News Release
April 6, 1998

Justice Department Lacks Basis for Antitrust Case Against Microsoft
Economic theory reveals the inherent weakness in government’s case

(OAKLAND, CA; April 6, 1998)—The U.S. Department of Justice would be ill-advised to prosecute Microsoft Corporation under the Sherman antitrust laws, according to several leading U.S. economists.

“While there’s no doubt the popularity of Microsoft products, including its Windows operating system, has led to a high market share, the Department of Justice has failed to provide any evidence to suggest that Microsoft has abused that status or that consumers are worse off,” said Stan Liebowitz, a Dallas-based economist and fellow at the Independent Institute, a public policy think tank based in Oakland, California.

“On the contrary, history shows that this is the way in which markets work to the benefit of consumers and competition.”

The pending Justice Department argument seems to stem largely from a new theory of market dominance, one that simply does not apply to the today’s highly competitive U.S. software industry. This theory recognizes that consumers sometimes tend to favor one product over its rivals because they think other customers will also favor it. However, the theory misinterprets this fact to mean that markets can irreversibly “lock in” inferior products to the exclusion of better ones, harming consumers in the long run.

However, the theory—called “network externalities” in academic and legal circles—is not empirically founded and should not be used as the basis for antitrust. Stan Liebowitz and Steve Margolis, two leading economists in the field of competition in high technology, have shown that the cases commonly cited as examples of “network externalities” are nothing but high-tech urban myths.

One myth that Liebowitz and Margolis refute is the claim that “network externality” theory was confirmed in the videorecorder “wars” between VHS and Beta in the 1970s. According to popular legend, Beta was the “better” technology but lost to the quick and widespread adoption of the VHS format, which “locked out” Beta. But Liebowitz and Margolis have shown that consumers preferred VHS, citing features like its almost double recording length. VHS dominance did not exclude rivals like Beta from the market, it simply offered consumers a product they preferred. Liebowitz and Margolis concluded that ill-informed regulators are unlikely to improve upon the decisions of millions of consumers.

Similarly, Microsoft has attained its popularity with customers by offering them products superior to those of its rivals. Similar to Beta, which lost out because consumers favored its rival, Netscape’s Web browser, IBM’s OS/2 operating system and the Lotus 1-2-3 spreadsheet once enjoyed very high market share. Like VHS, Microsoft was able to capture market share from them by offering customers superior products at lower cost.

In the current case, Microsoft’s competitors—chiefly Netscape—are attempting to use the Justice Department to compensate for their own failures. These include the failure to develop server-side software and not expanding their Web site into a general purpose search engine like Yahoo! or Lycos.

The Justice Department cannot build a case on the idea that Microsoft’s dominance is excluding rivals from the market. If Netscape believes they are being “locked-out,” then perhaps they should begin to give away their software for free, much like Microsoft did. Likewise, if they believe they are being squeezed out of the corporate market, then they should devise a market plan to squeeze back in. Instead, they are trying to use the Justice Department in order to compensate for their failure in the market. Paul Craig Roberts, a Research Fellow at The Independent Institute, reminds us that “Economists have known for decades that antitrust is what losers do to winners.”

The evidence that markets “lock in” inferior technology does not exist. Antitrust prosecution based on “network externality” theory serves neither consumers nor the competitive process of “creative destruction” that inevitably creates winners and losers in the marketplace as it serves consumers. If this process is hampered to accommodate the mistakes of Microsoft’s rivals, then consumers will be the ultimate losers in the long run.