Baby Bills?

The root case of the current antitrust legal battle between the US Department of Justice (DOJ) and 20 state Attorneys General against Microsoft has to do with competition in the desktop software market. Microsoft played dirty against DRDOS when introducing Windows 3.1 to beta testers in 1991 in order to win a monopoly in the operating system segment of this market, and has been foreclosing competition by tying products to Windows ever since. The DOJ tried once before to restore competition to the market place. In 1994, a Consent Decree agreement was signed with Microsoft which averted an antitrust trial at that time. Among other things, it ended tying of Microsoft products and per-processor licenses with original equipment manufacturers (OEMs). These were being used to disadvantage other software producers.

However, before agreeing to the Decree, Microsoft insisted that language be added that states that the prohibition on tying separate software products “shall not be construed to prohibit Microsoft from developing integrated software products.” The DOJ, not seeing the trap, agreed. Bill Gates, Microsoft’s CEO at the time, publicly and proudly stated that the agreement would have no material effect on his company. And in the short term, he was right.

Microsoft, rather than tying products together, instead “integrated” them. DOS and Windows were integrated to make Windows 95. Then disk-compression technology, Internet connectivity tools and even web-browsing technology were all integrated into Windows, killing or maiming competitors who could not ever hope have their software distributed alongside Microsoft’s in each operating system upgrade.

Fast forward today, and you have Microsoft at the wrong end of a bad decision by an annoyed Judge, and a distrustful DOJ which knows that Microsoft cannot be trusted with behavioral modifications. This leaves structural remedies, a topic few in the investment community even dared consider until recently.

Structural remedies can take many forms, and involves separating one or more parts of a company by divesting interests or, in the extreme case, breaking up a company onto two or more separate entities. In a telling development, the DOJ has retained a New York investment firm, Greenhill & Co., to look at how best to impose the needed restructuring while doing the least damage to the economy and the stock markets.

Most likely, Microsoft will be broken up along product lines. A split between the operating systems, productivity software, and content and entertainment divisions, for example. It is also possible that Microsoft could be forced to divest itself of all assets it has acquired in the past several years, for example, and not be allowed to buy any new companies or technologies for some period into the future.

One option which has been debated but isn’t likely is breaking up Microsoft into three or more identical mini-Microsofts, the so called “Baby-Bills” option named after the ATT breakup nickname “Baby-Bells”. Another unlikely scenario is the free release of the Windows source code, although unrestricted, non-exclusive licensing is likely to be forced.

What actually ends up happening is, of course, still to be seen. Hearings about the remedies won’t start until after Judge Jackson hands down his Findings of Law, expected in March of 2000. It is quite likely that Microsoft will not be structurally affected until well into 2001 or later.

This delay might actually be a bad thing for Microsoft, as it will give a single target for the many expected private antitrust lawsuits brought to trial by companies Microsoft has unfairly crushed over the years. There is already one such case underway, brought by Caldera who now own DRDOS. Many more are expected. Additionally, class-action lawsuits have been filed in the name of consumers of Microsoft products in several states, and again, more are expected.

While all this is bad news for Microsoft, it is great news for consumers. In the next article, we’ll look at how all these events are likely to effect the marketplace and end users.

Published in the Victoria Business Examiner.

The Case of Microsoft

Microsoft is a remarkable company which has consistently rewarded its stockholders with impressive, quarter-after-quarter gains in market share, profitability and stock price. In the last five years Microsoft’s share value has gone up over ten times, while its market share of the desktop operating system market has increased to 95%. The employees pride themselves on competing as aggressively as is needed to in order to win — completely. This is instilled in the company from the top down — Bill Gates, CEO and until recently also the President, has always been extremely smart and driven, and has made sure everyone in his company is equally focused. To Gates, failing is simply not an option, even if the limits are pushed a bit.

It was this posture, and a lucky deal with IBM to supply MS-DOS, which resulted in Microsoft growing from just another software company into the largest company in the entire US economy. And it was also this posture which became a problem once Microsoft had reached a dominant market share.

In the United States there are laws, known as the Sherman Antitrust Act, which prohibit a company with a monopoly in one area from using that monopoly to gain control of another, or to prevent entry of a competitor into the area where the monopoly is already held. Enacted in the late 19th century to break up Standard Oil, these laws have been used when needed to deal with abuse of monopoly situations ever since.

Last year the US Department of Justice (DOJ) along with 21 state Attorneys General filed a lawsuit against Microsoft claiming antitrust violations. One state dropped out when Netscape was purchased by AOL, but the rest brought the case before Judge Thomas Penfield Jackson, who last month released his Findings of Fact (FoF).

In a 207 page document, the Judge has found almost entirely in favor of the DOJ and states’ claims that Microsoft holds monopoly power, that it used this power to maintain its position, and it harmed consumers and distorted competition doing so. The Judge has also been careful in his judgment, and has taken the unusual step of issuing the FoF before the Findings of Law (FoL). There are two reasons for this.

First, Jackson hopes that by showing Microsoft, the DOJ and the states what he has found factually he can encourage them to negotiate an out-of-court settlement. Unfortunately, because of Microsoft’s aforementioned posture, it is extremely unlikely it will agree to the terms which are being demanded by the DOJ and the states. Microsoft instead seems to be betting it can overturn the ruling in appeal.

Which is the second part of Jackson’s strategy — an appeal judgment cannot change any of the FoF, because the appeal judges will not re-examine the evidence. The appeal can only examine the FoL as derived from the FoF. And, as a great many legal analysts have said since the FoF were released, they allow only one conclusion. Further, Jackson has the option of bypassing the appeals process entirely, and requesting the supreme court hear to the case instead.

Presuming there isn’t a settlement, Judge Jackson will likely release his Findings of Law in late March of 2000. At that point Microsoft will legally be a monopoly in the desktop operating system market and the court will begin looking at ways to correct the abuse of the monopoly. These remedies could take on many forms, which we will be looking at in the next article. We will also examine the issue of Microsoft’s exposure to private lawsuits.

What I think is most unfortunate about the whole Microsoft trial is that it didn’t have to happen. If the Microsoft executives had simply accepted they couldn’t compete quite as hard as they used to, they wouldn’t find themselves where they do now. IBM and Intel were in similar situations and, through prudent self management, avoided what Microsoft now faces.

Published in the Victoria Business Examiner.