Microsoft Is Dealt Blow by EU Judge

A senior European judge dealt a major setback to Microsoft Corp., ordering the company to immediately offer a version of its Windows operating system without media-player software and to share information that could help competing software makers.

President Bo Vesterdorf of Europe's Court of First Instance rejected Microsoft's request for a stay of a European Union ruling in March that had ordered changes in the company's business practices for violating EU antitrust laws.

Though the decision will have little near-term impact on Microsoft's business, the EU battle could set a damaging precedent against Microsoft's longtime strategy of meeting competition by adding new features to its dominant operating systems. U.S. officials, by contrast, have pursued antitrust remedies that don't intrude so directly in the design and engineering of Windows.

Microsoft said it will immediately comply with the ruling, though it is considering whether to appeal it. Meanwhile, the company continues to pursue an appeal on the merits of the EU's antitrust case before the same court, and press for a settlement that would end the litigation in Europe.

THE MICROSOFT CASE • See the EU's statement on the court ruling, Microsoft's response and Microsoft's conference call transcript   • Q&A: Explaining the Secret Codes   • Analysts React: Gauging the Impact   • Timeline: Key dates in antitrust action against Microsoft   • Microsoft Battles Piracy in Developing Markets   • Complete coverage

"There is ample room for us to continue to press forward," said Brad Smith, Microsoft's general counsel. The ruling gives "cause for optimism about our ability to prevail at the end of the day."

The Redmond, Wash., company said it will supply a version of Windows in Europe without its Windows Media software by January to computer makers, and by February to other system builders and resellers. It also plans to establish a Web site to offer rivals access to secret data that governs how non-Microsoft server software connects to Windows running on personal computers and servers.

Most attention has focused on the portion of the case that affects media-player programs, which manage how personal computers handle broadcast audio and video, as well as downloaded music files. Such software is widely viewed as a cornerstone piece of technology as more PCs are used as entertainment devices.

Just as it fought the U.S. Justice Department case about bundling of Internet browser software with Windows, Microsoft has argued vociferously against any ruling that would force it to remove software code that it views as necessary to improve its operating systems.

As a practical matter, however, yesterday's ruling also allows Microsoft to continue to offer Windows with Windows Media included at the same price as the unbundled version. Microsoft officials expressed doubt that there would be much demand for the stripped-down version of the operating system.

EUROPE V. MICROSOFT December 1998: Sun Microsystems Inc. complains to the European Union that Microsoft won't share technical information, preventing competitors from making products that work well with Microsoft's. Aug. 30, 2001: The EU broadens its investigation to include allegations that Microsoft improperly bundles its Windows Media Player with its operating systems. March 24, 2004: The EU rules that Microsoft has abused its monopoly position, ordering the company to sell a version of Windows without Media Player and to disclose technical information to competitors. Microsoft is fined €497 million ($666 million). Dec. 22, 2004: EU court orders Microsoft to comply with the March ruling, rejecting its request for a stay. The company's appeal of that ruling continues. Source: WSJ research

Philip Carnelley, an analyst at the technology-research firm Ovum Ltd., also said there is little incentive for computer makers to choose the version of Windows without the media player unless there is a difference in price. "What will the uptake be? I can't imagine it will be very much," Mr. Carnelley said.

But Dave Stewart, deputy general counsel of Seattle-based RealNetworks Inc., Microsoft's main rival in media-player software, said some personal-computer makers want more freedom to configure new systems with competing software and are likely to do so. More broadly, he said, the latest ruling rejected Microsoft's arguments -- used successfully in U.S. litigation -- that removing such software hurts consumers by preventing the operating system from working properly.

"It puts the lie to the notion that the technology can't be separated," Mr. Stewart said. Tom Reilly, a Massachusetts attorney general who opposed the Justice Department settlement with Microsoft, predicted the European order would eventually lead to computer makers offering U.S. consumers more choice of media players. "We had the right argument; we were just in the wrong continent," he said.

Shares of RealNetworks, which is pursuing a separate antitrust case against Microsoft, rose 26 cents, or 4%, to $6.72 at 4 p.m. composite trading on the Nasdaq Stock Market. Microsoft's shares slid 10 cents to $26.97 on the same exchange.

Linda Averett, a manager in Microsoft's Windows group, says that the company is testing a version of the operating system without 186 software files that were identified by the EU as associated with the media player. She said removal of those files won't hamper the basic operation of a PC, but it will add an inconvenience to computer users, who will have to install additional software to be able to play compact discs, MP3 music files and other media functions. It may also affect other software companies making products that work with Windows, she said.

Microsoft continues to invest in new areas -- such as antivirus programs and data-searching technologies -- that it could one day seek to add to Windows or other products. By 2006, the company is expected to deliver a version of Windows, code-named Longhorn, that integrates media-player functions even more deeply into the core operating system.

A final ruling in Europe that limits software bundling could hamper such plans. "That is something that doesn't have a direct revenue effect right now, but it may affect the way that Microsoft does business for a long time," said Nicholas Economides, a professor at New York University's Stern School of Business who testified in the U.S. antitrust case against Microsoft.

Horacio Gutierrez, Microsoft's top lawyer in Europe, said the ruling doesn't set very clear guidelines. But Microsoft would be required to remove media-player files from Longhorn if the order remains in force, he said. He praised some language in the ruling, however, including a finding that integrating technology features into an operating system isn't a monopolistic practice in all cases.

Microsoft has already paid a record $666 million fine in the antitrust case, which sprang from complaints by Sun Microsystems Inc. The computer maker alleged that Microsoft's own server software had an unfair advantage, because it withheld technical information that would make competing programs communicate effectively with Windows-based PCs.

Similar issues arose in the U.S. antitrust case. Under a settlement, Microsoft agreed to provide other companies information to help competing desktop software connect more easily with Microsoft server programs. That plan has been roundly criticized by competitors, particularly a provision that allows Microsoft to charge royalties for some information. Linux and other so-called "open-source" programs, which are often given away, are governed by rules that bar distributors from passing on obligations for paying royalties.

The European decision requires Microsoft to share information about communicating with Microsoft server and PC programs on a nondiscriminatory basis. But it also says Microsoft can demand payment for use of its intellectual property.

Mr. Vesterdorf's ruling is expected be followed in about 18 months by a second decision from a five-judge panel on the merits of the case. Microsoft's Mr. Smith said the company would prefer to settle the case. But his EU counterparts didn't sound as willing. "We are not negotiating," said Jonathan Todd, an EU spokesman.

Write to James Kanter at james.kanter@dowjones.com, Cassell Bryan-Low at cassell.bryan-low@wsj.com, Robert A. Guth at rob.guth@wsj.com and Don Clark at don.clark@wsj.com