Legal Battle Takes Glow Off Microsoft Aura

Whether the Microsoft monopoly gets broken up by federal trustbusters, many technology experts now believe the company has entered a legal bog from which it can never emerge as strongly as it entered.

Even if the world’s largest software firm prevails on appeal, analysts say, protracted litigation may push the once-dominant company toward irrelevance in a technology world it helped to create.

“The massive uncertainty [caused by the antitrust trial] causes Microsoft to lose control over its customers and causes its employees to lose confidence in their direction,” said Rob Enders, an analyst with Gig Information Group. “Even Microsoft’s partners will look around for companies that they can trust more.”

Earlier this month U.S. District Judge Thomas Penfield Jackson found the company guilty of violating antitrust laws, and on Friday the U.S. Justice Department, joined by 17 states, asked Jackson to split the software giant into two competing companies.

Separate from the antitrust case, Microsoft already faces long-standing weaknesses in the burgeoning Internet marketplace. The company has failed to create dominant software products outside its monopolies in PC operating systems and business-productivity applications such as word processors and spreadsheets.

Two more years immersed in the courts--now viewed as all but inevitable--will accelerate those trends, Enders said, “because you know that Microsoft will be changed, but you don’t know how much.”

The company’s stock--which closed at $69.75 in Nasdaq trading Friday--has lost more than a third of its value this year, a decline that hinders efforts to recruit and retain talent. In response, on Tuesday the company issued new stock options at the lower share price to all its employees.

Even so, since the trial started in 1998, the company has experienced an exodus of top executives and engineers. Brad Silverberg, who led development of the Internet Explorer Web browser, WebTV co-founder Steve Perlman and chief financial officer Greg Maffei are among the most damaging losses.

The company still remains stacked with some of the most talented people in the software industry. But industry observers attribute the brain drain partly to an ongoing malaise at the company, whose leaders seem unable to grasp the power of the forces arrayed against them or the magnitude of the judge’s rulings.

Microsoft founder Bill Gates shares the views of rank-and-file technologists in feeling punished for creating an engine of job creation they deeply believe has been beneficial to the industry and consumers.

IBM faced a similar crisis of confidence during its 13-year antitrust battle, settled in 1982.

But unlike IBM, “Microsoft is not a home away from home, a lifetime employer,” said Enders. “Microsoft is much more vulnerable than IBM was,” and the damage from talent attrition will be more rapid.

To be sure, even if Gates’ company is broken apart, each “Baby Bill” would be a power in its own right. Billions in cash, a giant stable of engineers and investments in a wide range of technology companies will preserve a degree of prominence and power.

“They have lost people, but Microsoft still has a collective IQ that is at least 20 points higher than any other company out there,” said Jeffrey Tarter, editor of the industry publication Soft-Letter.

Tarter and others, including many competitors, don’t rule out a resurgence by the company. If Microsoft scores a full victory on appeal sometime in the next year, as Gates predicts, these observers believe the company might walk away relatively unscathed.

“Absent legal action, I do not believe their era has passed,” said Mitchell Kertzman, chief executive of Liberate Technologies, a Microsoft competitor. “They’re willing to spend any amount of money and do anything--legal or illegal--to preserve their hegemony.”

But others suggest that the antitrust case already has abetted the company’s failure to innovate in a rapidly evolving marketplace, emboldening competitors and raising irreversible barriers to regaining its former dominance.

“The Justice Department . . . has made people feel psychologically that they can be competitors to Microsoft,” said James Love, director of the Consumer Project on Technology in Washington.

Even before formal sanctions are decided by Jackson, the legal battle has limited Microsoft’s ability to attack with its historically intimidating business practices.

“The peak of their hegemony has already passed,” said Roger Kay, a PC analyst with International Data Corp. “They don’t strike the same degree of fear in the heart of business partners.”

As recently as last year, investments in technology start-up companies were focused on staying out of Microsoft’s way, according to venture capitalists. Now, going against Microsoft is widely viewed as a good gamble, and venture funds flow rapidly into competitors, such as producers of Linux operating system software, a threat to Microsoft’s flagship Windows products.

Part of the change has been attributed to an industry trend away from the PC--Microsoft’s cash cow--in favor of Internet-connected appliances such as hand held computers, television set-top boxes, game consoles and advanced cellular phones.

Intel Corp., Microsoft’s longtime ally and producer of 80% of the world’s PC microprocessors, views Internet equipment as the key to its future. In the last two years Intel has developed a major networking-equipment business and announced its first Web appliance.

International Data Corp. projects Web appliances to outsell consumer PCs in the U.S. by 2002.

Kay gives Microsoft’s traditional sales model--in which every business PC user buys a Windows operating system and Microsoft productivity software--another five years before the vast majority of users migrate to network-based alternatives.

That trend could be devastating for Microsoft and already is stimulating competition in the business software market that had until recently been frozen out by the company’s monopoly.

Microsoft defeated Netscape Communications in the browser wars--making Internet Explorer far more popular than Netscape’s Navigator--only through an illegal use of its monopoly, according to Judge Jackson.

And while the company’s Media Player--a software tool for handling online audio and video--is beginning to gain popularity, it lags far behind the offering of the industry leader, Real Networks.

Microsoft’s Web portal site, MSN.com, despite ranking among the most visited sites on the Web, has been viewed both inside and outside the company as a disappointing also-ran to Yahoo and America Online.

Windows CE, a limited version of Windows designed for hand held devices and set-top boxes--has enjoyed only limited acceptance. Software designed for complex PCs has proved hard to adapt for simple appliances.

Meanwhile, the antitrust distraction continues to hamper Microsoft’s ability to move rapidly.

“You’re talking about a company that has defined itself as a fast follower,” imitating industry innovations and succeeding with marketing prowess and monopoly tactics, said Enders. “Anything that slows it down is potentially life threatening.”

A case in point: The company was blindsided by the rapid embrace of Linux by major PC makers, once Microsoft’s most loyal clients. Even Intel has invested heavily in Linux companies.

Ironically, the popularity of Linux derives in part from Microsoft’s growing inability to manage the complexity of Windows. For example, Windows 2000 was released earlier this year with about 63,000 incompatibilities with other software programs or hardware devices.

The product’s bulk and complexity has eclipsed Microsoft’s ability to squash those thousands of bugs.

Linux has been developed by tens of thousands of volunteer programmers around the globe. They donate their time to improve and trouble-shoot the program, which is available free from many sources.

The sheer size of that volunteer army has made Linux more dependable and less susceptible to bugs than Windows--helping it capture 25% of the fast-growing market for servers, which manage the Internet and other computer networks.

“More and more development is effectively being forced onto open source, because people can’t get sufficient reliability any other way,” said Eric Raymond in an interview earlier this month. Raymond helped found the “open-source movement”--the cooperative process under which Linux has been developed.

That element of cooperation equally characterizes the evolution of the Internet itself--a system that requires open, widely accepted technology standards.

Microsoft’s lock on the PC operating system market is based on proprietary software. Open standards have helped prevent Microsoft from dominating the online era.

“I expect the market forces to have taken down Microsoft before the Justice Department does so,” Raymond said.

The rapid ascendancy of new computing approaches has left even longtime Microsoft supporters wondering if the company can adapt.

“There’s some risk that Microsoft’s best days are behind them,” said Gordon Eubanks, chief executive of Oblix, a Cupertino, Calif., software company. Eubanks was a witness for Microsoft during the trial. “The world has changed so much that [Microsoft’s strongest skills are] not where the opportunities lie.”

Even so, Eubanks and others emphasized, Microsoft will not go quietly.

“Having watched people bet against Microsoft and throw up doom-and-gloom scenarios for almost 20 years, I’ve developed a healthy respect for their ability to bounce back,” said Tarter.

“Financial analysts love the company,” which generated $20 billion in revenues last year, he added. “Even the Justice Department runs on Microsoft software.”

Kertzman agrees.

“I don’t subscribe to the notion that Microsoft is a wounded beast,” he said. “It’s like saying organized crime is not effective in the 21st century. They can still do a lot of damage. Microsoft is still a mighty company, with a huge market valuation, a mountain of cash, and software monopolies--assets that give them powerful leverage.”

Many observers note another irony in the Microsoft saga: If the company had chosen to split itself up voluntarily a year or two ago, it would likely have created a combination of more nimble, innovative competitors. And shareholders could have benefited, much like the 1984 breakup of AT&T; dramatically increased competition and grew the telecommunications industry.

In such a scenario, Gates might have increased his personal wealth tenfold, said Kay of International Data Corp.

“Gates is an ideologue, not a cynical person playing poker with the government. He’s a true believer, which is disappointing because it’s less intelligent,” he added. “They don’t control their destiny because they decided to keep fighting.”