Typical examples of so-called “natural monopolies” are the telephone and railway systems. All phones need to be connected and work together to attain the highest benefit. All trains need to be able to use the same structure of tracks to for the same reason. The reason the telephone and railway systems are known as “natural monopolies” and not just normal monopolies is because many of the competitors in these markets tend to die out leaving just one or a few providers for any given geographic area. The concept of a natural monopoly is very simple—efficiency of a certain market requires that it be provided by the few rather than the many. The general rule for “natural monopolies” is that the larger firm in the industry will eventually rise to dominate the entirety of the industry. For the telephone example, the company with the largest number of consumers provides access to more people. Thus, those who are not a consumer of the larger company will switch in order to gain the increased access.
An example of “natural monopoly” that has risen in the last few years is the software industry. Why did the software industry develop in to a “natural monopoly?” First, software is much more efficient with uniformity. Uniformity is beneficial because it requires that users only have to learn how to use one system. Consider again the telephone example. All phones have 12 buttons that are all in the same position and labeled the same. Like telephones, a ubiquitous software system such as Microsoft office provides a universally understandable format to the average consumer. MacOS, Unix shells, Open Look, and many other software systems are designed to resemble the Microsoft platform as closely as possible for the sake of appealing to the most widely accepted software program.
The second benefit of a monopoly in the software industry is that it provides cheaper or better products due to the vast economy in the industry. Development of software poses a massive fixed cost to a company where distribution only comprises a small variable cost in the production process. This leads to what is known as an economy of scale. Essentially, economies of scale mean that a large producer can either do it better or cheaper than a smaller producer, ceteris paribus.
Microsoft provides the greatest example of a software company that holds a “natural monopoly” on its market. According to VentureBeat.com, Microsoft operating systems posses over 90% of the worldwide OS market (Protalinski). Because of this huge share of the market, Microsoft enjoys huge economies of scale. This means that smaller software developers could never spend as much as Microsoft can on product development and marketing. They would never make then money back without having to charge much more than Microsoft for the same product. While the barriers to entry in a market dominated by a “natural monopoly” are difficult to overcome, there is a way to conquer this obstacle—positive differentiation.
Apple’s iOS system is the most widely used operating system for mobile computing devices. Mobile computing is a relatively young development within the software market. Apple was able to take advantage of this opening in the software market by specializing in mobile-basesd devices such as the iPod, iPad, and iPhone. Since Apple must approve all software and apps used on iOS devices, the company can filter out duplications and security hazards to any entity that might try to copy the iOS platform. This also allows Apple to generate revenue from code produced by outside sources since all software developed for iOS devices must be sold through the Apple AppStore. The graphic below illustrates the ever-increasing revenue Apple is appropriating from the sale of Apps within the Apple AppStore. There are some arguments against the possibility of a true “natural monopoly” existing in the software market. While I pointed out earlier in this post that Microsoft has virtually all the qualities of a “natural monopoly,” recent evidence of Microsoft using its significant market power to stifle competition has begun to challenge the software giant’s position as being one of a more malevolent monopoly than a natural one. The biggest difference between a “natural monopoly” and Microsoft is that Microsoft “uses its market power not only to erect higher barriers of entry for its competition, but to threaten…anyone who dared knock at the door” (Roos).
The software industry was designed to become a market dominated by the few. Uniformity and quality of production and the large economy of scale required to produce software basically ensured that a “natural monopoly” would arise in the software market. The question now, however, requires us to ask if software giants such as Apple and Microsoft have gained so much power in the market that they now pose a threat to innovation and entry.
Apple, Jackdaw Research