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Saturday, April 3, 2004 - Page updated at 12:00 AM

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Microsoft, Sun reach truce with $2 billion deal

Seattle Times technology reporter

In a surprise move that may begin a new era of cooperation between Microsoft and the Silicon Valley, the Redmond software giant and Sun Microsystems yesterday agreed to end their acrimonious legal fight and work together on future technologies.

Sun is dropping an antitrust case that was Microsoft's biggest remaining legal threat, while Microsoft agreed to pay the Santa Clara, Calif., company nearly $2 billion — $700 million to resolve antitrust issues, $900 million to resolve patent issues and $350 million to use Sun technology in Microsoft products.

Sun Chief Executive Scott McNealy initiated settlement talks a year ago by inviting Microsoft Chief Executive Steve Ballmer to play golf.

McNealy said Sun customers, who generally use a mix of products from both companies, were demanding that he "cut the rhetoric" and start collaborating.

Feuding between the companies since the early 1990s helped polarize the technology industry into camps for and against Microsoft. Sun was an instigator of antitrust cases brought by the U.S. and European governments — cases that are forcing Microsoft to alter its business practices and comply with antitrust regulations.

Yesterday's settlement stems from the private antitrust suit Sun filed in 2002 in the wake of the U.S. case, but the effects of the agreement extend far beyond. It could:

• Help Microsoft settle its European antitrust case, in which the European Union last week imposed a heavy fine and demanded changes in Microsoft practices. Sun said yesterday's agreement addresses its complaints in that case.

• Enable Microsoft to increase its stock dividend by providing more certainty about what its various lawsuits may cost to resolve. Microsoft has maintained its huge cash hoard of more than $50 billion in part to cover potential legal liabilities.

• Theoretically reduce costs and headaches for companies that use both Sun and Microsoft products, with the two rivals pledging to make their technologies work better together.

• Rearrange the competitive landscape in the business-software market, especially if the agreement helps Sun and Microsoft compete against IBM.

• Lessen uncertainty for programmers using Sun and Microsoft products, who suffered from the companies' ongoing efforts to torpedo each other's products.

• Potentially improve the Internet experience for consumers and business users. The companies will make their technologies for logging into networks work together, and collaborate on software platforms.

"There's just a lot more we can do if we put the legal stuff behind and set up a framework around which to do joint (intellectual-property) development and technology sharing," McNealy said.

Ballmer said the settlement should "delight customers."

"We've been modeling it through together because we're looking for the downside, and I don't think there's any downside," he said.

Already, Microsoft Chairman and Chief Software Architect Bill Gates has been working with Sun's chief technology officer to make their products work better together.

Executives said the agreement is the start of a new relationship that could affect other products besides servers, the powerful computers and software that run computing networks.

Mark Tolliver, Sun's chief strategy officer, said they could even collaborate on Microsoft's Office and Sun's StarOffice productivity software in the future.

Stock analysts said the settlement should make Microsoft executives more comfortable about raising the company's dividend, but they still expect it will be awhile before the company's sales growth accelerates significantly.

"I don't think Microsoft has so much concern about Sun Microsystems as they did years ago in the days of the Java wars," Goldman Sachs analyst Rick Sherlund said, referring to the Sun-developed programming language once viewed as a threat to Microsoft's Windows operating system. "I think they're much more focused on making Windows more secure and also trying to address the risk of Linux encroaching into their market."

Customers in charge?

For those familiar with the companies' sometimes-vicious sniping, it was bizarre to hear Ballmer and McNealy yukking it up together at a San Francisco press conference yesterday announcing the settlement. One reporter asked McNealy if he would still call Microsoft software "a hairball welded shut," to which he replied, "I'm going to do my best to be good."

McNealy sidestepped questions about whether Microsoft had changed the behavior of which he used to be so critical.

"Maybe we've grown up," he said. "Maybe they've grown up. Who knows? Maybe the customers are more in charge these days."

Ballmer and McNealy played — and lost — as partners at a Pebble Beach golf tournament, but it took months and months of negotiations to reach an agreement.

The two grew up in a Detroit suburb, the sons of auto-company managers, and they attended Harvard and Stanford Business School at about the same time.

Yesterday, they talked up their background connections and exchanged Detroit Red Wings hockey jerseys, but they insisted the companies will still compete vigorously.

Microsoft is not admitting wrongdoing with the payout, said its chief counsel, Brad Smith.

Whatever the case, the settlement comes at a time when Sun, after prospering in the booming late 1990s, continues to struggle in today's more cost-conscious environment. It's faced with a market in which the heavy lifting is increasingly done by PCs running Microsoft products or products based on the freely shared Linux software.

Yesterday's announcement reflected that struggle, with the company saying it lost about $800 million in the past quarter and that it's laying off 3,300 people, or 9 percent of its staff.

Both companies benefit

If nothing else, the settlement appears to remove Microsoft's biggest antagonists, said Mark Anderson, a Friday Harbor technology pundit and investor.

"If you look back at both the EU and (Department of Justice) suits, I think you can fairly say that Sun was behind both of those lawsuits, so removing Sun from the playing field, if that's what this achieves, will mean a decade of freedom in terms of financial overhang in the stock market and general concern in the customer marketplace," he said.

"From the Sun side it's even better because during the last 10 years Scott McNealy has ignored proper management of his company in favor of what I call the 'Bill Disease,' " Anderson said. "He was worrying only about Bill and what he would do instead of worrying about how to run Sun and it has harmed the company."

Others questioned whether it will affect or quell anti-Microsoft sentiment.

"I don't think this is a fundamental change," said John Gilmore, a well-known activist in San Francisco who works on behalf of free software and other causes.

Gilmore, who was Sun's fifth employee, said the two companies would have had to work together eventually anyway.

Other companies in Silicon Valley and elsewhere continue to distrust Microsoft and its tactics, said Ed Black, president of the anti-Microsoft Computer and Communications Industry Association trade group, which had been partly funded by Sun.

"Getting a nearly $2 billion settlement is a complete vindication that they had been illegally dealt with by Microsoft," he said.

Black said his group will continue its cause — and its complaint against Microsoft before the European Commission — with support from other companies.

Settlement binge

Although the U.S. antitrust case focused initially on the "browser wars" that crushed Netscape Communications, some of prosecutors' strongest material involved Sun.

Microsoft feared Sun's Java programming language threatened Windows, and its aggressive tactics to defeat the challenger were determined to have broken the law. Federal judges in the U.S. antitrust case found the company liable for damages to Sun, and the company filed a $1 billion private antitrust lawsuit against Microsoft in 2002.

That case was going to trial in 2006, with Sun eligible for triple damages under antitrust law, or up to $3 billion.

Microsoft also has changed dramatically since its troubles with Sun began. It has had to be less combative and more conciliatory, in part because of its legal troubles but also because it's trying to move into new markets where coexisting with competitors often is a prerequisite.

In the past two years it's gone on a settlement binge, ending case after case brought by old foes. It settled private antitrust cases with Time Warner (parent of America Online and Netscape) and the Be software company.

On March 24, however, the EU handed down penalties after settlement efforts failed, imposing a $612 million fine and ordering Microsoft to share details of how Windows works with servers.

Microsoft plans to appeal, asking a European judge to delay the penalties until the case is resolved.

Ballmer and Smith denied that the Sun settlement was related to the European case. But antitrust expert Ernest Gellhorn, a professor at George Mason School of Law in Arlington, Va., said the deal could help Microsoft obtain a settlement in Europe as well.

"Of course it's affected by Europe, but the other side of that is there's increasing pressure on Microsoft to get this stuff behind them and move on," Gellhorn said. "They can't continue this kind of guerrilla warfare with competitors and governments on an ongoing basis, where the other side keeps winning."

Brier Dudley: 206-515-5687 or bdudley@seattletimes.com

Copyright © 2004 The Seattle Times Company

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