Microsoft's Referral Server Agreements: The Details Regarding the Good and the Bad

b. The Referral Server Agreements

253. In the late summer of 1996, at around the time that it announced the availability of the IEAK, Microsoft also introduced the Internet Connection Wizard (“ICW”) as a feature in Windows 95 OSR 2. If a user clicked on the ICW icon appearing on the Windows 95 desktop, the program would automatically dial into a computer maintained by Microsoft called the Windows Referral Server. The Referral Server would then transmit to the user’s computer a list of IAPs that provided connections to the Internet in the user’s geographic locale.

     
     

     Included in this list would be information about each IAP’s service, including its prices. If the user then indicated a desire to sign up for one of the listed IAPs by clicking on the appropriate entry, the user would be connected to an IAP-maintained server that would automatically configure the user’s PC to work properly with the IAP service.

254. For several reasons, IAPs viewed inclusion in the Windows 95 Referral Server as a valuable form of promotion. First, the ICW icon appeared prominently on the desktop of every PC running Windows 95 (from OSR 2 onwards), which, by the middle of 1996, accounted for the vast majority of all new PCs being shipped.

     
     

     Because Microsoft prohibited OEMs from removing any of the icons that it placed on the Windows desktop, IAPs knew that the ICW would confront all users of Windows 95 PCs the first time they turned on their systems. Second, inclusion in the Referral Server was a highly focused form of promotion, because the IAP list provided by the Referral Server presented itself to users who had already indicated some interest in signing up for Internet access.

     
     

     Third, the easy-to-use features of the ICW heightened the probability that a user who started using the program would complete the process of subscribing to an IAP. Finally, inclusion in the Referral Server was a relatively inexpensive means of distribution because, unlike “carpet bombing” with CD-ROMs, it did not require the production and dissemination of anything tangible.

255. Despite the value that IAPs attached to placement in the Windows 95 Referral Server, Microsoft elected to charge those that it granted placement a low bounty price that merely went to pay down the cost of maintaining the necessary server computers and leasing the network they ran on.

     
     

     Although it could have been exchanged for large bounties from IAPs, Microsoft decided to exchange placement in the Referral Server, along with other valuable consideration, for the agreement of the selected IAPs to promote and distribute Internet Explorer preferentially over Navigator and to convert existing subscribers from Navigator to Internet Explorer.

256. Between July 1996 and September 1997, Microsoft entered into Referral Server agreements with fourteen IAPs. These were AOL, AT&T WorldNet, Brigadoon, Concentric, Digex, EarthLink, GTE, IDT, MCI, MindSpring, Netcom, Prodigy, Sprint, and Spry. Three of these companies did not take the technical steps necessary to appear in the Referral Server even though they had signed agreements with Microsoft.

     
     

     Brigadoon failed to take those steps because it filed for bankruptcy. For its part, Digex left the ISP business to focus exclusively on Web hosting. GTE, on the other hand, decided to enter promotion agreements directly with OEMs rather than abide by the conditions Microsoft attached to inclusion in the Referral Server.

     
     

     Although AOL eventually entered a listing into the Referral Server, it waited until November 1998, after the release of Windows 98. The remaining IAPs in the Windows 95 Referral Server represented ten of the top fifteen Internet access providers in the North America.

257. Pursuant to the terms of the agreements it signed with these ten IAPs, Microsoft provided each with a listing in the Windows 95 Referral Server and mentioned them in press releases and marketing activities relating to the ICW.

     
     

     Microsoft also licensed Internet Explorer to them at no charge, and assisted them in customizing Internet Explorer for use with their services. In exchange, the listed IAPs agreed to offer Internet Explorer as the “standard,” “default,” or “preferred” browsing software with their services.

     
     

     For example, Microsoft’s agreement with EarthLink required it to “[o]ffer the Microsoft Internet Explorer as the standard web browser for [EarthLink’s] ISP Service.”

     
     

258. The agreements also imposed several restrictions on the ability of the IAPs in the Referral Server to promote and distribute non-Microsoft browsing software. First, the agreements required the IAPs to limit their promotion of browser products other than Internet Explorer.

     
     

     For example, the agreements prohibited the IAPs from providing any links or other promotions for Netscape on their services’ home pages. In fact, an IAP listed in the Referral Server was not permitted, either in its Referral Server entry or elsewhere, to express or imply to its subscribers that they could use a browser other than Internet Explorer with the IAP’s service.

     
     

     Second, the agreements prohibited the ten IAPs from providing non-Microsoft browsing software to their customers unless a subscriber specifically requested it. Third, the agreements gave Microsoft the right to remove from the Referral Server any IAP, that in two consecutive calendar quarters, allowed non-Microsoft browsing software to climb above a specific percentage of all browsing software distributed by that IAP.

     
     

     Thus, even if the IAP ensured that all users subscribing to its service through the Internet Connection Wizard received only Internet Explorer with their subscriptions, Microsoft could nevertheless remove the ISP from the Referral Server if copies of Navigator made up more than the specified percentage of the browsing software that the IAP distributed through all sub-channels.

     
     

     Twenty-five percent was the figure specified in most of the agreements. For Netcom and Sprint, the figure was fifty percent, while for IDT it was fifteen.

     
     

259. In addition to conditioning placement in the Referral Server on an IAP’s undertaking to limit its promotion and distribution of non-Microsoft browsing software, Microsoft through its Referral Server agreements exchanged valuable consideration for the commitment of the ten IAPs to convert existing subscribers from Navigator to Internet Explorer.

     
     

     Microsoft also compensated them for employing Internet Explorer-specific technologies whose dissemination would encourage the developers of network-centric applications to focus on APIs controlled by Microsoft, as opposed to Netscape or Sun.

     
     

     For example, in exchange for Netcom’s commitment to offer deals to its customers encouraging them to upgrade their software to the newest version that bundled Internet Explorer, Microsoft subtracted nine dollars from the referral fee.

     
     

     Microsoft also deposited one dollar into a co-marketing fund for each Netcom subscriber who actually upgraded to client software that bundled Internet Explorer.

260. Where the agreement with Microsoft required the IAP to abandon a distribution agreement already entered with Netscape, Microsoft compensated the IAP with additional consideration.

     
     

     For instance, in response to a representation from MCI that it had already committed to pay Netscape between five and ten million dollars for Web browsing software, Microsoft agreed to grant MCI a credit of five dollars toward a co-marketing fund (not to exceed five million dollars) for each copy of Internet Explorer that MCI distributed to an MCI Internet access customer who had not already received a copy.

     
     

     Finally, Microsoft offered yet further reductions in referral fees to the IAPs using Microsoft-controlled technologies likely to stimulate developers to focus their attention on Windows-specific software interfaces rather than the cross platform ones provided by Netscape and Sun.

     
     

     For example, Microsoft offered to reduce EarthLink’s per-copy referral fee by ten dollars in exchange for EarthLink’s use of at least two ActiveX controls in the design of its home page and the use of Microsoft FrontPage server extensions on its Web hosting servers.

261. Microsoft could have covered the cost of developing and maintaining the ICW and the Windows Referral Server, and even made a profit, by charging higher referral fees than it did to the favored IAPs.

     
     

     Instead, Microsoft bartered away so much of the referral fees it otherwise could have charged that the costs of running the Windows Referral Server have thus far exceeded the payments Microsoft has received from the favored IAPs.

     
     

     Microsoft readily made this sacrifice in order to induce the important IAPs to take actions that aided Microsoft’s effort to exclude Navigator from the IAP channel.

262. Microsoft’s motivation for the limits it placed on the distribution of non-Microsoft browsing software by IAPs in the Windows 95 Referral Server could not have been simply a desire to ensure that IAPs did not promote competing browsing software to subscribers acquired with Microsoft’s help.

     
     

     The agreements gave Microsoft the right to dismiss an IAP that either told its subscribers they could choose Navigator or distributed too many copies of non- Microsoft browser products.

     
     

     This was true even if the IAP never mentioned Navigator in its Referral Server entry and distributed nothing but Internet Explorer to the new subscribers it garnered from the ICW. In light of that fact, the Windows 95 Referral Server agreements emerge as something very different from typical cross-marketing arrangements.

     
     

     Furthermore, while facilitating for consumers the process of connecting to the Internet may have been one motivation for developing the Internet Connection Wizard, that motivation cannot explain the exclusionary terms in the Referral Server agreements.

     
     

     After all, contractually limiting the distribution of non- Microsoft browsing software by IAPs did nothing to help consumers gain easy access to the Internet.

     
     

     The real motivation behind the exclusionary terms in the Referral Server agreements was Microsoft’s conviction that even if IAPs were compelled to promote and distribute Internet Explorer, the majority of their subscribers would nevertheless elect to use Navigator if the IAPs made it readily available to them.

     
     

     Microsoft therefore paid a high price to induce the most popular IAPs to encourage their customers to use Internet Explorer and discourage them from using Navigator.

263. Absent the conditions Microsoft placed on inclusion in the Referral Server, the IAPs would have had no reason to limit the percentage of subscribers that used one particular browser or another.

     
     

     As Cameron Myhrvold explained to colleagues within Microsoft in April 1997, “ISPs are agnostic on the browser. It is against their nature to favor a browser or even a platform. This has been damn hard for us to influence.”

     
     

     In fact, Myhrvold told the same colleagues that he “had a hard time guiding the ISPs to IE loyalty even when I make them sign explicit terms and conditions in a legal contract.”

264. Microsoft monitored the extent of compliance of IAPs in the Referral Server with the shipment restrictions contained in their agreements. It did this by periodically asking each of the ten IAPs to send Microsoft estimates of the number of copies of Internet Explorer — and non-Microsoft browsing software — they were shipping.

     
     

     When, from time to time, various IAPs in the Windows 95 Referral Server (specifically Netcom, Concentric, and EarthLink) fell below the shipment quotas specified in their agreements with Microsoft, executives at Microsoft reacted by contacting the derelict companies and urging them to meet their obligations.

     
     

     Concentric and Earthlink eventually (by May 1998, if not sooner) reduced their Navigator shipments enough to bring them below the required percentage. Microsoft never formally removed an IAP from the Referral Server. For a time after the release of Internet Explorer 4.0, however, no entry for Netcom appeared in the new version of Referral Server.

     
     

     This was at least in part due to Netcom’s failure to ensure that Internet Explorer accounted for fifty percent of the browsing software it shipped.

265. In addition to failing, for a time, to meet the required shipment quotas, Concentric and EarthLink occasionally promoted Navigator in ways that were arguably prohibited by the Referral Server agreements. Despite their delinquency, Microsoft never removed Concentric and EarthLink from the Referral Server.

     
     

     Of much less concern to Microsoft than the shipment and promotion of Navigator by IAPs having signed Referral Server agreements was the fact that Concentric and EarthLink, along with Netcom and three of the other IAPs in the Windows 95 Referral Server, also appeared in Netscape’s referral server.

     
     

     This did not violate either the letter or the spirit of their agreements with Microsoft, for while the agreements prohibited the IAPs in the Windows 95 Referral Server from promoting Navigator, they did not purport to hinder Netscape in promoting those IAPs.

     
     

     At any rate, Microsoft did not have reason to be concerned with the appearance of its IAP partners in Netscape’s referral server, whose main exposure was to existing Navigator users interested in switching their IAPs.

     
     

     A listing in Netscape’s referral server did not help Netscape get its software on users’ systems, and pursuant to their agreements with Microsoft, the six ISPs in both Microsoft’s and Netscape’s referral servers were actually placing Navigator on far fewer users’ systems than they would have in the absence of their agreements with Microsoft.

266. In reaction to Microsoft’s Referral Server agreements, Netscape entered into agreements of its own with five of the Regional Bell Operating Companies (RBOCs). Under the Netscape agreements, the RBOCs agreed to make Navigator their default Web browsing software in all cases, except those in which subscribers affirmatively requested other browsing software.

     
     

     In exchange, Netscape agreed to list the RBOCs first among the IAPs included in Netscape’s referral server. In contrast to Microsoft’s agreements, Netscape’s agreements with the RBOCs imposed no restrictions on their ability to distribute other browsing software, such as Internet Explorer, whether in response to customer requests or otherwise.

     
     

     Furthermore, Netscape’s contracts with the RBOCs required them to set Navigator as the default only so long as AT&T and MCI were both restricted by their agreements with Microsoft from providing Navigator to their customers on par with Internet Explorer.

     
     

     In any event, the RBOCs currently deliver Internet access to less than five percent of the Internet access subscribers in North America.

267. Microsoft’s Windows 95 Referral Server agreements were of relatively short duration. For example, Microsoft’s agreement with EarthLink provided that it would expire two years from its signing in August 1996 unless either party elected to terminate it sooner, and both Microsoft and EarthLink were free to terminate the agreement for any reason on thirty days’ written notice. The other Referral Server agreements were similarly short in term.

     
     

268. In April 1998, coincident with rising public criticism, the impending appearance of Bill Gates before a Congressional panel on competition in the computer industry, and the imminent filing of these lawsuits, Microsoft unilaterally waived the most restrictive provisions in the Windows 95 Referral Server agreements. Specifically, Microsoft waived the provisions that restricted the IAPs’ ability to distribute non-Microsoft Web browsing software.

     
     

     With respect to promotion, the revised agreements merely required the IAPs to promote Internet Explorer at least as prominently as they promoted non-Microsoft browsers. Notably, however, the agreements still required the IAPs to make Internet Explorer their default browser.

     
     

269. By the end of September 1998, all of the Windows 95 Referral Server agreements had expired by their own terms. Microsoft’s Windows 98 Referral Server agreements do not contain any provisions requiring that Internet Explorer make up any particular percentage of the IAPs’ shipments.

     
     

     Furthermore, the Windows 98 Referral Server agreements offer no discounts on the referral fees predicated on the IAPs’ adoption of any particular Microsoft technology or licensing any Microsoft product. With regard to promotion, the agreements require only that the IAPs promote Internet Explorer no less favorably than non-Microsoft Web browsing software.

     
     

     Still, for those IAPs concerned with the costs associated with supporting two browser products, this parity requirement is enough to compel them not to not make Navigator readily available to their subscribers. The new agreements have a one-year term and are terminable at will by the IAP on ninety days’ notice.

270. IAPs no longer value placement in the Windows Referral Server as much as they did in 1996. For one reason, the ICW has apparently not been responsible for as many new IAP subscriptions as either Microsoft or the IAPs anticipated.

     
     

     In fact, from the third quarter of 1996 through the third quarter of 1998, only 2.1% of new users of the Internet became IAP subscribers through the Windows Referral Server.

     
     

     Partially on account of this realization, Microsoft began in the spring of 1998 to surrender significant control over the Internet sign-up process to OEMs. As described above, Microsoft gave the top fifty OEMs in the world the right to select both the IAPs (up to five) that appear in the Windows 98 Referral Server on the PC systems they sell and to determine the order in which those IAPs appear.

     
     

     Microsoft also permits the fifty OEMs to keep any bounties that the IAPs pay them for inclusion in the Referral Server. The OEMs simply pay Microsoft a nominal fee (a flat fee of approximately $10,000 plus thirty cents per subscriber) to defray the costs of operating the Referral Server program.

     
     

     Furthermore (as is also discussed above), Microsoft has allowed seven of the highest-volume OEMs to supplant the ICW altogether.

271. By both lifting restrictions in its agreements and ceding control over the IAP signup process to OEMs, in the spring of 1998, Microsoft relaxed the strictures that it had imposed in the fall of 1996 on the distribution and promotion of Web browsing software by the most popular IAPs.

     
     

     In the year-and-a-half that they were in full force, however, the restrictive terms in the Referral Server agreements induced the major IAPs to customize their client software for Internet Explorer, gear their promotional and marketing activities to Microsoft’s technologies, and convert substantial portions of their installed bases from Navigator to Internet Explorer.

     
     

     They may have welcomed more flexibility to distribute Navigator to those subscribers that expressed demand for it, but they had no incentive to launch an expensive campaign to reverse the tide that Microsoft’s restrictions had already generated.

     
     

     Consequently, few ISPs have responded to Microsoft’s contractual dispensations by increasing significantly their distribution and promotion of Navigator.

     
     

     Furthermore, one of the reasons Microsoft felt comfortable relaxing the controls on IAPs in the spring of 1998 was that it had achieved — and planned to maintain — control over the distribution and promotion of Web browsing software by AOL and the other major OLSs, whose combined subscriber base comprised most of North America’s Internet users.

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