Headed For Battle

By MICHAEL KRANTZ

It was a little ironic, and probably a pretty bad omen, that just as the three-day "cooling-off period" between Microsoft and the U.S. Justice Department reached its climax this weekend, the temperature in Washington soared into the 90s and the negotiators were driven out of their conference room in the 60-year-old main Justice building for lack of weekend air conditioning. They beat the heat in the offices of Microsoft's lawyers, Sullivan and Cromwell, but even there cooler heads did not prevail. In a matter of hours, the negotiations collapsed. "The government's theories for the personal computer industry," said Microsoft senior vice president William Neukom afterward in the company's combative official statement, "were not in the interest of PC users and would have set a bad precedent for other technology companies in the PC industry." The DOJ's terse statement merely noted that negotiations had "ended without resolution," and "at this point, the talks are not expected to resume." Except, that is, when they're conducted for keeps in front of a federal judge.

Until the final breakdown Saturday afternoon, it looked for a couple of days last week as if Bill Gates just might have found a way to slip out of this one relatively unscathed. Early Thursday morning, with only hours left before the press conference at which Attorney General Janet Reno and her antitrust chief Joel Klein were to announce one of the largest and most important antitrust cases in American history, Gates demonstrated the cold-blooded brinkmanship for which he is famous: with no time left on the clock, he suddenly made nice. O.K., he told Klein: Let's talk.

So with the future of the computer industry hanging in the balance, the launches of both Windows 98--and parallel antitrust suits by the Federal Government and some 20 states--were delayed until at least Monday to give the lawyers time to either find their way to common legal ground or determine that no such territory exists. By Saturday afternoon, though, it was clear that--probably by early Monday--Reno's press conference would almost surely be taking place after all.

At issue, of course, is the line between what Bill Gates can and cannot legally do with Windows, his de facto operating-system monopoly. Klein's team has spent the past year amassing what the DOJ clearly considers persuasive evidence that the software giant's behavior--from restrictive licensing arrangements with its so-called PC allies to me-only marketing deals with Internet service providers and websites--violates the venerable Sherman Act, the bedrock of U.S. antitrust law. Sherman, in essence, says it's O.K. to achieve a monopoly, but not to use one to wedge your way into other lines of business. Klein calls actions like the nasty one Microsoft is accused of taking against Compaq--threatening its largest PC partner with the revocation of its Windows license if Compaq chose Netscape's Web browser, Navigator, over Microsoft's competing Explorer--clear violations of the law. Gates and his supporters, by contrast, steadfastly insist (cue the Star-Spangled Banner sound track) that every deal they've ever struck is just another example of the company's ongoing effort to give the American consumer more and more "functionality" at lower and lower prices.

The fact that when push came to shove this spring, Gates suddenly started tossing out concessions like bonbons, however, tends to suggest that deep down he's known all along things aren't quite that simple. The past few weeks have been tough on Microsoft. Everyone from the DOJ to foreign governments to a growing band of state attorneys general stood ready to take the company to court. Its latest bumbling p.r. gambit--trotting out computer-industry execs like windup toys to halfheartedly raise the specter of widespread economic disaster should Win 98 be delayed, even for a matter of months--succeeded only in reinforcing the company's rep as a corporate bully. By the time the Microsoft CEO held his face-to-face sit-down with Klein two weeks ago, the DOJ team had already listened enough. "We were not prepared," says a testy Klein aide, "to hear another Bill Gates sermon."

But the antitrust chief also had plenty of incentive to cut a deal. With merger mania rampant in industries from banking to telecommunications, Klein had ample opportunity to prove his trust-busting mettle without taking on Microsoft in a long and costly battle that many legal scholars suspect he will have a tough time winning. Faced with the uneasy prospect of trying to prove consumer harm by a company that has helped make PCs better and cheaper, Klein must have held out at least faint hopes that Gates would renounce enough of his most egregious practices to let them both declare victory and go home. Unfortunately for all concerned (with the exception of Microsoft enemies like Netscape and Sun Microsystems, whose stock prices should rise with delight at their rival's newly bogged-down circumstance), the opposing parties' definitions of which practices were "egregious" and which remedies constituted "enough" turned out to be hopelessly divergent.

In the end it came down, unsurprisingly, to the browser. Microsoft's statement Saturday confirmed that Gates was willing to modify his licensing agreements with computer manufacturers to let them decide which products and services they could feature on their own machines. But Klein wasn't interested in settling for another minor pact reminiscent of his predecessor Anne Bingaman's infamous 1994 consent decree, now widely derided as a sellout that only postponed the day of reckoning. The deal, struck in 1994 and ratified in '95, granted Microsoft the right to sell "integrated" products--i.e., software like Windows that combines more functions than a Swiss Army knife. But the decree also prohibits the company from "tying"--forcing customers to buy any single product as a condition of licensing Windows itself.

The problems inherent in the wording of the consent decree became painfully apparent when Klein finally went after Gates last fall. For Klein, the intent of Microsoft's harsh licensing deals--its strong-arming of Compaq, for instance--was clearly to drive up the market share of Microsoft's Explorer at the expense of front runner Navigator's. Thus, he felt, those deals constituted tying. No, they don't, Gates shot back; Explorer is as much an integrated part of the operating system as type fonts or file-system managers. Months later, the battle is still being waged in appeals court; when a three-judge panel ruled last week that an injunction filed against Windows 95 does not apply to Win 98, Klein found himself backed into a corner. And so he struck.

As the antitrust chief sees it, the computer industry is at a historic turning point. Web browsers are indeed the on-ramp to cyberspace; letting Microsoft weave its browser software into the very fabric of Windows could leave the company with an uncomfortably firm grip on the unfathomable riches of the burgeoning world of online commerce. With a browser monopoly, Microsoft could give preferential treatment to services it owns or has contracts with. Anybody wanting to reach the largest number of Web surfers would have to pass through what analysts are starting to call the Microsoft tunnel.

But the browser is only the current example--albeit very attention getting--of the momentous legal principle that's at stake here. For beyond Explorer lies the endless stream of new technology products that will define the way we use tomorrow's computers--indeed, the way we live our very lives: voice and handwriting recognition. Banking and personal finance software. Real-time video and Internet television systems. Security and encryption programs. The Justice Department's view is that letting Microsoft integrate one new breakthrough after another into an OS that, at least for the foreseeable future, most of humanity will have little practical choice but to purchase will stifle innovation. It will leave no incentive for any new, and potentially better, competing products to enter the fray.

Klein's proposed solution appears to be aimed at separating Microsoft's operating system from its applications. In fact, the details of the talks that began emerging early Saturday evening made it clear Klein was looking for concessions that Microsoft was unlikely ever to grant. One demand, according to Microsoft, was that the company hide the Windows opening screen and let anyone in the software industry--except Microsoft--compete to offer a new one to PC makers. Another suggested that Microsoft either remove or turn off the Explorer browser that is even more thoroughly knit into Windows 98 than it was into Win 95. A third, according to Microsoft, was that the company include a copy of Navigator in every copy of Win 98 that it ships. "It would be a lot like asking Coca-Cola to ship three Pepsis with every six-pack," a Microsoft official fumed afterward.

Justice says these were just suggestions, not demands. Regardless, Bill Gates wanted no part of them. Right or wrong, Joel Klein's vision for Microsoft's future violates the principles upon which Gates' entire life's work has been based. If Justice and the states win what now appears to be their inevitable days in court, Microsoft will argue, the result would be a world in which federal judges determine which new software can be legally incorporated into new operating systems--highly technical issues at the heart of Microsoft's, and Silicon Valley's, business. What's more, the booming computer industry is hardly broke, yet the feds want the American people to believe that the time has come to step in and fix it.

Given the gap between these two perceptions of the industry's reality, the talks were probably doomed from the start. According to Justice negotiators, there was no "meaningful dialogue" between the two sides; in fact, Microsoft, which had opened the proceedings on Thursday by offering what were described as "major concessions," was backpedaling two days later. "The negotiations were a nonevent," a participant told TIME. "Any concessions were taken off the table in the first hour."

And so the case now goes to court, which, one suspects, was where Klein expected to end up all along. Bill Gates showed last week that he's too smart to cause storm clouds over relative trivia. But as anyone even remotely conversant with the Microsoft chairman's long and combative career well knows, he's also too tough to mortgage his company's future for blue skies today.

--Reported by David S. Jackson/Redmond, Declan McCullagh and Bruce van Voorst/Washington

With reporting by David S. Jackson/Redmond, Declan McCullagh and Bruce van Voorst/Washington