Breaking Up Is Hard to Do, So Don’t Do It

When the government launched its suit against Microsoft in 1998, it was in effect making a prediction about the evolution of technology. Microsoft, the government said, should not be allowed to beat back rivals who believed the future of computing rests with the Internet. Now, with the Justice Department’s new proposal to break Microsoft in two, it is again reading the crystal ball--this time betting that the fruits of Microsoft’s innovation, not to mention the market value of Nasdaq stocks, can survive micro-management.

Microsoft saw the Netscape Navigator Web browser as a threat to the value of Windows, its PC operating system. Navigator, it feared, was the vanguard of an Internet-based movement to usurp Windows’ prized role as a platform for running applications software. Thus, according to the government, Microsoft’s decision to spend a lot of money to make its Internet Explorer ubiquitous hurt consumers by eliminating a promising potential rival to Windows.

It’s a stretch to conclude that Microsoft’s efforts actually harmed consumers. Even the judge who found that Microsoft’s actions were anti-competitive grudgingly admits that Microsoft’s attempts to win converts from Navigator forced both companies to design better browsers--and then to give them away.

But assuming that Microsoft did squeeze Netscape unfairly, and that some remedy is presumably called for, does breaking the company into two parts--the Windows operating system and the rest--fit the bill?

Hardly. For one thing, the proposed remedy is only tangentially related to the alleged offense. This case almost entirely centered on the browser wars, not on the role of applications software, like the popular Microsoft Office, in defending Windows from competition.

If Netscape had been harmed by illegal behavior, then the straightforward solution would be to compensate Netscape. But Netscape’s stockholders are not hurting; the company was gobbled up for a handsome $10 billion in 1999 by mighty AOL. Nor are consumers, who were always welcome to stick with Navigator, being harmed. Besides, Netscape’s corporate parent still could transform Navigator into a formidable competitor overnight, simply by shifting its tens of millions of AOL customers to the new browser.

By the same token, the government seems to have taken no account of the potential impact of divestiture on Microsoft’s productivity. A conglomerate that makes, say, cigarettes and cheese can be broken up relatively easily--indeed, it seems to happen every time investment bankers arrive on the scene. But a company in the business of producing intellectual capital--in this case, key software used by hundreds of millions of people every day--is another story. I have no idea how to measure the disruption caused by breaking up Microsoft; neither does the government.

Or consider the impact on software prices. The idea of any remedy, of course, is to beat down costs and prices in the long run. But as MIT economist Paul Krugman has noted, breaking up a company that dominates two markets (operating systems and office software) into companies that each dominate one market could have the perverse effect of raising prices.

Moreover, contrary to government claims, the full package of remedies would involve lots of regulation. The Justice Department wants any new programs (like browsers) that come with Windows to be removable by consumers. But what really constitutes a new program? Only your friendly Washington regulator knows.

Perhaps the most disturbing precedent in the government’s remedy is the failure to take account of the market’s wish for common standards. It is no accident that we ended up with a dominant PC operating system. Such standardization makes life infinitely easier for consumers who need learn only one set of commands, as well as for applications software makers who don’t have to tailor versions to be compatible with multiple systems. If the losers in battles for such winner-take-most markets can appeal the verdict in the courts, information technology companies will soon employ as many lawyers as engineers.

The battle between Microsoft and the government started as a dispute over what a dominant firm in the technology business should do to protect its market dominance. Now it seems to be about cutting the most visible symbol of corporate power in the New Economy down to size. That the government can so easily propose to break up the world’s largest software company hardly increases confidence in its stewardship.