Wall Street Journal - April 25, 2000
Why the Case for a Breakup Breaks Down
By Richard B. Mckenzie and William F. Shughart II. Mr. McKenzie, a professor at the University of California, Irvine, is author of "Trust on Trial: How the Microsoft Case Is Reframing the Rules of Competition" (Perseus, 2000). Mr. Shughart, a professor at the University of Mississippi, is author of "Antitrust Policy and Interest-Group Politics" (Quorum, 1990).
The Justice Department is awfully busy this week. By Friday its Antitrust Division is due to submit a proposed remedy in the case of U.S. v. Microsoft. The department reportedly will ask Judge Thomas Penfield Jackson to order Microsoft to break itself up into two or more separate companies, so-called Baby Bills. The advocates of a breakup contend that dissolution is preferable to a "conduct decree" that would leave Microsoft intact but impose restrictions on its behavior.
Advocates of a breakup argue that it would make software markets more competitive and would avoid the continuing judicial and regulatory oversight a conduct decree would entail. They point out that after Standard Oil was dissolved in 1911, the collective market value of the 30 successor companies quickly rose above the oil trust's pre-breakup market value, making John D. Rockefeller Sr. into history's first billionaire.
The implication is that the same antitrust medicine for Microsoft will be beneficial all around -- to consumers, who would get more competitively priced software, and to Microsoft's owners, who would become wealthier than they already are. How could anyone object to such a win-win solution?
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The problem is that the underlying argument is wrong on both the facts and the logic. No wonder that news of a possible breakup helped send the Nasdaq Stock Market into a tailspin Monday.
The Standard Oil comparison is based on a half-truth. Yes, the total market value of the 30 "Baby Oils" tripled between 1911 and 1913. But the stock market was rising rapidly across the board. A new study by VMI economist Atin Basu Choudhary and University of Mississippi economists Robert Tollison and one of the authors (Shughart) finds that, contrary to conventional wisdom and independent of other market forces, the dissolution of Standard Oil had no persistent impact on the wealth of the company's owners. More to the point, Rockefeller's stock-market gains were not proportionately greater than those of ordinary investors in other oil and industrial companies. Hence, the rise in the market value of Standard Oil after its dissolution can't be used to justify a breakup of Microsoft. Indeed, these economists argue that the Standard Oil case is a classic example of antitrust policy failure.
The logic underlying the contentions of Microsoft's critics is also faulty. If Microsoft were truly acting like a predatory monopoly -- restricting sales with the intention of raising product prices and garnering profits in excess of competitive levels -- then a breakup would be expected to lead to more intense price competition and, therefore, lower profits and a lower stock-market value for the Baby Bills. By arguing that a breakup would increase the Baby Bills' total stock-market value, the critics must believe that in some way the breakup will make software markets less competitive, with the prospects of higher prices and profits.
What about the argument that a breakup would press the Baby Bills to become more efficient, enhancing their values? That is sheer speculation, not well grounded in theory. After all, even monopolies have strong incentives to hold their costs in check.
As for the claim that a breakup would reduce software prices, the reverse is probably true. According to economist Stan Liebowitz, a breakup of Microsoft into two operating-system companies could increase software-development costs by $30 billion in the first three years, given that programmers would have to adapt their applications to more than one version of Windows. Application companies surely would pass these costs on to their customers.
A true monopoly doesn't have to compete, and Microsoft is nothing if not a fierce competitor, using its market prowess to win competitive races with rivals, such as Sun, Netscape (now part of America Online) and IBM. Microsoft's interest in doing that is a plus for consumers. By not acting like a monopolist, it holds its prices (and profits) below what they would otherwise be. While such a pricing strategy might make life difficult for Microsoft's rivals, consumers benefit by getting higher quality software products and lower prices than they would otherwise.
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Under these circumstances, the proposed breakup of Microsoft amounts to a plan to force consumers to pay higher prices than they are now. This is not exactly the kind of outcome the Justice Department and Judge Jackson should want or seek -- if their real goal is to benefit consumers.
What is telling -- and disturbing -- about the Microsoft case is that it is the company's rivals, not consumers, who are pressing for a breakup. Microsoft's rivals should want Microsoft to act like a monopolist -- that is, restrict its output for the purpose of raising its prices. They would then be able to sell more of their own products at higher prices. The rivals would not rationally support any remedy that will make their markets more competitive, given that more-competitive markets would mean lower prices and profits for them. The rivals' support of the proposed remedy suggests that the effect of a breakup will be to do what antitrust enforcement should never do, help competitors at the expense of consumers.