Barriers to entry can be defined as circumstances within a given industry that hinder new companies from entering the market. Creating these barriers to entry are considered to be a strategy that aid industry leaders to continue a strategy of sustained growth, thus attributing them with a degree of competitive advantage. In the global industry of computer technology, Microsoft is a company that has leveraged barriers of entry to their full advantage, achieving monopolistic status.
Microsoft’s strategy is one that has relied on pre-existing natural barriers to entry, as well as the creation of artificial barriers to avert competition in the software business. While the company has often come under fire for their highly aggressive, and at time unethical monopolistic business practices, it does not change the fact that the company has gained a dominant position, holding a 90% market share in the early 1990s (Jenkins & Bing, 2007) that it will continue to enjoy for a long time to come.
The artificial barriers that Microsoft has erected have helped speed up its development into a monopolistic concern. These barriers are as follows:
1. Per-Processor Licensing – Microsoft’s initial distribution strategy was that end-retailers, or OEMs, had to pay Microsoft a fee for each computer they sold, regardless of whether that computer was equipped with Microsoft’s Windows operating system. This acted has a disincentive for the OEMs to sell any other operating system, regardless of whether they were of better quality or more cost effective. Microsoft has since been forced to withdraw this policy, but not before their market share was boosted immensely.
2. Price Discrimination – A preferential pricing structure was given to those OEMs that sold or distributed Microsoft’s other products. Thus, many converted to exclusive Microsoft distributers since it was more cost-effective, thus stifling a vital source of distribution for competing software.
3. Bundling software and Predatory Pricing: Microsoft always bundles key software with its Windows operating system. This is a clear example of both predatory pricing where a company undercharges for its products for the sole purpose of forcing its competitors out of business and a tying arrangement (Jenkins & Bing, 2007).
Strong natural barriers to competition exist in the software industry. The more predominant a company is, the greater the natural barriers that will be erected. Microsoft benefits from this predominance, and still reaps the benefits of the first mover advantage it gained by creating the market for personal computers in the 1980s. These artificial barriers helped Microsoft gain the predominance it needed for natural barriers to come into effect. These natural barriers include:
1. Network Effect – The exclusive distribution that Microsoft inspired led to Microsoft software spreading across many homes, institutions, businesses etc. The further it spread the greater Microsoft’s reputation as being the “reliable” software to use became. This is known as the Network Effect, where users of the software were perceived by potential buyers as being third party endorsers of the Microsoft brand. Third party support took on a viral marketing nature, and increasingly people and businesses have come to see Microsoft as the standard, and thus a safer investment to make in terms of both time and money.
2. Investment Effect – When people, and especially businesses, make a commitment to a particular software or technology platform, the commitment is for the long term. Once particular software is bought, it must be learned, thus it requires both time and money. The users will then proceed to use subsequent upgrades of the same software, rather than switch to a new, often alien platform. This is because learning new software is perceived as being difficult, stressful, and time consuming. There is also the added compatibility with old files. Thus, through this system of investment and upgrade, people and businesses are effectively locked to the company.
The Case of Microsoft and Netscape
In 1995, Microsoft found itself in a dilemma. The company’s cash flows were tied to desktop computing, but there was a fundamental shift underway, toward networked computing (Allen, 1997). Essentially Microsoft was just beginning to realize the impact the creation of the Internet would have on computing needs and habits. It soon realized it would require presence on the Internet, by utilizing web browsing software platforms. There are two further strategies that Microsoft employs to erect barriers against competition. We will discuss both of these strategies using the example of how Microsoft drove Netscape out of the market.
The first is Microsoft’s significant financial resources, which gives it the ability to completely outspend the budgets of any of its competitors. Microsoft spent millions of dollars in creating a competitor to Netscape’s web browser. Then, it gave away the software to consumers for free. And not just for free, but also drove promotional campaigns that got consumers to switch to their browser in order to get other additional software for free. They drove Netscape out of business by effectively paying customers to not use Netscape, and use Microsoft’s browser instead.
The second strategy Microsoft uses is corporate mergers, and technology buyouts. Again the case of Netscape is relevant. Microsoft attempted to get Netscape to stop making Windows OS compatible internet browsers, so that only Microsoft created web browsers would be used. Netscape declined however. Thus, Microsoft proceeded to license out web browser software from a company named Spy Glass, and launched it under the name of Internet Explorer.