Microsoft: First Europe, Then...?

EU penalties may change how the giant does business abroad -- and at home

European Union regulators are on the verge of handing down a ruling in the five-year-old antitrust case against Microsoft Corp. (MSFT ), and it looks like the software giant will get a slap across the face that could sting for a while. Details leaking out suggest regulators will require Microsoft to pay a substantial fine and disclose details about how rivals' server software can work better with Windows PCs.

But the proposed penalty that could be most vexing is a requirement to produce two versions of the Windows operating system for the European market, one that includes digital media playback software and another that doesn't. European antitrust watchdogs argue that by including Media Player -- software that plays audio and video from CDs and the Internet -- in Windows, Microsoft is squeezing out rivals such as RealNetworks Inc. (RNWK ). The concern is that innovation in digital media could be stifled if PC makers, content providers, and consumers have fewer choices in such software. Right now, 64% of Europeans use Media Player, vs. 22% for RealNetworks' RealPlayer and RealOne offerings, according to researcher Nielsen//NetRatings.

Just how hard Microsoft gets slapped is likely to be decided in the next few weeks. Regulators from the 15 EU states will meet in Brussels on Mar. 15 and 22 to review the case. Although a settlement is still possible, legal analysts believe the national authorities will give EU Competition Commissioner Mario Monti a green light, clearing the way for a final decision in April. While the remedies likely won't have much short-term impact on Microsoft, longer-term they help level the playing field and could set a precedent preventing Microsoft from illegally dominating emerging software markets.

A BLIGHT ON BUNDLING? Any tinkering with Windows code would undoubtedly prompt CEO Steve Ballmer to appeal. Microsoft's bedrock principle is to fight fiercely against any attempts to dictate what can and can't be built into Windows. Says Microsoft senior vice-president Will Poole, "We've been pretty clear on our views in that area for five-plus years." Legal experts in Europe say that because the remedies don't cause Microsoft near-term harm, it's likely they would go into effect while the company's appeals wend through the courts.

Microsoft is more than able to pay any financial penalty the EU could levy. EU law provides for fines in cases like this of up to 10% of a company's annual revenues -- which would be a $3.2 billion hit for Microsoft. But, based on past rulings, legal experts say the company would likely pay much less. That would barely put a dent in its $52 billion cash hoard.

Far more nettlesome for Microsoft is the unbundling remedy. Its Windows Media Player is one of the world's three most popular applications for viewing videos and listening to music on PCs. If the EU requires Microsoft to ship a version of Windows without the software in Europe, and at a lower price, PC makers would be able to replace the application with alternatives from RealNetworks and Apple Computer Inc. (AAPL ), which are available for free on the Web. While the EU mandate would cover only Europe, PC makers could ask for Windows-lite elsewhere, though Microsoft wouldn't have to comply.

How strong demand for the software would be depends on the price. PC makers typically pay about $50 for Windows now, and a few dollars off would make a big difference to companies with razor-thin margins. "If you could give them $5, they'd take it in a second," says analyst Roger Kay with market researcher IDC. None of the major PC makers would comment on the EU matter.

BUNDLING CHILL. It's the legal precedent, however, that could hurt Microsoft longer term. If the EU forces it to sell a Media Player-less version of Windows, what's next? Eleanor M. Fox, professor of law at New York University School of Law, says that would have implications for other applications that Microsoft might want to include in Windows in the future. The company is considering adding Internet search in the next update, code-name Longhorn, due in 2006. Search leader Google Inc. could cite the Media Player precedent and seek an injunction in Europe. "It would chill Microsoft's bundling," Fox says. Google declined comment.

While analysts have focused on Media Player, another part of the proposed ruling is significant, too. Brussels legal sources confirm that the EC will demand that Microsoft reveal detailed information about how its server software interacts with Windows. Right now, because Microsoft has a monopoly in desktop software and a leading share of server operating systems, it's able to fine-tune the interactions between the two kinds of computers so users get more out of their machines. If rivals were able to do the same, they could compete with Microsoft on a more equal footing. "We just want to be able to compete on the merits of our software, not a secret handshake," says Lee Patch, vice-president of legal affairs at Sun Microsystems Inc. (SUNW ).

For competitors, the EU remedies would be an improvement on the consent decree reached between the U.S. Justice Dept. and Microsoft in 2002. Microsoft agreed to disclose secret Windows technologies to competitors so their programs could work smoothly with Windows. The deal also gave computer makers more control over the software that they could include in PCs. But it did little to check Microsoft's dominance of the PC software business or prevent it from using its Windows monopoly to gain advantage in emerging markets.

Microsoft's rivals aren't waiting around for regulators to protect them. Instead, they focus on where Goliath is weak. Microsoft is an also-ran in areas such as TV set-top boxes, mobile phones, and consumer electronics. Meanwhile, RealNetworks has cut deals to put its media players on mobile phones made by Nokia (NOK ) and Sony Ericsson Mobile Communication. And Norway's Opera Software supplies browsers for set-tops, handsets, and home appliances. "People in the mobile business and other areas we're going after don't depend on Microsoft now, and they don't want to in the future," says Opera Chief Executive Jon S. von Tetzchner.

The EU ruling alone won't change the balance of power in the computer industry. Microsoft remains free to use its cash, its clout, and, in most cases, desktop dominance to muscle into new markets. Still, if these penalties get approved, the software giant could be smarting for a while.

By Jay Greene in Seattle and Andy Reinhardt in Paris, with bureau reports

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