More of a Ripple Effect Than Shock Wave

Even as Microsoft Corp. faces a court-mandated breakup into two companies, the immediate impact of the ruling may be surprisingly slight.

Although the company’s power has already declined in a technology world shifting rapidly to Internet-based products, experts believe Microsoft’s monopoly power over PC software may ensure its preeminence while years of likely legal appeals are played out.

“The [immediate] effects on everybody will be so negligible that it will be hard to see any difference,” said Jeffrey Tarter, editor of industry newsletter Soft-Letter. “The sun will rise in the east, people will continue to buy Microsoft products, and money will keep flowing into Redmond.”

Wall Street had already taken into account the inevitability of the breakup ruling, and analysts don’t expect dramatic changes in Microsoft’s share price, which has lost more than a third of its value this year. Microsoft shares gained 88 cents to close at $70.50 in Nasdaq trading Wednesday, rising as high as $72 in after-hours trading after the judge’s decision.

“We think at these levels Microsoft’s valuation is very defensible, even if you look at the sum of the parts not being as big as the whole” after a breakup, said Chris Galvin, an analyst with investment bank Chase Hambrecht & Quist in San Francisco.

U.S. District Judge Thomas Penfield Jackson ordered that Microsoft be broken into two companies--a computer operating systems business, which would include its Windows operating systems, and another company with its applications businesses, including the Internet Explorer Web browser.

Jackson also ordered “behavioral remedies” on Microsoft that would begin in 90 days, unless contradicted by another court.

Those provisions would bar Microsoft from threatening or intimidating PC makers--the software giant’s most important customers--to deter them from supporting competing products. This could have the effect of creating wider options for PC customers, including a range of choices for operating systems and business productivity applications.

PC makers would also be allowed to customize Windows and Microsoft would be prohibited from using preferential pricing to reward allies or punish more independent companies.

The judge’s ruling would further require Microsoft to give competitors the same technical data about the Windows operating system used by Microsoft’s own personnel. This move could help other software makers enhance their products for optimum effectiveness in a Windows-based PC.

Some Agreements in Question

The order would prevent Microsoft from binding new “middleware” products--such as e-mail programs, Web browsers and multimedia viewers--to a Windows operating system. The incorporation of its Web browser was a key element of the government’s case.

The judgment could also be interpreted to prohibit Microsoft from investing in a company on the condition that it uses Microsoft products.

Last year, Microsoft invested $5 billion in AT&T; Corp. in order to get its Windows CE operating system installed on millions of cable set-top boxes deployed by the telecom giant. If Wednesday’s judgment stands, that agreement would be unenforceable, according to Chris LeTocq of GartnerGroup in San Jose.

Microsoft invested $150 million in Apple Computer Inc. on the condition that its longtime rival sell Macintosh computers with Microsoft’s Internet Explorer browser. Apple would no longer be required to ship iMacs with Explorer, LeTocq said.

Microsoft said it will appeal those remedies and ask the higher court to forestall Jackson’s order until its arguments are heard.

Legal experts said judges commonly allow serious punishments in civil cases to be delayed while they consider their merit.

But if the full range of behavioral sanctions are indeed implemented, “they have the potential to do such damage to the company that Microsoft will no longer be Microsoft,” said Rob Enderle, an analyst with Giga Information Group in Santa Clara, Calif.

Even if the sanctions are stayed during appeal, years of antitrust problems have already altered the software giant’s trajectory.

Love-Hate Relationship With PC Makers

While Microsoft has struggled to build effective Internet appliances based on Windows, top PC makers have shown increasing independence. Most now offer the insurgent Linux operating system--a direct competitor to Windows--as an alternative to Windows.

Computer maker Gateway recently formed an alliance with Microsoft rival America Online to produce Internet appliances based on Linux.

But such moves fall far short of open revolt.

PC makers have “always been of two minds,” said Roger Kay, an analyst with International Data Corp. in Framingham, Mass. “They love the status quo and hate the fact that Microsoft has the franchise. It’s a humiliating relationship.”

But both PC makers and corporate buyers are by nature conservative, and will not flood to upstart competitors such as Linux.

T.R. Reid, a spokesman for Dell Computer, emphasized that Windows and other Microsoft products remain at the center of their business--and will stay there even if a breakup occurs.

“We will work with whatever Microsoft emerges,” Compaq Computer Chief Executive Michael Capellas said last week.

And Reid said Dell would not increase the array of customer choices for operating systems and applications for word processing, spreadsheets and the like unless consumers want it.

“We’re not in the business of introducing products of any kind looking for a market,” he said.

Still, the industry’s ground is shifting underfoot--and shifting alliances once considered solid.

This week, Apple Computer Chief Executive Steve Jobs said his company would for the first time include in its own operating system a piece of software to make programs written in Sun Microsystem’s Java computer language run better on iMacs.

That move was a thumb in the eye of Microsoft, which creates crucial versions of Microsoft Office software for Apple’s computers. Java is designed so its programs can run on any operating system, an assault on Microsoft’s dominance.

“Scrutiny is good,” said Scott McNealy, chief executive of Sun. “Scrutiny might have helped the Apple deal,” by convincing Apple that it would not face retaliation from Microsoft.

Such events drain away Microsoft’s authority, and will accelerate, Microsoft rivals and analysts predicted.

“I’ve seen grown men, men in their 50s, shake in their boots about the thought of making [Bill] Gates cross with them,” said Jean-Louis Gassee, a former Apple executive. “This is how tyrannies end: when people stop fearing the tyrant.”

Life After Breakup Will Be Altered

Even if legal sanctions are delayed, Enderle said, “Every move Microsoft makes will be under scrutiny and any move they do will land them back in court.” This could accelerate the exodus from the company’s executive and engineering ranks, if top employees see more favorable opportunities elsewhere.

And over time Windows looks to be losing importance as software for hand-held Internet appliances, Web browsers and database software take precedence over PC operating systems in an Internet-based environment.

Microsoft recently announced Next Generation Windows Services, a program meant to buttress Windows’ role on the Web. That product “is stillborn unless they can get out from underneath this,” Enderle said.

International Data Corp.’s Kay believes that Microsoft may already be contemplating life after a breakup, even as it espouses public confidence that it will prevail on appeal.

“Microsoft would seem to be walking this tightrope without a net. But there may be a hidden effort to [prepare] plan ‘B’ “--plan breakup, Kay said.

And in a breakup, the interests of the new companies could maintain powerful symbiosis for a long time, he said.

“Microsoft is a really strong company,” said Richard Shaffer, principal with Technologic Partners in New York. “It has enough bright people and strong managers for two really strong companies--in fact, maybe for three or four strong companies.”

‘Throwing Gasoline on the Fire’

Analyst Tarter noted that Microsoft has recently taken actions that could be viewed as similar to the business practices that brought the antitrust troubles upon it.

“In a few cases you’d expect Microsoft to keep a low profile, and they have not,” he said, citing the company’s move to tightly link its Office 2000 productivity software suite with the Windows 2000 operating system, which operates server computers that manage networks. The combination makes Office 2000 more effective with Windows than with competing software.

“They are trying to make the Internet more proprietary. They are throwing gasoline on the fire and don’t think there is much danger,” said Tarter. “And so far as I can tell, they are right.”

To be sure, despite acting with apparent impunity in such cases, the company faces a world of trouble. The ruling Wednesday will almost certainly accelerate the longer-term erosion of its hold on once-loyal allies and customers.

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Piller and Menn reported from San Francisco, Kaplan from Los Angeles.

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Microsoft Breakup Plan

Judge Thomas Penfield Jackson ordered Microsoft to be split to form an operating systems company and an applications company. Here is a look at how the new companies will line up if Jackson’s decision holds up under appeal.

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Operating Systems

This company will include all Microsoft Windows operating systems (Windows 95, 98, NT and 2000), the mobile operating system Pocket PC and the upcoming Windows Millennium Edition and Whistler. Nearly 90% of the world’s personal computers use Windows operating systems:

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Applications

This company will handle all of Microsoft’s applications programs, including the popular Office suite and Internet Explorer Web browser, and its other business segments, including games, hardware, MSNBC and Media Player.

Many of Microsoft’s legal problems stem from its bundling of the Internet Explorer Web browser with its operating systems. Under the breakup order, the Web browser will become part of the applications company:

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In the popular office-productivity applications software market, Microsoft is dominant, capturing more than 90% of the revenue in both word processing and spreadsheet applications. Most office-productivity software is sold in a suite of applications:

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Sources: International Data Corp., Giga Information Group, Associated Press

Researched by NONA YATES/Los Angeles Times