Gateway bows to Microsoft's power

Anthony Fama, Gateway's group counsel, said in testimony submitted by nine states and the District of Columbia that the Redmond, Wash.-based software maker can still use Windows licensing agreements and other contractual provisions to extract concessions from PC makers.

Fama, who also appeared in court Monday and will likely take the stand again Tuesday, was critical of the proposed settlement because, he asserted, it effectively gives Microsoft too much wiggle room.

Microsoft, for instance, can grant or withhold market-development funds more or less at will under the new licensing agreements. Such funds pay for a substantial part of a PC maker's television and print advertisements and can add up to huge sums. PC makers that agree to ship all PCs with Windows, for example, can receive $10 per PC in market development funds.

The company also imposes a "two strikes" policy, which it can use to terminate a PC maker's Windows license. Under previous Microsoft licenses, PC makers were granted three strikes.

"The (two-strike) threat...has a remarkable chilling effect on an OEM's (original equipment manufacturer's) willingness to promote non-Microsoft middleware, platform software or otherwise," Fama testified. "Microsoft retains incredible power over Gateway and, presumably, other OEMs."

But Microsoft spokesman Jim Desler disagreed. "The non-settling states and Gateway's special-interest complaints ignore the purpose of the proposed settlement between the DOJ, nine bipartisan states and Microsoft," he said. "All of the government parties, including the non-settling states, took the position that Microsoft should have uniform terms among OEMs."

Fama's testimony is significant in part because until now only Microsoft competitors, such as AOL Time Warner, RealNetworks or Sun Microsystems, have appeared in court. Gateway is a customer.

"Competitors' comments and criticisms can be dismissed by Microsoft as sour grapes," said Emmett Stanton, an antitrust lawyer with Fenwick & West in Palo Alto, Calif. "The customers who are suffering from Microsoft's conduct simply can't be dismissed that way."

Microsoft on Sunday filed to strike large portions of the submitted testimony from the proceeding before U.S. District Judge Colleen Kollar-Kotelly. She did not grant the request.

Microsoft dictates terms
In theory, Microsoft's November settlement with the Justice Department and nine of 18 states should have leveled the playing field and put a stop to potential retaliatory tactics. That settlement is pending, awaiting Kollar-Kotelly's approval.

But Fama charged that the uniform licensing provision, which mandates that all PC makers receive the same contract, leaves Microsoft plenty of room to play favorites and reset terms to the detriment of PC makers.

Microsoft sent a letter to Gateway dated Dec. 12, explaining that Microsoft would soon be changing to a uniform licensing mechanism as required by the settlement. The new terms would affect contracts written after Dec. 16 for the top 20 PC makers.

The new license "contained provisions that were more favorable to Microsoft than the previous versions of the corresponding agreements Gateway had negotiated," Fama testified.

For instance, under the two-strikes provision, Microsoft could terminate any PC maker's Windows licenses without notice after sending two default notices. The notices would not need to be for serious offenses, either, Fama said. Under its previous license, Gateway had a three-strike provision.

"Microsoft licenses its software products through a Web of interlocking agreements," Fama testified, so "it would not be surprising if an OEM often was not in compliance." He noted that Gateway received four such notices in June 1997.

Fama noted that the litigating states' remedy proposal ignores a "strikes" approach and instead mandates "a 60-day cure period" for resolving serious disagreements.

Gateway, like Hewlett-Packard and Sony before the remedy proceeding started, balked at another provision that would effectively prevent PC makers from suing Microsoft for infringement of their patents. Microsoft contends that changes later made to the settlement resolved these issues.

Microsoft also more closely circumscribed release dates of software. Under Gateway's old licensing agreement, the company could begin shipping the new Windows version as soon as any other PC maker. The uniform licensing agreement would restrict PC makers to a date communicated by Microsoft, Fama testified. Therefore, Microsoft could let some companies sell a new OS before others and sweep up early buyers.

"Allowing one OEM to get a jump on advertising and distributing a new Microsoft product, particularly a new Windows product, could be particularly advantageous to that OEM and significantly disadvantageous to its competitors," Fama said.

Gateway also faulted another provision of the new licensing agreement, which requires PC makers to pay a Windows royalty on every PC shipped, even if it didn't include Windows. To top it off, to qualify for market development funds, PC makers have to put a Microsoft OS on every PC. As a result, trying to sell non-Windows PCs, or even PCs without software, is a financial loser for computer makers.

"In other words, Gateway must comply with this provision in order to receive any market development funds," Fama said. The discount is substantial: $10 per copy of Windows.

"Since that $10 discount would apply to each copy of Windows XP that Gateway distributes during 2003, it would not be commercially practical to consider compliance...as optional," Fama testified.

Fama's testimony also included the volume discount that PC makers receive on Windows, but that part of his testimony was removed from the publicly distributed copies, with one exception: PC makers selling one to 599,999 units receive no discount.

Fama concluded that the new uniform pricing mechanism benefits those companies selling the highest volumes, such as Dell Computer.

Any provisions of the agreement that hold true for Gateway should apply to other PC makers, Stanton said.

"Any large customer should be a pretty good proxy for the others, because the terms are supposed to be uniform," Fama said. "Dell may not want to be a witness, but Dell is affected in similar ways to Gateway because of uniform licensing."

Other companies, though, including Intel, offer discounts to the largest purchasers.