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Created: 1999-10-14
Last Modified: 1999-10-14
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Review of Charles Ferguson, High Stakes, No Prisoners

J. Bradford DeLong and A. Michael Froomkin

October 1999

DeLong is a professor of economics at the University of California at Berkeley, and a research associate of the National Bureau of Economic Research.

Froomkin is a professor of law at the University of Miami Law School, and a non-executive director of the Internet startup company Out2.com.


A link to Charles Ferguson (1999), High Stakes, No Prisoners (New York: Times Books: 0812931432) at amazon.com.

This is an early draft of a book review that will bve forthcoming in the Harvard Business Review.


Charles Ferguson has written a very honest book. That honesty is one chief reason to read it: he dishes the dirt on Netscape, Microsoft, his lawyers, his venture capitalists, and not least himself. But his very honesty gives the reader some critical distance--and gave us the tools to question how long the core conclusions of the book will continue to apply.

In 1993 Charles Ferguson--MIT-trained engineer, consultant, and high-tech industry analyst--had a brilliant idea: the world needed a visual development software tool to create online information systems. The tool had to be visually-oriented to be useful to the non-programmers who knew the information. Yet the tool had to be sophisticated to allow organizations to structure their data in useful ways. Ferguson sunk his then-life savings into his idea. He created his software corporation, Vermeer. With his partner, Randy Forgaard, he assembled a very good programming staff. He raised venture capital. He pursued the enterprise with monomania mixed with paranoia. And by the end of 1995 there was code that was more sophisticated than the code of potential competing programs like NaviPress, Netscape Composer, or PageMill, and that actually ran.

Ferguson and his startup jumpstarted an important part of how we interact with the Internet. Because of his idea, because he backed it to the hilt, and because others saw what he was doing and imitated him, we as a society got a nine-month head start on the development and diffusion of visual tools for Internet information systems design. This has enriched us all: we are in his debt. And he managed to carve off for himself a small slice of the user surplus that he and his organization created, and become rich.

At the end of 1995 Microsoft offered somewhat more than $100 million for Vermeer, for Vermeer's key technical personnel--and for Ferguson's silence for two years. Ferguson and the rest of Vermeer's board accepted. His software project was renamed "Microsoft Frontpage."

The two years of silence have elapsed. This book is Ferguson's story of the Internet startup that made him rich. Or, rather, the story of the Internet startup Vermeer is one of three major threads that make up this book. For there are really three essays of varying length woven together within one set of covers:

The first essay is the story of Vermeer and of its founding entrepreneur, Charles Ferguson.

The second essay is the story of the rise of the Internet and a briefing on the dilemmas of high-technology corporate strategy, written by engineer-consultant-business analyst, Charles Ferguson.

The third essay is an attack on the harmful effects of Microsoft, written by someone--Charles Ferguson--who feels guilt at having profited from and added to Microsoft's economic leverage.

Other topics ranging from the Microsoft anti-trust trial to privacy law to
productivity theory are raised, briefly discussed, then dropped. One of the more interesting asides is Ferguson's analysis of the sources of today's high technology: although the development came from the private sector, in his view the research came and had to come from the government. One of the more substantial tangents is a ten-page attack--the particulars of which seemed to go awry in places (or so says DeLong, whose office is on the same hall as two of Ferguson's targets)--on the Regional Bell Operating Companies and the economists who consult for them. This is a book rich in asides.

It is also a book that is less than completely successful. The essays braided together to make up the body of this book are not quite the best in their respective classes.

First, for entertaining and informative entrepreneur's eye view stories about business enterprise in the computer age, Andrew Grove's _Only the Paranoid Survive_ gives a more nuanced and deeper view of the industry. The pseudonymous "Robert X. Cringely"'s _Accidental Empires_ does a better job of placing the developments that made today's high-tech what it is in their full and proper perspective.

Second, if you want a briefing on the dilemmas of high-technology corporate strategy, Carl Shapiro's and Hal Varian's _Information Rules: Competitive Strategy in the Information Age_ provides a better analysis of what high-tech industries are like, and what are the features that make competition in these industries different and interesting. To a significant degree this is simply a problem of space: Ferguson is cramming three books into the space of one. To some degree this is a problem of narration: Ferguson sees the world in sharp black and sharp white only. There are no shades of grey, no tolerance of ambiguity, no recognition that things look different from different points of view. To his great credit Ferguson recognizes--as few analysts are ever adult enough to do--that he has been very certain yet wrong in the past. Yet this recognition of error in the past does not lead to a recognition of uncertainty and ambiguity in the present: people are geniuses or idiots, corporate strategies are brilliant or misguided, organizations are healthy or fatally diseased.

Third, the Microsoft essay is too short to be fully convincing. You can get Ferguson's point of view much more depth and thicker description by reading _Hard Drive_ or _Competing on Internet Time_. Moreover, Ferguson's Microsoft essay is somewhat limited by the fact that he adopts a point of view too close to that of Microsoft's competitors and not close enough to the broader view of consumer surplus and the public welfare. Ferguson feels sorry for Borland and Netscape because Microsoft gave them "cashectomies": giving away the equivalent of their flagship products for nearly free (in the case of Borland) and completely free (in the case of Netscape). But from a public interest standpoint it is hard (though possible) to complain vociferously about the result: the bird in the hand is that lots of users got lots of good software very cheap, while the value of those still in the bush is unclear. As we argue below, there is at least a case to be made that Microsoft may not retain long-run market power through its software giveaways.

So if the three main threads are not quite best-of-breed, why read this book?

People should read this book because Charles Ferguson is an entrepreneur *and* a business consultant *and* a policy analyst. He thus has a very interesting multiplicity of vision. Ferguson-the-entrepreneur launching the Internet startup Vermeer is watched in the back of his head by Ferguson-the-industry-analyst, who is thereby led to rethink his views on the relative comparative advantage of large U.S. companies vs. the Silicon Valley system. Ferguson-the-entrepreneur's ideas about what Vermeer should do are powerfully and explicitly influenced by Ferguson-the-industry-analyst's views on how to create an entrenched market position in the information age.

Usually industry analysts and consultants have little clue about how difficult it actually is to run a business. Usually entrepreneurs have a hard time expressing the vision of industry dynamics that they intuit. They cannot--even when successful--easily explain just what it was that led them to follow the strategies for creating market position that they adopt. Ferguson can, and does. Usually policy analysts have little grasp of how the private sector really works, and of what government interventions in the market will actually do. Ferguson-the-entrepreneur has a solid grasp of these issues.

The combination gives the book a combination of a wealth of perspective with a form of street credibility that few books about the Internet economy possess, and makes it worth reading. Thus, for example, when Ferguson tells us that government R&D people are "light years ahead" [59] of their counterparts in industry in both brainpower and vision, that conclusion cannot be dismissed as the rambling of some academic consultant who has never run a business or taken a product to market.

And there is all the dirt Ferguson dishes. It is very entertaining to watch it fly.


Vermeer

In early 1994 MIT-trained engineer, management consultant, and computer industry-watcher Charles Ferguson had the spectacularly good idea that extraordinary utility could be created by the combination of:

--a common information server architecture.

--a common information browser architecture.

--a visual development tool that would allow organizations without programmers to structure the data they wanted to place on their information server to make it accessible and useful.

As Ferguson quickly discovered, the first two parts of this combination, the http protocol and the web browser, had already been created by Tim Berners-Lee of CERN, the inventor of the world-wide-web. The fact that they were open-source--that their specifications were published, that any programmer anywhere in the world was free to try to improve the running code, and that any programmer anywhere in the world was free to try to interface with or extend the system--was key to the explosion of the world-wide-web. By going the open-source route Berners-Lee traded away a small chance of becoming a billionaire and in return received a role as the human whose work has had the greatest consequences for the world of anyone in this decade. And the open-source success of the web made it impossible for any alternative, proprietary wide-area information architecture to succeed. As Microsoft CEO Bill Gates recognized early in 1995, the open-source nature of the web doomed Microsoft's launch of the proprietary Microsoft Network [MSN]: as he wrote, Microsoft had no answer to information distributors and users who asked "why they should use MSN instead of just setting up their own web server."

But Ferguson and his partner, Randy Forgaard, recognized that the third part was absent. The wildfire spread of the open-source web greatly enhanced the potential value of creating the third part--a powerful visual development tool for building and maintaining world wide web sites. By late 1995 it was clear that the Vermeer team had mostly succeeded. In large part because of Ferguson's monomania, they had a shipping product, a sophisticated visual web development tool, six to twelve months ahead in functionality of all of its major competitors. They had an excellent good programming staff with experience at this slice of business. But by this time Ferguson loathed his CEO and his VC backers.

Moreover, Vermeer did not have a functional marketing organization. Ferguson reports that during the three months between Vermeer's launch of its product, FrontPage, and its acquisition by Microsoft, it sold less than 300 copies--a rate of total sales of less than $600,000 a year for a company with a then-burn rate of perhaps $10 million a year. Thus by the end of 1995 the only live option was to sell out to a software company that did have functional sales and distribution organizations.

Of the companies that might have acquired Vermeer, AOL had already bought a company in Vermeer's line of business--Navisoft, with the NaviPress web development tool and with NaviServer (now called AOLserver, a now open-source product that many consider to be, along with open-source Apache, the best-of-breed in webserver programs). Adobe had bought PageMill. Netscape and Microsoft, however, were still thinking about acquiring web development tools.

Entrepreneur-Ferguson sold Vermeer to Microsoft for $130 million, in spite of qualms high-technology policy analyst Ferguson felt about the social utility of adding a leading position in another market segment to Microsoft's assets. What did Microsoft get for its $130 million? It got a nine-month head start in web development tools embodied in the code and in the technical team that it acquired.

The story of Vermeer is interesting and entertaining. However, the lessons learned will probably not be of much use to others in similar situations who are now trying to obtain venture funding and rapidly expand their organizations. The book contains a lot of true knowledge about how one bargains with venture capitalists for funding. But this is one case in which information is not (much) power: the VCs have the money, and you need it. Ferguson's lament that VCs do not compete against each other because they know they will deal with each other again may be tempered slightly by the growth in the number of funds seeking to bankroll startups, but the basic power imbalance remains so long as the number of would-be startups grows at least as quickly.


Software Markets

As Vermeer walked its path toward launching its product, Ferguson focused on two things. First, he focused on trying to get the programmers to design and create the best possible visual development tool for creating and maintaining websites. Second, he focused even more on trying to design a visual development tool that would make money for the company.

The second is an extremely difficult task because of the features of software markets.

The first is that in general in any software niche there can only be one highly profitable product: the one with the largest market share. Costs of manufacturing software are almost all up-front, one time, costs. The production economies of scale are massive because software is what economists call non-rival. One master copy on a disk can be duplicated essentially for free and run by any number of users. These supply-side economies of scale are matched by demand-side economies of scale as well. If your co-authors, your supervisors, or your subordinates use Microsoft Word, you have to use Microsoft Word as well unless you want to waste half your life dealing with file-format-translation glitches.

Given the relatively small size of the consolation prize, it is no wonder that the drive to become *the* standard becomes all-consuming. Software makers like Vermeer become obsessed with speed-to-market, secrecy (to prevent competitors from recognizing what their product will be), and initial market share. The need for dominant market share also encourages software bloat. As Ferguson perceived it, "You can't become the industry standard unless your product covers every major portion of the market."

Success in this strategy acts as a barrier to entry. Given the high fixed costs of making a compatible and multi-functioned product, competitors may often will be discouraged from even entering the market segment if there is an entrenched early mover with a large market share. Indeed, even a firm willing to commit substantial resources may find that a pre-existing proprietary standard cannot easily be dislodged. Microsoft, after all, found it expedient to acquire FrontPage rather than assign a team of programmers to reinvent it. An open source standard is even harder to dislodge or control: Bill Gates originally hoped that Microsoft could make its Word document format displace the HTML format as the standard for web-based publishing, but soon had to admit that HTML was not going to go away.

Thus Vermeer and its software designers had a big problem. They had to create a version 1.0 that was good enough to rapidly achieve a dominant market share. They also had to have plans for versions 2.0 and 3.0 that would make users wish to pay to upgrade. Without upgrades and revenue from upgrades you do not have a future revenue stream. And they had to--somehow--lock consumers into FrontPage, so that when they did wish upgrade they would find it very expensive to upgrade to anything other than the latest version of FrontPage. (Ferguson is acid about Netscape's failure to appreciate the need to lock-in--or even identify--its customers, and attributes much of their difficulties to this.)


Microsoft and Open Source

Perhaps Ferguson's most successful long-run contribution from the standpoint of Microsoft's bottom line was to manage to create a software architecture that did achieve a substantial amount of lock-in. The server-side extensions of Microsoft FrontPage do indeed make it very expensive for users who have utilized these advanced features to shift to any other program. Moreover, it appears to be difficult to install the server-side features on any machine that is not running Microsoft's Internet Information Server--there appears to be lock-in not only over time, but between different Microsoft programs as well.

But this lock-in makes users' lives more difficult: it is definitely *not* in users' interest for such lock-in to be successfully created. It is, Ferguson thinks, definitely not in users' or in America's interest for Microsoft to take its two current effective monopolies--in operating systems and office productivity suites--and add to them three more monopolies, in browser software, in web development tools, and in server software. Yet when Ferguson looks back on the impact of Vermeer, he sees it as having accomplished three things: (a) made him and his people rich, (b) jumpstarted the web development tools industry, and (c) given Microsoft a very good chance of extending its dominance into new markets. And this third worries policy-analyst Ferguson very much, for he thinks that the world is ill-served by a Microsoft dominant across many different software markets.

Ferguson sees Microsoft's business model as based on two principles: (i) establish and control its own industry standards, and (ii) commoditize every other related business. The first is accomplished through embrace-and-extend. Microsoft initially embraces a standard proposed by others. Then it cuts its price to or beyond the bone in order to gain a significant market position. Then it extends the standard in proprietary ways that its competitors cannot easily match. And it winds up with an effective monopoly. The second is accomplished by Microsoft--in cooperation with Intel, and usually some PC manufacturers--making sure that new hardware functions are standardized in an open, non-proprietary way. This produces a hardware industry with a high degree of interoperability that is ruthlessly competitive. And because competition means that users spend less on hardware, they have more to spend on Microsoft.

Hence his policy recommendation: dismember Microsoft in a way that prohibits it ever getting back together, or any piece of it ever recovering its present market position. If this is not accomplished, Ferguson fears, progress and innovation will slow as Microsoft ossifies, and we all will be the poorer for it.

Ferguson's fear of Microsoft is built on the insight that "the key prize in high technology is proprietary control of an industry standard" [24], an insight that he arrived at in 1992. It was this insight that led him to place so much stress on protecting intellectual property and creating lock-in while he was running Vermeer. It worked, and made him rich. Call this the "Microsoft Vision," for it was the proprietary-standard lock-in possibility created by Vermeer's server side extensions that made Vermeer worth so much to Microsoft. (Moreover, there was the possibility that perhaps the server side extensions could be made to work more easily and effectively with Microsoft's Internet Information Server and other Microsoft software than with competing products.) Thus Ferguson's current fear of Microsoft is the product of much the same mindset that made Microsoft think that Ferguson's company was a valuable acquisition, for Microsoft certainly believes in the Microsoft Vision.

Yet perhaps this insight has outlived its usefulness. Perhaps what worked--gloriously, for Ferguson--in the 1990s will not work ten years from now. In reading _High Stakes, No Prisoners_ we were frequently struck by a strange silence. As we at least look at Microsoft today, other than the possibility of action by the Justice Department, its principal competitive threat and restraint--in the operating system business at least--is not Apple or Sun but is the open source Movement and its freeware operating system, Linux. That open source vision may or may not come to provide serious long-run competition for the Microsoft Vision. It may or may not provide long-run constraints on Microsoft's profitability and market power. But it seems fair to ask that any discussion of market structure and competition policy in the software industry address the issue of competition from Open Source software.

All this is not on Ferguson's radar screen at all.

The Open Source movement has interesting properties that suggest to us it is worth taking seriously. Essentially volunteer software development would seem particularly vulnerable to the tragedy of the commons, but open source has evolved a number of strategies that at least ameliorate and may even overcome this problem. One is the now-familiar ways in which open source authors gain status and participate in a sort of online gift-exchange. Perhaps less well understood, but ironically well-revealed by _High Stakes, No Prisoners_ itself, is the way in which participation in an Open Source development process provides a strategy for undercapitalized or risk-averse software designers who do not themselves wish to be in the open source business. Using an open source process may limit your upside but it also protects your flank. As Microsoft's failed attempt to replace html with Word's .doc standard demonstrates, once an open source standard takes root even a well-financed proponent of a propriety solution may be stymied.

Similarly, from the user perspective, open source provides at worst a mixed blessing. The absence of the prospect of an enormous payout may retard the development of new features, and also reduce the richness of the feature set. However, since most people apparently use a fairly small subset of the features provided by major packages open source may make proprietary designer add-ons both technically feasible and economically rational. Open source may also revise slower, arguably a blessing these days, but it tends to be very stable (e.g. Debian). Customer support may be no worse under open source, as provided by a combination of dedicated, even obsessed, volunteers (sometimes the designers themselves) and value-added aftermarket commercial opportunists.

Indeed, one of the great strengths of the open source movements, albeit one not always endorsed by its hard-core devotees, is the extent to which it creates opportunities for market-driven complementary products and services that are much more difficult to provide for proprietary solutions. Thus, for example, Red Hat can make a successful business providing easy to install Unix and technical support in a way that is all but inconceivable for a supplier of Windows 98 assistance.

Ultimately, Open Source stands a good chance to provide a counterpoint to the Microsoft Vision because it offers a different and apparently viable solution to the "problems" of high fixed costs, of non-transparency, and even "non-excludibility". The fixed cost problem is solved by spreading the cost to all the participants in Open Source development. Since no one can control the standard, and the point of the exercise is to allow competing products to bloom, there is no need for secrecy, and the paranoia level can go down. All providers in the software market are assured that their access to it will remain. The non-transparency problem is not eliminated, since predicting the future is as hard as ever, but users can be reassured that the openness of the source means that if they desperately need a feature they can pay someone to code it for them.

Open source even alleviates what economists call the non-excludiblity problem. In normal software markets the manufacturer has a very difficult time making sure that only those with valid licenses are running programs. Sophisticated copy protection systems go haywire enough and cause enough hassles for legitimate users that they have all but vanished in the course of the past two decades. And in the absence of such copy protection schemes manufacturers are reduced to relying on users' respect for manufacturers' intellectual property rights to produce a consistent revenue stream. In open source, the revenues cannot come from traditional intellectual property rights alone. One must provide some sort of other value, be it help desk, easy installation, or extra features in order to be paid. The danger that one may not be paid at all is the Achilles heel of the Open Source vision, and the reason why we are not prepared to say it will necessarily predominate.

Ferguson's blind spot about Open Source software is surprising since his entire business--his entire business model--depended on Open Source software several times over. As he notes, critical to the development of the Internet was the adoption of servers based on the UNIX operating system [53]. The world wide web as we know it exists because Tim Berners-Lee Open Sourced html and http. (It may be telling that Ferguson found Berners-Lee "unrealistic" when he first met him, and slams the W3C consortium that Berners-Lee joined as a "rather useless, nonprofit Web standards group.") Yet as Ferguson also recognizes--were there a Nobel Prize for computer science, he would award it to Berners-Lee--the market for his web design tool existed only because Mosaic and Netscape web browsers, and Httpd and Apache servers, were being given away for free.


Conclusion

There is a sense in which the characteristics that made Ferguson a successful entrepreneur both strengthen and weaken this book. They strengthen the book by providing street credibility and consistency checking. Ferguson-the-business-analyst gives Ferguson-the-entrepreneur a much more intelligible voice than enterpreneurs possess by providing both a framework to organize the narrative and clear well-written prose. They weaken the book because they lead Ferguson to be so d--- sure of everything, to see sharp lines between black and white. An intolerance for ambiguity, a refusal to recognize uncertainty both beforehand and in retrospect--these are characteristics that made Ferguson an excellent and decisive entrepreneur. But they also make readers of the book unsure as to just how strongly they should hold the conclusions Ferguson reaches, and unsure just how strong the evidence for those conclusions is. Does he really want us to believe that in 1995 Janet Reno had no one working for her who understood high-tech and Microsoft?

Ferguson reports that his track record as a consultant and policy analyst has been uneven. He thought at the time that IBM's hire of Lou Gerstner was a disaster, he greatly underestimated the value of the Silicon Valley system, and he overplayed the Japanese threat to America's comparative advantage in high-tech industries. Will his next book, in a decade or so, begin with an admission that he failed to recognize that Open Source had achieved a state of maturity that vastly undermined the value of "proprietary control of industry standards"?

We are not sure. But we find our confidence in his analytical judgment is somewhat reduced by the fact that he doesn't find Open Source worth thinking about. And we also find ourselves somewhat disappointed: for we are very curious to learn what he would have to say.


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Just read your draft review of my book. You're certainly right that I'm opinionated. I have, however, thought about open source software, and I believe that I discuss it in the book; I am pretty sure that I discuss Linux at least briefly.

For various reasons, I doubt that open source software will/would sufficiently discipline Microsoft in the absence of other antitrust remediation; the open source AOL/Netscape browser certainly hasn't. I'd be happy to talk with you about that, or anything else.

Many thanks, though, for taking the time to think about the book carefully. I would welcome a chance to chat; I live half time in Berkeley.

Contributed by Charles Ferguson (chf@cferguson.com) on May 3, 2000.


in case you missed this by Charles Ferguson

To view the entire article, go to http://www.washingtonpost.com/wp-dyn/article s/A20897-2000Apr5.html

Dismantle Microsoft, With Care

To the surprise of nobody--except, apparently, the stock market--Judge Thomas Penfield Jackson has ruled that Microsoft violated the antitrust laws. The Justice Department and states must now recommend remedies; Jackson must decide; and then his decision, if sustained upon appeal, must be implemented. I'm not a lawyer; I pass on the strictly legal issues. But for the good of both consumers and industry, a major structural solution is called for. But if such major surgery is to be undertaken, it is important to do it correctly. Microsoft should be split into its technologically natural components--operating systems, applications and possibly a third company for Internet services. (For the record, most of my wealth consists of Microsoft stock.)

Contributed by glenn@econ.berkeley.edu (glenn@econ.berkeley.edu) on May 3, 2000


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