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Tuesday, 15 June, 1999, 08:18 GMT 09:18 UK
IBM chief: Microsoft killed OS/2
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IBM's Garry Norris: "You had to have Windows 95 to be in the PC business"
by independent computer industry analyst Graham Lea

The deposition and testimony provided by Garry Norris - IBM's chief negotiator with Microsoft before and after the introduction of Windows 95 - has provided a cornucopia of fascinating evidence in the Microsoft trial. Much of it was previously unknown or unconfirmed.

His evidence showed how Microsoft effectively controlled IBM's PC hardware and software businesses by making the price of Windows considerably higher than for other comparable PC makers.

Mr Norris described in detail to Philip Malone, counsel for the Department of Justice, five cases where Microsoft had succeeded in modifying, or had attempted to influence, IBM's choice of software to load on its PCs. These were with OS/2, Lotus Notes, Lotus Smartsuite, World Books, Netscape's browser, and the version of Windows.

IBM's competitive operating system OS/2 was a significant challenger in 1994 and 1995 to Windows 3.x and then Windows 95.

As a consequence of its alleged Windows monopoly and IBM's need to include Windows with some PCs because its customers wanted it, the licence price has grown and grown:

  • In 1995 IBM paid Microsoft $40m for Windows
  • In 1996, after the launch of Windows 95, it was $220m
  • By 1997, after Microsoft insisted that IBM would have to pay higher prices if it wished to license Windows NT 4, IBM paid Microsoft $330m for Windows
  • In 1998 this increased to $440m

Mr Norris said that PC manufacturers who wanted to license OS/2 were threatened by Microsoft. Compaq was one of these, and IBM was informed of Microsoft's intimidation by Compaq vice-president Mike Clark. As a consequence, Compaq did not license OS/2.

It was revealed that Bill Gates was "surprised" that IBM was not prepared to "jointly and exclusively promote Microsoft products [and] reduce shipments of OS/2".

Mr Norris also related that "Microsoft had taken a number of retaliatory actions against IBM ... (becoming) non-responsive to phone calls, slow in getting beta code (of Windows 95 to IBM for testing)".

Mr Norris explained that Microsoft worked to kill OS/2 in a number of ways:

  • First, there were milestones for royalty reductions which had the overall effect of IBM reducing, eliminating or dropping OS/2 in the market;
  • Second, Microsoft asked IBM to eliminate, drop, reduce or stop shipping OS/2; and
  • Third, Microsoft employed financial incentives of $48m that "would have the effect of killing OS/2 in the market".

Many OS/2 developers and users were dismayed at the sudden change in IBM policy towards OS/2, which resulted in its further development and marketing being severely scaled back.

Microsoft vice-president Joachim Kempin relayed to IBM that: "LVG (Lou Gerstner, IBM's CEO] should have called Gates to explain (IBM's acquisition of Lotus in June 1995)". The threat posed by Lotus SmartSuite, a rival to Microsoft Office, infuriated Microsoft, and three days after the Lotus deal, Microsoft became non-responsive to efforts to finalise a licence for Windows 95.

On 17 July 1995, IBM announced that Smartsuite would be the primary desktop offering from IBM in the United States. Lotus Notes competed with Microsoft Exchange. Microsoft was very concerned that Notes and SmartSuite would erode Microsoft's market share of Exchange and Office, and cause pressure on Microsoft's pricing.

It was at this point that IBM vice-president Rick Thoman had a call with Bill Gates in an attempt to improve relations. Mr Norris said he was able to hear a "pretty loud" Bill Gates, despite the fact that Mr Thoman "had the phone up to his ear".

Mr Kempin also exerted pressure on IBM over the CD-Rom Encyclopaedia IBM World Book, which competed with Microsoft's Encarta. Bill Gates "was really mad about the World Book deal", it was revealed.

Mr Norris said that IBM was verbally offered a financial incentive to ship Internet Explorer and not Netscape Navigator, providing what Microsoft called "no objectionable applications" were shipped. Microsoft insisted that the systems should be "neutral", meaning with no competing products.

One of the big surprises from the evidence of Garry Norris was the news that IBM had underpaid royalties to Microsoft. To speed up the independent audit that Microsoft had demanded, Microsoft decided to link the negotiation of a Windows 95 licence to the audit settlement. Microsoft was well aware of IBM"s great need to obtain the final Windows 95 code.

Mr Norris revealed that Mr Kempin had said: "We would agree to settle the audit if you don't ship SmartSuite for six months". IBM flatly rejected this and instead offered Microsoft $10m to delink the audit from the Windows 95 licence negotiation.

IBM admitted that its own internal audit had shown an underpayment of royalties to Microsoft to the tune of $16.7m for OS/2 and LAN Manager. A further $14m was agreed, the audit was settled, and the Windows 95 licence agreement was signed on Windows 95 launch day, just 15 minutes before the launch.

The evidence showed that when Jerry York, IBM's chief financial officer, called Mike Brown, his Microsoft equivalent, the call was "well-received". Presumably IBM were apologetic.

When Microsoft was described by Lou Gerstner in Business Week as 'a great marketing company, but not a great technology company' Mr Gates was furious according to evidence presented. He is said to have complained about 'smear campaigns' against Windows 95.

Mr Norris was pressed about this, but pointed out that "smear" was Mr Gates' word. He told Mr Pepperman, counsel for Microsoft: "We did promotions and marketing campaigns for OS/2 during this time frame. If you refer to them as 'smear', that's one thing. If we refer to them as normal marketing competitively, that's another."

IBM decided it would like to offer its customers a choice between Windows 3.11 or Windows 95 at a time when there was considerable resistance from customers about moving to Windows 95. Mr Norris told Mr Pepperman that "for about a six-month period of time, Microsoft made us pay royalties, for both Windows 3.11 and Windows 95."

But this payment of double royalties was not the only iniquity: "We also paid Microsoft royalties on what they called designated systems, whether we shipped a licence with that system or not. We also paid you royalties on OS/2 as well."

Mr Malone, in his redirect examination, revealed from documents introduced into evidence that "IBM currently pays a higher royalty for Microsoft operating systems than our leading competitors. This is estimated at $5 to $15 per copy for Windows 95 and from $25 to $40 per copy for Windows NT. These higher costs put IBM at a competitive disadvantage. In addition, IBM has less flexible terms and conditions."

Some of the conditions that Microsoft presented to IBM for getting Windows 9x or NT4 licences were: "adopt Windows 95 as the standard operating system for IBM (for $3 discount per Windows 95 licence)"; agree that "Windows 95 is the only operating system mentioned in advertisement" (to gain a $1 MDA reduction); and "reduce, drop or eliminate OS/2" (which would be worth a total of $8 in MDA reduction).

Mr Norris observed: "We really had no commercially viable alternative to Windows 95. You had to have Windows 95 to be in the PC business."

IBM also tried to license Microsoft Office, but Mr Kempin said in a conference call that Microsoft wanted $250 for it, the same as the retail price. As a consequence, IBM continued to ship SmartSuite.

At one stage, Judge Jackson pointedly asked how much longer Mr Pepperman would be. When he heard "five or six hours", he said: "I'm not sure how much progress you have made so far ... but be economical with your examination." The judge enquired whether that would "keep you on schedule".

From this, it is possible to deduce that there appears to be an informal agreement that each side will have eight court days for rebuttal, which would mean that the present phase will end by 1 July, in good time for the American independence day holiday (4 July).

Graham Lea is a leading computer industry analyst specialising in Microsoft, who is following the case for News Online - his views do not represent those of the BBC.

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