Steve Ballmer, Microsoft’s hard-charging chief executive, grasped for the first time just how much trouble he was in not long after lunch on March 16 2004.

Hours earlier, as the software giant’s five-year battle with the European Commission entered its endgame, he had landed in Brussels from the US to lead the final stage of negotiations.

His team was in high spirits, confident it was just a whisker away from an agreement that would allow the company to escape both a massive fine and a ruling that denounced its behaviour as anti-competitive. All the CEO would have to do, his high-priced legal talent was sure, was put his name to a deal.

But suddenly Mario Monti, the European Union’s competition commissioner who had issued a settle-or-else ultimatum the previous day, had raised the stakes once more.

To avoid punishment, the company had thought, it needed simply to agree measures to address the two main concerns thrown up by the Commission’s probe.

To that end, it was prepared to license potentially sensitive information about its operating system to rival companies keen to develop server software that would function smoothly with its Windows operating system. It was also prepared to create a level playing field in the market for media player software – by carrying three rival sound-and-vision products alongside the group’s own Windows Media Player.

The optimism evaporated, however, when corporate chief and commissioner met in the competition directorate’s sleek new building in a quiet Brussels side-street. The outcome would provide salutary lessons for executives worldwide about how to handle regulators who seek to trammel their business ambitions in the name of the public interest.

As they sat down together in Mr Monti’s private conference room, the contrast between the Italian and the American could hardly have been greater: Mr Monti, an ascetic man who spoke with professorial precision and never departed from his written brief, faced Mr Ballmer, a ruddy-complexioned, beefy-handed extrovert known for having the loudest voice in any room he occupied and possessor of an enthusiasm and self-belief that tended to drive all before it.

But now it was Mr Monti who was calling the shots. First he demanded a succession of small improvements to Microsoft’s offer. Mr Ballmer accepted them without a murmur.

Then Mr Monti dropped what Microsoft saw as a bombshell (an interpretation the Commission rejects). The company had to agree not to integrate further programs of its own into Windows unless it also offered an “unbundled” version that did not contain the new program. Consumers would be served by nothing less, he insisted.

Mr Ballmer and Brad Smith, Microsoft’s general counsel, felt blind-sided. They believed the demand went beyond anything mooted in the months of discussions the team had held with Mr Monti’s subordinates. Microsoft, they told the commissioner, could not sanction a deal that would severely limit the company’s ability to improve its flagship product. “They said: ‘Any wording of this kind goes against our fundamental business model of developing an integrated system’,” one Commission official recalls.

Mr Ballmer and Mr Smith asked to meet alone with Philip Lowe, the competition department’s top civil servant who for months had headed its negotiating team, and Mr Monti. According to two participants, the Microsoft executives took the gloves off – warning that if the case came to court, big legal weaknesses would be exposed and supporters in the industry would desert the Commission. “You will have to face this battle alone,” Mr Smith told Mr Monti.

According to people present, he added: “I want you to know that at the moment you have a bunch of companies asking you to do this but at the same time they are coming to us, asking for a settlement, asking for money. By the time this goes to the court, every one of these companies will abandon you. They will all settle with us.” (His prediction proved accurate: Sun, Novell, RealNetworks and the Computer and Communications Industry Association representing numerous other makers, all settled their disputes with Microsoft – forcing the group to pay out more than $5.3bn in the process.)

Mr Monti stood his ground. The Commission, he told the two men, had joined battle with Microsoft not to help the company’s rivals but to uphold the law and, ultimately, defend the interests of European consumers. He told a deflated Microsoft delegation they must draft a new “letter of commitments” to present to the Commission the next morning.

Mr Ballmer, Mr Smith and other lawyers worked on the letter deep into the night. At 2am Bill Gates, the company’s billionaire founder, endorsed the new offer by telephone. But when talks resumed it was immediately obvious that for Mr Monti it was too little, too late. One senior Commission official says: “On the future, [Microsoft] basically said: ‘We will consult you’.”

It was irresistible force versus immovable object. The Commission was determined that Microsoft should accept real constraints on its future ability to integrate elements into the Windows package. With equal adamance, Microsoft opposed an outcome that would undermine the very strategy on which the group’s success had been built.

When the two sides parted later that Wednesday, the Microsoft team was all but certain that the battle had been lost. The next day, they knew it for sure. There was a last meeting between Messrs Monti, Lowe, Ballmer and Smith. The atmosphere, one participant recalls, was “cordial” and there were even some jokes. Mr Ballmer winced when he learned the official ruling would probably be issued on March 24 – his 48th birthday. “I am not sure that is what you wanted as a present,” Mr Monti told him.

Fortunately, perhaps, the two sides were unaware that this was to be the warmest meeting for months. Soon afterwards, they began to argue over the precise meaning of Mr Monti’s ruling and the obligations it imposed on Microsoft, in what turned into a pernicious cycle of mutual obfuscation and incomprehension.

Everyone has a theory about why Microsoft failed to secure a deal. In private, several members of Microsoft’s defence team do not hide their anger, alleging that the Commission was bent from the start on ruling against them. One says: “We were tried and convicted when the process was started. That’s our feeling. The rest was just formality.”

A senior Microsoft attorney couches his criticism of the Commission in the form of “regrets”. Above all, he regrets that the Microsoft team did not insist on negotiating with high-level Commission officials earlier. “If we had started talking in June 2003 [with Mr Lowe] we might just have been able to make more progress,” he adds.

Naturally, officials at DG Comp, the Commission’s directorate-general for competition and state aid, recall the negotiations very differently. Officials maintain it took Microsoft until the beginning of 2004 – only weeks before the final ruling – to make a meaningful offer. “Everything they did, they did too late. They were playing poker games,” one member of the case team declares.

Arguably, the negotiations had been bedevilled from the start by a clash of cultures. Microsoft approached the Commission as if theirs was a disagreement between equals. Yet the Commission felt towards Microsoft as a judge towards a thief caught red-handed – the notion of negotiating with the group on level terms was preposterous.

Microsoft’s decision to employ tactics similar to those it would have used with suppliers or customers annoyed a regulator charged with defending the public interest.

The Commission, meanwhile, never believed its job was to grease the wheels of a deal. DG Comp had identified a problem, which Microsoft could choose to resolve by coming forward with a solution. If not, it would be resolved through the imposition of a formal ruling. Since the end would be the same, DG Comp had no preference as to means.

Microsoft was by no means the first US group to misread the Brussels regulator. General Electric famously failed to realise at first that its takeover bid for Honeywell required Commission approval, and later made things worse through its none-too-subtle lobbying tactics. Even European companies are regularly bewildered by the complex procedures and awesome powers of DG Comp – a problem felt all the more keenly by executives from the other side of the Atlantic.

And yet, despite these differences, the two came surprisingly close to agreeing terms. Mr Monti notes approvingly that the group never resorted to the heavy-handed approach GE deployed. Yet he is clear about why agreement between the two sides proved impossible.

Ultimately, he says, “it was really about a crucial aspect of their business model that was incompatible with competition law and consumer interest”. Compromise – for either side – was just not an option.

It is now more than two years since Mr Monti issued his ruling – years in which relations between the two sides have become more fractured than ever. He left office in November 2004 and now serves as president of Italy’s respected Bocconi university and an “international adviser” to Goldman Sachs, the investment bank. He is considered a potential Italian finance

Today the EU competition directorate is headed by Neelie Kroes, a former Dutch transport minister and businesswoman. Microsoft had hoped her arrival would mark a fresh start.

But the complexity of Mr Monti’s ruling swiftly came back to haunt the new commissioner.

Through much of 2005, the officials in Brussels and the lawyers at Microsoft found themselves in a stand-off as frustrating as the one they had experienced ahead of Mr Monti’s ruling. At its heart was a disagreement over how much technical information Microsoft was obliged to surrender to rivals.

The group says it was waiting for the Commission to say exactly what it should do. However the team at C3, the DG Comp electronics unit headed by Cecilio Madero, a Spanish ex-banker, thought their opponent was trying to stall the process. They felt Microsoft had failed to draw up “complete and accurate” interoperability information as required by the ruling.

The case is continuing but the Commission appears poised to impose fresh fines on the group – they will be levied until it is satisfied that Microsoft has fully complied with the 2004 ruling. Brussels has threatened to impose a daily penalty of up to €2m.

Every conflict produces winners and losers, yet in the case of the six-year antitrust battle between the Commission and Microsoft the two are not easy to distinguish.

True, Microsoft singularly failed in its drive for a negotiated settlement and has failed ever since to draw a line under the costly battle with Brussels. But the Commission has little cause for celebration. Even DG Comp’s supporters in the software industry admit the two remedies imposed by the Commission over Media Player and interoperability have failed to achieve their desired effect.

More than two years after Mr Monti’s ruling, no more than 1,400 versions of unbundled Windows have been shipped to PC manufacturers and consumers. As many observers predicted at the time, a failure to force Microsoft to price the bundled and unbundled versions differently meant there was little incentive for anyone to buy Windows without Media Player. The interoperability remedy, on the other hand, proved so complex that, far from resolving the case, it has spawned an entire new one.

To date, no company has taken out a licence on Microsoft’s technical documentation (showing, in Microsoft’s mind, how pointless the order was and, in the Commission’s view, how successful the group has been in torpedoing it).

In the meantime, Microsoft’s share of both the media player and server market has continued to increase. Despite the Commission’s efforts, the group’s use of its monopoly power in operating systems to conquer adjacent markets has been wildly successful.

Much hangs on the outcome of the appeal hearing that opens next week at the European Court of First Instance – not only for the Commission but for Mr Monti personally.

Although he is still widely admired in Brussels for his integrity and intellect, Mr Monti also presided over several other highly controversial rulings, some of which were thrown out by European courts. Critics see that as an embarrassment but supporters believe it smacks of personal courage. One lawyer says: “Mario Monti had all these negative court cases against him. He was on the ropes and then he took on the biggest company in the world. That is impressive.”

Even some Commission officials glumly acknowledge, though, that the balance of power may have tilted against the regulator. Microsoft, some say, is simply too big, too powerful and able to fight on too many fronts simultaneously to be curbed by Brussels.

“If they are successful in even half the things they are trying to do, I believe Microsoft will become a real problem. You cannot have so much power in so few hands,” one DG Comp official laments.

Already, the group’s rivals are complaining that Microsoft is busy stamping out the next competitive threat – the challenge posed by internet-based applications. Again, they have turned to the Commission, filing a complaint to Brussels in late February. Mr Madero’s C3 unit is once more leading the charge. The software industry is again lining up behind the two camps. Law firms are being hired and more complaints may be filed.

To the officials and lawyers who fought each other almost to a standstill in the five years from December 1998 it must all provide an unsettling sense of deja vu. Throughout the long days and nights they worked on the case, they knew they were taking part in something momentous: the biggest antitrust fight in European history.

But the real war, it seems, may have only just begun.

For first part of this two part series go here


While Brussels has failed to weaken Microsoft’s grip on the software industry, a new generation of internet companies led by Google may pose a bigger threat, writes Richard Waters.

Applications that depend only on a browser rather than the software in Windows and Office threaten to bypass Microsoft’s big money-earners. The spread of the web to mobile devices, where Microsoft has tried to seed Windows with little success, also promises to be a game-changer.

Yet the launch of the Windows Vista operating system within a year will again give Microsoft the chance to extend its dominance. Internet search will be built in, along with security features sold by independents.

Also, software to distribute media over the internet could make Windows the main content platform.

“If Microsoft has its way, it will make the internet proprietary,” warns Bruce Chizen, chief executive of the rival Adobe. “That would hurt not just a company like Adobe – it would hurt content companies, it would hurt device manufacturers.”

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