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Leave it be? Regulate it? Break it up? Soon, the U.S. will have to make the call

America's high-tech industry is the economic success story of the 1990s. Accounting for some 30% of the increase in gross domestic product since 1994, the explosive growth of the country's software and computer companies has enabled the U.S. to regain its supremacy in the global marketplace. Not since the heyday of the railroads in the 1800s has prosperity been tied so closely to one sector of the economy.

The engine inside this economic steamroller is Microsoft Corp., which provides the operating system for virtually all personal computers, along with the leading applications and many of the top programming tools. With a single company setting key software standards, businesses and consumers are able to buy software and hardware without worrying about compatibility. And the computer industry has mushroomed into a $700 billion business.

But few have grown as much as Microsoft. In 1997, Microsoft's $3.4 billion in net income accounted for 41% of the profits of the 10 largest publicly traded software companies, by BUSINESS WEEK's calculation. Now, Microsoft, with its $10 billion cash pile and 25,700 employees, is reaching beyond the PC into new markets--everything from computerized toys and TV set-top boxes to selling cars and airline tickets over the Internet.

The sheer pervasiveness of Microsoft in an increasingly digital world raises profound questions: Should a single company exercise so much economic power? And what should the government do, if anything?

These may well be the most critical economic-policy decisions facing the U.S. today. And they are coming to a head. Later this month, Microsoft is expected to launch its publicity blitz for Windows 98--a new version of its operating system. This product release is a lightning rod from an antitrust viewpoint, since it integrates an Internet browser, a new product, into Windows--an existing monopoly. Any day now, the Justice Dept. is expected to head that off by trying to force Microsoft to provide an alternative version of Windows without the browser. In the face of imminent government action, Microsoft legal executives are meeting with Klein and his deputies on Apr. 10 in Washington to get a clear picture of the government's concerns and see if they can address them, insiders say.

As part of its suit, Justice could also aim at curbing a wide range of allegedly anticompetitive practices, including exclusionary contracts and Microsoft's control of the opening screen. And trustbusters are marshalling forces for a possible second suit, which could be filed during the next several months, that could focus on some of the company's stakeholds in video technology, Apple Computer Inc., and other businesses.

TOUGH QUESTIONS. For Microsoft's part, executives deny any wrongdoing and say that government interference will hurt not only their company but the entire industry. Microsoft Chairman William H. Gates III explains it this way: ''The software industry's success has not been driven by government regulation, but by freedom and the basic human desire to learn, to innovate and excel.''

The stakes are enormous: Any government action runs the risk of hobbling the most dynamic sector of the economy. And even though Justice's antitrust staffers have been quizzing industry executives in recent days on suitable remedies, they have received no clear-cut answers.

So BUSINESS WEEK has assembled a package examining three alternative strategies. The first piece analyzes the argument for leaving Microsoft alone (page 115). The second focuses on regulatory solutions, in which the trustbusters restrict Microsoft's behavior to give rivals a better chance at surviving (page 118). And the third explores the possibility, however unlikely, that Justice could break Microsoft up into two companies (page 122). While Justice insiders say such a radical move is not under serious consideration, it is a remedy suggested by some computer executives and economists, and so deserves a hearing.

These three approaches represent the main strands of U.S. antitrust policy. Since its inception more than 100 years ago, that policy has swung between relying on market forces, policing conduct, or trying to make major structural changes to ensure competition.

Certainly, there's strong sentiment for leaving Microsoft alone. The supporters of a do-nothing policy believe that the software industry naturally coalesces around a single standard, so that artificially creating competition in PC operating systems and related software would be inefficient. What's more, the presumption is that market pressures and the threat of new technologies will keep Microsoft from taking advantage of its position.

But the idea of letting the market operate unchecked has not proved acceptable to the Justice Dept. Rather, it has chosen the middle ground--trying to regulate Microsoft's business practices. In 1995, it won a consent decree that prohibited certain licensing practices for Windows 95 as well as tying the sale of one product to another. Still, focusing solely on conduct remedies could be problematic: Most of these options would mean intrusive government oversight.

There is precedent for a third option: breaking up Microsoft. Worries about dominant companies exercising too much power have been part of antitrust policy from its beginning through the breakup of Standard Oil in 1911 up to the split of AT&T in the early 1980s. Now, the long reach of Microsoft has brought the same sentiments back to life. ''Ultimately, society can't stand that kind of concentration of power,'' says Robert Ingle, president of Knight-Ridder New Media, which competes against Microsoft's news and local entertainment Web sites.

DEJA VU. It's not just populism, though, that motivates regulators. Even if Microsoft has been playing by the rules, its dominant position could prove harmful to the economy. Consider innovation. Microsoft has done an excellent job of improving its product line over time--what Harvard business school professor Clayton M. Christensen calls ''sustaining innovations.'' But many of those improvements came after rivals pointed the way--Apple Computer Inc.'s graphical user interface, for example. That's because large companies, by nature, are unlikely to encourage ''disruptive'' innovation--entirely fresh approaches that could kill off current technology.

Oddly enough, Microsoft itself in some ways was the child of antitrust. The government's 13-year attempt to break up IBM, though it failed, profoundly affected Big Blue's behavior. Deals with companies such as Microsoft were done without taking an equity stake. ''We didn't want to look like we were stepping on the small guy,'' says an IBM insider. And no one can argue that the outcome was bad: We wound up with the most vibrant high-tech industry in the world.

So what's the right thing to do? Read on, and judge for yourself.

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Updated Apr. 9, 1998 by bwwebmaster
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