Retaliation by Microsoft Alleged
IBM Executive Says Windows Price Was Tied to OS/2 Rivalry
By Rajiv Chandrasekaran
Washington Post Staff Writer
Friday, May 28, 1999; Page E01
RALEIGH, N.C., May 27—Microsoft Corp. forced IBM to pay higher prices for Windows software -- at least $8 more per copy -- because IBM refused to stop distributing rival products, according to testimony today from an IBM executive who will be the government's star rebuttal witness in the Microsoft antitrust trial.
In seven hours of detailed, sometimes contentious testimony in a deposition here, executive Garry Norris said Microsoft Chairman Bill Gates at one point offered IBM major financial incentives if it would dump its OS/2 software. Gates spoke of a close business partnership including pricing discounts, preferential marketing programs and advanced technical support for IBM, Norris said.
When International Business Machines Corp. spurned the offer, Norris
said, Microsoft retaliated by raising prices, refusing to share advanced software code, disinviting IBM officials from Microsoft events and not returning phone calls.
"We rejected these deals from time to time, and as a result of these
rejections we were told we would suffer higher prices -- and we did,"
Norris said during the deposition, held in a federal courtroom here. "We were told we would not get other things our competitors got."
Norris was the IBM executive in charge of the firm's relationship with Microsoft from 1995 to 1997. When the trial resumes next week,
government lawyers plan to use his testimony to demonstrate in vivid
detail how they believe Microsoft has illegally used its market clout to squelch competition in the industry.
His allegations, which likely will be delivered in even greater specificity on the witness stand, could strengthen the government's case significantly. Until now, the government has been unable to persuade any large computer manufacturer to testify against Microsoft because, it maintains, they fear that Microsoft might retaliate.
IBM, the world's largest computer company, may have less to fear
because the sales of Windows-based personal computer account for
only a small portion of its annual revenue. At the same time, the
government hopes the testimony will show that Microsoft's monopoly
power was so potent that it was able to bully a company several times
its size.
Microsoft officials have maintained that there was nothing illegal about its negotiations with IBM. The Microsoft attorney who conducted
today's deposition, Richard C. Pepperman II, suggested at various
times that the strains in the IBM-Microsoft relationship were the result of various IBM actions, including making disparaging comments about Windows and failing to properly compensate Microsoft for its software.
The two companies were once close allies in the computer market: In
1981, IBM gave Microsoft its start as a leader in the global technology industry by putting Microsoft's MS-DOS operating system in the first IBM personal computers. In the mid-1980s, the two companies
collaborated to develop OS/2 to replace DOS.
A few years later, they began feuding and Microsoft dropped out of the joint effort to focus on its Windows product, which today is installed on about 90 percent of the world's new PCs.
IBM, however, kept plugging away at OS/2. But as Microsoft jumped
ahead, Norris said, the software giant began actively hindering IBM's
efforts to sell OS/2.
Norris said, for instance, that in 1993 an executive with Compaq
Computer Corp., a large PC maker, told him that when Microsoft
discovered Compaq was considering selling OS/2, a Microsoft
representative vowed to "make it difficult for Compaq." Norris said
Compaq eventually decided not to sell OS/2.
"We were told on several occasion by several PC manufacturers that
they had a desire to license OS/2, they had customers who wanted
OS/2, but once Microsoft discovered they were in negotiations with
IBM, that threats were made to them," Norris testified.
In late 1994, when IBM's PC division decided to start shipping
machines with both OS/2 and Windows, Norris said Microsoft began to
retaliate by instituting a steep price increase for its Windows 95
software.
Microsoft, which had charged IBM $9 per copy of early versions of
Windows, told IBM that it would have to pay much more for a copy of
Windows 95.
In addition, IBM would not be eligible for an $8 marketing rebate
because it was selling a rival operating system, he said. Negotiations between the firms broke down in early 1995. They resumed only within weeks of the Windows 95 launch in August, and the two companies agreed on terms 15 minutes before the product was unveiled, he said.
IBM eventually wound up paying about $46 per copy, which caused the
firm's operating system bill to jump to $220 million in 1996 from $40
million in 1995. Compaq and Dell Computer Corp., two of Microsoft's
closest allies, paid less than $40 each, according to industry sources.
"Microsoft told us repeatedly, 'Because you compete with us, you're
going to get unfavorable terms and conditions,' " Norris said.
Norris said the problems between the firms took a turn for the worse in November 1994 at the Comdex computer trade show in Las Vegas,
when IBM executives notified Microsoft officials, including Gates, that IBM would not abandon OS/2.
"In the meeting, I'm told Gates was surprised," Norris said. "He was
surprised because he didn't expect that to happen."
In the following weeks, Norris said, Microsoft notified IBM that "we
would be treated just like any other" PC maker. He also said IBM "was
cut off and uninvited to several [computer manufacturer] events" held
by Microsoft.
To support the allegations, IBM has given the government hundreds of
internal documents and Norris has turned over dozens of pages of
handwritten notes taken during his Microsoft negotiations, according
to sources close to the case. Norris, who works at an IBM facility at
Research Triangle Park, N.C., is scheduled to testify at the trial in the second week in June.
During the deposition, Microsoft's Pepperman suggested that IBM was
responsible for the allegedly unfavorable treatment. He questioned
Norris about an internal IBM document that referred to Gates being
upset that IBM was conducting a "smear campaign" against Windows 95.
Pepperman also cited an audit Microsoft conducted of IBM that showed
IBM had failed to pay Microsoft about $50 million in Windows royalties. Norris said his firm later paid $10 million to settle the dispute.
After the OS/2 dispute had subsided, Norris said, Microsoft in 1996
began to target other types of software that IBM was including on its
PCs, including Netscape Communications Corp.'s Internet browser and
the SmartSuite office application, which is made by Lotus Development
Corp., an IBM subsidiary, and competes with Microsoft's Office
software package.
"We were offered financial incentive from Microsoft to stop shipping
certain products," Norris said. "Microsoft repeatedly told us that as
long as we were shipping competitive products," Microsoft "will not
treat you the same as Compaq. You will suffer in terms of price."
But Pepperman noted that IBM did manage to get some of the things it
wanted in its negotiations with Microsoft, including the right to place a backup copy of Windows on a CD-ROM disk that was distributed to IBM customers. Said Norris: "It could have been worse."
© Copyright 1999 The Washington Post Company
It could have been better too.
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