Microsoft On Trial: The View At Halftime

Justice has scored a few major points, but a rout against the company is unlikely

For the past five years, Microsoft Corp. has been subjected to one of the most intensive investigations any company has ever endured. Dozens of government lawyers have been digging through Microsoft's files, reading its executives' E-mail, and interviewing its competitors, partners, and economists about the company's controversial business practices. The goal: to prove that America's leading software company is a danger to the public.

Using 1,400 of the juiciest documents that it could find, as well as damning testimony from top executives at Netscape Communications, America Online, Apple Computer, and Intuit, the government has done its best during the past 13 weeks to prove that Microsoft is indeed a predatory monopoly. So now it's fair to ask: Has the Justice Dept. managed to make its case?

The halftime verdict: that Justice and 19 state attorneys general are headed toward, at best, a partial victory over Microsoft. The majority of the trial watchers interviewed by BUSINESS WEEK expect the trustbusters to prove that Microsoft engaged in unfair contractual practices that forced business partners to shun Netscape Communications Corp.'s Internet browser. Some observers think that the agency will also be able to win a verdict that the company is guilty of a clear pattern of anticompetitive acts. But few of them believe that, by the time this case finishes the appeals process, Justice will prevail on the charge that set off the suit in the first place: that it was illegal for Microsoft to bundle an Internet browser into the Windows operating system.

Of course, this court battle is far from over. Microsoft is likely to make headway when it presents its own witnesses--and could score big points if CEO William H. Gates III chooses to testify and presents a strong defense of his company's actions. But the software colossus could also lose ground if its witnesses fall apart under the cross-examination of David Boies, the Justice Dept.'s legendary lead litigator. Below are the government's key charges, a summary of how well Justice has done in proving them, and an analysis of Microsoft's most likely course of counterattack.

MONOPOLY: Does Microsoft face meaningful competition?

To win the case, Justice first has to prove that Microsoft is a monopoly. Under antitrust law, none of the company's allegedly predatory practices could be deemed illegal unless Judge Thomas Penfield Jackson decides that it virtually owns the operating-system market.

Fortunately for the feds, this point is a slam dunk. Microsoft has sold the dominant personal-computer operating system for many years. According to Justice, its market share rose from 93% in 1991 to 95% last year. In pretrial deposition testimony, executives from Gateway, Hewlett-Packard, and other computer makers have testified that they have no reasonable alternative to Windows. Asked what would happen if her company were to try selling non-Microsoft operating systems, Gateway Associate Business Manager Penny Nash said it "would be suicide."

Because this issue of competition provides the foundation for the feds' case, Microsoft is not giving up. Richard L. Schmalensee, an economist for the defense, testified on Jan. 11 that the software market is so dynamic that Microsoft's dominance could erode at any time--just as IBM's once did. As evidence of this dynamism, he points to the recent merger of America Online Inc. and Netscape. Most experts, however, don't believe that this argument will hold much sway with Jackson. "Microsoft has a pretty heavy burden in demonstrating that there is a realistic potential for eroding the market," says Albert A. Foer, president of the American Antitrust Institute.

BULLYING: Did Microsoft prevent other companies from marketing Netscape's browser?

Of all the charges against Microsoft, this is the one that's most likely to stick. Antitrust law prohibits monopolists from pressuring their distributors not to offer their competitors' products. But Microsoft's business partners have repeatedly told Jackson that the company did just that in its attempts to win the Internet browser market from Netscape.

Microsoft was able to bully other companies into favoring its Internet Explorer browser over Netscape's Navigator by leveraging the power of its dominant operating system, argues Justice. Media giants Walt Disney Co. and AOL have both testified that they agreed to exclusive deals with Microsoft in exchange for prize real estate on the Windows desktop. Labeling the software company "the 1,000-pound gorilla of the industry," Disney Internet exec Steve Wadsworth said in his deposition that Microsoft held "all the cards because they have this broad distribution capability through...Windows." Justice also introduced evidence that Compaq Computer Corp. had to favor Internet Explorer if it wanted to get Windows at all.

Through exclusive deals, according to Justice, Microsoft was able to squeeze Netscape out of many of the main channels for browser distribution. "This is the strongest part of the case," says Brookings Institution antitrust expert Robert E. Litan. "They've got multiple examples of Microsoft telling people: `We're not going to give you shelf space if you do business with Netscape."'

In cross-examination, Microsoft lawyers argued there are still plenty of ways for Netscape to distribute its product. It can use the Internet, the thousands of Internet service providers that don't have deals with Microsoft, or its new parent AOL. Expect Microsoft executives such as Joachim Kempin, its lead negotiator in dealing with computer makers, to say that Explorer bested Navigator simply because it's a better product.

But because there do not appear to be legitimate business justifications for Microsoft's exclusive deals, most experts don't expect these arguments to succeed in convincing Jackson. Indeed, one sign of Microsoft's vulnerability on this issue is that it voluntarily relaxed some of its contract terms last year, just before the trial started, such as those limiting the ability of Internet service providers to promote Netscape.

TYING: Did Microsoft illegally bundle its browser into Windows?

In many ways, this is the most important issue in the case. By claiming it was illegal for Microsoft to bundle Internet Explorer into Windows, the government challenged the company's fundamental business model, which is based on steadily adding new features into its monopoly operating system.

The problem for the government is that in June, the U.S. Court of Appeals for the District of Columbia, which will review the case after Jackson rules, said the company had broad leeway to design its product any way it liked. Indicating that Justice would have to prove there are no benefits at all from bundling, it set a legal standard that's almost impossible to meet. "Integration is the most difficult issue for Justice," says Washington antitrust lawyer George S. Cary.

But that hasn't stopped the trustbusters from trying to win on this point. The feds have presented evidence that some customers want operating systems without browsers, that there's no technical reason to meld the two products, and that PC makers could determine what software features consumers receive just as well as Microsoft. Argued computing expert David Farber, a Justice witness: "Taken to its logical extreme, [the appeals court standard] would mean that Microsoft could bundle together all existing and future applications with its current (already massive) product sold as Windows 98."

But given the appeals court's views, company witnesses will try to make a strong case to the contrary. Senior Vice-President James E. Allchin is likely to give Judge Jackson illustrations of how bundling helps consumers. Noting that users need to retrieve information from a variety of sources, including the Web, floppy disks, and CD-ROMs, for instance, Microsoft is set to argue that it makes sense to give consumers all the tools to do so in one uniform package. And that means wrapping a browser into the operating system.

More important, Microsoft's lawyers will argue that any move by a federal judge to second-guess the configuration of Windows will start the government down the slippery slope of interference in the design of a computer operating system. And that's just what the D.C. Circuit appeals court decried.

DIVIDING MARKETS: Has Microsoft tried to split markets with competitors?

The most explosive accusation Justice has hurled at Microsoft is that it proposed allocating the browser market in a June, 1995, meeting with Netscape. Apple's Avadis Tevanian Jr. and Intel Corp.'s Steven D. McGeady backed up this charge when they testified that Microsoft had made similar proposals to their companies. Despite the fireworks, there's little hard evidence to support Justice's claims. No one caught Microsoft proposing to divide markets on tape, nor are there any "smoking gun" documents.

Because Justice's charges are based primarily on the testimony of Microsoft's enemies, plus some indirectly incriminating E-mail and internal company documents, many experts question whether the market-division charge will hold up during the second half of the trial. "The government has made a circumstantial case so far," says Brookings' Litan. "The door is open for Microsoft to cut it down."

Details of the key meeting are murky. Netscape CEO James L. Barksdale testified that Microsoft execs discussed drawing a "line" between the two companies' markets--with Microsoft providing browsers for Windows 95 and Netscape getting everything else. In support of this version of events, Justice has offered a day-after memo written by Dan Rosen, Microsoft's general manager of new technology, to Gates saying that one goal of the meeting was to "establish Microsoft ownership of the Internet client platform for Win95."

But Microsoft tells a different story--and has its own documents to show the judge. Microsoft says the get-together was simply an opportunity to tell Netscape about features it intended to put into Windows. There's nothing illegal about that, the company argues; such meetings with applications developers were routine.

To support its case, the company is likely to point to different passages in the memo written by Rosen the day after the meeting. In one of them, he indicates that Microsoft execs told Netscape about plans to expand Windows to include some--though not all--of the functions in the Netscape browser. The company claims the goal of this discussion was not to divide the browser market but rather to give Netscape the information it needed to build its browser on the wider Win95 base. "[M]uch of the conversation centered on a discussion of how the lines would be drawn between [Windows] and their value-added," Rosen wrote.

Which side is telling the truth? The ultimate resolution of this game of he-said-he-said will probably depend on the testimony of key witness Rosen.

SABOTAGE: Did Microsoft attempt to derail Java?

The government's primary charge against Microsoft is that it tries to kill any competitive threat to Windows. As evidence, it has alleged that the company attempted to subvert Sun Microsystems Inc.'s Java programming language--a product that allows software developers to write programs that run on any operating system, thereby giving Windows no special advantage over other products.

Justice says that by creating its own version of Java, Microsoft was attempting to destroy the rival product's key advantage: its ability to run on all types of hardware. Justice offered up a heap of incriminating internal E-mail as proof of Microsoft's malicious intent. Some don't leave much room for innocent explanation. In one, platforms and applications Vice-President Paul Maritz told former Microsoft exec Brad A. Silverberg that a need exists "to fundamentally blunt [Java] momentum" to "protect our core asset Windows." The government's charges were bolstered when a California federal judge recently awarded Sun a preliminary injunction in a suit charging Microsoft with violating its Java license.

But Justice's argument has one big hole: When Microsoft modified Java, it improved it. During testimony by James A. Gosling, a top scientist at Sun, Microsoft's legal team presented a stack of evidence that Java does not really work as it's advertised to. The judge seemed impressed. At the end of Gosling's testimony, Jackson put him on the spot: Microsoft's lawyers have "presented evidence that Microsoft grasped the importance of Java and ran with it and just made a better product. What's your response?" Gosling admitted that Microsoft's Java "virtual machine," the software that allows Java-based programs to run on a computer, is superior in some ways and that Microsoft has improved its technology faster than Sun.

Antitrust experts say, though, that the mere fact that Microsoft improved Java won't necessarily offset its seemingly predatory intent. So this issue is still up for grabs. The outcome could turn on the credibility of Senior Vice-President Robert Muglia, who will tell Microsoft's version of the Java story.

HARM: Do Microsoft's actions hurt consumers?

The Supreme Court once declared that antitrust law exists "for the protection of competition, not competitors." That means that Justice won't win if it proves only that Microsoft's business practices hurt Netscape. It also has to convince Jackson that the company threatens consumers.

Right now, that's the trustbusters' Achilles' heel. Microsoft's products keep getting better, and their prices generally hold steady or, in many cases, fall. That puts Justice in a tough position. It has to show that the company's software is not as good and cheap as it would be if the company played by the rules.

That's not easy to do. To assert, for example, that Microsoft is overcharging for Windows, government witness economist Frederick R. Warren-Boulton argued that its price hasn't fallen as rapidly as other types of computer products. He cited Microsoft documents noting that Windows, which accounted for just 0.5% of the cost of a personal computer in the early 1990s, might eventually account for 10%. But Microsoft's economic expert will have a ready response: that The performance of Windows has improved to such a degree that the relative price increases are justified.

The issue of innovation is also a problem. Justice's theory is that Microsoft's aggressiveness scares other companies away from inventing new products. But under cross-examination, Netscape's Barksdale admitted his company continued improving its product during Microsoft's competitive attack. And despite Microsoft's efforts to torpedo Sun's Java and Apple's QuickTime, those two products are still on the market. On Jan. 12, Justice economic witness Franklin Fisher gave Microsoft an unexPected boost when he said that consumers were not harmed "up to this point" and that the danger was down the road. "At an absolute minimum, the government is saying that they may have a case someday, but certainly not yet," scoffs New York antitrust attorney Robert A. McTamaney.

The Justice Dept.'s case that Microsoft has hurt consumers "doesn't add up to an awful lot," says Ernest Gellhorn, a professor of antitrust law at George Mason University. "It certainly doesn't justify any kind of major remedy. I can see conduct remedies [such as] an injunction saying you shall not put exclusive restrictions on your contracts. I can't see them saying we're going to break you up, or you can't offer the browser as an embedded part of Windows 98."

WHAT'S AHEAD. At the halfway point in the trial, there are still a few X-factors that could influence the outcome. One is that the many discreet issues in this case, taken as a whole, may add up to more than the sum of their parts. Under the Sherman Act, it's possible that Jackson might find that Microsoft engaged in an illegal pattern of conduct intended to defend its monopoly--even if he simultaneously finds there's not enough evidence to prove individual charges such as tying or market division.

If Bill Gates ends up on the witness stand, he, too, would have a major impact on the case. But it's hard to predict if the mogul would charm Jackson with his passion for Microsoft's mission or alienate the judge with his famed temper. A settlement is also still possible. Both sides appear to be far apart, but warring parties often work things out as the prospect of a verdict approaches. As at halftime of a closely contested football game, there's still plenty of room for surprises.

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