Microsoft Uncut

By ADAM COHEN

The long-running tech soap opera that is United States v. Microsoft had slogged along for much of the summer without a major twist, so it was fine timing when the Justice Department jumped in last week and moved the plot along. The newest twist: the government announced it is abandoning its long-held goal of breaking Microsoft up into smaller companies.

As declarations not to do something go, this was a significant one. Justice took off the table the one possible remedy that Microsoft has most bitterly opposed. Just as important, it provided some tantalizing clues to the key question that has hovered over the case all year: What will the Bush Administration do with this high-profile case left over from the Clinton era?

The answer was a clear one, for the shift in strategy was actually a twofer for Microsoft. At the same time as its no-breakup announcement, the department said it would similarly not pursue the suit's "tying" claim, that Microsoft had illegally leveraged its monopoly by bundling its Internet browser in Windows. The two moves could be read as confirmation that the Bush Justice Department won't be as aggressive on antitrust matters as its Democratic predecessors.

Adding weight to that theory: the curious timing. The putative explanation for the government's thinking is that, with the case due for an in-court status hearing this week, Justice wanted to give Microsoft an idea of what would be on and off the table. But after that hearing, the case is headed into settlement talks, and it's Negotiation 101 to hold onto all your bargaining chips until you get to the table. Why abandon, in exchange for nothing at all, the one scenario Microsoft fears the most?

Microsoft's critics are grumbling that politics and payola may have played a role. They point to the company's newfound interest in campaign finance, notably the $2.5 million Microsoft contributed to President Bush and the Republicans in the 2000 election cycle. The Bush Administration took the unusual step of letting it be known that it is not second-guessing the judgment of Charles James, the recently appointed head of the Justice Department's antitrust division. (In a Senate hearing last week, Justice also disputed charges that it was politically motivated in its attempts to settle the $20 billion lawsuit against the tobacco industry, another big Republican contributor.) Microsoft spokesman Vivek Varma called the charges unfair and pointed out that competitors such as Sun Microsystems and Oracle, which have cheered Justice on, are also big political contributors.

Justice, for its part, insists it is fully committed to pursuing Microsoft, which, after all, even a Republican-dominated federal appeals court has now branded a monopolist. The department gave up on the breakup and the tying claim, it said in a statement, "to streamline the case with the goal of securing an effective remedy as quickly as possible." In fact, both of the now abandoned issues would have required the production of piles of evidence, followed by lengthy hearings. Adding credibility to Justice's explanation are the 18 state attorneys general, parties to the suit, who followed the Federal Government's lead and agreed to drop the two claims. The state A.G.s have long taken a harder anti-Microsoft line than Justice, and it's unlikely they would have signed on if they had thought doing so would significantly weaken the case.

Microsoft, which has been quick in the past to hail even mixed court decisions as victories, was uncharacteristically tight-lipped last week. "We remain committed to resolving the remaining issues in the case as quickly as possible," says Varma. Several state A.G.s, including Eliot Spitzer of New York and Tom Miller of Iowa, made it clear late last week that they would pursue the case separately from Justice if they believe the feds are going too easy on Microsoft in the settlement phase.

Justice, the state A.G.s and Microsoft will meet in the coming weeks and months for settlement talks. This week the parties plan to submit a joint game plan to Judge Colleen Kollar-Kotelly, who takes over from Thomas Penfield Jackson, the judge who ordered Microsoft to be broken up and was then removed from the case for improperly talking to reporters. Kollar-Kotelly, who has a reputation for brisk efficiency, will probably encourage the parties to hammer out an agreement.

With "structural" remedies like breakup off the table, the focus will shift to "conduct" remedies--agreed-upon rules designed to prevent Microsoft from using its monopoly over the desktop operating system in an anticompetitive manner. Justice said last week its starting point in developing these rules will be the interim conduct provisions handed down previously by Judge Jackson.

If those interim rules are a guide, any consent decree Justice works out with Microsoft will seek to change how the company leverages its Windows monopoly when it deals with other companies. Microsoft will probably be prevented from bullying other companies, as it was found to have done at trial, into using its products or not manufacturing competing products. And it could prevent Microsoft from forcing computer manufacturers to include Microsoft applications like instant messaging and media players as a condition for loading Windows on their machines.

Those applications--so-called middleware--will probably be the crux of any settlement. Microsoft is planning to use its new Windows XP software to promote its Windows Media Player, Windows Messenger and MSN Internet Service. The company's critics fear that Microsoft will use its Windows monopoly to create new middleware monopolies, much as Microsoft's Internet Explorer--which was bundled in the last version of Windows--took the browser market away from onetime leader Netscape.

In July Microsoft said it would allow computer makers leeway in deciding which icons to put on the Windows desktops of PCs they sold. But when Compaq announced that it would put AOL on its PC desktops, Microsoft decided that manufacturers that added any outside icons also had to add MSN, Internet Explorer and Microsoft Media Player icons. (AOL, Netscape and TIME are all part of AOL Time Warner.)

One critical unanswered question is what last week's decision means for the launch of XP, scheduled for Oct. 25. The government, or even private competitors, could seek an injunction preventing XP from being shipped in its current form, on the grounds that it is illegally anticompetitive. Although Justice could still try to do that, the emphasis on negotiations in its statement makes such action appear unlikely. If settlement talks break down, seeking a court order halting XP--or altering it after it shipped--would remain an option.

Trying to break up Microsoft was always an uphill battle--it's an extreme remedy under antitrust law. But dividing a company has the practical advantage of being self-enforcing. "One of the pluses of a split is that it is far less intrusive in the long run than a long consent decree," says Salil Mehra, a Temple University law professor and former antitrust-division lawyer. Two newly created Baby Bills would have had an economic incentive to act competitively, meaning that the market would guard against future monopolistic activity. Conduct remedies, by contrast, require a court to monitor the offender's actions for prolonged periods to ensure that they do not lapse into illegal activity.

Which is just what Microsoft's critics are worried will happen. This case started when the government took Microsoft to court in 1997 for violating a prior consent decree. Some in the tech industry say this is what Microsoft will probably do again. "The government made a decision a year ago that it needed a structural remedy," says Edward Black, CEO of the Computer & Communications Industry Association and an outspoken Microsoft critic. "If anything, Microsoft's market dominance has only gotten worse since then."

Anxieties that Microsoft may not be in a penitent frame of mind emerged last month when Microsoft CEO Steve Ballmer insisted at a press conference in Brazil that Microsoft had plenty of competition in the software business. Seeming to ignore the findings of a federal district court and a unanimous appeals court in this case, Ballmer told reporters, "I don't know what a monopoly is until somebody tells me."

Supporters of the antitrust lawsuit are worried that last week's announcement by Justice may be only the first shoe to drop. The next, they fear, could be a fuller capitulation, with the government settling the suit on terms that will let Microsoft continue to abuse its monopoly position. But Justice insists it's just trying to balance morality and mortality. "We hope," a top official said last week, "to bring the Microsoft case to a resolution in all of our lifetimes."