Text of a recent Netscape letter to the Justice Department

Joel Klein, Esq.
Deputy Assistant Attorney General
International/Policy Matters
Department of Justice
10th & Constitution, N.W.
Room 3208
Washington, D.C. 20530

RE: Microsoft Illegal Conduct and Ramifications for Consent Decree

Dear Joel:

This letter is intended to supplement and clarify our earlier communications with the Department concerning conduct by Microsoft that violates both the existing Consent Decree as well as the substantive antitrust laws.

The Internet software industry currently exhibits great innovation, with the development of an astonishing number of new products and technologies that promise to transform the way that computers are used. These new products and technologies are being developed by a wide array of companies, from new start-ups to more established software firms. Many of the smaller Internet software vendors (including companies that make Internet software tools and servers), however, now face the threat of elimination from the market by reason of Microsoft's illegal conduct. While Netscape has greater resources to fight back against Microsoft's predation, both in the marketplace and through means such as this letter, many of these smaller Internet software vendors have made it clear that they have insufficient resources to fight back against Microsoft's illegal conduct in the market.

Much of Microsoft's conduct appears to violate both the letter and spirit of the existing Consent Decree entered in United States v. Microsoft. Indeed, Microsoft's behavior is, if anything, more anticompetitive and pernicious than the conduct addressed specifically in the Decree. In engaging in this far-reaching anticompetitive behavior, Microsoft hurts consumers and restricts consumer choice.

Microsoft's conduct

Microsoft's recent conduct far exceeds any reasonable definition of procompetitive, welfare enhancing behavior. Microsoft has made written offers to OEMS; Internet Service Providers ("ISPs"), including many "local and long distance telephone companies"; Value-Added Resellers ("VARs"), including systems integrators; and to large corporations. These offers provide for either clandestine side payments, discounts on the Microsoft system (Windows), or payments in the form of "real estate" on the Windows 95 screen. These inducements are made on the condition that the offeree make competitors' "browsers" (more correctly known as "Internet clients") far less accessible to users than Microsoft's own "browser." (Microsoft's browser, as you know, is called Internet Explorer.) A number of these offers have already been accepted and are in the process of being implemented.

In addition to these under-the-table arrangements, Netscape's recent investigation has uncovered numerous additional steps that Microsoft has taken for the purpose of eliminating competition in the Internet software markets. Microsoft's tactics include manipulating the disclosure of APIs; predatory pricing; and the bundling of products such as FrontPage, Internet Explorer, and Microsoft's Internet server ("Internet Information Server," or "IIS") with Microsoft's monopoly operating systems. This anticompetitive behavior directly threatens numerous small Internet software companies that are competing in these markets. Microsoft's illegal acts include the following:

With respect to original equipment manufacturers ("OEMs"), i.e. personal computer makers, Microsoft began by bundling its "browser" free for redistribution. Now, Netscape has been informed that Microsoft has gone even further, offering OEMs discounts on the license price of the Windows operating system if the OEM not only continues to feature the Microsoft browser on its desktop, but also makes competitors' browsers far less accessible to users.
The net effect is this. Every OEM automatically gets the Microsoft browser on the Windows desktop provided by Microsoft, whether desired by the OEM or not. If the OEM wants to give the consumer a fair and even choice of browsers by placing competitors' browser icons in a comparable place on the desktop, Netscape has been informed that the OEM must pay $3 more for Windows 95 than an OEM that takes the Windows bundle as is and agrees to make the competitors' browsers far less accessible and useful to customers.
Some OEMs have gone so far as to indicate that the Microsoft Windows discount really buys exclusivity. For example, Hitachi has refused to bundle Netscape Navigator with its laptop computer because it says that it is prohibited from carrying the product under its license with Microsoft. Indeed, Hitachi now has gone even further, and informed another company that it cannot carry its software because that product includes Netscape Navigator and therefore is prohibited by the Microsoft license.
The potential magnitude of Microsoft's secret tax on the OEM channel -- all for the purpose of restricting consumer choice -- is truly breathtaking. If estimates are correct that Windows 95 is selling at a rate of 40 million copies or more a year. it will cost OEMs more than $10 million to offer their customers non-Microsoft Internet software on an equal footing with that of Microsoft. And Microsoft has made sure that customers will never learn about these under-the-table deals. Microsoft muzzles all of the OEMs with "non-disclosure" terms that place them in an entirely untenable position: they have been induced with secret payments, and ostensibly cannot tell anyone, including their customers, about them.
In addition to its efforts to to strong-arm OEMs Microsoft has also targeted Internet Service Providers with special inducements based on its position as a monopolist. Microsoft has offered a wide array of sweeteners even to to the smaller ISPS-- one ISP, for example, apparently was offered not just free software but free hardware as well as free advertising if it would agree not to make Netscape Navigator (or other Internet browsers) accessible to customers. Netscape believes that Microsoft also has offered to "buy out" the contracts that larger ISPs have with Netscape, and some of the international ISPs have apparently received side payments in the form of $400,000 "marketing funds" on condition that they will not sell any Netscape or other Internet software. (There are also what appear to be complicated "bounty" payments from ISPs to Microsoft; Netscape is still trying to ascertain the nature of these payments.) Microsoft's most important inducement to the large ISPs, however, is in the form of currency that no other company in the world can match; a place on the Windows 95 screen. This unique asset, which Microsoft controls because of its monopoly in operating systems, is one that AT&T and NetCom could not pass up -- just like the online services before them. In all of these cases, Microsoft is directly using its monopoly to hinder consumer choice. The transactions work like this: the ISP (or online service) gets "paid" with a spot on the Windows 95 screen. Their customers, however, do not receive any "trickle-down" from this payment -- they do not, for example, get equal access to Microsoft's browser along with Netscape's and those of other Internet vendors. To the contrary: the "payment" that Microsoft extracts from these resellers is that they agree to make other Internet software less accessible to their customers.
Microsoft also is using its monopoly position in operating systems to restrict consumer choice in lnternet servers. For example, Windows NT Workstation is the platform of choice for consumers in many operating environments, and Netscape, O'Reilly and Associates, and Process Software (among others) have developed lnternet servers designed to provide consumers using this platform with the best possible functionality at the lowest possible price.
Microsofl is trying to take away this consumer choice. Microsoft has taken the position (as we informed you by separate letter last week) that these companies must artificially limit the functionality of their Internet servers to 10 connections. lt asserts that claim even though it admitted in its July 19 press release that it is "in the best interests" of "the large number of customers who are planning to base their Internet and intranet solutions on Windows NT Workstation" not to face such a limit. But Microsoft now claims that it can make its competitors abide by such a limit, just because it says so.
Moreover, Microsoft has expanded its strong-arm tactics on this issue to OEMS. For example, Microsoft has threatened OEMs that their users may be violating the Microsoft license agreement if the OEM bundles NT Workstation with Netscape's Internet server. And Netscape believes that independent software vendors writing products to run on Netscape's or other third parties' Internet servers have received the same implicit or explicit threat.
Microsoft's technical and legal manipulations on the 10-connection issue are not its only use of anticompetitive tactics in its effort to monopolize Internet servers. Equally notorious among Internet vendors was Microsoft's use of secret APIs in Windows NT Server to gain a preferential speed advantage for its lnternet server software ("IIS"). These APIS, which have a very significant impact on Internet server performance, were only disclosed by Microsoft in late 1995 in its "Service Pack 3," but were already incorporated into the beta of IIS released shortly thereafter. Plainly the IIS developers had been given these APIs months before the rest of the industry.
It was not until the end of June 1996 that Netscape was able to release a final version of its Internet server that incorporated the two new NT Server APIs. Other, smaller Internet server vendors. with fewer resources available, undoubtedly found it more difficult to catch up with Microsoft's unfair advantage. During this half-year interval, reviews (such as PC Week's March 1996 Internet server review) repeatedly emphasized Microsoft's speed superiority. But that superiority was not because its programmers were better than the rest of the industry's -- it is because they had an unfair advantage as a result of their operating system monopoly. Indeed, once Netscape was able to integrate these APIs in its June release, its Internet server did not simply match Microsoft's Internet server in speed, but significantly exceeded it. The APIs therefore were decisive in the half-year advantage that Microsoft held in Internet server speed.
Finally, Microsoft has resorted to a wide variety of predatory pricing and bundling behavior that violates the antitrust laws. For example, with corporate customers, Microsoft has agreed to a whole spectrum of free products and services, including free operating system upgrades, free consulting, free dialers, and so forth if the customer accepts the free Microsoft browser. Microsoft even offered international telecommunications customers $5 for every installed Netscape Navigator that they removed from their corporation and installed with Internet Explorer.
Microsoft is also bundling its "free" Internet Explorer and IIS with its operating systems. which according to news reports have already led some vendors to decide to quit the market. And its bundling of tools such as FrontPage for "free" with its operating system products (as well as distribution of FrontPage as a stand-alone product for "free" at least until the end of the year) have threatened the lnternet tools market, which includes promising young companies with "hot" products like NetObjects. In short, it is plain that Microsoft intends to "zero out" the markets for Internet servers, and lnternet tools (like Internet browsers), and drive all other competitors out of these markets.

The reason for Microsoft's conduct

Obviously, Microsoft has so little confidence in the success of its products in a fair comparison with those of other software vendors that it has resorted to undisclosed, under-the-table payments and other forms of coercion to impose its products on consumers. Survey after survey has shown that in a straightforward comparison, end users, both in individual and corporate environments, would choose a non-Microsoft product. For example, a recent survey of lntranet computer users found that companies provide employees with Netscape Navigator 58% of the time, and Microsoft's Internet Explorer 17% of the time (with other vendors making up the rest). When asked which product they primarily use, however, Netscape's share shot up to 89%, and Microsoft's dropped to 4%. In other words, Microsoft's product was offered four times as often as it would have been based on consumer preference, while Netscape Navigator was offered far less. Microsoft's conduct in buying off suppliers has inhibited if not precluded unfettered consumer choice.

Nor wouId resellers themselves, if left to their own devices, prefer to bundle Microsoft's browsers. They are forced to do so by Microsoft's overwhelming market power. Typical comments to Netscape include:

"All I can tell you is that the pressure and incentives from Microsoft are so outrageous they're scary."

and "Microsoft gave me a deal I couldn't refuse. Free dialer, browser, developers kit, free distributable, etc. ... I know Netscape is better, but $0 vs. $18K is impossible to beat."

The money to support these under-the-table payments comes directly from Microsoft's monopoly over the operating system. a point Bill Gates openly conceded to the Financial Times this June:

"Our business model works even if all Internet software is free," says Mr. Gates, "We are still selling operating systems. What does Netscape's business model look like (if that happens)? Not very good."

The point was made even more bluntly by a Microsoft representative who brazenly announced to hundreds of people in attendance at a program sponsored by Motorola:

"Our intent is to flood the market with free Internet software and squeeze Netscape until they run out of cash."

The entire industry will suffer if Microsoft is permitted to succeed. First. if the market remains open, it is far more likely that innovative developments will come from small competitors like NetObjects than from Microsoft. And to the extent that Microsoft does try to innovate, it will do so only under the spur of competition.

Second, the: Internet revolution has the potential for providing competition to Microsoft's desktop operating system monopoly. That is the reason, Netscape believes, why Microsoft has resorted to such desperate measures in trying to eliminate its Internet software competitors. The point was explicitly made in a speech by Bill Gates that was posted on the Microsoft Web page. While his speech is focused on Netscape, it would more accurately be directed at the entire Internet software revolution:

Netscape's strategy is to make Windows ... all but irrelevant by building the browser into a full-featured operating system with information browsing. Over time Netscape will add memory management, file systems, security, scheduling, graphics and everything else in Windows that applications require. The company hopes that its browser will become a de facto platform for software development, ultimately replacing Windows as the mainstream set of software standards.

Steve Ballmer made the point even more emphatically in an interview, also posted on the Internet.

"I want the thing that replaces Windows to be Windows. I don't want to wake up in a position one day where the guys at Netscape say, 'Isn't Windows just that little thing that we use to put up menus and draw lines.'"

The promise to the Consent Decree

As you know, Paragraph IV(E)(1) prohibits Microsoft from licensing Windows 95 under terms that are "expressly or impliedly conditioned upon the licensing of any ... other product." Similarly, the following paragraph of the Decree, Paragraph IV(E)(2) states that the licensing of Windows 95 cannot be expressly or impliedly conditioned upon the OEM "not licensing, purchasing or distributing any non-Microsoft product." If Microsoft's conduct is not an outright violation of the Decree, it is, if anything, far more disturbing than that expressly precluded by the Decree. Microsoft is conditioning the license of Windows 95 on inhibiting consumer access to products that, in Microsoft's view. could successfully develop "into a full-featured operating system."

In its argument in support of the entry of the Decree, the Antitrust Division expressly promised that it would ensure that Microsoft would not be permitted to engage in such conduct. In its Memorandum in Support of the Motion to Enter Final Judgment, signed by the Assistant Attorney General herself, the Department of Justice made an important promise, upon which the industry has relied:

It is important to note ... that an alternative to Microsoft's operating system might arise at some point, an operating system that either displaces Microsoft's or attracts sufficient users to gain the benefits of increasing returns to the point where the market is divided between the world of Microsoft and the world of this new operating system. The proposed Consent Decree insures that this new operating system, when developed, will have access to the market.

It is time for the Department of Justice to act on that promise. If action is not taken immediately, Microsoft will be able to maintain unilaterally its monopoly of desktop operating systems, to increase the installed base of its Internet software, and to inhibit the continued growth of competition through conduct of the very type addressed by the Decree, Action at some future date will simply not be effective. Action at a future date might stop Microsoft from engaging in future conduct, but only after the harm which the Decree is intended to prohibit has already occurred.

The various written proposals and agreements made by Microsoft that are set forth in this letter have come to our attention orally. The offers are universally made under nondisclosure agreements, thereby prohibiting the offeree from providing us a copy of the offer/agreement, or even providing us with a complete set of terms. Simply put, Microsoft does not want the proposals to see the light of day. However, the Department of Justice could easily and rapidly gather detailed information. By issuing Civil Investigative Demands to local and long distance telephone companies and other ISPs, value added resellers, OEMS, and large corporate users, the Antitrust Division would be in a position to ascertain and act upon Microsoft's illegal offers.

Time is of the essence. We know that the Antitrust Division has open file with respect to Microsoft. However, insofar as we know, the Division currently has no outstanding Civil Investigative Demands of any type. It has been almost a year since the Antitrust Division even sought documents from Microsoft. All of this leads us to wonder whether the Antitrust Division is truly in a position to investigate and restrain the illegal behavior on a timely basis.

Perhaps the public interest would be better served given its possible staffing constraints, if the Department returned the matter to the Federal Trade Commission. The FTC has recently expressed interest in the subject matter and has allocated staff that has developed a very detailed report on antitrust concerns arising from networked industries. That report recognizes the need for "heightened scrutiny" in network markets such as the software industry. The FTC's conclusions are particularly germane in view of the threat that Microsoft's illegal behavior poses to the nascent Internet software industry, which its conduct places directly at risk.

In any event, we are requesting immediate action. If you need any help in identifying potential CID recipients. we will be happy to work with your personnel. Please respond to me at your earliest opportunity.

Sincerely, Gary L. Reback

[ TBTF for 1996-08-25 ]


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