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Microsoft backs away from deals

While publicly defending its business practices, Microsoft is quietly backing away from some controversial Internet Explorer deals.

Repeatedly and adamantly, chief executive Bill Gates defended Microsoft's business practices and denied any wrongdoing in Senate testimony this week. Outside the political spotlight, however, his company is quietly backing away from some of the deals that drew much of the government's scrutiny in the first place.

In the months since the Justice Department first brought charges against it, Microsoft has begun dropping restrictions involving its Internet Explorer browser with computer makers, content companies, and Internet service providers. Some of these include contracts that have drawn the attention of Sen. Orrin Hatch (R-Utah), who has criticized Microsoft deals with such media giants as Disney and Time Warner, as well as national ISPs like EarthLink Network.

"It's a slow retreat for Microsoft to fall into a middle ground with the government," said George Koo, an analyst with Burnham Securities in New York. "They are backing down."

All of these deals were part of Microsoft's aggressive plan to promote Internet Explorer and take market share from Netscape Communications' Navigator, still the dominant Web browser but rapidly losing ground. The Justice Department has accused Microsoft of unfairly leveraging its Windows operating system dominance to foist its browser on business partners, and Hatch called Tuesday's Senate Judiciary Committee hearing to address concerns arising from the case.

Industry analysts and legal experts say the company's recent retreat from some of its contracts appears to be aimed at heading off any government regulation. In a worst-case scenario for Microsoft, the company could eventually be ordered to break up parts of its business, not unlike the divestiture of AT&T more than a decade ago.

"They're clearly making these changes because of government scrutiny but doing it in a way that doesn't add up to admitting they've been doing anything wrong," said antitrust attorney Rich Gray, a partner with Bergeson Eliopoulos Grady and Gray in San Jose, California.

The government continues to press its case against Microsoft and is strongly considering whether to broaden it to include Windows 98. The Justice Department has formally requested information from some of the company's IE partners, including EarthLink, America Online, MCI Communications, and CNET, which publishes NEWS.COM. This week, 27 state attorneys general joined the department's antitrust case.

Microsoft's position at Tuesday's hearings was a hard line: The investigation is threatening the company's ability to innovate, no one company could ever control access to the Internet, and it is no more of a monopolist than Sun Microsystems, whose network computers threaten the Windows operating systems.

However, analysts and lawyers argue, Microsoft's actions speak louder than its words. They point to some recent examples:

  • The company plans to drop its Active Channels bar in the next release of IE, according to a company source and remarks made Tuesday by Sen. Diane Feinstein (D-California). The bar is a gateway to content on the Web for IE users, similar to channels on a television set. Microsoft critics allege that deals between the content partners on the channel bar, such as Disney and Time Warner, give the software giant undue influence in the delivery of information on the Net--a charge that Microsoft vehemently denies. In testimony Tuesday, Gates said very few people actually had used the channel bar, which works with "push" technology. Microsoft confirms that it is considering dropping the bar but says it has no plans to change any contracts with channel partners.

  • Last Friday, Microsoft agreed to drop some of the requirements it imposes on U.S. Internet service providers in cross-promotional licensing deals. The changes will liberalize terms for advertising and promoting browsers other than IE, such as Navigator. These agreements also have drawn scrutiny from Hatch and other lawmakers, as well as the Justice Department. The changes are being made to make the contracts consistent with those of European ISPs, Microsoft said.

  • At year's end, Microsoft let a deal expire with Paramount Digital Entertainment that pointed to popular Web content from Star Trek and Entertainment Tonight on the software giant's free MSN site. Some of the content was available only through IE under the deal. Microsoft said Paramount chose IE because of its multimedia features and added that Navigator users could still enter the site, albeit it in a more limited way. Paramount has since struck a technology deal with IBM that does not require any specific browser.

  • In an agreement reached with the Justice Department in January, Microsoft said it would provide computer vendors immediately with the most up-to-date version of Windows 95 without the desktop icon for Internet Explorer. The agreement--part of a compromise in which the government withdrew contempt-of-court charges--cleared the way for computer manufacturers to offer a version of Windows 95 that does not have Microsoft's Web browser preinstalled.

    "It's smart on Microsoft's part to slowly become a little more flexible in their position," Koo said. "Hopefully there will be some sort of a [compromise] deal before a court decision."

    Gray agreed about the motive behind Microsoft's recent moves but was less certain that the plan would work. "The government is going to continue its investigation," he said.

    Microsoft executives, Gates included, say they are not reacting to any government pressure. They insist that decisions on any IE promotional deals are made on a case-by-case basis, based on customer feedback. They add that such contracts are routine--and routinely changed.

    "There's no basis for anyone to believe that these agreements are in any way anticompetitive," Microsoft spokesman Mark Murray said. "These kinds of decisions are primarily business decisions."

    He did, however, offer this observation: "If we also have the impact of addressing regulators' concerns at the same time, then so much the better."

    According to the language of one contract with Microsoft, some content partners must agree not to "directly or indirectly license or otherwise authorize distribution...of company content or logos by companies which produce other browsers."

    The contract, a copy of which was obtained by NEWS.COM, is standard and only applies to a limited amount of any company's Web content, said Brad Smith, Microsoft's assistant general counsel. But some critics worry that it is too restrictive, particularly as Microsoft moves to integrate its browser with Windows, the world's dominant operating system for PCs.

    Industry rivals and other critics reacted predictably to Microsoft's changes. "The fact that they backed out [of the ISP agreements] proves the point we've been making all along," Barksdale said at this week's Senate hearing.

    At a hearing last November, Hatch decried a co-marketing deal between Microsoft and EarthLink that he said blocked the ISP from telling some new subscribers that they could choose browsers other than IE. European regulators also had closely scrutinized the contracts.

    EarthLink, one of the ISPs affected by the change, declined comment.

    Microsoft's Smith said the decision to change the ISP agreements has nothing to do with the current government inquiries. Gates too reiterated Monday that the changes were "based on a business review" rather than an effort to curb the investigations.

    Hatch, who had criticized the ISP deals, praised Microsoft's decision to amend the contracts. "Senator Hatch is pleased that Microsoft--after ongoing discussions with the Judiciary Committee--has agreed to remove provisions of licenses with ISPs that have the effect of excluding alternative browsers," committee spokeswoman Jeanne Lopatto said. "We view this as a positive development."

    Even so, analysts say, such concessions do not necessarily indicate that Microsoft will abandon core parts of its business strategy. "My guess is that Microsoft is not going to make the kinds of concessions that the Justice Department wants it to make," said David Vellante, an analyst with International Data Corporation.

    One key issue Microsoft will fight to defend is integration of the browser and the operating system--a melding of technologies that opponents say gives the company an unfair market advantage.

    "My sense from the body language and hyperbole of the hearings is that Microsoft believes that, if it loses on the integration issue, it is losing the OS," Vellante said. "Microsoft is rightly concerned about that. Imagine having the launch of new products subject to government inspection."