Microsoft's innovative route to monopoly power

Just2Clicks bubble

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Just2Clicks to shut down and return £33m to shareholders

In a speech this week, John Vickers, director general of Fair Trading, said he was for zero tolerance of anti-competitive behaviour. The problem, in a world of rapid technological change and innovation, is defining what amounts to such behaviour and what to do about it if ever it can be defined.

The US judicial system has been grappling with these questions for the best part of the last five years, and to judge by this week's ruling by the Court of Appeals in the case of the Justice Department versus Microsoft, it is still no nearer finding the answers.

In the past 25 years, Bill Gates and his team have built Microsoft from nothing to what even after the recent technology sell-off is still the second most highly valued company in the world. To many Americans, and indeed to many in this country too, he's a folk hero, a shining example of what can be achieved through hard work and innovation. Why knock it?

And yet under the last Administration, regulators seemed intent only on undermining Mr Gates and breaking up his company. That there was good cause for concern about aggressive, anti-competitive behaviour is not in doubt. But there was more to it than that. America is a strongly anti-authoritarian society, and sticking up for the rights and dignity of the little guy is deeply ingrained in its culture, laws and constitution.

Mr Gates' admirers are more than matched by those who think he's arrogant, out of control and needs cutting down to size. This is the sociological backdrop that underlies US competition policy – never let someone get too big for his boots or he'll end up trying to control you. It's an admirable sentiment, but in the Microsoft case, it has also produced a lot of soul searching.

In his speech, Mr Vickers tried to address the question of how you draw the balance between the conflicting need to encourage innovation by allowing adequate reward and that of encouraging competition by allowing others to copy the innovation. Or as he put it: "The trade off regarding patent length is that longer protection enhances the reward for innovation but retards the efficient diffusion of successful innovations. These two factors....have opposing effects on economic growth".

In the Microsoft case, the problem becomes more complex still, since Microsoft's patent on its operating system, and its virtual monopoly of the operating system market, is not really at issue. There is little the competition authorities can do when the market on masse decides to select one operating system over all rivals for the purpose of convenience, conformity and establishing a common standard. In most technologies, a single standard eventually becomes dominant, and for the time being, Microsoft controls that standard for PC operating systems.

No, the issue in this case is Microsoft's attempt to leverage that monopoly into other markets, or "bundling" as the jargon calls it, of the operating system with browsers and other applications. To Microsoft, and indeed to many of its customers, it doesn't look like that, of course. To Microsoft, it is just about improving and adding value to the basic product. By what right does a regulator interfere with a businessman's right to innovate in this way? To others, however, it looks like an attempt to shut out rivals, to migrate a monopoly of the standard into a monopoly of its use.

There's nothing wrong with bundling as such. It happens in all walks of business and commerce, and is, for instance, the basic premise that underlies most forms of retailing. Bundling becomes questionable only when applied by those with a monopolistic position of the basic product.

GE's acquisition of Honeywell has run into problems with European regulators because GE is one of only three dominant aircraft engine manufacturers in the world, and its ability to sell Honeywell avionics as part of a package with its own engines would be unfair on the others. That's not to say it wouldn't be convenient for customers. It might well be. But it could also damage Rolls-Royce, and if Rolls-Royce is weakened beyond a certain level, then in the long term, buyers of aircraft engines will be disadvantaged too.

Microsoft achieved its "victory" in the US Court of Appeals mainly because of the stupidity of the original trial judge, who so discredited himself with his his obvious bias against Microsoft, that his findings and remedies have now largely been struck out. As it happens, the fiercely competitive and innovative nature of the software market is much more likely to bury Microsoft than any court, but the great debate on where you draw the line between innovation and monopoly will rumble on regardless.

Just2Clicks bubble

At the height of the South Sea Bubble, someone famously persuaded investors to stick their money into an endeavour of great advantage, but no-one to know what it is. That was in the eighteenth century, but it is hard to believe investors could have been so gullible even then. It wouldn't happen these days. No siree. We're all far too worldly wise, long in the tooth and ringed around by rules and regulations to fall for that one. Or maybe not.

When you think about it, Just2Clicks, which raised £50m in February last year just as the dot.com boom was peaking, wasn't so very different from the eighteenth century adventure of great advantage. At the time - and by the way, investors include some of the City's most sober institutions, the Pru, 3i and Invesco among them - the company had very little idea what it was going to invest the money in.

Ostensibly, J2C was targeted at what was then thought of as the next big thing: Business to Business exchanges. Investors had already begun to tire of Business to Consumer websites, and indeed for many of these companies, the bubble had already burst. But B2B - well, that was different. In theory, these internet exchanges offered big old economy companies the possibility of huge cost savings by turning traditional supply chains upside down. It was hot stuff and everyone wanted a part of it.

Accept J2C, it would seem. Nearly a year and a half after the float, J2C still has £36.1m of cash left burning a hole in the balance sheet. Against the profligacy of other internet entrepreneurs, J2C seems to have been commendably parsimonious with its money. True, a number of internet exchanges were set up, but none of them amounted to very much and they are all now either closed or being sold. The big transforming deal that J2C has been searching for has failed to materialise, so the company has decided that rather than waste any further cash, it is going to hand the money back to investors. Compared to most dot.coms, it looks like a lucky escape.

But the person it is particularly lucky for is the founder and chief executive, Karl Watkin. Mr Watkin owns 12 per cent of the company, which when it was issued to him was almost wholly free equity of the type that entrepreneurs get for their entrepreneurial input. Assuming distribution of the whole of the £36.1m, Mr Watkins stands to trouser £4.3m. He and others in the same position have agreed not to vote on the proposal, which is decent of them, but it looks like pretty good money for running a company that during its brief and inglorious appearance in the firmament achieved precisely nothing. No wonder Mr Watkins wants to wind up the company. It beats working for a living any day.

j.warner@independent.co.uk