Is Microsoft of the 1990s similar to Apple of today?

That’s Paul Krugman’s claim today in the NYT. He argues that when Steve Ballmer took over, Microsoft was secure in its core business on the basis of operating system — applications network externalities that raised switching costs for consumers. That led to Microsoft being blind to new developments, such as the smart phone, and hence failing to grow new product lines. Krugman impressively traces this back to the 14th century as a problem of incumbency but I think really sidesteps the depth of the problem to glibly place the same issues on Apple and Google.

Now I don’t normally comment too much on Microsoft strategy as I have worked for them and consulted for them. But since Krugman is a bigger splash than usual I’ll wade in here to try and disentangle all this.

First of all, Microsoft’s core business has grown with the PC market. That means growth has been slower than in the past because the PC became a standard thing with high penetration. But we have to be cautious in comparing this to Apple. For one, Apple is now the most profitable PC maker in the world. But in so doing, it benefits from being integrated and by virtue of that the accounting is going to look better for it. We would have to add to margins for Windows and PC makers to work out the same comparison — looking at company books isn’t enough. Even so, if Apple doesn’t have the scale of Microsoft it is plausible to think that this is because Apple does not choose to have Microsoft’s scale (it prices higher and does better with short-run profits).

On that score, going back to the initial Apple vs PC battle, Apple priced its products too high. But if you read the biography of Steve Jobs, that wasn’t Steve Jobs’ choice. He saw the longer-term issue and wanted to price Macs, in particular, lower. He lost that argument but I think history suggests that Apple would have been better off sacrificing short-term profits at that time.

Second, arguably, the reason Microsoft’s value hasn’t grown is that the new product areas it has entered into (with the exception of X-box but this is a relatively small part of its business) didn’t work out. Lots of cost and not enough revenue to show for it. If Microsoft had been “more blind” it would arguably be a more valuable company now. The hard issue is to work out if it rolled the dice correctly or not.

Third, which brings us to smart phones. Krugman is disingenuous when he lays this blindness at the feet of Microsoft. In its core business, it is hard to think that Microsoft has lost much because of smart phones (although tablets may turn out to be another matter but that is really hard to tell). Instead, Krugman laments that it lost that market opportunity that came to others in the same area. But if anyone was blind it was surely the other device makers. Basically, they have all lost out to new entrants — Apple, Samsung, HTC etc. That was their core business. In many respects, they took too long to approach Microsoft for help or adopt Google’s free opportunity. You can’t hold this up as Microsoft’s big failing when those who were actually in the same market were worse.

Fourth, Apple were, however, in Microsoft’s business and got the opportunity. Krugman argues it is because Apple was lost and so saw opportunity. However, at the time it developed the iPhone, Apple was resurgent. It had restored the Mac business and created a new one, the iPod. This was precisely the time that it should have been blind to opportunities (and given the resources devoted to mobile phone developments it was hard to see that as opportunity) and it should have had traditional difficulties in managing new opportunities when it was trying to keep focus on its growth areas (a la Clay Christensen). So Krugman’s narrative isn’t right. He likes to discount the entrepreneur in this story but it is really hard to make that case. The “without Steve Jobs” preface just looms too large. Failing Ballmer for not being Jobs isn’t a great critique as it turns out neither was anyone else.

Fifth, but why couldn’t Microsoft mobilise. At least on the enterprise side, it surely had huge opportunity to sweep in after Apple. And here I think is where the Krugman, incumbency story comes to the fore. And the story isn’t one of philosophy as much as one of organisation. Microsoft was organized on traditional product lines: Windows, Office, Services, X-Box. Each one had a product with its own revenues and its own costs. The problem is that it is precisely because of network effects that the importance of platforms that this organisational form was outmoded.

Instead, Microsoft needed to break apart these devisions and recognise that revenues flowed to particular areas that were not specifically tied to the traditional costs of those areas. If you want to get into search because that will complement Windows and Office, you have to recognise that costs incurred in search will increase revenues in Windows and Office. Not surprisingly, product divisional managers resist new costs but some form of pass through is required to make decisions for the good of company profits rather than products. Microsoft has now conducted this re-organisation and it was Ballmer’s last significant act to get that done. Put simply, we can’t really judge him until we see how that works out even if the narrative becomes that it came later than it ought to have.

Finally, back to the issue of whether Apple today is the Microsoft of yore. Krugman in trying to understand the iPhone relies on network effects (people have apps and are locked in) but apps are so cheap it is hard to imagine this is anything remotely the same as that in the past. Krugman also considers Apple high priced but that is very recent. Before the followers came in, Apple’s iPhone was significant precisely because it was so cheap compared to other proposed smart phones. The same is true of the iPad.

Indeed, that gives us the current narrative. Competitors can use price to compete with Apple (which they couldn’t do with the old Microsoft). Apple, therefore, has to keep quality high and consumers satisfied to survive. That is precisely why the share market has such a hard time with it than with say Amazon that arguably relies more on switching costs to keep its customers. The important point is that that is what we want in the tech world. We want competition on the basis of price and quality and we want it to be tough. In many respects, therefore, we have the free from monopoly cost market that we tried to get in the 1990s and should be happy for it.