FAIR USE NOTICE. This document contains copyrighted material whose use has not been specifically authorized by the copyright owner. The Managerial Economics course is making this material available as part of our mission to promote critical thinking about economic issues. We believe that this constitutes a `fair use' of the copyrighted material as provided for in section 107 of the US Copyright Law. If you wish to use this copyrighted material for purposes of your own that go beyond `fair use', you must obtain permission from the copyright owner.

November 8, 1999

WSJ Interactive Edition

Showdown: The Microsoft Case

Portrait of an Monopolist:
Threats, Profits and Power

By DON CLARK
Staff Reporter of THE WALL STREET JOURNAL

Through nearly nine years and multiple government inquiries, Microsoft Corp. executives
argued that all the allegations about its behavior amounted to sour grapes from incompetent
competitors. Armed with all the facts, they said, a reasonable person would see that
Microsoft played hard but fair, acting in ways that helped consumers.

Judge Thomas Penfield Jackson forever changed the debate. After weighing evidence for a
year, including the strongest arguments of Microsoft's amply funded legal team, the judge
came away convinced that the software company has behaved more like a thug in its dealings
with competitors and customers.

That opinion is now part of high-tech history, no matter what appeals, settlements or legal remedies may follow. For Microsoft's image, the damage is incalculable. For thousands of people who competed with the company, whether successfully or not, Judge Jackson's findings of fact are sweet vindication.

"This stuff about us being incompetent was just absurd, and I cannot tell you how much that irritated me," said James Barksdale, former chief executive officer of Netscape Communications Corp. "That was Microsoft's opinion, and now the judge has said, 'These are the facts.' "

Here are the companies that are most central to the case and some of the judge's key findings concerning them:

NETSCAPE

The company that almost single-handedly popularized the Web fought a long, losing battle before being sold to America Online Inc. Microsoft, the judge found, used a variety of tactics to deter PC makers, Internet-access-service companies and Web content providers from using Netscape's Web browser, Navigator, which threatened Microsoft's Windows monopoly.

In meetings in June 1995, Microsoft executives presented Netscape's Mr. Barksdale with a proposal for a "special" relationship, in which Netscape would abandon trying to make Navigator a competing platform for writing Internet-based software.

The ruling doesn't use Justice Department language that the proposal was an illegal attempt at "market division." But the judge made it clear that Microsoft's proposal would hurt competition. "Had Netscape accepted Microsoft's proposal, it would have forfeited any prospect of presenting a comprehensive platform for the development of network-centric applications," he wrote.

Because Netscape turned down the special relationship, Microsoft for three months withheld technical information that Netscape needed to make a browser work with the Windows 95 operating system, introduced in August 1995, the judge concluded.

More broadly, the judge ruled, Microsoft executives concluded that Microsoft couldn't significantly improve the market share of its browser by just improving the product. It used licensing agreements and technical integration to make sure that computer makers and other partners had little choice but to use Microsoft's Internet Explorer.

Based in large part on statements in Microsoft internal documents, he discounted the company's central trial argument that it integrated Internet Explorer to Windows to improv consumers' experience. Rather, competition with Netscape was the overriding motivation.

The intent was to make it more difficult for anyone, including systems administrators and everyday users, to remove Internet Explorer from Windows 95. He found that the aim was simultaneously to complicate the experience of using Navigator with Windows 95. As Microsoft official Brad Chase wrote to his superiors near the end of 1995, "We will bind the shell to the Internet Explorer, so that running any other browser is a jolting experience."

SUN

Sun Microsystems Inc., through its Java programming technology, offered a way for programmers to write products that worked on other operating systems in addition to Microsoft's Windows. The judge concluded that Microsoft moved to create a version of Java that remained tied to Windows and took other steps to slow Java's progress.

For example, it pressured Intel Corp. to stop aiding Sun in developing Java technology that would support advanced multimedia features, he found. The judge concluded that it isn't clear whether, without Microsoft's interference, Sun's Java efforts would have weakened Microsoft's Windows franchise. "What is clear, however, is that Microsoft has succeeded in greatly impeding Java's progress to that end with a series of actions whose sole purpose and effect were to do precisely that," he wrote.

IBM

International Business Machines Corp., originally an important Microsoft partner, by the early 1990s was both a big customer and competitor of Microsoft's. IBM needed Microsoft's Windows 95 to make its PCs, but it angered Microsoft by selling the OS/2 operating system and other products it would acquire in a June 1995 deal to buy Lotus Development Corp.

On July 20, 1995, three days after IBM announced plans to install some Lotus software on PCs it sold, Microsoft terminated negotiations for IBM to license Windows 95, stating that the reason was that it wanted first to resolve an ongoing audit of IBM's past royalty payments to Microsoft. The prospect of the delay could have crippled IBM PC sales during the crucial Christmas selling season.

"IBM executives pleaded with Microsoft to uncouple the license negotiations from the ongoing audit and offered Microsoft a $10 million bond that Microsoft could use to indemnify itself against any discrepancies that the audit might ultimately reveal," the judge wrote.

A Microsoft executive suggested during a meeting that IBM's obligation for a lump-sum payment of back royalties could be reduced if IBM offered a concession acceptable to Microsoft Chairman Bill Gates, such as agreeing not to bundle Lotus's SmartSuite with its PCs for a period of six months to one year.

IBM didn't go along with Microsoft's requests. Microsoft didn't grant IBM a license for Windows 95 "until 15 minutes before the start of Microsoft's official launch event on Aug. 24, 1995," the judge wrote. That day, IBM agreed to pay Microsoft $31 million for back royalties.

But IBM missed "substantial revenues" from the initial surge in demand for Windows 95-based computers and back-to-school purchases that year, the judge wrote. Because of IBM's software stance, the computer maker continued to pay substantially more for Windows than other rivals. "In sum, from 1994 to 1997 Microsoft consistently pressured IBM to reduce its support for software products that competed with Microsoft's offerings, and it used its monopoly power in the market for Intel-compatible PC operating systems to punish IBM for its refusal to cooperate," the judge wrote.

INTEL

Chip company Intel Corp., Microsoft's original partner in the personal-computer business, began developing software in the 1990s that became a bone of contention between the two companies.

One flash point was a technology called Native Signal Processing that Intel developed to stimulate the development of software that used the capabilities of its most advanced chips. Microsoft objected, in large part because programmers that adopted NSP could more easily convert their programs to non-Microsoft operating systems. "In short, Intel's NSP software bore the potential to weaken the barrier protecting Microsoft's monopoly power," the judge wrote.

Microsoft repeatedly complained to Intel officials and pressured PC makers not to accept NSP. Intel decided to withdraw the technology.

Later, at an Aug. 2, 1995, meeting between Mr. Gates and Intel Chief Executive Officer Andrew Grove, Mr. Gates broadly objected to Intel's software-development efforts.

"In fact, Gates said, Intel could not count on Microsoft to support Intel's next generation of microprocessors as long as Intel was developing platform-level software that competed with Windows. Intel's senior executives knew full well that Intel would have difficulty selling PC microprocessors if Microsoft stopped cooperating in making them compatible with Windows and if Microsoft stated to [PC makers] that it did not support Intel's chips," the judge wrote. "Faced with Gates' threat, Intel agreed to stop developing platform-level interfaces that might draw support away from interfaces exposed by Windows."

APPLE

Apple Computer Inc. sold an alternative to Windows-based PCs but also relied on Microsoft to develop software for the Apple Macintosh. The companies began arguing about an Apple multimedia technology called QuickTime that the computer maker wanted to market for the Macintosh and Windows, making it easier to write software that ran in both worlds.

Microsoft repeatedly, and unsuccessfully, tried to get Apple to drop that effort. "Because QuickTime is cross-platform middleware, Microsoft perceives it as a potential threat" to Windows, the judge wrote.

Another dispute arose when Apple balked at standardizing the shipment of Internet Explorer with the Macintosh. The judge found that Microsoft used the threat of withholding development of a Macintosh version of Microsoft Office to try to persuade Apple to adopt the Microsoft browser. After Steve Jobs resumed control of Apple, the two companies in August 1997 signed a broad deal that included Apple's endorsement of that browser, a patent cross-license agreement and a Microsoft investment in Apple.

Microsoft has argued that it needed a negotiating lever because Apple was trying to get Microsoft to pay a huge amount of patent royalties. But the judge concluded that Microsoft's Office threat was more directly linked to Microsoft's quest to hurt Netscape Navigator, and said Microsoft later continued to use the threat if Apple wavered from encouraging Internet Explorer use inside Apple. "Though the language of the agreement uses the word 'encourage,' I think that the spirit is that Apple should be using it everywhere and if they don't do it, then we can use Office as a club," one Microsoft executive wrote in February 1998.

COMPAQ

Compaq Computer Corp. had a closer relationship with Microsoft than IBM. But the big PC maker also irked Microsoft with a plan to ship some Presario PCs without the screen icons for Internet Explorer and MSN, Microsoft's online service.

Microsoft repeatedly protested this move as a violation of its licensing agreements. "Finally, after months of unsuccessful importunity, Microsoft sent Compaq a letter on May 31, 1996, stating its intention to terminate Compaq's license for Windows 95 if Compaq did not restore the MSN and Internet Explorer icons to their original positions," the judge wrote. "Compaq's executives opined that their firm could not continue in business for long without a license for Windows, so in June Compaq restored the MSN and IE icons to the Presario desktop."

The companies later ended their differences and signed one of the most favorable contracts between Microsoft and any PC maker (also known as an OEM, for original equipment maker).

"In return for Compaq's capitulation and revival of its commitment to support Microsoft's Internet strategy, Microsoft has guaranteed Compaq that the prices it pays for Windows will continue to be significantly lower than the prices paid by other OEMs. In addition to a guaranteed most-favorable price on Windows, Compaq has enjoyed free internal use of all Windows products for PCs since March 1998," the judge wrote.