A MEGALOMANIAC SEEKING TO BE THE WORLD'S MOST POWERFUL person in the coming century might logically conclude that the best stepping stone to this goal is to take control of the computer-driven information industry. To do so, she would have to overcome two main obstacles: Intel and Microsoft.
Though Intel has 85 percent of the personal computer (PC) microprocessor market, Microsoft, with more than 70 percent of the PC operating system market and most of the market for many leading software programs, is arguably even more strategically situated. Since most mass-market computer software programs must be designed to run on Microsoft's operating systems - DOS and Windows - the company wields enormous influence over the smaller software companies that it rivals. What is more, Microsoft has positioned itself to extend its tentacles downstream to produce and sell a whole new array of online multimedia and information systems, including home banking and other personal computing services. Given its huge share of the critical PC operating system market, critics argue that there is little room for fair competition in whatever branch of the computer-information industry that Microsoft chooses to enter.
If these charges are true, fair entry and industry competition are stifled, thereby depriving other companies of business and denying product choice and competitive prices to consumers. Some critics suggest that the implications are even broader and more ominous. Vast concentrations of economic power corrode democracy, particularly when the commodity in question is information. "This is an area where the public interest community must get involved because this sort of technology in the hands of consumers and public interest groups gives tremendous access to information systems," says a former public interest lawyer who works in one of the Silicon Valley's leading PC intellectual property practices. "To turn the keys to all of that over to a megacorporation like Microsoft is unconscionable," says the lawyer, who requested anonymity on behalf of his clients.
As a testament to the firm grip that the world's largest software producer holds on this $77 billion industry, its rivals will not publicly challenge Microsoft's most questionable business practices for fear that the company would retaliate. But recently, a lone judge's ruling and the Justice Department's first imposition of checks on Microsoft's expansion have given lesser software titans hope that the government or the courts may curb Microsoft's unrelenting growth. Microsoft's business practices have been the subject of federal antitrust investigations for five years, and, in the past 12 months, the Justice Department, ever so gently, has begun to rein in Microsoft.
Modus operandi
The springboard for Microsoft's software dominance was IBM's 1980 selection of Microsoft DOS as the operating system for IBM's popular line of personal computers (PCs). A computer's operating system is the basic set of instructions it follows. It acts as the go-between that makes the machine (or "hardware") interact productively with the programs (or "software") that instruct a PC to perform such tasks as word processing, number crunching, electronic communications or computerized games. By licensing DOS to IBM and dozens of manufacturers of cheap IBM clones, Microsoft took up residence in more than 120 million PCs around the world, well over 70 percent of the market.
Critics say Microsoft and its founder, Bill Gates, exploited their control of the industry's standard operating system to expand Microsoft's commanding share of the software market. Microsoft counters that the market is competitive and its market share of software reflects the popularity of its products.
Once Microsoft's operating systems became the industry standard, many consumers were reluctant to invest the time and frustration needed to master a new operating system. Consumers also shopped for computer products that were compatible with DOS and its more user-friendly offspring, Windows. As a result, Microsoft found itself in a position where it could play hardball with manufacturers of both computer hardware and software. Since demand was limited for PCs that lacked Microsoft operating systems, PC manufacturers felt compelled to license this technology on terms dictated by Microsoft. "These are classic anticompetitive practices by Microsoft because they have the market power to force people to play their game," the Silicon Valley lawyer says.
Similarly, Microsoft operating systems were the means through which most software interacted with a PC, which gave Microsoft significant control over software production. To be a relevant player in the PC market, most software engineers must design programs to work with the operating systems that Microsoft is continually updating and improving.
Software developed by engineers with incomplete information about an operating system is likely to contain serious flaws. Obviously, the company with the most up-to-date information about Microsoft operating systems is Microsoft. This is an increasingly decisive advantage, as Microsoft aggressively seeks to acquire rival software companies and expand its offerings of in-house software and other spin-off products. Another advantage Microsoft enjoys is that many software companies submit prototypes of their newest products to ensure that they will be compatible with next-generation versions of Microsoft operating systems, a practice that gives Microsoft an opportunity to preview competitors' new software.
For Apple Computer, Microsoft's growing dominance has been a double-edged sword that has been wielded against Apple's hardware and software. As Windows establishes itself as the industry standard, there is less incentive for software makers to design programs that run on Apple Macintosh computers. The relative shortage of software for Apples encourages more consumers to buy PCs rather than Macintosh computers. Apple also has alleged that Microsoft kept details of its coming Windows 95 operating and graphics interface system from Apple for more than a year - until the U.S. Justice Department's Antitrust Division urged Microsoft to share the information with Apple.
Gary Reback of Wilson, Sonsini, Goodrich & Rosati, Silicon Valley's leading intellectual property law firm, submitted other antitrust charges against Microsoft to federal courts earlier this year as a federal judge reviewed an antitrust settlement between Microsoft and the Justice Department. Reback's charges are controversial because he made them on behalf of anonymous clients in the software industry, who industry observers suspect come from a small pool of lesser titans: Apple, Sybase, Borland, Novell and Sun. When it became clear that the federal judge would listen to such charges, Apple complained openly about Microsoft practices. Reback says his clients will not challenge Microsoft publicly due to concerns about retaliation from the industry giant. Microsoft argues that anonymity violates its due process rights.
Prominent among Reback's allegations are two alleged Microsoft practices:
Among the supporting documents that Reback submitted to the courts were two internal Microsoft employee self-evaluation forms. Reback presented these evaluations as smoking-gun evidence of Microsoft's vaporware tactics against competitor Borland International. One Microsoft marketing employee wrote, "I developed a rollout plan for QuickC and CS that focused on minimizing Borland's first mover advantage by preannouncing with an aggressive communications campaign." QuickC is a software tool used by engineers to develop other software programs.
Operating the system
A three-year Federal Trade Commission (FTC) investigation into antitrust charges against Microsoft ended when the FTC commissioners deadlocked over whether to take action against the company. Then, the Justice Department stepped in. Justice's complaint against Microsoft focused on business practices that it concluded "may have contributed to Microsoft's maintenance of monopoly power" and threatened "to impede future innovation and competition in [computer] operating systems." In its complaint, which it released in August 1994 along with a consent agreement with which the government and Microsoft proposed to settle the charges, Justice charged Microsoft with four anticompetitive practices:
Under the Justice-Microsoft settlement - which the company reportedly has implemented - Microsoft abandoned volume pricing and all-or-nothing licensing agreements. It also capped license terms at one year and limited the terms of its nondisclosure agreements with software companies to either one year or the date of a new operating system's commercial release, whichever comes first. In consenting to these agreements, Microsoft denied that any of its practices violate antitrust laws or are unethical.
Although the settlement addressed Justice's charges, the lesser titans - which include such computer companies as Apple, Sun Microsystems, Borland International, Sybase, America Online, Oracle, Lotus and Novell - regard it as wholly inadequate to the scale of Microsoft's dominance of the industry. The consent agreement confines itself to remedies that, with varying degrees of success, address Microsoft's licensing of PC operating systems. What disturbs the lesser titans is how much the agreement overlooks.
Survival of the biggest?
The settlement agreement's limited focus on PCs worries Sun Microsystems, a Microsoft rival that produces software and computer workstations (computers that are more sophisticated than PCs), a market that the agreement leaves Microsoft free to dominate. A couple years ago, Microsoft introduced the Windows NT Workstation system. Windows NT is faster and has more sophisticated networking capabilities than Windows for PCs. George Paolini, a spokesperson in Sun's Mountain View, California headquarters, declines to respond directly to questions about whether Sun is concerned about Microsoft eventually dominating workstation operating systems to the degree that it has captured the PC market today. "Windows NT is not included in the [Microsoft-Justice] consent agreement," Paolini says. "You can infer from that what our concern might be."
The most far-reaching limitation of the consent agreement for consumers and other software companies is its exclusive focus on operating systems. Nothing in the agreement prevents Microsoft from aggressively expanding its current dominance of PC operating systems (DOS and Windows), word processing (MS-Word) and mathematical spreadsheets (MS-Excel) into entirely new software realms.
Last October, the company made a $1.5 billion bid to acquire Menlo Park, California-based Intuit Inc. This acquisition would have made Microsoft a leader in financial software and services. Intuit produces Quicken, the number-one personal finance software. It also owns both ChipSoft, the leading producer of tax software, and the National Payment Clearinghouse, a top provider of bank electronic payment services. Microsoft viewed Intuit as a major stepping stone for its plan to expand into electronic banking and commerce via its Microsoft Network online service, which is to be launched in August.
Like so many of the company's new forays, the Intuit acquisition and Network prompted antitrust concerns. Network's most immediate threat is to providers of online computer services, such as America Online, Prodigy (owned by IBM and Sears, Roebuck) and CompuServe (owned by H & R Block). Microsoft intends to build the Network service into its long-awaited Windows 95 upgrade. When installing the new Windows on their PCs, customers will be presented with an option of subscribing to Network for a monthly fee, giving Microsoft an advantage in signing up new customers that other online providers lack.
Jane Torbica, a spokesperson for Columbus, Ohio-based CompuServe, concedes that Microsoft's operating system base will give the company an advantage in signing up new subscribers. Noting that online service is her company's core business, however, Torbica says CompuServe eventually will woo away many initial MS Network subscribers. Steve Case, President and Chief Executive Officer of Vienna, Virginia-based America Online, is less optimistic. "Microsoft, as the provider of the dominant operating system, should not be permitted to limit consumers' equal access to other online services by giving preference to their own online service within the Windows '95 environment," Case said in a statement issued at the time Justice moved to block the Intuit acquisition. "We hope the Justice Department will take additional action to prevent Microsoft from exerting its dominant market power to control the emerging market of online services."
"A lot of people would like to become players providing network services," adds Ed Black, president of the Computer Communications Industry Association (CCIA). "But if Microsoft offers it and bundles and packages it with other software, they can subsidize the cost and out-compete even better products that might come to the market. Investors are leery to invest in someone who will compete with Microsoft," he says. Once Microsoft gains a market advantage, it can raise prices and recoup money lost through its initial discounts.
Other fertile areas targeted for Microsoft expansion include:
With rapid convergence occurring between such once-isolated technology-based industries as computers, telephones and broadcast and cable television, and with technology beginning to catch up with "information superhighway" hype, a big concern among these industries is what kind of multimedia content they will be able to deliver to consumers once the infrastructure is in place. Competitors are racing to secure deals with partners who can provide such content. On May 16, Microsoft and NBC announced that they had formed a "strategic multimedia alliance" to provide audio-video online services, entertainment software and interactive television services. The new deal dovetails with the introduction of the online Microsoft Network slated to debut in August. Under the terms of the deal, NBC, which has been providing material to America Online and Prodigy, will supply Microsoft exclusively.
Because of the many high-tech areas that the consent agreement would allow Microsoft to dominate, the lesser titans view it as a sweetheart deal for Microsoft. They are not alone.
Unexpected Valentine
On February 14, 1995, U.S. District Judge Stanley Sporkin issued an order rejecting the consent agreement. Sporkin's order followed his examination of the settlement under the 1974 Tunney Act, which requires judicial review of antitrust consent agreements to assure that they serve the public interest. Sporkin electrified the computer industry by concluding that the agreement did not meet the public interest test established in prior case law. According to this test, the remedies proposed in an antitrust agreement must "effectively pry open to competition a market that has been closed by defendant illegal restraints."
Sporkin, a former Securities and Exchange Commission enforcement director, said the Microsoft agreement failed the public-interest test because:
The immediate effect of Sporkin's order was to energize the lesser titans, who saw Sporkin as a champion of their all-but-abandoned cause. The Valentine's Day order also threw together Microsoft and Justice, the original adversaries in U.S. v. Microsoft, both of whom used similar arguments in appealing Sporkin's order to the Federal Appeals Court for the D.C. Circuit.
Leading the charge, U.S. Attorney General Janet Reno denounced Sporkin's order, suggesting that Sporkin had exceeded his authority by attempting to review the government's entire Microsoft investigation. "If I file criminal charges against somebody and work out an appropriate negotiation and take it to court, the judge can say, æI don't like the sentence you are recommending to me and if that's your deal I don't want it,'" Reno said in a February 16 press conference. "But [the judge] can't turn around and say I want you to charge this person with another crime that you've not charged him with because I don't think you've thoroughly investigated this case." Assistant U.S. Attorney General Anne Bingaman, head of the agency's antitrust division and wife of U.S. Senator Jeff Bingaman, D-New Mexico, had a bristling courtroom showdown with Sporkin over the extent of his powers.
Responding to criticism that he had usurped Justice's role as prosecutor, Sporkin wrote an unusual March 15 clarification order that says the court did not tell the government to revise its pleadings. "All the court did was hold that, based on the record before it, the court could not find the proposed settlement to be in the public interest," he wrote. "Other than being told the Government spent a great deal of time on a wide ranging inquiry and that the defendant is a tough bargainer, the court has not been provided with the essential information it needs to make its public interest finding," Sporkin's February opinion says. Sporkin said the government remained free to drop the case, take it to trial, renegotiate the agreement or document to the court that the agreement served the public interest.
In its appellate brief, Justice argues that upholding Sporkin's broad interpretation of the Tunney Act and meeting his demands for publicly disclosing any deals the government might have made with Microsoft in their negotiations would mark the end of consent agreements in antitrust cases. Like Justice, Microsoft argues in its appellate brief that Sporkin exceeded the scope of his authority in issuing a ruling that is "an invitation to anarchy." Microsoft argues that Sporkin prejudged the company on the basis of extrajudicial information and urges the appeals courts to remand Sporkin's order to a different district judge.
Personal vs. corporate finance
The Justice Department clearly did not welcome Judge Sporkin's decision, which brought heightened scrutiny of Microsoft's alleged anticompetitive tactics and fed criticisms that Justice's complaint was too narrow. This pressure may have been a catalyst for Justice's decision to try and block Microsoft's Intuit acquisition, though Justice officials insist they are two unrelated cases with separate facts. "Public pressure on the Justice Department had a major impact on their broader approach" toward the Intuit acquisition, the Silicone Valley lawyer says.
In its April 27, 1995 antitrust complaint seeking to block the Microsoft-Intuit merger, Justice notes that Intuit commanded 69 percent of the personal finance software market in 1994; when Microsoft's share is factored in, the post-merger company would have 91 percent of the market. "The proposed acquisition would eliminate competition between Microsoft and Intuit, which has benefited consumers by leading to high quality innovative products at low prices," the complaint says. The complaint notes that Microsoft spent four years and incurred substantial losses to garner 22 percent of the personal finance market with its MS-Money software. Lesser titans would be unlikely to try to penetrate this market after the merger.
In an effort to evade antitrust hurdles to the proposed merger, Microsoft offered to give away MS-Money to its competitor Novell. Justice's complaint rejects this giveaway as a solution, noting that Novell would have little chance of competing with Intuit's Quicken, MS-Money's main competitor, since it has little experience in personal finance software and the Microsoft staff that developed MS-Money would not transfer to Novell with the software. An internal June 1994 Microsoft memo cited in Justice's complaint notes that no intelligent competitor would pay good money for MS-Money knowing that the giant was acquiring Quicken.
In contrast to Justice's August 1994 complaint and proposed settlement with Microsoft, which kept a narrow focus on PC operating systems, the new complaint recognizes that the proposed acquisition "could reach well beyond today's" personal finance market. Current personal finance software users are likely to lead the charge into PC-based home banking, a vast emerging market in which consumers would perform such transactions as banking, investing, shopping and paying bills through their home computer. Microsoft had already cultivated relationships with third parties such as Visa International, Chase Manhattan Bank, First National Bank of Chicago and US Bancorporation to provide these home-banking services.
Intuit's strengths in banking and personal finance software would pose a major competitive hurdle to Microsoft's plans. Justice's complaint quotes internal memos from both companies that suggest that the proposed merger was designed to eliminate that competitive hurdle. Intuit "is the clear and dominant leader in PF [personal finance] software and the current installed base of users would likely prefer to stay with Quicken when they do electronic transactions," an August 1994 analysis of the proposed merger by a Microsoft executive says. "MS owns Windows and Marvel [a code name for Network] and therefore is in a much better position to access many millions of users in the future with PF service options. Since neither company has both of these strengths, the banks, credit card associations and others are in a stronger position to play us off against each other. As a combination, we would be dominant."
Faced with what was likely to be a long, acrimonious and expensive court battle with Justice over their right to consummate such dominance, Microsoft and Intuit called off the deal May 20, 1995.
Microsoft's appeal
Oral arguments before the appellate court on April 24 provided a glimpse into the clash Microsoft and Justice had with Judge Sporkin over the proposed operating system settlement.
Sparring with Microsoft's attorney, Richard Urowsky, Judge Laurence Silberman, a member of the three-judge appeals panel, showed some sensitivity to issues that have been raised by the lesser titans, demanding to know why the proposed settlement is limited to PC operating systems - ignoring other Microsoft software.
After apparently failing to convince the judge that such products as Windows NT do not raise relevant antitrust issues because they "have a tiny share of their market," Urowsky retreated to the argument that the courts lack the authority to raise issues that Justice's complaint did not broach. Statements made by each member of the three-judge panel suggest that they share this view. Judge James Buckley said that most of the issues raised by attorneys sympathetic to the lesser titans vanish "if we construe the Tunney Act as constraining [judicial antitrust settlement] review to charges made by the government." The appeals court is unlikely to entertain issues that go beyond Justice's narrow complaint, the Silicon Valley intellectual property lawyer says. Such an approach by the appeals judges would bury many of Sporkin's antitrust concerns about Microsoft - at least for now.
Microsoft's Enviable Market Shares
Market Product Share
PC Operating Systems DOS, Windows 82%
PC Word Processing Word for Windows 64%
Macintosh Word Processing MS Word 60%
PC Spreadsheets Excel for Windows 61%
Macintosh Spreadsheets Excel 89%
Source: Fortune magazine