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Weekly Column

With a Name Like Smuckers: What Microsoft Learned (and the Department of Justice Didn't) From the Grocery Business

Status: [CLOSED]
By Robert X. Cringely

More than three months into the federal anti-trust trial of Microsoft Corporation, there has emerged a pretty clear image of the world's largest software company as a paranoid and mean-fisted outfit that sees its job as more one of killing competitors than serving customers. But is this anti-trust? Are consumers hurt or helped by Microsoft's business practices? This is the dilemma faced by Judge Thomas Penfield Jackson. Sure, Microsoft wanted to kill Netscape and to corrupt Sun Microsystems' Java language, but does either act hurt consumers? These actions, in themselves, probably don't hurt consumers. But that doesn't mean Microsoft is innocent — just that the Department of Justice has followed the wrong strategy.

The question here is not whether Microsoft crushes competitors but whether Microsoft hurts consumers. Crushing competitors is part of business and not illegal. Netscape doesn't have some intrinsic right to exist in a world otherwise controlled by Microsoft. Where Microsoft would get in trouble is if consumers were being forced to pay higher prices than they ought to specifically because of monopolistic Microsoft business practices. The Department of Justice's mistake has been to concentrate on the woes of Microsoft's competitors rather than those of Microsoft's customers. Forget about Netscape and Java. A trip to some local computer stores is all it takes to realize that Microsoft is gouging us.

The fantasy version of retail theory says that publishers like Microsoft sell product at discount through distributors to dealers and then to you and me. Everyone along this food chain takes a piece of the profit, with the publisher setting a suggested retail price and the dealer setting the actual selling price. That's the fantasy. Reality is completely different. In the real world, dealers don't actually make money by selling software. They make money by selling shelf space to software publishers.

Publishers provide what are called Market Development Funds (called MDF in the business) in exchange for shelf space. MDF takes the risk out of selling software because the dealer gets paid whether the product sells or not. To keep this easy money coming, dealers typically sell software at no profit at all. So far this sounds great for consumers, eh?

Addiction to MDF puts the publishers in control of what dealers stock and sell. Publishers can also set a Minimum Advertised Price (MAP) that is tied directly to MDF. Dealers that charge too little for the product can lose some or all of their MDF, effectively giving the publisher control of retail pricing, too. So Microsoft, as the biggest software company with the most money, can effectively control both the products we have to choose from and the prices we have to pay. And by raising MDF, they can effectively push poorer competitors off the shelf and out of business. This is part of what the Department of Justice doesn't understand.

One reason why the Department of Justice has trouble seeing the danger in MDF is that the whole practice of selling shelf space like this comes from the grocery industry, where it works quite well. The difference between supermarkets and computer superstores, though, is that Smuckers sees itself as competing only for jam and jelly space, while Microsoft competes for every shelf in the whole darned store.

If Microsoft effectively has what appears to be monopoly power, why don't they raise prices and really sock it to us? That's the traditional monopoly behavior that anti-trust laws are designed to prevent. Yet Microsoft's prices have tended to be flat or even to decline slowly over time. This is no way to run a monopoly, right? Wrong. It's exactly the right way to run a monopoly if your goal is to run that monopoly forever. Fasten your seat belts, because we are about to enter the bizarre world of Microsoft economics, where strange forces apply.

One good reason for Microsoft not to raise prices through the roof is because doing so would trigger an anti-trust investigation. Beyond this little point, Microsoft doesn't raise prices because it isn't in the company's long term interest to do so. And long term is the way Microsoft tends to view everything. This is in contrast to almost every other high tech company where the best buck is the quick buck. But the core concept underlying any global Microsoft strategy is not making money, but building the company's market capitalization. The whole idea is to make Bill Gates even richer. And the way to do this is through steady earnings growth.

Microsoft has plenty of money. With no debt and more than $17 billion in cash, the company has more money than it can spend. Operating as it does in a growing market and selling products that have almost no manufacturing cost, Microsoft can do quite well with flat pricing. It is in Microsoft's interest to keep the market growing, and that, too, argues for price moderation. These are farmers, not hunters. But without Microsoft's influence, software prices would be dropping even faster. The difference between prices that are dropping slowly and prices that would have been dropping quickly is borne by you and me. This is the cost to consumers that the Feds have so far been unable to show.

But wait, there's more! While Microsoft the company is making plenty of money, that doesn't mean that divisions and business groups within Microsoft don't need to make more money to prove their worth. Staid products like word processing programs and spreadsheets still need new versions if their developers are to stay gainfully employed. But how do you justify a new version of a product that already does everything you need? Now this is a challenge.

In years past, the way to get people to buy new versions was by adding features. Computer magazines helped with this strategy by publishing feature check lists in their reviews. If the other spreadsheet had a feature, your spreadsheet better have that feature, too. Never mind that 80 percent of most software features aren't used at all.

But in time, this strategy failed because new features became harder to think of and, more importantly, because magazines and consumers both began to complain about bloated software. Enter a new and improved strategy — file format changes.

An associate sends you an e-mail message with an attached word processor file. But your copy of Microsoft Word won't open the file. This is because your associate is using Word 2000 and you are using Word 98. It takes awhile to figure this out, of course, but eventually you learn that there are two solutions to this problem: 1) your associate can send you a new version of the file saved in Word 98 format, and; 2) you can buy an upgrade to Word 2000.

Eventually, you'll be forced to buy the upgrade, just because the problem will crop up again and again, and sometimes it won't seem proper to go back to the sender and ask for a new version. So you upgrade, spend time and money to gain a few new features you don't explore and never use. One question that lies unanswered, of course, is why Microsoft felt the need to change file formats at all? Why to get you to buy the damned upgrade, of course! And most of the revenue Microsoft gains from those otherwise unnecessary upgrades can be counted as a cost to consumers. Pay attention, Department of Justice.

Not only should the feds pay attention, so too should Microsoft's competitors. That's because Bill Gates is not the only one to play these file format games. These same companies that are quietly eager for Microsoft to lose its antitrust case are likely to find themselves affected by any new rules that emerge. Microsoft's competitors should be careful what they wish for.

Consumers, on the other hand, don't have to think twice about wishing for a few simple things — real competition on software prices, the opportunity not to upgrade ceaselessly, and a Justice Department that understands why these things matter.

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