Microsoft: No Letup And No Apologies

Antitrust scrutiny hasn't eased its competitiveness

On May 10, Microsoft CEO William H. Gates III was on the phone with Justice Dept. investigators from his family compound near Washington's Hood Canal. He was attempting--unsuccessfully--to head off a federal antitrust suit against his company. Meanwhile, across the continent, executives from Intel and Oracle, a Microsoft rival, landed in New York on a flight from Silicon Valley. The next day, they were to seal their $250 million investment in Road Runner Group, a high-speed Internet-access service. But the Road Runner people called to say the deal was off. Another bid had come in--from Microsoft--and it was nearly twice as high.

The deal was a coup for Microsoft Corp., giving it the inside track on selling its software for digital set-top boxes to Road Runner. But it was also an unmistakable signal to anyone who thought Gates & Co. might tone down their legendary competitiveness in the face of the government antitrust suit. "Their arrogance is incredible," says an executive on the losing side of the Road Runner deal. "Microsoft wins because it can pull out its checkbook--which is unlimited. That stifles competition and is dangerous to the economy."

Whether Microsoft illegally stifles competition or is merely pugnacious will be determined in an antitrust trial that is set to start in Washington, D.C., on Oct. 19. The company has made occasional efforts to soften its public image and has retreated only from some restrictive licensing terms that had already served its purpose.

Nevertheless, one thing is clear: In the year since the feds sued Microsoft for violating a consent decree, the software maker has not backed off from the aggressive tactics that have made it the most powerful force in the computer industry. If anything, Microsoft is pressing harder than ever, barreling into new markets while tightening its hold on customers that rely on its PC software. "It's overwhelmingly clear that Microsoft is dialing it up," says Jeffrey Papows, president and CEO of rival Lotus Development Corp.

Unlike other industry leaders, such as Intel Corp. and IBM, Microsoft hasn't even adopted a code of conduct for avoiding antitrust violations. Mike Maples, a former top executive who still does projects for Microsoft, has been asked to look into creating one. "I've thought through it a lot, but I can't find the principles that would mean the world would like us more," he says. "We can't tell people not to be so aggressive or don't compete so hard."

It's extreme capitalism. Even while Microsoft's lawyers hustle to pull together their defense, Gates is dreaming up ways that his company can extend its reach into new markets far afield from PC software--from electronic bill payments and cordless phones to software for gas pumps, traffic signals, and even TV remote controls. Indeed, when you drink a glass of milk next year, consider this: There's a chance that Microsoft software helped test its purity.

Surprised? You won't be for long. As new President Steven A. Ballmer takes over daily operations, Gates will have more time to plot the company's long-term course. Today, his company is the master of desktop software. Tomorrow, he wants it to rule the world of information appliances.

Gates's grand vision surfaced in an internal memo called "The Era Ahead" that was sent to several hundred executives and employees on Sept. 8 and released to the press on the eve of the trial. In it, Gates lays out his view of Microsoft's challenges. The company must make its software much easier to use--and it needs to extend well beyond the PC to provide the software that will run the tiniest devices and the most powerful computers.

Clearly, there's no brake on this train. For Gates, it's business as usual. Indeed, the day the trial starts, he'll be heading off for one of his biannual "think weeks." The message from the top is that there's no easing off the pedal. "We try everything we can to win the business," says Jeffrey S. Raikes, group vice-president in charge of sales. James E. Allchin, a senior vice-president in charge of Microsoft's Windows division, even defends the warlike language in internal E-mails--which the Justice Dept. cites as evidence of the company's bullying behavior. "Yes, we're a competitive company," he says. "We don't apologize for that."

GIZMOS. What drives Gates to go full-throttle in the face of the biggest antitrust investigation since AT&T's breakup in 1984? Paranoia. He has seen leading technology companies fall off their perches. Topping that list is IBM--the subject of a grueling 13-year anticompetitive probe that ended with no action but a weakened company. Hypersensitive to appearing too dominant, Big Blue instructed employees not to talk about their market share or to define markets for fear that the Justice Dept. would later use their words to prove they owned a monopoly. "You always wondered what the lawyers would say before you would make a move," says Sam Albert, a management consultant who was a marketing manager at IBM for 30 years. "The company tied one hand behind its back."

Gates is determined to avoid that mistake. With Microsoft's desktop PC software market nearly saturated, the company is plunging into all-new territory. And no one at Microsoft is more aggressive about venturing into new realms than Rick Thompson, the vice-president in charge of the company's hardware division. What was once a side business for the software maker--computer mice and joysticks--has become an important source of new revenue: $500 million last year.

Microsoft's hardware megahit last year was Barney: The plush talking doll reaped $50 million in sales. This holiday season brings a veritable shopping cart full of new Microsoft-branded gizmos, including PBS' talking characters Arthur and DW ($109 each), PC stereo speakers ($249), a cordless PC phone with messaging and caller I.D. ($199), a motion-sensing joystick ($69) for flying and motocross games, and a universal remote control ($299) that lets you operate all of your home entertainment gear with one device. That last item could be the company's first baby step into providing hardware for home automation, says Thompson.

A similar pitter-patter of baby steps has been unleashed all across Microsoft. In April, its consumer-appliances group released a $495 developer kit so that companies that make specialized devices will use Microsoft's pint-size version of its software called Windows CE. Microsoft has snagged more than 100 takers making everything from bar-code scanners to factory equipment--none of which will carry the Microsoft brand. Idexx Laboratories in Westbrook, Me., for instance, makes a milk-quality tester for dairies that will be introduced early next year, says Steven Maillet, an Idexx software engineer.

STANDARD. Microsoft is coming from behind, but hopes to convince companies that they don't have to design expensive specialized software to run each new machine. Indeed, Microsoft hopes to recreate the dynamics of the PC market, where Windows became a standard that helped hundreds of hardware and software makers create products more efficiently--while making Microsoft the most richly valued company in the world. Wall Street's Dain Rauscher Wessells estimates that the market for such software will top $2.3 billion by 2001.

Some of these devices may tap into services Microsoft is creating on the Internet. One potentially lucrative effort is TransPoint, an electronic-billing service that Microsoft is developing with partners. Later this year, they plan on launching nationwide service involving a handful of banks and a host of billers. TransPoint will charge the billers 30 cents for every electronic bill it handles. It figures E-bills will someday be as common as E-mail--only much more profitable.

There's no assurance that Microsoft will thrive in all of these new markets. Look at Sidewalk, its 18-month-old effort to create a network of hometown arts-and-entertainment guides on the Web. Sidewalk has undergone fits and starts.

But what makes Microsoft so tough to beat is that it almost never gives up. Sidewalk will be reborn in November as a national consumer-shopping guide focusing initially on entertainment, consumer electronics, computing, and appliances--and connecting consumers with retail or online shops. Since the start of the year, Microsoft has sold an enviable $26 million in ads for the revamped site to more than 6,000 advertisers. And Sidewalk will be tied to Microsoft's new portal site,

Microsoft's tenacity--and ceaseless quest for new markets--is bad news for competitors. The company is a force to be reckoned with wherever it forages, thanks to a $13.9 billion cash hoard and the power of its Windows monopoly.

Microsoft's critics say those assets give it an unfair advantage. The software giant prices products aggressively when faced with tough competition--bundling programs such as the Web browser for free with other products or throwing in freebie software to close a big sale. At the same time, it is tightening the rules for some corporate customers in ways that boost their software bills. And Microsoft isn't afraid to do things that look like bullying--its unsuccessful attempt last spring to co-opt 3Com Corp.'s popular Palm name for Windows-based handheld PCs is one example.

That's the picture Justice is trying to paint. Rather than trying to prove only that Microsoft illegally tied its Web brower to Windows to head off competition, government lawyers are now hoping to show a broad pattern of anticompetitive behavior. They say Microsoft is unfairly using its clout to defend its desktop monopoly and to gain ground in new markets.

COPYCATS? Just ask the folks at the Palm division of 3Com, maker of the Palm electronic organizer, a runaway hit. Microsoft decided to call handheld devices based on its Windows CE operating system Palm PCs. 3Com sued, claiming it owned the Palm name. "In the middle of this antitrust investigation, Microsoft was trying to steal our brand," says Donna Dubinsky, the former head of 3Com's Palm Div. who now runs startup JD Technology Inc. Even after Microsoft backed off, it offered buyers of its Palm-size PCs a free copy of Windows 98.

To its critics, Microsoft's tactics in emerging markets look a lot like the techniques it used so successfully to squelch competition in the PC software industry. Some of Microsoft's new competitors complain that it makes misleading claims and preannounces products in order to freeze buying decisions or that it leverages its strength in PC software to boost new products.

In electronic billing, Microsoft's press releases boast that it will offer the world's "first end-to-end bill-presentment service" in spite of the fact that CheckFree Corp. in Atlanta has been offering such services for nearly a year. (Microsoft's explanation is that CheckFree still issues some paper checks, so it's not totally electronic.) "This harms our business," says CheckFree CEO Peter Kight. "We're out ahead, but they try to get people to stop and wait for them."

It's a similar situation in the market for software used in industrial devices, according to Wind River Systems Inc. in Alameda, Calif., the leader in that category. A year and a half ago, Microsoft promised developers it would produce a version of its Windows CE software capable of running factory-automation sensors. That software is still a year off, though Microsoft maintains it didn't formally announce the product until last April. And when it lacks experience in a market, Microsoft can always throw money at a problem--the way it's spending $200,000 for the biggest booth at the upcoming Embedded Systems West trade show.

Microsoft's clout in PCs is one of its most strategic weapons. Take electronic-commerce software. In mid-October, Microsoft began testing a service for selling its software programs off of its site. Customers who click on an "Order Now" button are referred to a handful of online retailers. It's tremendously valuable for merchants to be directly linked to the Microsoft site, and they pay a fee for it. But, perhaps more vital for Microsoft, participating retailers are required to use Microsoft's Commerce Server software. That makes the service work more smoothly, Microsoft says, but it also discourages retailers from buying E-commerce software from rivals.

Microsoft has eased back only a fraction under pressure from Justice and a Senate committee. While Microsoft dropped some restrictions on PC makers and Net service providers' freedom to promote alternative browsers, the damage had already been done to rival Netscape Communications Corp. According to International Data, Netscape's browser market share dropped from 50% to 43% during the first half of this year.

Microsoft's monopoly profits allow it to give away a lot of software, such as browsers, where it needs to gain ground. For example, the company will soon throw a basic data analysis program--for which Oracle charges $4,995 for a rival product--into its SQL Server database. "They create a platform that has the potential to suck in all of their competitors," says Vern Keenan, president of consulting firm Keenan Vision Inc.

Microsoft's pricing strategies can cut against customers, too. Gartner Group Inc., which consults to corporations, says Microsoft hooks customers with low bids during an initial sale but makes up for it later with policy shifts that raise overall costs--a view Microsoft vehemently disputes. In a recent memo to clients, Gartner Research Director Mary Welch warned that companies "using Microsoft software should expect to pay 50% more per year through 2002 as a result of changes to terms and conditions."

And Microsoft is making it even easier to hook customers. It has started offering so-called Enterprise licensing agreements where, for one price per desktop, they get unlimited use of Windows NT, Office, and BackOffice, as well as upgrades. That unfairly ties the licensing of the operating system to other Microsoft products, contends Ken Wasch, president of the Software Publishers Assn., and "has an adverse impact on anyone competing with the Microsoft suite of products."

ATTENTION. Gartner takes "an extreme view" of Microsoft's licensing policies, says Deborah Willingham, vice-president of Microsoft's Enterprise Customer Unit. She says the changes are part of an effort to simplify complex licensing agreements and that Microsoft is willing to negotiate with any customer who fears its costs will go up. And the one-price-for-all enterprise agreements are not uncommon in the software industry.

Even some of its harshest critics acknowledge that most of what Microsoft does is legal. And many of the software maker's recent successes came as a result of a relentless pursuit of deals and partners rather than competitive misdeeds.

Look at how the company is rallying support for its SQL 7 database--a vital program that stores data and manages transactions for corporations that is due out in November. Oracle Corp. and IBM are way out ahead in that $6.6 billion market category, but Microsoft has persuaded a half-dozen major corporations to take a huge risk and run vital parts of their businesses on a test version of the software--and help Microsoft demonstrate on launch day that the product is safe and sound.

To win participants over, Microsoft offered an unprecedented package of assurances and around-the-clock help. For Penzoil Co., Microsoft even created an exact replica of a key corporate database in Redmond, Wash., and tested it repeatedly. The result: Penzoil switched over to SQL Server in just two days.

It's Microsoft's flat-out attention to the needs of partners that distinguishes it from some of its rivals. Atlanta (Ga.)-based Radiant Systems Inc., for instance, evaluated Microsoft's Windows and Sun Microsystem's Java operating system for its fast-food ordering kiosks and mulitmedia gas pump-payment systems. It went with Windows because Microsoft's people showed an intense interest in Radiant's plan. "They get down into the guts of a business until they understand it and can respond to needs--and they are very aggressive about it," says Jimmy Fortuna, Radiant's product-line director for platforms.

Microsoft's rivals aren't always as willing--or able--to bend over backward. Microsoft intends to defend itself in court in part by showing that rivals such as Netscape got into trouble because of their own missteps.

Even so, government trustbusters say they've gathered enough damaging evidence to prove that Microsoft has unfairly used its power. That's why many industry observers think Microsoft would be wise to notch back its hyperaggression. James Cannavino, an ex-IBM exec who is now ceo of CyberSafe Corp. in Issaquah, Wash., thinks Microsoft needs to grow up: "When you're a little company fighting bigger fish, it's O.K. to write exclusive contracts. But when you have market power and exclude competitors with contracts, that just won't fly."

Microsoft might do well to adopt a strict antitrust-compliance program that could help it steer clear of trouble with the law. Intel's program, for instance, requires new employee training, quarterly reviews by top execs, and a once-a-year refresher course. Lawyers review every major transaction. If somebody doesn't play by the rules, they're sent back for remedial training.

You're not likely to find Microsoft's employees keen about that. Although lawyers review its business activities for violations, most employees don't get antitrust training. "We don't want to discourage our people from being imaginative and zealous in how they do business," says William H. Neukom, vice-president for legal affairs. But unless Microsoft finds a way to avoid setting off alarms at every turn, its long walk with Justice on its back may start to feel like an endless journey. Even if it wins the current case, it will still have the one after that, and the one after that, to worry about.

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