Microsoft's long-playing business record

Have courtroom battles become just another business expense for the software giant?

John Borland
John Borland Staff Writer, CNET News.com
John Borland
covers the intersection of digital entertainment and broadband.
8 min read
The antitrust investigation into Microsoft's activities lasted nearly half a decade, but by the time regulators finally came to a landmark conclusion, Microsoft had already established its position and the rival product was all but defunct.

The European Union's ruling against Microsoft last month? Or was that the outcome to the case involving Netscape? Neither: Try Novell's suit over the DR-DOS operating system in 1994, which followed four years of investigation by the Federal Trade Commission and Department of Justice. Since that first serious brush with regulators, Microsoft has been perpetually in and out of court, accruing fines and settlement payments in the billions of dollars.

Losing or settling case after case, Microsoft has tested the bounds of antitrust and patent infringement law, with little evidence that its power has waned or that its behavior has been substantially changed. Rivals and many legal experts say antitrust law itself has come out the worse for the skirmishes, while Microsoft appears to have built the ongoing scrutiny, fines and remedies into a strategy showing scant sign of reform. Even last month's tough stance by the European Commission may not be able to slow the giant.


What's new:
Losing or settling case after case, Microsoft has tested the bounds of antitrust and patent infringement law, with little evidence that its power has waned or that its behavior has been substantially changed.

Bottom line:
Microsoft appears to have built the ongoing scrutiny, fines and remedies into a strategy showing scant sign of reform. Even last month's tough stance by the European Commission may not be able to slow the company as it heads for additional showdowns with new adversaries.

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"I can't see how (the courts) have learned," said Marc Schildkraut, an antitrust attorney at Howrey & Simon in Washington, D.C., who led the FTC's early 1990s investigation of Microsoft's business practices. "They're confronting problems (on a case-by-case basis) that they haven't been able to solve in any meaningful way."

A decade of investigations and lawsuits involving Microsoft's business practices has outlined a pattern of high-pressure business deals and unceasing expansionary aims. The company's core strategy has been to make its OS--MS-DOS, then Windows--as ubiquitous as possible, while continually adding features that often started off as separate products developed outside Microsoft. In some cases, rivals have charged abuse of market, while others have claimed Microsoft has infringed on their patented technology without payments.

For years, the company has settled most of these complaints, while staunchly defending its right to add new features to its products. In 2003, the price tag for these court actions skyrocketed close to $2 billion. The agreement with Sun Microsystems earlier this month added another $1.6 billion ($700 million to settle antitrust claims and $900 million over patent claims). And Monday's settlement with InterTrust over patent infringement charges tacked on $440 million.

None of this has appeared to be a significant financial drain on a company with more than $52 billion in cash and short-term investments. Some experts say the costs have simply become a part of doing business for the company.

"If you incur a fine of a billion dollars, but it protects that monopoly, that might be worth it from a pure dollars-and-cents perspective," said Carl Shapiro, a professor at the University of California Berkeley's Haas School of Business, who once testified for the Justice Department in its case against Microsoft. "What's the Windows franchise worth?"

So far, shareholders have been mute, but the stock has traded in a tight range as Microsoft continues to write one nine-digit check after another. The company's shares now trade at about $25, essentially unchanged from a year ago. Meanwhile, the Nasdaq has climbed about 40 percent in 12 months, though the Nasdaq tumbled much further during the tech bust than Microsoft did.

"If you incur a fine of a billion dollars, but it protects that monopoly, that might be worth it."
--Carl Shapiro, UC Berkeley

A Microsoft spokesman said the company has changed its behavior, particularly after the settlement with the U.S. government, however. The company has since instituted extensive training and a legal review process before new products are released, the spokesman said.

"I think throughout (the company's life), we have worked very hard to conduct ourselves in a way that is fully compliant with all laws and regulations," Microsoft spokesman Jim Desler said.

But what exactly is compliance? In a recent interview with CNET News.com, Microsoft CEO Steve Ballmer explained that the consent decree with the Department of Justice "says we can do, from a product design standpoint, most anything we think is appropriate. But we have to do it with certain obligations for flexibility, publishing, etc. Between the district court and the appellate court, there is some notion of what they call a 'rule of reason'--that is, what we are doing has to be better for consumers than it is bad for competitors."

Asked whether the "rule of reason" test would have prevented Microsoft from bundling the browser, the issue at the heart of the Justice Department's antitrust lawsuit, Ballmer was adamant: "I would still integrate a browser. We would still integrate the Media Player...Nobody ever said the browser did not meet the rule-of-reason test. It absolutely met the rule-of-reason test to go in."

While Ballmer is correct that no court ever said the browser bundling failed the rule-of-reason test, it must be noted that no court has ever had the opportunity to weigh the issue. In dismissing the original verdict against Microsoft, the U.S. Court of Appeals ruled that the lower court had misjudged antitrust law, and that the so-called rule of reason should be applied to Microsoft's efforts to bundle the browser with Windows.

However, the Department of Justice soon afterward dropped the portion of the case dealing with "tying" the browser. Thus, that test of reason was never applied in the courtroom.

Adding features, building 'moats'
In a 1997 e-mail to investor Warren Buffett, senior Microsoft executive Jeff Raikes summarized the company's strategy in simple terms. The operating system is the core business, and others are "moats" that protect it, he wrote. The Office software, the Web businesses, and other feature additions served as layers of protection for the company's core product, as well as potential profit centers, he said.

"If we own the key 'franchises' built on top of the operating system, we dramatically widen the 'moat' that protects the operating system business," Raikes wrote. "If I owned the most successful daily newspaper in Buffalo, I wouldn't want to leave it to my competitor to own the Sunday edition."

Microsoft's recent statements have made it clear that it is set on continuing to widen those moats via other features and businesses, despite the growing pressure of fines and judgments. Here are a few examples of what Microsoft now refers to as "integrated innovation" that could become fodder for future court skirmishes:

•  Search--In a widely covered recent speech, CEO Steve Ballmer conceded that the company was late to recognizing the importance of Internet and data searching. He reiterated earlier statements that Microsoft is building its own new search engine to be added into the next version of Windows, bringing it in close competition with current leaders Google and Yahoo.

•  Gaming--The company continues to subsidize heavy losses on the Xbox game console, while trying to catch up to leader Sony. Microsoft recently released new tools that would let game developers streamline an increasingly expensive production process by using the same components for PC and Xbox games.

•  Mobile phones--The company has tried with little success for a decade to move into the mobile phone OS business. But recent product releases from Motorola and AT&T have some worried that the company is finally gaining traction, aided by the high-powered phones' ability to tap into corporate Outlook e-mail servers.

Microsoft has argued consistently in court that it must add new features to its products simply by virtue of being in the fast-paced software business. If the company doesn't consistently innovate, it will be out of business itself, its executives say publicly and in the internal e-mails that have come to light in the course of various trials.

In response, several respected economists have argued in articles and books that Microsoft's dominance in succeeding markets has come because it creates high-quality products that consumers choose in the marketplace.

Indeed, many close observers say the company's developers do not have antitrust on their minds when they're trying to improve their products.

"I can tell you with 100 percent certainty that when managers are deciding what features to put inside products, they are not considering antitrust issues unless it is in a very narrow area covered by the DOJ settlement," said Matt Rosoff, an analyst with Directions on Microsoft, a research firm that closely covers the company.

Has the EU really changed anything?
Some believe that the European Union decision last month, if upheld, will be the first one to put serious constraints on Microsoft's actions in these new areas.

In contrast to the U.S. Appeals Court, which set rules for analyzing Microsoft's bundling but did not issue a final opinion on its legality, the Europeans said they thought Microsoft's addition of Media Player to the operating system had clearly crossed a line. They ordered a version of Windows to be produced without it. This doesn't directly affect future products, but some believe it will serve as enough of a precedent that Microsoft will be more careful.

Some believe the European antitrust ruling will make Microsoft more careful.

"This will make them have to think harder about when and how they bundle," said Bob Kimball, general counsel for multimedia software company RealNetworks, which is suing Microsoft for $1 billion on its own antitrust charge. "It will make regulators quicker to go after them for future bundling activity."

Others aren't so sure. According to statements from Ballmer and European Competition Commissioner Mario Monti, settlement talks failed over issues dealing with future products. Had that settlement been struck, a process might have been put in place to deal quickly with future complaints about bundled products.

"They wanted to go beyond the specific issues in this case to try to create a precedent that would govern our ability to include new features into future versions of Windows," Ballmer wrote in a March 18 e-mail to employees. "While this is not the outcome we wanted, it is an outcome that I am confident will ultimately work out for the best."

Ballmer's "best" could mean that future issues will also have to be independently investigated and litigated, a process that often has taken a half-decade or more. That has typically given Microsoft enough time to solidly establish itself in the new markets, often with lethal effect on competitors, some observers say.

"In the case of Standard Oil or the rail industry, those markets developed over decades," Berkeley's Shapiro said. "But what can happen in two or three years in the software industry is much more significant in terms of market structure and irreversibility than was the case with oil in 1895."

"Government is really not equipped to regulate in such a fast-moving industry as technology," Rosoff added. "That's why the most aggressive antitrust commentators originally pressed for the breakup of the company."

CNET News.com's Ina Fried and Scott Ard contributed to this report.