Outlook: Security breaches threaten Microsoft monopoly

Vodafone/AT&T

By any standards, Microsoft has had a terrible week. In what has become a regular occurrence, the company has been forced to issue yet another critical update to repair a flaw in its Windows operating system. Left unaddressed, the flaw might have enabled hackers to breach security and gain access to company and personal computer systems across the world.

The latest patching exercise is only the most high profile in a long line of similar updates, which is forcing Microsoft to repair its operating system on a sometimes weekly basis. As if this were not bad enough, Microsoft yesterday announced that portions of its Windows 2000 and NT 4.0 code have been made available on the internet illegally.

All this may seem to belong more to the annual convention of geeks and nerds anonymous than the business pages, yet their significance is hard to overestimate. Only a tiny fraction of the source code has been revealed, but if Microsoft cannot protect its core intellectual property, then it lowers public trust in the security of its software, and may in the long run further undermine the supposed advantages of Microsoft over alternative, open source operating systems.

The global economy has become almost wholly dependent on computing and communications infrastructure, which in turn is highly exposed to Microsoft software. Every time Microsoft is forced to patch up its Windows operating system because another security flaw has been exposed, it further encourages companies to think about the alternatives. So far, Microsoft has been extraordinarily successful in defending its operating system monopoly both in the market place and the anti-trust courts. These latest incidents again raise the question of how long this can continue to be the case. Linux and other open source operating systems have already begun to mount a serious challenge to Microsoft in the server market. Even in desktop operating systems, where Microsoft has more than 90 per cent of the market, Microsoft's position is under growing bombardment.

The advantage of an open source system over a proprietary one is that it is perpetually subject to peer review, so that bugs are quickly identified and swatted. Companies and individuals can build their own security around the open access. The Microsoft code by contrast is a secret one, which is why it is sometimes referred to in the market place as "security by obscurity".

As a consequence it relies on Microsoft's own internal technical department to identify the flaws, which is necessarily slow and inexact. Updates are free, but for IT departments they are costly and time consuming to install. Their growing regularity is causing IT directors to question whether Microsoft is really worth the price. If hackers gain access to elements of the source code, it makes the situation potentially much worse, as they would then have the opportunity to find the flaws themselves, causing a mass break down in security.

The chances of that happening grow stronger by the month. Indeed Microsoft is being steadily hoisted by its own petard. Post September 11, there was growing concern in the US and overseas over the security implications of a closed system product. Microsoft responded with its Government Security Program, which released parts of its source code with tight security to a select group of government agencies and connected educational establishments. Some large corporations were also given access to chunks of the code. This may have helped reassure elite customers, but it has almost certainly increased the chances of the code leaking more generally into the public domain.

Microsoft is one of the world's greatest ever entrepreneurial achievements, and likely to be a lasting one at that. In the little more than 25 years it has been in existence, its products have become hardwired into virtually all aspects of the world economy. Such a core infrastructure isn't easily challenged or dismantled. Yet when a tipping point is reached, it tends to happen quite quickly. In growing numbers, corporations and government agencies are voting with their feet and quitting for less expensive and perhaps ultimately more trustworthy open source software. Microsoft will be with us for many years to come, but its glory years are already behind us.

Vodafone/AT&T

Vodafone is the only mobile phone company in the world with something approaching a global foot print and a global brand strategy to match. Yet there are two key geographic areas where the prize of achieving control of a market leading mobile phone network continues to elude. One is France, where Vodafone must play junior partner to Vivendi in SFR, the number two in the market. The other is potentially the biggest market of the lot, the United States. Here again, Vodafone has a substantial economic interest in the region through its 45 per cent holding of Verizon Wireless, but it doesn't have control (the majority stake is held by the separately quoted Verizon Communications), and is, therefore, unable to impose its own brand, systems and technology on the company. Hence Vodafone's interest in the auction for AT&T Wireless.

Trouble is that Verizon is the biggest and the best. AT&T Wireless is a struggling third in the hierarchy, with a clapped out network and a bombed out management to match. Verizon is a much more obviously desirable property than AT&T Wireless, despite the fact that it runs on a different technology to Vodafone's dominant GSM standard, but unfortunately it is not for sale. AT&T Wireless, on the other hand, can indeed be bought and recreated in Vodafone's image.

For regulatory reasons, Vodafone wouldn't be allowed to own both. The question facing the company's board; is it worth swapping Vodafone's minority holding in the biggest and the best but with no chance of integration into the whole for control of an also ran in need of substantial new investment? Add to that the possibility that sale of the Verizon stake would trigger potentially vast tax liabilities, and the judgement call becomes more difficult still. In the short term at least, any such swap would be hugely value destructive. Arun Sarin, Vodafone's newish chief executive, is stuck between a rock and a hard place.

What we do know is that Vodafone had definitely lodged a bid by last night's deadline for the AT&T auction, and at $35bn, a pretty full one it is too. However, this doesn't necessarily tell us anything about Mr Sarin's ultimate intentions. In order to win a seat at the table, he has to appear serious. If he so much as blinks, the game's up. It could be his real purpose is merely to examine the books and forcing the main rival in the auction, Cingular, a partnership of Bell South and SBC Communications, to overpay.

Both publicly and privately, Mr Sarin is inscrutable. He appears in deadly ernest, but can be really be serious? His shareholders are almost universally sceptical as to the merits of buying AT&T Wireless, and the board too is worried by the consequences. Since Vodafone's interest in the auction became public, its share price has fallen by nearly 10 per cent. If it wins, the shares will undoubtedly fall further still.

Mr Sarin's task would be to persuade the City that the opportunity value of spreading the Vodafone brand to the United States will, in the long term, be worth more than the short-run cost of bailing out of Verizon and revitalising AT&T Wireless. It's a tall order.

There are undoubtedly merits in Vodafone'sglobal brand strategy, but the benefit is, in the main, intangible and hard to quantify. Few customers outside a jet-setting business elite are likely to sign up with Vodafone simply because its mobile phone handsets will work in Japan and the US as well as Europe. In any case, that kind of inter-operability will soon be common to all networks. As for tariff structures, they are always likely to be determined locally.

There may be some cost benefits in global advertising and procurement, while the advantages of scale ought to allow the global brand to stay ahead of the game in the provision of unique applications, which in turn should help drive subscriber retention and growth. But it's hard to see how any of these synergies might outweigh the cost. If I were in Cingular's position, I'd call Mr Sarin's bluff.