SYNOPSIS: Looks at Bill Gates' genius as a Business Strategist.

So Bill Gates is stepping down -- or up, or sideways, or something -- from his position as C.E.O. of Microsoft. Nobody seems to think that this will make much difference either to the way Microsoft is run or to the desire of the Justice Department to break up the world's most valuable company and humble its founder. But maybe the announcement provides a good occasion to reflect on the achievements of this elder statesman (44 years old!) of the New Economy.

You might say that Mr. Gates is to business strategy what Heinz Guderian, the father of the blitzkrieg, was to military strategy. Germany didn't invent the tank or the bomber; but the German command understood, in a way that the British or the French did not, how these inventions changed the nature of war, and very nearly ended up conquering the world. Microsoft didn't invent either the personal computer or the point-and-click interface; but Mr. Gates understood, in a way that other contenders for empire did not, how these inventions changed the nature of business competition, and some think that he has come equally close to global conquest.

You could say that each of the two other companies one might have expected to dominate the New Economy was the victim of a flawed philosophical premise. I.B.M.'s fallacy was that of crude materialism: accustomed to providing software free with its mainframes, the computer giant believed that market power rested in the hands of manufacturers, and did not realize its mistake until far too late. Apple, by contrast, suffered from naïve idealism: its managers believed that having the better idea, the better product, was in itself enough to ensure victory in the marketplace.

Only Mr. Gates seems to have realized the importance, in this new competitive realm, of "network externalities," which is economese for the incentive most of us have to use the same software -- or video format, or typewriter keyboard -- that everyone else uses. It's not a new concept, and around the time Mr. Gates was starting to build his empire economists were working out a theory of how companies should conduct themselves when network externalities are crucial. (Perhaps the leader among these theorists was Berkeley's Carl Shapiro; not coincidentally, Mr. Shapiro took a leave in the mid-90's to become a top official at the Justice Department's antitrust division.) The essence of that theory is that you have to lose money to make money: your product must initially be sold cheaply, even given away, until enough people are using it that the rest feel that they have no alternative.

This seems obvious now, but in the 1980's Apple thought that simply because the Macintosh was insanely great it could be sold at a premium price from day one. It was Mr. Gates who understood the power of ubiquity, and used that knowledge to build an unassailable market position. "Windows 95 is Macintosh 89," declared the losers bitterly when the struggle was all over. They were right, but that in itself tells you how much better Mr. Gates played the game.

Did Microsoft overplay its hand? Judge Thomas Penfield Jackson thinks so, and though many independent economists think that his "findings of fact" were rather one-sided -- Nicholas Economides of New York University, whose Web site on network externalities is much admired among aficionados, describes the judge's report as "unusually harsh" -- there is a reasonable chance that in the end Microsoft will be broken up into an applications company and one or two operating systems companies. But that will not be the end of the story, because Microsoft is unique only in the scale of its success. Monopoly is inherent in the logic of network externalities: the normal life cycle of new industries will be one in which an initial field of competitors is brutally winnowed until only one major player remains. Indeed, investors are counting on this process: since everyone now knows that you have to lose money to make money, and acts on that knowledge, only the eventual prospect of big monopoly profits can justify the prices now being paid for money-losing tech stocks. When does the legitimate attempt to capitalize on victory in a competitive race become an illegal abuse of market power? So far, nobody has laid down the ground rules.

So don't cry for Bill Gates, America. The truth is, he isn't leaving us -- and even when he does, there will still be plenty of other Bills to pay.

Originally published in The New York Times, 1.15.00