Network Effects: Does Luck or Talent Rule the High-Technology Market?

Network Effects: Does Luck or Talent Rule the High-Technology Market?

Onpoint No. 2
February 26, 1998

Does luck matter more than talent in the marketplace after all?

Many of today’s calls for antitrust interference in the marketplace are rooted in a new theory of "network effects." These effects occur with certain products that acquire more usefulness and value the more people there are that use them. Fax machines, phones, computer operating systems, and Web browsers are prime examples.

While such products are clearly more effectual when we all use them, some now warn darkly that inferior versions of network technologies can become inefficiently "locked-in" by early adoption or by luck or chance rather than superior quality.

Market unjust after all? In other words, being at the right place at the right time and getting a head start matters immensely in business. To the new critics of unfettered commerce, luck rather than merit often rules the marketplace – so, lo-and-behold, the free market really is unjust after all. And since the market is unjust, the policy conclusion is inevitable: Government must set things right.

Microsoft is bearing the brunt of this theory today. One cannot escape hearing the common claim that Microsoft’s Windows was an inferior computer operating system to begin with, and that it won out over technologically superior competitors like Apple and IBM’s OS/2 through luck and marketing. These themes dominate in the current high-profile antitrust action charging that the company is "leveraging" its Windows dominance to secure an ill-gotten monopoly for Explorer, its Web browser.

It is hard to overstate the importance the lock-in theory holds for those seeking antitrust intervention in free markets today. Without this foundation, most of today’s antitrust attacks in the high-tech arena fall to the ground.

Lock-in myths. As facts would have it, the world of inefficient technological lock-in is make-believe. Absent a government franchise that outlaws competition altogether, there are no credible instances of inferior products or technologies winning out and harming consumers through lock-in. As the pathbreaking work of economists Stan Liebowitz and Stephen Margolis has shown, even the most prominent examples of inefficient lock-in are invalid.1 They’re simply myths.

Betamax video was not superior to VHS, for example. The technologies were the same, but the Betamax tape was too short to record a movie or game. Also, the much-praised "Dvorak" typewriter keyboard layout was not superior to today’s "Q-W-E-R-T-Y" keyboard configuration in objective typist-timing tests.

Apple computer’s superiority is another legendary example of the best losing out to the lucky. But as a user of an Apple, I can note without chauvinism that Apples are more expensive for the same capability than the competition; upgrades are rare; software for them is more expensive; they are harder for corporate network administrators to configure centrally; and since the Mac operating system is not licensed to other computer makers, they are too risky for a corporate market that prudently avoids relying on one vendor for critical equipment.

Do we still use vinyl? While temporary lock-in of worthy standards is normal and desirable, protracted lock-in of inferior technology simply is not a part of the economic landscape. A world plagued by such sub-technological lock-in would contain no CD players, because everyone owned vinyl records and turntables; cars couldn’t emerge because there were no gas stations. No color television broadcasting stations could arise because all consumers owned black-and-white TVs.

Network effects or no, truly inferior products create profit opportunities that entrepreneurs find ways to exploit by introducing more worthy alternatives. If Dvorak keyboards saved data entry time, for example, large companies could switch and save millions. Indeed, anyone running Windows 95 can this very moment click Start/Settings/Control Panel/Keyboard/Properties to select the presumably superior Dvorak keyboard layout. The fact no one bothers is revealing.

Consumers’ free choices in the marketplace, even when network effects are present, do not lead to coercive monopoly power. "Lock-ins" can promote innovation by settling on a standard upon which a market grows. Nonetheless, "creative destruction" reigns, showing no mercy for the incumbent when genuinely better options arise.

Moreover, it is by no means apparent that consumers want government deploying antitrust intervention as a means of choosing among today’s competing technologies, such as between PC’s versus Network Computers, between wireless communication and fiber optics or between Web browsers by Microsoft and Netscape.

Second bite at the apple. Indeed, considerable research has unmasked antitrust as special interest regulation, more adept at artificially protecting inefficient firms’ profits than at ensuring consumer welfare. Inferior competitors too often realize antitrust gives them a second bite at the apple in the courtroom if they fail in the marketplace. And, unlike those of the marketplace, government’s choices are binding upon all. When government calls the shots in the competitive marketplace and substitutes its choices of winners and losers for those of millions of consumers, those choices become genuinely "locked in" in the true sense of the term.

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Clyde Wayne Crews is the Fellow in Regulatory Studies at the Competitive Enterprise Institute in Washington, D.C.1See, i.e, Stan Liebowitz and Stephen E. Margolis, Policy and Path Dependence: From QWERTY to Windows 95, Regulation, 1995 Number 3, pp. 33-41.