Antitrust: What Is It Really Against, Part 3 — Why Did People Fear Microsoft 20 Years Ago?

Tech's ruling dynasties keep changing; the laws that regulate them are stuck decades in the past.

In the antitrust argument over America's big tech companies that has flared up again over the past two weeks, Microsoft's name keeps coming up.

"In the 1990s, Microsoft tried to use its dominance in operating systems to gain dominance in internet browsing. The federal government sued Microsoft for antitrust violations and ultimately reached a settlement. The government's antitrust suit against Microsoft opened the way for the rise of Google and Facebook." Elizabeth Warren, the Democratic candidate who wants to break up big tech, cites the 1998 antitrust suit that nearly split Microsoft in two as the theoretical basis for breaking up Apple, Amazon, Facebook, and Google today.

Opponents like to bring up Microsoft too. They point to the Microsoft suit — above all to the EU's later ruling that forced Windows to unbundle the IE browser — as proof that breaking up tech companies wastes money and hurts the consumer experience.

One thing is certain, though: 20 years ago, Microsoft really was a company people feared. Steve Jobs, Gates's old rival, returned to Apple in 1997, ended the patent fight with Microsoft, and agreed to preinstall IE on the Mac in exchange for Gates's money. Jerry Yang, founder of Yahoo — then the biggest internet company — said publicly, "You never, ever want to compete with Microsoft. If they want to compete with you, you'd better run and go do something else."

Windows held more than 90% of the desktop market at the time, and no other company in the industry came close. Today, in the global market and in China's separate one alike, a handful of tech giants each sit on their own piece of infrastructure.

But the arguments about antitrust are strikingly alike.

Mark Zuckerberg sat through eight hours of congressional questioning last year. Twenty years ago Bill Gates also defended his company in public against the U.S. Department of Justice — though Gates was vaguer and more contemptuous, barely hiding what he thought of the officials' intelligence.

The logic of the antitrust charge is the same as in the other big breakups of the past: once a company holds a critical piece of infrastructure, it works that infrastructure to keep competition from appearing. Once it was oil and railroads; then Microsoft's operating system; today it is search engines, social networks, shopping platforms, and app stores.

The rebuttals are alike too. Milton Friedman, the Nobel laureate economist and one of the leading voices for free markets, called the suit ill-considered and said it could do further harm to consumers and to innovation. Twenty-one years later, people are pushing back at Warren with the argument that "getting big is not a crime."

That lawsuit ran three years, spanning the internet bubble and its collapse, and caught changes of power at both Microsoft and the White House. Twenty years on, the tech industry has grown into something nobody then imagined, and the argument over antitrust for tech companies still has no ending.

From Windows to Office: How Microsoft Built Its Huge PC Empire

Microsoft's huge empire began with a $50,000 purchase of intellectual property. Like the company's name, the deal was driven by co-founder Paul Allen, the man whose fame has always trailed a little behind Gates's.

In 1979, less than four years after it was founded, Microsoft landed a big order: build a personal computer operating system for IBM.

IBM was then the world's largest computer maker, and its customers were governments, institutions, and companies. Its request was simple. It had decided to build a personal computer for households and small and mid-sized businesses, and it needed an operating system that was easy to use. The young personal computer market was already spreading fast, pulled along by the Apple II.

In 1981, Allen led the purchase of the full copyright to 86-DOS from Seattle Computer Products for $50,000 (about $140,000 today). The operating system had been written by Tim Paterson, then a 24-year-old programmer. Microsoft reworked it into a new version that met IBM's needs and renamed it MS-DOS (Microsoft Disk Operating System).

In August, the IBM PC shipped with MS-DOS. The market at the time was full of personal computers built to different standards — Apple's, the TRS-80, and plenty of others. IBM, long seen as bureaucratic and closed, suddenly changed course and decided to build its computer in the open.

The next year IBM published the technical standards for its personal computer, so that other manufacturers could build and sell compatible components and software to IBM's specifications.

IBM's aim was clear: one standard, lower production costs. The strategy worked. It drew in a crowd of board makers and system assemblers and gave the PC a complete supply chain.

At first Microsoft looked like just one link in that chain. But Allen made a shrewd deal — he signed an agreement with IBM that let Microsoft license DOS to other PC makers without paying IBM any share of the licensing money.

Many people call this one of the most successful deals in business history.

Software was seen then as an appendage to hardware, but Microsoft saw that software sat closer to the customer than hardware did. Under an open IBM PC standard especially, companies in the United States, Japan, Taiwan, and South Korea all started building PCs — and hardware brands were interchangeable, while what consumers and companies cared about was the software they used. What decided which software they used was the operating system.

As Jobs put it years later, "Before anyone had figured out what a software company was, Bill had built the first one."

In 1983 Microsoft built the Windows 1.0 operating system for the IBM PC, showing off a graphical interface with icons, a mouse, and windows before Apple's Macintosh. It cut the cost of learning sharply: you no longer needed a programming language to use a PC.

Windows 1.0 shipped in 1985, on Microsoft's tenth anniversary. Like most Microsoft product lines, it was terrible to use. But the Microsoft Works office suite, released in 1986, lifted sales, and after that Windows got a major update every two or three years, quickly making Microsoft the company that really controlled the PC.

Once Windows made PCs easy to use, more hardware companies joined the fight. Makers kept squeezing costs to compete, but none of them could get around Windows or around Intel, which supplied the chips — and most of the profit in the PC market went to those two.

In 1991 Fortune ran a cover story looking back at "ten years of personal computer history". The only people it interviewed were Jobs and Gates. Nobody cared about IBM anymore.

Microsoft's power had become immovable. By the time Windows 95 came out, the Windows operating system held more than 80% of the market, and Microsoft's annual sales passed $1 billion for the first time.

The Windows disc in a box was not what mattered most. Preinstallation and bulk buying by corporate customers were the core of Microsoft's revenue. In 2000, Microsoft's total revenue topped $22.9 billion, of which corporate customers contributed $20.4 billion.

Companies became Microsoft customers because of Windows and, later, Office. With those customers in hand, Microsoft raised its walls higher — by selling them more software.

Corporate customers signed Enterprise Agreements (EAs) with Microsoft and kept buying more and more Microsoft business software at a discount: Windows, the Windows server system (NT), Office, databases, and the rest.

Around 1994, Word, Excel, and PowerPoint each held more than 50% of their markets; by 1998 that was close to 100%.

Windows and Office were Microsoft's engines of growth through the 1990s. Total revenue rose from $1.8 billion in 1991 to $23 billion in 2000, and net profit from $463 million to $9.4 billion.

At the peak of the internet bubble in early 2001, Microsoft's market value hit $600 billion (about $910 billion today). At one point this single company accounted for as much as 11% of NASDAQ's total value, and its every move moved capital markets. By comparison, Apple at its highest value last year was worth less than 3% of all of NASDAQ.

Microsoft used Windows to control PC manufacturing and take the industry's profits, and on that base it decided what software companies and individuals used.

By the time new Linux-based personal computer operating systems took several runs at Windows in the late 1990s, they had no chance of winning. Apple, too, chose to take Microsoft's investment and preinstall Microsoft software on the Mac.

The Antitrust Case Ran Four Years: Microsoft's Crime Was Using Its Monopoly to Control the Gateway to the Internet

Before the 1998 suit, Microsoft had already run into trouble several times over the way it competed.

In 1994 the U.S. Department of Justice brought its first antitrust suit against Microsoft, charging that the company had signed exclusive agreements with computer manufacturers that stopped them from choosing any operating system but Microsoft's.

That case was settled. The next year Microsoft signed a consent decree and rewrote its Windows licensing agreement to drop the exclusivity terms.

It did the company no harm. The software ecosystem had already formed, Windows already had mainstream acceptance, and computer makers had nowhere else to go. It is the same logic as the EU punishing Android today while Android keeps an absolute monopoly.

Around the same time, Caldera sued Microsoft for suppressing competition. Court documents included internal Microsoft emails showing that executives followed an "FUD" tactic (fear, uncertainty, doubt), misleading the public into believing that a product competing with MS-DOS could not run properly on Microsoft's Windows 3.x because of compatibility problems — using Windows's dominant position against it. Microsoft ended up paying $275 million in damages.

The biggest trouble was the browser. In 1995 Microsoft tied Internet Explorer to Windows and preinstalled it free; every Windows computer had the IE icon on its desktop.

Preinstallation won IE market share fast — 20% in 1996, 40% in 1998, 80% by 2000. Its rivals were crushed: Netscape, which had once held 80% of the market, was down to 13%.

In September 1996 the Justice Department formally opened an investigation into whether tying Windows to the IE browser amounted to a monopoly.

After two years of tug of war, in May 1998 the Justice Department under the Clinton administration and the attorneys general of 20 states jointly sued Microsoft for antitrust violations, opening the most closely watched business trial of the turn of the century.

That was exactly the year Windows tightened its grip further. Windows 98 shipped; in 1997 Microsoft had invested in Apple and struck a deal to preinstall IE and Office there, taking out the only competitor of any value left in the personal computer market.

In its filing, the Justice Department said Microsoft had suppressed innovation in the software industry: "Consumers and computer manufacturers should have the right to choose the software they want to install on their personal computers. Our goal is to preserve competition, promote innovation in the computer software industry, and ensure that anyone developing a software program has a fair chance to compete in the marketplace."

Over the next eight months the Justice Department and Microsoft each put witnesses on the stand, Microsoft's competitors among them. During those months Netscape collapsed and was bought by AOL in 1999. In January 2000, Bill Gates stepped down as Microsoft's president and chief executive.

On April 3, 2000, Microsoft was found to have broken the Sherman Act. The presiding judge, Thomas P. Jackson, formally ruled that Microsoft be split into two companies, barred from merging for ten years. It was the harshest forced breakup ordered in the United States since AT&T was broken up in 1984.

The ruling explained that the evidence showed users had no alternative to Microsoft's operating system, and might have none in the near future either. Judge Jackson's findings of fact said the web browser was a kind of "middleware": it could not exist on its own but had to be built on the platform's — the operating system's — APIs. He compared Microsoft to Standard Oil and Bill Gates to Rockefeller. What Microsoft held was the infrastructure of the internet, the way those companies had held oil and railroads.

That was what made Microsoft frightening. It could decide which browser people used and what information they saw.

Microsoft's lawyers argued that tying IE to Windows was purely the product of innovation and competition, that the two could not be separated, and that consumers came out ahead, because it made products like Netscape's browser, which used to cost money, free.

To prove that IE served consumers in the end, Jim Allchin, then a Microsoft vice president, played a video in court showing that removing IE slowed Windows down. The video was later shown to be faked.

Gates himself was as vague as he could be under questioning. In an hour of deposition video later made public, Gates said "I don't recall" six times, "I forget" 14 times, and "I don't know" 22 times — at one point making the judge in the room laugh.

In the end Microsoft was never broken up.

In June 2000 the U.S. Court of Appeals for the D.C. Circuit voted 7-0 to throw out the breakup order. The judges held that Microsoft was still a company with monopoly power, but that tying the IE browser to Windows was lawful innovation.

Two months later it came out that Judge Jackson had violated judicial procedure by leaking details of the case to the press, and he was taken off it. Colleen Kollar-Kotelly was appointed to take over the Microsoft antitrust trial.

Finally, on September 6, 2001, three years after Microsoft was formally sued, the Justice Department announced that it would no longer seek a breakup, and dropped the tying charges.

Microsoft then agreed to pay fines and to open part of the Windows source code, and to let PC makers choose their operating system freely (though they had nothing to choose from). In 2003 Microsoft paid a total of $1.55 billion to settle the states' suits.

Whether to Act Against Microsoft Was Fiercely Disputed, Mostly Over Whether It Was Good for Consumers

From a competitor's point of view, Windows held 90% of the market, and Microsoft controlled the software business built on top of that operating system too, squeezing out the room to compete.

From a consumer's point of view, there was nothing frightening about Microsoft. That was the question that finally let Microsoft turn the case around: its browser was free and kept getting better (at least up to IE6 in 2001), and it had not hurt consumers.

The argument still has no clear answer.

Milton Friedman, the Nobel laureate economist and standard-bearer of the Chicago school, held that the breakup order was a waste of money and effort, one that "set a dangerous precedent of government interference in the free market and planted the seeds for stalled technological progress across the industry."

Goldman Sachs predicted that if Microsoft were split up, corporate administrative costs would inevitably rise — $43 billion more in spending over the next ten years — on top of extra costs such as system integration.

Stan J. Liebowitz, an economics professor at the University of Texas, also argued that Microsoft was good for consumers. In his book Winners, Losers & Microsoft, he wrote that if Microsoft raised prices once it had monopoly power, that would in fact push the industry to improve on price, while smaller rivals would not dare to move and would simply follow Microsoft's pricing.

Consumers did not back a breakup either. A 2000 Gallup survey found 54% of respondents opposed to the federal government's breakup plan and only 34% in favor.

Many people thought Microsoft did have a monopoly problem, but that breaking it up was not the answer.

Paul Krugman, the MIT economics professor and Nobel laureate, wrote after the breakup order came down that the question was not whether Microsoft had broken the law but that the breakup could not be carried out — and would hurt consumers instead. The spun-off operating system company would give up its restraint on prices and charge more on the strength of its monopoly, while software that had been free would start charging. Again, consumers would take the damage.

Some said Microsoft got lucky. At the turn of the century the case happened to fall across the handover of power from Clinton to Bush, and Bush took a far more relaxed line on antitrust.

In January 2001, a spokesman for the Bush transition team said in an interview: "Our society and our government too often turn to litigation to solve problems, and that itself is a problem."

Tech Companies Have Changed a Lot; the Laws That Restrain Them Have Not Moved

The Justice Department, it turned out, overestimated the browser's power as a gateway to the internet. In 2004, the year Google went public, Microsoft's IE browser held 95% of the world market; ten years later it was down to 10%, and only 14% of connected devices worldwide still ran Windows. Today Google Chrome holds more than 60% of the browser market, PC and mobile together.

Microsoft was no longer something new companies feared. Paul Graham, co-founder of the Silicon Valley incubator Y Combinator, published a blog post in 2007 titled "Microsoft Is Dead"; he saw that the founders of the day no longer felt the fear Yahoo's Jerry Yang had described: "Microsoft still makes a lot of money, but no one is afraid of them anymore. They're not dangerous."

Graham listed four reasons: the rise of Google, the end of the desktop era, broadband (the faster the network, the less you need local desktop storage), and Apple.

Like the Justice Department, Microsoft misjudged the internet's future. In 1995, Gates set out his picture of the internet's next 20 years in an internal memo. He thought unified formats mattered: in the future, Mac and Windows would put out files in one format, allowing free collaboration over the internet. Looking back, Microsoft's early picture of the future was all desktop thinking.

But it is also hard to call the Justice Department's worries about Microsoft unfounded.

The United States never broke Microsoft up, but the company faced antitrust investigations in Europe, South Korea, and China. In 2008 the European Commission ruled that Microsoft had failed to comply with its 2004 antitrust decision and fined the company $1.35 billion.

IE never became what an operating system is, but a browser really can exert more control than mere "middleware." China's internet industry threw up a few examples: 3721, or Sogou and Tencent using browsers to push their search products. Microsoft, which gave no quarter when it crushed a competitor, never went that far — probably in no small part because of the threat of more lawsuits.

In 2008 Microsoft planned to buy Yahoo at a 62% premium; the talks fell apart four months later, with antitrust scrutiny following the whole affair. The Justice Department and the Senate antitrust subcommittee both said plainly that they might investigate the deal, and Google spoke up to accuse Microsoft of trying to monopolize the internet through it. In practice, antitrust kept Microsoft from making a big acquisition to compete with Google during Google's fastest rise.

The browser is a thing of the past; today's Microsoft concentrates on its enterprise business, much as IBM did 20 years ago. But the new giants' control of the internet has moved on again.

Amazon, Apple, Facebook, and Google — or, in China, Alibaba and Tencent — each hold an overwhelming, hard-to-challenge share of one particular consumer need. Companies offering internet services no longer have to care about the operating system; once they become giants themselves, they are the gateway to their own territory.

The way each of them ties users to its own products, in experience and in efficiency, goes far beyond what Windows plus IE ever managed.

Just as Microsoft did 20 years ago, they use their monopoly over a piece of infrastructure to suppress competition and even to monopolize speech. The EU has fined Google enormous sums twice; Spotify has sued Apple over its unreasonable cut of revenue. Monopoly brings regulatory investigations and public condemnation — the same events returning 20 years later.

As in the argument over Microsoft 20 years ago, the new giants have brought consumers benefits. People use apps that update constantly, send and receive messages free, look at maps free, use office software free. Amazon has unified e-commerce and pushed prices down. Consider that Microsoft was not even entirely free: it still charged PC makers, who passed the cost to consumers in the end.

The new giants also find it easier than Microsoft did to win consumers over — or rather, users can no longer get out. When IE was slow and clumsy, users could switch to Firefox or to Chrome at no cost. And now? Social networks hold vast amounts of personal data and social connections, and even with Facebook condemned around the world, the other choices are little more than its own two other products, Instagram and WhatsApp.

The giants that dominate the tech industry have gone from Microsoft, which controlled fewer than 600 million personal computers (in 2000), to Apple, Amazon, Facebook, and Google, each of which controls at least a billion people today. Tech companies are worth more, touch more human beings, and are harder to challenge than ever.

Time, in a 2014 article looking back at the Microsoft antitrust case, summed up Microsoft's decline and the rise of the mobile internet this way: "Power has shifted from Microsoft to its rivals — and so has regulators' attention."

But the hard questions the Microsoft case failed to settle 20 years ago are still unsettled. How exactly do you judge that a tech company has not harmed consumers? Is control over price grounds for calling something a monopoly?

Tech's ruling dynasties keep changing; the laws that regulate them are stuck decades in the past.

Cover image from Pixabay