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July 7, 2008
Evolving theory of network effects

Should antitrust enforcers be concerned about entry barriers in the search ad market? Some believe the market exhibits "network effects," according to the New York Times.

Although traditionally applied to Industrial Age industries with high fixed costs like railroads and telephone exchanges, anything now exhibits a network effect if its value increases because more people use it. Network effects are "everywhere," according to a top former antitrust official. Coke and Pepsi drinkers, for example, "benefit from the network of their fellow consumers because Coke and Pepsi are widely available in restaurants and in vending machines," claims Timothy J. Muris.

A preexisting network of vending machines is admittedly tough for soft drink imitators to replicate. But a barrier to imitation can also be viewed as a spur to innovation because it acts as a reward which inspires creators and investors. Not an incentive to create a barely distinguishable alternative, to be sure, but to create something transformative.

The alleged network effects in search advertising are more subtle than in the case of railroads, telephone exchanges or soft drinks (in fact, they even bear a striking resemblance to what one might term legitimate and hard-won competitive advantages).

[E]conomists and analysts point out that Google does indeed have network advantages that present formidable obstacles to rivals. The "experience effects," they say, of users and advertisers familiar with Google's services make them less likely to switch. There is, for example, a sizable cottage industry of experts who tailor Web sites to get higher rankings on search engines, which drive user traffic and thus ad revenues. These experts understandably focus their efforts on the market leader, Google -- another network effect, analysts say.
This sounds remarkably like how the European Union sees the market for streaming media players. The EU prohibits Microsoft from including a free player with its PC operating system because its competitors couldn't give away enough copies of their own media players.

Network effect theory overlooks whether, perhaps, there are no other objective differences in the value propositions of the competing products. If consumers have a choice between a superior product versus an inferior product which most of their neighbors are using, the theory assumes most consumers will choose the latter. Thus, there is no incentive for anyone to design a superior streaming media player for a desktop PC.

But that may not be a bad enough thing to warrant letting politicians and bureaucrats rearrange the market. It is inherently destructive to innovation to allow them to do that, because they principally serve constituencies who are more interested in preserving the status quo.

June 16, 2008
Trade war

Picking up on Braden Cox's recent post over at Technology Liberation Front, "Abuse of Power? Competition Commissioner that Pushes 'Smart Business Decisions,'" it's no secret that Europe's software industry is years behind Microsoft, and not surprising the industry is seeking help from politicians in Brussels. When Kroes, a politician, talks about open standards one must assume she is referring to the European software industry, not to the open source movement generally. Of course, for the moment "the enemy of my enemy [may be] my friend," as they say.

In her remarks last week Kroes said,

"I know a smart business decision when I see one -- choosing open standards is a very smart business decision indeed," Ms. Kroes told a conference in Brussels. "No citizen or company should be forced or encouraged to choose a closed technology over an open one."
This statement could be read either as an innocent statement of personal opinion, or more like an informal, unofficial statement of official policy with plausible deniability. I suspect it is the latter, and that if you are a European bureaucrat or business leader you now understand what is expected of you as far as your future software procurement is concerned.

Why would Kroes need to be opaque? Because there are both structural (e.g., excessive tariffs, unreasonable licensing terms, etc.) and nonstructural trade violations (e.g., certain winks and nods) which are actionable. And because two or more can play this game.

A good reason for governments to not encourage boycotts of foreign goods is because foreign governments can do the same thing.

That can lead to trade war, in which your efforts to protect one of your small, insignificant struggling industries may result in foreign retaliation against your most successful exporters.

Trade wars don't always have serious repercussions, but they have sparked global recessions and many think a trade war sparked the Great Depression.

That's another good reason why maybe politicians on both sides of the Atlantic ought to leave software procurement decisions up to the marketplace.

August 31, 2006
Here's a tip for promoting innovation through "competition" law: Define market to get results you want

Microsoft Windows now represents 34.2% of the server market according to the most recent statistics reported by IDC this month. Microsoft is considered a "dominant" company in Europe only because the European Union measured "price band" and "workload" so it could carve the market just so, isolate a particular segment and report that its intended victim, in this case, Microsoft, has a share of "at least 60%."

Richard Rahn pointed out once that, "If you define products and markets too narrowly, you will see all types of monopolies where, in fact, none exist. You may find Ford Motors has a 90 percent market share for 4X4 pickup trucks in a certain weight category in the color red in Albany County, GA."

Using statistics compiled by IDC, the EU focused only on servers costing less than $25,000 -- the "low-end server market" or the "volume server market." This happens to be the segment in which Microsoft performs best. The EU concluded that Microsoft's share of this segment of the market was 61.0%. Next, the EU noted that looking only at price band would obscure the fact that some servers are devoted to specific tasks outside work group networks.

Continue reading "Here's a tip for promoting innovation through "competition" law: Define market to get results you want" »

July 13, 2006
EU fining successful American companies

The European Union's first financial penalty against any company for defying antitrust orders, according to the Wall Street Journal, was levied against an American company in the amount of €280.5 million.

When politicians have to deliver disappointing news, they like to employ nuance. Take, for example, the EU's Commissioner in charge of competition, Neelie Kroes, who visited Washington, D.C. in March and began her comments to a group of antitrust lawyers with: "I am sure you are aware, the top priority in Europe at the moment is to boost the number of jobs and the quality of the jobs. Competition policy has a lot to contribute to this agenda..."

Then there was the visit Kroes made to New York last September, where she said:

I am aware that it is often suggested that -- unlike Section 2 of the Sherman Act - Article 82 is intrinsically concerned with "fairness" and therefore not focused primarily on consumer welfare. As far as I am concerned, I think that competition policy evolves as our understanding of economics evolves. In days gone by, "fairness" played a prominent role in Section 2 enforcement in a way that is no longer the case. I don't see why a similar development could not take place in Europe.

Of course it is artfully stated, but the message seems to be that the goal here is to create jobs in Europe at America's expense, and, although they know it is bad and ultimatately self-defeating economics, America is just going to have to deal with it for the time being because the EU isn't sure what else to do.

The EU itself is unpopular within Europe -- for instance, in Kroes' own Holland, 62% of Dutch voters voted against the proposed EU constitution last year -- and Europe lags in job creation and IT growth. The European Commission is desperate to demonstrate that it is something more than an expensive cost center, and Microsoft, unfortunately, was in the wrong place at the wrong time.

See "Roundtable Conference with Enforcement Officials American Bar Association Section of Antitrust Law Spring Meeting," Washington, D.C., March 31, 2006

See "Preliminary Thoughts on Policy Review of Article 82 Speech at the Fordham Corporate Law Institute," New York, 23rd September 2005

April 26, 2006
Microsoft v. EU, Part 1

Microsoft's legal challenge to the European Commission's antitrust ruling got underway this week in the European Court of First Instance. At issue on the first day of the hearing was the requirement that Microsoft separate its media player from its operating system. The commission's ruling and subsequent enforcement gets more absurd every day, and I can't imagine it would have been taken seriously by any competent court of law in the U.S.

Jean-Francois Bellis, an attorney for Microsoft, told the court that 1,787 versions of Windows without Media Player (Edition N) have been ordered, compared with 35 million versions of Windows with Media Player, the Financial Times reports. The lawyer for the European Commission conceded that "I am afraid we cannot say our remedy has had any real impact, as far as we can see," according to the the Times of London. Then he hinted that the commission may regulate how Microsoft prices the two products, according to the International Herald Tribune, to entice consumers who otherwise lack any compelling reason to buy the stripped-down version. This case is thus a classic example of regulatory quicksand, or the inexorable tendency of regulation to degenerate into micromanagement.

This all may seem like good news to Microsoft's competitors, but its certainly a defeat for consumers and investors. When bureaucrats, here or there, attempt to suspend the laws of supply and demand, we all suffer.

Does the Bush Administration realize this?

March 29, 2006
EU Treating Microsoft like a Utility

Microsoft has been warned by Commissioner Neelie Kroes of the European Union that there are some features it should not bundle into its new operating system (see, e.g., "European regulator warns Microsoft about new operating system" from European Business News Online). The EU's competition directorate has already decided that competition could be costly and involve risk for Microsoft's competitors. Yes, it sounds ridiculous -- but essentially that's what it is. Kroes' warning may indicate that Microsoft is losing its freedom to innovate and in effect will now be required to obtain preapproval from the EU for any new product design. If so, the EU could be doing to Microsoft what the FCC did to the Regional Bell Operating Companies by forcing them to share every element of their business. Commenting on the folly of the FCC's grand strategy to achieve a state of perfect competitive equilibrium in telecom, Justice Breyer noted that forcing firms to share every resource creates "not competition, but pervasive regulation."

November 16, 2005
EU Threatens Innovation in Action Against Microsoft

Microsoft's work group server competitors claim they can't keep up with the complexity of Microsoft's product upgrades.

"We are, in many fields, ten years behind Microsoft. And the lag is growing with every new step Microsoft takes"

according to Volker Lendecke of the Samba Users Group, an organization dedicated to free software that anyone can copy.

Continue reading "EU Threatens Innovation in Action Against Microsoft" »

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