May/June 1998 | Volume 49, Issue 3
In theory it works fine; in practice it has often made situations much worse
Like Freddy Krueger in the Nightmare on Elm Street movies, antitrust keeps coming back. The latest company to find itself in the sights of the Antitrust Division of the Justice Department is Microsoft. It was recently ordered by a judge to make available copies of its operating system, Windows 95, without the Internet browser. Why was Microsoft forced to do this? What was its “crime”? Well, the crime, believe it or not, was making its browser available to the public for free.
Now the average consumer might be forgiven for thinking that free is a pretty satisfactory price to pay for something useful. But to the theoreticians of antitrust, this was a classic case of “predatory pricing.” With predatory pricing, a rich and powerful company, such as Microsoft, charges a low price, or no price, to force weaker competitors (in this case Netscape) out of the market and thus gain a monopoly. But once Microsoft rules the browser marketplace, according to theory, the company will jack up prices and drain America’s wealth into Bill Gates’s already amply filled pockets.
But if the people at Justice who don’t want you and me to have a good computer program for free would lift their noses out of the theory books and take a peek at history, they might be surprised. To be sure, there have been any number of instances in which a local or temporary monopoly has been used to gouge (a hardware store tripling the price of snow shovels after a blizzard, for instance). But there has never been a case in which a company with a dominant position in a free market has used that power to fleece the public with high prices over the long term.
Just consider. Perhaps the nearest thing to a true monopoly of a vital commodity ever known in this country was Standard Oil’s control of the petroleum market in the years before the company was broken up in 1911. It was certainly true that Standard Oil would regularly underprice competitors that it wanted to buy until they either went bankrupt or agreed to be taken over. But even when Standard Oil controlled 85 percent of the domestic oil market, it did not raise prices. In fact, between 1870, when Standard Oil was formed, and 1911, the price of petroleum products fell, almost continuously, until they were on average only one-third what they had been in the late 1860s.
Likewise, the Ford Motor Company had 55 percent of the American car market in the early 1920s (and a far higher percentage of the low-priced car market). But Henry Ford nearly brought the company to ruin by his obsession with improving manufacturing processes so that he could sell the Model T at ever lower prices. The first Model T’s, in 1909, sold for $850. The last ones, in 1927, even after the inflation caused by World War I, sold for as little as $260.
The reason companies in dominant positions in their industries do not maximize prices is simple: They would rather maximize profits. The economics could hardly be clearer (except, apparently, to those whose job is to protect the public from predatory pricing). There are only two ways to increase profits: Raise prices or lower costs. Raising prices, however, inevitably cuts demand, so an increase of, say, 10 percent in the price over and above costs will not result in a 10 percent increase in profit. Rather it will be some lesser percentage as some people decide do without or to conserve.
Lowering costs while keeping prices steady, however, does not affect demand, so a 10 percent cut in costs translates into a 10 percent increase in profit. Even better, using part of the lower cost to lower prices results in increased demand and thus yet higher total profits, which, after all, is the only thing that counts.
Still, it’s an old saying that to someone in charge of a hammer, everything begins to look like a nail. And those with the hammer of antitrust in their hands have had a record of doing at least as much harm as good. Often their timing has been nearly surreal. Standard Oil was broken up just as Royal Dutch Shell was beginning to provide true competition. In 1948, the very year that television really took off in this country with the debut of the “Texaco Star Theater,” with Milton Berle, Hollywood studios were forced to change several practices. The purpose was to lessen their stranglehold on popular visual entertainment; the result was to move power in Hollywood from the Samuel Goldwyns to the Barbra Streisands. I am not sure that is progress.
In 1969, on the last day of the Johnson administration, the Antitrust Division sued IBM. With 65 percent of the market at that time, IBM was the eight-hundred-pound gorilla of the computer industry. But by the time the case was finally abandoned as unwinnable, in 1982, the next oversize anthropoid of computing, Microsoft, was already shipping its software and IBM was headed into the worst decade of its existence.
But perhaps the best example of the harm antitrust has sometimes done to our economy is RCA. The company was founded in 1919 as a patent consortium to exploit the nascent industry of radio broadcasting in this country. Its major owners were originally General Electric (30.1 percent), Westinghouse (20.6 percent), AT&T (10.3 percent), and, of all companies, United Fruit (4.1 percent). These four companies contributed no fewer than two thousand patents to the new enterprise, and it soon achieved dominance as the broadcasting industry expanded explosively in the 1920s.
By 1930 a most remarkable man named David Sarnoff was in charge of RCA, and research to go beyond radio and transmit sight as well as sound was well under way. An impoverished immigrant from Russia, Sarnoff had gained worldwide fame the old-fashioned way: being in the right place at the right time. In 1912, as a twenty-one-year-old operator for American Marconi station in Manhattan’s Wanamaker store, Sarnoff picked up faint signals on his headset and heard a terrible story come crackling through the ether: The liner Titanic had sunk. As reports trickled in and the scope of the disaster became increasingly clear, anxious New Yorkers pressed into Wanamaker’s to get what news they could of relatives who had been aboard, and Sarnoff stayed at his post, a link between the most famous disaster of the twentieth century and an American public that could not (and still can’t) get enough of it.
When American Marconi became part of RCA, Sarnoff was on his way. By 1921 he was general manager, by 1930 he was president. That year the Antitrust Division demanded that the cozy arrangement among the electronic powerhouses that had brought RCA into existence be terminated. That, of course, suited David Sarnoff just fine. By the time the dust settled in late 1932, RCA was an independent company. Moreover, with two networks, manufacturing facilities, and up-to-the-minute research laboratories, it was the dominant company in a broadcast industry of seemingly limitless potential.
By this time it was clear that television was going to be a major part of that potential. Rapid developments in the next decade, many pioneered by RCA, made commercial television possible, and Franklin Roosevelt would be the first President to appear on television when he opened the New York World’s Fair in 1939. That year, too, RCA began selling television sets, with five-inch and nine-inch screens and prices ranging from $199.50 to $600.
Needless to say, the outbreak of World War II in September of that year brought the development and spread of television to a dead halt as RCA and other electronic companies, such as Philco, Emerson, and Sylvania, began to devote their efforts to military technology, especially radar. During the war RCA shared patents with these companies to help the war effort.
As soon as the war was over, television began to take off and immediately had a profound effect on American life. To give just one example, in 1948 both the Democrats and the Republicans held their conventions in Philadelphia. It was not a coincidence. Philadelphia lay in the middle of AT&T’s coaxial cable from New York to Washington. Thus the conventions could be telecast through fourteen stations that covered a substantial portion of the country’s population. The following year television sets made their first appearance in the Sears, Roebuck catalogue.
RCA, of course, was in the best position to exploit the situation. That’s when antitrust kicked in. In 1946 the companies that RCA had shared patents with during the war brought suit under the antitrust laws asking that RCA be forced to continue sharing those patents. In other words, Macy’s wanted the U.S. government to require Gimbel’s to tell it everything. The eventual consent decree forced RCA to do just that, but it contained a curious proviso. While RCA had to share its patents with domestic companies for free, it was permitted to license the patents to foreign companies for the usual royalty arrangement. Naturally, RCA, being a profit-seeking company and no longer able to keep its immensely valuable technology to itself, sought to maximize its profits by licensing abroad as much as possible.
The result was not long in coming. In 1960, when David Sarnoff visited Japan, he was awarded the Order of the Rising Sun for his contributions to the Japanese electronics industry. By the 1970s the domestic manufacture of consumer electronics goods had virtually ceased. By 1990 RCA had lost its corporate independence and was once more merely an appendage of the General Electric Company. To protect an American industry from the dominance of one company, antitrust had killed off the entire industry.
That’s a bit like using a guillotine to cure a headache.