Ever since September, software giant Microsoft has been facing a tough battle because of its inability to convince the European Commission that it is not unfairly dominating the European market. The company is facing a harsh fine and may even be forced to make changes in its software programs that open them to competition. Brussels expects to issue its decision in the case by spring of 2004.


But Microsoft is expert at emerging unscathed from judicial conflicts.  The most appropriate example goes back to June 2001, when the U.S. Court of Appeals of the District of Columbia (United States) reversed a judgment that required the company to break up into two independent businesses, although the court recognized the existence of monopolistic practices. However, not everything has been a bed of roses for Microsoft, which has had to reach out-of-court agreements with nine states in order to side-step accusations of anti-competitive practices. Moreover, Microsoft has had to pay millions of dollars in compensation to competitors such as AOL Time Warner in order to avoid additional judgments.


Nevertheless, Europe’s determined position can mark a 360-degree turn in the strategy of the company and, above all, in the development of the sector. The history of the software sector has yet to be written, and innovation is at its epicenter rather than being mere window dressing designed to win competitive advantage. Microsoft’s competitors trust that Brussels will be able to impose drastic measures that the United States did not manage to carry out, although it remains to be seen to what degree European authorities are going to be able to wound the American giant.


“I doubt that Mario Monti, commissioner of competition, takes drastic measures such as the original sentence of Justice Thomas Penfield Jackson, which ordered Microsoft to break up into two independent companies. It is more probable that he will impose a fine that sets a precedent,” notes Ramon Casadesús-Masanell, professor at the IESE business school. “According to the law of the Community, the maximum fine that the Commission can impose is 10% of the global sales of a company,” he adds.


During the last fiscal year, Microsoft earned $9.99 billion on a sales volume of $32.18 billion. That means the largest sanction that it could face would round off to some $3.2 billion. “That’s a considerable amount for any company,” continues Casadesús-Masanell. “What we don’t know is if that fine will be enough to induce a change in Microsoft’s behavior. The company will modify its behavior if the value of a similar punishment in the future is greater than the earnings that it derives from continuing to exploit its monopolistic position in operating systems. Otherwise, it will continue.”


Francesco D. Sandulli, professor of business management at the Complutense University of Madrid, and an online consultant in business administration at DMR Consulting, also has his doubts about the impact that the Brussels decision can have. “Despite the way things appear in principle, the measures expected from the Commission cannot be considered drastic measures. The Commission would distance itself from the ultimate focus used by American justice – insofar as it reversed the requirement that Microsoft divide the company in two – if it forces Microsoft to include products that compete with its Media Player within the overall Windows system. In this case, the Commission would be forcing Microsoft to undertake a test of the marketplace that would demonstrate which one (or more) of the various multimedia players in the market are best. In the United States that sort of market test never got off the ground in the case of Internet browser software, failing to deliver on the requirements originally laid out by the American plaintiffs.


An Endless Trial

Whatever decision Brussels takes, the company run by Bill Gates can still count on the possibility of appealing to the International Court of Justice in The Hague. If the Commission decides that Microsoft has infringed on Article 82 of the Treaty of the European Union – which prohibits “abusive exploitation on the part of a company that has a dominant position in the marketplace or a substantial part of the same” – the company will have to pay a fine and accept conditions that are necessary for correcting that infraction. Once that decision is taken, all parties involved will be able to present their own formal complaints in order to obtain appropriate reparations from Microsoft.


But the software giant has two months to present an appeal against the Brussels decision at the Court of First Instance of the European Union. That would bring to a standstill any judicial process on the part of Microsoft’s competitors. Moreover, this court can repeal the decision and, in case one of the parties is not in agreement with this decision, it can turn to a plenary session of the Court of Justice of the European Communities.


Legal differences between Europe and the United Status have also raised doubts about how Microsoft can be affected by the existence of two different frameworks and, above all, about the possible repercussions for the industry if Europe takes a tougher position in the area of competition. “In general terms, I don’t think that the [two] markets are developing in a very different way. Despite the legal frameworks, the software industry is a global industry and will probably evolve in a very similar way on both sides of the Atlantic,” notes professor Sandulli. Nevertheless, he recognizes that Microsoft’s commercial strategy can be affected “in the case of multimedia players” if Brussels forces Microsoft not to include its Media Player in its operating systems.


For his part, Casadesús-Masanell believes that “in reality, the American case and the European case are not that different. The two cases have to do with Microsoft using its dominant position in the PC operating systems space to derive a competitive advantage in another market. In the American case, it’s the market in [Internet] browsers. In the European case, it’s the market in operating systems for servers and in multimedia software. On the other hand, in the American case Microsoft was defending itself against Netscape, which was the first company to enter that market, and was trying to become the dominant company in the browser space. In Europe, nevertheless, the analysis involves action taken by Microsoft that could be clearly illegal.”


Beyond the effect that the Brussels decision might have on Microsoft, this ruling can lay the foundations for a change in the sector. Companies such as Real Networks and Sun Microsystems have already warned the Commission that the independent development of key technologies is in its hands; above all, in the case of digital media. “One of the main problems in the Microsoft case consists precisely in showing whether the linkage between software applications and the operating system is beneficial or damaging for consumers,” stresses Sandulli.  If it is shown that the company is undermining its competitors’ capacity for innovation and, to that degree, damaging the general public, Sandulli believes that Microsoft should be penalized. “But [this should be] not so much because of its position of dominance as because of the supposedly illegal practices.”


Sandulli makes such a distinction because he believes that “Microsoft’s dominant position is the reward for its ability to innovate; in that respect, it should not be penalized at any time for having that dominant position. Software companies usually incur large start-up costs, hoping to be able to recover them in the future by obtaining a dominant position. If we penalize companies for their dominant position, we are providing disincentives for innovation.”


In fact, one of the arguments used by Microsoft’s defenders is that it has attained its position thanks to its capacity for innovation; and if shackles are imposed on the company, it will reduce the incentive that is driving industry forward. “Competition is what gives the biggest boost to innovation,” notes professor Casadesús-Masanell. “Brussels must look for the always complex balance between promoting competition and allowing companies to create and sustain their competitive advantage. Authorities should defend those competitive advantages that are derived from innovation and efficiency, not those that are achieved from the exploitation of a dominant position in a related market. This is especially clear for products where the Net has a major impact. In such cases, once a company has obtained a sufficient advantage – a ‘tipping point’ or ‘point of no return’ – there is little or nothing that its competitors can do in order to challenge the leader’s dominance.


Microsoft’s competitors and the European Commission believe that the American company is taking advantage of its dominant position in the space of operating systems to create a competitive advantage in the space of multimedia software, “the way it did in the Internet browser space. Thus, it is important that the Commission act rapidly to avoid reaching the point of no return; that is, before it is too late. The Commission could force Microsoft not to include its Media Player within Windows, or, if Microsoft does include it, to also include other similar programs from other companies, such as RealPlayer or QuickTime.”


The Time for Free Software

Amidst the many lawsuits ensnaring Microsoft for unfair competition, a new sort of network is being created, and it is getting ready to snatch away the company’s throne. It’s the free software industry. Beyond judicial action and moves by its competitors, Steve Ballmer, chief executive of the company, has acknowledged that “Linux is our enemy number one.”


Casadesús-Masanell remembers how the company’s fear of the development of free software was confirmed with the publication of the “Halloween documents.” These in-house company documents were leaked to the public, and can be viewed at www.opensource.org/halloween/. “In those documents, they say that free software represents a short-term danger to Microsoft’s revenues and its platform, especially in the server segment.”


What makes this industry so attractive is that, by and large, the software can be obtained free of charge. Moreover, users can directly incorporate their own ideas for improving the code or for fixing errors. “Free software has taken off in a spectacular way,” adds Casadesús-Masanell. “This year, Linux’s market share in the server segment will be able 37%, compared with less than 1% barely a decade ago.”


But the penetration of Linux continues to be a lot smaller in the customer segment, because PC users still lack sufficient knowledge to be able to install and maintain this type of software. “Companies such as Red Hat are taking advantage of this business opportunity to offer technical support for the adoption of Linux,” adds Casadesús-Masanell. Notes Sandulli: “It remains to be seen if the main advantage of free software – the possibility of adapting it to the needs of customers because they have the freedom to make use of the source code – doesn’t collide, to a certain extent, with the current trend in business software of integrating applications, now that the existence of a confirmed standard like Windows facilitates integration,” notes Sandulli.


Nevertheless, Sandulli recognizes that “with time, free software will become stabilized and will be considered by companies as a valid alternative to Windows, provided that it competes under equal conditions. This implies, for example, that some secrets of Windows are revealed.” Casadesús-Masanell adds that “a recent study done by IESE and the Harvard Business School on the competitive dynamic between free software and commercial software suggests that the behavior of some governments who are using free software, along with the support of companies such as IBM, can provide a major boost so that some free software projects overtake traditional software in terms of market share.”


Assuming even that Microsoft ends up making public the entire source code of Windows, it’s not certain that it would lose its competitive advantage. “Other companies in the information technology sector, such as IBM and Xerox, failed when it was time for them to identify change, and they lost their position of dominance. Nevertheless, for the moment Microsoft has been able to recognize when radical change takes place in its industry. More important, it has been able to manage it, and take advantage of change. Microsoft did that when the Internet developed, and it seems that it is doing so when it comes to the development of web services and the integration of technology platforms.”