Answers to Chapter 6 Questions

“I just got out of the hospital. I was in a speed reading accident. I hit a book mark and flew across the room.” –Steven Wright

Q: What competitive advantages does Microsoft enjoy in the operating system industry?

The only segments within the PC world with features suggesting that there are barriers to entry protecting incumbent firms from new entrants are operating systems and CPUs. In both there are a small number of competitors and stable market share. Microsoft enjoys both customer captitivy and economies of scale in the operating systems business. Customers prefer to stick with what they know, especially regarding software. Swithching costs can be prohibitive when many users have to be taught to use unfamiliar programs. Search costs also inhibit change because the buyer has to have confidence in the reliability of the new system and the survivability of its creators.

The most important advantage is economies of scale. Writing complicated software keeps expensive engineers at their terminals and benches for hundreds of thousands of work hours. On the other hand, the marginal costs of the next unit of the operating system can be low as zero, and seldom more than a few dollars, even when burned on a CD and boxed with a manual.

Network effects enhance both customer captivity and economies of scale.

Q2: Why have “box makers” not been able to establishy a competitive advqtage over other competitors? Why was the enormous growth in the market for PCs such a problem for Compaq specifically? Did it have any alternatives that might have worked out better than its chosen strategy? Did Apple?

The Compaq story is so interwined with the hsitory of the PC that it is easy to miss the more general significance. It lost its competitive advantage and the resulting high levels of profitability as the markets grew and allowed competitors to develop equivalent economies of scale. Rosen, the venture capitalist, was astute to recognize that the quality and economies of scale advantages of Compaq benefited from in the 1980s were now history, and that unless Compaq changed its business plan, it was going to be fighting against lower-cost but qualitatively equal competitors. He and his team pursued the operational efficiency in the absence of competitive advantage.

Apple confronted a grim situation. In the two market segments–microprocessors and operating systems–there were powerful competitive advantages, enjoyed by Intel and Microsoft, based on economies of scale, supplemented by captive customers and some proprietary production technologies. The other segments were highly competitive.

Apple operated, either by itself or in partnership with Motorola, in five market segments within the PC universe. Apple did not possess a competitive advantage. Tying those segments together in the name of “synergy” did not help. Also, the evolution of the industry toward separate maor players in each segment argued strongly against the existence of significant advant5ages from vertical integration. Apple held only 10% of the PC market so it had no bargaining power in alliances.

Apple should have specialized and focused on operational efficiency at least to where it could have earned its cost of capital.


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