Breakup of Microsoft Is Overturned on Appeal


Confident that no court would tear apart the company, Microsoft Corp. worked feverishly during the last year to release a battery of new products that could make the software giant even more dominant in the computing world.

Microsoft last month introduced Office XP, the latest version of the ubiquitous set of word-processing and other business programs that provides more than 30% of Microsoft's revenue. Windows XP, the operating system that computer makers hope will revive flagging PC sales, arrives in October. And November will bring the unveiling of Xbox, a high-powered video game console for which Microsoft is committed to spend $500 million to market during the next 18 months.

A hand-held computer that Microsoft supports, Compaq Computer Corp.'s iPaq, is outselling rival products by pioneer Palm Inc. More significant, Microsoft is planting a flag at the center of the World Wide Web, unabashedly using the same approach that troubled regulators in the first place.

The strategy ups Microsoft's bet that it can prevail against antitrust claims by the U.S. Justice Department, competitors and state prosecutors. A federal appeals court Thursday struck down the proposed breakup, ordering a new lower court judge to hold more hearings on the extent of Microsoft's wrongdoing.

"Conduct by Microsoft in the past year would appear to repeat many of the things that were problematic here, and they do it on a larger stage," said Tom Miller, the attorney general of Iowa.

Even as the technology industry has been staggered by an economic slowdown, Microsoft has emerged as a more potent force. The company, based in Redmond, Wash., has $30 billion in reserves, generates cash flow from operations exceeding $1 billion a month and plans to hire 8,000 new workers this year.

Even before Thursday's ruling, Microsoft's gamble was paying off in a huge way. The company's stock is by far the best performer this year of the 30 issues in the Dow Jones industrial average, gaining more than 68% as the overall index fell about 2%.

Microsoft actually has benefited from the dot-com implosion, which wiped out many small firms that offered competing services and products--firms that were big customers for Microsoft rivals Sun Microsystems Inc. and Oracle Corp. Young Linux companies aiming to provide upgraded services tied to the free operating system--a direct competitor to Windows--also have fallen victim to the tumult in the stock market.

Meanwhile, Bill Gates stepped down as chief executive last year, remaining chairman and re-focusing on software strategy. Longtime No. 2 Steve Ballmer became CEO and the public face of Microsoft. The management team no longer sends everything to Gates for approval.

That team has kept cash rolling in, prodding corporate customers into longer-term licenses that include software upgrades and support.

In the most recent quarter, Microsoft profit climbed to $2.45 billion on sales of $6.46 billion, up from a $2.39-billion profit on revenue of $5.66 billion a year earlier.

Going after small and medium-size businesses worried about their technology costs, Microsoft also used $1 billion of its $30-billion kitty to acquire Great Plains software, a leader in accounting and other programs for the mid-size set.

By aggressively developing new products and refusing to change what detractors call predatory behavior, Microsoft has positioned itself to capitalize if the company is not broken apart.

At the heart of Microsoft's new wave of products is what it calls the ".NET" strategy--a set of Internet services that will organize and automate functions that are now performed piecemeal from office and home computers, cell phones and other devices.

"It was very important for us to stay focused on our product work," Gates said Thursday, calling the past year's roll-outs "some of our best work."

Microsoft's services rely on a programming language called XML, which allows information to be exchanged easily from one format to another. Each new product has been developed with increasing amounts of XML capability.

One advantage is that users can set up preferences for all their activities online. For example, if a flight booked online is delayed, the airline could send an e-mail warning, then page the user if there's no response within 10 minutes.

"They are a monopoly on the operating system, they are a monopoly on the productivity applications, and they are trying to move into the services space," said Ted Holmes, an analyst with Microsoft stockholder Brinson Partners in Chicago.

The first big piece of the system is Microsoft's Passport service, which asks users to enter contact and credit card information to facilitate and manage online transactions. Windows XP will automatically prompt users to enter Passport data. Passport is free for now, and Microsoft plans on it becoming a central repository of individual information, smoothing both one-time and automated transactions for goods and services.

"We're way out in front on this," Gates said in a recent speech. "It's a new model for user-centric computing."

The problem, as Microsoft foes see it, is that the introduction of .NET services echoes how Microsoft crushed Netscape by bundling its own Explorer Web browser into Windows. The new, cleaner Windows start-up screen does not leave room for America Online or entry points into other non-Microsoft programs.

Passport and the other services that will follow could push Microsoft into the middle of most Web transactions as an authentication service. And because the programmers who develop new applications must conform to Microsoft's guidelines, their systems may work only on Microsoft's Windows and other proprietary software.

The result could be a self-perpetuating cycle, in which new services compel the few holdouts to buy the latest Microsoft products, which will drive even more Web software to the company's system.

The bundling tactic also will put Microsoft's new and improved instant-messaging service on Windows, an effort to gain ground on No. 1 America Online. Microsoft says it has about 32 million MSN Messenger users, less than a third of AOL's instant-messenger base.

The new Windows offers easy videoconferencing and allows multiple users to work on documents and other applications simultaneously.

To some, the most brazen use of Microsoft's clout was a feature in the just-released Office XP called Smart Tags, which also was to appear in Windows XP and forthcoming versions of the Internet Explorer browser.

In Windows XP test versions, Smart Tags highlighted words in Web pages and offered to direct viewers to sites of Microsoft's choosing. A stock-market symbol for IBM, for example, would be underlined and a quick trip to Microsoft's financial information site for a price quote would be suggested.

Critics said Smart Tags violated copyright protections for individual Web sites and demonstrated how eager Microsoft was to use its software to control Internet traffic.

Late Wednesday, Microsoft responded to the criticism, saying it would drop Smart Tags from Windows XP until it works out a less controversial way of using the technology.

But other examples in test versions of Windows XP bear out the company's pattern of bundling. An automated help function that allows experts to take control of a user's machine works only with Microsoft's instant messaging, not AOL's. A tab offering music purchases from Windows Media Player takes users only to sites that have deals with Microsoft, including CDNow.

So Web purists are even less happy with the new, emboldened Microsoft than they were with the company's earlier attempts to alter Web standards in its own favor.

But given the appeals court action and Microsoft's recent performance, the company's investors aren't very worried.

"Two years ago, we had a somewhat negative view. We were concerned about the PC business," said Tim Swanson, head of equity investments at Wachovia Asset Management, which has been buying more Microsoft shares. "We're more comfortable with Microsoft's prospects compared to others. They have a very good track record of dealing with risks."

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