Technology and path dependency
Does the best technology always win out? Some economists say no. They have argued in recent years that chance often plays a decisive role in the adoption of technologies and that advantage normally goes to the first-movers in a new market. During the bull market, such views were widely accepted and served to hype the tech bubble. In more sober times, the same claims are receiving the scepticism they deserve.
It was Stanford economist W Brian Arthur who put forward the hypothesis that historical accident often determines the success or failure of competing new technologies. According to Arthur, new technologies are characterised by “network effects”: the more people who use them, the more attractive they become. As a result, consumers get “locked-in” to the particular technology which gains initial market share, even when it is inferior to competitors.
Arthur found “path dependency,” as he called it, in particular historical episodes when “inferior” technologies had seen off their “superior” competitors. He cited the adoption of the Qwerty keyboard for typewriters in the 19th century, which prevented later improved keyboards (such as the Dvorak keyboard, developed in the 1930s) from making inroads. Arthur also cited the victory of the VHS video system over Sony’s Betamax, which some claimed was technologically superior. VHS was said to have won this battle by chance, getting more shelf space in rental stores early on, until the market tipped decisively in its favour.
The theory of “path dependency” has important implications for investment. If a single business could dominate its entire market and the marginal cost of acquiring new customers was next to zero, then the value of the business would be limited only by the size of the market it served. This was part of the investment case for the new economy: start-up companies were told to go for broke, losing vast amounts of money in the hope of infinite riches.
In fact, the theory of path dependency is highly dubious. Neither of Arthur’s historical examples stands up to close scrutiny. For instance, all personal computers now offer users the option of switching to the Dvorak keyboard, but very few choose to do so because it does not actually increase typing speed substantially. Claims that people would find it difficult to learn a new keyboard are overblown. After all, over the last decade millions of people have switched from their old…