Caselets On Production

Case study: Microsoft – increasing or diminishing returns?
In some industries, securing the adoption of an industry standard that is

favourable to one’s own product is an enormous advantage. It can involve
marketing efforts that grow more productive the larger the product’s market
share. Microsoft’s Windows is an excellent example. The more customers
adopt Windows, the more applications are introduced by independent
software developers, and the more applications that are introduced the
greater the chance for further adoptions. With other products the market can
quickly exhibit diminishing returns to promotional expenditure, as it becomes
saturated. However, with the adoption of new industry standards, or a new
technology, increasing returns can persist. Microsoft is therefore willing to
spend huge amounts on promotion and marketing to gain this advantage and
dominate the industry. Many would claim that this is a restrictive practice, and
that this has justified the recent anti-trust suit against the company. The
competitive aspects of this situation will be examined in Chapter 12, but at this
point there is another side to the situation regarding returns that should be
considered.
Microsoft introduced Office 2000, a program that includes Word, Excel,
PowerPoint and Access, to general retail customers in December 1999. It
represented a considerable advance over the previous package, Office 97, by
allowing much more interaction with the Internet. It also allows easier
collaborative work for firms using an intranet. Thus many larger firms have
been willing to buy upgrades and pay the price of around $230.
However, there is limited scope for users to take advantage of these
improvements. Office 97 was already so full of features that most customers
could not begin to exhaust its possibilities. It has been
estimatedthatwithWord97evenadventuroususers were unlikely to use more
than a quarter of all its capabilities. In this respect Microsoft is a victim of the
law of diminishing returns. Smaller businesses and home users may not be too
impressed with the further capabilities of Office 2000. Given the enormous
costs of developing upgrades to the package, the question is where does
Microsoft go from here. It is speculated that the next version, Office 2003, may
incorporate a speech-recognition program, making key board and mouse
redundant. At the moment such programs require a considerable investment
in time and effort from the user to train the computer to interpret their
commands accurately, as well as the considerable investment by the software
producer in developing the package.
Questions 1 : Is it possible for a firm to experience both increasing and
diminishing returns at the same time?
2. What other firms, in other industries, might be in similar situations to
Microsoft, and in what respects?
3. What is the nature of the fixed factor that is causing the law of diminishing
returns in Microsoft’s case?
4. Are there any ways in which Microsoft can reduce the undesirable effects of
the law of diminishing returns?
Case study: State spending
A particularly controversial example of the law of diminishing returns is in the
area of state, or public, spending. Some recent studies indicate that
diminishing returns have been very much in evidence in developed countries in
recent decades, with returns even being negative in some cases. An example is
the IMF paper by Tanzi and Schuknecht, which examined the growth in public
spending in industrial economies over the past 125 years and assessed its
social and economic benefits. At the beginning of this period, 1870,
governments confined themselves to a limited number of activities, such as
defence and law and order. Public spending was only an average of 8% of GDP
in these countries at this time. The higher taxes that were introduced to pay
for the First World War allowed governments to maintain higher spending
afterwards. Public spending rose to an average of 15% of GDP by 1920. This
spending increased again in the years after 1932 in the surge of welfare
spending to combat the Great Depression. By 1937 the average for industrial
countries had reached nearly 21% of GDP.
The three decades after the Second World War witnessed the largest increase
in public spending, mainly reflecting the expansion of the welfare state.
By1980 the proportion of GDP accounted for by state spending was 43% in
industrial countries, and by 1994 this had risen to 47%. By this time there were
large variations between countries: the EU average was 52%, in the UK it was
43%, in the USA 33%. In the newly industrializing countries (NICs) the average
was only 18%. These variations over time and area allow some interesting
comparisons regarding the benefits of additional spending.
Tanzi and Schuknecht found that before 1960 increased public spending was
associated with considerable improvements in social welfare, such as in infant-
mortality rates, life expectancy, equality and schooling. However, since then,
further increases in public spending have delivered much smaller social gains,
and those countries where spending has risen most have not performed any
better in social or economic terms than those whose spending has increased
least. In the higher-spending countries there is much evidence of ‘revenue
churning’: this means that money taken from people in taxes is often returned
to the same people in terms of benefits. Thus middle-income families may find
their taxes returned to them in child benefits. Furthermore, in many of those
countries with the lowest increase in public spending since 1960, efficiency and
innovation appear to be greater; they have lower unemployment and a higher
level of registered patents.
Another study found a similar pattern in Canada specifically. Inthe1960s public

spending, at modest levels, helped the development of Atlantic Canada. Most
of the money went into genuinely needed roads, education and other
infrastructure. Later large increases in spending not only had a smaller effect,
but in general had a negative effect. For example, generous unemployment
insurance reduced the supply of labour and impeded private investment.
Subsidized industries, like coal, steel and fishing, involved using labour that
could have been employed in more productive areas, as well as in the last case
decimating the cod stocks. Even the roads eventually deteriorated, as local
politicians had little incentive to spend public funds wisely, and voters felt
unable to discipline them.
Questions 1 In what areas of public spending do there appear to be
increasing returns?
2 In what areas of public spending do there appear to be diminishing or
negative returns?
3 Explain the difference between diminishing and negative returns in the
context of public spending, giving examples.
4 Explain what is meant by ‘revenue churning’, giving examples.
5 Why do local politicians have little incentive to spend public money wisely?
6 Is it possible to talk about an optimal level of public spending? How might
this level be determined?

Caselets On Production

Uploaded by

Copyright:

Available Formats

Caselets On Production

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Caselets On Production

Uploaded by

Copyright:

Available Formats

Case study: Microsoft – increasing or diminishing returns?

In some industries, securing the adoption of an industry standard that is

Another study found a similar pattern in Canada specifically. Inthe1960s public

You might also like