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One More Turn In Software Story
People's Democracy
(Weekly Organ of the Communist Party of India (Marxist)
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Vol. XXVIII
No. 28
July 11, 2004
One More Turn In Software Story
C P Chandrasekhar
Microsoft's attempt to buy the biggest maker of corporate applications
represents an attempt at vertical integration as a competitive response.
EARLY in June, Microsoft shocked the global software industry once more. The
company revealed that for months starting some time last year it was engaged
in takeover talks with German software major SAP. The German company is no
new kid on the block. Valued at more than 50 billion dollars, it is the
third ranking independent software company. Besides, it is a company unlike
Microsoft. While Microsoft is technically a "hybrid solutions" company
offering both software products and services, it is primarily into products
that run the now ubiquitous personal computer. On the other hand, SAP
specialises in enterprise services such as systems integration and
maintenance and is a dominant player, along with Oracle and IBM, in the low
profile but high spending world of corporate back offices.
MONOPOLISING THE SOFTWARE BUSINESS
Although the talks were reportedly called off this spring, analysts are hard
put to understand why SAP considered the option for as long as it did. The
explanation offered by Henning Kagermann, SAP's chief executive officer,
that SAP "routinely evaluates" mergers that would improve its competitive
position, hardly clears the mist. What is obvious though is the set of
factors driving Microsoft --- an aggressive player hell bent on monopolising
the software business.
On the surface, the attempt at acquiring a major like SAP seems to be a
continuation of Microsoft's aggressive expansion that transformed it from a
garage adventure into the world's largest independent software company. As
its pockets deepened in the course of that expansion, Microsoft used its
surpluses, estimated at 56 billion dollars of cash-in-hand at the end of
March 2004, to aggressively defend and extend its control over the market
for PC software and direct-to-consumer accessories.
The evidence of such aggression is, to say the least, excessive. Examples
include the use of threats of destructive competition to acquire innovative
products and technologies generated by small start-ups. Thus the
web-publishing software, Frontpage, was acquired from Vermeer Technologies
and subsequently packaged with versions of Microsoft Office. In other
instances, acquisition came after alleged infringement of patents on
innovative technologies developed by small firms. Thus, it is alleged that
Microsoft adopted without licence the touch-based technology used in video
game consoles, including Microsoft's Xbox, developed by Immersion. Microsoft
chose to go in for an out-of-court settlement with Immersion on a patent
infringement case filed in February 2002. Interestingly, Microsoft paid 26
million dollars to acquire a minority stake in Immersion along with
licensing rights over the company's patent portfolio. This is one of many
cases that Microsoft has settled out of court, and yet there are a few dozen
patent-related lawsuits reportedly pending against Microsoft.
The interesting feature of this trajectory, however, is not the aggression
that has always been visible, but the more conciliatory moves that Microsoft
has been making ever since its extremely favourable "settlement" with the
United States Department of Justice in 2002. Recently, in fact, the pace at
which high-profile cases challenging the company are being settled out of
court has accelerated. In April 2004, for example, a private anti-trust suit
filed by Sun Microsystems was settled for nearly 2 billion dollars,
including a payment of 350 million dollars in licensing fees. Similarly, a
patent infringement complaint by InterTrust, which first developed the
technology used to protect music, movies and other digital "content" on the
Internet, was settled for 440 million dollars.
But it is not always that Microsoft chooses to opt for quick resolution once
the case is seen as unwinnable. In other instances, where the cost of
settlement is seen as high, the case is dragged on so as to exploit a
pre-existing position in the market and allow technology to make the issues
on which anti-trust complaints have been filed irrelevant. Two cases where
Microsoft has adopted this strategy with some effect have received quite
some attention. These are its efforts to monopolise the market for browsers
and media players, by bundling its own version of the required software with
the Windows operating system.
In the first case, Microsoft fought a hard battle against the US Department
of Justice and managed a settlement that was far weaker than the outcome
that was originally expected - a decision to break up the company and force
it to license a stripped-down version of Windows to competitors so that they
could offer it along with their own supportive software. The settlement came
after Microsoft was indicted in 2000 for maintaining through illegal means
its monopoly in personal computer operating systems. Although that decision
was upheld in a Court of Appeal, the court watered down the original remedy
to break up the company.
However, the court granted 17 US states the right to pursue class-action
cases on the grounds that the company had abused its Windows monopoly.
Microsoft has been working on settlements with most of these states, nine of
which accepted one without pursuing the case. To Microsoft's discomfiture,
some states chose to pursue the case and demand disclosure by Microsoft of
software interfaces, which would allow competitors to write programmes that
inter-operate directly with Windows.
ATTITUDE OF CONCILIATION
Although most of these cases are yet to be resolved, Microsoft's attitude of
conciliation is already visible. A Minnesota lawsuit went before a jury in
March this year. However, soon thereafter, the software company arrived at a
settlement with the state. These settlements with or without a case have
cost the company a packet, touching an estimated 1.1 billion dollars in
California and 202 million dollars in Florida.
Outside the US too Microsoft has been the target of a European Union (E U)
anti-trust investigation over the last five years, triggered by Sun
Microsystems and the Computer & Communications Industry Association (CCIA).
The EU's case also deals with Microsoft's tactic of "bundling" new software
with its Windows operating system. In this case, the software concerned is
Media Player, which the European Commission (EC) believes has been bundled
with Windows to tilt unfairly competition against rival products, especially
RealNetworks' RealPlayer.
Recently, the EC ruled against Microsoft on both these counts and imposed a
heavy penalty. Microsoft has chosen to go on appeal. But here too, efforts
at conciliation are visible. A recent legal settlement with Sun Microsystems
is seen as part of an effort to reverse the EC ruling. This is because the
settlement with Sun, under which Microsoft agreed to pay 1.6 billion dollars
to end anti-trust and patent infringement claims, silences the company's
most vocal critic which had directed the attention of Europe's anti-trust
regulators at Microsoft and triggered the EU investigation when it filed an
official complaint in Brussels five years ago. Sun is also a leading member
of the CCIA that had also lodged a complaint against Microsoft in Europe.
Not surprisingly, Brad Smith, Microsoft's general counsel, reportedly said
that the Sun settlement "means that the only company that has had a formal
complaint against us for the past five years has said that it is entirely
satisfied". This, in his view, indicated that antitrust and patent disputes
could be resolved through private agreements and did not require broad
regulatory action.
Although as of now the EC is not willing to relent and sees its actions as
being part of a wider strategy of promoting competition and protecting
consumers, Microsoft's own strategy of conciliatory bargaining is clear.
Microsoft's view is reflected in Brad Smith's statement that if a private
settlement with Sun had been reached last year, it could have set the stage
for a settlement of the EU's case instead of last month's formal anti-trust
ruling.
What explains this conciliatory edge on the part of Microsoft, which has
been the industry's most aggressive and disliked player? An analysis of
software business trends indicate that the explanation lies in the changing
nature of the business itself, which warrants both a closer link with rival
players as well as a degree of consolidation that cannot occur if current
anti-trust tendencies persist.
MICROSOFT’S LOOSENING STANCE
There are three trends that are significant for understanding Microsoft's
loosening stance. The first is that despite Microsoft's efforts at
dominating the PC software market linked to the Windows operating system, it
is under threat because of the growing popularity of the Linux operating
system. Microsoft sees the need to diversify away from software products
that run PCs if it is to maintain growth and profitability.
Second, such diversification is also warranted by the fact that the software
market is moving up "the stack", away from the operating systems and towards
the "middleware" that ties different systems together and the applications
that run on them. This is seen as the result of the emergence of a new
generation in technology resulting from the growth of the Internet that
requires far greater integration between software technologies than we had
before. It is, therefore, an area where a greater degree of interoperability
between software products is important, necessitating more cooperation and
less rivalry between competing firms.
Third, in the search for dominance in the new technological context, firms
are trying to restructure their operations. Thus, IBM is seen as having
abandoned the applications business a few years ago in order to focus on
middleware. On the other hand, Oracle is seen as seeking to extend its reach
from middleware into applications, both through developing its own products
and more recently through acquisitions, as its failed effort to take over
PeopleSoft illustrates. Any firm planning to enter the middleware business
must respond to these tendencies.
Clearly, Microsoft has responded to all these trends. It is choosing to move
away from products. It is willing to "deal" with its rivals. And it is
considering acquisitions to strengthen its position. Initially, it developed
its own Dotnet technology to generate the "web" for a more decentralised
computing world. This signalled rivalry, since its competitors were using
the Java software standard developed by Sun Microsystems for the purpose.
But such rivalry has been tempered in recent years with the company willing
to work with competitors. The evidence quoted earlier indicates this new
mood of cooperation.
The Microsoft effort to negotiate a takeover deal with SAP is a corollary of
this new strategy of Microsoft. SAP invented enterprise resource planning
software, with which a large number of companies manage back-office
functions.
For Microsoft, which sells most of its software to customers through
computer makers and resellers, entering this area on its own would have
involved a major shift in the direction of an engineering-centric culture
and a process of learning the rules of a new business. Firms in the
"enterprise" market rely on direct sales and extensive maintenance and
service operations.
Seen in this light, Microsoft's attempt to buy the biggest maker of
corporate applications represents an attempt at vertical integration as a
competitive response. It is another matter that the deal if worked out would
have run into regulatory barriers that even Microsoft would have found
difficult to break down. But the fact that it was even contemplated points
to the process of transformation of the software business.
