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Microsoft Corp.'s intent to
acquire Intuit Inc. for $1.5
billion sent competitors run-
ning for cover—and to
lawyers, who composed a 49-page White Paper arguing for gov-
ernment intervention against the merger. UPSIDE makes available
an exclusive version of the White Paper, which has been circulat-
ed only to U.S. Department of Justice officials and, presumably,
to the undisclosed companies that financed it. In the paper, four
- attorneys from the Palo Alto, Calif., law firm of Wilson, Sonsini,
Goodrich & Rosati, buttressed by arguments from two Stanford
University economists, set forth new theories about Microsoft's
domination of the digital revolution. Though the paper (edited
. for length but not otherwise changed by UPSIDE) reads as though
lawyers and economists wrote it, it's important because it repre-
sents one of the most complete accounts of Microsoft's strategy to
dominate the software industry. It also presents compelling rea-
sons why the government should take action against Microsoft.
52 UP SIDE FEBRUARY 1995 ILLUSTRATION BY BRUCE MCGILLIVRAY
Approximately three years ago, Microsoftentered the personal financial software marketwith its own product, Microsoft Money. With
the proposed acquisition of Intuit, however, Microsoft isabandoning Money and reentering the market by way ofacquiring Quicken. It also is entering the tax prepara-tion software market for the first time, with the acquisi-tion of TurboTax. The deal at bottom raises the follow-ing question: Is the substitution of Microsoft for Intuitas the market leader, and Novell (or any other company)for Microsoft as a competitor, likely to be anticompeti-tive and to tend to create a monopoly?
Both the personal finance software and consumertax preparation software markets are extremely concen-trated. Regarding personal finance software, the mostcommonly cited figure for Quicken is that it controlsapproximately 70 percent of the market, and thatMicrosoft's Money accounts for another 10 percent. TheHHI [an economic measure of dominance in a market]for this market accordingly would exceed 5,000 [out of apossible 10,000]. In retail sales, moreover, it appears thatQuicken's share is even higher—in the range of 86 per-cent. The HHI for retail sales in personal finance soft-ware thus might well exceed 7,000.
The numbers are likewise extremely high for thetax preparation market. At the time the Department ofJustice addressed the proposed Intuit-ChipSoft transac-tion in December 1993, it estimated that ChipSoft'sTurboTax and Meca's TaxCut together accounted forapproximately 75 percent of the tax preparation soft-ware market. Of that, ChipSoft, which is now owned byIntuit, is estimated to hold a 55-60 percent marketshare, again yielding a very high HHI of more than 3,400(assuming 55 percent for ChipSoft and 20 percent forMeca). As in personal finance, the retail numbers lookeven higher: One source gives Intuit a 78-85 percentmarket share (and 15-18 percent for Meca). These num-bers would yield a market concentration figureapproaching that in personal finance software, on theorder of an HHI of 6,000 or more.
Not only are these markets extremely concentrated,but recent experience indicates that they have very highbarriers to entry. Computer Associates, in trying toincrease market share in the personal finance softwaremarket, is reported to have given away for "free"(excluding postage and shipping charges) 1,000,000copies of its personal finance programs. CA is reported,however, to have achieved little market share.Microsoft's experience in trying to increase marketshare for Money also supports the conclusion that barri-ers to entry are high. After three years in the market, inwhich it frequently charged approximately one-third theprice that Intuit did for Quicken and made a very sub-stantial commitment in marketing staff and resourcesto Money, it gained only approximately a 10 percentmarket share.
These high barriers to entry appear to reflect thesubstantial lock-in effects that exist in both the personal
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way. The Intuit acquisition is intended to control the gate-way on the home-to-business client side and leverage towardthe home-to-business server. Application of "increasingreturns" economic analysis would reasonably predict that,given the present situation, Microsoft will succeed inmonopolizing the entire network (just as it has monopolizedthe desktop) and that the monopoly will remain in place for avery long period of time. Indeed, the Intuit acquisition islikely to hasten the development of a monopoly on theenterprise and home-to-business server markets so vast thatMicrosoft will be able to extract monopoly rents on notonly financial transactions, but also the transmission ofinformation and data.
There are two underlying characteristics of the tech-nology at issue here that give rise to increasing returns.First is the fact that users are physically connected in anetwork. Networks exhibit and produce certain impor-tant economic results. Since the purpose of the networkis to enable communication with others, the value of thenetwork increases with the total number of users whojoin the network. Consequently, once a network such asthe Microsoft Network is in place, a competing networkwould have to enter the market with at least as large anumber of nodes in order to displace (or even competemeaningfully) with the Microsoft Network.
The second basic characteristic of this type of tech-nology is referred to as "compatibility" in the economicliterature. Unlike other, more conventional industries,the value of the technology to end users increases withthe number of users who use compatible technology.Unlike the "network" feature of the preceding paragraph,which draws its force from the physical interconnection,the "compatibility" driver of demand-side economies ofscale arises from a dependency of mutual use by con-sumers without regard to actual physical interconnection.
There is as yet no economic literature that appliesincreasing returns economics to precisely the situation atissue here. However, there is an extensive theoretical lit-erature, with direct empirical application to industriessuch as telecommunications, broadcasting, computersand ATMs. Application of the literature and logic ofincreasing returns economics to Microsoft's strategy (andsuccess) of targeting, linking, leveraging and locking invarious gateway points on the network, strongly indi-cates that, notwithstanding Microsoft's incipient posi-tion in certain products and markets, the forces of theeconomy will not be sufficient to impede Microsoft'smove toward dominance. Indeed, increasing returns anal-ysis would suggest that government intervention will beoptimal in producing competition if undertaken at theincipient stage. Once the network is successfully imple-mented, the social and economic costs of dismantling itare overwhelming, and, in any event, there would simplybe no significant competitors to restore to the market.
Increasing returns economic analysis would logicallysuggest that the American software industry is headedfor IBM redux, but on a far greater scale. Microsoft willlikely be able to dominate the entire server network and
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exert tremendous power over all information transmission.Just as was the case with IBM, it is not reasonable to expectthat other countries will permit the concentration of suchvast economic and political power under the control of a sin-gle company—and certainly not an American company. Inthe 1970s IBM crushed the American mainframe computerindustry, but Japan and Europe protected their mainframecompanies, with the result today that the only meaningfulcompetition for IBM mainframes comes from Japanese andEuropean companies.
It is reasonable to expect that the same will occurwith respect to software and on-line information ser-
*) vices. The markets today consist almost entirely ofjj American competitors. But without government inter-
vention, Microsoft will in short order crush this competi-tion. Foreign governments will intervene to protect their
E o w n companies and markets, and the only competitionin the future will come from foreign sources. • > t
ANTITRUST PERSPECTIVE
O n one level, the antitrust laws, as currentlyapplied, seem ill-equipped to deal with anincreasing returns network. The MergerGuidelines, for example, suggest that mar-
ket power derives largely from horizontal concentrationswithin a market, and hence, the Guidelines seem tofocus on static market concentrations. No meaningfulanalysis of related markets, much less targeting, linkingand leverage, can be found in the Guidelines. Even inrecent years, mergers were evaluated without a sufficientappreciation of the impact of market interrelationshipswithin the software industry.
There are certainly more progressive trends. A num-ber of courts, including the Supreme Court, have begun toevaluate conduct in one market based upon conditions inan adjacent, related market. Relevant decisions havebegun to reflect increasing returns analyses. A plaintiff'suse of leverage in lock-in situations has frequently beencited in the lower courts as a principal basis for the denialof summary judgment motions in both tie-in and monop-olization situations. In short, both the case law and theGuidelines would permit consideration of the Intuitacquisition on a basis other than static market considera-tions. Moreover, the case law would support actionagainst Microsoft based upon increasing returns analyses,notwithstanding Microsoft's incipient position in somemarkets on the larger network.
Optimally, the acquisition of Intuit should be en-joined. Employing a static market analysis, the effect ofthe acquisition "may be substantially to lessen competi-tion" in the markets for financial planning and tax prepa-ration software. More importantly, viewing the homeclient as part of the larger network, the anticompetitiveeffects of the acquisition at other points in the networkbecome readily apparent or, at the very least, probable.
There are certainly less restrictive alternatives thatwould preserve most of the efficiencies of vertical inte-gration Microsoft would enjoy by outright acquisition.
66 UPSIDE FEBRUARY 1995
cuting electronic bankcard transactions across global publicand private networks." In the question-and-answer session fol-lowing the press release, the Visa spokesperson said the drivingforce in Visa's decision to do the deal with Microsoft was thefact that Microsoft had sold 60 million copies of Windows.
If Microsoft is successful in establishing the standard forthe home-to-business server, it will be able to leverage into theenterprise server market both from the desktop, which italready controls, and the home market. Once a businessdecides that it should use the Microsoft server to communi-cate with customers, there is no point in having a different,probably incompatible, server for intrabusiness needs. Afterall, the OS for the server side of Microsoft's home-to-businessserver is Windows NT. Why have a different enterprise-serverOS? Similarly, the database service on Microsoft's home-to-business server will be either Microsoft SQL Server and/orMarvel. A business is unlikely to have a different database ser-vice for intrabusiness needs. This connection between thehome server and the business server is clearly Microsoft's con-templation because Microsoft has already anounced thatMarvel will connect directly to a company's server.
THE INTUIT PURCHASEicrosoft's acquisition of Intuit is highly strategic.It is preemptive. It gives Microsoft a monopolyon the client side of home-to-business fromwhich to leverage "backward" to the home-to-
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business server and the enterprise server. Microsoft is paying a100 percent premium to market for Intuit. This is not merelyMicrosoft's attempt, as a matter of ego, to put out of businessthe competitor which continued to have success in the face ofMicrosoft's efforts. Nor is it merely an attempt to monopolizethe PC tax and financial software markets, where products sellfor less that $50. Rather it is part of a well-thought-out plan tocontrol the client side of the home-to-business server market,leverage that control to control the home client OS, and backto control of the server.
On the most trivial level, Microsoft can bundle Quickenand TurboTax into a suite of home-based applications (includ-ing, e.g., Encarta), thereby solidifying its monopoly of homeapplications. Neither Lotus nor Novell could offer a viablecompetitive product. Microsoft would then have additionalpower to leverage to the enterprise server by putting additionalserver technology into Windows and Windows applications, asit has already been doing. Greater strength in the enterpriseserver market , in turn, allows Microsoft to exploit theWindows N T connection and begin to control the home-to-business server through leverage from the enterprise server.
The more important leverage comes through the operatingsystem. Microsoft will use the enormous market power ofQuicken and TurboTax to accelerate the acceptance ofWindows 95. Windows 95 will be "hooked" through Marvelback to the home-to-business server. For example, by control-ling Quicken and TurboTax, Microsoft can put features into
those products that require the user to~>* - buy Windows 95. Or, for that matter,
Microsoft could give away Windows 95by including it free of charge with thenext upgrade of TurboTax and Quicken.Many homes would not need (or yetwant) the enhanced functionali ty ofWindows 95 (and it will be more difficultto install than merely an upgrade of a taxprogram), but by using the market powerof Intuit 's products, Microsoft can fur-ther insinuate Windows 95 into the mar-ket, thereby controlling the architectureof the home client. Even if Microsoftdoes not make Quicken and TurboTaxavailable only on Windows 95, it could atthe very least make the Intuit productsbehave better or deliver enhanced func-tionality on Windows 95. Windows 95,of course, directly connects with Marveland provides a seamless pathway back tothe server OS, Windows NT. For busi-nesses that want and need home-to-busi-ness connections, Windows 95 will beubiquitous at the home client. Marvelwill link to Windows NT and WindowsNT will work best with the MicrosoftSQL Server.
Microsoft will use the market powerof the Intuit products to leverage bothvertically within the home client and
I
1
Mark StahlmanRobert SteinShinobu ToyodaDouglas TrumbullJohn WarnockRobert WinterKristina WoolseyStrauss Zelnick
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horizontally to the home-to-business server, with the resultthat Microsoft will initially dominate home banking and even-tually all home-to-business server products. Home banking is avery attractive client/server application. It has broad consumerappeal in that everyone has a bank account. It requires theintegration of several sources of data including bank accounts,brokerage accounts and credit information. Because ofQuicken's commercial success, there is a strong network exter-nality (lock-in) attached to a user's viewing his personal finan-cial information through the Quicken user interface.Accordingly, Quicken provides tremendous leverage into thehome banking market. Microsoft will provide an enormousmarket power edge to its own on-line service, Marvel, by mak-ing Quicken available exclusively (as among on-line services)on Marvel.
Domination of home banking provides the optimum plat-form from which to dominate other on-line services, including,for example, shop-at-home. Businesses that want to providefinancial information to Quicken users, or who want to pro-vide other on-line services, will want to choose server softwarefor interacting with Marvel. Microsoft will be able to use all ofits vertical integration skills developed in the desktop andenterprise server marketplace to ensure that businesses chooseMicrosoft home-to-business server software.
Of course, other on-line services may cobble together a net-work, but consumer acceptance would be difficult, particularlyat the point of sale where Microsoft is leveraging Quicken'sacceptance. By controlling the architec-ture and embedding proprietary OLEtechnology, Microsoft will be able to pre-clude interoperability over its network,and, given its monopoly power in variousgateways including the home client(through Quicken), businesses will havelittle option but to choose Microsoft'sdistribution network.
As a result, Microsoft will be able touse its market power and near exclusivityto reap tremendous profits. Query: IsMicrosoft's market power so strong thatit could demand control of the content ofthe software distributed across its net-work? What about the content of infor-mation, like raw educational or politicalinformation? What content providerwould be in a position to resist Micro-soft's demands for content control as aquid pro quo for distribution?
But why should Microsoft botherwith publishers at all? It can provide con-tent itself and put competing publicationsout of business. Once competing publica-tions are gone or diminished, Microsoftcan exercise content control over the fac-tual and information contents of thematerial on the Network. If this seemsfar-fetched, note that Microsoft's Encartaencyclopedia already outsells Encyclo-
pedia Brittanica. Microsoft is clearly aiming to conquer elec-tronic publishing.
It is difficult to imagine that in an open society such as thisone with multiple information sources, a single companycould seize sufficient control of information transmission so asto constitute a threat to the underpinnings of a free society. Butsuch a scenario is a realistic (and perhaps probable) outcome.
1 IN <^ K fccINCREASING RETURNS
iven the anticompetitive ramifications of the Intuitacquisition in the markets for personal finance soft-
- ware and tax preparation software, Microsoft must,of necessity, try to justify those effects by pointing
to benefits in some larger market. In the larger market,however, given Microsoft's market power at various gateways,the net effect of the acquisition is more likely anticompetitivethan pro-competitive. The economic characteristics of thetechnologies and markets at issue here differ markedly fromother, more conventional industries, in that these products(software products) and markets (networks) exhibit "increasingreturns," also sometimes called "network effects."
It is readily apparent that Microsoft's strategy of targeting,linking and leveraging from the desktop OS has been success-ful in seizing control of the business client. It is also apparentthat Microsoft is leveraging from the business client to thebusiness server and is vertically integrating within the busi-ness server so as to seize control of the critical server OS gate-
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INTRABUSINESS SERVER
M icrosoft's next goal is the intrabusiness server.There is currently intense competition in thevarious layers of the server markets. Novellenjoyed early entry into the server OS market
and still has significant share in its product NetWare, as towhich network externalities have attached. Similarly,Informix, Oracle, Sybase and others enjoy strong positions inthe database services market. Microsoft will make everyattempt to displace all of this competition, just as it did indesktop, by employing multiple linkages and leverage. It willdo so chiefly through three strategies: (a) vertical linkagessimilar to those that worked in the desktop markets, (b) hori-zontal linkages from desktop to intrabusiness server, and (c)horizontal linkages from home-to-business server to intra-business server.
Microsoft began the implementation of its strategy bycreating a new server OS (Windows NT) that horizontallyleverages from the monopoly position of DOS/Windows inthe client market. Indeed, Microsoft has increasingly placedserver functionality into Windows and Windows applications(e.g., Access, Fox Pro, Excel). At the same time, Microsoft dis-continued OS/2 development efforts because Microsoft wasso strong (and IBM so weak) that Microsoft no longerneeded to leverage IBM's mainframe monopoly position.
This horizontal leverage would not be sufficient todisplace competitors in the OS and higher levels, soMicrosoft applied vertical leverage as well. Examining thevertical layers of the server side, Microsoft readilyobserved that it could leverage from OS to database ser-vices and that database services was a key technology,which, if controlled by Microsoft, could be leveraged"down" against Novell in the OS layer, as well as "up"against application providers.
In order to exploit the database services level,Microsoft needed to move from its position as a resellerof Sybase's SQL Server on Microsoft operating systems, toa position in which it controlled its own database prod-uct. It did this by negotiating with Sybase to obtain rightsto the SQL Server technology, with which Microsoft wasalready familiar. Microsoft will now leverage verticallywithin the server side, both upward and downward.Microsoft markets Windows NT, touting tight integra-tion between Windows NT and Microsoft SQL Server.Similarly, Microsoft markets its SQL Server, based on thelinkage between the monopoly position in Windows OS,Windows applications and SQL Server. This can be cor-roborated by various Microsoft prospective customers.
Microsoft still faces a "problem" in that current ver-sions of Windows work with competitors' database ser-vices products too well. But in statements to potentialcustomers, Microsoft has promised to break the interop-erability between Windows and competitors' databaseservices products so that Windows applications will workbest with the Microsoft SQL Server. This will be accom-plished, in part, through the introduction of new OLEinterfaces into both the server and the applications, and acorresponding de-emphasis of open interfaces like ODBC.
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Microsoft also enhances its power in the server applica-tions layer by horizontally bundling these products into asuite (the Back Office) in the same way Microsoft bundleddesktop applications into a suite. Just as with the desktopapplications, there is also vertical leverage to enforce the hori-zontal bundle by making all server applications OLE-enabled.
H O M E - T O - B U S ! NESS SERVER ;
I ncreasingly, business will need to communicate with thehome in order to sell products or services and in order toprovide information, for work or other purposes.Obviously, businesses that exploit this channel will have
a strong advantage over competitors that do not, with theresult that all businesses will seek entry. Control of thehome-to-business server market by a single company wouldproduce an enormous windfall. First, of course, the companywould be able to extract a toll for a large percentage of con-sumer financial and product transactions. More strategically,a company that controlled the home-to-business server mar-ket could leverage that control back to the intrabusiness, orenterprise server market. Control of both sides of the servermarket, intrabusiness (enterprise) and home-to-business,would place enormous power (financial, informational, edu-
cational, etc.) in the hands of a single company. Microsofthas this power within its grasp.
Microsoft is pursuing its policy of targeting, linkingand leverage to seize control of the architecture of thehome-to-business server. Microsoft already markets NTwith the Microsoft SQL Server as the way to communi-cate with customers in homes. Microsoft tells the cus-
<«J tomers of other database services providers that the cus-£2 tomers already have Microsoft on the home desktop and
the [database] customers should move to NT because it ischeap. Microsoft argues that its engineers know the inter-nals of Windows NT and will create (and maintain) aserver for that market with links that competitors cannot
__* replicate, given their lack of access and information., Microsoft has announced its own on-line service
^ known as Marvel. Microsoft will use OLE-based tools to*~! enable businesses, developers and users to create object-
oriented documents that can be transmitted over Marvel.Indeed, Microsoft CEO Bill Gates has stated that "we'llgive you access to [Marvel] with Windows 95. . . . If (thesoftware) notices you have a modem, it will ask you if
O | you want to register electronically." This access to cus-£3 tomers through Windows 95 gives Microsoft "a potentf—i plan for spreading Marvel" that dwarfs the installed base•4_> of other existing competitors in this market (an estimatedO 14 million users, compared to 1.25 million subscribers for
T - Q America Online).- j - Even without the Intuit deal, Microsoft has such enor-
1 i i mous market power, from compounded positive feedbackon its various monopolies, that it likely will end up con-trolling the home-to-business server and client unless
QJ there is strong government intervention. The power ofMicrosoft's positive feedback is best demonstrated by theNovember 8, 1994, announcement of Microsoft and Visa
C/5 for the provision of a standard and secure method "for exe-
6 2 U P S I D E FEBRUARY 1995
As new technologies overcame the old mainframe mar-ket, the market for computer products formed into a numberof horizontal markets (featuring aggressive competition) thatare vertically related to each other. From the initialmonopoly bestowed on it by IBM, Microsoft has leveragedand linked a series of powerful monopolies with the intent offorming a new verticality on the market. There was littleresistance to Microsoft's efforts to unify the OS because aunified OS (or a small number of competitors) is necessaryfor the industry to grow. More importantly, after establishingseveral monopolies with enormous leverage potential, thepositive feedback from the verticality imposed by Microsoftwill in short order eliminate competition on all horizontallayers within the server market, just as it has already elimi-nated competition in the horizontal layers on the desktop.
THE BUSINESS DESKTOP
A n understanding of Microsoft's conduct on thebusiness client is critical to an understandingof Microsoft's targeting, linking and leveragingto the server and to the home client. As previ-
ously noted, IBM bestowed a monopoly on Microsoft inthe form of the OS. Microsoft then targeted the adjacentlayer with the highest number of fragmented players,i.e., desktop applications. Microsoft used the moneyfrom licensing the OS to fund the development of appli-cations to run on DOS, in competition with softwarevendors which had no operating system control (e.g.,Lotus, Borland, WordPerfect). But because of the relative-ly open nature of DOS, Microsoft could not exercise suf-ficient control to give its applications a strong competi-tive advantage over those with significant installedbases, as to which powerful network externalities hadattached.
Microsoft "solved" this problem by (1) developing anew operating environment (Windows) that it totallycontrolled, (2) targeting functionality in the applicationlayer that it could either embed in or link with the OS,and (3) using its power over DOS to migrate users toWindows. Microsoft thereby got more control over theOS, added value to the OS it controlled and forced inde-pendent application publishers to rewrite all of theirapplications twice (once for Windows and a second timefor OLE).
This strategy succeeded in monopolizing both thedesktop OS and desktop applications. Once Microsofthad control of the operating system, which is the keyarchitectural technology for desktop computing, it wasable to maintain its share, even with an inferior product.The introduction of DR DOS from Novell showed thatMicrosoft had failed to keep MS-DOS abreast of leadingtechnology. Yet Novell's compatible offering in the DOSmarket (DR DOS) stopped selling when Microsoft madeit clear that Microsoft would create versions of Windowsthat were incompatible with DR DOS. It is common for"better" products to fail if a competitor controls thearchitecture in which the product operates. At the sametime, Microsoft dominated the application market by
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moving the GUI from the application (where it previouslywas, except on Apple) to the operating system-
Microsoft leveraged its control over Windows to controldesktop applications, following a carefully crafted plan. First,Microsoft copied an application from the market leader inthat application (e.g., Lotus), breaking the network externali-ty of the installed base by providing file and keystroke com-patibility. Microsoft based its own compatible applicationprogram on unique components in the operating system thatit had unique or early access to (e.g., Windows). Microsoftclaimed it was "open," but actually used hidden features andfunctions to gain competitive advantage. It provided a propri-etary architecture with a supposedly "open" system. And itused its profits from its monopoly position in OS for (1) mas-sive marketing to promote the linkage features of the OS,and (2) sustaining a protracted battle with independent appli-
cation vendors in a new market that, without the profitsfrom the leveraged market, could not be sustained.
Microsoft further exploited its leverage, both vertical-ly and horizontally. Horizontally, within the desktopapplication layer Microsoft moved to other applications,touting and exploiting the benefits and advantages of itsvertical linkage (to the OS): e.g., word processing (Word),database (Fox Pro and Access) and presentations (Power-Point). Microsoft also employed horizontal leverage (inthe application layer) through its marketing practice ofbundling a group of applications into a suite, which issold at low price points. Microsoft funded applicationdevelopment and low-priced suites from OS profits.Vertically, Microsoft created interoperability betweenapplications by creating a new standard, OLE, which it"appropriated" from Hewlett-Packard's New Wave. Withmarket power on both sides of the interface (i.e., in bothapplications and the OS), Microsoft easily displaced the
tZ existing standard, DDE, in favor of OLE. It embeddedj*£ OLE functionality into both its OS and its applications,
and it heavily marketed this new functionality using themonopoly profits from its market position in OS.
Microsoft asserted that it was sharing specificationswith competitors, but it actually seeded specificationsfor OLE (and Windows and Windows NT) to its ownapplications group early, thereby guaranteeing betterintegration between its own applications and the OS(Windows) than any other applications vendor could pro-vide, and/or, at worst, an 18- to 36-month lead because ofcompetitors' normal software development cycle afterreceiving specifications.
This strategy has been enormously successful on thedesktop. Microsoft's share of OS sales is a staggering 85percent. IBM's OS/2, however, still commands about 10percent of current sales, notwithstanding Microsoft's
E best efforts to displace it. Similarly, in desktop applica-tions, despite having a tiny share of the pre-Windowsmarket, in 1993 Microsoft commanded an 85 percentshare of the Windows application suites sold. Hence,although Microsoft's share of desktop applications wasinitially quite small, it achieved market power quickly
fd through linkage and leveraging.
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60 UPSIDE FEBRUARY 1995
Microsoft's proposed acquisition would be likely to increasemarket concentration in two already highly concentratedmarkets and to raise barriers to entry. It would also reducecompetition by eliminating Microsoft itself as a competitorin these markets. Because there can be little doubt that theacquisition will have anticompetitive effects and is like-ly to tend towards a monopoly in these markets, thetransaction is an appropriate one for the Department toset aside under Section 7 of the Clayton Act.
THE LARGER MARKET
At the outset, two characteristics should beemphasized. First, the products at issue aresoftware products, composed almost entirelyof intellectual property content. Because of
the nature of software, there can be greater flexibility inthe formation of vertical relationships than is presentwith respect to more conventional products. That isbecause vertical integration does not require exclusivity:Unlike a pipeline, many competitors can vertically linktheir software, through software compatibility, to prod-ucts in the markets above and below them.
Second, the markets at issue are "server" markets.Previous governmental evaluations of Microsoft focusedprimarily on the "desktop." But the desktop is reallyonly an interrelated component of a network that con-tains desktops and servers. These software networksbear many of the characteristics that economists havebegun to associate with networks in other industries,including "increasing returns" or "network effects."Indeed, software networks manifest increasing returns,or demand-side economies of scale, even more stronglythan do other networks in more conventional industries.
There are two basic components of the server mar-kets. The intrabusiness server is the backbone of busi-ness. Microsoft has projected that there will be 300 mil-lion servers in the business community, runningeverything from phone systems, to copying systems, tocash registers. If a single company controls all businessserver markets and applications, that company has fargreater market power in various sections of the economythan, say, mere control of the desktop would bestow.Microsoft is pursuing a vertical integration strategy onthe intrabusiness server side similar to that pursued onthe intrabusiness client side.
The second aspect of server technology is the home-to-business server markets, sometimes known as "on-line services." Today, most on-line services run offmainframe computers the way Lexis and Nexis do.Businesses will increasingly need to sell directly into thehome through on-line services to remain competitive.Control by a single company of the home-to-businessserver markets would have significant economic ramifi-cations. Of course, control of both sides of the servermarkets would have very powerful anticompetitiveeffects. The home-to-business server does not yet exist,except in Microsoft's plans. It can be readily assumedthat the home-to-business server would look much like
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the intrabusiness server, with only Microsoft products beingvertically integrated
In short, Microsoft's overall business approach and strate-gy is based on the creation of technological linkages betweenlayers within the same market (e.g., DOS to Windows on the
desktop) and between layers in one market and corre-sponding layers in another market (e.g., Windows NT toMarvel to Windows 95 on the home client). To fullyunderstand Microsoft's strategy and its economic impli-cations, however, it is necessary to understand two addi-tional strategic Microsoft technologies: OLE andWindows.
OLE (object linking and embedding) is the Microsoft-imposed standard for sharing information both amongapplications, and between applications and the operatingsystem. During the earlier DOJ investigation, desktopapplication companies complained that Microsoft seededOLE to its captive application developers before giving itto ISVs (independent software vendors), thereby giving itsown applications a lengthy head start over the competi-tion. Microsoft is doing the same thing on the server side.Microsoft has made it clear that OLE will be strategictechnology for the home-to-business server market, buthas not provided sufficient specifications to independentdatabase server providers to enable them to release equal-ly well-behaved products on the same time schedule asMicrosoft's own products.
Microsoft's first Windows products were targeted forthe desktop and were built on top of Microsoft's domi-nant desktop operating system, MS-DOS. Because oftheir DOS legacy, these products are unable to take fulladvantage of the capabilities of the 32-bit microproces-sors they run on. Microsoft's current product in this areais Windows 3.1, which is preinstalled on most desktopsystems presently sold. Microsoft plans to proliferateWindows 95 widely next year as the successor toWindows 3.1. Windows 95 is a true 32-bit operating sys-tem being targeted to the mainstream personal computermarket. Furthermore, Windows 95 breaks the reliance onMS-DOS that precluded long file names and more effi-cient file servers.
Windows NT was Microsoft's first true operating sys-tem for 32-bit microprocessors. NT's principal use is inthe server market, but Microsoft has also targeted its NTmarketing to power users running high-end personalcomputers or workstations. Microsoft markets a versionof NT with advanced server capabilities, called WindowsNT Advanced Server, as an enterprise-wide computingsolution. Microsoft offers a suite of applications forAdvanced Server called Back Office that includesdatabase services, electronic mail, systems management,and connectivity to mainframe and minicomputers.Microsoft's vision for enterprise computing is being mar-keted through its plans for a replacement for WindowsNT, currently code-named Cairo. Cairo brings object-ori-ented technology into the file server and operating sys-tem. Microsoft already controls object standards throughits OLE specification.
58 UPSIDE FEBRUARY 1995
HAMBRECIIDB
Communications
Group
has agreed to merge with
LDDSCommunications
Pending
$65,400,000
Alliance
Semiconductor
Follow-On Offering
• Lead Managed •
October 21, 1994
DNX Corporation
Baxter International
have formed a newCompany,
Nextran
August 1994
$8,500,000
CDP
Technologies
Initial Public Offering
• Lead Managed •
June 14, 1994
$12,900,000
Targeted
Genetics
Initial Public Offering
• Lead Managed •
May 20, 1994
Concord Holding
Corporation
has agreed to merge with
The BISYS Group
Pending
$15,000,000
FPA Medical
Management
Initial Public Offering
• Co-Managed •
October 21, 1994
Read-Rite
merged with
Sunward Technologies
August 1994
$17,300,000
Diametrics
Initial Public Offering
• Lead Managed •
June 14, 1994
$25,000,000
Marcam
Private Placement ofSubordinated Notes
with Warrants
May 1994
$25,900,000
Micrel
Initial Public Offering
• Lead Managed •
December 9, 1994
$37,300,000
PRI Automation
Initial Public Offering
• Co-Managed •
October 13, 1994
MacNeal-
Schwender
acquired
PDA Engineering
August 1994
$41,800,000
Itron
Follow-On Offering
• Lead Managed •
December 7, 1994
$88,800,000
Mariner Health
Group
Follow-On Offering
• Lead Managed •
October 12, 1994
$65,600,000
PLATINUM
technology
Follow-On Offering
• Lead Managed •
December 6, 1994
$20,800,000
SUGEN
Initial Public Offering
• Co-Managed •
October 4, 1994
$13,800,000
Micrion
Follow-On Offering
• Lead Managed •
November 29, 1994
Versatest
was acquired by
Hewlett-Packard
October 1994
Financing$40,000,000
InfoVest
Private Placement ofCommon Stock and
Preferred Stock
June 1994
Mammoth Micro
Productions
was acquired by
The Washington PostCompany
May 1994
$18,100,000
Fresenius USA
Follow-On Offering
• Co-Managed •
June 3, 1994
Mariner Health
Group
merged with
Pinnacle Care
May 1994
$40,000,000
CCC InformationServices
Private Placement ofRevolving andTerm Loans
June 1994
inanci
$20,700,000
Transaction
Network Services
Initial Public Offering
• Lead Managed •
April 22, 1994
$39,000,000
Quintiles
Transnational
Initial Public Ollcrin),
• Co-Managed •
April 21, 19'11
GrowthForOve
$65,600,000
Novellus Systems
Follow-On Offering
• Lead Managed •
March 14, 1994
Octel
Communications
merged with
VMX
March 1994
Tocor II
was acquired by
Centocor
in an exchange offer forall outstanding units
of Tocor II
March 1994
Rational
merged with
Verdix
to createRational Software
Corp.
March 1994
Chalone Wine
Group
Advisory
March 1994
$22,100,000
Global Village
Communication
Initial Public Offering
• Co-Managed •
February 23, 1994
$81,000,000
Renal Treatment
Centers
Follow-On Offering
• Co-Managed •
February 22, 1994
$26,5C
Soft.
Initial Publ
•LeadM
February
EXPERIENCE. F(SAN FRANCISCO (415-576-3300) NEW YORK
who get too close to Murdoch getburned. Those who do get drawn intoworking closely with Murdoch for aperiod of time discover that "their mar-riage goes to hell, and their families, andtheir health, because it's almost impos-sible to keep up with his schedule," saysa senior executive. (Former Fox chiefBarry Diller is but one example of anexecutive who was too powerful tocoexist with Murdoch.)
With his 32.6 percent share in thecompany, Murdoch is well supported bythe board. Despite his reputation forkeeping the power to himself, he wasalso surprisingly well liked by seniorand middle management. Nevertheless,says a senior News Corp. executive whoasked to remain unnamed, "If I wantedto wield power I would understand thatrestricting people from infor-mation is the best way to dothat. Rupert never lets oneperson run anything because[that person] would under-stand it much better than hedoes, and that's not the way you can runan autocracy."
There are very few company veter-ans who are viewed to be in a positionto succeed him. Among those few isSam Chisholm, the tough-talking 54-year-old director of News Corp. Ltd. anddirector of Star Television. According toinsiders, however, Murdoch is groominghis own children to take over hisempire. Son Lachlan, just graduatedfrom Princeton, currently runs hisAustralian newspaper operations.Daughter Elizabeth, who has worked ina number of capacities at Fox, currentlyowns two television stations inCalifornia (not owned by News Corp.).Both are highly respected and well likedthroughout the company. His wife,Anna, who serves on the board, alsoknows the business inside out and iswell suited to take on the job as aninterim measure, say company insiders.Last fall, Murdoch smoothed the wayfor his children to take control of theempire by buying out the interests of hisextended family. The arrangementallows his four children to eventuallyhave 100 percent of Cruden Invest-ments, the private firm that owns 32percent of News Corp.
As Murdoch prepares for the transi-
tion to the future, and tenaciously pur-sues new opportunities, he also is dem-onstrating a surprising ability to let go.He has given the nod to a managementbuyout of News Electronic Data (NED),being led by Evans. According to Evans'colleagues, Murdoch is allowing Evansto buy out that promising company inappreciation of his 20 years of guidanceat News Corp.
Evans' colleagues say that being partof a gargantuan organization like NewsCorp. was slowing the NED founderdown, despite his impressive trackrecord of shoving the company into suc-cessful new business ventures. Thoseclose to Murdoch suspect that he willstill remain close to Evans, and bothwill support each other's efforts.
Nevertheless, Evans is not shy aboutacting on his beliefs that newmedia will require even moredramatic changes in howmedia companies traditional-ly think about relationshipsw i t h t h e i r a u d i e n c e .
"Murdoch still has a one-to-many viewof the world. The glacier has moved,however. Things have changed becauseof technology more than anyone imag-ines," he says.
At the same time, Evans recognizesthe benefits of Murdoch's almighty con-trol of the company: "They say in Koreathat fish rot from the head down. Sothey obviously must prosper from thehead down, too."
Amid his nonstop adventures,Murdoch knows that, regardless of thetwists and turns the infobahn may take,in the end the core of his businessremains the same. The new media busi-ness still involves all the elements ofthe traditional business: money fromadvertising, subscriptions and transac-tions. "The printing presses change,"Honey says. "But there are a lot of waysthat guys like Rupert Murdoch under-stand it." •
Wendy Goldman Rohm is a contribut-ing writer to UPSIDE and editor at largefor Interactive Week. She also writes forfor Wired, the Chicago Tribune and theBoston Globe. Rohm, who lives inEvanston, 111., welcomes contact viaphone at (708) 869-3140 or via e-mail [email protected].
Packard BellEuropean distribution,service center, assembly
ComputervisionMultinational telesales center
UnisysTelesales center andinternational distribution center
Hewlett-PackardEuropean call center,assembly, andcustomer support
KatunEuropean distribution center
MeriselEuropean distribution center
CordisManufacturing and R&D
GenzymeEuropean sales, marketing,regulatory headquartersand production
To learn how these and many othercompanies have entered or expandedin the European market through theNetherlands, please mail or fax thiscoupon to: Cap Vermeulen
-—JSfetheilands—fbreienlnvestment
—Agency-™—One Rockefeller PlazaNew York, NY 10020FAX 212-246-9769
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