Microsoft Ordered Split

In the end, the seemingly irresistible force ran smack into an immovable object. The force: Bill Gates, chairman of Microsoft Corp. and über-geek, defiant to the end, denouncing the "unwarranted and unjustified intrusion" into the company he built into a cathedral of software expertise. The object: Thomas Penfield Jackson, U.S. federal judge and conservative Republican, issuing the judicial equivalent of an uppercut to the jaw. Microsoft, he declared, is an "untrustworthy" monopoly that deserves the ultimate penalty - to be split in two and forced to comply with a host of restrictions on its aggressive business practices.

The breakup may never happen. Months - perhaps years - of legal appeals remain to further enrich lawyers on both sides. But even as Gates himself was vowing to fight on and calling Jackson's ruling "the first day of the rest of this case," it was clear that Microsoft had already been humbled - in large part as a result of its own actions. Once the unchallenged ruler of its domain, it is no longer the most valuable company in history. Investors have beaten down its stock by 40 per cent in just a little over five months (it closed last week at $68.81). Newly emboldened competitors are circling, taking advantage of market opportunities that Microsoft has been slow to exploit. Computer makers who once feared its wrath are striking deals with upstart rivals. Many young software wizards shun it as a dinosaur. And its own attempt to leap from the age of the desktop PC to the new frontier of the Internet is under a serious cloud. In short, a lousy week.

How did it come to this? By last week, Jackson's final order in an anti-monopoly suit that lasted just over two years came as no surprise. In two earlier rulings, on matters of fact and matters of law, he had laid out his view that Microsoft had violated 110-year-old U.S. antitrust laws by using its near-monopoly in personal computer operating systems to bully competitors. In fact, Jackson's findings were so close to the allegations put forward by the U.S. justice department that it was widely predicted he would also adopt the government's suggested remedies: dividing Microsoft into two separate companies and imposing so-called rules of conduct to prevent it from abusing its power before the breakup is completed.

But though the penalty was not unexpected, neither was it unavoidable. What began as the main issue in the trial - the battle between Microsoft and Netscape Communications Corp. to dominate the market for Internet browser software - was irrelevant by the end. Netscape was vanquished by Microsoft, then bought out by America Online Inc. Microsoft, say many analysts who have followed the case, could have compromised early by agreeing to separate its Internet Explorer browser from its Windows operating system, and avoided Jackson's penalty. But Gates and other senior Microsoft executives dug in, insisted they had done nothing wrong - and lost decisively. As far back as 1995, when the government was still just investigating Microsoft's business practices, Gates blithely proclaimed that "this antitrust thing will blow over."

But as the investigation turned into a formal charge and trial, the company steadfastly maintained its innocence and insisted that the government was trying to apply 19th-century law to an industry it did not understand. The eventual result: a judicial Waterloo for Microsoft. "Separating the browser and the operating system would have done them no damage at all," says Rob Enderle, an analyst with Giga Information Group Inc. in San Jose, Calif. "They could have accepted a parking ticket. But they came out with the death penalty."

Not quite death, and not just yet. Microsoft said it will appeal Jackson's verdict, and immediately moved to suspend the restrictive rules of conduct imposed on it while its appeals are heard. The justice department indicated that it wants the case to go directly to the U.S. Supreme Court, a move allowed in some important antitrust cases. But Microsoft would prefer that it proceed to the federal appeals court for the District of Columbia, where it has won favourable rulings in the past. Either way, the case will drag on for at least another year, possibly two - and by then the political climate in Washington could be quite different. Republican George W. Bush has voiced doubts about the wisdom of the government's case against Microsoft. If he wins the White House in November, his appointees at the justice department would likely not press the case so hard. "With a Bush administration you could see a settlement offer on terms that Microsoft might find congenial," says Robert Levy, senior fellow at the Cato Institute, a Washington think-tank.

Splitting the company, if it comes to that, would be a monumental task. Previous landmark antitrust cases that led to breaking up big monopolies - notably Standard Oil in 1911 and AT&T in 1984 - involved companies that could be divided largely along geographical lines. Microsoft, with 90 per cent of its work done at its headquarters in Redmond, Wash., does not lend itself easily to such a division. But Jackson followed the government's recommendation that Microsoft be split into two new firms.

One, dubbed Ops Co. in government documents, would produce the Windows operating system and Windows-related systems for hand-held computing devices. The other, dubbed Apps Co., would be responsible for all other Microsoft products, notably its highly successful applications such as Word, Excel, Outlook and PowerPoint, as well as its Explorer browser. Executives of both new companies would be forbidden from working for or owning shares in the other; neither new company could cut special deals with the other for the 10-year life of Jackson's order.

At the same time, if the judge's ruling is carried out, Microsoft will have to abide by a host of so-called conduct remedies designed to prevent it from imposing its will illegally on other companies. Jackson ordered it to stop discriminating against computer makers who support rival products. It must charge basically the same price for Windows to all customers, instead of cutting special deals for manufacturers who agree not to install other operating systems on their computers. It must allow PC makers to remove applications like browsers and e-mail programs from Windows, disclose technical information that would allow other companies' products to work with Windows, and allow PC makers who install Windows to modify the start-up sequence and desktop in order to remove Microsoft icons and other features. Those measures are aimed at stopping Microsoft from turning the dominance of Windows into a lock on other applications - as Jackson ruled that it did in the past.

Already, that dominance is starting to crumble, in part because of the lawsuit. Major PC suppliers such as Compaq and Gateway, which once installed only Microsoft products, have signed deals to produce computers that run on the upstart Linux system. That will provide more choice for consumers - though perhaps at the cost of balkanizing standards and making it harder for computers to communicate with each other. More importantly, Microsoft has failed to extend its dominance from the world of desktop PCs to fast-emerging Internet-based systems, such as hand-held computing devices like the Palm personal organizers and its rivals, wireless e-mail, and so-called hosted software that is accessed over the Internet rather than bought on CDs and loaded into computers.

Microsoft hopes to enter that exploding market in a major way with its Next Generation Windows Services, or NGWS. It was set to announce the project at a splashy ceremony on June 1, but postponed it because of Jackson's impending ruling. The launch is now set for June 22, but it will inevitably be overshadowed by legal issues. NGWS is expected to be a far-reaching Internet strategy that would connect a wide range of devices, from PCs to home appliances. Few details are publicly known, but it may even further blur the distinction between operating systems and applications - the very thing that Jackson's ruling opposes. As a result, says Enderle of Giga Information Group, NGWS "will be stillborn. I don't see how they can execute it with this cloud over them."

Another concern is that Microsoft may suffer a significant brain drain as its legal woes continue and its market dominance erodes. If the company is finally split, say analysts, the most creative and ambitious executives and software developers might well abandon the operating system firm for the new Apps Co., which would have more potential for innovation. Others might quit the Microsoft empire altogether. In fact, the company finds it increasingly difficult to attract the brightest young talent. "There's already a hardening of the arteries there," says Dwight Davis, who tracks Microsoft for Summit Strategies Inc. in Kirkland, Wash., near Redmond. "It's just not as exciting a place to work for those who want to be at the forefront of innovation. The youngest generation of software developers see it a bit like Bill Gates once viewed IBM - the dinosaur of the industry." And that, for a man who views himself as a revolutionary, may be the unkindest cut of all.

Ops and Apps

Judge Jackson ordered that Microsoft be broken into two separate companies-one devoted to its operating systems software and the other handling the rest of the firm's activities, especially its applications business.

A Pitched Battle

May, 1995: Bill Gates sends "right-hand turn" memo, informing top executives the company's priority is the Internet.

September, 1997: Microsoft releases its Internet browser, Explorer 4.0, to compete with Netscape's Navigator.

May, 1998: Justice department and 20 states (later 19) file two antitrust suits against Microsoft.

October, 1998: Federal District Court Judge Thomas Penfield Jackson begins hearing antitrust trial in Washington.

November, 1999: Jackson rules in a preliminary finding that Microsoft harmed consumers by exploiting its dominance in operating systems to limit competition.

April, 2000: Jackson finds that Microsoft violated antitrust laws.

June, 2000: Jackson orders that Microsoft be broken into two separate units.

Maclean's June 19, 2000

Ops Co.

Windows operating systems.

Apps Co.

Microsoft Word, Internet Explorer, Outlook Express, MSN.com, Expedia travel Web site.