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.
Sources:
Roos, Bob. “Top 5 Myths About Microsoft.” HowStuffWorks. N.p., 28 July 2009. Web. 13 Mar. 2016.
Apple, Jackdaw Research
10 Comments
Here’s a piece of jargon: Platform.
Here’s another: Network Economies.
Can you all refine these and use them to organize the information in this post?
One minor note: I grew up with dial phones, which only had 10 possible positions, not 12. There are still a few such phones around, but you really have to look to find one! I did speak to an old businessman from Boston who remembered when there were 5 phones on a banker’s desk, because there were multiple, competing phone companies that did not interconnect. What jargon does the end of that situation point toward?
This natural monopoly has however had some antitrust watch, as Microsoft was indeed the subject of an antitrust suit by the US government around the turn of the century. I think too, though, other companies have had some success entering smaller markets within the operating software market – see Mozilla Firefox and Google Chrome. Chrome actually outperforms Internet Explorer as far as browsers are concerned – 34.7% to 28.3%. Both Gmail and Hotmail too outperform Microsoft’s Outlook as far as email services are concerned, and even Yahoo mail is currently more used than Outlook (Apple’s service doesn’t even register, however). Based off of this evidence, it would seem that more specialized firms can be successful upon entrance into the computer market, and it will be interesting to see in the future how computer and technology firms like Google and Yahoo continue to diversify offerings to take more market share away from Microsoft and Apple services.
http://www.zdnet.com/article/the-most-u-s-popular-web-browsers/
http://www.techtimes.com/articles/15802/20140917/most-popular-email-service-in-the-world.htm
We also cannot forget the failed Zume compared to Apple’s iPod. Other companies have found kinks in Microsoft’s chain mail and have exploited them. IPod has now developed into the iPhone and we have seen big competition in smartphones and smartphone technology. Also, the same competition expands to iPads and other tablets, and the software seems to favor Apple over Microsoft and Google. This market will continue to see competition as the new smart watches and other “gadgets” will continue to enter the market.
An interesting characteristic of natural monopolies and the cause of their success are “barriers to entry”. Typically this can be high up front costs to enter the market from acquiring capital, or the difficulty in acquiring a large enough market share to operate/obtain revenues. The higher the barriers to entry, the more likely an existing monopoly is to stay in power ceteris parabus. However, an interesting component of the software industry is the rapid rate at which technology advances. A software company which is a natural monopoly should constantly stay up to date with technology and systems that are being introduced into the market. Without this constant innovation, a natural monopoly could easily be usurped. As well, technological advances in software are being discovered at a faster rate and on smaller scales compared to past innovations in other industries. A change in code could yield superb speeds and compression rates compared to leading industry software, and this code can be developed by a lone coder in a garage. With this information and proper guidance, a lone coder has the possibility to create his own natural monopoly. The tech industry is very adaptable to change and eager for the latest improvements, given that anyone has the potential to create better improvements than current industry standards, a dissolvement of a natural monopoly.
Another interesting comment about the advancement of technology is in the field of social media. We’ve seen the rise of a company like MySpace that was essentially the birth of social media. It rose to popularity so quickly and appeared to be a great way to generate revenue, but then its popularity quickly faded away. Then we had the rise of Facebook, who has been able to maintain its popularity for the longest duration of time in the social media era. Now you have companies like Twitter, Instagram, and Vine appearing out of the woodwork trying to invent new and original ways for users to interact. Not to say that any of these companies is a natural monopoly, but it is very interesting to consider how important it is for a company to keep up with the times.
But even Vine, FaceBook, Instagram and other popular social media that appeared “out of the woodwork,” must fall into line with iOS, for example, to be sold in the Apple store. When so much of their revenue comes from mobile users, these apps are essentially beholden to behemoth companies such as Apple. When Chase mentions innovation being stifled by these natural monopolies, I don’t think it necessarily means innovation in app development or ideas. A single coder can write a new app that could be worth millions, but it’s almost impossible to imagine a single coder creating a whole new operating system that could ever come close to knocking out Apple or Microsoft. Good ideas can continue to enter the market, but at this point, those good ideas have to cooperate with the Apple Store, for example. MySpace, FaceBook, Twitter, Instagram, Vine – any and all apps that are popular even for a short time – have been sold on these platforms. So I wonder if it really is necessary to keep up with the times.
You are right (sort of). While coding is an easy to learn, it is extremely time consuming to master. Microsoft’s Excel program is comprised of 30+ million lines of code. A single misplaced comma on line 15 million could change the entire meaning of the following code. Additionally, large software companies such as Microsoft have the financial means to hire teams of highly-talented programmers to work on constructing, testing, compiling, and altering code. The fact of the matter is the time and resources it would take a lone programmer in a garage to create a comparable product are just too big of a hurdle to overcome–thus the barrier to entry.
The key to entering the software market, as I mentioned in my post, is to innovate ahead of the curve. Oculus has made a name for itself in the gaming industry with its pioneering work into VR software. Apple’s most successful software platform is the iDevice. These are just two examples of creative divergences from the traditional software market that allowed smaller firms to become major players.
Building off that, all these companies (Microsoft, Apple, FaceBook, etc) are trying to hire the best and most creative coders/software engineers/etc to tweak existing products and create entirely new products. The companies have actually put in a lot of effort to create a good working environment for these employees, and can afford to pay them well. So maybe creative processes have been allowed to flourish rather than flounder in these massive companies.
Back to “platform”: it’s not just that users only have to learn one system, it’s that they can interact with everyone else on the platform. As a business that’s critical: you don’t want everyone in your firm, and every customer and supplier, to have to use the identical computer and specific software. Instead “Windows” is a broad platform and “Excel” is a narrower platform.
In the background, is not a key part of a “platform” not just how widely it’s been adopted – the “network economies” – but also the extent to which it standardizes data formats, input-output structures and so on? That way any piece of software can recognize what is a file and retrieve it from a USB drive, and an excel file from an old machine can be opened on a new machine (though not necessarily the other way around)? Or once you know how to “sandbox” software (one key “invisible” security component of Apple’s current OSX) then you can readily (re)write other software to work?
Both standards and networks are hard to overturn. Even if there’s a technically cleaner alternative to Facebook, would you switch to it if your friends don’t know about it? Would you really remain active on two social media systems simultaneously? I’m part of Linked In and Facebook but I seldom look at the former except to know whether someone has changed jobs, that sort of thing. (I have a twitter account but use it only to put out the work when I do a new post on Autos and Economics.)
The importance of platform is one of particular interest. I could easily see how an individual’s ability or inability to interact with other users could act as a barrier of entry into the industry. From my personal experience alone, I have tried using Keynote and Numbers (Apple’s version of Powerpoint and Excel) but I have run into a numerous problems when trying to convert the software while giving a presentation or following my teacher’s financial model in class. I have made the personal decision to stick to Microsoft softwaring program purely because of its widespread use. Therefore I see Chase’s connection to the phone companies natural monopolies because Microsoft similar to Verizon is more convenient due to its number of users. If a company wanted to overcome this seemingly natural barrier I would think they would need to target a specific industry in hopes of changing the platform those users interacted on.
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