Justice Vs. Microsoft: What's The Big Deal?

There's a lot more at stake than Web browsers. Here's help in understanding the issues

Corporate paragon or rapacious monopolist? Microsoft Corp. has been called both. But there is no question that the Redmond, Wash., software maker is one of the most successful companies on the planet. Microsoft's market capitalization of $163 billion is more than that of General Motors, Chrysler, and Ford Motor combined. Its Windows operating system runs on 90% of the world's personal computers, and its Office suite currently commands just slightly less of the market for office productivity applications.

As its power has grown, so have complaints from competitors, who charge that Microsoft plays unfairly and that its monopoly power in operating systems stifles competition. These concerns have spurred trustbusters to investigate the company, starting in 1991 with a Trade Commission probe. When FTC commissioners deadlocked, the case was taken up by the Justice Dept. That resulted in a narrowly focused July, 1995, consent decree that restricted some of Microsoft's Windows licensing practices. On Oct. 22, Justice renewed the legal tug-of-war with a petition charging Microsoft with violating that decree. What follows is a look at the ins and outs of a complex and far-reaching battle.

What is the latest charge all about?

It centers on Microsoft's Internet Explorer 4.0 Web browser. Microsoft rival Netscape Communications Corp. has complained that Microsoft forces PC makers that license its Windows operating system to also install IE on every machine. An operating system is software that controls the basic functions of a computer; a browser sits on top of the operating system and lets people view World Wide Web sites and navigate the Web's hyperlinks.

Microsoft's virtual monopoly in personal-computer operating systems means that most new computer buyers see IE prominently displayed when they start up their machine. PC makers can include Netscape's Navigator browser as well, but that involves paying an extra licensing fee. IE, on the other hand, is virtually free, since Microsoft considers it to be an extension of Windows.

In its Oct. 20 petition, what did Justice charge Microsoft with doing wrong?

Justice has asked the court to hold Microsoft in contempt for violating terms of the 1995 consent decree, which forbade Microsoft from requiring makers of personal computers to license one product in order to obtain another. In its suit, the Justice Dept. charged that Microsoft is improperly requiring PC makers to license and ship IE in order to get Windows 95. A brief in support of the complaint faults Microsoft for "abuse of monopoly power"--leveraging its Windows dominance to gain unfair advantage in another market, namely the market for Web browsers.

What is Justice's biggest concern?

Justice is worried that Microsoft will use its dominance in operating systems not only to gain an unfair advantage in Web browser and other markets but also to protect its current monopoly.

In its complaint, Justice argues that Internet browser technology developed by Microsoft's competitors "may be an important element in the reintroduction of competition to the PC operating-system market." The government points out that Web browsers can serve as a new "platform" for which applications can be written. Justice contends that by forcing computer makers to distribute its browser, Microsoft is trying to keep its operating-system monopoly from diminishing.

What evidence does Justice have that Microsoft is coercing PC makers?

The government released depositions and correspondence from several prominent PC makers, including IBM and Compaq Computer Corp., reporting that they had been reminded by Microsoft that their license for Windows 95 requires them to install IE. Compaq, for instance, revealed that in 1996, after it removed IE from some models and replaced it with Navigator, Microsoft threatened to terminate its Windows license. Compaq backed down.

What is Microsoft's response to the Justice complaint?

Microsoft does not deny that it requires computer makers to ship IE along with Windows 95, but it argues that IE is an extension of Windows and not a separate product. Further, it is claiming that the government was well aware of its plans to create a Web browser and ship it with Windows 95 and did not object at the time of the consent decree. The company says the consent decree explicitly recognizes the company's right to add new capabilities to its operating system and to create "integrated" products. The government's suit, Microsoft maintains, is an improper attempt to meddle in software product design--a move that it contends could stifle innovation in the computer industry. Justice was expected to respond on Nov. 20.

So is Internet Explorer a separate product or part of Windows?

Microsoft argues that browser functions are a natural extension of an operating system--the way printing or graphical user interfaces are. It argues that just because IE can be sold or installed separately doesn't mean it isn't integrated. It's comparable to windshield wipers and a car, Microsoft argues. Wipers can be sold separately, but they're an integral part of a new car when you drive it off the lot.

Whether or not that analogy holds is open for debate. But most analysts and experts say IE 4.0 in its current form is a distinct product--separately branded, marketed, and sold at retail. Although Microsoft has begun bundling IE 4.0 with the Windows 95 program it licenses to PC makers, Justice argues that it is physically possible to separate the two. Without IE, Windows still runs.

Where do legal experts come down in the debate?

The case will be a close call. Justice has to prove that Microsoft violated the terms of the 1995 consent agreement--a much easier task than bringing an antitrust case. But the wording of the consent agreement could prove tricky. The provision in question forbids Microsoft from tying the licensing of one product, such as Windows, to the licensing of another, say, a browser. However, the decree also states "this provision in and of itself shall not be construed to prohibit Microsoft from developing integrated products."

Microsoft interprets that as a license to build features such as Web browsing into its operating systems. That's what it intends to do with Windows 98, a new version of Windows due next spring. Justice may be able to win a case that says that IE 4.0 is a separate product from Windows 95, but it could be a short-lived victory once Microsoft integrates browsing capabilities into the operating system next year. "The law largely has favored defendants toward broad freedom to make product design choices," says William E. Kovacic, a professor at George Mason University School of Law.

Microsoft also has released documents that indicate the Justice Dept. knew during the consent decree negotiations that the software maker intended to integrate browser features into the operating system. Even if Justice has a strong antitrust case, this kind of proof could torpedo the contract issue that is part of the current cause of action.

What's the impact of the case on Microsoft and the computer industry?

Hard to say. The two sides will argue their case before U.S. District Court Judge Penfield Jackson on Dec. 5. He'll decide whether to order a trial--which could take several months to get under way. Justice has asked for a $1 million-per-day fine against Microsoft if the court finds that it has violated the consent decree. That's small change for Microsoft, but the company says it will quickly comply with a court order if it loses rather than pony up fines.

That would clearly be a plus for Netscape, but if the case drags on, that buys time for Microsoft to build browser market share. It also buys time for Microsoft to ready Windows 98, which it says will thoroughly integrate Web browsing.

Is Windows 98 affected by the government's petition?

The complaint doesn't address Windows 98 directly, and Justice officials say they're withholding judgement on whether Windows 98 will violate the consent decree. Justice insiders say any action against Windows 98 will depend on how tightly interwoven the products are. "Windows 98 presents different questions," says one Justice official. "If they redesign into a single product that is generally integrated, we won't prohibit it. But if they take Windows 95 and IE 4.0 and do nothing but relabel it, that's a different case."

So is this all a tempest in a teapot?

Not necessarily. The Justice Dept. has signaled that the petition may just be the beginning of a broader crackdown on Microsoft. It is investigating Microsoft's investments in Apple Computer Inc. and the software maker's equity stakes in several small companies that make Internet video technology.

Why all the fuss about a product that is virtually given away for free?

True, Web browsers bring in little direct revenue for their developers. The basic Netscape Navigator sells for $39, and the company licenses it to PC makers for just a few dollars a copy. Microsoft gives its browser away for free. But that belies a much more significant value.

As the software the PC user sees, the browser is strategic. It can be a powerful marketing tool that helps promote Web sites by the mere mention of another locale on the Net or the placement of so-called "channels" that allow companies to deliver info directly to PC users. A highly popular browser can also act as a calling card to corporations that may be more willing to then buy the company's powerful (and lucrative) server software. Browsers also play an important role in defining standards for viewing Web content. If a software company makes the predominant browser, it could dictate the way Web developers create their content.

Moreover, the Internet is developing into a vast commercial marketplace where consumers can do everything from investing to shopping for a car, so whoever owns the "window" to the Web--the browser--could wield a lot of influence by helping direct traffic.

Is Microsoft in for a fall?

The company has been under government scrutiny since 1991 but so far has escaped with just a slap on the wrist. And, in spite of the consent decree, Microsoft's competitive position has become even stronger in the past two years. But the chorus of anti-Microsoft criticism is getting louder. And a win in this case could embolden Justice to bring a wider antitrust action.

Microsoft is in no immediate danger of losing the $8 billion in sales it makes from PC software. But the Net represents a huge new market. If Microsoft is hampered by the feds, its growth could be slowed. If nothing else, Microsoft's image could be tarnished just when it is trying to broaden its appeal to consumers through WebTV, consumer software, and Web services. It's one thing to be seen as Darth Vader by the computer industry and quite another when you're marketing your products on cornflakes boxes--as Microsoft does now.

Will Microsoft destroy Netscape if the government does not intervene?

Netscape has been able to hang on to 60% to 70% of the browser market. But Microsoft expects to reach 50% soon. It has already made impressive inroads: According to one recent study by Dataquest Inc., Microsoft's IE has captured nearly 40% of the browser market, up from 20% at the end of last year, while Netscape's share has fallen to 57%, from 73% late last year. Microsoft's IE 4.0, introduced this fall, has won critical raves--in part because it is designed to work closely with Windows 95. Another advantage: It's free. So Microsoft is likely to continue gaining market share.

Netscape is trying to move away from a reliance on browsers to selling more server software for running Web sites and online stores. Still, it makes the bulk of its revenues from browsers--38% in the quarter ended Sept. 30, vs. 33.5% for server software. In sales to corporate customers, the two products usually go hand in hand, so it's critical for Netscape to maintain a prominent share in browsers. The remaining 28.5% of Netscape's revenues comes from services--mainly selling space on its Web site to advertisers and search-engine companies. That business, too, depends on a strong browser. So if Microsoft continues to encroach on Netscape's browser business, the outlook is not good.

Ultimately, what's at stake here?

This case could have far-reaching reverberations beyond the browser wars. It could set a precedent for how software is developed in the future and set the tone for competition and innovation in the vast emerging Net market.

It's a tricky balancing act: Over the past 10 years, PC operating systems have advanced slowly--at least compared to the lightning pace unleashed by Netscape. The innovation in the Internet software market can be credited to the free-wheeling, competitive atmosphere. If any single company dominates the Net, than innovation could be dampened. But if the prospect of Microsoft dictating the course of software development on the Net is scary, the prospect of software design decisions made in Washington is even worse.

Before it's here, it's on the Bloomberg Terminal.