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Krugman: The dramatic rise and fall of e-empires

  • Microsoft CEO Steve Ballmer recently announced plans to retire. (JEFF CHIU / Associated Press)

Steve Ballmer's surprise announcement that he will be resigning as Microsoft's CEO has set off a huge flood of commentary. Being neither a tech geek nor a management guru, I can't add much on those fronts. I do, however, think I know a bit about economics, and I also read a lot of history. So the Ballmer announcement has me thinking about network externalities and Ibn Khaldun. And thinking about these things, I'd argue, can help ensure that we draw the right lessons from this particular corporate upheaval.

First, about network externalities: Consider the state of the computer industry circa 2000, when Microsoft's share price hit its peak and the company seemed utterly dominant. Remember the T-shirts depicting Bill Gates as a Borg (part of the hive mind from “Star Trek”), with the legend, “Resistance is futile. Prepare to be assimilated”? Remember when Microsoft was at the center of concerns about antitrust enforcement?

The odd thing was that nobody seemed to like Microsoft's products. By all accounts, Apple computers were better than PCs using Windows as their operating system. Yet the vast majority of desktop and laptop computers ran Windows. Why?

The answer, basically, is that everyone used Windows because everyone used Windows. If you had a Windows PC and wanted help, you could ask the guy in the next cubicle, or the tech people downstairs, and have a very good chance of getting the answer you needed. Software was designed to run on PCs; peripheral devices were designed to work with PCs.

That's network externalities in action, and it made Microsoft a monopolist.

The story of how that state of affairs arose is tangled, but I don't think it's too unfair to say that Apple mistakenly believed that ordinary buyers would value its superior quality as much as its own people did. So it charged premium prices, and by the time it realized how many people were choosing cheaper machines that weren't insanely great but did the job, Microsoft's dominance was locked in.

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