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Wednesday, 16 March 2011

Behavioral Anti-Trust: Microsoft To Apple

Slipped Halos

Back in 1999 the world’s stockmarkets were floating high on humankind’s incurable optimism for all things technical. The internet was changing everything and everyone wanted a part of it. As we saw in The Halo Effect: What’s In a Company Name? merely adding “.com” to the end of a corporation’s name was enough to send its price skedaddling skywards.

Then it all went wrong, and by some measures we’ve been paying the price for the associated excess of exuberance every since. Quite why it went wrong is still a matter of some debate, but one of the trigger points appears to have been the finding that Microsoft was using its monopoly status to suppress competition. For 1999 read 2011 and for Microsoft read Apple: could it happen again?

Bungled Bundling

Although theories abound about quite why the world’s investors went mad at the end of the last century there’s a fairly reasonable case that it was, in part, a fallacy based on an inaccurate analogy. At the time Microsoft was the dominant player in the IT market, with Windows the de-facto standard for PC operating systems the world over. The stock price reflected this: the ultimate manifestation of the build once, sell many times gearing effect of software, when you get it right.

The nub of the anti-trust case against Microsoft was that it was using its position to snuff out innovation by bundling software with its core operating system and destroying the ability of new entrants to compete. The paramount example was the deliberate decision to bundle Internet Explorer with Windows, as enshrined in a memo written by a senior executive:
“I do not believe we can win on our current path. Even if we get Internet Explorer totally competitive with [Netscape] Navigator, why would we be chosen? They have 80% of the market share. My conclusion is that we have to leverage Windows more … We need something more: Windows integration”.
Irrational Anti-trust

Bundling Internet Explorer with their monopoly product would have been a dangerous ploy at any point. Remarkably, though, this memo was written three months after the federal investigation started. In the end Judge Thomas Penfield Jackson found against Microsoft on the 5th November 1999, and the long slide of the market was underway.

As we well know, people do irrational things in finance. Microsoft did, in retrospect, some truly irrational things. Anti-trust laws are there for a purpose, and attacking monopoly suppliers is most definitely core to that purpose. Oddly, though, most anti-trust law is actually built on the assumption that corporations behave rationally. As Arvishalom Tor points out much of this has assumed that:
“Some allegedly anticompetitive practices were unlikely ever to take place because rational actors would not find them beneficial. This has been the case, for instance, with allegations of predatory pricing by dominant firms. According to this view, which has been adopted by the Supreme Court, a rational seller would be extremely unlikely to sell its products below cost in order to drive its rivals from the market”.
No Entry

This, of course, is an economic view of the world we’re all familiar with and it is, in general, profoundly wrong. Alternative approaches to anti-trust, based on behavioural economics, are now being suggested. So, for example, the aforementioned irrational behaviour is regarded as entirely likely in a behavioural model where managers are risk seekers and apt to poor judgement about the likely beneficial impact of driving competitors out of the market.

Moreover this approach casts doubt on the rational anti-trust idea of “entry”, which argues that even where there is a dominant player in a market they won’t be able to exploit that monopoly because predatory pricing will lead to new market entrants. So here it’s the very threat of competition which means that anti-trust laws can be applied lightly, and this is the basis for allowing many mergers which are, on the face of it, likely to be highly injurious to consumers.

Dumb Money

As it turns out, however, most new entrants into markets dominated by incumbents are pretty much guaranteed to fail because the managers of these companies are psychologically inept. Or, to put it more kindly: they’re just as dumb as the rest of us. As Tor puts it:
“Entrants tend to be overconfident and typically fail without penetrating the market, a reliance on entry rates can be misleading”.
Basically, relying on entry to keep monopolists honest is likely to be a flawed strategy because most new entrants are stupid enough to believe they can take on a monopolist in the first place. Really effective potential competitors will probably find something better to do with their money.

Bad Behavior

Behavioural anti-trust approaches are not without their detractors. Wright and Stone make a case in Misbehavioral Economics: The Case Against Behavioral Antitrust in which they argue that behavioral economics is simply too woolly to be useful: it just doesn’t provide sufficient predictive capacity to be useful. As an example they too look at the issue of entry:
“It is true that an irrationally optimistic incumbent may attempt to predate more often than predicted by rational choice theories”.
This, of course, is the Microsoft issue: despite cold logic suggesting they’d have been mad to attack Netscape by bundling Explorer with Windows with an anti-trust investigation under way this is exactly what they did. However, Wright and Stone go on:
“Notice, however, that the first order competitive effects of assuming present-biased or irrationally optimistic entrants mitigate against antitrust intervention. The same bias, when applied to entrant firms, suggests excessive entry and more competition”.
Or: irrational firm behaviour will lead to more competition than expected. Which is probably a fair point, as is the observation that behavioural economics offers a poor methodology for making predictions: it can tell us why antitrust models today are wrong, but not what to replace them with. Which is pretty much par for the course for the discipline, unfortunately.

Moving to Mobile

Moving to the present day we find Microsoft’s old sparring partner, Apple, riding the second wave of global connectivity, this time on the mobile platform. Having moved to exploit their platform dominance by demanding an array of charges from content suppliers this has led to a storm of protest and they too have now found themselves the subject of antitrust scrutiny.

Frankly, with competition from the more open source Android and Nokia/Microsoft platforms looming it’s hard to see annoying content providers as a successful long term business strategy. It’d be an even great achievement to do that and attract the ire of the antitrust authorities simultaneously. Of course, it’d also be wantonly irrational – but when did that ever stop any corporation?

The bigger danger is that kicking away Apple’s control will spook the market for innovative mobile based solutions. If Apple is prevented from exploiting its natural monopoly why should Google or Facebook fare any better? It may take a while coming, but enthusiastic investors need to be careful about the value they place on future earnings, as anti-trust investigations often mean that these have a nasty habit of failing to appear.

Related articles: Pulling Up the Intellectual Property Ladder, Behavioral Law and Disorder, Finance: Where the Law of One Price Doesn't Apply


  1. I'm always a bit dubious about the Apple monopoly argument. It's market share is relatively small. Apple lock down their devices to their users & 3rd party service providers to improve the end user experience. This, shock horror, seems to have done rather well. They're now doing the same with content on their devices. However, unless you like that locked down user experience, there is nothing forcing you to use it. This is in stark contrast to the MS situation, when even today, I need a Windows box around to run some software. I'm a big Apple laptop fan but would never use an iPhone. This has not limited in me in any way compared to iPhone users. Where's the monopoly?

  2. Apple has a low market share today and what they are doing is pretty brilliant. They are dominating device categories individually and long-term once they control each category they will make all devices work seamlessly together-ie the ipod,iphone,ipad, mac, apple tv, etc. w/ itunes making all content move around effortlessly. Apple isn't a monopoly...yet...the interoperability of their solutions long term will make them much harder to displace though than a normal hardware company or even software company. Technology companies are difficult to invest in because as they get more powerful they can't buy anything and the innovators gain share. So, Google, for instance, will likely find it near impossible to buy any business of size in the future. This will hurt them significantly long term. - Adrian Meli