TCS Daily


The Broken Windows Fallacy

By Paxton Hehmeyer - August 15, 2002 12:00 AM

Consumers spent $4.6 billion on Digital Video Discs (DVDs) last year - more than twice as much as they did in 2000 - beating out VHS cassette sales for the first time. DVDs sold spectacularly even though VCRs are in four times as many households as DVD players. Some chain stores, such as Circuit City and Borders, expect this trend to continue and are replacing their VHS inventories with DVDs. If this sounds familiar, it may be because the VHS format itself had trounced its rival, Beta, in the mid to late 1970s.

Some complained that the success of the VHS format locked consumers into an inferior technology. But in their book Winners, Losers & Microsoft, economists Stan Liebowitz and Stephen Margolis challenge the notion that Beta was better than VHS. Although Beta did provide a technically better picture, consumers could not notice this difference on the televisions of the late seventies. VHS, on the other hand, offered a longer taping time than Beta a feature especially desirable for recording long movies and football games.

Since the end of the VHS/Beta wars, however, "lock-in" continues as a popular and often cited business legend. The lock-in theory claims that consumers can sometimes become "locked in" to an inferior technology simply because it has a sufficiently large number of users either because of chance or because consumers adopted it before better alternatives were offered. (Lock-in allegedly occurs in markets where the so-called "network effect" is present; where a product, such as a fax machine, becomes more useful if more consumers use it.)

Unfortunately, theories can gain a life of their own even when facts do not support them. During the 1990s, lock-in theory was cited in several antitrust cases brought against companies such as American Airlines, MasterCard, and Visa. In 2000, U.S. District Court Judge Thomas Penfield Jackson found that Microsoft violated antitrust laws because "positive feedback loops" (i.e., lock-in) kept the company's rivals from effectively
competing in the market for personal computer (PC) operating systems (OS).

True, Microsoft holds the dominant share of the market for operating systems. But this does not mean that Windows is any less immune to competition than VHS is from DVDs.

Here, the case of VHS vs. Beta is particularly instructive. Supposedly neither Beta nor, later, laser discs could break the barriers to entry that VHS's consumer base presented. But DVDs are doing so and at an astounding rate. Even if Beta and laser discs offered superior technology, most consumers obviously decided that it was not worthwhile to switch from the VHS format until something sufficiently better came on the market.

More than likely, DVD will become the new industry standard, until something else replaces it, just as VHS superseded Beta. As Liebowitz and Margolis observe, some markets only efficiently support one technology, which then becomes the industry standard, until a much better standard emerges and supplants it, and so on.

Court-imposed sanctions to dismantle a market leader in such a situation, say the economists, would only lead to the emergence of a new leader resembling the old one in terms of market share. Indeed, such market leadership may actually be the best option for both businesses and consumers.

As Microsoft and others await Judge Colleen Kollar-Kotelly's imposition of a remedy for the company's violation of antitrust laws, Microsoft is already developing new operating systems and features intended to replace Windows in the same way that Windows replaced DOS. This technology could very well render pointless all the litigation against Microsoft's dominant position in the PC operating systems market by changing the very definition of the market itself.

Consumer choices made DVDs one of the fastest growing electronics products ever, toppling VHS's 20-year dominance of the recorded media market. Similarly, it should be consumer choices, not court-imposed restrictions or mandates, that select the new standard in OS technology - one that will likely break Windows.

Paxton Hehmeyer is a public affairs intern with The Independent Institute in Oakland, Calif.
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