The Big Blue Diaries As the trial resumed, the government produced a Microsoft competitor with a telltale journal. But did the evidence show a crime?
(FORTUNE Magazine) – TUESDAY, JUNE 1: "It looks like old home week," says Judge Thomas Penfield Jackson, cracking a smile as he calls Round Two of the Microsoft antitrust trial to order. Round One, you'll recall, ended three months ago with Microsoft's defense seemingly in tatters and the government confident it had won the case.
In the interim, Judge Jackson presided over a grueling drug and murder trial. The combatants were busy too. A month into the recess, Microsoft and the government met to talk about a possible settlement. They were so far apart they never had a second meeting. Instead, the two sides spent the rest of their time girding for this next battle. Microsoft's lawyers, intent on making the recent AOL-Netscape merger a central part of its defense, subpoenaed merger documents and deposed AOL executives. The government's lawyers, meanwhile, went searching for a computer executive who might be willing to testify about Microsoft's alleged predatory practices. They found one from IBM who, we hear, turned over a handwritten diary filled with details about alleged threats Microsoft made against Big Blue. He's up next week.
This is the rebuttal phase of the trial. In the first part, which spanned last fall and winter, the litigants were each allowed 12 witnesses to make their cases. This time, the judge has allotted each side three witnesses--and two weeks (ha!)--to rebut the other side's earlier testimony. In an antitrust trial, that inevitably means that economists will retake the stand--and so it is here. Franklin Fisher and Richard Schmalensee--MIT colleagues who testified on opposing sides during Round One--are scheduled to return for Round Two. Fisher, in fact, is the government's first rebuttal witness, and he's on the stand right now.
As the rumpled, white-haired professor begins to answer questions put by David Boies, the government's chief prosecutor, I too am struck by the feeling that it's deja vu all over again. The witness, the lawyers, the reporters, even most of the spectators are the same people who were here last fall and winter. To me, though, it feels less like old home week than the first day of school after summer vacation: You're happy to see all your old friends, but your brain isn't ready to tackle the business at hand.
To save time, Jackson had witnesses in Round One turn in written direct testimony. In Round Two, he is letting the lawyers conduct the direct examinations in court, and Boies is using the first part of his exam of Fisher as a kind of Microsoft refresher course. Microsoft has a monopoly in the operating-system market, Fisher asserts in response to a Boies question. It has used its monopoly power to damage rivals, such as Netscape. In fact, says Fisher, many of Microsoft's anticompetitive acts--such as bundling its browser into Windows and giving it away for free--can only be explained as the actions of a monopolist trying to protect its monopoly. We trial regulars think: yadda, yadda, yadda.
Just as we're about to nod off, Fisher does something that causes our heads to jerk up. He begins to denigrate Schmalensee. We knew that he would be criticizing his colleague's economic analysis; Schmalensee, after all, testified in January that Microsoft did not have monopoly power and that its actions were not anticompetitive. Yet Fisher brings a relish to this task that is startling. He accuses Schmalensee--the dean of MIT's business school and a leading light in his field--of a "lack of systematic thinking." He says that Schmalensee is "reasonably confused," that "he behaves rather peculiarly" in some of his thinking, and that his arguments are "silly" and even "ridiculous."
What makes this so striking is that the two men aren't just colleagues, they're friends. Schmalensee was once Fisher's student. When the government first asked Fisher to testify against Microsoft, he sought out Schmalensee, who was already working for the software giant. Schmalensee told him not to worry. "This isn't a holy war," Fisher recalls Schmalensee saying at the time. But a holy war is what it's become.
WEDNESDAY, JUNE 2: Here's something new. Remember how, during Round One, there would be two spin cycles each day? At the lunch break, and again at the end of the day, Boies and Mark Murray, Microsoft's chief trial spokesman, would stand before a battery of cameras and microphones and take turns explaining how the latest testimony helped their respective causes. Reporters complained about the heavy-handedness of Microsoft's spin-doctoring, but we never stopped showing up. The spin sessions became one of the trial's rituals.
But yesterday and again today, only Boies has stepped to the microphones. Murray and the other Microsoft flacks have declined to appear. Mystified, reporters begin asking about this change in tactics. "The sessions just weren't that fruitful," shrugs Jim Cullinan, Murray's feisty young assistant. "They were counterproductive." He adds, "We're just listening to what you folks told us," making it sound as though canceling the spin sessions is in response to press complaints. In fact, Microsoft still has squads of PR troops at the trial and every intention of getting its message across. But the company appears to have realized that its daily courthouse statements--in which it often seemed to be saying that black was white and night was day--came across as shrill and not believable. Murray tells me that the company flacks will talk to reporters individually instead of in large groups with cameras rolling. Then he adds the shocker: Microsoft flacks are going to stop having drinks with the press corps on Thursday nights. Another Round One ritual bites the dust.
THURSDAY, JUNE 3: Does Franklin Fisher know anything about the software industry? We're starting to wonder.
Last time he was here, Fisher didn't seem particularly well prepared; this time he almost seems to be winging it. Even during his direct exam by Boies, his testimony is almost entirely lacking in hard figures--and you could just smell what was going to happen during cross-examination. Michael Lacovara, Microsoft's best courtroom lawyer, would torture Fisher over the lack of specifics in his direct testimony. This would have two consequences. First, it would cast doubt on Fisher's qualifications for making charges about Microsoft. And second, it would make Fisher squirm.
Sure enough, that's pretty much what's taken place since Boies handed Fisher over to Lacovara yesterday morning. The irrepressible "Laco" is enjoying putting Fisher on the rack. For instance, in order to show that Microsoft is charging "monopoly rents" for Windows, Fisher offered a complex calculation that uses $953 as the cost of a computer. (Schmalensee, who did his own complex calculation to show just the opposite, used a far higher price.) "Did you know that that price excludes the cost of the monitor?" Laco asks, in a tone of withering contempt. No, Fisher replies. "Do you still think it's appropriate to use $953?" "That's a fair point," Fisher concedes.
Fisher has insisted that computer prices have steadily declined during the 1990s; Lacovara displays a chart showing that the average price jumped substantially in mid-decade. During his direct exam, Fisher said that Microsoft had raised the price of Windows--which, he alleges, the company can do with impunity because of its monopoly. How much additional revenue was raised by those price hikes? asks Lacovara. When Fisher says he doesn't know, Laco snorts is disbelief. He asks if the economist has made any empirical studies to back his assertions. No, says Fisher. And Laco skewers Fisher when the discussion turns to Linux, the operating system that Microsoft claims is a potential threat to Windows. Under questioning from Boies, Fisher had claimed that Linux was not a threat because there weren't enough software applications written for Linux to give it widespread appeal. That, he said, was the "applications barrier to entry" that protected Microsoft's monopoly. Now, however, Fisher is forced to admit that he hasn't the faintest idea how many applications have been written for Linux, or any other operating system. And on, and on. "This is a Fish fry," chortles John Warden, Microsoft's lead trial lawyer, at the midmorning break.
After the break, Laco moves in for the kill. One of the critical issues in the case is whether Microsoft used monopoly power to force computer makers to abandon Netscape's browser in favor of Microsoft's. The government says that's exactly what happened--and last October former Netscape CEO James Barksdale agreed. "We're basically out of that [channel]," he testified. As he described it in court, Microsoft made threats against computer manufacturers that wanted to pre-install Netscape's browser--and they all folded.
But in the treasure-trove of AOL-Netscape documents it subpoenaed, Microsoft discovered one that put the percentage of pre-installed Netscape browsers at 24%. This document seems particularly credible because it was prepared by AOL's investment bankers, Goldman Sachs, as part of the merger's due diligence process. What's more, the document was secretly prepared last fall--just weeks before Barksdale testified!
First, Lacovara shows the document to Fisher. Then he reads Barksdale's testimony aloud. What can Fisher say? "If they really had...24% penetration," he admits, "then I think this is an exaggeration." In one stroke, Laco has undermined the credibility of both Barksdale, the government's star witness when the trial began, and Fisher, its chief economic witness. And he's clearly made an impression on Judge Jackson, who mentions the document several times before the day is out.
At the spin session after court ends, Boies dismisses the discrepancy as inconsequential and insists that Barksdale's credibility has not been seriously damaged. But the press isn't buying it; for once, it's the prosecutor, rather than Microsoft, who appears to be saying that black is white and night is day. I nudge Cullinan, who's standing next to me. "You're not going to make a statement after a day like this?" I ask. He chuckles. "I think we'll just let the events in the courtroom speak for themselves," he replies.
MONDAY, JUNE 7: Phil Malone is in some ways the unsung hero on the government's team. Operating out of the Justice Department's San Francisco office, the 40-year-old Malone led the antitrust division's investigation into Microsoft's business practices. Before Boies came onboard, Malone also served as lead prosecutor; when Boies arrived, Malone accepted without complaint his role as the No. 2 litigator. Though he has continued to play an important behind-the-scenes role, Malone only got to cross-examine one fairly minor Microsoft witness during Round One. Now, however, he's been handed the juiciest of assignments. Today Malone begins the direct examination of government rebuttal witness No. 2--yes, the IBM guy with the handwritten diaries.
The IBM guy's name is Garry D. Norris. A 41-year-old African American--the first nonwhite male, by the way, to testify in this trial--Norris bears an importance to the government's case that's almost impossible to overstate. Ever since the government filed suit last May, it has been pleading with computer manufacturers to testify. They, after all, are supposed to be the ones most at the mercy of Microsoft, since they are out of business without Windows. And they're all said to resent Microsoft's power over them. Gateway, for instance, answered a series of government interrogatories with some scathing allegations about Microsoft. Yet no one from Gateway was willing to come forward to testify.
Why has Big Blue decided to step into the ring now? No one will say. The most likely explanation is that the company has been emboldened by the government's apparent successes in Round One and sees a chance to help bury its long-time rival. (To be sure, an IBM executive did testify in the earlier part of the trial. But he was not from the PC division, and his testimony was not particularly significant.) The government doesn't really care why IBM has stepped forward. Norris is here, and on the stand--and he's making just the kind of allegations that the feds prayed for.
Here is Norris' story: Between March 1995 and March 1997, his job consisted primarily of negotiating Windows license agreements with Microsoft. When he took the position, IBM was paying a royalty of $9 for each copy of Windows 3.1 that it loaded onto its computers. That was a better deal than any other manufacturer's, the result of IBM's having helped develop the operating system. But in the spring and summer of 1995, as Microsoft was preparing to launch its all-important Windows 95, relations with Big Blue grew increasingly chilly. First, Microsoft asked that IBM stop selling its competing operating system, OS/2. When IBM refused, a Microsoft executive told IBM that it would have to pay $75 per copy of Windows 95. "Where else are you going to go?" Norris quotes a Microsoft official as saying. "We're the only game in town." (The executive who allegedly made those remarks later told the New York Times and the Washington Post that he had never said anything of the sort.)
Then, that summer, IBM bought Lotus--which had its own array of products that compete with Microsoft offerings--and relations got even worse. Microsoft demanded to know whether IBM was going to load Lotus' SmartSuite products onto its computers, and was furious to learn that it was. Gates, according to the witness, screamed so loudly at an IBM executive that Norris, who was present in the room, could hear what he said--even though Gates was on the other end of the phone. All that summer, as other manufacturers were getting access to Windows 95 to prepare for the launch, IBM was frozen out. According to Norris, Microsoft made it plain that as long as IBM was going to compete with Microsoft in such areas as operating systems and office-productivity suites, it would never get the same favorable treatment as friendlier computer manufacturers such as Compaq. Though Microsoft finally granted IBM a Windows license, the signing took place just 15 minutes before the official launch. Because it was so far behind, says Norris, IBM missed the back-to-school season, losing tens of millions of dollars in sales. In addition, it was forced to pay a higher royalty than other manufacturers--costing hundreds of millions more. This, he says, was IBM's punishment for insisting on its right to compete against Microsoft.
It is a stunning day of testimony. Norris is confirming what the government has been saying since this case began: that Microsoft uses its Windows monopoly to stifle competition. So dramatic is Norris' testimony that the Washington Post puts its account on page one. But the news stories don't convey the weirdly matter-of-fact way in which this electric testimony is conveyed. Malone is as low-key as Boies is charismatic, and he conducts his examination in a steady, methodical, somewhat bland fashion. Norris is much the same. The rare witness in this trial who does not expound, pontificate, or bluster, he is as low-key as Malone. But the testimony is so powerful that even without Boies-style fireworks, it's still riveting. When the day ends, we trial regulars all agree that Microsoft has taken a serious hit.
TUESDAY, JUNE 8: Hey, wait a minute. Where are the handwritten diaries? Weren't they supposed to be the best part of Norris' testimony? Yesterday, Malone introduced only one page of the diaries as evidence, and it didn't amount to much. But it turns out that Malone was saving the best for last. This morning he begins trotting them out--and they more than live up to their billing.
During a Feb. 17, 1997, meeting with a Microsoft executive named Bengt Akerlind, Norris wrote, "Bengt Akerlind. SmartSuite, [Lotus] Notes, World Book, etc. Gates. Why are we working with IBM when they are doing these deals? Don't work with them." When Malone asks him to explain the cryptic note, Norris says, "I recall [Akerlind] saying that Gates was really upset...that we continue to compete with Microsoft with SmartSuite, now Notes and World Book.... He [Akerlind] said that's what Gates said: 'Don't work with them.'" Malone moves to another diary entry, this from a meeting in early March 1997. The item reads, "IE 4.0. In exchange, neutral system...." Again Norris explains: Microsoft was offering to give its new browser, Internet Explorer 4.0, to IBM for free. "But in exchange," he adds, "we would have to agree to load a neutral system." What is a neutral system, according to Microsoft? "Microsoft defined a neutral system as a system that contained Microsoft software...and no IBM or competing system."
One more meeting, one more diary item: "CDT. No ship with NTW and SmartSuite...QPQ access to source, NT and Back Office and 95." This meant, Norris said, that Microsoft wanted IBM to forgo loading SmartSuite on any commercial desktop brand (CDT) that shipped with the Windows NT operating system (NTW). In return, Microsoft would give IBM access to the source code for Windows NT, BackOffice, and Windows 95.
What does QPQ mean? Malone asks. Norris look directly at Judge Jackson and responds slowly: "Quid. Pro. Quo."
WEDNESDAY, JUNE 9: Maybe, just maybe, the dynamics of the Microsoft trial really are changing. Maybe the events of last week, when Laco left Fisher in a writhing heap, were not some aberration but a signal of a tidal shift. Maybe Microsoft is finally figuring out how to defend this case.
Admittedly, I did not think that yesterday afternoon, when Microsoft's cross-examination of Norris began. Richard Pepperman, a young, well-liked Microsoft lawyer, got off to a terrible start--irritating the judge with frivolous lines of questions, making a series of small but telling blunders, and generally appearing to be in over his head. During a sidebar conference in the afternoon, the judge went so far as to tell Pepperman, "I'm not sure how much progress you've made so far." Pepperman, after one slip-up, actually told the judge that it was the result of his "inexperience." It looked like Round One all over again: Witness makes searing allegations against Microsoft. Microsoft's lawyers not only fail to regain ground, but dig the hole even deeper. Judge gets mad at Microsoft. Press has field day.
But this afternoon, Pepperman raises his game to another level. In the space of two hours, he asks a rapid-fire series of questions that poke gaping holes in Norris' account. Isn't it true, he asks, that Microsoft never threatened to withhold Windows 95 from IBM, even after Big Blue turned down Microsoft's request to stop competing? Yes, concedes Norris, that's true. And isn't it true that although Microsoft originally wanted to raise the price of Windows 3.1 from $9 to $63, IBM eventually negotiated it down to $19.95? Again, Norris is forced to agree. ("Pretty good negotiating with the only game in town," adds Pepperman.) And isn't it true that Compaq got a better deal because it had helped develop Windows 95--just as IBM had done with Windows 3.1? Again, Norris has to agree.
By the time Pepperman is finished, we're wondering: What precisely is the crime that Microsoft is supposed to have committed here? If IBM consistently refused to bend to Microsoft's wishes--and still got access to Windows--how is this an abuse of monopoly power? Doesn't even a monopolist have a right to extract the best possible price for its products--and give price breaks to companies that agree to promote its products exclusively?
The Justice Department insists that Microsoft's treatment of IBM is a clear example of predatory tactics. But antitrust observers say this is far from clear--and that case law probably favors Microsoft on this point at least. In any case, as Pepperman grills him, Norris becomes increasingly petulant, argumentative, and forgetful--just like so many Microsoft witnesses during Round One. When the session ends, the Microsoft troops are positively buoyant.
Back in the old days of this trial, when Microsoft was getting killed in court on a daily basis, Mark Murray would often begin his part of the spin session by saying, "It was another good day for Microsoft." Among the press corps, it became a running joke--a symbol of Microsoft's denial of reality. Today, during a short recess after Pepperman completes his cross-examination, Murray sidles up to me and says something very similar. "We had a good day today." I don't roll my eyes. This time, black isn't white and night isn't day.