Introduction

Mr. Chairman and Members of the Committee, thank you all for conducting these oversight hearings to evaluate the competitive forces in what is clearly one of the country˙s most important industries. The vigorous growth of the software industry has played a significant part in the overall growth of the U.S. economy in the past decade with a wide array of dynamic companies working to establish what consumers should expect in the software industry - competition, innovation and choice. The rapid pace of change in technology and the emergence of the Internet make this a particularly critical moment to evaluate the competitive forces in the software industry. Preservation of healthy competition, customer choice, and innovative products must be an important public policy and economic objective as we head towards the year 2000.

I am the President and CEO of Lotus Development Corporation based in Cambridge, Massachusetts. Founded in 1982, Lotus popularized the personal computer (˙PC˙) spreadsheet with Lotus 1-2-3, and launched the PC business software industry. In more recent years, Lotus has become the leading supplier of so-called messaging and groupware products with Lotus Notes and Lotus Domino: innovative software products for e-mail, shared applications and information, and e-business. At the present time, our premier product, Lotus Notes is running on over 25 million personal computers worldwide, and Lotus employs more than 8000 people. Lotus was acquired by IBM in 1995, and now operates as an independent subsidiary of IBM.

Mr. Chairman, there has been a great deal of attention on the competition for Internet browser software and on the overall state of competition in the software industry. My testimony will focus on a practice that I believe threatens our industry and its role as an innovative force - the use of a dominant position in one area to eliminate competition in other areas and ultimately to stifle innovation and limit consumer choice. If one company-- in this case Microsoft-- is allowed to leverage its dominance in one product using licensing practices, bundling and other tactics to gain dominance in other product areas, then not only competition but also consumers and our economy will suffer.

I would like to preface my discussion today with a comment on Lotus˙ relationship with Microsoft. While I appreciate the invitation to testify today, I do so reluctantly. Lotus has a long and complex relationship with Microsoft. On the one hand, Lotus˙ products run on Microsoft˙s operating systems. Our products are optimized for Microsoft˙s technology and will continue to be. In fact, Lotus is one of Microsoft˙s most successful partners. In that role, Bill Gates and I have worked together to build a constructive relationship because it provides benefits to our common customers. On the other hand, we compete for many of those same customers, and it is the behavior to ˙win˙ the customers that is the subject of my testimony - and the object of my concern for Lotus and our industry.

I do not have issue with all of Microsoft business practices or even many, and certainly not with Microsoft in general. I am referring specifically to the following two: the leveraging of its dominant position with product bundling activities, and "OEM pressure tactics.˙
Historical Background

Microsoft has followed a strategy of gaining dominance in new areas by leveraging its dominant position in existing products. First, Microsoft established a foothold in PC operating systems with DOS (the first "disk operating system"). As its DOS product gained majority share, Microsoft used that market position to ensure PC manufacturers (Original Equipment Manufacturers or OEMs in the industry jargon) preloaded Windows. Subsequently, Microsoft employed bundling tactics with the OEMs relying on the fact that they have no viable alternative but to ship Windows, to ensure that the OEMs shipped other Microsoft products as well, such as Microsoft Office (a software package including word processing, spreadsheet, presentation graphics and personal database management applications).

One of the tactics employed by Microsoft has been to pressure OEMs to distribute Microsoft, and only Microsoft, productivity applications on their computers. For OEMs in the highly competitive world of PCs, faced with the possibility of losing the right to distribute Windows - and therefore, being effectively out of business - or paying a higher price for Windows, I can imagine that there was no real choice. A July 19, 1998 Reuters news report, quoting from a former Acer employee, confirms what we and other independent software vendors (ISV) have been told over the years about certain hardball sales tactics used by Microsoft with OEMs in order to achieve market dominance in business software applications. These tactics include a combination of veiled threats and pricing structures to dissuade OEMs from shipping competing products. The effects of this pressure have been stunning: e.g., Microsoft's share of productivity applications and suites shipped has climbed to 90%, and they are using the fruits of this success - to the tune of several billion a year - to fund their moves into other areas.

The emergence of the Internet spurred a new, healthy competition in the software industry. The Internet browsers offered users an alternative graphical interface-- a "virtual desktop" that often became the environment in which they spent the bulk of their computing time while ˙surfing˙ the Internet. Microsoft surely recognized that not only did the platform independence of the Internet threaten to undermine its Windows-based market control, but also, the Internet was the most important new software market in a decade. In any event, Microsoft quickly moved to establish itself in that market, using Windows as leverage when necessary, with a series of tactics that have become public as a result of the current litigation. Microsoft entered the Internet browser market in 1995, offering Internet Explorer for free and bundling it at no separate charge as a part of the Windows operating system. Today, Microsoft holds over 40% of the Internet browser market according to most reports.
The Current Problem

Having gained a solid foothold in the browser market, Microsoft is now turning its attention to messaging and groupware, which are key products in both corporate networks and the Internet. The messaging and groupware market is a good barometer of the software industry˙s potential for vitality. Messaging and groupware is a segment that analysts estimate will be a $20 billion-dollar market by the year 2000. As we move forward into the next century, this software will provide the basic underpinnings for engaging in business over the Internet. I expect that an increasing percentage of software applications will rely on the underlying messaging and groupware product.

Messaging and groupware refers to a class of software applications that enable users to send and receive e-mail and to share other information within corporate computer networks and beyond, across the Internet. Users PCs (clients) are connected to another computer called a server that handles requests from PCs. Users can enter, retrieve, and manipulate information stored on the server, while the server can secure, manage, and analyze the same data.

For example, groupware products can allow users to browse a catalog of available products in an "on-line store," select merchandise, and place an order. The on-line catalog may contain an interactive discussion database to provide information on available products and answer customer questions. Once an order is placed, the software will automatically and securely route the purchaser's credit card or other payment information and arrange for fulfillment of the order. After the product is shipped, the software would adjust the inventory and account for the receivable.

The Lotus messaging and groupware offering, with the "Lotus Notes" client and "Lotus Domino" server software, is routinely used to create applications such as the one described above. It combines e-mail with a robust and secure database capability, a rich applications development environment, and a sophisticated messaging system. With Lotus Domino, users can create secure, interactive business solutions for the Internet and corporate intranets.

While messaging and groupware represent areas of tremendous competition today, there are several trends which I find disturbing. Five years ago, Microsoft contended with a number of significant competitors in messaging and groupware. Today, few companies remain--- Lotus (with Lotus Notes and Lotus Domino), Microsoft (with Outlook and Exchange), Novell (with its Groupwise product). The only company other than Microsoft with significant market share is Lotus, which IDC reports as a 26% share. Microsoft today holds approximately a 14% share. Lotus achieved our success by introducing superior products to Microsoft˙s - and being first to market. While Lotus expects to compete vigorously and remains a viable and significant competitor, we see Microsoft using some of the same behaviors to gain market dominance in the messaging, groupware, and server software market as it used so successfully in the desktop suite and internet browser segments.
Bundling

Microsoft is including two e-mail clients at no additional charge with other products to ensure every new PC comes with Microsoft e-mail software, effectively locking up the ˙client˙ market. Microsoft offers an e-mail product called Outlook Express at no charge with its Internet Explorer browser, and both this browser and this e-mail functionality are integrated into Windows ˙98. Microsoft also includes its Outlook groupware product with Microsoft Office. Although similar in name to Outlook Express, Outlook is in fact a different product with more functionality - it includes mail, personal calendar and group scheduling and groupware and information-sharing capabilities. Outlook is the closest competitor to Lotus Notes.

An excellent example is Microsoft˙s bundle of its Exchange e-mail client with Microsoft Encarta Virtual Globe and the experience a user had with this particular bundle. Earlier this year, Brit Hume reported in The Business Journal in San Jose that in simply launching Internet Explorer after installing Encarta Virtual Globe, he was unable to use the browser ˙mail˙ command and send e-mail as he had always done but instead the program pulled up Microsoft Exchange. After days of examining documentation, settings on the PC, reference books and asking technically astute friends he stumbled on the answer - Microsoft had, unbeknownst to him and the other references he had checked, included a new version of Internet Explorer with the Encarta program that loaded the Exchange e-mail program. It would not work with other e-mail. In his own words, Hume describes the experience as a ˙disaster...no matter how many times we rebooted the computer and reconnected to the Internet, we couldn˙t escape. Clicking on the Mail command brought up that useless Exchange program every time. We had no access to e-mail...˙. This type of ˙bundling˙ deprives customers of choice, pure and simple.

Microsoft is extending its reach for dominance into the server market by creating close ties between Windows NT, its operating system for servers, and its Exchange messaging server, the competitive alternative to Lotus Domino. The behavior used by Microsoft in operating system and productivity applications is repeating itself in network server software. This behavior once again takes the shape of bundling. Microsoft now bundles a group of server software products, called BackOffice, with its popular Windows NT server operating system. The server software in BackOffice includes the Exchange messaging server and Microsoft's Internet server, offerings which compete directly with products from Lotus, Netscape and others. Indeed, Mr. Gates

˙ himself confirmed this would happen in a May 1997 interview in Fortune, ˙We are a very predictable company. What we did with Windows on the desktop, we˙re doing with Windows NT on the server. What we did with Office on the desktop, we˙re doing with BackOffice on the server.˙ [David Kirkpatrick, ˙He Wants All Your Business - And He˙s Starting to Get It,˙ Fortune, May 26, 1997.]

Conclusion

I leave it to the members of the Committee to form their own judgments about the practices I have described. However, as someone who has spent many years in this industry, I can assure you that Microsoft has the effect of foreclosing competition on the merits and extending their acknowledged dominance in operating systems for personal computers into other areas. This is not based on products offering more consumer benefits, but based on the fact that there is simply no credible alternative for their operating systems. I believe that to the extent success flows from leverage rather than the consumer value of the particular product, innovation and consumer choice will ultimately suffer. And for that reason, I believe the committee should give these practices close scrutiny.

So in closing, I urge the Committee to continue to hold hearings to air the sorts of concerns I have discussed with you today. I also urge the Committee to include Microsoft in your discussions. They are a critical and valued member of the industry, and I believe their participation is necessary to ensure a procompetitive, proconsumer resolution. The Committee can play a very positive role in encouraging Microsoft to compete on the merits.

Thank you for this opportunity to address a topic I consider essential to the continued health of the software industry, an industry that promises to have a profound effect on our country in the years ahead. I˙m sure you share my hopes that the promises - which are finally the fruits of free and open competition - are fulfilled.