Microsoft Sees Adobe Trouble Brewing

The companies will likely battle over inclusion in Microsoft's next Office suite.
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Updated from 2:33 p.m. EDT

Microsoft

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expects

Adobe Systems

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to file a complaint with European regulators over antitrust concerns.

Over the last week, the two software companies reached an impasse in talks concerning Microsoft's plans to incorporate Adobe's portable document format (PDF) and its own related technology in upcoming versions of its software, a Microsoft representative said. In response to the breakdown in talks, Adobe has indicated to Microsoft that it plans to take the issue to the European Union's antitrust regulators.

"We're hoping they don't, but that is what we are expecting," said the Microsoft representative, who asked not to be named.

The

Wall Street Journal

reported Friday that the breakdown in talks between the two companies would likely lead to Adobe filing a lawsuit against Microsoft in Europe. But the Microsoft representative stressed that what they expected was a regulatory complaint, not a lawsuit.

Microsoft has faced antitrust scrutiny by European regulators before. The company is still embroiled in a dispute with the EU concerning software used to play digital media files. Following complaints by

RealNetworks

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, whose RealPlayer software and technology competes with Windows Media, European regulators forced Microsoft to offer two different versions of Windows, one with and one without its Windows Media Player. They also have assessed a nearly 500 million euro fine on the company. Microsoft has appealed the ruling.

The prospective legal dispute between Adobe and Microsoft and concerns the software behemoth's move to incorporate Adobe's portable document format (PDF) technology into the next iteration of Microsoft's Office suite. Negotiations between the two companies concerning Microsoft's use of PDF broke down earlier this week, Brad Smith, Microsoft's general counsel told the

Journal

.

The core point of contention between the two companies is whether Microsoft will charge Office customers an extra fee for the PDF feature, the

Journal

reported. Adobe, which wants Microsoft to charge for the feature, has insisted that Microsoft separate the feature from Office. Microsoft has agreed to remove the feature but does not want to charge for it, company spokeswoman Stacy Drake said in a statement.

"We have taken a number of significant steps to accommodate Adobe, and offered many proposals in an effort to avoid a dispute, but we have now reached a point where we feel what they are asking for is not in the best interest of our customers," Drake said. "Adobe is asking us to charge our customers a price for using what everyone else in the world can use for free."

Adobe has raised concerns about Microsoft's use of the PDF format, an Adobe representative told the

Journal

. But the representative declined to say whether the company is planning an antitrust suit against its bigger rival.

Representatives from Adobe didn't return calls seeking comment.

Adobe invented PDF, which companies typically use to create secure versions of documents. The format has become one of the de facto standards on the Web.

Adobe's Acrobat products are used to read or write PDF documents. In a move to make the standard more ubiquitous, Adobe has given other companies the technical specifications of the format for free and allowed them to build their own applications using PDF.

However, Microsoft is under regulatory scrutiny in both the U.S. and Europe for abusing its monopoly on PC operating systems. The company has been frequently accused of trying to extend that monopoly into new markets by incorporating into its software features that were previously offered as separate programs. By including PDF features into Office programs such as Word, Microsoft potentially could undermine the market for Adobe's Acrobat.

In preview versions of Office 2007, Microsoft has included a feature that allows users to save files in PDF format or in the company's own competing XML Paper Specification (XPS) format. To accommodate Adobe's concerns, Microsoft plans to remove the ability to save in either format from the final version of the new Office suite, which the company expects to release early next year, Drake said.

In addition to including the XPS technology in Office, Microsoft plans to build it into Windows Vista, its upcoming update to its flagship operating system. But to further address Adobe's complaints, Microsoft plans to allow computer makers to remove the ability to read or write XPS files from Windows Vista itself, the Microsoft representative said.

Beyond its attempts to address Adobe's concerns about the PDF and XPS technologies, Microsoft also offered to ship Adobe's Flash and Shockwave software with every copy of Windows Vista. Flash and Shockwave are used for multimedia presentations and, like the PDF format, are widely used on the Web.

Microsoft's decision to remove the PDF creation feature from Office is a slight positive for Adobe, Piper Jaffray analyst Gene Munster said in a research note on Friday. Although the Acrobat family of software accounts for about 20% of Adobe's revenue, it's only the entry-level Acrobat PDF creation software that is likely to be affected by Office's "save as PDF" feature, Munster said.

That entry-level product accounts for just 1% to 2% of Adobe's revenue, said Munster, whose firm has done non-investment banking business for Adobe in the last year.

Investors in both companies appeared to take the potential complaint in stride on Friday. Shares of Adobe closed regular trading on Friday up 28 cents, or about 1%, to $29. Microsoft's stock closed off 6 cents, or less than 1%, to $22.76.