A New World For Microsoft?

If the EU ruling against the software giant is upheld, it could force changes in the way Microsoft does business

For 14 years, one regulator or another has chased after Microsoft -- mostly unsuccessfully. In 1990, the Federal Trade Commission launched an investigation into a long list of allegedly predatory practices. The probe was dropped. In 1998, the Justice Dept. tried to prevent Microsoft from using its Windows monopoly to corner the emerging Web browser market. Microsoft fought back and got only a slap on the wrist. Now European regulators are taking their shot at restraining the software giant. Microsoft is fighting back again, but there's a reasonable chance that regulators will at last help rivals compete with Goliath on a more equal footing.

In its Mar. 24 ruling, the European Union labeled Microsoft Corp. an abusive monopolist and issued a sweeping set of penalties. The company will have to offer computer makers in Europe two versions of its monopoly Windows operating system: one with Windows Media Player, which lets users watch videos and hear music, and one without. The EU also ruled that Microsoft must share technical information with rivals that will help their server software work better with Windows. And the commission slapped Microsoft with the biggest fine it has ever levied -- $613 million. "We are simply ensuring that anyone who develops new software has a fair opportunity to compete in the marketplace," says Mario Monti, competition commissioner for the EU.

TARGET: BUNDLING. The ruling strikes at the heart of Microsoft's strategy. For more than a decade, it has bundled new features into Windows, giving customers reasons to upgrade -- and often trouncing rivals in the process. But in finding that Microsoft has illegally leveraged the power of its Windows monopoly to destroy its competition, the EU is trying to do more than just punish Microsoft for past transgressions. If the ruling is upheld, it could seriously limit Microsoft's ability to add features to its software in the future. It also offers the potential of far faster relief for rivals who feel they've been wronged.

Although the ruling officially applies only to Europe, its impact is expected to be felt worldwide. "As far as the eye can see, Microsoft is going to be challenged by competitors and by governments anytime it wants to add something to Windows," says Michael A. Cusumano, a professor at Massachusetts Institute of Technology's Sloan School of Management.

Microsoft wasted no time dismissing the decision as overreaching on the part of Monti. "We believe that every company should be able to improve its products to meet the needs of consumers," says CEO Steven A. Ballmer. What's more, Ballmer calls the standards set by the 2002 settlement in the U.S. antitrust case "guiding principles." He says Microsoft doesn't plan to reconsider its future product design or bundling plans.

The company will appeal the ruling, and it plans to seek a stay of some, if not all, of the penalties. It argues that EU law only empowers the Commission to address "contractual tying," not the sort of technical bundling of products the company does. And it will argue that illegal tying exists only if it's inconsistent with commercial norms, which isn't the case here since every other operating system includes a media player.

Microsoft faces hurdles in court. There isn't a lot of legal precedent, but to the extent it exists, it tends to favor Monti in the area of tying. For instance, in a 1994 case involving construction products maker Hilti Corp., the European Court of Justice -- the highest court on the Continent -- upheld a lower court ruling that the company could not force customers who bought its market-dominant nail guns to also buy nails. But in the area of interoperability, available legal precedent tends to favor Microsoft. In a 2002 case involving Intercontinental Marketing Services Health Inc., the Court of First Instance held that dominant companies can refuse to license their intellectual property to rivals. That may give Microsoft grounds for objecting to rules that force it to share proprietary interface information with others.

For the time being, there are more questions than answers, but that uncertainty itself threatens to put Microsoft's software development strategy in doubt. For starters, Microsoft has to gin up a version of Windows without a media player within 90 days. Computer makers can decide if they want to buy Windows-lite and include digital media technology from a Microsoft rival, such as RealNetworks (RNWK ) or Apple Computer (AAPL ). But since Microsoft can charge the same for both products, it's unlikely that the media-playerless version will appeal to PC makers. RealNetworks is considering offering computer makers that ship PCs with its media player exclusively the ability to offer free limited subscriptions for such products as its Rhapsody online music service.

The ruling could start to have more impact as soon as next year. That's when Microsoft is considering releasing an intermediate update of Windows that may include the ability to search the Web directly from the main Windows screen. That could put search rivals such as Google Inc. at a disadvantage since PCs don't ship with its service displayed in Windows. Google says it doesn't plan to try to block Microsoft in court, but the ruling may give Microsoft pause anyway.

APPOINTING A PAROLE OFFICER. Those issues compound with Longhorn, the next major version of Windows, expected in 2006 or 2007. Microsoft has talked about including everything from Internet search to speech-recognition software. If rivals complain to the EU, it might try to prevent some of the planned bundling. That could force Microsoft to rethink its design plans for Longhorn, which could delay the product. Microsoft, however, says it has reviewed Longhorn bundling plans with its developers and lawyers and believes they're legal.

Meanwhile, Microsoft's competitors can't wait to take advantage of Monti's ruling on sharing technical information. Right now, Microsoft's desktop and server software packages communicate with one another in a private language. "We have been excluded so far," says Matthew J. Szulik, CEO of Linux software distributor Red Hat Inc. (RHAT ). He hopes the ruling will give rivals what they need to smooth their interactions with Windows.

To make all this work, Monti is creating another precedent: a Monitoring Trustee. Much as federal Judge Harold H. Greene oversaw the breakup of AT&T (T ) a quarter-century ago, Monti will appoint a trustee to handle oversight of Microsoft's compliance. The idea is to keep up the pressure on Microsoft so it can't sidestep the penalties by bogging the Commission down in bureaucratic and technical wrangling.

While there's a long way to go in this case, it's fundamentally different from what Microsoft faced in the U.S. because EU regulators have more authority than their U.S. counterparts. They get to make an initial determination of liability and propose a remedy without going to court. To forestall future anticompetitive behavior, they have the authority to quickly investigate and bring new charges against Microsoft if new complaints arise.

In addition, because the ruling contains findings about Microsoft's market dominance and tactics that rivals can use to build future cases, "new cases will be much easier because the law has already been decided," says New York University School of Law antitrust professor Eleanor M. Fox. That could put an end to the cycle that unnerves foes who land in Microsoft's crosshairs: endless legal skirmishes that delay rulings until long after Microsoft has used its monopoly power to pummel them in the marketplace.

It's still too early to say if the ruling will substantially alter Microsoft's conduct. Rivals were jubilant four years ago when U.S. District Judge Thomas Penfield Jackson ruled Microsoft a monopolist and ordered the company split in two. Microsoft managed to escape that fate, and it clearly expects to do the same here. But one thing's for certain: The Old World has imposed a new world order that could make Microsoft mighty uncomfortable.

By Jay Greene in Seattle, Andy Reinhardt in Brussels, and Mike France in New York

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