Commentary: Settlement or Sellout?

Justice's plan gives Microsoft lots of room to run over rivals

By Mike France and Jay Greene

Trustbusters have a long history of letting Microsoft Corp. (MSFT ) off the hook. The Federal Trade Commission started investigating the company in 1990 but dropped its inquiry after three years. The Justice Dept. took over in 1993 and pressured Microsoft Chairman William H. Gates III to sign a consent decree that was supposed to cut off his ability to prey on rivals--but in fact had little effect.

When trustbusters took on the company for a third time, in 1998, they vowed to make a difference. And for a while, it seemed as if they would. Justice won a powerful court decision against Microsoft last year and then had the core of the case unanimously upheld by a conservative appeals court. For a moment, it seemed as if trustbusters would solve the technology industry's most important and vexing policy problem: figuring out a way to keep Microsoft from abusing the power it holds as the owner of the Windows PC operating system--a critical piece of the nation's information infrastructure.

That now seems like an illusion. Instead of a long-term solution to the Microsoft dilemma, we're seeing history repeat itself. Even a cursory analysis of the settlement signed by the Justice Dept. and nine state attorneys general reveals that it continues to leave the company with an unfair advantage over rivals in the software market--and in a position to squelch innovative startups. Despite the crowing of Justice's antitrust chief, Charles A. James, the settlement leaves the company free to repeat almost all of its old tricks. "This, along with AT&T, is one of the two most important cases of the postwar period," says Albert A. Foer, president of the independent American Antitrust Institute. "The settlement is a shocking disappointment."

Partly, that's because it solves the problems of the past in a fast-moving industry. If the deal goes through, Microsoft will be in a position to use its monopolies to expand into new businesses. Says Marc Benioff, chairman of Web software startup Inc.: "Fundamentally, what it means is the 800-pound gorilla is out of the cage." Just as the company has elbowed aside its competitors in PC applications and browsers, it could use Windows to go after everything from online music downloads to digital photo printing services to instant messaging. Netscape, Borland, and Lotus were targets in its past. Now the likes of AOL Time Warner Inc. (AOL ) and streaming-media leader RealNetworks Inc. (RNWK ) are in Microsoft's crosshairs.

QUANDARY. To be sure, the deal isn't final. It is still being opposed by nine state attorneys general and a pack of competitors. U.S. District Judge Colleen Kollar-Kotelly plans to give the dissident states an airing early next year. According to a source in contact with the attorneys general, the nine states that are still suing may seek to force Microsoft to sell versions of Windows that don't include the code for certain types of software, such as instant messaging and media players. That would help level the playing field.

In fairness to James, it should also be said that there are no easy answers to the Microsoft quandary. At a time when the nation is at war and the economy is suffering, an argument can be made that the government shouldn't make life harder for the nation's leading software company. James has argued, and some independent experts agree, that the courts would not have supported a much stronger remedy. And the proposed settlement does impose a few new restrictions on the company's conduct. "We think that it's a document that is very positive for consumers and the tech industry," says James. "It resolves quite successfully the issue that was the whole point of the Microsoft case--Microsoft throwing up roadblocks and impediments to the use of alternative [software]."

Others agree. George Mason University antitrust professor Ernest Gellhorn says James is taking a reasonable position. The court of appeals "made clear that product integration is acceptable--even by a monopolist," says Gellhorn. "What they held to be unlawful was exclusive dealing, retaliation, giving an advantage to their favored ones, manipulating prices, refusals to deal--and each one of those is dealt with in the settlement."

LOOPHOLES. Under the terms of the proposal, Microsoft would have to give computer makers more power to choose software sold by other companies. Microsoft also would have to do a better job of sharing technical information about Windows with rivals that need to hook their products into the operating system.

That all sounds great, in theory. But a close look at the deal reveals that these requirements will be easy to evade (table). One provision would allow Compaq (CPQ ) or Dell (DELL ), for example, to hide access to Microsoft's Media Player and replace it with RealNetworks' competing product without fear of retaliation. But if the language of the settlement offers PC makers a taste of freedom, the economics of their business snatches it away again. Theirs is a low-margin business, where every extra dollar spent on hardware and software components can evaporate profits. They're not inclined to take on the expense of gathering software from a variety of companies and plugging it into their systems. Often enough, there are glitches with non-Microsoft software. The easiest course for them is to just take what Microsoft hands them.

Other provisions of the settlement are aimed at preventing Microsoft from retaliating against computer makers that don't favor Microsoft products. For instance, one key tool the company uses to control PC makers is the price of Windows. Because PC makers have thin margins, a small change in Windows pricing can make or break them. The proposed settlement tries to nullify this tactic by forcing Microsoft to sell Windows with "uniform licensing agreements." Yet the software giant is still fully free to punish PC makers that use rival products by charging them higher prices for the company's other software, such as the Office suite, critics say. They also worry that it may also be able to evade the decree by entering sweetheart joint ventures with favored computer manufacturers. In fact, Microsoft won't have to alter its dealings with computer makers in big growth segments outside of PCs, such as handheld devices.

PC makers are reluctant to talk about the settlement. Publicly, they say they are pleased with the flexibility that this deal gives them. Privately, executives say they are deeply disappointed. "I didn't see any significant compromise on Microsoft's part," says an executive at one major PC maker. "And I saw a lot of outs for Microsoft." Indeed, he says the settlement doesn't allow PC makers to do anything they aren't already doing today. What the PC makers would like: the freedom to customize the way their products look and work to the liking of an individual customer. The way things are now, they have to constantly look over their shoulder to see if Microsoft will let them have a say about the PC user interface.

Along with computer makers, independent software manufacturers are supposed to be the second-biggest beneficiaries of the settlement. In fact, they're left practically defenseless. Software makers have long complained that Microsoft withholds critical technical information they need to allow their products to run on Windows. For example, during the trial, Intuit Inc., which makes the Quicken family of personal-finance software, accused Microsoft of withholding information about the new version of Windows until the last minute to give Microsoft programmers a time-to-market advantage.

To fix this problem, trustbusters have installed a provision forcing Microsoft to disclose more information about its so-called application programming interfaces, or APIs. Those are the critical technical hooks that enable software programs to run on top of the operating system. Yet the settlement only applies to so-called middleware, such as Web browsers--not to traditional applications such as Quicken.

WEB POWER. Perhaps more troubling, there's nothing in the settlement that stops Microsoft from leveraging its monopoly into new Web services markets. Microsoft's services include Passport, which allows people to sign on to a number of Web sites with one password, and Microsoft Wallet, which lets people fill in billing information once and shop on many e-commerce sites. Microsoft is free to include these services with Windows--just as it did with its Internet Explorer browser, the action that provoked the government to launch its antitrust case. Meanwhile, rivals in Web services such as AOL Time Warner sometimes have to pay PC makers to include their services on their PCs. "The agreement fails to protect consumer choice and promote competition by leaving Microsoft free to continue to abuse its monopoly," says AOL General Counsel Paul T. Cappuccio.

AOL isn't in danger of being put out of business by Microsoft anytime soon, but upstart Web services companies are vulnerable. Take QPass Inc., a Seattle maker of software that authenticates visitors' identities on Web sites and provides e-commerce payment systems. Microsoft's ability to place Passport in a prominent position on Windows XP helps it gain customers, potentially setting itself up to be the main authentication service on the Web. If that happens, "We would be gone in a puff of smoke that nobody noticed," says QPass CEO Chase Franklin, a former Microsoft employee. "This becomes an innovation choke point. It's just too much of a concentration of power."

WORRIED RIVALS. For its part, Microsoft executives insist the settlement is no sellout. Among other things, the company must submit to the rulings of a three-member technical committee that will oversee enforcement of the settlement.

The company and the government will get to choose one representative apiece, and they, in turn, will choose the third member. Based on the company's Redmond campus, the committee will have the power to hire staff at Microsoft's expense, as well as interview company employees and inspect their documents. If the committee believes Microsoft has violated the terms of the consent decree, it is supposed to issue a confidential report to the Justice Dept. and the attorneys general.

More broadly, Microsoft says it learned valuable lessons from the trial, a three-year ordeal in which many partners shied away from supporting the giant. "We will focus more on how our actions will affect other companies," says Gates. "Along with this settlement come new responsibilities--to communicate in new ways, to be even more open, and to offer new design flexibility." In fact, for the past few years, Microsoft has been a leader in adopting Internet standards--which provide a more level playing field for tech companies.

Microsoft's rivals still have a hard time believing the company is chastened. Consider Opera Software, a small Norwegian company that has developed a browser that has a modest legion of users. On Oct. 25, Microsoft launched MSN 7.0, a facelift to its online service. The facelift blocked Opera users from accessing the MSN site, instead opening a Web page that encouraged users to download the latest version of Internet Explorer. Within a week, Microsoft bowed to pressure and opened MSN up to every browser, but Opera is still worried for its future. "Microsoft has put us on a blacklist," says Opera CEO Jon S. von Tetzchner. "We can't continue to send out press releases every time they put in a glitch." Unless the Justice Dept.'s deal is strengthened, he may have to get ready to do just that.

Legal affairs Editor France follows the Microsoft antitrust case. Seattle Bureau Chief Greene covers Microsoft.

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