Microsoft Corp.'S Intent to Acquire Intuit Inc. for $1.5 Billion Sent

icrosoft

Microsoft Corp.'s intent to

Must Be 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- S-H V ed only to U.S. Department of Justice officials and, presumably,

to the undisclosed companies that financed it. In the paper, four

• e - attorneys from the Palo Alto, Calif., law firm of Wilson, Sonsini, "3 Goodrich & Rosati, buttressed by arguments from two Stanford U University economists, set forth new theories about Microsoft's

Oil domination of the digital revolution. Though the paper (edited

. for length but not otherwise changed by UPSIDE) reads as though

.V- lawyers and economists wrote it, it's important because it repre- 03: o sents one of the most complete accounts of Microsoft's strategy to

CO " 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 pproximately three years ago, Microsoft entered the personal financial software market Awith its own product, Microsoft Money. With the proposed acquisition of Intuit, however, Microsoft is abandoning Money and reentering the market by way of acquiring Quicken. It also is entering the tax preparation software market for the first time, with the acquisition of TurboTax. The deal at bottom raises the following question: Is the substitution of Microsoft for Intuit as the market leader, and Novell (or any other company) for Microsoft as a competitor, likely to be anticompetitive and to tend to create a monopoly? Both the personal finance software and consumer tax preparation software markets are extremely concentrated. Regarding personal finance software, the most commonly cited figure for Quicken is that it controls approximately 70 percent of the market, and that Microsoft's Money accounts for another 10 percent. The HHI [an economic measure of dominance in a market] for this market accordingly would exceed 5,000 [out of a possible 10,000]. In retail sales, moreover, it appears that Quicken's share is even higher—in the range of 86 percent. The HHI for retail sales in personal finance software thus might well exceed 7,000. The numbers are likewise extremely high for the tax preparation market. At the time the Department of Justice addressed the proposed Intuit-ChipSoft transaction in December 1993, it estimated that ChipSoft's TurboTax and Meca's TaxCut together accounted for approximately 75 percent of the tax preparation software market. Of that, ChipSoft, which is now owned by Intuit, is estimated to hold a 55-60 percent market share, again yielding a very high HHI of more than 3,400 (assuming 55 percent for ChipSoft and 20 percent for Meca). As in personal finance, the retail numbers look even higher: One source gives Intuit a 78-85 percent market share (and 15-18 percent for Meca). These numbers would yield a market concentration figure approaching that in personal finance software, on the order of an HHI of 6,000 or more. Not only are these markets extremely concentrated, but recent experience indicates that they have very high barriers to entry. Computer Associates, in trying to increase market share in the personal finance software market, is reported to have given away for "free" (excluding postage and shipping charges) 1,000,000 copies of its personal finance programs. CA is reported, however, to have achieved little market share. Microsoft's experience in trying to increase market share for Money also supports the conclusion that barriers to entry are high. After three years in the market, in which it frequently charged approximately one-third the price that Intuit did for Quicken and made a very substantial commitment in marketing staff and resources to Money, it gained only approximately a 10 percent market share. These high barriers to entry appear to reflect the substantial lock-in effects that exist in both the personal Step ill Over Your Competition It Conventional Steppers. PAS 5500/100 Steppers. 30% Smaller. 30% Faster.

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$19,000,000 $35,100,000 $28,800,000 $20,000,000 $5,500,000 $11,000,000 Peet's EP Technologies Cannondale Pinnacle Systems Tele-Matic Khepri _ 1 Coffee & Tea Follow-On Offering Initial Public Offering Initial Public Offering Initial Public Offering Private Placement of Private Placement of • Co-Managed • • Lead Managed • • Lead Managed • • Lead Managed • Preferred Stock November 28, 1994 November 15, 1994 November 8, 1994 Novembers, 1994 November 1994 November 1994

CSL Limited Quantum $37,600,000 $28,000,000 Sierra $16,100,000 acquired the assets of Corporation Affiliated Pacific Semiconductor mm JL J Pay Video oystemJyott JRH Biosciences Inc. acqu red Computer Services acquired the remaining Digital Equipment Initial Public Offering Private Placement of portion of Initial Public Offering Corporation's Data Preferred Stock Porton Storage Business PMC-Sierra • Lead Managed • ^r mm... • Co-Managed • International PLC October 1994 Scptermu 2". 1994 Septcm >cr 1994 September 1994 August 4, 1994 August 1994

Health Infusion, Koala Springs $10,400,000 T2 Medical Curaflex and was acquired by Geoworks Medisys merged to create Private Investor Initial Public Offering Group Fhe Future Coram Healthcare • Lead Managed • July 1994 July 1994 June 23, 1994

CCC Information Evans & Dienhart & Co. $11,000,000 Services Sutherland Network Services sold the brand and assets of NPS asubsdaryof spun off to s lareholders acquired Pharmaceuticals InfoVest Hitchcock GmbH Fortune to Initial Public Offering completed a Tripos, Inc. Telecommunications recapitalization Tropicana • Lead Managed • ;-, . •••••-'-: - .• •- •.:, .- •- • • ••• • •. June 1994 June 1994 June 1994 June 1994 May 26, 1994 ompamcs $11,200,000 $47,400,000 Intersolv $35,900,000 $32,900,000 $35,500,000 Cambridge Dialogic Applied Digital GaSonics Chronimed Soundworks merged with Access Initial Public Offering Initial Public Offering Follow-On Offering Initial Public Offering Q+E Software Initial Public Offering 25 Years • Lead Managed • • Lead Managed • • Co-Ma laged • • Co-Managed • * Lead Managed • April 4, 1994 April 11, 1994 Apr.lWi March 29, 1994 March 21, 1994 March 16, 1994

0,000 $18,500,000 $56,900,000 $37,400,000 Emulex $13,900,000 $47,200,000 Network General esk Sonic Solutions Cephalon ALANTEC spun off to s lareholdcrs Celestial Wonderware Seasonings merge with c Offering Initial Public Offering Follow-On Offering Initial Public Offering Follow-On Offering Follow-On Offering ProT ools naged • • Lead Managed • • Co-Managed • • Lead Managed * • Co-Managed • • Co-Managed • 0,1994 February 10. 1994 Februarys, 1994 February 3, 1994 February 1994 January 25, 1994 January 13, 1994 Januai / 1994 DCUS. RESULTS (212-207-1400) BOSTON (617-574-0500) Communicai o.i» • February 27 * C»*to ^ s > . » v»?*;c«> Oat"\ * Aiartfec • Digital Link* Ascend work Peripherals • Security Dynamics • McAfee Assoc •nsirter • Banyan • No\eli • Hicros.ofr • Legato • Feb . f _J> * Newbridge • Stratocom * level One C o rii m u n i t * Cirrus Logic * RF Monelitlms • FTP Soft- ware * NetMan Wdtl Uata • Xcelicaet»Intervofc«j • Octe» • Centigram * Applied Digital Act ess • Vitesse • March I * Orbi Systems « February 28 * Avid % * fc;cv\i»nic£ tot " March I • ADFlex

A in$>""*aivif nts » Cognex » V Convex * Marci AST * Compa: 28 • C-Cube M •Alias Researc! for Imaging • J Four Days, March I • Learn Sierra Oniine Acclaim • Iwer Six Conferences Education • f&bruary 2ii ^v.,»c»ias£scs Steck- 5 Vaughn «Syivai --,T,=rg . Bsiri-Ws •> C !"*" - March I • Davidson»Bro< -Mynd " Leiriistg Conipapy * Serniconduc- tors • February 8 A>foittst * Le^^i One CoTO"»unieations • Communications ^nns * Aitera - Xi!d«itec * Or VTINUM • < Education • - Micros*. eymoyr * C >npanies • S Semiconductors Walker Interae • February 28 Software & Services

ROBERTSON •>'c SoHtion STEPHENS & i Com COMPANY roder The Ritz-Carlton Hotel wini«e * SpS: Byte»3DO»E San Francisco 555 California Street February 27-March 2 ,!, Suite 2600 * Acciaim »Act •".ZKZ' San Francisco, CA 94104 iina Marketing March 2 * Spelling Ente =nnitii-i • For registration information, Nintendo * Se , v; i -n-n please fax 415.956.2663 way. The Intuit acquisition is intended to control the gate- exert tremendous power over all information transmission. way on the home-to-business client side and leverage toward Just as was the case with IBM, it is not reasonable to expect the home-to-business server. Application of "increasing that other countries will permit the concentration of such returns" economic analysis would reasonably predict that, vast economic and political power under the control of a sin- given the present situation, Microsoft will succeed in gle company—and certainly not an American company. In monopolizing the entire network (just as it has monopolized the 1970s IBM crushed the American mainframe computer the desktop) and that the monopoly will remain in place for a industry, but Japan and Europe protected their mainframe very long period of time. Indeed, the Intuit acquisition is companies, with the result today that the only meaningful likely to hasten the development of a monopoly on the competition for IBM mainframes comes from Japanese and enterprise and home-to-business server markets so vast that European companies. Microsoft will be able to extract monopoly rents on not It is reasonable to expect that the same will occur only financial transactions, but also the transmission of with respect to software and on-line information ser- information and data. *) vices. The markets today consist almost entirely of There are two underlying characteristics of the tech- jj American competitors. But without government inter- nology at issue here that give rise to increasing returns. vention, Microsoft will in short order crush this competi- First is the fact that users are physically connected in a rd 5-H tion. Foreign governments will intervene to protect their network. Networks exhibit and produce certain impor- J—, Eowrd n companies and markets, and the only competition tant economic results. Since the purpose of the network O in the future will come from foreign sources. • > t is to enable communication with others, the value of the c network increases with the total number of users who v ANTITRUST PERSPECTIVE join the network. Consequently, once a network such as n one level, the antitrust laws, as currently the Microsoft Network is in place, a competing network B applied, seem ill-equipped to deal with an would have to enter the market with at least as large a a 0/5 increasing returns network. The Merger number of nodes in order to displace (or even compete o Guidelines, for example, suggest that mar- meaningfully) with the Microsoft Network. O ket power derives largely from horizontal concentrations

The second basic characteristic of this type of tech- •T—I within a market, and hence, the Guidelines seem to nology is referred to as "compatibility" in the economic C/5 focus on static market concentrations. No meaningful literature. Unlike other, more conventional industries, I analysis of related markets, much less targeting, linking the value of the technology to end users increases with V i and leverage, can be found in the Guidelines. Even in the number of users who use compatible technology. recent years, mergers were evaluated without a sufficient Unlike the "network" feature of the preceding paragraph, appreciation of the impact of market interrelationships which draws its force from the physical interconnection, O within the software industry. the "compatibility" driver of demand-side economies of There are certainly more progressive trends. A num- scale arises from a dependency of mutual use by con- ber of courts, including the Supreme Court, have begun to sumers without regard to actual physical interconnection. evaluate conduct in one market based upon conditions in There is as yet no economic literature that applies rd o an adjacent, related market. Relevant decisions have increasing returns economics to precisely the situation at begun to reflect increasing returns analyses. A plaintiff's issue here. However, there is an extensive theoretical lit- use of leverage in lock-in situations has frequently been erature, with direct empirical application to industries cited in the lower courts as a principal basis for the denial such as telecommunications, broadcasting, computers of summary judgment motions in both tie-in and monop- and ATMs. Application of the literature and logic of olization situations. In short, both the case law and the increasing returns economics to Microsoft's strategy (and C/3 a Guidelines would permit consideration of the Intuit success) of targeting, linking, leveraging and locking in acquisition on a basis other than static market considera- various gateway points on the network, strongly indi- c tions. Moreover, the case law would support action cates that, notwithstanding Microsoft's incipient posi- 2 G against Microsoft based upon increasing returns analyses, tion in certain products and markets, the forces of the notwithstanding Microsoft's incipient position in some economy will not be sufficient to impede Microsoft's v markets on the larger network. move toward dominance. Indeed, increasing returns anal- 3 4-> Optimally, the acquisition of Intuit should be en- ysis would suggest that government intervention will be cr c joined. Employing a static market analysis, the effect of optimal in producing competition if undertaken at the u o the acquisition "may be substantially to lessen competi- incipient stage. Once the network is successfully imple- rd tion" in the markets for financial planning and tax prepa- mented, the social and economic costs of dismantling it ration software. More importantly, viewing the home are overwhelming, and, in any event, there would simply 3 O client as part of the larger network, the anticompetitive be no significant competitors to restore to the market. effects of the acquisition at other points in the network Increasing returns economic analysis would logically c become readily apparent or, at the very least, probable. suggest that the American software industry is headed V There are certainly less restrictive alternatives that for IBM redux, but on a far greater scale. Microsoft will would preserve most of the efficiencies of vertical inte- likely be able to dominate the entire server network and gration Microsoft would enjoy by outright acquisition.

66 UPSIDE FEBRUARY 1995 cuting electronic bankcard transactions across global public business server and the enterprise server. Microsoft is paying a and private networks." In the question-and-answer session fol- 100 percent premium to market for Intuit. This is not merely lowing the press release, the Visa spokesperson said the driving Microsoft's attempt, as a matter of ego, to put out of business force in Visa's decision to do the deal with Microsoft was the the competitor which continued to have success in the face of fact that Microsoft had sold 60 million copies of Windows. Microsoft's efforts. Nor is it merely an attempt to monopolize If Microsoft is successful in establishing the standard for the PC tax and financial software markets, where products sell the home-to-business server, it will be able to leverage into the for less that $50. Rather it is part of a well-thought-out plan to enterprise server market both from the desktop, which it control the client side of the home-to-business server market, already controls, and the home market. Once a business leverage that control to control the home client OS, and back decides that it should use the Microsoft server to communi- to control of the server. cate with customers, there is no point in having a different, On the most trivial level, Microsoft can bundle Quicken probably incompatible, server for intrabusiness needs. After and TurboTax into a suite of home-based applications (includ- all, the OS for the server side of Microsoft's home-to-business ing, e.g., Encarta), thereby solidifying its monopoly of home server is Windows NT. Why have a different enterprise-server applications. Neither Lotus nor Novell could offer a viable OS? Similarly, the database service on Microsoft's home-to- competitive product. Microsoft would then have additional business server will be either Microsoft SQL Server and/or power to leverage to the enterprise server by putting additional Marvel. A business is unlikely to have a different database ser- server technology into Windows and Windows applications, as vice for intrabusiness needs. This connection between the it has already been doing. Greater strength in the enterprise home server and the business server is clearly Microsoft's con- server market, in turn, allows Microsoft to exploit the templation because Microsoft has already anounced that Windows NT connection and begin to control the home-to- Marvel will connect directly to a company's server. business server through leverage from the enterprise server. The more important leverage comes through the operating TH1 liEt INTUI1 1> T PURCHASE system. Microsoft will use the enormous market power of icrosoft's acquisition of Intuit is highly strategic. Quicken and TurboTax to accelerate the acceptance of It is preemptive. It gives Microsoft a monopoly Windows 95. Windows 95 will be "hooked" through Marvel on the client side of home-to-business from back to the home-to-business server. For example, by control- M which to leverage "backward" to the home-to- 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 95 Just Published! I by including it free of charge with the VOLUME 5: CONTENT AND COMMUNIC next upgrade of TurboTax and Quicken. In the series on Technologies for the 21st Century Many homes would not need (or yet Edited by Martin Greenberger •1. 11 1 want) the enhanced functionality of "A story has a beginning, a middle, and an end. The story of Windows 95 (and it will be more difficult multimedia so far has a beginning and a middle, and the middle has just begun. ...It may last another two years, another two to install than merely an upgrade of a tax decades, or another century or two. The longer it lasts, the more program), but by using the market power interesting the ending is likely to be. It's not your typical story.' of Intuit's products, Microsoft can fur- The press is reveling in this digital drama, first creating myths, ther insinuate Windows 95 into the mar- then destroying them. To get the real McCoy, it helps to speak with the people involved firsthand, asking questions, listening ket, thereby controlling the architecture to them talk among themselves. of the home client. Even if Microsoft There have been five roundtable discussions to does not make Quicken and TurboTax date, with three volumes now in publication: available only on Windows 95, it could at 1. On Multimedia, 1990 the very least make the Intuit products 3. Multimedia in Review, 1992 behave better or deliver enhanced func- 5. Content and Communication, 1994 tionality on Windows 95. Windows 95, Watch the story of multimedia unfold in these encounters arrong experts in the field with their of course, directly connects with Marvel insightful analyses and lively confrontations. and provides a seamless pathway back to Live out the story with the leaders. the server OS, Windows NT. For busi- A STELLAR CAST OF PARTICIPANTS, INCLUDING: nesses that want and need home-to-busi- Robert Abel James Cuilen Alan Kay Nicholas Negroponte Mark Stahlman ness connections, Windows 95 will be Bill Atkinson John Doerr John Kernan Donald Norman Robert Stein John Perry Barlow Lucie Fjeldstad Robert Kerrey Ruth Otte Shinobu Toyoda ubiquitous at the home client. Marvel James BHlington George Gilder Vinod Khosla Seymour Papert Douglas Trumbull Scott Billups Bill Gross Brenda Laurel Robert Pittman John Warnock will link to Windows NT and Windows Stewart Brand Trip Hawkins David Liddle John Sculley Robert Winter Steve Case Danny Hillis Robert Lucky Jonathan Seybold Kristina Woolsey NT will work best with the Microsoft James Clark Strauss Zelnick Robert Kavner Roger McNamee Alfred Sikes SQL Server. Volume 5 is $29.95 per copy, volumes 1 and 3 are $24.95 each, plus shipping and handling. Delivery by Federal Express is available. A discount of 20% will be given on orders of three books or more. Microsoft will use the market power of the Intuit products to leverage both vertically within the home client and

64 UPSIDE FEBRUARY 1995 The Event of the Year!! Digital Hollywood Awards Gala Dinner Wednesday, February 22

The Media Marketplace Beverly Hills Hilton • February 20-23, 1995 UBigital tiollywood Awards for Technical Excellence Luncheon • Tuesday, February 21 -~H Deal Making & Demos in the Suites & Exhibits Business gets serious at Digital Hollywood, bringing together the producers, distribu- tors & title developers, the tools & technology providers, the production houses and digital magicians, the communications, technology & financial communities.

American Expositions, Inc. • 110 Greene St., #703, New York, NY 10012 • 212 226 4141 horizontally to the home-to-business server, with the result pedia Brittanica. Microsoft is clearly aiming to conquer elec- that Microsoft will initially dominate home banking and even- tronic publishing. tually all home-to-business server products. Home banking is a It is difficult to imagine that in an open society such as this very attractive client/server application. It has broad consumer one with multiple information sources, a single company appeal in that everyone has a bank account. It requires the could seize sufficient control of information transmission so as integration of several sources of data including bank accounts, to constitute a threat to the underpinnings of a free society. But brokerage accounts and credit information. Because of such a scenario is a realistic (and perhaps probable) outcome. Quicken's commercial success, there is a strong network exter- nality (lock-in) attached to a user's viewing his personal finan- INCREASIN1 IN <^ K fc G RETURNS cial information through the Quicken user interface. iven the anticompetitive ramifications of the Intuit Accordingly, Quicken provides tremendous leverage into the acquisition in the markets for personal finance soft- home banking market. Microsoft will provide an enormous - ware and tax preparation software, Microsoft must, market power edge to its own on-line service, Marvel, by mak- c of necessity, try to justify those effects by pointing ing Quicken available exclusively (as among on-line services) to benefits in some larger market. In the larger market, on Marvel. however, given Microsoft's market power at various gateways, Domination of home banking provides the optimum plat- the net effect of the acquisition is more likely anticompetitive form from which to dominate other on-line services, including, than pro-competitive. The economic characteristics of the for example, shop-at-home. Businesses that want to provide technologies and markets at issue here differ markedly from financial information to Quicken users, or who want to pro- other, more conventional industries, in that these products vide other on-line services, will want to choose server software (software products) and markets (networks) exhibit "increasing for interacting with Marvel. Microsoft will be able to use all of returns," also sometimes called "network effects." its vertical integration skills developed in the desktop and It is readily apparent that Microsoft's strategy of targeting, enterprise server marketplace to ensure that businesses choose linking and leveraging from the desktop OS has been success- Microsoft home-to-business server software. ful in seizing control of the business client. It is also apparent Of course, other on-line services may cobble together a net- that Microsoft is leveraging from the business client to the work, but consumer acceptance would be difficult, particularly business server and is vertically integrating within the busi- at the point of sale where Microsoft is leveraging Quicken's ness server so as to seize control of the critical server OS gate- acceptance. By controlling the architecture and embedding proprietary OLE technology, Microsoft will be able to pre- .. .for making GeoPartners clude interoperability over its network, GeoPartners the leading management and, given its monopoly power in various consulting firm helping gateways including the home client high technology companies (through Quicken), businesses will have Research, Inc. succeed at strategic, techno- little option but to choose Microsoft's logical, and organizational distribution network. transformations. As a result, Microsoft will be able to would like use its market power and near exclusivity GeoPartners specializes in to reap tremendous profits. Query: Is • corporate strategy .,..,,,- Microsoft's market power so strong that to thank its development it could demand control of the content of • improving alliances and the software distributed across its net- supplier networks work? What about the content of infor- clients... • strengthening the horizontal mation, like raw educational or political organization information? What content provider • enhancing leadership would be in a position to resist Micro- and execution soft's demands for content control as a We will continue to dedicate quid pro quo for distribution? ourselves to the personal But why should Microsoft bother service we believe is key to with publishers at all? It can provide con- our success. For information tent itself and put competing publications on GeoPartners, or for a free out of business. Once competing publica- copy of James Moore's tions are gone or diminished, Microsoft McKinsey Award-winning can exercise content control over the fac- GeoPartners Research, Inc. Harvard Business Review tual and information contents of the Management consultants article material on the Network. If this seems in strategy, technology, and "Predators and Prey: A New far-fetched, note that Microsoft's Encarta implementation. Ecology of Competition," encyclopedia already outsells Encyclo- call us at 617 492-3600. INTRABUSINESS SERVER Microsoft also enhances its power in the server applica- icrosoft's next goal is the intrabusiness server. tions layer by horizontally bundling these products into a There is currently intense competition in the suite (the Back Office) in the same way Microsoft bundled various layers of the server markets. Novell desktop applications into a suite. Just as with the desktop enjoyed early entry into the server OS market applications, there is also vertical leverage to enforce the hori- M zontal bundle by making all server applications OLE-enabled. and still has significant share in its product NetWare, as to which network externalities have attached. Similarly, ; Informix, Oracle, Sybase and others enjoy strong positions in HOME-TO-BUS! NESS SERVER the database services market. Microsoft will make every ncreasingly, business will need to communicate with the attempt to displace all of this competition, just as it did in home in order to sell products or services and in order to desktop, by employing multiple linkages and leverage. It will provide information, for work or other purposes. do so chiefly through three strategies: (a) vertical linkages I Obviously, businesses that exploit this channel will have similar to those that worked in the desktop markets, (b) hori- a strong advantage over competitors that do not, with the zontal linkages from desktop to intrabusiness server, and (c) result that all businesses will seek entry. Control of the horizontal linkages from home-to-business server to intra- home-to-business server market by a single company would business server. produce an enormous windfall. First, of course, the company Microsoft began the implementation of its strategy by would be able to extract a toll for a large percentage of con- creating a new server OS (Windows NT) that horizontally sumer financial and product transactions. More strategically, leverages from the monopoly position of DOS/Windows in a company that controlled the home-to-business server mar- the client market. Indeed, Microsoft has increasingly placed ket could leverage that control back to the intrabusiness, or server functionality into Windows and Windows applications enterprise server market. Control of both sides of the server (e.g., Access, Fox Pro, Excel). At the same time, Microsoft dis- market, intrabusiness (enterprise) and home-to-business, continued OS/2 development efforts because Microsoft was would place enormous power (financial, informational, edu- so strong (and IBM so weak) that Microsoft no longer cational, etc.) in the hands of a single company. Microsoft needed to leverage IBM's mainframe monopoly position. has this power within its grasp. This horizontal leverage would not be sufficient to Microsoft is pursuing its policy of targeting, linking displace competitors in the OS and higher levels, so and leverage to seize control of the architecture of the Microsoft applied vertical leverage as well. Examining the home-to-business server. Microsoft already markets NT vertical layers of the server side, Microsoft readily with the Microsoft SQL Server as the way to communi- observed that it could leverage from OS to database ser- cate with customers in homes. Microsoft tells the cus- vices and that database services was a key technology, <«J tomers of other database services providers that the cus- which, if controlled by Microsoft, could be leveraged £2 tomers already have Microsoft on the home desktop and "down" against Novell in the OS layer, as well as "up" the [database] customers should move to NT because it is against application providers. rd cheap. Microsoft argues that its engineers know the inter- In order to exploit the database services level, U nals of Windows NT and will create (and maintain) a Microsoft needed to move from its position as a reseller server for that market with links that competitors cannot of Sybase's SQL Server on Microsoft operating systems, to __* replicate, given their lack of access and information. a position in which it controlled its own database prod- , Microsoft has announced its own on-line service uct. It did this by negotiating with Sybase to obtain rights ^ known as Marvel. Microsoft will use OLE-based tools to to the SQL Server technology, with which Microsoft was be *~! enable businesses, developers and users to create object- already familiar. Microsoft will now leverage vertically 3 oriented documents that can be transmitted over Marvel. within the server side, both upward and downward. Indeed, Microsoft CEO Bill Gates has stated that "we'll Microsoft markets Windows NT, touting tight integra- give you access to [Marvel] with Windows 95. ... If (the tion between Windows NT and Microsoft SQL Server. software) notices you have a modem, it will ask you if Similarly, Microsoft markets its SQL Server, based on the O | you want to register electronically." This access to cus- linkage between the monopoly position in Windows OS, £3 tomers through Windows 95 gives Microsoft "a potent Windows applications and SQL Server. This can be cor- f—i plan for spreading Marvel" that dwarfs the installed base roborated by various Microsoft prospective customers. •4_> of other existing competitors in this market (an estimated Microsoft still faces a "problem" in that current ver- O 14 million users, compared to 1.25 million subscribers for sions of Windows work with competitors' database ser- T-Q America Online). vices products too well. But in statements to potential - j- Even without the Intuit deal, Microsoft has such enor- customers, Microsoft has promised to break the interop- 1 ii mous market power, from compounded positive feedback erability between Windows and competitors' database o on its various monopolies, that it likely will end up con- services products so that Windows applications will work trolling the home-to-business server and client unless best with the Microsoft SQL Server. This will be accom- o QJ there is strong government intervention. The power of plished, in part, through the introduction of new OLE u Microsoft's positive feedback is best demonstrated by the interfaces into both the server and the applications, and a November 8, 1994, announcement of Microsoft and Visa corresponding de-emphasis of open interfaces like ODBC. C/5 for the provision of a standard and secure method "for exe-

62 UPSIDE FEBRUARY 1995 As new technologies overcame the old mainframe mar- moving the GUI from the application (where it previously ket, the market for computer products formed into a number was, except on Apple) to the operating system- of horizontal markets (featuring aggressive competition) that Microsoft leveraged its control over Windows to control are vertically related to each other. From the initial desktop applications, following a carefully crafted plan. First, monopoly bestowed on it by IBM, Microsoft has leveraged Microsoft copied an application from the market leader in and linked a series of powerful monopolies with the intent of that application (e.g., Lotus), breaking the network externali- forming a new verticality on the market. There was little ty of the installed base by providing file and keystroke com- resistance to Microsoft's efforts to unify the OS because a patibility. Microsoft based its own compatible application unified OS (or a small number of competitors) is necessary program on unique components in the operating system that for the industry to grow. More importantly, after establishing it had unique or early access to (e.g., Windows). Microsoft several monopolies with enormous leverage potential, the claimed it was "open," but actually used hidden features and positive feedback from the verticality imposed by Microsoft functions to gain competitive advantage. It provided a propri- will in short order eliminate competition on all horizontal etary architecture with a supposedly "open" system. And it layers within the server market, just as it has already elimi- used its profits from its monopoly position in OS for (1) mas- nated competition in the horizontal layers on the desktop. sive marketing to promote the linkage features of the OS, and (2) sustaining a protracted battle with independent appli- THE BUSINESS DESKTOP cation vendors in a new market that, without the profits from the leveraged market, could not be sustained. n understanding of Microsoft's conduct on the rd business client is critical to an understanding Microsoft further exploited its leverage, both vertical- of Microsoft's targeting, linking and leveraging ly and horizontally. Horizontally, within the desktop to the server and to the home client. As previ- U application layer Microsoft moved to other applications, A touting and exploiting the benefits and advantages of its ously noted, IBM bestowed a monopoly on Microsoft in the form of the OS. Microsoft then targeted the adjacent E vertical linkage (to the OS): e.g., word processing (Word), layer with the highest number of fragmented players, V o database (Fox Pro and Access) and presentations (Power- i.e., desktop applications. Microsoft used the money V5 CX Point). Microsoft also employed horizontal leverage (in the application layer) through its marketing practice of from licensing the OS to fund the development of appli- C/5 cations to run on DOS, in competition with software bundling a group of applications into a suite, which is vendors which had no operating system control (e.g., be .9 sold at low price points. Microsoft funded application development and low-priced suites from OS profits. Lotus, Borland, WordPerfect). But because of the relative- .£ 4—i ly open nature of DOS, Microsoft could not exercise suf- rd Vertically, Microsoft created interoperability between ficient control to give its applications a strong competi- .£ applications by creating a new standard, OLE, which it tive advantage over those with significant installed c "appropriated" from Hewlett-Packard's New Wave. With bases, as to which powerful network externalities had a rd market power on both sides of the interface (i.e., in both attached. o applications and the OS), Microsoft easily displaced the Microsoft "solved" this problem by (1) developing a v tZ existing standard, DDE, in favor of OLE. It embedded new operating environment (Windows) that it totally j*£ OLE functionality into both its OS and its applications, controlled, (2) targeting functionality in the application and it heavily marketed this new functionality using the layer that it could either embed in or link with the OS, C monopoly profits from its market position in OS. and (3) using its power over DOS to migrate users to QJ Microsoft asserted that it was sharing specifications Windows. Microsoft thereby got more control over the with competitors, but it actually seeded specifications OS, added value to the OS it controlled and forced inde- QJ for OLE (and Windows and Windows NT) to its own pendent application publishers to rewrite all of their c applications group early, thereby guaranteeing better applications twice (once for Windows and a second time o rd integration between its own applications and the OS for OLE). u (Windows) than any other applications vendor could pro- This strategy succeeded in monopolizing both the ~d vide, and/or, at worst, an 18- to 36-month lead because of desktop OS and desktop applications. Once Microsoft rd competitors' normal software development cycle after had control of the operating system, which is the key receiving specifications. architectural technology for desktop computing, it was £ This strategy has been enormously successful on the able to maintain its share, even with an inferior product. O 'rd desktop. Microsoft's share of OS sales is a staggering 85 The introduction of DR DOS from Novell showed that o percent. IBM's OS/2, however, still commands about 10 Microsoft had failed to keep MS-DOS abreast of leading £ percent of current sales, notwithstanding Microsoft's technology. Yet Novell's compatible offering in the DOS u 'rd best efforts to displace it. Similarly, in desktop applica- market (DR DOS) stopped selling when Microsoft made E tions, despite having a tiny share of the pre-Windows it clear that Microsoft would create versions of Windows O market, in 1993 Microsoft commanded an 85 percent that were incompatible with DR DOS. It is common for share of the Windows application suites sold. Hence, "better" products to fail if a competitor controls the u although Microsoft's share of desktop applications was architecture in which the product operates. At the same c initially quite small, it achieved market power quickly time, Microsoft dominated the application market by o fd through linkage and leveraging. 60 UPSIDE FEBRUARY 1995 Microsoft's proposed acquisition would be likely to increase the intrabusiness server, with only Microsoft products being market concentration in two already highly concentrated vertically integrated markets and to raise barriers to entry. It would also reduce In short, Microsoft's overall business approach and strate- competition by eliminating Microsoft itself as a competitor gy is based on the creation of technological linkages between in these markets. Because there can be little doubt that the layers within the same market (e.g., DOS to Windows on the acquisition will have anticompetitive effects and is like- desktop) and between layers in one market and corre- ly to tend towards a monopoly in these markets, the sponding layers in another market (e.g., Windows NT to transaction is an appropriate one for the Department to Marvel to Windows 95 on the home client). To fully set aside under Section 7 of the Clayton Act. understand Microsoft's strategy and its economic impli- cations, however, it is necessary to understand two addi- C/5 THE LARGER MARKET V tional strategic Microsoft technologies: OLE and t the outset, two characteristics should be Windows. emphasized. First, the products at issue are V OLE (object linking and embedding) is the Microsoft- software products, composed almost entirely imposed standard for sharing information both among of intellectual property content. Because of 4 applications, and between applications and the operating Athe nature of software, there can be greater flexibility in o system. During the earlier DOJ investigation, desktop the formation of vertical relationships than is present c application companies complained that Microsoft seeded with respect to more conventional products. That is u OLE to its captive application developers before giving it because vertical integration does not require exclusivity: '5b to ISVs (independent software vendors), thereby giving its Unlike a pipeline, many competitors can vertically link _o own applications a lengthy head start over the competi- their software, through software compatibility, to prod- tion. Microsoft is doing the same thing on the server side. ucts in the markets above and below them. "o Microsoft has made it clear that OLE will be strategic Second, the markets at issue are "server" markets. c technology for the home-to-business server market, but Previous governmental evaluations of Microsoft focused 1 has not provided sufficient specifications to independent primarily on the "desktop." But the desktop is really u database server providers to enable them to release equal- only an interrelated component of a network that con- V ly well-behaved products on the same time schedule as tains desktops and servers. These software networks o Microsoft's own products. bear many of the characteristics that economists have c Microsoft's first Windows products were targeted for begun to associate with networks in other industries, c o the desktop and were built on top of Microsoft's domi- including "increasing returns" or "network effects." a nant desktop operating system, MS-DOS. Because of Indeed, software networks manifest increasing returns, 3 V their DOS legacy, these products are unable to take full or demand-side economies of scale, even more strongly t advantage of the capabilities of the 32-bit microproces- than do other networks in more conventional industries. u o sors they run on. Microsoft's current product in this area There are two basic components of the server mar- u is Windows 3.1, which is preinstalled on most desktop kets. The intrabusiness server is the backbone of busi- V systems presently sold. Microsoft plans to proliferate ness. Microsoft has projected that there will be 300 mil- S Windows 95 widely next year as the successor to lion servers in the business community, running c c Windows 3.1. Windows 95 is a true 32-bit operating sys- everything from phone systems, to copying systems, to o tem being targeted to the mainstream personal computer cash registers. If a single company controls all business V market. Furthermore, Windows 95 breaks the reliance on server markets and applications, that company has far MS-DOS that precluded long file names and more effi- greater market power in various sections of the economy pi cient file servers. than, say, mere control of the desktop would bestow. Windows NT was Microsoft's first true operating sys- Microsoft is pursuing a vertical integration strategy on tem for 32-bit microprocessors. NT's principal use is in the intrabusiness server side similar to that pursued on v the server market, but Microsoft has also targeted its NT the intrabusiness client side. c marketing to power users running high-end personal The second aspect of server technology is the home- o computers or workstations. Microsoft markets a version to-business server markets, sometimes known as "on- ID U of NT with advanced server capabilities, called Windows line services." Today, most on-line services run off _1 i * V^ NT Advanced Server, as an enterprise-wide computing mainframe computers the way Lexis and Nexis do. solution. Microsoft offers a suite of applications for Businesses will increasingly need to sell directly into the 4 v Advanced Server called Back Office that includes home through on-line services to remain competitive. database services, electronic mail, systems management, Control by a single company of the home-to-business and connectivity to mainframe and minicomputers. server markets would have significant economic ramifi- o c Microsoft's vision for enterprise computing is being mar- cations. Of course, control of both sides of the server V keted through its plans for a replacement for Windows markets would have very powerful anticompetitive O V NT, currently code-named Cairo. Cairo brings object-ori- effects. The home-to-business server does not yet exist, u ented technology into the file server and operating sys- except in Microsoft's plans. It can be readily assumed V tem. Microsoft already controls object standards through that the home-to-business server would look much like its OLE specification.

58 UPSIDE FEBRUARY 1995 HAMBRECI

IDB Concord Holding $25,900,000 $41,800,000 $65,600,000 $13,800,000 Communications Corporation PLATINUM Group Micrel Itron Micrion technology has agreed to merge with has agreed to merge with Initial Public Offering Follow-On Offering Follow-On Offering Follow-On Offering LDDS Communications The BISYS Group • Lead Managed • • Lead Managed • • Lead Managed • • Lead Managed • December 9, 1994 December 7, 1994 December 6, 1994 November 29, 1994 Pending Pending

$65,400,000 $15,000,000 $37,300,000 $88,800,000 $20,800,000 Versatest Alliance FPA Medical Mariner Health PRI Automation SUGEN Semiconductor Management Group was acquired by Follow-On Offering Initial Public Offering Initial Public Offering Follow-On Offering Initial Public Offering Hewlett-Packard • Lead Managed • • Co-Managed • • Co-Managed • • Lead Managed • • Co-Managed • October 21, 1994 October 21, 1994 October 13, 1994 October 12, 1994 October 4, 1994 October 1994

DNX Corporation MacNeal- Read-Rite Schwender

Baxter International merged with acquired have formed a new Company, Sunward Technologies PDA Engineering Nextran Financing August 1994 August 1994 August 1994

$8,500,000 $17,300,000 $40,000,000 $18,100,000 $40,000,000

CDP InfoVest CCC Information Diametrics Fresenius USA Services Technologies Initial Public Offering Initial Public Offering Private Placement of Follow-On Offering Private Placement of inanci Common Stock and Revolving and • Lead Managed • • Lead Managed • Preferred Stock • Co-Managed • Term Loans June 14, 1994 June 14, 1994 June 1994 June 3, 1994 June 1994

$12,900,000 $25,000,000 Mammoth Micro $20,700,000 $39,000,000 Growth Mariner Health Targeted Productions Group Transaction Quintiles Marcam Genetics was acquired by Network Services Transnational merged with Initial Public Offering Private Placement of The Washington Post Initial Public Offering Initial Public Ollcrin), Subordinated Notes Company • Lead Managed • with Warrants Pinnacle Care • Lead Managed • • Co-Managed • ForOve May 20, 1994 May 1994 May 1994 May 1994 April 22, 1994 April 21, 19'11

$65,600,000 Octel Tocor II Rational $22,100,000 $81,000,000 $26,5C Communications merged with Chalone Wine was acquired by Global Village Renal Treatment Novellus Systems Soft. Centocor Verdix Group merged with Communication Centers to create Follow-On Offering in an exchange offer for Initial Public Offering Follow-On Offering Initial Publ VMX all outstanding units Rational Software Advisory • Lead Managed • of Tocor II Corp. • Co-Managed • • Co-Managed • •LeadM March 14, 1994 March 1994 March 1994 March 1994 March 1994 February 23, 1994 February 22, 1994 February EXPERIENCE. F( SAN FRANCISCO (415-576-3300) NEW YORK who get too close to Murdoch get tion to the future, and tenaciously pur- Packard Bell burned. Those who do get drawn into sues new opportunities, he also is dem- European distribution, working closely with Murdoch for a onstrating a surprising ability to let go. service center, assembly period of time discover that "their mar- He has given the nod to a management riage goes to hell, and their families, and buyout of News Electronic Data (NED), Computervision their health, because it's almost impos- being led by Evans. According to Evans' Multinational telesales center sible to keep up with his schedule," says colleagues, Murdoch is allowing Evans Unisys a senior executive. (Former Fox chief to buy out that promising company in Telesales center and Barry Diller is but one example of an appreciation of his 20 years of guidance international distribution center executive who was too powerful to at News Corp. coexist with Murdoch.) Evans' colleagues say that being part Hewlett-Packard With his 32.6 percent share in the of a gargantuan organization like News European call center, assembly, and company, Murdoch is well supported by Corp. was slowing the NED founder customer support the board. Despite his reputation for down, despite his impressive track keeping the power to himself, he was record of shoving the company into suc- Katun also surprisingly well liked by senior cessful new business ventures. Those European distribution center and middle management. Nevertheless, close to Murdoch suspect that he will says a senior News Corp. executive who still remain close to Evans, and both Merisel asked to remain unnamed, "If I wanted will support each other's efforts. European distribution center to wield power I would understand that Nevertheless, Evans is not shy about Cordis restricting people from infor- acting on his beliefs that new Manufacturing and R&D mation is the best way to do media will require even more that. Rupert never lets one dramatic changes in how Genzyme person run anything because media companies traditional- European sales, marketing, [that person] would under- ly think about relationships regulatory headquarters and production stand it much better than he with their audience. does, and that's not the way you can run "Murdoch still has a one-to-many view an autocracy." of the world. The glacier has moved, There are very few company veter- however. Things have changed because ans who are viewed to be in a position of technology more than anyone imag- to succeed him. Among those few is ines," he says. Sam Chisholm, the tough-talking 54- At the same time, Evans recognizes year-old director of News Corp. Ltd. and the benefits of Murdoch's almighty con- To learn how these and many other companies have entered or expanded director of Star Television. According to trol of the company: "They say in Korea in the European market through the insiders, however, Murdoch is grooming that fish rot from the head down. So Netherlands, please mail or fax this his own children to take over his they obviously must prosper from the coupon to: Cap Vermeulen empire. Son Lachlan, just graduated head down, too." from Princeton, currently runs his Amid his nonstop adventures, Australian newspaper operations. Murdoch knows that, regardless of the Daughter Elizabeth, who has worked in twists and turns the infobahn may take, -—JSfetheilands— a number of capacities at Fox, currently in the end the core of his business fbreienlnvestment owns two television stations in remains the same. The new media busi- —Agency-™— California (not owned by News Corp.). ness still involves all the elements of Both are highly respected and well liked the traditional business: money from One Rockefeller Plaza throughout the company. His wife, advertising, subscriptions and transac- New York, NY 10020 FAX 212-246-9769 Anna, who serves on the board, also tions. "The printing presses change," knows the business inside out and is Honey says. "But there are a lot of ways well suited to take on the job as an that guys like Rupert Murdoch under- interim measure, say company insiders. stand it." • Name Last fall, Murdoch smoothed the way Title for his children to take control of the Wendy Goldman Rohm is a contribut- empire by buying out the interests of his ing writer to UPSIDE and editor at large Company extended family. The arrangement for Interactive Week. She also writes for allows his four children to eventually for Wired, the Chicago Tribune and the Telephone have 100 percent of Cruden Invest- Boston Globe. Rohm, who lives in Address ments, the private firm that owns 32 Evanston, 111., welcomes contact via percent of News Corp. phone at (708) 869-3140 or via e-mail at City As Murdoch prepares for the transi- [email protected]. State Zip