Welcome to the first edition of Strategic Visions!   

In this month’s issue, Christopher Bates explores the Microsoft anti-trust case using a unique historical and business perspective.  The article suggests some alternative strategies for Microsoft to progress its business.  The thoughts are applicable to other complex and competitive business situations.

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Executive Summary

The battle between Microsoft and Netscape is not the first instance in the 20th century that a high tech, fast evolving industry environment led to anti-trust clashes.  The motion picture industry experienced similar growth and change 100 years ago.  The efforts of a successful entrepreneur/inventor to control that market led to his company's eventual exit from the industry.  The moral of the story .  .  . 

Throw Away the Handcuffs, Bill

Business leaders and consultants frequently comment on the rapid pace of change in the commercial environment and the futility of examining the past as a key to understanding what the future holds or of which path to take.  However, the velocity of change today is not unprecedented in our history.  Even business luminaries as skilful as Microsoft’s Bill Gates would do well to examine the past for a key to their future.

The rapid pace of technical development and consumer acceptance of the personal computer closely parallels the turn of the century advent of another product heralded for its impact on both education and entertainment; the motion picture.   In twenty years, roughly the same time as Microsoft has been in existence, the motion picture was invented, improved, and the architecture of the industry, from production to delivery, underwent several rapid evolutions, finally settling upon  modes that closely resemble what is extant today.   The industry showed technical improvements equivalent in velocity to “Moore’s Law” in semiconductor processing power (delivering longer, increasingly improved and sophisticated amusements for a constant admission price of a nickel).   This industry’s history is much more relevant to current anti-trust deliberations about Microsoft than rail and steel with which pundits seem to incessantly draw the company into comparisons.

Totally absent from the industry of today is the “Bill Gates” of motion pictures who had tried to grasp too tightly an industrial and social phenomenon that could not be constrained.    Known at the time as the Wizard of Menlo Park, Thomas Edison was a prolific experimenter and inventor, but was also known as a shrewd, some felt ruthless, businessman.  Credited with developing economic electric lighting and inventing the phonograph, he held patents for motion picture cameras and projection equipment.   His use of the patents to stifle competition and attempt to monopolize the industry led both to a reduction in technical and commercial innovation and his company’s eventual exit from the industry.

Kinetoscopes were the earliest evolution of film in which Edison was involved.   Released for sale in 1894, these machines allowed a single viewer to enjoy twenty to thirty second amusements for the price of five cents.   Machines and films were sold to arcades, vaudeville houses and entertainment centers.  Despite its commercial acceptance, sales showed only moderate growth.

The next evolution of commercial film was the projected motion picture.  Having invested in the development of single viewer Kinetoscopes, Edison grudgingly followed others into this innovation.  Again, the initial consumers were arcades and vaudeville halls who utilized film as an alternative entertainment. 

Nickelodeons, or dedicated theatres set up in storefronts which showed only films, had a brief, but startling, impact.   They exploded on the scene in Pittsburgh’s summer of 1905 and by the end of 1906 had spread across the country.  They created the market segment known today as the “movie-goer” who went to see twenty minute short subject films consecutively screened in a dedicated, albeit small and simply adorned, movie hall, all for the price of a nickel.   From this point Edison Manufacturing sales and profitability of projectors (operating systems) and films (in today’s Internet parlance “content”) jumped, with growth peaking in the financial year 1906/1907 at 48%.

By the summer of 1907, the success of, and competition between, nickelodeons led to their downfall.  Increased consumer demand for more and longer feature films increased the cost to the operator of the film at the same time as it reduced the number of showings and hence the number of patrons who could view it per day at a fixed price of five cents.  Unable to increase prices, operators had to build larger, more comfortable theatres to accommodate more viewers.  The opulent “movie house” was born.

Before the rise of the nickelodeon, films were mostly sold to the operator of the projector.   With increased turnover of films (they frequently only played for one week at a location)  and movement of reels from primary urban markets to secondary cities, a new link in distribution was forged by entrepreneurs who became “exchanges” or distributors.  With the boom in nickelodeons, exchanges began to expand geographically and compete across territories.  This led to an improvement in service to the exhibitors and a price war that drove margins out of the distribution business.   Unable to demand more from the exhibitors and facing a limited supply of content, some of these distributors decided to go into import or production.

Edison’s response to competition and changes in the industry are valuable to explore.  Edison had experienced difficulty securing patents for his motion picture camera.  His first patent issued in 1893 for the method of steadily advancing the film led to revisions and a stronger camera patent in 1897.   Immediately, Edison launched legal challenges against both producers and exhibitors.  This drove a number of competitors to close, capitulate and buy Edison licenses, projectors or films, or move overseas.   In July, 1901, Edison won a US circuit court case against American Mutoscope & Biograph Company.  The defendant appealed to a higher court during which time they were allowed to continue producing films.  To protect themselves, however, Biograph continued to produce films in a 70mm format which they felt gave them a legal distinction in their fight with Edison.  The fallout had greater implications.   Other infringers were forced to consider negotiation with Edison.  Again, other competitors moved overseas or got out of production and imported the newer 35mm format films from abroad.

In March 1902, however, the court ruled in Biograph’s favor in such a way that both the uniqueness of Edison’s and Biograph’s processes were supported.   This emboldened Edison to sue seven more producers of films between 1902 and 1904.   The mushrooming of producers after the advent of nickelodeons and the erosion of margins for distribution again made Edison rethink his position.  He first sued the new producers some of whom became licensees.  Distributors who were smarting from excessive competition created the Film Service Association to regulate their trade.  They wanted to deal with a producer’s association which Edison was determined to control.  The Association of Edison Licensees was established and instituted a number of rules and fees to which the distributors and operators had to adhere or risk not being supplied films or equipment.  Biograph set up a competing organization.  Edison sued theater operators but was found by the courts to be harassing them.

As his grasp over the film monopoly unraveled, he joined forces (and patents) with his former competitor, Biograph, to form the more formidable Motion Picture Patent Company (MPPCo) in December, 1908.   The goal was to establish insurmountable control over supply of content so that distributors and operators would be forced into submission.  The strength of the patents combined with agreements with licensed producers, importers and Eastman Kodak (who agreed ostensibly to sell film stock only to MPPCo members), allowed standardized pricing and MPPCo gave film exchanges six weeks to capitulate.  They also threw their weight against the exhibitors by levying a fee of two dollars per week per theatre to be paid to MPPCo and persuading projector manufacturers (of which Edison was a major one) to establish  a price floor for machines on top of a five dollar royalty fee per machine.  

Distribution feared that MPPCo would use its clout to eliminate them from the food chain and attempted to form a new collective association, the revised Film Service Association.  In perhaps a self fulfilling prophecy, the MPPCo responded by establishing the General Film Company to act as a master exchange association, marginalizing FSA membership.  

At this point, in 1909, Columbia Phonograph, citing patents it held on a unique camera, announced it was going to go into production of film.   Separately, Carl Laemmle, an early investor in nickelodeons and film exchanges and a key member of the FAS, quit the MPPCo group of licensed exchanges and set up his Independent Motion Picture Company.  This was eventually to become Universal Studios.   He and others were sued by Edison for patent infringement, but Laemmle challenged the patents in courts and eventually won.  The MPPCo and General Film Co. were brought to court and in 1915 the MPPCo was found guilty of antitrust violations and was forced to pay triple damages.  

Edison Manufacturing exited the movie business as profits plummeted to only $2,480 in 1916.  Though known in the early years for its innovative films and quality of visual reproduction, it had failed to invest sufficiently in upgrading its production or projection offering to the market in later years.  More tellingly, its collaborative method of film production was being superseded by the studio and contract player systems evolving in far away Hollywood (where, it is said, producers had gone not only to enjoy the low cost and consistent weather but also the quick escape to Mexico should they lose the pending cases lodged by MPPCo!).  

The rest, as they say, is history.   But what of the history we see unfolding before our eyes as Microsoft battles to maintain its “right” to dominate.   Our answers will be informed by adopting a perspective seen through the lens of  complexity science.   In times of exceptionally chaotic and rapid change, the outcome is sensitive to initial conditions as well as the path traveled.  One is more likely to succeed by anticipating the approximate outcome of change and arrive there first, than to try to control or stifle the change as it is in process.  The complexity of the situation means that attempts to control it will yield unforeseen outcomes. 

Especially in the areas of distribution and exhibition, Edison Manufacturing neither initiated, anticipated nor supported the organic, evolutionary change that was taking place within the industry it led.   Instead it attempted to use its tenuous control over production of content to bully distribution and exhibition into conforming to its desired business model.  Edison tried to reduce the rate of change to his advantage, but market forces were driving inevitable change. 

For Microsoft, Intel and their competitors, the important message is to throw away the commercial handcuffs they employ which are anathema to anyone who views the PC as a tool of personal liberation (from ignorance, impotence, and disconnection) which on one level or another are most users.    The challenge for Microsoft  and others  is to anticipate the evolution of their industry and move to radically redefine what the customer can have today, creating stunningly brilliant, “must have” products which have no peer.

      
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