Krugman’s (Probably) Wrong about Apple and Network Externalities

26 August 2013, 0846 EDT

Paul Krugman has an op-ed in today’s New York Times in which he likens the rise and decline of technology companies to Ibn Khaldun’s account of the rise and decline of dynasties: success breeds complacency and soon the barbarians are running the show. This happened, he argues, to Microsoft, which once upon a time dominated the computer industry thanks to network externalities:

The odd thing was that nobody seemed to like Microsoft’s products. By all accounts, Apple computers were better than PCs using Windows as their operating system. Yet the vast majority of desktop and laptop computers ran Windows. Why?

The answer, basically, is that everyone used Windows because everyone used Windows. If you had a Windows PC and wanted help, you could ask the guy in the next cubicle, or the tech people downstairs, and have a very good chance of getting the answer you needed. Software was designed to run on PCs; peripheral devices were designed to work with PCs.

This state of affairs bred complacency and Microsoft failed to anticipate the shift to mobile devices. Now Apple risks the same fate.

Anyway, the funny thing is that Apple’s position in mobile devices now bears a strong resemblance to Microsoft’s former position in operating systems. True, Apple produces high-quality products. But they are, by most accounts, little if any better than those of rivals, while selling at premium prices.

So why do people buy them? Network externalities: lots of other people use iWhatevers, there are more apps for iOS than for other systems, so Apple becomes the safe and easy choice. Meet the new boss, same as the old boss.

Now, the iPhone and iPad are extremely successful and Apples makes tons of money on them. But Apple does not, in fact, dominate the smart-phone market. Indeed, iOS accounts for something like 13% of the worldwide market. Rather, in the US, Apple sales account for a plurality of mobile devices. Indeed, it isn’t at all clear that the App Store drives demand for Apple rather than, say clever branding. Indeed, I’m having trouble tracking down surveys but I suspect the fame of the App Store is much more important than the variety of its offerings. But my guess is that much of Apple’s relative success comes from design principles. Their products are easy to use, generally “just work,” and have superior aesthetics.

Moreover, any story about iOS needs to start with the iPod, which is were Apple built its reputation and the consumer base for the iPhone. MacOS may have suffered from Microsoft’s positive network externalities–driven originally by dominance of the business market–but iOS didn’t, and here Krugman gets it right, face the same market ecology.*

Bottom-line: it isn’t clear that network externalities explain Apple’s ginormous profits–and we shouldn’t conflate those profits, or US market share, with actual dominance of the overall mobile-device market.

*But this should lead less to a comparative analysis  of Microsoft, but of RIM/Blackberry.