Linux, Libertarians, and Antitrust

By Garnet Harris

Introduction

Many libertarians are critical of antitrust laws for a variety of reasons. One of them is that antitrust laws are unnecessary because the market will not tolerate an abusive monopoly. Competitors, due to the profit motive, will arise; and the market will self correct. When discussing the Microsoft case, the critics typically use Linux¹ as an example of this in action.² However, they rarely address Linux's development model³. This failure of examining the development model obscures an important point. The development model used by Linux undercuts the argument as much, if not more, then it supports the argument. I will examine the development model and the implications it has on this argument.

Anti-Antitrust Argument

An abbreviated version of this argument follows.⁴ No company can achieve or keep a monopoly position without government intervention unless it offers the best product at the best price. If the monopoly tries to exploit its monopoly position by raising prices or reducing quality, competitors will arise causing the market to self-correct. Competitors, motivated by the high profits, will rush in to get a share of those profits.

Once a competitor enters the market, the monopoly can decide to fight to maintain its monopoly or accept lower profits and share the market with the competitor. If the monopoly decides on the latter, it no longer has a monopoly and the problem is solved. If the it decides on the former, it can try to maintain its monopoly by either selling its product at a loss or buying out the competitor.

The monopoly may succeed in temporarily regaining its monopoly. However, the moment it raises its prices back to the monopoly level, other competitors will jump into the market. This cycle will continue until either the monopoly goes bankrupt from selling at a loss or raises its prices to a profitable level that allows competition.⁵

Where Are the Competitors?

One test of a monopoly is if it has the power to raise prices regardless of market conditions and without worrying about competitor's reactions.⁶ While other IT companies were reporting a decrease in earnings and laying off employees, Microsoft reported an increase in earnings.⁷ While companies were cutting back on their IT spending, Microsoft changed their licensing terms which increased the cost for many customers. Few customers switched to a competitor although many were unhappy with the new terms.⁸ Microsoft has a cash reserve over $40 billion and no debt.

The OS market on the x86 platform is a extremely profitable market for Microsoft.⁹ Microsoft has a profit margin of over 80%. They have net current assets of $37 billion dollars and no long term debt. The cash reserves and lack of debt gives Microsoft the capability to continue operations for over 15 years without any revenues.

There is a lucrative market and dissatisfied customers. Where are the competitors predicted by anti-antitrust argument? Digital Research, noting that MS-DOS had stagnated, tried to enter the market in the early 90s. They went bankrupt. Netscape tried to position their products as an alternative to Windows. They lost money and were sold to AOL. BeOS, the latest attempt, closed its doors on March 15, 2002.

Even with those failures, shouldn't the Venture Capitalists be beating the bushes for any competitor that will be able to take a share of the OS market? According to the anti-antitrust argument, yes. In reality, the answer is no.¹⁰ Venture capitalists will always ask the "M" question: What is your Microsoft strategy?

The anti-antitrust argument also predicts that a monopoly would lose money during the battle for its monopoly. Microsoft did not. Microsoft increased earnings while defending their monopoly.

Which brings us to Linux.¹¹ Why is Linux succeeding where others fear to tread?¹² Why is Linux the exception?

Open Source Development

One difference between Linux and the other competing OSes is the method used to develop the software. All the others used the proprietary development model. They acquired funding to form the company. They hired programmers to write the code. They retained all rights granted under copyright law. And, they only distributed the binaries. The source code was owned and controlled by the company.

Linux, on the other hand, uses the Open Source Development model. Linus Torvalds received no funding. He didn't hire any programmers. He licensed it under the GPL¹³ which gives away most of the rights allowed under copyright law and distributed the source code.

The GPL allows anyone to download, make copies and distribute the program without charge. It also allows make modifications to the source and distribute those modifications. The only requirement to distributing a modified version of the software is that the programmer must include the source to his modifications. Linus Torvalds isn't being paid a dime from the companies that distribute Linux.

This fact alone appears to undermine the typical antitrust critic's analysis since they place strong emphasis on the profit motive. Ten years ago, they would have scoffed at anyone who suggested that unpaid programmers could write an OS that would rival Microsoft's. Even today, they are still skeptical.¹⁴

Another problem with this development model, from the antitrust critic's viewpoint, is that there is no design, no master Plan, or to use Microsoft's phrase, no road map. Linus did not write Linux in order to compete with Microsoft. He wrote it because he wanted to run a UNIX operating system on the Intel platform. He wrote a buggy program and put it on the Internet. Linux has evolved from there. As one person phrased it, "Linux really isn't going anywhere in particular and seems to be making progress through sheer luck."¹⁵

Why Linux?

Why is Linux succeeding when other challengers to Microsoft's OS monopoly have failed? There are several reasons for this; but, the main one is the fact that the contributers to Linux are not concerned about being paid for the code they contributed. Their motivation for the contribution lies in other areas. They may be doing it for reputation. They may be looking to earn income in other areas, e.g. support, other then the sale of the software itself. Them maybe solving a particular problem they have. Or, they may be doing it for the fun of it. The lack of profit motive allows Linux to circumvent, avoid, or minimize the various problems experience by the for-profit competitors.

Single Target

The code of the other challengers was owned by a single company. This presents a single target to Microsoft. If they can "kill" the company, they removed the competing product from the market.¹⁶ They were all vulnerable at the bottom line since they were for-profit companies. If Microsoft can take away the competitor's profits, the competitor will eventually remove the product or go out of business.

Linux, by contrast, is a multi-headed hydra. There are currently over 200 different distributions of Linux.¹⁷ Even Microsoft does not have the resources to drive them all out of business. Even if Microsoft did, it still wouldn't remove the product from the marketplace. If all 200 distributors went out of business tomorrow, anyone is entitled, due to the GPL, to take their existing copies and continue to distribute Linux.¹⁸ New sources of the product can spring up over night. And, if for some reason, no one took up the "distributor" torch, hardware manufacturers are still allowed to use their existing copies to install it on their models.

Development Costs

A for profit company competitor would need to develop their code from scratch. It is estimated that it would cost about $1 billion dollars to develop an OS similar to Linux or Windows2000.¹⁹ This is just development costs and doesn't include marketing, support, or distribution costs. Where will this amount of capital come from? Not the Venture Capitalists.²⁰

One possibility is for established profitable companies to use their reserves to enter the market without outside funding. This is not a likely outcome if we assume, as antitrust critics insist, that the companies are rational players. A rational player does not only look at the potential payout, he must also evaluate the probability of succeeding versus the cost of losing. The development costs of $1 billion represents 14% of IBM's net current assets.²¹ They would be competing against a company that can afford to give away the products for 15 years while IBM couldn't go 4 months without any revenue. They would have to look at the track record of other competitors. IBM would be betting the future of their company on a proposition that has little chance of success.²²

Distribution Channel

Another problem any competitor faces is Microsoft's stranglehold on the distribution channel. Most customers do not want to deal with the aggravation of installing their own operating system. They want to buy the computer with the operating system pre-installed. This presents a problem for any competitor. How do they get the OEMs to pre-install there OS.

BeOS²³ tried to give it away. They offered it free to any OEM who would install it with computers as a dual boot system. This was an opportunity for the OEMs to differentiate themselves in a highly competitive market by offering two OSes for the price of one. Consumers would have been given the opportunity to try a different OS at no risk.²⁴

Four OEMs, Dell, Compaq, Micron, and Hitachi, expressed interest until they received calls from Microsoft's lawyers. Three backed away from the offer. Hitachi did ship a dual boot model. But, they were prevented from offering the consumer the choice of OSes at boot up. Anyone who just turned on the computer would not know that two OSes had been installed. The only way to actually boot into BeOS was a cryptic command which Hitachi was not allowed to publish. Microsoft's domination of the market prevented BeOS from giving their OS to OEMs.

Even Linux hasn't been able to break into this distribution channel yet. However, because of its nature, Linux has an alternative distribution channel: giving it away over the Internet or having a friend install their copy. Users of Linux are legally allowed, even encouraged, to use their copy of the software to install on their friends computers. For-profit companies can not duplicate this distribution channel and stay in business.

Company Stability

Another entry barrier for a competitor is the perceived stability of the company. Switching to an alternate OS has costs. For individuals, it is the time and inconvenience of installing and learning a new OS. For companies, it is the cost of converting existing machines plus the cost of replacing existing applications. A company will not switch if they are not convinced that the competitor will still be in existence in five to ten years. If the competitor goes out of business or stops distributing the product, the company will have to pay the transition cost twice. Once, when they switch to the competing product. Then they will have to pay the same costs again when the competitor goes out of business.

Linux sidesteps this barrier with the GPL license. As noted earlier, even if every Linux distributor goes bankrupt tomorrow, Linux will still be available. A company that switched to Linux can continue to install it on new machines. They can continue to modify it to suit their needs. They only have to pay the switching costs one time.

BSD

Another question needs to be asked. Why Linux instead of any of the other Open Source OSes, e.g. xBSDs? One possible explanation is media exposure.²⁵ Another reason is the licensing. Benkler²⁶ pointed out that the "free rider"²⁷ is not a deterrent to commons-based peer production. But, unilateral appropriation can be. Unilateral appropriation can take many forms.

One type of unilateral appropriation is where someone uses the input of the contributors for their economic gain while excluding the contributors. One example is Microsoft's attempt to embrace and extend Kerberos.²⁸ Microsoft took a publicly available specification, added extensions, and would not disclose those extensions. This allowed Microsoft to make their product compatible with everyone else's version of Kerberos while preventing competitors from making their versions of Kerberos compatible with Microsoft's.

When Linux first emerged into the general public's awareness, it had some deficiencies that prevented it from being considered an enterprise-class OS, e.g. the four CPU limit. IBM, among others, contributed some of the code they developed for their own OSes in order to overcome these deficiencies. They would have been reluctant to do this if Linux was licensed under a BSD license.²⁹

Antitrust Trial

We can not ignore the fact that Linux owes some of its current success to the Microsoft antitrust trials. The biggest benefit it received was the media exposure it received during the trial. In a few short months, the reaction to Linux went from "never heard of it" to "oh yeah, I did read something about it." I can't imagine the size of marketing budget would have been required to achieve the same result that the trial achieved. This removed one barrier to the market. In order for people to choose your product, they must first know that it exists.

The settlements also opened the door for the major OEMs to offer Linux pre-installed. The 1994 settlement prohibited Microsoft from using per processor licenses. Microsoft modified their licenses to apply to model lines. While it was not a major change in the licensing terms, it was enough to give major OEMs the opportunity to pre-install Linux on a few select models. Something DR-DOS could not achieve.

The current settlement prohibits Microsoft's OEM license from disallowing dual boot machines. This was the tactic used against BeOS. It also allows OEMs to pre-install other applications without Microsoft's permission. This was a tactic used against Netscape.

Another benefit the trail had was to change the public's and competitor's perception of Microsoft. Before the trial, competitors tended to view Microsoft as invincible. BeOS tried to stay out of Microsoft's cross hairs by targeting a niche market. They also realized that partnering with Microsoft had risks. This lead to many companies taking a serious look at Linux as an alternative.

The public's perception of Bill Gates as the fair-haired wonder boy was also tarnished. They did not like his Clintonesqe answers during the deposition. They also had a distaste for many of the business practices used by Mircosoft. The misrepresented video tape they presented as evidence of download speeds didn't help matters.

Conclusion

The libertarian argument that competitors, due to the profit motive, will jump enter the market is suspect. Its proponents will have to refine the argument. The success of Linux demonstrates that there is a demand for an alternative operating system on the x86 platform. But, the only viable competitor is Linux which is given away, not sold.

They will have to demonstrate that Linux would be as successful as it is without the help of the antitrust trial. They have to explain why the only way to compete directly with Microsoft is to give your product away. In fact, they have to explain how an unorganized group of volunteer programmers could write a competitive complex OS that would cost a company $1 billion to develop.