Moments after a federal appeals court issued its long-awaited decision in the Microsoft (MSFT) antitrust case on June 28, CEO Steven A. Ballmer declared victory. "The sun was definitely shining in Seattle," he gloated.
Maybe so, but Microsoft ought to keep an umbrella handy. True, the court tossed out Judge Thomas P. Jackson's breakup order. But it also dealt the company a serious blow: In a unanimous decision, seven judges held that Microsoft Corp. does not have an automatic right to put whatever features it wants into its Windows operating system. To the contrary, the court ruled that the software giant's decision to add Internet-browsing technology into Windows violated at least one, and possibly two, provisions of the Sherman Antitrust Act.
Rather than let Microsoft off the hook, the decision could pose a huge obstacle for the software giant. Extending Windows to every computer, Net appliance, phone, and TV is the company's core strategy. Indeed, the next version of the operating system, Windows XP, contains several new features that used to be separate products, including a media player and instant messaging. Now, because of the appellate court, Microsoft's whole "embrace-and-extend" philosophy is in jeopardy.
A crucial legal question is suddenly hanging over the company: When is it O.K. to add new features to Windows? This issue has become one of the most important technology-policy debates in decades. The answer will determine not only the company's fortunes but also will have an enormous impact on the rest of the technology industry--and ultimately on everyone who uses a computer. At its heart is the decades-old question of whether a monopoly in technology helps or hinders innovation. On one hand, the Windows monopoly has created a standard the rest of the industry has rallied around to create products that work well together. On the other, Microsoft has grown so powerful that it has expanded into new markets, gobbling up rival technologies and possibly smothering potential innovations.
Unfortunately, the Court of Appeals punted. Rather than issuing a clearly defined set of rules for when Microsoft can add new features to Windows, the court said that each new instance of bundling needs to be evaluated separately. The test the judges are applying: whether the integration will help or hurt consumers. That's a fine idea, but it leaves the company, the tech industry, and consumers in the air. Essentially, the judges have said that the company's ability to add new features to Windows will depend on a cost-benefit test. But they fell short of providing any guidelines for weighing the costs and benefits.
The court's incomplete ruling has left the industry in need of a road map. Because most consumers want an operating system to have the latest features, Microsoft should have broad leeway to include new code. But Microsoft broke the law. So when it does add features, there should be a strict set of rules to ensure that rival software makers have a fair shot at success. At times, that could mean that new technologies won't be allowed in Windows. A Special Master, deputized by a federal judge, could be in charge of making tough calls about what code gets excluded from the operating system.
No doubt, this would be an ugly, cumbersome system. There would be a judge constantly looking over the shoulders of Ballmer and Chairman William H. Gates III, much as Judge Harold H. Greene supervised AT&T (T) for years. Critical technology decisions could be slowed while lawyers get rich. But if you worry about the consequences of such an aggressive company owning a crucial piece of the information economy--yet think breakup is too harsh--it's the only option. And given that breakup is probably out of the question, it is the direction trustbusters are likely to take, either in negotiations or in court. "We think any settlement that doesn't involve fundamental change would be doomed to failure," says Connecticut Attorney General Richard Blumenthal. Some thoughts on how to make this cost-benefit calculation:
SOME THINGS DON'T BELONG IN THE OPERATING SYSTEM. Judge Jackson, the man who heard the Microsoft trial, was wrong about many things. But he got one key point right: It's not good for the world if Microsoft bundles too many products into Windows. Software integration can sometimes be a predatory weapon that kills rivals. "With bundling, at what point does that become a euphemism for eliminating consumer choice?" asks Peter Thiel, chairman of PayPal, an e-mail payment service that competes with Microsoft partner Citigroup (C).
What code should be integrated into Windows? Let's first consider what an operating system does. Think of it as a conductor orchestrating the innards of the PC. It controls communication between hardware and software, shuttling around data about how much memory is left, how much disk space is available, and when the printer should zap out a page. The rule for deciding if a feature should go in Windows is whether it improves the computer's overall functioning and is shared by several programs. In effect, Windows would become a common carrier, comparable to a phone network.
This standard would allow the bundling of a wide variety of new features. One example is the audio and video capabilities in media players, which will be wrapped into Windows XP. Another is voice-recognition software. These features are fundamental building blocks that are used by other programs, such as e-mail documents and browsers.
This standard would, however, exclude things that aren't core shared technologies. One example: highly prominent on-screen "buttons" that exist solely to drive business to Microsoft or its business partners. If Microsoft insists that a feature be included that oversteps this rule, then it must include rivals' software that performs the same job. An example: The company would be barred from packaging Windows with a link to its MoneyCentral Web site unless there were similar links to competitors' services. Similarly, Microsoft would also have to halt its plans to have Windows XP channel customers with digital cameras to its partners in the photo-printing industry. If it wants to link Eastman Kodak Co. (EK), say, it should also link to Fuji Photo Film Co. (FUJIY) and others. The primary goal of the operating system should be to help computers work better--not to help Microsoft squeeze new revenues out of its locked-in customers.
Under the rules outlined here, Microsoft would be given quite a bit of freedom to put new software into Windows. But when it does, it would be forced to comply with a set of rules to ensure that there's a level playing field in the software market. The basic goal of this regimen: to insure that it is impossible for the software maker to harm competitors in the many ways that were detailed in the appeals court ruling.
NO MORE BULLYING. Microsoft must stop making business partners sign exclusionary contracts. In the 1990s, for instance, Microsoft negotiated exclusive deals with computer makers that put Microsoft's browser, rather than Netscape Navigator, on most desktops. More recently, it tried to get AOL Time Warner Inc. (AOL) to alter its exclusive relationship with RealNetworks Inc. (RNWK) as a condition of a deal to include AOL's service in Windows XP. The company should also publish a price list for Windows and charge all computer makers the same rate schedule. Together, these steps would deprive Gates of two crucial predatory tools.
CHOICE. These days, Microsoft largely dictates the way your computer screen looks. New rules should be established to give computer makers more power over what's on the Window's menu screen. One example: the Start menu. With Windows XP, Microsoft has cleaned up the look of the operating system. Computers will ship with no icons on the desktop. Instead, users will click the Start button, and a menu of applications and folders will pop up. But Microsoft is mandating that the Start menu must include buttons to launch its own browser and e-mail. What's more, computer makers will be able to control only three out of eight menu buttons. That's too coercive. Computer makers should have control of at least half the buttons, plus the ability to replace e-mail and the browser.
TRANSPARENCY. Microsoft can thwart competition with technology as well as contracts. One way is through Windows' applications program interfaces (APIs). These are the hooks an application uses to attach itself to Windows. Without knowing how APIs are configured, a competing software developer can't make products that run on Windows. What to do? The short answer: Force Microsoft to publish technical data on its APIs in a timely manner. This will be time-consuming, but it's the only way to ensure that rivals have an equal opportunity to reach consumers.
A SECOND LOOK. To be sure, none of these remedies is guaranteed to work. It's easy for a wily and aggressive company to evade these kinds of rules if it wants to. And Microsoft is nothing if not wily and aggressive.
That's why trustbusters should insist on a chance to revisit the Microsoft remedies package. By including a so-called look-back provision in any settlement agreement, they could take three years or so to see if these new rules help consumers. If they don't, the government could ask the courts to reconsider a breakup. That should be a big enough incentive to force Gates & Co. to play by these new rules of the game--and to ensure that the sun shines outside of Seattle, too. By Jay Greene and Dan Carney