Matthias Beck and Lynn Drennan suggest that Microsoft's inability to prevent the US government's decision to break up the software giant could be the risk management failure of the century.
Microsoft had ample time to compromise with government demands, to actively fight its image as monopolist, to audit its business practices and, lastly, to institute a business structure less vulnerable to accusations of anti-competitiveness. So how and why did it lose out in what is predestined to enter the annals of risk management as one of the greatest management blunders of the 20th century?
When, on 7th June 2000, Judge Thomas Penfield Jackson ruled that Microsoft be broken up into two companies, with additional restrictions being imposed on the company's ability to develop further products, this ruling came as no surprise to industry experts. It also could not have surprised Microsoft's management.
The Department of Justice (DOJ) investigated Microsoft in the early 1990s. As a result oftliese investigations, the company signed a consent decree with the DOJ in July 1994, which stated that Microsoft could not require computer manufacturers who licensed windows to licence other software products as well. At least at this stage six years before the actual judgment requiring a break up - the company knew that the possibility of legal action had become a serious risk for its business.
There was also little doubt about the continuing commitment of the US government to its anti-trust law. Often considered as civil rights for the small business, the US anti-trust law was enacted in the latter part of the 19th century, when big business had developed a number of questionable techniques for exploiting its economic power, often at the cost of small business and consumers. During the 1890s, the Sherman antitrust act was enacted to prohibit conspiracies, contracts and combinations in restraint of trade, monopolisation, or contracts, combinations and agreements intended to monopolise a business activity. This was followed by the Wilson tariff act of 1895, and the Clayton act of 1914. Today, the Sherman act, together with the Clayton act, as amended by the Robinson-Patman act, and section 73 of the Wilson tariff act, constitute the federal antitrust law of the United States.
While the will to employ this body of legislation has varied under different presidents, no single administration has ever questioned its underlying philosophy, nor made attempts to weaken its remit and powers. Thus, during the Nixon and Reagan administrations, comparatively little progress was made in enforcing this legislation against big business, but the Bush and, even more so, the Clinton administrations brought with them a marked increase in anti-trust activity.
It is unclear whether the rise of moderate to left politics, the growth of business through mergers and acquisitions during the 1990s, or other factors caused the renewed prominence of anti-trust law, yet the trend towards more stringent enforcement should have been obvious to any company - and should have been viewed as a very real threat, especially by a company as sophisticated and diverse in its operations as Microsoft.
As to whether anti-trust law could be applied to Microsoft's operations, there was also little question. With the 1951 supreme court judgment in the case of Lorain Journal Co et al vs the United States, there existed an unambiguous precedent of an anti-trust action against a company which, albeit on a regional level, had become a monopoly for the transmission of information. The Lorain case concerned a newspaper that "enjoyed a substantial monopoly of the dissemination of news and advertising of a local and national character", having a 99% coverage of the families in its area. When a local radio station was established in a town eight miles away, the newspaper responded by refusing to accept advertising from any business that advertised on that station.
While the link between a regional newspaper and the software giant Microsoft, might seem tenuous at first, legal experts noted the parallels between Microsoft and the Lorain case early on. The case eventually did provide part of the basis of Judge Jackson's judgment against Microsoft.
Robert Bork, a Harvard law professor and one time contender for a seat on the supreme court, argued that, like Lorain, "Microsoft has a similarly overwhelming share of the market for personal computing operating systems and it imposes conditions on those with whom it deals that exclude rivals without any apparent efficiency justification for such behaviour". Professor Bork's analysis of the Lorain case, should have sent warning signals to Microsoft, dispelling any hopes ofwinningits case, either in its current incarnation or on appeal.
Bork had argued that: "the case against Microsoft is not an attack on vertical integration; that is not the objection to the coupling of Microsoft's browser, the internet explorer, and its windows operating system. Like the Lorain judgment, the Microsoft case concerns a monopolist's horizontal attempt to preserve its monopoly, just as the newspaper imposed a requirement that advertisers not deal with the radio station. Microsoft imposes a multiple requirement on customers and suppliers that inhibits their dealings with Microsoft's rivals."
Whatever we may think about the legality or illegality of Microsoft's conduct; whether we believe Microsoft imposed anti-competitive restrictions on its competitors or not, one thing is obvious. With a dominant market share, Microsoft had to expect these or similar grievances. From a risk management perspective, one of the most relevant risks to Microsoft was not competition, but the fact that it was so successful in beating its competitors.
If we accept that Microsoft could have envisaged successful anti-trust action being taken against the company, the crucial question becomes - how could the company have prevented these actions?
Anti-trust risk
Like most historical pieces of legislation, US anti-trust law combines a few clear "black and white" prescriptions with many "greyer" demands that ultimately depend on the specific characteristics of a business operation. Despite this complexity, the key principles of US anti-trust law are relatively straightforward. The American Enterprise Institute (AEI), among others, has assembled checklists containing the key principles that any business operating in the US has to follow. They include the following: * Do not price below some meaningful measure of cost with the intention of using deep pockets to drive out competitors or discourage a new entrant. * If you have significant market power, consider the effect on competitors of any planned action. * Feel free to suggest retail prices to dealers but do not coerce them to accept these prices. * Do not tie the sale of one product to another. * Use exclusive dealing arrangements (only) if they are justified by business necessity.
In addition, the AEI recommends that companies institute and support a vigorous, custom designed antitrust compliance programme and consult with counsel when specific problems or questionable activities occur.
Assuming that the software giant instituted such a compliance programme, we do not know what it looked like, nor what resources were committed to it. What we do know, however, is that its efforts to demonstrate compliance failed, with Microsoft being accused of violating virtually every one of the guidelines listed above.
Preventing the crunch
While members of the legal profession might consider it heresy to say that public policy is as much about image as it is about facts, there is now clear evidence that Microsoft's uncompromising stance has harmed its position as regards anti-trust proceedings. There is a long history of US companies surviving the threat of anti-trust action through a combination of minor concessions and intense publicity efforts aimed at convincing the public of their commitment to competitive practices.
Such ongoing publicity efforts have proved particularly helpful to industries who in the past were accused of non-compliance with anti-trust laws. The US Asphalt Recycling and Reclaiming Association (ARRA), for instance, has included a compliance statement in its Statutes of Association since 1986. This statement notes that "It is recognised by the board of directors of ARRA that the Association and its varied activities could be regarded by some as a forum or opportunity to promote anti-competitive conduct. For this reason, the board of directors has taken this occasion, through this statement of policy, to make clear its unequivocal support for the policy of competition served by the anti-trust laws, as well as its uncompromising intent to comply strictly in all aspects with these laws".
Today, statements of this kind are the rule rather than the exception, other than, paradoxically, in the frontier industries of software development and ecommerce. Here, the belief that one operates in uncharted terrain seems to have led some companies to ignore the dangers of alerting the attention of antitrust enforcers. Microsoft and its competitors may be right in their view that existing anti-trust laws are difficult to apply to the challenges of the electronic age, but it is unlikely that the regulators will be sympathetic to those views, especially where key principles of competitive practice are at stake.
The fate of Microsoft is destined to cause a fundamental rethink on these matters. This may ultimately lead to an emphasis on anti-trust compliance in this industry, as increasing numbers of companies compete for market share. Whether this will be good news for the industry and consumers remains to be seen.
One group, however, will certainly benefit from the Microsoft fiasco. These are the multinational legal consultants who offer anti-trust advice and, most importantly, anti-trust audits.
Anti-trust audits have been a prominent feature of the US landscape for more than two decades. US companies are known to perform them in a number of contexts. These include seemingly harmless events, such as the disappearance of a competitor, or the adoption of a new marketing distribution strategy, as well as the more obviously threatening news of an impending investigation by the regulator. Anti-trust audits are also frequently part of pre-acquisition due diligence, where the audit serves to uncover potential or looming anti-trust liabilities in the acquired company.
Exploring failure
It is relatively easy and almost always cost effective to acquire the expertise of anti-trust consultants, but the real problem lies in implementing their advice. There is little doubt that Microsoft's managers knew what they would have to do to comply with anti-trust legislation and to avoid the proposed break up. The question as to why the software giant decided not to pursue these avenues is destined to become an issue of intense debate among the business historians of the future.
One obvious reason why companies choose not to comply with anti-trust requirements, or indeed any other regulation, is that they feel that the costs of compliance outweigh its benefits. It could be argued that Microsoft's profits would have fallen if the company had fully and expeditiously complied with the wishes of government officials and its competitors. However, it is unlikely that compliance could have seriously harmed the economic well-being of the software giant. In other words, non-compliance was certainly not a matter of survival for Microsoft, no matter how competitive the software market had become. The question then is whether Microsoft underestimated the possible cost to the company of anti-trust proceedings.
Economic theories of corporate behaviour would suggest that decision makers estimate the future costs of a legal action by jointly assessing the probability of a positive or negative outcome and the costs of the negative outcome. The costs of anti-trust proceedings to Microsoft have already been astronomical and are likely to become even more so. This would suggest that Microsoft's decision was to forego long-term stability for short-term profits.
An alternative explanation is that Microsoft's estimate of the probability of a successful action against it was deficient. Microsoft did possess a number of allies, ranging from members of Congress and influential academics to libertarian think tanks such as the Cato Institute, but to expect any of them to affect the outcome of a well prepared and lengthily investigated federal lawsuit was optimistic. Equally unlikely is the possibility that Microsoft will be able to reverse Judge Penfield Jackson's decision to break up the company. Microsoft's enormous success may have led to complacency, which left it blind to the risks it faced from anti-trust legislation and deficient in the risk management required to control such a major risk.
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Matthias Beck is Professor of Risk Management and Lym Drennan is head of department, Division of Risk, Glasgow Caledonian University, Tel: 0141 331 3152 e-mail: mpb@gcal.ac.uk
