Microsoft, bundling and all that

Brad DeLong argues that he has been harmed by getting IE for free with Windows.

Remember the days when there was not one single dominant browser that came preinstalled on 95% of PCs sold? Back then there was ferocious competition in the browser market, as first a number of competitors and then Netscape and Microsoft worked furiously to upgrade their browsers and add new features to them....Progress in making better browsers was rapid, because browser-makers wanted to make a better product and any new idea about what a browser should be was rapidly deployed to a large enough user base to make it worthwhile for web designers to try to use the new feature.

But why was competition in the browser market so furious? Hmmm... couldn't have been because each firm knew that the winner would be a monopoly, could it? The alternative to Microsoft winning the browser war was not competition between many firms but a different dominant monopolist. Focusing on the economics, i.e. without getting into arguments about which firm was the better innovator etc., is there any reason to prefer one monopolist over another?

The double monopoly problem, first explained by Augustin Cournot in 1838, suggests that Microsoft might be the better monopolist. The double monopoly argument says that if two products are going to be monopolized its better if they are monopolized by one firm than by two (or more). The reason is that the single monopolist will take into account complementarities between the two products. The better the brower, for example, the more operating systems Microsoft will sell and vice versa. Separate the two products and you lose this added incentive to lower price and/or improve quality. (If you know the tragedy of the commons argument, the double monopoly problem is the same thing with the customers serving as the common resource).

An unappreciated aspect of this argument is that the reason that Microsoft might make the better monopolist is the same reason it will likely win in any battle with a stand-alone competitor. Microsoft has more to lose from losing and more to win from winning than does the stand-alone and will therefore put more resources into winning. This explains why the European directive requiring Microsoft to sell two versions of its operating system, one with and one without the media player, is pointless. Microsoft will simply sell the two versions at the same price - then which one would you choose?

Aside: I also think that Brad doesn't appreciate enough the power of potential competition. Low marginal costs and ease of distribution in the software market mean that one of the now relatively small competitors to IE could grow very rapidly. Microsoft knows this and cannot rest on its laurels/behind (your choice). Consider how rapidly the browser substitutes known as RSS readers are growing.