The Cops Converge On Microsoft

Justice is ready to pounce on Win98, as state AGs map their own attack

By the time Bill Gates assembled 60 business associates on May 5 to help him stage a last-minute public plea for mercy from trustbusters, the clock was running out. Barring a last-minute settlement, BUSINESS WEEK has learned, the Justice Dept. is prepared to launch an expansive antitrust action against Microsoft Corp. within days. Ideally, the agency wants to pounce by May 15, the date on which the software giant is scheduled to start shipping the Windows 98 operating system to PC makers. In any event, Justice wants to move no later than June.

Meanwhile, officials from states including Texas, New York, and California are in the final stages of assembling their own lawsuit--probably to be filed in federal court and most likely with some coordination with the Justice Dept. So far, the states are tight-lipped about what they're after--except to say that they hope to force Microsoft to ship a version of Win98 without an integrated Web browser. According to sources in these states, the suit could come early in the week of May 11. "We're waiting for final approvals from the top guys," the source says.

Gates's May 5 rally was staged to head off a rumored move by the states to prevent shipments of Win98 entirely--a threat that now seems unlikely. Then he flew to Washington to deal with his bigger problem: the federal probe.

During a two-hour meeting with Justice's antitrust division chief Joel I. Klein at the offices of Microsoft's law firm, Sullivan & Cromwell, Gates made his case and listened to Klein's concerns. A Microsoft spokesman says that Gates was not asked whether he's willing to make an accommodation, such as hiding the icon that leads to the Internet Explorer browser on Win98. "We're going forward with integration," says the spokesman.

BROWSER-LESS. Justice, too, is going forward. Sources familiar with the case have told BUSINESS WEEK how the agency would proceed. The heart of the matter is the charge that Microsoft uses illegal means to protect its monopoly in PC operating systems and to extend monopoly power into other markets.

The feds are prepared to launch a quick court action to force Microsoft to alter Win98. By bundling the Internet Explorer browser, Justice lawyers have concluded, Microsoft gives PC makers little choice but to distribute its browser rather than competing products, while still allowing the sale of an integrated version. Justice would ask the court to force Microsoft to offer a browser-less version of Win98 that would be sold at "a commercially reasonable" price--meaning significantly less than the version with the browser. The idea is to give rival browser suppliers such as Netscape Communications Corp. an opportunity to compete. Initially, Justice may ask Microsoft to simply hide the browser. Later it may press for a fully browser-less Win98.

Another immediate action would be aimed at the contracts Microsoft uses to dictate what PC makers show on the opening screen of computers that run Windows. Microsoft has insisted that certain of its programs, including Internet Explorer, show up as icons. If Justice gets its way, PC makers would be allowed to install whatever they want.

Also on Justice's list of immediate remedies is a ban on all Microsoft deals designed to promote its browser at the exclusion of rivals'. To head off litigation, Microsoft has given up contract language that forbade Net services that feature Explorer from telling new users about other browsers. But online providers like America Online and CompuServe are still bound by such contracts.

The Justice suit will also address the bigger issue of bundling in general--to determine what features can and can't be included in the operating system. Justice lawyers are weighing whether including services such as voice recognition, video streaming, and messaging will kill off growing markets. In cases where that may be a possibility, the agency would ask Microsoft to price those features separately--like the browser. Microsoft could still bundle features, however, if the company proves there are not separate markets for these functions.

Meanwhile, Justice lawyers are also considering remedies aimed at "undoing the effects" of Microsoft's bundling of the browser--including a sort of affirmative action program to make up for the ground Netscape lost to allegedly illegal maneuvers by Microsoft. Netscape's market share, which once was 85%, has dropped to 60%, while Microsoft's share has risen from zero to 40%. Justice is exploring ways to give Netscape a better crack at PC makers, online service providers, and other channels of distribution. It might even require Microsoft to include a copy of Netscape Navigator with Windows, some experts speculated.

Microsoft isn't about to accept anything so drastic without a massive fight. It's willing to make minor compromises, but, according to Paul Maritz, group vice-president in charge of platforms and applications, "nobody should think we won't be really serious about things that are core to our business." Microsoft denies it has broken antitrust laws and claims the right to decide for itself what features it will add to its operating system. It's adamantly opposed to any government move that would force it to sell features separately. Says Maritz: "An a la carte menu would be a nightmare for users and add years to our development of operating systems."

ALL UPHILL. What about something as simple as disabling Internet Explorer? Microsoft remains opposed to the idea of a browser-less version of Windows 98. But company officials have conceded that it's easy to hide the Internet Explorer browser icon so it doesn't appear on the Windows desktop screen. What they most fear--and what prompted Gates to seek public support and that meeting with Klein--is a court injunction that orders the company to remove the browser code from Win98, which could delay shipment by months, according to analysts.

If either Justice or the state attorneys attempt to get an injunction to block the release of Windows 98, it's likely to be an uphill struggle. "Windows will be very hard to stop," admits one attorney representing a Microsoft rival. "They'll have to show irreparable harm. That will take a lot of convincing." A temporary restraining order is more readily achievable--but it only lasts a few days until a hearing can be held.

As Justice puts the finishing touches on its suit, Netscape and other Microsoft critics continue to hope for more draconian relief. Gary Reback, a Palo Alto (Calif.) attorney who represents 10 high-tech clients, is calling for "structural" changes that will prevent Microsoft from abusing its monopoly power. "What the government does has to change the fundamental calculus of market power," says Reback, who favors breaking up Microsoft.

Until now, Justice officials have said they didn't foresee seeking a breakup. But they now concede that could be the result if the court concludes that splitting the software giant is the best solution.

Any sort of remediation would certainly be welcome at Netscape. The Web browser pioneer has posted losses and laid off employees as its market share has dwindled. Says Roberta Katz, Netscape's vice-president for legal affairs: "We don't sit around and say, `Woe is us.' But you have to ask how big would we have been if we weren't subjected to illegal exclusionary behavior? That's worth a lot."

With D-Day approaching, an eleventh-hour settlement seems the only way out for both sides. Otherwise, Bill Gates can expect to make many other high-profile appearances to tout Microsoft's unfettered right to design products as it sees fit. Only, next time the venue may not be a New York rally. It may be a federal court.

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