Overdrive, page 4
Federal antitrust bloodhounds first began snooping around Microsoft in early 1990, a few months after the computer industry’s biggest biannual shindig, known as Comdex, a trade show where more than 200,000 industry junkies gather in glitzy Las Vegas to schmooze, talk shop, and show off the latest software and technology. It was during the November 1989 Comdex that Microsoft and IBM had jointly issued a five-page, double-spaced news release, titled “IBM and Microsoft expand partnership; set future DOS and OS/2 directions.”
DOS, an acronym for disk operating system, was developed by Microsoft for IBM’s first personal computer in 1980. It became an industry standard and helped establish Microsoft as the most powerful software firm on the planet. OS/2 was a second-generation operating system, which in 1989 was under joint development by Microsoft and IBM.
FTC staff believed that the agreement between IBM and Microsoft smacked of anticompetitive collusion, and the investigation was on, run from an office on Pennsylvania Avenue across the street from the FTC building. It did not begin, as has been reported, because some of Microsoft’s rivals complained about the IBM/Microsoft agreement. Instead, FTC attorney Norris Washington, who would become the lead investigator on the case, read about the agreement in Byte magazine and discussed it with Marc Schildkraut, an assistant director in the Bureau of Competition. But industry events soon overtook the investigation when the Comdex agreement fell apart.
Actually, the nine-year marriage between Microsoft and Big Blue was on the rocks months before they issued their “partnership” press release. The divorce was in the works a few months after Comdex, when Microsoft decided to abandon its role in the development of OS/2 in favor of Windows. Gates had chosen to bet the company on the future of Windows, and won, big time. IBM, on the other hand, stuck with OS/2, and lost.
Gates had made the smart move when he cut his ties with Big Blue, although the divorce papers would not be signed until mid-1992, after some legal fighting over what amounted to the prenuptial agreement—who got what. Microsoft agreed to pay IBM, in a lump payment, about $25 million for the use of various IBM patents. IBM relinquished all rights to the code for NT, and was allowed to use Windows code only until September 1993. In addition, IBM agreed to pay Microsoft royalties for each copy of OS/2 that it sold, since Microsoft had been part of the original development team. Neither IBM nor Microsoft would say publicly how much that royalty was, but it was believed to be about $23 per copy. The settlement brought down the final curtain on an historic relationship.
The split meant that the reasons for the initial FTC probe no longer existed. But the investigation had already taken on a life of its own, and it began to grow like mushrooms in the rainy Pacific Northwest, as competitor after competitor gave FTC staff an earful about the way Microsoft did business.
Despite the FTC “inquiry,” as Microsoft liked to call it, Gates did not back off. Not only did he not take prisoners, but he shot the walking wounded. In early 1992, Microsoft had launched an all-out attack against Borland International for control of the database business. In December, Microsoft bought out Access, a database program aimed squarely at the $450-million-a-year market segment dominated by Borland, and initially offered Access buyers an 86 percent discount from the product’s normal price.
Microsoft also hired away from Apple a top executive, Roger Heinen, to run its database operations. At Apple, he had been in charge of about 1,000 of the company’s most crucial programmers and engineers. The move took everyone at Apple by surprise. Heinen’s defection came just days before he was supposed to deliver the keynote address at the MacWorld Exposition in San Francisco.
Access became Microsoft’s first homegrown database program, although Microsoft had actually begun its move into Borland’s turf with the acquisition, earlier in the year, of Fox Software, which sold a database product called FoxPro. Microsoft paid $173 million for Fox—its biggest acquisition ever—and moved Fox’s entire 50-person technology team to the Redmond campus. At the time of the acquisition, Fox had about 10 percent of the database market; within a few months, thanks to Microsoft’s killer sales force, Fox’s unit sales increased 50 percent.
By buying Fox, Microsoft was able to go after some of Borland’s customers immediately, essentially striking another blow against Gates’s archenemy Philippe Kahn, Borland’s flamboyant, French-born founder. The two industry pioneers were like matter and antimatter; bring them together and there was bound to be an explosion. In an interview in early 1992, Kahn had compared Microsoft’s power to that of “Nazi Germany.”
At Stewart Alsop’s annual Agenda Conference that September in La Jolla, California, Gates had confronted Kahn over a comment he had made to an industry magazine that Microsoft used unfair tactics to maintain its stranglehold on the market. “What exactly did you mean by that?” Gates had demanded as he poked his finger at Borland’s chairman.
Microsoft’s move into the database market was extremely effective—and crippling for Borland. In December 1992, Borland reported a $61.3 million loss for the quarter. Kahn laid off 15 percent of his 2,200 employees, blaming Gates and Microsoft’s heavy-handed business practices.
Kahn would later say: “Gates looks at everything as something that should be his. He acts in any way he can to make it his. It can be an idea, market share, or a contract. There is not an ounce of conscientiousness or compassion in him. The notion of fairness means nothing to him. The only thing he understands is leverage.”
And it was leverage that had become a growing concern to lawyers with the FTC’s Bureau of Competition throughout 1992 as they zeroed in on Microsoft’s questionable business practices. In December, the bureau’s staff filed with the five- member commission a 250-page report on Microsoft, which recommended that the commission seek a court injunction against Microsoft. The purpose of the report was to get Gates’s attention and to bring his company to the negotiating table. Typically, antitrust charges brought by the FTC are heard by an administrative law judge, who decides after a trial whether the company did indeed break the law. But the FTC staff wanted the commission to take a quicker route, and a court injunction would bar Microsoft from what the commission considered illegal practices. This would force the company to change its business practices before the case worked its way through administrative proceedings.
The staff report on Microsoft spelled out action to be taken against Microsoft in several different areas. One involved the company’s packaging of DOS with each computer, what Microsoft called its “per-processor” licensing. For some 10 years, Microsoft had been offering computer makers a huge discount on DOS, provided they paid a royalty for each computer shipped, even if DOS was not installed on the machine. The computer makers had a choice: they could pay Microsoft for each copy of DOS they bought, or they could simply pay a royalty to Microsoft and get the discount. The per-copy cost of DOS was about $90, compared with about a $30 royalty per machine. The biggest computer makers might pay as little as a $7 royalty per machine. FTC staff pushing for action against Microsoft believed the arrangement dissuaded PC makers from offering competing operating system software since they were already paying for DOS with each machine they shipped.
Complaints about this practice were being raised not only in the United States, because in November 1992, Microsoft Ltd. began offering a per-processor licensing arrangement with computer makers in Britain, which prompted a probe there by the Office of Fair Trading. But the British review was not expected to turn into a full-blown investigation unless the FTC moved against Microsoft.
“It’s like an old-fashioned monopolist. I’m afraid we’re dealing with classic smoothies,” Labor Party MP Nigel Griffiths, often considered Britain’s answer to American consumer advocate Ralph Nader, had told Business Week.
The FTC’s case against Microsoft was not limited to the licensing arrangement. Microsoft’s tactic of “tying” application and operating systems had also come under examination. Competitors complained to the FTC that Microsoft offered cut-rate prices on DOS or Windows to a customer, provided that the customer bought large quantities of other applications, such as Word or Excel.
FTC staff had also spent many hours investigating allegations that Microsoft had not imposed a barrier between its applications and operating systems divisions. Competitors had long complained that they received critical information about operating systems such as DOS for Windows long after Microsoft’s application people. Thus, Microsoft gained an advantage over them in developing applications that ran with Windows, for example. Over the years, Microsoft executives had made conflicting statements about whether this so-called Chinese Wall between the two divisions actually existed. In 1983, Microsoft Vice President Steve Ballmer had told Business Week,
“There is a very dear separation between our operating system business and our applications software. It’s like the separation of church and state.” Eight years later, in 1991, Microsoft executive Mike Maples gave a very much different answer in an interview with InfoWorld: “We didn’t want there to be a Chinese Wall, and I don’t think we’ve ever claimed that there was a Chinese Wall.”
The Chinese Wall was always just a myth, according to Tim Paterson, the Microsoft programmer known as the father of DOS. “It doesn’t exist; it never did,” he said. “I remember Bill Gates saying many times, ‘There is no Chinese Wall.’ Somebody got this idea that there was this wall between systems and applications so we couldn’t talk to each other. There’s no such thing. We don’t have any separation here, just one big company. ... We don’t have any limits to our cooperation across those boundaries. We never did. And there’s no reason to. That doesn’t make sense.”
At the same Agenda Conference in September 1992 at which an angry Gates had confronted Kahn, Gates, too, had proclaimed there was no Chinese Wall. Eric Schmidt, chief technology officer for Sun Microsystems, was at the conference and took notes on what Gates said about the alleged separation between Microsoft’s applications and operating systems divisions. “He denied there was a Chinese Wall at Microsoft,” Schmidt wrote in his notebook, “and clearly stated that the software groups throughout all of Microsoft Corporation talked to all others. He claimed that the use of hidden APIs was an error by the team.”
Sun was among the Microsoft competitors that had been talking to FTC investigators. “We had felt for a long time that Microsoft went beyond the bounds of proper behavior,” said Schmidt, “and to the degree that we were aware of this, we pointed it out to them [the FTC].”
The hidden APIs referred to by Schmidt are applications programming interfaces, or “calls,” programming codes integrated into an operating system such as Windows to allow it to respond to commands from an application program. If competitors don’t know about these hidden or undocumented calls, their applications will not work as well as Microsoft’s. During its investigation, the FTC had received numerous complaints from software companies that these undocumented calls prevented their applications for DOS or Windows from performing as well as Microsoft’s Word and Excel, for example. Microsoft had long denied that it deliberately designed hidden calls into its operating systems, but in the summer of 1992, Andrew Schulman, a programming expert living in Cambridge, Massachusetts, published his book Undocumented Windows, which confirmed that Microsoft had lied. Microsoft later acknowledged that Excel and Word used at least 16 APIs that had been hidden in Windows.
Although some staff lawyers with the FTC’s Bureau of Competition favored breaking up Microsoft into two companies, one for applications and one for operating systems, this argument never got very far. Microsoft would have regarded any such move as an assault on its very existence and would have waged an all-out legal battle to defend itself.
Much of the 250-page staff report on Microsoft by the FTC’s Bureau of Competition focused on complaints leveled by Novell, complaints that investigators believed had merit. Novell, headquartered in Provo, Utah, had mounted an intense lobbying campaign to bring down Microsoft and its chairman.
Although Microsoft and Novell had long been fierce rivals, the open hostility that surfaced during the FTC investigation had its roots in two overtures by Gates to buy Novell, overtures that Ray Noorda had regarded as highly suspicious. Microsoft wanted a beachhead in a market that it did not control—the software that linked computers in networks, which was Novell’s turf. When it came to networking software, Novell, not Microsoft, set the standard, capturing nearly 70 percent of the market.
Microsoft’s network software lagged far behind. Given Microsoft’s deep pockets, Gates once again played the if-you- can’t-beat-’em-buy-’em card.
At the Comdex show in 1989, even while Microsoft and IBM were doing their partnership dance, Gates had quietly approached Noorda about a possible merger. Noorda, though surprised at the overture, said he was willing to talk. Later that month, Gates sent Ballmer, his most trusted lieutenant, to meet with Noorda at a hotel restaurant in Houston, Texas.
“Bill wanted Novell,” said one Microsoft executive. “It was no ruse. We understood even then that networking was going to become very important to this industry. We saw Novell as our number-one competitor and this was a way to take them out of the picture.”
Microsoft offered to buy Novell for about $2 billion, and Gates met with Noorda in late November to work out the details. But Gates soon had second thoughts. When Noorda did not hear anything more from Microsoft, he called Gates in January 1990 to find out whether the merger was still on. It wasn’t. Noorda was told it was not practical to merge the companies; there were too many technical problems. Ballmer would later explain to Noorda in a letter that Gates was worried about potential antitrust problems. Noorda, however, didn’t accept Microsoft’s spin on the merger breakdown. He believed the merger had been a ruse all along and that Microsoft had used the talks to gain access to confidential information about the company’s networking business.
There was no more talk about a merger until July 19, 1991, when Gate? called Noorda out of the blue to talk merger once again. Noorda would later say he thought the call was a “joke.” It wasn’t. But the poker player Gates was keeping his cards close to the vest. Although Microsoft would later deny it, Gates had another reason for calling Noorda. A couple of days earlier, Novell had announced that it planned to buy Digital Research, a software company in scenic Pacific Grove, California, whose main product was an operating system called DR DOS. It was the only significant competition to Microsoft’s DOS, and it had received good reviews in trade publications. Many users said it had features superior to Microsoft’s operating system. Although DR DOS had only about 5 percent of the operating system market, in the hands of an aggressive competitor like Novell, DR DOS would almost certainly gain a bigger share.
Supposedly Gates had dismissed DR DOS as little more than a bad “clone” of Microsoft’s operating system. The irony of his attitude was not lost on those who knew the history of the development of Microsoft’s DOS. When in 1980 IBM decided to join the personal computer revolution and build its own machine for the masses, it sent a representative to visit Gates to determine whether Microsoft wanted to develop an operating system for the new machine. Gates sent the IBM representative to his friend Gary Kildall, a software pioneer who had founded Digital Research and developed an operating system then widely in use—CP/M. Gates told Kildall by phone that the IBM rep was coming down to the Monterey Peninsula to visit Digital Research. The story that became part of computer industry lore was that Kildall was on a business trip when the representative arrived, so no deal for CP/M was made. The IBM man returned to Microsoft and struck a deal with Gates and Paul Allen, and Kildall became known as the guy who blew the deal of the century. There wasn’t time for Microsoft to develop an operating system from scratch, so Gates and Allen bought one, for $50,000, from a tiny company called Seattle Computer. The operating system, 86-DOS, had been designed by the company’s programmer Tim Paterson, who soon went to work for Microsoft.
In time, CP/M evolved into DR DOS. Until his tragic and mysterious death from a head injury suffered in a fall in a Monterey restaurant in July 1994, Kildall maintained that Paterson had ripped off much of the code in CP/M when he designed the DOS that Microsoft bought for IBM's first personal computer. Not long before his death, Kildall self-published his memoirs, Computer Connections. Only a limited number of copies were printed and privately distributed to a handful of close friends and to Kildall’s family. In this book Kildall described Microsoft’s DOS as a “clone” of CP/M, and he wrote of Gates: “I have grown up in this industry with Gates. He is divisive. He is manipulative. He is a user. He has taken much from me and the industry.” And about Microsoft’s version of DOS he wrote: “To those who knew the industry, Gates’s DOS was a blatant misappropriation of proprietary materials, and of my personal pride and achievements.”
The weekend after Gates phoned Noorda on July 19, 1991, the two met briefly in San Francisco, at the American Airlines Admiral Club lounge to discuss the merger. Gates played his trump card. Before any merger could go forward, he said, Novell had to drop its plans to buy Digital Research. Noorda would later say that when he raised the possibility that the Justice Department might try to block a merger between the first and third biggest software companies on the planet, Gates responded: “Don’t worry, we know how to handle the federal government.” Gates denied ever saying such a thing, though he did acknowledge that Microsoft wanted Novell to drop its acquisition of Digital Research because clearly the antitrust folks at the Justice Department would not approve a merger if it appeared that Microsoft was buying out its only competition in the operating systems business.
