Is Microsoft Too Powerful?

It's a chilly November night in Las Vegas, but 10,000 technoids are in full fever pitch. They're in town for 1992's Fall Comdex, the computer world's biggest convention cum celebration. Tonight is the annual Chili Cook Off, a charity event for the National Center for Missing & Exploited Children. Each year, the crowd pours in for kegs of beer, vats of chili, and live music. For one night, archrivals in the industry are expected to put aside their bitter feuds and just goof off.

But not this year. The Grayson brothers, Paul and George, founders of software house Micrografx Inc. and organizers of the event, are thanking com- panies that ponied up money. Each gets a round of applause. That is, until one of the hosts offers "a special thanks to Bill Gates and Microsoft," donors of $30,000. The crowd's reaction: scattered cheers, drowned out by a round of boos.

BIG GREEN. The fear and loathing on display in Las Vegas--as well as envy and a grudging respect--are the natural responses to Microsoft Corp. these days. Long a power in personal computer software, Microsoft has now emerged as clearly the most important single force in the entire computer industry. Where Microsoft leads, computer makers and customers follow. Where it stakes a claim, rivals steer clear. And as it springboards from its dominance in operating systems into a commanding position in applications programs, Microsoft leaves less and less territory for its software rivals. Many venture capitalists these days say they won't consider funding a software startup that looks like it might wind up competing on Microsoft's expanding turf.

Such a concentration of clout and power has not been seen in the computer industry since the glory days of IBM. Even Intel Corp., whose microprocessors are as pervasive as Microsoft's software, does not have the leverage of Microsoft, in part because Intel now must respond to chip clones. Some software executives refer to Microsoft, headquartered amid the evergreen trees of Redmond, Wash., as "Big Green." Says Alan K. McAdams, the chief economist in the Justice Dept.'s fruitless antitrust suit against IBM in the 1970s: "It sure sounds familiar. Microsoft is using its power in ways that are just like IBM's."

But does that mean Microsoft is too powerful? Does its dominance really inhibit competition in the software market, and does it hamper advancement of the computer industry itself? And, perhaps most worrisome, will it ultimately lead to fewer competitors and less innovation in an industry founded on the latest, the greatest, and never-before-thought-of? Those questions are critical because computer software has become one of the driving forces in the economy. Not only is the software industry a key area for job creation, but it also produces the tools other industries need to boost productivity. Is such a vital industry best served by having a single dominant company?

FTC PROBE. Microsoft's competitors answer no. Software rivals insist that Microsoft's hyperaggressiveness--its use of every trick at its disposal to gain an edge, enter a new segment, or eke out one more iota of market share--has started to edge out innovation itself as the force that determines the shape of the industry. Microsoft Chairman William H. Gates III says such charges are ridiculous. "Our success is based on only one thing: good products. It's not very complicated," he says. "We're not powerful enough to cause products that are not excellent to sell well." Still, complaints from other software makers helped spur a 2 1/2-year investigation by the Federal Trade Commission into Microsoft's tactics. FTC sources say the nonpublic probe was completed at the close of 1992 and focused on allegedly unfair tactics used to squelch competition (table). According to a confidential outline obtained by BUSINESS WEEK, the FTC investigated practices ranging from the way Microsoft prices software to the way it allegedly uses tying arrangements to force customers who want one Microsoft product to also buy others. Sources close to the investigation say that FTC staffers recommended a number of actions, including a preliminary court injunction, ordering Microsoft to cease the offending practices immediately, pending the outcome of the case.

NECESSARY EVIL? That they would even contemplate such an injunction--rather than wait for the outcome of a commission proceeding--is an indication of how serious the situation appears to the FTC staff, says Terry Calvani, a former FTC commissioner. "The reason the staff went into this uncharted area was the concern that there are companies in business today that may no longer be" by the time the FTC could finish trying a case against Microsoft, he says. But an injunction was only one staff recommendation among many and, so far, the FTC commissioners have not acted. On Feb. 5, they considered the recommendations and split 2-2 on what action, if any, to take. They are expected to meet again in a few weeks, but Calvani says the tie does not bode well for competitors who were hoping to see dramatic action.

Even if the FTC does nothing, the dominance of Microsoft will remain a maelstrom of controversy. Interviews with more than 60 industry executives and customers and a review of still secret FTC documents point to one overriding concern: Microsoft's methods and its growing control over the computer industry could choke the life out of any company that stands in its way. Steven P. Jobs, chairman of NeXT Computer Inc. and an outspoken critic of Microsoft, has publicly called for the breakup of Microsoft into two companies: one for operating systems and one for applications programs. That move--considered, then rejected by the FTC staff--would keep Microsoft from using its operating-systems business to give its applications business an extra edge, as now alleged.

For the most part, customers can't see what all the fuss is about: Most seem happy with what they're getting and with what they're paying for it. And even if computer makers grouse about how much influence Microsoft now exerts over their business plans, they concede that the standards Microsoft sets are helping to keep their industry vibrant. Says an executive with a top-tier PC maker: "Microsoft is not just a necessary evil at this point. It's necessary for the industry to proceed."

For many customers, Big Green has already taken on the role that had been Big Blue's. The saying among computer managers used to be: "Nobody ever got fired for buying IBM." Now, says the information-technology manager of a major French manufacturer: "If you put all your marbles in the Microsoft hat, you're safe--like the old IBM."

Even Gates, who pooh-poohs comparisons with the mighty IBM of the 1970s, agrees that his company has partially taken on the leadership role Big Blue has lost. "Who's there to fill that vacuum? Microsoft, more than anyone else," he says. Adds Roger McNamee, a partner in technology investors Integral Capital Partners: "Microsoft has been anointed the industry tsar. When that happens, people make it very, very rich."

WINDOWS AND ORPHANS. Rich indeed. Microsoft's MS-DOS operating system is used by 81% of the 22 million IBM-compatible PCs built every year, according to Sanford C. Bernstein & Co. Microsoft Windows, which gives MS-DOS a graphical "look and feel," is selling at the rate of 1 million copies a month. And because it has been first to market with top-notch applications packages for Windows, Microsoft is now the king of that white-hot growth segment. Lotus Development Corp., the king of spreadsheets in the MS-DOS world, has just 20% of the $756 million Windows spreadsheet market, while Microsoft's Excel now claims 73%, says market researcher Dataquest Inc. In word processing, the MS-DOS leader, Wordperfect, has 31% of the Windows market, compared with 53% for Microsoft Word.

In short, Microsoft is cleaning up big time--at the expense of its smaller rivals. While other software makers were announcing shrinking market share, losses, or layoffs in 1992, Microsoft tacked on $975 million in calendar-year revenues--more than 90% of all the revenue growth in the PC software industry, according to preliminary Dataquest figures. Microsoft's share of the world desktop PC software industry reached 44% last year, Dataquest figures. And if, as analysts project, Microsoft sales rise 36%, to $3.75 billion, in the fiscal year ending June 30, Microsoft will have more revenues than its seven closest publicly held rivals combined. And at nearly $1 billion, it will have more than twice their net income (chart).

All that money, rivals fear, will soon translate into even greater power for Microsoft. Without healthy profits, other software makers may find it impossible to fund new development or finance upgrades of complex programs such as data bases, which comprise millions of lines of code. Borland International Inc. Chairman Philippe Kahn blamed pressure from Microsoft's foray into Borland's data-base turf when he laid off 15% of his 2,200 workers in December. Borland then reported a $61.3 million loss for the quarter and put on the back burner a word processing project that had been two years in development. Gates says Borland suffered mainly because its products were late to market.

Lotus, once No. 1 in PC applications programs, had its first-ever layoffs in 1992. Now, it's concentrating its resources where Microsoft isn't--yet: Programs such as Notes, which helps groups of workers collaborate.

'TOTAL UNDERDOG.' Such a sharp contrast between one have and many have-nots worries industry executives. They fear there will be few major players, more consolidation, and less money for everybody except Microsoft. They also warn of a chill on software startups. John M. Grillos, who manages technology investing for Robertson Stephens' venture-capital arm, says that there are still new opportunities for startups and scores are on the drawing boards--in promising new areas such as multimedia. But he has a long list of phone numbers at Microsoft and checks the behemoth's plans before going ahead with an investment. Does he call very often? "You bet," he says. "I'm not crazy."

Gates, the billionaire mastermind of the Microsoft empire, says such worries are nonsense. Is Microsoft too powerful? "The answer is simply no," he says. He points out that Microsoft still lags in some important markets. "Take networking. We're the total underdog." And, he asserts, in markets such as spreadsheets and word processing, Microsoft's presence has prodded the competition to improve their wares.

Gates also points out that his commanding position does not guarantee him success in the next generation of software: operating systems that will let networks of personal computers take on the big computing jobs now done by mainframes, minicomputers, and workstations. Microsoft's entry, Windows NT, will square off with Novell's UnixWare, Sun Microsystems' Solaris, IBM's OS/2, and NeXT's NextStep.

Still, none of those competitors has the momentum that Microsoft gets from Windows. That should help Gates reach his stated goal of selling 1 million copies of NT the first year. But he insists that doesn't mean NT is already the winner. "This is a hypercompetitive market," Gates says. "Scale is not all positive in this business. Cleverness is the positive in this business."

To be sure, competitors such as Lotus and Borland have contributed to the myth of Microsoft's invincibility through their own less than clever moves. Equally true, there are examples of software companies that have kept well ahead of Microsoft. Many, such as Intuit Inc., a maker of personal finance software, are masters of lucrative niches.

The biggest player to successfully fend off Microsoft so far has been Novell Inc., the $933 million Provo (Utah) maker of networking software. But Microsoft is aiming for this key software market by building some features similar to Novell's NetWare into Windows NT. Says Kanwal S. Rekhi, a Novell executive vice-president: "Microsoft will keep us on our toes." Then, half-jokingly, he adds: "I hope they don't kill us."Novell can afford to joke. For now, it still holds 70% of its market. But the rest of the industry isn't laughing. Rival software companies give Microsoft credit for building good products and marketing them cleverly. But many software executives also are fuming about what they say are Microsoft's unnecessarily tough, sometimes downright mean-spirited tactics. Says the CEO of a rival software company: "If you were in my shoes, you would probably want to go and shoot them. It's not a level playing field. IBM was the most opportunistic and ruthless in the 1970s. And that's exactly what Microsoft is today."

VAPOR TIGERS. Indeed, industry veterans say there's a striking parallel between how Big Blue behaved back then and how Microsoft acts now. Computer executives say that just like the IBM of yore, Big Green bullies partners, withholds vital information, disparages competitors, and stalls the market by announcing products long before they're ready. Microsoft denies such charges. While such tactics are in the playbooks of many competitors, in the hands of the richest and most powerful player, they can be lethal.

Take IBM's classic move of announcing a product long before it was ready to ship--a tactic known as "preannouncing." In software, such products are called "vaporware" and no one pays much attention--unless the company promoting vapor holds a dominant position. In that case, the market freezes. Facing upstart Control Data Corp. in the 1960s, IBM paralyzed the market for scientific mainframes by announcing it was working on machines that would be far faster than CDC's. These paper tigers, as they came to be known in a subsequent antitrust trial, prevented CDC from winning a single order in 18 months.

Microsoft preannouncements now have a similar effect. Take the case of Adobe Systems Inc., maker of software that controls how computer printers produce typefaces. In September, 1989, Microsoft and Apple Computer Inc. said they would jointly develop a rival product. Adobe's stock fell 20% in one day, and for the next nine months the company spent 90% of its time answering customer's questions and "fighting vaporware," says Chairman John E. Warnock. As it turned out, Apple backed off and Microsoft did not ship its competing product, TrueImage, for two years.

Microsoft has turned this Big Blue weapon on IBM itself. Just as IBM was getting OS/2 Version 2.0 off the ground in mid-1991, Microsoft announced plans for Windows NT. Like the IBM product, NT would be a 32-bit operating system, meaning that it would tap all the powers of Intel's fastest chips. Customers could buy the 32-bit system from IBM then or wait at least 18 months for NT.

POWER PITCH. Guess what? Most of the market is waiting for the leader. An executive at a top PC company tells of one customer that felt the squeeze after committing to buy 36,000 copies of OS/2. The way the exec tells it, Microsoft came and pitched NT, and the buyer put the OS/2 order on hold. "It used to be IBM could put orders on hold," says the executive. "Now it happens with Microsoft."

And NT? It's the toast of the tech world even though it's still not ready. After a six-month delay, it's now scheduled for shipment by June--two years after it was announced. It could be a big hit. Even Borland is developing software for it. Says CEO Kahn: "There's no choice. The issue is not whether NT is good or bad. The issue is NT is being pushed by Microsoft."

And Microsoft is already talking about an operating system beyond NT. It's called Cairo, and it's due by 1995. The company says that package will match features of Novell's most advanced networking programs and the object-oriented programming features of NextStep and Pink, the operating system due by 1995 from Taligent, the joint venture between IBM and Apple.

F.U.D. MISSILES. Gates says Microsoft preannounces systems software because customers and outside developers need details to plan ahead. And once Microsoft tells developers, word spreads fast. "We tell 100 developers," Gates says. "And believe me, that is out in the press the next day."

Whatever the legitimate purpose, preannouncing is part of a larger strategy computer makers say IBM used effectively for years. It's called F. U. D.--for fear, uncertainty, and doubt--and it really works only for the big guy. It's essentially a whispering campaign suggesting it would be terribly unsafe to bet on a competitor. Gates snorts at the notion Microsoft uses F. U. D. as a weapon. "We have a whole department in charge of F. U. D.," he jokes. Seriously, he adds that Microsoft simply gives its opinions and expects customers to judge for themselves. "We're giving our honest view of how wise it is to buy these products," he says.

Where any discussion of Microsoft's power gets dead serious is when rivals--and the FTC--consider the power stemming from Microsoft's dominance in operating software. Like IBM, whose aggressive tactics for preserving its dominance in mainframes led to the Justice Dept.'s 1969 antitrust suit, Microsoft seems most bare-knuckled when perpetuating its position in operating sytems.

Microsoft's most controversial tactic is a "per-processor" discount plan for MS-DOS, which it offers to the highest-volume PC makers. On average, PC makers pay $13 to $14 per copy. For the steepest discounts, the PC maker must agree to pay for a copy of MS-DOS for each PC it ships, whether or not the software is actually installed. That makes it "undesirable for a manufacturer to ship anything but MS-DOS," says a PC executive. Microsoft says that PC makers are offered a number of ways to buy MS-DOS. But with other plans the discounts are smaller, and PC makers locked in a bloody price war can ill afford to pass up the steepest discounts.

DOS & DON'TS. When pricing isn't inducement enough, Microsoft allegedly uses other means. One PC maker says it told Microsoft that it planned to ship DR-DOS, Novell's clone of MS-DOS, on about 10% of its machines. By shipping MS-DOS on 90% of its PCs, the company figured it would still get the best discount. Microsoft's response: It doubled that customer's price on MS-DOS, which quickly forced the PC maker to drop the idea of offering a choice to customers. Says a company executive: "In my opinion, any monopoly situation is not good for the customer." A senior Microsoft executive says he wasn't aware of this charge but says it would not be common practice.

Such alleged tactics may seem a tad over the top, but maintaining dominance in PC operating systems is critical. Like IBM's dominance in mainframes, it gives Microsoft an extremely reliable, enormously profitable revenue stream. "Microsoft's mainframe is its operating system," says one software executive. Analysts estimate that between 1989 and 1992, MS-DOS and Windows generated revenues of $2.3 billion, with $998 million of that in 1992 alone. Net profits on those sales last year were $278 million, according to Sanford C. Bernstein & Co. Such profits have helped fund forays into almost every major software market. Microsoft's new data-base program, Access, cost a staggering $60 million to develop--and it was just one of a dozen products Microsoft brought to market last year. By contrast, last year's entire R&D budget at Borland was $50 million. At Lotus, it was $35 million.

That's not all. Microsoft also had the money to offer an introductory price of $99 for Access--less than one-third the retail price for similar packages. Result: Microsoft sold 700,000 copies in just three months. The entire market in 1992 was only 1.2 million units.

Gates shrugs off the notion that operating systems are his cash cow. "That's the biggest joke I ever heard," he snaps and points out that products such as Word and Excel are his most profitable. Yet in the next sentence, as he elaborates on the returns from operating systems, he says: "If you just took the cash cow business and did not factor in the development costs of NT and Cairo, yes, you'd get a huge profitability."

Gates is accurate when he points out that his applications business now generates more profits--about 50% of net income--than operating software. But it took years to reach that point--years during which Microsoft funded many versions of Word before it was good enough to grab substantial market share. Only when the Windows 3.0 version appeared, in 1990, did it take off.

The operating system business does more than spin profits. Competitors charge that because Microsoft writes operating systems, it also has an unfair edge in writing the applications programs that work with them. They say Microsoft's applications developers get a peek at the inner workings of new operating systems early so they can write programs to take advantage of new features first. In the FTC document, investigators referred to this as Microsoft's "fake Chinese Wall" and listed a dozen other ways Microsoft allegedly abuses its position. Microsoft denies any unfair crossover or inside knowledge.

Software developers also complain that Microsoft is slow or even reluctant to deliver needed information about operating systems. Perhaps the most ironic such charge comes from Claris Corp., Apple's software subsidiary. Executives there say they tried for a year to get information for writing Windows applications from Microsoft, to no avail. Claris says Microsoft was worried there were cracks in the Chinese Wall between Claris and Apple's operating system team--just what rivals say occurs at Microsoft. But after executive meetings and assurances of no cracks, the situation was resolved. Microsoft's head of developer relations says he wasn't aware of the Claris problem but does concede a general "concern about giving information to our operating system competitors."

Microsoft says it's doing its best to get information out to thousands of companies and that it doesn't withhold information to favor itself. Says Pat Bellamah, a manager in Microsoft's developer group: "It's ironic to us that people feel they're having a hard time getting information when that's all we're putting out there." Gates estimates Microsoft spends $80 million a year disseminating information to developers.

One reason Microsoft draws so much criticism is simply that wherever it competes, it seems to play a particularly hard-core game of hardball. Take its dealings with Logitech Inc. Until last June, Logitech had a license to buy Microsoft Windows 3.0 at a discount, then sell it together with Logitech's mice. But Microsoft abruptly canceled the deal, saying that it was losing money on such "bundles" involving inexpensive hardware, according to Logitech President Pierluigi Zappacosta. Only Microsoft still continued to sell Windows bundled with its own mice--for about $10 more than Logitech had been charging.After Zappacosta publicized his situa- tion in September, Microsoft relented. But there was a catch: The new license fee would be 30% higher. Zappacosta says that priced him out of the market, depriving his company of about $20 million annually. Microsoft continues to sell its Windows-and-mouse bundle. Says Zappacosta: "Microsoft is extremely aggressive in using everything it can to its advantage." Microsoft denies that it forced Logitech out of the market but declines to discuss its pricing.

STAC ATTACK. Occasionally, Microsoft's hardball tactics have resulted in civil suits. The latest was filed in January by Stac Electronics, a maker of data-compression software. In its suit, Stac claims that Microsoft violated its patent by including Stac's technology in test versions of MS-DOS 6.0 without permission. Stac says it was negotiating with Microsoft to license the technology, but talks broke down when Microsoft did not offer a sufficient royalty. The suit claims that Microsoft executives then showed Stac a spreadsheet, detailing the "adverse impact on sales of Stacker" if Microsoft opted for another company's technology. Microsoft denies the claim, saying it bargained in good faith and offered "real money" for a license.

As the stories multiply, it also becomes clear that Microsoft long ago became everybody's favorite whipping boy. There's certainly resentment on the part of bright young software entrepreneurs who may never see millions, much less Gates's billions. And for all the companies that grouse about their dealings with the industry giant, there are dozens that are ardent admirers. Says Morton H. Rosenthal, CEO of software distributor Corporate Software: "We all live in a Microsoft-centric world. Working with Microsoft is like skiing behind the Queen Mary. It's a good ride. But getting up is a little rocky."

Indeed, with Big Blue's waning influence, there's a genuine need for a leader. Customers want good software and good prices. They also want a relationship with a software maker that's going to be around for the long run. They uant a new IBM. "If I were a software company, I'd be complaining about Microsoft, too," says Greg Chetel, director of systems planning and research at Gillette Co. "But I don't care who wins. I just want quality products."

In the end, that may be the key to assessing whether Microsoft does indeed have too much power. Software makers are right to cry foul when they think Microsoft's practices have been anticompetitive. They have done so, and the FTC has listened. But as long as Microsoft's dominance stems from keeping customers like Gillette satisfied, it is hard to argue that its power, per se, is harmful.

The danger is that Microsoft will start to use the power of its position, rather than the appeal of its products and services, to stay on top. "If Microsoft runs out of bandwidth," says McNamee of Integral Partners, "then there will be a problem." That's when there will be reason to fear that competition will be stifled and innovation squelched.

If the history of Big Blue is a guide, Microsoft's dominance will be in danger of waning long before it can distort the market with nefarious practices. When the Justice Dept. began its antitrust suit in 1969, IBM's hold on the mainframe market made it seem invincible. By the time federal prosecutors withdrew their suit in 1982, however, the market had taken care of the problem: New technologies such as minicomputers and PCs had made IBM's near-monopoly in mainframes largely irrelevant.

History could repeat itself: Says Joe Guglielmi, a former IBM executive, now CEO of Taligent: "Today, everyone is in fear of Microsoft." "But in the end, everyone will compete. There are thousands of Bill Gateses out there who will find pieces of this market and win them." Just the way Microsoft won its place in the sun.

      CHARGE To preempt competing products, rivals say, Microsoft sometimes announces 
      products years before they actually exist. Even if a rival's product already 
      has the features that Microsoft promises, many customers are reluctant to buy 
      it, preferring instead to wait for the "safe choice"--Microsoft 
      RESPONSE Microsoft says it is important to let outside software developers know 
      Microsoft's directions in system software so they can develop application 
      programs. In fact, software developers demand it. And, Microsoft says, it is 
      important to let customers know where it's headed so they can plan accordingly 
      CHARGE Makers of applications programs allege that Microsoft's applications 
      programmers have advance details of its operating system software, and the 
      company is slow to share vital information. They say Microsoft uses this edge 
      to bring out better applications sooner. This, rivals complain, is a big reason 
      Microsoft has more than 60% of the market for programs that work with Windows
      RESPONSE Microsoft says it freely shares its knowledge with the industry and 
      enjoys no substantial advantage in developing applications that work with its 
      operating systems. The company says its software sells well because it's good
      CHARGE Rivals say that the way Microsoft licenses MS-DOS and Windows to major 
      PC manufacturers makes it nearly impossible for them to compete. Under some 
      Microsoft licensing contracts, PC makers pay a fee to Microsoft for every PC 
      they ship, even if they don't install the Microsoft software on each machine. 
      Because of this, PC makers are unlikely to substitute a competing operating 
      RESPONSE Microsoft says PC makers can, and do, choose several different ways to 
      license MS-DOS. The controversial "per processor" licensing arrangement 
      offers a lower price for higher volume
      CHARGE Microsoft can offer low-ball prices in two ways: by including extra 
      programs with its operating systems and by using profits from operating system 
      sales to support low pricing of applications programs. For instance, because it 
      has not made much headway so far against Novell in sales of networking 
      software, Microsoft is now building networking into Windows and MS-DOS
      RESPONSE Microsoft says it is an industrywide trend that, as operating system 
      software is improved, more features, such as networking, communications and 
      graphics, are included to make computing more seamless for customers
      CHARGE As the dominant force in PC software, Microsoft uses its unique position 
      to spread "fear, uncertainty, and doubt" about its rivals to stop customers 
      from buying rival products. Microsoft, competitors say, warns buyers that if 
      they buy IBM's OS/2 or Novell's DR-DOS--both of which claim advantages over 
      Microsoft's operating systems--they will be throwing away their money because 
      those products may wind up incompatible with Windows or may not be around in a 
      few years 
      RESPONSE Microsoft says customers ask for advice on many products, and, when it 
      comments it is just responding to questions
      CHARGE Several companies charge that Microsoft has, in effect, stolen their 
      ideas in the course of exploring collaborative agreements. Go Corp., for 
      example, says that Microsoft expressed interest in writing applications for 
      Go's operating system for pen-based computers. After Microsoft programmers 
      examined Go's technology, however, Microsoft said it was no longer interested, 
      Go says. Then, Microsoft announced plans for a competing system, developed, in 
      part, by those who visited Go
      RESPONSE Microsoft says it is upsetting that companies accuse it or imply it 
      stole from them. Microsoft says it always honors nondisclosure pacts
Before it's here, it's on the Bloomberg Terminal.