It explains why Microsoft added a browser to their OS, for example. It is easy to get free browsers, just as to get free OSes. If browsers are free, and OSes are free, it would seem that there is no way to make money from browsers or OSes. But if you can integrate a browser into the OS and thereby imbue both of them with new features, you have a salable product.
Setting aside, for the moment, the fact that this makes government anti-trust lawyers really mad, this strategy makes sense. At least, it makes sense if you assume (as Microsoft's management appears to) that the OS has to be protected at all costs. The real question is whether every new technological trend that comes down the pike ought to be used as a crutch to maintain the OS's dominant position. Confronted with the Web phenomenon, Microsoft had to develop a really good web browser, and they did. But then they had a choice: they could have made that browser work on many different OSes, which would give Microsoft a strong position in the Internet world no matter what happened to their OS market share. Or they could make the browser one with the OS, gambling that this would make the OS look so modern and sexy that it would help to preserve their dominance in that market. The problem is that when Microsoft's OS position begins to erode (and since it is currently at something like ninety percent, it can't go anywhere but down) it will drag everything else down with it.
In your high school geology class you probably were taught that all life on earth exists in a paper-thin shell called the biosphere, which is trapped between thousands of miles of dead rock underfoot, and cold dead radioactive empty space above. Companies that sell OSes exist in a sort of technosphere. Underneath is technology that has already become free. Above is technology that has yet to be developed, or that is too crazy and speculative to be productized just yet. Like the Earth's biosphere, the technosphere is very thin compared to what is above and what is below.
But it moves a lot faster. In various parts of our world, it is possible to go and visit rich fossil beds where skeleton lies piled upon skeleton, recent ones on top and more ancient ones below. In theory they go all the way back to the first single-celled organisms. And if you use your imagination a bit, you can understand that, if you hang around long enough, you'll become fossilized there too, and in time some more advanced organism will become fossilized on top of you.
The fossil record--the La Brea Tar Pit--of software technology is the Internet. Anything that shows up there is free for the taking (possibly illegal, but free). Executives at companies like Microsoft must get used to the experience--unthinkable in other industries--of throwing millions of dollars into the development of new technologies, such as Web browsers, and then seeing the same or equivalent software show up on the Internet two years, or a year, or even just a few months, later.
By continuing to develop new technologies and add features onto their products they can keep one step ahead of the fossilization process, but on certain days they must feel like mammoths caught at La Brea, using all their energies to pull their feet, over and over again, out of the sucking hot tar that wants to cover and envelop them.
Survival in this biosphere demands sharp tusks and heavy, stomping feet at one end of the organization, and Microsoft famously has those. But trampling the other mammoths into the tar can only keep you alive for so long. The danger is that in their obsession with staying out of the fossil beds, these companies will forget about what lies above the biosphere: the realm of new technology. In other words, they must hang onto their primitive weapons and crude competitive instincts, but also evolve powerful brains. This appears to be what Microsoft is doing with its research division, which has been hiring smart people right and left (Here I should mention that although I know, and socialize with, several people in that company's research division, we never talk about business issues and I have little to no idea what the hell they are up to. I have learned much more about Microsoft by using the Linux operating system than I ever would have done by using Windows).
Never mind how Microsoft used to make money; today, it is making its money on a kind of temporal arbitrage. "Arbitrage," in the usual sense, means to make money by taking advantage of differences in the price of something between different markets. It is spatial, in other words, and hinges on the arbitrageur knowing what is going on simultaneously in different places. Microsoft is making money by taking advantage of differences in the price of technology in different times. Temporal arbitrage, if I may coin a phrase, hinges on the arbitrageur knowing what technologies people will pay money for next year, and how soon afterwards those same technologies will become free. What spatial and temporal arbitrage have in common is that both hinge on the arbitrageur's being extremely well-informed; one about price gradients across space at a given time, and the other about price gradients over time in a given place.
So Apple/Microsoft shower new features upon their users almost daily, in the hopes that a steady stream of genuine technical innovations, combined with the "I want to believe" phenomenon, will prevent their customers from looking across the road towards the cheaper and better OSes that are available to them. The question is whether this makes sense in the long run. If Microsoft is addicted to OSes as Apple is to hardware, then they will bet the whole farm on their OSes, and tie all of their new applications and technologies to them. Their continued survival will then depend on these two things: adding more features to their OSes so that customers will not switch to the cheaper alternatives, and maintaining the image that, in some mysterious way, gives those customers the feeling that they are getting something for their money.
The latter is a truly strange and interesting cultural phenomenon.
THE INTERFACE CULTURE
A few years ago I walked into a grocery store somewhere and was presented with the following tableau vivant: near the entrance a young couple were standing in front of a large cosmetics display. The man was stolidly holding a shopping basket between his hands while his mate raked blister-packs of makeup off the display and piled them in. Since then I've always thought of that man as the personification of an interesting human tendency: not only are we not offended to be dazzled by manufactured images, but we like it. We practically insist on it. We are eager to be complicit in our own dazzlement: to pay money for a theme park ride, vote for a guy who's obviously lying to us, or stand there holding the basket as it's filled up with cosmetics.
I was in Disney World recently, specifically the part of it called the Magic Kingdom, walking up Main Street USA. This is a perfect gingerbready Victorian small town that culminates in a Disney castle. It was very crowded; we shuffled rather than walked. Directly in front of me was a man with a camcorder. It was one of the new breed of camcorders where instead of peering through a viewfinder you gaze at a flat-panel color screen about the size of a playing card, which televises live coverage of whatever the camcorder is seeing. He was holding the appliance close to his face, so that it obstructed his view. Rather than go see a real small town for free, he had paid money to see a pretend one, and rather than see it with the naked eye he was watching it on television.