz argue that path 
dependence survives because it is an argument that suits some of the 
biggest players in the global antitrust drama: competitors. Jack 
Welch of General Electric complained last week in a different context 
(the European Commission's review of GE's plan to merge with 
Honeywell), of regulators being more concerned with competitors than 
consumers.

But while competitors have much to lose in battles against strong 
companies, it is not necessarily true that their defeat is also the 
consumer's. That is a valuable warning at a time when vigorous 
antitrust action has become the norm.

* Winners, Losers and Microsoft. J. Liebowitz and Stephen E. 
Margolis. The Independent Institute



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