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Gates's Splitting Headache

News: Analysis & Commentary

Gates's Splitting Headache

Would a Microsoft breakup make the computer industry more competitive?

It's tough to recall darker days at Microsoft Corp. than these. Warnings about slowing sales growth from the chief financial officer. Threats by the government to break up the company. And a dizzying 16% dive in Microsoft's market value after an unusual, lukewarn earnings report. Things seemed so bleak that on Apr. 25, CEO Steven A. Ballmer blasted an e-mail to Microsoft's 35,000 employees, dangling more stock options their way and promising, "This company, which has done so many great things for consumers and for the American economy over the last 25 years, will not be broken up."SUMMER RULING. Oh, yeah? Signs indicate that's precisely what the government aims to do. The Justice Dept. and the 19 states suing Microsoft for antitrust relief have until Apr. 28 to submit their proposed remedies to U.S. District Judge Thomas Penfield Jackson, who plans to rule by summer. Though last-minute negotiations could change the outcome, the government is leaning strongly towards a proposal that would chop the software giant in two, creating one $10 billion company that makes computer operating systems and another $14 billion behemoth that builds applications such as word processing, spreadsheets, and database software--as well as Web software and sites. In all likelihood, Microsoft's Internet Explorer, the Web browser whose inclusion in Windows 98 spurred the whole antitrust suit, will end up in the applications company.

If the courts accept the proposal, the implications for the industry and the economy couldn't be bigger. The move would cleave a company that has been a symbol of high-tech might and growth for more than a decade. If the split works as envisioned, it could spur competition in PC software while preventing Microsoft from extending its dominance into new sectors such as the Internet. And it would set a high-water mark for government intervention in the high-tech sector. Even Vice-President Al Gore, who has avoided commenting on the antitrust squabble, acknowledges the magnitude of a breakup. "The potential impact goes beyond the antitrust characteristics and runs to the economy itself," Gore says."A CLEAN SOLUTION." Radical though it may seem, splitting Microsoft in two is seen by trustbusters and many in the computer industry as the only reliable way to rein in a lawless predator. As recently as a week before the deadline, federal and state lawyers were still mulling so-called conduct remedies that would have curtailed Microsoft's behavior and subjected it to years of government oversight. But, eager to avoid the kind of protracted supervisionthat occurred after the AT&T breakup, Justice opted for a simpler approach. "It's a clean solution, where the government doesn't have to police Microsoft into the future," says Robert Young, CEO of Linux software maker Red Hat Inc.

What would the new siblings look like? The government will likely recommend that Microsoft devise its own reorganization plan, subject to judicial approval. One unit would keep all of Microsoft's operating systems--Windows 98 for consumer PCs, Windows 2000 for corporate computers, and Windows CE for smaller gizmos. The more diverse applications company would include Microsoft's dominant Office suite--word processor, spreadsheet, and so on--as well as e-mail and database software and the company's growing Web businesses. The judge would have to approve Microsoft's proposals for dividing up its personnel and cash hoard, and there would be cross-ownership limitations between the two companies. Chairman William H. Gates III and CEO Ballmer could choose to join either company, sources say.

The theory behind splitting Microsoft is to eliminate the so-called "barrier to entry" that prevents potential competitors from developing alternatives to Windows and Office. That barrier primarily takes the form of close technical links. Competitors have long claimed that Microsoft withholds data about Windows from independent software makers that is available to its own employees. But there are nontechnical factors as well, such as market leverage. Microsoft sells its array of products to corporations as a smorgasbord, offering discounts for buying more. Without the ability to sell the whole enchilada, Microsoft loses the power to use its strength in Windows to gain unfair advantage in new markets.BIG QUESTION. The big question now is: Would a breakup succeed in making the computer industry more competitive? Rival execs surely think so. It "would be wonderful," crows Jean-Louis Gassee, CEO of tiny software maker Be Inc. Gassee predicts that the "evil twins" will quickly go to war, opening up opportunities for companies such as his. Meanwhile, the Microsoft applications company, freed from its bond to Windows, could develop its programs for other operating systems. That could help fuel alternatives, such as the free Linux system. "It would give us a real opportunity," says Young of Red Hat.

A breakup also could boost competition in big-ticket corporate software. Take Exchange, the Microsoft package that runs large e-mail networks. Right now, Exchange works only on Windows NT, Microsoft's high-end operating system for corporations. If Exchange were cut loose from the operating system business, customers would more likely see a version that works on Unix--the operating system of choice for many big companies and Net providers. Corporations could get Exchange without having to take Windows NT.

Not everybody thinks breakup is the end of the story. Some worry that both new companies would remain monopolies in their respective areas. More important, as software programs from calendars to word processors move off the desktop and on to the Web, breakup may be a 2000 solution to a 1995 problem.

Five years ago, Microsoft's control over the link between Windows and Office gave it huge advantages--both in optimizing its office software and in adding new features to Windows. But in a Net-centered world, those links are less important. "The desktop is not where the world is focused," says Gordon Eubanks, CEO of e-commerce start-up Oblix Inc., who testified for Microsoft during the trial. Microsoft is trying to adjust to this by creating new software standards for the Web. Rivals worry it will parlay its desktop monopoly into dominance of the Net. And a breakup may not stave that off.

What's more, even if Judge Jackson approves it, the breakup proposal might not survive in court. Microsoft could topple the trustbusters' proposal in two ways: by winning its appeal of the underlying suit or by convincing the courts that the inefficiency of divestiture outweighs the benefit of eroding its market power. Most antitrust experts believe that the software giant has a good shot on both fronts. "We've got a vibrant industry here, and we're risking undercutting it at its core," says George Mason University antitrust professor Ernest Gellhorn.

He's not the only one made nervous by the scope of the government's remedy. But for all the questions a breakup raises, Justice officials appear to have decided it is the best among an imperfect set of options. Now, prosecutors just have to convince the courts to agree.By Jay Greene in Seattle, with Mike France in New York, Dan Carney in Washington, and Peter Burrows and Jim Kerstetter in San Mateo, Calif.Return to top

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