Microsoft awaits punitive EU judgment

update: After Microsoft's last-ditch attempts to reach a settlement with the European Union and avoid antitrust action failed, a landmark legal ruling looms next week.

Microsoft chief executive Steve Ballmer had flown in earlier this week for talks with EU Competition Commissioner Mario Monti. But those talks collapsed on Thursday, and Monti said in a statement that the two sides had failed to agree on commitments for Microsoft's future business practices.

"A settlement to the Microsoft case has not been possible," Monti said. "In the end, I had to decide what was best for competition and consumers in Europe. I believe they will be better served with a decision that creates a strong precedent. It is essential to have a precedent which will establish clear principles for the future conduct of a company with such a strong dominant position in the market. "

EU antitrust regulators have concluded that the software giant violated competition rules by "tying" its media player to Windows. Now they're weighing remedies that could go as far as forcing Microsoft to offer computer makers two different versions of its operating system, one with audio and video playback features and another without them.

In a statement, Microsoft expressed its hope that it would be able to reach a settlement as the case enters its next phase.

"I believe we reached agreement on the issues of the case," Ballmer said. "But we were unable to agree on principles for new issues that could arise in the future."

"We worked very hard to try to resolve these issues without litigation," said Ballmer. "Because of the tremendous value we attach to our relations with governments all across Europe, we made every possible effort to settle the case, and I hope that perhaps we can still settle the case at a later stage."

If the talks had been successful, it would have meant Microsoft agreeing to change the way it conducts its business in Europe. The settlement would have helped the company avoid a legal finding against it that could make any future antitrust lawsuits easier to pursue.

Instead, the EU is now set to impose a massive fine with a formal legal ruling on 24 March that's expected to say Microsoft illegally abused its dominant market position in operating systems to give it an advantage over companies offering media player software.

In essence, that means Microsoft could be forced to open up its proprietary, top-secret Windows source code to rivals as well as providing an alternative stripped-down version of the operating system that doesn't come with media software bundled in.

"The key to the current decision is to establish principles and not simply solutions to individual issues," said David Wood, a competition lawyer for antitrust law firm Howrey Simon in Brussels.

Details of the settlement
Microsoft's settlement proposal focused on two areas: media-player software, and increasing the interoperability of Windows with competing software by making more technical information available to rivals, according to Jim Desler, a Microsoft spokesman.

The software giant did not offer to sell two distinct versions of Windows -- one with Media Player and one without -- as the EU had reportedly suggested as a potential remedy.

Instead, the software maker proposed that during the installation of Windows, competing media player software would be placed on PC hard drives. Those programs -- presumably from Real Networks and other competitors -- would not be integral to the operating system, as Media Player currently is.

Also, Microsoft's settlement offer would have applied worldwide, Desler said. Any remedy handed down by the EU will apply only to the European economic area.

"We were willing to go beyond what was required in order to achieve an amicable resolution of these matters. We made concessions that we hoped would achieve a settlement," said Desler.

The settlement offer also included discussion of issues surrounding Windows Server, and how it interoperates with competing software. Desler would not comment on those discussions.

What's unclear is how any potential remedy will affect future products and technologies, such as Microsoft's upcoming release of Windows, code named Longhorn, which is expected to include more advanced media handling technologies. "Both parties agree that further clarity by the court will be instructive here," said Desler.

Microsoft plans to appeal what it expects to be a negative ruling by the court next Wednesday, said Desler.

Antitrust lawyer Wood said he was not surprised by Monti's decision to announce that the negotiations had failed.

"I suppose he felt there was no prospect of a rapid resolution of the case based on past interviews, and he didn't want to prolong anybody's agony. This hasn't just cropped up. Whatever proposal they could have made tomorrow, they could have made last year," said Wood.

It's not unusual for corporations to try to get a last-minute settlement in competition cases, but treating a public policy wrangle like a business deal is rarely effective, said Wood.

"One of the recurring themes of confrontation between the Competition Commission and business is that corporate leaders don't understand that the commission is a bit like an ocean liner -- it takes time to turn around, and you can't blame an ocean liner for being slow," said Wood.

Fines, features and the fast track
Most observers agree that the court is likely to find against Microsoft, and that big fines are now in the cards.

"I don't think there is any doubt whatsoever that there is going to be a fine. It could be anything up to 10 percent of Microsoft's turnover, which is about £3bn," said James Governor, principal analyst at RedMonk. "It's unlikely to be anything like that, but I think it will be substantial."

Microsoft's vast resources make the issue of fines secondary to the larger issue of the company's market power, Wood said.

"The EU will impose fines, but who cares about that? The most important thing is what will it do to future issues? We do see a pattern of behaviour by Microsoft, and the commission wants to break that. They want to deal with the combination of market power in the OS market and the exercise of that power in other markets," said Wood.

Wood sees the present case dealing with the market for server software and media player as a test case for dealing with the broader issue of establishing how Microsoft behaves when it moves into other markets.

"The area of consumer electronics is one that particularly concerns people. It's one thing to have monopolised the office market, it's another to monopolise the home. Anyone who likes audiovisual content using their computer must start to feel anxious that any content would only be accessible via Microsoft products," said Wood.

European regulators argue that a 2001 ruling in the case brought by the US Justice Department and state attorneys general did not go far enough in restraining Microsoft's allegedly anticompetitive conduct.

In that lawsuit, a federal appeals court overturned an earlier ruling from US District Judge Thomas Penfield Jackson ordering that Microsoft be carved into two different companies. Eventually a new judge, Colleen Kollar-Kotelly, was appointed and levied less stringent remedies including publishing details of key software interfaces and restrictions on what kind of contracts Microsoft could enter into.

Richard Donovan, a partner at Kelley Drye who chairs the firm's antitrust practice, said European regulators might welcome the chance to pick up where the US Justice Department left off. "Unless Microsoft were to change its position at the last minute, it seems like they're ready to go forward," Donovan said.

"It's possible that the EU would look here to be able to step out on the world stage and be the first ones to really hit Microsoft hard."

Donovan warned, however, that such a decision would just be the beginning of a lengthy set of proceedings. "They're somewhat on new ground here," he said.

"There hasn't been a proceeding analysing conduct like this before. The commission has been reversed by the [court of first instance] several times over the last few years, primarily in merger cases. But still there is precedent for the court not being willing to follow the interpretation of the commission."

Appeals from the Court of First Instance go to the European Court of Justice, which is the highest court in the European Union.

Michael Parsons of ZDNet UK, and Andy McCue of Silicon.com reported from London. CNET News.com's Mike Ricciuti and Declan McCullagh contributed to this report.