CASE 1 THE COCA-COLA COMPANY
STRUGGLES WITH ETHICAL CRISES
Coca-Cola has the most valuable brand name in the world and, as one of the most visible companies worldwide, has a tremendous opportunity to excel in all dimensions of business performance. However, over the last ten years, the years, the firm has struggled to reach its financial objectives and has been associated with a number of ethical crises. Warren Buffet served as a member of the board of directors and was a strong supporter and investor in Coca-Cola but resigned from the board in 2006 after several years of frustration with Coca-Cola’s failure to overcome many challenges.
Many issues were facing Doug Ivester when he took over the reins at Coca-Cola in 1997. Ivester was heralded for his ability to handle the financial flows and details of the soft-drink giant. Former-CEO Roberto Goizueta had carefully groomed Ivester for the top position that he assumed in October 1997 after Goizueta’s untimely death. However, Ivester seemed to lack leadership in handling a series of ethical crises, causing some to doubt, “Big Red’s” reputation and its prospects for future. For a company with a rich history of marketing prowess and financial performance, Ivester’s departure in 1999 represented a high-profile glitch on a relative clean record in one hundred years of business. In 2000, Doug Daft, the company’s former president and chief operating officer, replaced Ivester as the new CEO. Daft’s tenure was rocky, and the company continued to have a series of negative events in the early 2000s. For example, the company was allegedly involved in racial discrimination, misrepresenting market tests, manipulating earnings, and disrupting long-term contractual arrangements with distributors. By 2004 Daft was out and Neville Isdell had become president and worked to improve Coca-Cola’s reputation.
HISTORY OF THE COCA-COLA COMPANY
The Coca-Cola Company is the world’s largest beverage company, and markets four of the world’s top five leading soft drink: Coke, Diet Coke, Fanta, and Sprite. It also sells other brands including Powerade, Minute Maid, and Dansani bottled water. The company operates the largest distribution system in the world, which enables it to serve customers and businesses in more than two hundred countries. Coca-Cola estimates that more than 1 billion servings of its products are consumed every day. For much of its early history, Coca-Cola focused on cultivating markets within the United States.
Coca-Cola and its archrival, PepsiCo, have long fought the “coca wars” in the United States, but Coca-Cola, recognizing additional market potential, pursued international opportunities in an effort to dominate the global soft-drink industry. By 1993 Coca-Cola controlled 45 percent of the global soft-drink market, while PepsiCo received just 15 percent of its profits from international sales. By the late 1990s, Coca-Cola had gained more 50 percent of the global markets in the soft-drink industry. Pepsi continued to target select international markets to gain a greater foothold in international markets. Since 1996 Coca-Cola has focused on traditional soft drinks, and PepsiCo has gained a strong foothold on new-age drinks, has signed a partnership with Starbucks, and has expanded rapidly into the snack-food business. PepsiCo’s Firto-Lay division has 60 percent of the U.S. snack-food market. Coca-Cola, on the other hand, does much of its business outside of the United States, and 85 percent of its sales now come from outside the United States. As the late Roberto Goizueta once said, “Coca-Cola used to be an American company with a large international business. Now we are a large international company with a sizable American business.”
Coca-Cola has been a successful company since its inception in the late 1800s. PepsiCo, although founded about the same time as Coca-Cola, did not become a strong competitor until after World War II when it began to gain market share. The rivalry intensified in the mid-1960s, and the “cola wars” began in earnest. Today, the duopoly wages war primarily on several international fronts. The companies are engaged in an extremely competitive-and sometimes personal-rivalry, with occasional accusations of false market-share reports, anticompetitive behavior, and other questionable business conduct, but without this fierce competition, neither would be as good a company as it is today.
By January 2006, PepsiCo had a market value greater than Coca-Cola for the first time ever. Its strategy of focusing on snack foods and innovative strategies in the non-cola beverage market helped the company gain market share and surpass Coca-Cola in overall performance.
Coca-Cola is the most- recognized trademark and brand name in the world today with a trademark value estimated to be about $25 billion. The company has always demonstrated a strong market orientation, making strategic decisions and taking actions to attract, satisfy, and retain customers. During World War II, for example, company president Robert Woodruff committed to selling Coke to members of the armed services for just a nickel a bottle. As one analyst said later, “Customer loyalty never came cheaper.” This philosophy helped make Coke a truly global brand, with its trademark brands and colors recognizable on cans, bottles, and advertisements around the world. The advance of Coca-Cola products into almost every country in the world demonstrated the company’s international market orientation and improved its ability to gain brand recognition. These efforts contributed to the company’s strong reputation.
However, in 2000 Coca-Cola failed to make the top ten of Fortune’s annual “America’s Most Admired Companies” list for the first time in a decade. Problem at the company were leadership issues, poor economic performance, and other upheavals. The company also dropped out of the top one hundred in Business Ethics’ annual list of “100 Best Corporate Citizens” in 2001. For a company that spent years on both lists, this was disappointing, but perhaps not unexpected, given several ethical crises.
Coca-Cola’s promise is that the company exists “to benefit and refresh everyone who is touched by our business.” It has successfully done this by continually increasing market share and profits with Coca-Cola being the most-recognized brand in the world. Because the company is so well known, the industry so pervasive, and a strong history of market orientation, the company has developed a number of social responsibility initiatives to enhance its trademarks. These initiatives are guided by the company’s core beliefs in the marketplace, workplace, community, and environment. For example, Coke wants to inspire moments of optimum through their brands and their actions, as well as creating value and making a difference everywhere they do business. Their vision for sustainable growth is fostered by being a great place to work where people are inspired to be the best they can be, by bringing the world a portfolio of beverage brands that anticipate and satisfy peoples’ desires and needs, by being a responsible global citizen that makes a difference, and by maximizing return to share-owners while being mindful of their overall responsibilities.
SOCIAL RESPONSIBILITY FOCUS
Coca-Cola has made local education and community improvement programs a top priority for its philanthropic initiatives. Coca-Cola foundations “support the promise of a better life for people and their communities.” For example, Coca-Cola is involved in a program called “Education on Wheels” in Singapore where history is brought to life in an interactive discovery adventure for children. In an interactive classroom bus, children are engaged in a three-hour drama specially written for the program. It challenges creativity and initiatives while enhancing communication skills as children discover new insights into life in the city.
Coca-Cola also offers grants to various colleges and universities in more than half of the United States, as well as numerous international grants. In addition to grants, Coca-Cola provides scholarships to more than 170 colleges, and this number is expected to grow to 287 over the next four years. It includes 30 tribal colleges belonging to the American Indian College Fund. Coca-cola is also involved with the Hispanic Scholarship Fund. Such initiatives help enhance the Coca-Cola name and trademark and thus ultimately benefit shareholders. Each year 250 new Coca-Cola Scholars are designated and invited to Atlanta for personal interviews. Fifty students are then designated as National Scholars and receive awards of $20,000 for college; the remaining 200 are designated as Regional Scholars and receive $4000 awards. Since the program’s inception in 1986, a total of over twenty-five hundred Coca-Cola scholars have benefited from nearly $22 million for education. The program is open to all high school seniors in the United States.
The company recognizes its responsibilities on a global scale and continues to take action to uphold this responsibility, such as taking steps not to harm the environment while acquiring goods and setting up facilities. The company is proactive on local issues, such as HIV/AIDS in Africa, and has partnered with UNAIDS and other non-government organizations to put into place important initiatives and programs to help combat the threat of the HIV/AIDS epidemic.
Because consumers trust its products, and develop strong attachments through brand recognition and product loyalty, Coca-Cola’s actions also foster relationship marketing. For these reasons, problem at a firm like Coca-Cola can stir the emotion of many stakeholders.
The following documents a series of alleged misconduct and questionable behavior affecting Coca-Cola stakeholders. These ethical and legal problems appear to have had an impact on Coca-Cola financial performance, with its stock trading today at the same price it did ten years ago. The various ethical crises have been associated with turnover in top management, departure of key investors, and the loss of reputation. There seems to be no end to these events as major crises continue to develop. It is important to try to understand why Coca-Cola has not been able to eliminate these events that have been so destructive to the company.
Perhaps the most damaging of Coca-Cola’s crises-and the situation that every company dreads-began in June 1999, when about thirty Belgian children became ill after consuming Coca-Cola products. Although the company recalled the product, the problem soon escalated. The Belgian government eventually ordered the recall of all Coca-Cola products, leading officials in Luxembourg and the Netherlands to recall all Coca-Cola products as well. The company eventually determined that the illnesses were the result of a poorly processed batch of carbon dioxide. Coca-Cola took several days to comment formally on the problem, which the media quickly labeled a slow response. Coca-Cola initially judged the situation to be minor and not a health hazard, but by that time a public relations nightmare had begun. France soon reported more than one hundred people sick and banned all Coca-Cola products until the problem was resolved. Soon after, a shipment of Bonaqua, a new Coca-Cola water product, arrived in Poland, contaminated with mold. In each instance, the company’s slow response and failure to acknowledge the severity of the situation harmed its reputation.
The contamination crisis was exacerbated in December 1999 when Belgium ordered Coca-Cola to halt its “Restore” marketing campaign in order to regain consumer trust and sales in Belgium. A rival firm claimed that the campaign strategy that included free cases of the product, discounts to wholesalers and retailers, and extra promotion personnel was intended to illegally strengthen Coca-Cola’s market share. Under Belgium’s strict antitrust laws, the claim was upheld, and Coca-Cola abandoned the campaign. This decision, along with the others, reduced Coca-Cola’s market standing in Europe.
Questions about Coca-Cola’s market dominance started government inquiries into its marketing tactics. Because most European countries have very strict antitrust laws, all firms must pay close attention to market share and position when considering joint ventures, mergers, and acquisitions. During the summer of 1999, Coca-Cola became very aggressive in the French market. As a result, the French government responded by refusing to approve Coca-Cola’s bid to purchase Orangina, a French beverage company. French authorities also forced Coca-Cola to scale back its acquisition of Cadbury Schweppes, another beverage maker. Moreover, Italy successfully won a court case against Coca-Cola over anticompetitive prices in 1999, prompting the European Commission to launch a full-scale probe of the company’s competitive practices. PepsiCo and Virgin accused Coca-Cola of using rebates and discounts to crowd their products off shelves, thereby gaining greater market share. Coca-Cola’s strong-arm tactics proved to be in violation of European laws and once again demonstrated the company’s lack of awareness of European culture and laws.
Despite these legal tangles, Coca-Cola products, along with many other U.S. products, dominate foreign markets throughout the world. According to some European officials, the pain that U.S. automakers felt in the 1970s because of Japanese imports is the pain that U.S. firms are meting out in Europe. The growing omnipresence of U.S. products, especially in highly competitive markets, is why corporate reputation – both perceived and actual – is so important to relationships with business partners, government officials, and other stakeholders.
Racial Discrimination Allegations
In the spring of 1999, initially fifteen hundred African American employees sued Coca-Cola for racial discrimination but eventually grew to include two thousand current and former employees. Coca-Cola was accused of discriminating against them in pay, promotions, and performance evaluations. Plaintiffs charged that the company grouped African American workers at the bottom of the pay scale, where they typically earned $26,000 a year less than Caucasian employees in comparable jobs. The suit also alleged that top management had known of the discrimination since 1995 but had done nothing. Although in 1992 Coca-Cola had pledged to spend $1 billion on goods and services from minority vendors, it did not seem to apply to their workers.
Although Coca-Cola strongly denied the allegations, the lawsuit evoked strong reactions. To reduce collateral damage, Coca-Cola created a diversity council and paid $193 million to settle the racial discrimination lawsuit.
Problems with the Burger King Market Test
In 2002 Coca-Cola ran into more troubles when Matthew Whitley, a mid-level Coca-Cola executive, filled a whistle-blowing suit, alleging retaliation for revealing fraud in a market study performed on behalf of Burger King. To increase sales, Coca-Cola suggested that Burger King invest in and promote frozen Coke as a child’s snack. The fast-food chain arranged to test market the product for three weeks in Richmond, Virginia, and evaluate the results before agreeing to roll out the new product nationally. The test market involved customers receiving a coupon for a free frozen Coke when they purchased a Value Meal (sandwich, fries, and drink). Burger King Executives wanted to be cautious about the new product because of the enormous investment that each restaurant would require to distribute and promote the product. Restaurants would need to purchase equipment to make the frozen drink, buy extra syrup, and spend a percentage of their advertising funds to promote the new product.
When results of the test marketing began coming in to Coca-Cola, sales of frozen Coke were grim. Coca-Cola countered the bad statistics by giving at least one individual $10,000 to take hundreds of children to Burger King to purchase Value Meals including the frozen Coke. Coca-Cola’s action netted seven hundred additional Value Meals out of nearly one hundred thousand sold during the entire promotion. But when the U.S. attorney general for the North District of Georgia discovered and investigated the fraud, the company had to pay $21 million to Burger King, $540,000 to the whistle-blower, and a $9 million pretax write-off had to be taken. Although Coca-Cola disputes the allegations, the cost of manipulating the frozen Coke research cost the company considerably in negative publicity, criminal investigations, and a soured relationship with a major customer, and a loss of stakeholder trust.
Inflated Earnings Related to Channel Stuffing
Another problem that Coca-Cola faced during this period was accusations of channel stuffing. Channel stuffing is the practice of shipping extra inventory to wholesalers and retailers at an excessive rate, typically before the end of a quarter. Essentially, a company counts the shipments as sales although the products often remain in warehouses or are later returned to the manufacturer. Channel stuffing tends to create the appearance of strong demand (or conceals declining demand) for a product, which may result in inflated financial statement earnings thus misleading investors.
Coke was accused of sending extra concentrate to Japanese bottlers from 1997 through 1999 in an effort to inflate profits. In 2004 Coca-Cola reported finding statements of inflated earnings due to the company’s shipping extra concentrate to Japan. Although the company settled the allegations, the Securities and Exchange Commission (SEC) did find that channel stuffing had occurred. Coca-Cola had pressured bottlers into buying additional concentrate in exchange for extended credit, which is technically considered legitimate.
To settle with the SEC, Coca-Cola agreed to avoid engaging in channel stuffing in the future. The company also created an ethics and compliance office and is required to verify each financial quarter that it has not altered the terms of payment or extended special credit. The company further agreed to work on reducing the amount of concentrate held by international bottlers. Although it settled with the SEC and the Justice Department, it still faces a shareholder lawsuit regarding channel stuffing in Japan, North America, Europe, and South Africa.
Trouble with Distributors
In early 2006, Coca-Cola faced problems with its bottlers, after fifty-four of them filed lawsuits seeking to block Coca-Cola from expanding delivery of Powerade sports drinks directly to Wal-Mart warehouses beyond the limited Texas test area. Bottlers alleged that the Powerade bottler contract did not permit warehouse delivery except for commissaries and that Coca-Cola had materially breached the agreement by committing to provide warehouse delivery of Powerade to Wal-Mart and by proposing to use a subsidiary, CCE, as its agent for warehouse delivery.
The problem was that Coca-Cola was trying to step away from the century-old tradition of direct-store delivery, known as DSD, wherein bottlers drop off product at individual stores, stock shelves, and build merchandising displays. Coca-Cola and CCE assert they were simply trying to accommodate a request from Wal-Mart for warehouse delivery, which is how PepsiCo distributes its Gatorade brand. CCE had also proposed making payments to some other bottlers in return for taking over Powerade distribution in their exclusive territories. But the bottlers had concerns that such an arrangement would violate antitrust laws and claimed that if Coca-Cola and CCE went forward with their warehouse delivery, it would greatly diminish the value of the bottlers’ businesses.
The problems faced by Coca-Cola were reported negatively by the media and had a negative effect on Coca-Cola’s reputation. When the reputation of one company within a channel structure suffers, all firms within the supply chain suffer in some way or another. This was especially true because Coca-Cola adopted an enterprise resource system that linked Coca-Cola’s once almost classified information to a host of partners. Thus, the company’s less-than-stellar handling of the ethical crises has introduced a lack of integrity in its partnerships. Although some of the crises had nothing to do with the information shared across the new system, the partners still assume greater risk because of their relationships with Coca-Cola. The interdependence between Coca-Cola and its partners requires a diplomatic and considerate view of the business and its effects on various stakeholders. Thus, these crises harmed Coca-Cola’s partner companies, their stakeholders, and eventually, their bottom lines.
International Problems Related to Unions
Around the same time, Coca-Cola also faced intense criticism in Colombia where unions were making progress inside Coke’s plants. Coincidently, at the same time, eight Coca-Cola workers died, forty-eight went into hiding, and sixty-five received death threats. The union alleges that Coca-Cola and its local bottler were complicit in these cases and is seeking reparations to the families of the slain and displaced workers. Coca-Cola denies the allegations, noting that only one of the eight workers was killed on the premises of the bottling plant. Also, the other deaths all occurred off premises and could have been the result of Colombia’s four-decade-long civil war.
Coke Employees Offer to Sell Trade Secrets
A Coca-Cola administrative secretary and two accomplices were arrested in 2006 and charged in a criminal complaint with wire fraud and unlawfully stealing and selling trade secrets from the Coca-Cola Company. The accused contacted PepsiCo executives and indicated that an individual identifying himself as “Dirk,” who claimed to be employed at a high level with Coca-Cola, offered “very detailed and confidential information.” When Coca-Cola received the letter from PepsiCo about the offer, the FBI was contacted, and an undercover FBI investigation began. The FBI determined that “Dirk” was Ibrahim Dimson of Bronx, New York. Dirk provided an FBI undercover agent with fourteen pages of Coca-Cola logo-marked “Classified – Confidential” and “CLASSIFIED – Highly Restricted.” In addition, Dirk also provided samples of Coca-Cola top-secret products. The source of the information was Joya Williams, an executive administrative assistant for Coca-Cola’s global brand director in Atlanta, who had access to some information and materials described by “Dirk.” Employees should be held responsible for protecting intellectual property, and this breach of confidence by a Coca-Cola employee was a serious issue.
Despite Coca-Cola’s problems, consumers surveyed after the European contamination indicated they felt that Coca-Cola would still behave correctly during times of crises. The company also ranked third globally in a PricewaterhouseCoopers survey of most-respected companies. Coca-Cola managed to retain its strong ranking while other companies facing setbacks, including Colgate-Palmolive and Procter & Gamble, were dropped or fell substantially in the rankings.
Coca-Cola has taken the initiative to counter diversity protests. The racial discrimination lawsuit, along with the threat of a boycott by the NAACP, led to Daft’s plan to counter racial discrimination. The plan was designed to help Coca-Cola improve employment of minorities.
When Coca-Cola settled the racial discrimination lawsuit, the agreement stipulated that the company (1) donate $50 million to a foundation to support programs in minority communities, (2) hire an ombudsman who would report directly to CEO Daft, (3) investigative complaints of discrimination and harassment, and (4) set aside $36 million for a seven-person task force and authorize it to oversee the company’s employment practices. The task force includes business and civil rights experts and is to have unprecedented power to dictate company policy with regard to hiring, compensating, and promoting women and minorities. Despite the unusual provision to grant such power to an outside panel, Daft said, “We need to have outside people helping us. We would be foolish to cut ourselves off from the outside world.”
Belgian officials closed their investigation of the health scare involving Coca-Cola and announced that no charges would be filed against the company. A Belgian health report indicated that no toxic contamination had been found in Coke bottles, even though the bottles were found to have contained tiny traces of carbonyl sulfide, which produces a rotten-egg smell; the amount of carbonyl sulfide would have to have been a thousand times higher to be toxic. Officials also reported that they found no structural problems with Coca-Cola’s production plant and that the company had cooperated fully throughout the investigation.
CURRENT SITUATION AT COCA-COLA
While Coca-Cola’s financial performance continues to lag, one issue that may have great impact on the success of the company is its relationship with distributors. Lawsuits that distributors have launched against Coca-Cola for its attempt to bypass them with Powerade
have the potential of destroying trust and cooperation in the future. Other issues related to channel stuffing and falsifying market tests to customers indicate willingness by management to bend the rules to increase the bottom line.
Although Coca-Cola seems to be trying to establish its reputation based on quality products and socially responsible activities, it has failed to manage ethical decision making in dealing with various stakeholders. An important question to consider is whether Coca-Cola’s strong emphasis on social responsibility, especially philanthropic and environmental concerns, can help the company maintain its reputation in the face of highly public ethical conflict and crises.
CEO Isdell developed a two-year turnaround plan focused on new products, and the company created one thousand new products, including coffee-flavored Coca-Cola Blak to be marketed as an energy beverage and soft drink. The company is also adopting new-age drinks such as lower-calorie Powerade sports drink and flavored Dasani water. These moves are an attempt to catch up with PepsiCo who has become the noncarbonated-beverage leader. Coca-Cola continues developing products such as bottled coffee called Far Coast and black and green tea drinks called Gold Peak. Although PepsiCo has outexecuted Coca-Cola since 1996, Coca-Cola still has a 50 percent market share, but PepsiCo has become the larger company in 2006 and Coca-Cola’s long-term earnings and sales have been lowered. If so many ethical issues had not distracted Coca-Cola, would its financial performance have been much better?
Why do you think Coca-Cola has had one ethical issue to resolve after another over the last decade or so?
A news analyst said that Coca-Cola could become the next Enron. Do you think this is possible and defend your answer?
What should Coca-Cola do to restore its reputation and eliminate future ethical dilemmas with stakeholders?
CASE 2 MICROSOFT: ANTITRUST BATTLES
William H. (Bill) Gates III and Paul G. Allen founded Microsoft Corporation in 1975. Since that time, the company’s innovative products and marketing prowess have made it the world’s leading marketer of computer software. Among its many product lines are operating systems for personal computers (PCs), network servers, and other devices; office productivity software; software development tools; Internet products such as Internet Explorer and the MSN online network; and gaming devices such as Xbox. The company has grown to nearly fifty-one thousand employees worldwide with annual revenues exceeding $28 billion. Microsoft’s stated mission is “to enable people and businesses throughout the world to realize their full potential” through its products.
Along with its innovative products and marketing, Microsoft contributes substantially to charities. For example, in 2002 the company donated $246.9 million, as well as thousands of volunteer hours. When Microsoft employees personally donate, the company matches their contributions, up to $12,000 per employee. Organizations that have benefited from these contributions include low-income housing developments, the YMCA, Easter Seals, Boys and Girls Club of America, museums, and schools. Another important program is Libraries Online through which Microsoft provides computers, cash, and software to help link libraries to the Internet. The goal is to enable people who may not have access to computers to learn about PCs, explore the latest software, and experience the Internet. The company focuses its philanthropic contributions on four areas: helping provide technology access to underserved communities around the world, strengthening nonprofit organizations, supporting technology training and education for underserved people around the world, and building communities.
MICROSOFT’S REPUTATION AND LEGAL ISSUES
Regardless of Microsoft’s reputation for innovation and charity, the company has faced significant ethical and legal issues stemming from its dominance of particular software markets. In 1990, for example, the Federal Trade Commission (FTC) began investigating Microsoft for possible violations of the Sherman and Clayton Antitrust Acts. By August 1993, the FTC was deadlocked on a decision regarding the possible Microsoft violations and handed the case over to the U.S. Department of Justice (DOJ). Microsoft eventually agreed to settle those charges without admitting any wrongdoing. Part of the settlement provided the DOJ with complete access to Microsoft’s documents for use in subsequent investigations.
Another important part of the settlement was a provision to end Microsoft’s practice of selling its MS-DOS operating system to original equipment manufacturers (OEMs) at a 60 percent discount. Manufacturers received the discount if they agreed to pay Microsoft for every computer they sold (a per processor agreement) as opposed to paying Microsoft for every computer they sold that had MS-DOS preinstalled (a per copy agreement). If an OEM installed a different operating system, the manufacturer would in effect be paying for both the Microsoft and the other operating system – that is, paying “double royalties.” Critics argued that this practice was unfair to both consumers – who effectively paid Microsoft even when they bought a rival operating system – and manufacturers because it made it uneconomical to give up the 60 percent Microsoft discount in order to install a less popular operating system. Competitors claimed the practice was monopolistic.
The U.S. Supreme Court defines a monopoly as the “power to control prices or exclude competition.” In other words, a monopolist is a company that can significantly raise the barriers to entry within the relevant market. They many engage in practices that any company, regardless of size, could legally employ; however, they cannot use its market power in such a way so as to prevent competition. In essence, a company is allowed to be a monopoly, but when a monopolist acts in a way that only a monopolist can, it has broken the law.
Despite the settlement, Microsoft’s legal woes were far from over. The next battle was against Apple Computer. Apple alleged that Microsoft’s CEO, Bill Gates, threatened to stop making Macintosh-compatible products if Apple did not stop developing a program that was to compete with a similar Microsoft program. Because Microsoft is the largest producer of Macintosh-compatible program, Apple argued that it was being forced to choose between a bad deal or extinction. Apply also alleged that Microsoft would not send it a copy of Windows 95 until it dropped Microsoft’s name from a lawsuit. Over the years, the two companies worked out their differences, and in late 1998, Microsoft bought $150 million of nonvoting stock in Apple and paid $100 million for access to Apple’s patents.
The next legal battle was Sun Microsystems’ trademark and breach-of-contract case. Sun accused Microsoft of deliberately trying to sabotage its Java “write once, run anywhere” promise by making Windows implementations incompatible with those that ran on other platforms. Specifically, the suit alleged that Microsoft’s Java compatible products omitted a so-called Java native interface, as well as a remote method invocation – features that help developers write java code. Sun claimed that Microsoft replaced certain parts of the Java code with Windows – specific code in a way that confused programmers into thinking they were using pure Java. Sun acknowledged that Microsoft fixed some earlier problems, but added two new alleged incompatibilities to its list. One allegation concerned the addition of new keywords that are available to programmers, and the other revolved around new directives in Microsoft’s Java compiler that make it dependent on Windows implementations.
In 1998 Sun added new allegations of exclusionary conduct on Microsoft’s part and requested an injunction that would require Microsoft to either make the Java features in its new Windows 98 operating system compatible or to include Sun’s version of Java with every copy of Windows sold. In 2000 the Ninth District Court of Appeals ruled that it was software developers and consumers, not Sun, who would decide the value of Microsoft’s language extensions. Therefore, Microsoft was allowed to support its development tools with its own Java enhancements. Furthermore, Sun’s motion to reinstate the injunction on the basis of copyright infringement was denied. The court ruled that the compatibility test was a contractual issue, not a copyright issue.
After various companies such as Netscape Communications continued to complain about Microsoft’s competitive practices, the federal government took an aggressive stand and charged Microsoft with creating a monopolistic environment that substantially reduced competition in the industry. The company settled the charges and consented to a decree that prohibited it from imposing anticompetitive licensing terms on PC manufacturers.
The DOJ also asked a federal court to hold Microsoft in civil contempt for violating the terms of that consent decree and to impose a $1 million-per-day fine. This time the issue was over Microsoft’s “bundling” of its Internet Explorer Web browser into the Windows 95 operating system. Microsoft argued that Internet Explorer was an integral, inseparable part of Windows 95 and that it had not integrated the browser technology solely to disadvantage rivals such as Netscape. A U.S district court judge disagreed and issue an injunction prohibiting the company from requiring Windows 95 licensees to bundle Internet Explorer with the operating system. Microsoft filed an appeal and asked for the petition to be heard on an expedited basis while it supplied PC makers with an older version of Window 95 without the Internet Explorer files or with a current version of Windows 95 stripped of all Internet Explorer files. The modified product would not boot up, however, a problem that Microsoft later admitted it knew about beforehand. Consequently, the DOJ asked the district court to hold Microsoft in contempt. When Microsoft’s stock price began to drop, it agreed to provide computer vendors with the most up-to-date version of Windows 95 without the Internet Explorer desktop icon.
MICROSOFT’S REBUTTAL TO THE ALLEGATIONS
In response to its detractors, Microsoft denied all the essential allegations, arguing that it had planned to integrate Internet Explorer into the Windows operating system long before rival Netscape even existed. Microsoft also refuted the government’s central accusation that it incorporated its browser technologies into Windows only to disadvantage Netscape. They argued that its Internet Explorer was gaining popularity with consumers for the simple reason that it offered superior technology. In addition, Microsoft rejected government allegations that it tried to “illegally divide the browser market” with rival Netscape and that it had not entered into exclusionary contracts with Internet service providers or Internet content providers. Finally, Microsoft argued that it did not illegally restrict computer manufacturers from altering the Windows desktop screen that users see when they turn on their computers for the first time.
Like other software products, the Federal Copyright Act of 1976 protects the various versions of Microsoft’s Windows operating system products. This act states that copyright owners have the right to license their products to third parties in an unaltered form. Thus, Microsoft asserted a counterclaim against twenty state attorney generals because it believed they were inappropriately trying to use state antitrust laws to infringe on Microsoft’s federal rights.
THE DEPOSITION AND TRIAL
After two years of negotiations, the federal government, along with twenty states, charged Microsoft with abusing its monopoly in the computer software business. The three primary issues raised in the lawsuit were (1) bundling the Internet Explorer Web browser with the Windows 98 operating system to damage competition, particularly Netscape Communications Inc., (2) using cross-promotional deals with Internet providers to extend its monopoly, and (3) illegally preventing PC makers from customizing the opening screen showing Microsoft.
In 1998 the depositions of Microsoft and Gates began. The first one lasted thirty hours. During this deposition, Gates refused to answer most questions and quibbled over the exact meaning of such words as complete and ask when they were used in deposition questions. When asked about controversial e-mails sent throughout the company regarding treatment of competition, he did not provide an effective argument as to their exact meaning. It seemed that Gates was not concerned about the forthcoming trial.
The trial began on October 19 when the government accused Gates of illegal bullying, coercion, and predatory pricing to undermine Netscape because that company’s products were becoming more popular than Microsoft’s. Gates denied being concerned about Netscape’s increasing browser market, but memorandums and e-mail messages presented in court suggested otherwise. Moreover, Netscape’s CEO, James Barksdale, told the court that Microsoft and Netscape executives had met in June 1995 to discuss “ways to work together.” Barksdale testified that Microsoft’s proposal at the time involved illegally dividing the market. When Netscape rejected the proposal, Microsoft allegedly used predatory pricing, along with other tactics, to “crush” the company.
By the time Microsoft began its defense in 1999; its credibility had been severely damaged. During this time, several company witnesses testified regarding the e-mails in question only to be rebutted. The most damaging testimony came from Jim Allchin, who was referred to as “Microsoft’s Lord of Windows.” Allchin’s testimony was supposed to demonstrate that Internet Explorer could not be separated from Windows without detrimental effects. His demonstration lost its credibility when a reappearing Explorer icon made it apparent that the videotape had been doctored.
At that point, Microsoft attempted to settle the case, and by February 1999, it was given some options by the DOJ. First, the government wanted to assign government-appointed people as active members of Microsoft’s board of directors. Microsoft viewed this as an attempt by the government to take control of the company. In November 1999, Judge Thomas Penfield Jackson released his findings, a document of 412 paragraphs with 4 paragraphs being favorable toward Microsoft. Judge Jackson also named Allchin, a computer expert and long-time Microsoft employee, as the mastermind behind the bundling of Internet Explorer and the operating system so as to destroy Netscape. Jackson then appointed Judge Richard Posner, a well-respected member of the Seventh Circuit Court, to try one more time to make a deal, but the gap between the two sides remained insurmountable. The last meeting took place on June 2, 2000.
On June 7, 2000, Judge Jackson ordered Microsoft to split into two independent companies – one to sell Windows and the other to sell everything else. Jackson offered several grounds for his dramatic decision, the first being simply that Microsoft would not admit to any wrongdoing. He also stated that intent of his decision was to prevent Microsoft from insulting the government by refusing to comply with antitrust laws. He said he found Microsoft to be “untrustworthy” because of its past behavior, including sending defective Windows software after it had been ordered to unbundle the Internet browser from the operating system. Jackson further indicated that he was trying to prevent Microsoft from bullying its competitors. By splitting Microsoft into two independent companies, he expressed the hope of achieving several objectives. First, the split was intended to reignite competition in the industry. Second, it could potentially spur some innovation that had been stifled by the software giant’s size and force. Third, the split might rejuvenate some of the “dead zones” in the industry, such as word processing, spreadsheets, databases, and e-mail. Fourth, and perhaps most important, lessening Microsoft’s power in the industry would hopefully renew creativity among software engineers.
But Microsoft didn’t see the ruling as fair. Instead, Gates viewed the idea of splitting the company into two as the equivalent of a “corporate death sentence.” They countered that rather than spur innovation, it would stifle it. The split would make software development more complex and effectively integrating two or more programs across two businesses much more difficult. They further argued that the separate marketing of Windows and Microsoft’s non-Windows software would drive up consumer prices. Finally, Microsoft saw the split as leading to delays in completing and introducing new products.
Microsoft has long viewed itself as a symbol of the American Dream for its customers, and a public opinion poll conducted by Harris Interactive supported that notion. More than 50 percent of 3830 people surveyed agreed that Gates was a positive role model, and nearly 50 percent said they disagreed with the government’s proposal to split Microsoft into two companies. However, 42 percent also believed that Microsoft was a monopolist, with 75 percent feeling that Microsoft treated its competitors in an inappropriate manner. Another survey showed that over 50 percent of the people questioned felt that Microsoft was guilty of deliberately trying to crush its competitors.
Clearly unhappy with the decision, Microsoft appealed, thereby suspending the implementation of the ruling. Although the DOJ wanted the U.S. Supreme Court to review the case, bypassing the District of Columbia Circuit Court of Appeals, the Supreme Court declined the case. In June 2001, a federal appeals panel agreed with Jackson’s ruling that Microsoft had violated antitrust laws but reversed his breakup order and returned the case to the lower court for a new remedy. While attempting to have the Court vacate that ruling, the various parties continued to negotiate to settle the suit. In November 2001, the U.S. government and nine states reached agreement with Microsoft on a tentative settlement. California and eight other states continued to hold out for stricter remedies and stronger enforcement.
On November 1, 2002, U.S. District Judge Colleen Kollar-Kotelly approved most of the provisions of the settlement, barring Microsoft from retaliating against computer manufacturers, permitting customers to delete desktop icons for some Microsoft features, and requiring the company to disclose specific technical data to software developers. To satisfy the holdout states, Kollar-Kotelly included a provision in the settlement that made independent Microsoft board members responsible for the company’s compliance efforts instead of the technical committee that Microsoft had wanted to oversee compliance. CEO Gates declared, “It represents a fair resolution of this case. I am personally committed to full compliance.” Although the company’s stock rose on the news of the final settlement, some critics expressed concern that the decision failed to eliminate Microsoft’s virtual monopoly over some aspects of the computer industry. Sun Microsystems’ special counsel, Mike Morris, said, “The weak steps that Microsoft has taken to comply with the requirements already show that the settlement will be ineffective in curbing Microsoft’s monopolistic and anti-competitive practices and how difficult it will be to enforce.”
POST-2002, HAD ANYTHING CHANGED?
Even though Microsoft continues to hold a dominant position in the operating system and browser market, the agreement appears to have achieved its objectives, even though individual users might find little change.
As industry specialists argue, the main problem with Microsoft being dominant with Internet browser and operating systems is that it is vulnerable to attack by worms, viruses, and the like. The 2002 agreement to curb the monopolistic power of Microsoft, however, seems to have worked. Other companies are becoming competitive against Microsoft in key areas such as media players (Apple and Real), search engines (Google and Yahoo!), and instant messaging (Yahoo! And AOL) (Figures C2-1 to C2-3).
Wherever Microsoft is not dominant, it appears to be in categories not bundled with Windows (games, PDAs, handheld PCs). The antitrust ruling has also resulted in benefits to individual customers in California, Florida, Kansas, North Carolina, North Dakota, South Dakota, Tennessee, West Virginia, and the District of Columbia. Customers in these states are receiving rebates and cash-back offers by Microsoft. The extent of cash back and the procedures such as “with or without proof of purchase,” bundled rebate or item by item rebate, and deadlines to apply for cash back depend on the individual states. Finally, the antitrust case decision against Microsoft has seen volume software licensees getting larger discounts. It is doubtful whether these benefits will be passed on to individual customers or PC users.
In 2005 Judge Kollar-Kotelly, felt that a significant impact was made on the way Microsoft was behaving, especially in making its documentation quality better. The latest compliance status report stated that Microsoft has been on track with its compliance with the settlement, especially with licensing its communications protocol program (MCPP) and making available its technical documentation. The MCPP licensing allows other software manufacturers to integrate their tools with Windows because Microsoft must provide access to the source code to its MCPP (source code is the human-readable form of Microsoft’s protocol technology).
However, in 2006 the DOJ found that Microsoft failed to comply with key provisions of its 2002 antitrust settlement and asked a federal judge to extend existing restrictions and government oversight of the company’s conduct by two years, until 2009.
Figures C2-1 Internet Search Engine Market
Ask Jeeves 9
0 10 20 30 40 50 Percent
SOURCE: Neilsen/Netratings (2006).
Figures C2-2 PDA Operating System Market
SOURCE: IDC (December 2003)
Figures C2-3 Operating System Market
1% 3% 3%
Linux Mac Others
SOURCE: IDC (December 2003)
BUT DOES THIS MEAN THAT MICROSOFT’S TROUBLES ARE FINALLY OVER? NOT REALLY
As the 2002 ruling was being implemented, Microsoft started facing problems from other countries, notably the European Union (EU). The EU antitrust commission’s case is based on Microsoft’s near monopoly on Windows audio – and video – playing software as well as computer server software designed for small networks of PCs. In 2004 a 302-page decision by the EU antitrust commission ruled against Microsoft’s policy of bundling media players with its Windows operating system, quoting it as an unfair use of monopolistic power to curb competition. It ordered Microsoft to provide a version of Windows stripped of its media software along with the available Windows operating system versions and fined them $612 million to comply with these issues. The compliance was to be done in ninety days, or Microsoft would face a daily fine of $2.4 million. The starting date was March 24, 2004.
Though Microsoft has paid out the fine, it is still negotiating with the commission regarding the deadline for compliance. Extensions have been given to Microsoft to comply with the settlement. Industry and legal experts in the European Union feel that Microsoft has minimal chances of succeeding in its appeal to reverse the decision because the decision has been “one of the most carefully formulated decisions in history.” Experts also feel that if Microsoft continues to delay enforcement further, it could nullify the ruling because the commission’s ruling will have no impact on the very distant future. In 2006 the EU Commission once again fined Microsoft $356 million for noncompliance with a mandate to disclose technology documents. Microsoft asserted that the order was unclear and that it had been trying to develop the documents. It plans to appeal the fine.
Other legal issues involving Microsoft’s post-U.S. antitrust case include the following:
In August 2003, a Chicago court ruling ordered Microsoft to pay $520 million in damages to the University of California and a private company (Eolas Technologies) on the basis of infringement of a patent by Microsoft’s Web browser. The patent relates to (partially) accessing and executing an embedded program object from the browser.
In December 2005, South Korea’s antitrust regulator fined Microsoft $32 million for violations of fair-trade regulations and ordered the company to remedy alleged unfair-trade practices. The ruling similar to the European Union’s ordered Microsoft to unbundle its media software from its operating system.
Gates stepped down as CEO in January 2000 and was replaced by Steve Ballmer. In 2008 Bill Gates will leave his full-time position at Microsoft to spend more time managing the Gates Foundation for charitable contributions. In 2006 Warren Buffet announced that he would be donating $37 billion to Bill Gates’s charitable foundation; it was thought to be the largest charitable gift ever in the United States. With most of its major legal battles resolved, Microsoft is turning its attention to its mission of developing new products.
Why has there been so much debate about the software industry and Bill Gates?
What legal and ethical issues in the Microsoft case relate to U.S. culture, and do these same issues extend to other countries that use Microsoft products?
Discuss Microsoft’s corporate culture with respect to the ethical and legal issues involved
Identify the types of power associated with each player in this case and discuss how and why each player is using these types of power. What are the potential ramifications of their actions?