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Microsoft Plays The Underdog

By Steven Levy
Friday, February 15, 2008

In the fall of 1997, I was interviewing Bill Gates at a conference in Scottsdale, Ariz. Suddenly the door to the room we were using sprung open, and William H. Neukom, then Microsoft's general counsel, rushed up to Gates and pulled him from the room. I later learned what the urgency was about: A federal judge had ruled that Microsoft violated a consent decree concerning its anticompetitive behavior in promoting Windows.

The next year, Microsoft had to defend itself in a full-blown antitrust case, one that dragged on for years and wound up with a judgment against the company and, eventually, a settlement. Microsoft still must submit to federal oversight of its practices, a condition recently extended until 2009. The company has also been stung by a series of judgments from the European Union and has been forced to pay more than $1 billion to settle lawsuits by Netscape, Sun Microsystems and Real Networks. It has paid millions more to various states and consumers that joined in the litigation.

Considering this, you would think Microsoft would do anything to avoid a similar imbroglio. But combined, Microsoft and Yahoo have an 85 percent share of portal front pages, an 80 percent share of Web mail, almost a 90 percent share of Web-based instant messaging, and by far the largest sites in business, music, sports and many other areas.

Presumably, the Internet behemoth formed by the alliance could be a staging ground to further embed Microsoft's dominant products -- Windows and Office -- on the screens of an already semi-captive public. The Justice Department's antitrust division has expressed interest in the proposed deal. Congress is readying itself for hearings. And the European Union, which seems to relish slapping down Microsoft on competitive abuse issues, is undoubtedly salivating at another chance to poke chief executive Steven A. Ballmer.

"The E.U. almost always scrutinizes Microsoft to distraction," said Carl W. Tobias, a law professor at the University of Richmond.

Microsoft thinks there are antitrust issues involved in its proposed takeover, which would be a serious tilt in the marketplace, where customers' choices are limited. But the dominance that the Microsoft forces refer to is Google's, not its own.

When I spoke to Microsoft's general counsel, Bradford L. Smith, last week, he said a Microsoft-Yahoo combination could slow the runaway devastation caused by the Godzilla of search. "Google has a super-dominant market in the areas of search and advertising," he said. Regulators, he said, will approve the takeover because it is the only way that a credible competitor can emerge to fight Google's advantage in selling ads alongside search results. Furthermore, he said, advertisers are rooting for Microsoft to combine its lowly third-place search site with Yahoo's only slightly less lowly search site so Google would not be so powerful that it could raise ad rates at will. "Regulators look to what [customers] say," Smith said.

Google tries to keep the focus on potential abuse by Microsoft. In a blog posting last week, Google's chief legal officer, David C. Drummond, wrote that a Microsoft takeover of Yahoo would raise "troubling questions" about whether Microsoft could stack the Internet deck in its favor: "Could a combination of the two take advantage of a PC software monopoly to unfairly limit the ability of consumers to freely access competitors' e-mail, IM, and Web-based services?"

Google takes particular satisfaction in pursuing this line because in the past year the search giant has been fending off similar complaints about one of its proposed acquisitions, the $3 billion friendly takeover of the online ad company DoubleClick. Who was complaining? Microsoft. It was an odd stance for Microsoft to take, considering that it spent the past decade arguing that monopolies don't really exist in the ever-shifting landscape of technology. And after whining over a $3 billion Google deal to buy an ad company, Microsoft bought a different ad company, aQuantive, for $6 billion. Now, of course, it's proposing to pay $45 billion for Yahoo. But that's different.

Where does Yahoo stand on the antitrust issue? At one point in its communications, the company cited the discussion of the regulatory hurdles that would come with such a powerful merger. But word has leaked out that one of Yahoo's alternatives would be to subcontract its search business to Google, so it could cut costs and focus on media and services. Such an arrangement, however, would boost Google's already huge market share in search -- probably to the point that regulators would knock down the deal, experts said.

All of this is like one of those optical illusions that your mind perceives as one picture until someone points out that there's a totally different way of looking at the image. Depending on the market that people consider, the takeover is either an egregious boost to Microsoft's power or a tonic to Google's excessive search share. The lesson seems to be that technology companies -- once valiant defenders of the idea that the government should keep its hands off this dynamic marketplace -- are eager to see regulators jump in to temper a runaway market leader. Unless, of course, the company is that leader.

Steven Levy, a senior editor at Newsweek, can be reached atsteven.levy@newsweek.com.

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