Have Tech's Bullies Been Tamed? Microsoft is shaking hands with Sun, paying fines, and--gasp!--ceding ground to rivals. What gives?
By Fred Vogelstein

(FORTUNE Magazine) – To most people, Microsoft's image has long been blissfully uncomplicated: It's a big, bad bully with so much money-- $53 billion to be exact--that it is practically above the law. Even after the U.S. government's celebrated antitrust victory in 2000, Microsoft escaped with just a slap on the wrist. Now the EU is trying to take a whack. In March it fined Microsoft $611 million for antitrust violations dating back to the 1990s. But with the company's virtually unlimited legal resources, it's hard to see how it could end up paying the full fine.

Then comes the news that Microsoft has agreed to pay archrival Sun Microsystems nearly $2 billion for past antitrust and licensing misdeeds and to cooperate with Sun to make their respective software and hardware products work better together. After years of jousting that often got personal, Microsoft CEO Steve Ballmer and Sun CEO Scott McNealy made the announcement together on the same stage.

It's unclear how long the Sun detente will last. Sun is still hell bent on using Linux and its own software to supplant Microsoft on both desktop computers and servers. Indeed, the two companies compete directly today more than they ever have. What is clear, however, is that the world's view of Microsoft as a rapacious monopoly needs serious rethinking.

When the U.S. government filed suit in 1998, Microsoft really did use its monopoly power to strong-arm competitors and vendors. It really did thumb its nose at anyone who dared question its motives. It really was scary to do business with. Today, because of its own bumbling and hubris, Microsoft bears as much resemblance to that entity as a nurse shark does to a great white.

Look at what's happening in search. MSN has been left in the dust by Google and Yahoo. In music, Apple is running away with the market with iTunes and the iPod. In home entertainment, the battle between Microsoft's Xbox and Sony's mighty PlayStation isn't even close. And in cellphones, handheld devices, and other consumer electronics, Linux or Java is the software of choice, not Windows CE. Microsoft doesn't even scare companies the way it used to. Dell, once a loyal Microsoft ally, now sells close to 20% of its servers with Linux and is teaming with Microsoft rival Oracle to boost those sales. HP, another ally, has teamed up with Apple--Apple!--to sell HP-branded iPods and PCs with iTunes.

Even Microsoft's Windows and Office businesses--which generate 85% of its revenue--are seeing meaningful challenges for the first time. Hackers discover a major security flaw every six months, it seems. Meanwhile, Linux has become a true alternative. During the Microsoft trial, government lawyers scoffed at the company's Linux fears. But today Linux is its biggest competitor in server software. On the desktop, Microsoft's monopoly was once so total that no one bothered to take it on. Now a tiny company called Lindows has sold more than 100,000 Linux desktops through Wal-Mart and other resellers; Microsoft has sued it for trademark infringement. Sun Microsystems just signed a deal with the Chinese government to supply its Linux desktop operating system and office program to as many as a million PCs there--instead of Microsoft Windows and Office. Microsoft is so worried about governments and companies in Europe and Asia switching their infrastructures to Linux that it is doing what no monopoly ever does: It's cutting its prices to keep customers.

No one would pay any attention to these issues if Microsoft's revenues and stock price were still growing 40% a year. But revenues are projected to grow about 11% this year and about half that in 2005. During the past five years its stock, at about $25 a share, has underperformed all three major indexes and has even lagged behind IBM and HP. "What's really stung, and kept me away from the stock," says David Readerman, a portfolio manager at Marsico Funds and a longtime tech analyst, "is that for all the money and talent they have thrown at the business, nothing has come close to replicating the returns of Windows and Office." And if nothing can replicate those returns, he asks, should Microsoft be spending $7 billion a year on R&D?

The prevailing view in Silicon Valley is that Microsoft will eventually morph back into the same old rapacious beast. "People said exactly the same thing about them when AOL and Netscape looked like they had the edge," says Bill Krause, CEO of Caspian Networks and one of the founders of networking giant 3Com. Microsoft can afford a process of trial and error no other corporation can match. What will Google and Yahoo do when Microsoft starts bundling its own search with its new operating system and web portal? What will Apple do when Microsoft uses its balance sheet to subsidize a better online music store?

But Microsoft has never faced so many assaults on so many different fronts before, says Michael Cherry, an analyst at Directions on Microsoft, who worked at Microsoft for more than a decade. The Valley was equally scared of IBM in the 1980s before startups with names like Oracle, Cisco, Sun, and Microsoft drove its business onto the rocks. "Look at what it took Linus Torvalds to write Linux--a cheap PC and lots of time," says Cherry. For Microsoft, dealing with these forces in the marketplace will be much harder than anything any government can dish out.

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