Competing Against Microsoft and Intel

How could a company compete against Intel or Microsoft? Ideally, the company would sidestep the duo’s network externalities by marketing a compatible product. Absent compatibility, even if your company designed a cheaper and easier-to-use operating system than Microsoft’s, consumers would still be reluctant to purchase it because most existing software would be incompatible with your operating system. If, however, your operating system could run Microsoft-compatible software, then you could imperil Microsoft’s dominance.

AMD, in fact, has adopted such a strategy against the microprocessor maker Intel. AMD makes microprocessors that, from the consumer’s viewpoint at least, function almost identically to Intel’s. Consequently, AMD has been able to capture a small share of Intel’s market.

IBM, of course, did lose its dominance to competitors’ compatible products. Since many companies have made cheap IBM clones, IBM received no benefit from network externalities. When a consumer decides whether to buy an IBM or a Dell personal computer, his choice is based upon price or quality. This puts IBM and Dell on a level playing field where the edge goes to the company with the superior manufacturing skills. In contrast, network externalities protect Microsoft’s market position, so even if another company made a cheaper, better product, most consumers would still buy their operating system from Microsoft.

In addition to making a compatible product, you could also compete against a company with network externalities by selling to niche markets. For example, Apple has a large share of the market for personal computers used in grade schools. Apple has the advantage when selling to grade schools because its computers have historically been easier to use than IBM-compatible computers. Furthermore, since so many grade schools use Apple computers, much grade school–specific software is written for Apple computers, and thus Apple enjoys network externalities in the grade school niche market.

For high technology products at least, perhaps the best way to attack a firm protected by network externalities is to wait until the firm’s consumers decide to play another mass coordination game. High technology products quickly become obsolete. For example, most software written today wouldn’t run very well on a computer bought even seven years ago because of the rapid increase in computer speed, graphics, and memory.

The quick obsolescence of computer products limits the benefits of network externalities. To understand this, consider two types of software a consumer might want: (1) old software that has already been written, and (2) new software the consumer hopes to buy in the future. Microsoft and Intel have two advantages over potential competitors. Because their products have dominated the computer market, there exists a large stock of software compatible with their products. Furthermore, because people expect most computers in the future to run on Microsoft’s operating system and Intel’s microprocessors, consumers expect that most future software will be compatible with these companies’ products.

Now, imagine your company develops a new type of computer that won’t run existing software. Unfortunately, consumers will be reluctant to buy your computer when an IBM-compatible computer (with a Microsoft operating system and an Intel microprocessor) will run far more software. You can’t do anything about the existing stock of software. If you could convince software makers that your computer is going to be a big hit, however, then they should be willing to write new software that runs on your computer. The continual improvement in computer performance thus actually hurts Microsoft and Intel because it reduces the benefit of the existing stock of software that is exclusively compatible with their products.

Technological obsolescence and the challenges of achieving backward compatibility gives competitors another advantage over Microsoft and Intel. Both of these companies must continually improve their products as engineers figure out ways to make computers better, faster, and cheaper. To preserve network externalities, however, Microsoft and Intel desperately try to keep their new products compatible with old software, but it’s technologically difficult to make products backward compatible. It would be easier for both Microsoft and Intel to design their products if they didn’t have to worry about compatibility. If your products won’t run old software anyway, your engineers won’t be hindered by the limitations of backward compatibility. As a result, if your company has the same level of engineering skills as Microsoft and Intel, you should be able to make a better product. Of course, the superior quality of your product might not be sufficient to overcome the benefits of network externalities that both Microsoft and Intel enjoy.