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May 28, 2009

The Price of Competition

Antitrust laws aim to protect consumers and spur innovation by fostering competition, but in some industries ingenuity thrives under monopolists.


Since 2005, microprocessor developers Advanced Micro Devices (AMD) and Intel have been tangled in one of the most significant antitrust lawsuits since United States v. Microsoft. When the United States Department of Justice sued Microsoft in 1988, the case hinged on whether Microsoft’s bundling of Internet Explorer, its Web browser, with the Windows Operating System monopolized the browser market. (The case took a number of curious turns and was ultimately settled out of court.)

In the current lawsuit, Advanced Micro Devices v. Intel Corporation, AMD claims that Intel used exclusionary and predatory practices — such as paying a portion of the distributors’ advertising costs and providing other incentives to broker exclusive deals — to monopolize the market for the x86 microprocessor, which both firms manufacture. The lawsuit, which is scheduled to go to trial in 2010, has sparked a series of investigations by the Federal Trade Commission (FTC) and the Korea Fair Trade Commission, among others; earlier this month the European Commission fined Intel $1.45 billion for what it determined were illegal practices that stifled innovation and consumer choice.

Lawmakers enforce antitrust laws to protect consumers and ensure that the nation remains technologically advanced by preserving competition, which is widely believed to foster innovation. Between 2000 and 2003, for example, the U.S. Department of Justice and the FTC challenged 109 mergers; in 41 of these cases, they cited slower projected innovation rates as the reason for challenging the mergers.

But economists and lawmakers have long questioned whether competition fosters or stifles innovation. Six decades of research on the question has proved inconclusive, Professor Brett Gordon says. “Much of the theory tells conflicting stories, and past empirical work has been plagued by data and measurement problems. Yet this inconclusive research is all lawmakers have to look to when making policy decisions.”

AMD and Intel’s conflict intrigued Gordon, prompting him to search for a better way to answer the question of whether competition helps or hurts innovation. “In this industry, Intel has been a near monopolist, and AMD second, for a long time,” he says. “And a lot of people in the industry believe that competing with AMD has actually fueled Intel to innovate at a faster rate.”

Working with Ronald Goettler of the University of Chicago, Gordon studied the dynamics between the two firms and developed a mathematical model that allowed the researchers to predict Intel’s behavior if it were the sole microprocessor developer in the industry. The researchers were particularly interested, Gordon says, in determining the rate of technological innovation and whether consumers would be better or worse off if Intel had no competitors.

To capture the competitive dynamics between the two microprocessor developers, the researchers compiled 12 years of data from both firms on sales, prices, research-and-development expenditures and production costs. First, the researchers fed the data into their model to establish a baseline level of innovation with both firms competing in the market. Next, they ran only Intel’s data through the same model to predict its rate of innovation if it was the only player in the field.

“There is all of this conventional wisdom that says competition is good for innovation,” Gordon says. “But, our model indicates that Intel would innovate more rapidly if it weren’t competing with AMD.”

Why? First, as the world’s only microprocessor developer, Intel would have pricing power in the market, allowing it to charge more for its products. The increased profit margin would allow Intel to invest more money in research and development, which would result in a higher rate of innovation.

Second, as the sole microprocessor developer, Intel could potentially put itself out of business if it didn’t innovate often enough. If, for example, Intel sold a microprocessor today, it is unlikely the same customer would purchase another microprocessor unless the new processor was more technologically advanced. This provides another incentive for Intel to innovate rapidly.

“Not surprisingly,” Gordon says, “we found that consumers are willing to pay higher prices and upgrade regularly for products that offer sufficiently better service and are more advanced.”

Gordon’s research is unique to the dynamics of the competitive relationship between AMD and Intel — a duopoly. Still, Gordon cautions that his findings indicate a discrepancy between conventional wisdom — the idea that competition promotes innovation while monopolies stifle it — and the fact that the rate of innovation differs based on several factors, including dynamics unique to each industry and how many firms are in play.

“We recommend that the FTC and lawmakers study and evaluate each industry individually,” Gordon says. “Looking at the relationship between innovation and competition in a given industry is more relevant than trying to apply one rule to every industry.”

Brett Gordon is assistant professor of marketing at Columbia Business School.

Read the Research

Brett Gordon, Ronald Goettler

"Does AMD spur Intel to innovate more?"

View abstract/citation  Download PDF  


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