Microsoft Lacks Innovation, Fairness in Pricing of Protocols, EC Says

Published: March 7, 2007

by Alex Woodie

The regulatory battle between Microsoft and the European Commission continued last week when the EC issued a fresh statement of objections and threats of new fines concerning the royalties that Microsoft charges others to obtain the "communication protocols" for developing client-server applications. Microsoft, which has four weeks to respond, contested the new allegation, and claimed it is offering protocols for 30 percent less than competitors.

The latest act in this regulatory play revolves around innovation--namely, how much of it is in Microsoft's work on communication protocols, and whether there is enough of it to justify the fees that Microsoft is charging its competitors to obtain them. (At some level, it seems absurd to try to categorize and quantify something as elusive as innovation. But both Microsoft and the EC have agreed to play by this set of rules, so now we hand it over to the lawyers, executives, and regulators to act out this peculiar drama.)

The EC says its technical experts found "no significant innovation" in Microsoft's communication protocols and the written documentation that accompany them. This led the group to conclude that Microsoft's protocol pricing scheme is "unreasonable." Microsoft, for its part, claims there is "considerable innovation" in its protocols, which, in turn, makes its pricing fair (or even a bargain).

"Microsoft has agreed that the main basis for pricing should be whether its protocols are innovative," says the EC's competition commissioner, Neelie Kroes. "The commission's current view is that there is no significant innovation in these protocols. I am therefore again obliged to take formal measures to ensure that Microsoft complies with its obligations."

Microsoft has two separate licensing arrangements for its communication protocols as part of its Work Group Server Protocol Program (WSPP). The first arrangement is a "No Patent Agreement" that grants licensees access to the protocols, but doesn't grant them a license to patents that Microsoft holds (which could open up licensees to legal action down the road). The second scheme, called the "All IP Agreement," combines the first scheme with a license for the disputed patents.

For both schemes, Microsoft offers Gold, Silver, and Bronze packages, which are priced according to the claimed "degree of innovation" in the protocols and documentation. (The two sides also agree there is a fourth category of protocols that can be had with no royalty payment because they lack innovation.) In addition to the packages, customers can purchase individual protocols for prices ranging from $5,000 to $100,000.

On the advice of its technical experts, the EC found there is "virtually no innovation" in Microsoft's No Patent Agreement. Interestingly, the higher level Gold and Silver packages had zero innovation, whereas the Bronze package--which one would think would have the least amount of innovation--actually sports "a limited degree of innovation."

As for the All IP Agreement, the EC found "some associated innovation" in the protocols and documentation work. However, the EC still found problems with this licensing scheme, including a lack of information for using the protocols with non-Windows operating systems, and the finding that there are comparable protocol technologies--even some from Microsoft itself--available on a royalty-free basis.

In short, the EC claims Microsoft hasn't done any real, innovative work to justify the cost of its protocols. "All of the described features were considered either to have been Microsoft implementations of prior developments by others, or . . . minor extensions to that prior work."

Brad Smith, Microsoft's general counsel, defended the software giant's protocol work in a statement released last week. "Microsoft has spent three years and many millions of dollars to comply with the European Commission's decision," he says. "We're disappointed that this feedback is coming six months later and in its present form, but we're committed to working hard to address" the EC's objections.

Smith cited a reference by the accounting firm PricewaterhouseCoopers which "found that our proposed prices were at least 30 percent below the market rate for comparable technology," he says. He also cited Microsoft's 36 current patents and another 37 patents pending in the U.S. and Europe concerning the protocols, and the millions of dollars it took to achieve that level of innovation. "It's hard to see how the Commission can argue that even patented innovation must be made available for free," he says.

Microsoft has four weeks to respond to the latest objections from the EC. The company has the right to an oral hearing in front of the EC following its response, then the EC will issue its decision. If the EC finds Microsoft has not done enough to address its protocol licensing and royalty scheme, it could impose daily fines of €2 million, or $2.6 million at current exchange rates.

The EC could choose to make the fine retroactive to December 2005, when the regulatory body first objected to Microsoft's approach to documenting its protocols. If so, it would be the second time in less than a year that Microsoft has been retroactively fined to December 2005. Last summer, Microsoft was fined $357 million for dragging its feet on the initial March 2004 antitrust ruling. That fine came on top of the EC's initial $613 million fine against Microsoft in March 2004.

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