Air Force's upgrade decision could resonate industrywide

The Air Force's threat to hold Desktop IV contractors in default if they do not supply Microsoft Corp.'s Windows 95 operating system and Office 95 free to users could have broad ramifications for buyers and sellers of federal information technology.

Prime contractors Government Technology Services Inc. (GTSI) and Zenith Data Systems (ZDS) are caught in a financial squeeze—trapped between Microsoft, which maintains the software is a new product and not an upgrade, and the government, which has ruled the software is an upgrade under the terms of the contract. Both primes are scrambling to resolve questions about who is responsible for providing the software.

Last August, as Microsoft was preparing to release Windows 95 and Office 95, the Air Force informed its Desktop IV contractors that it believed it was entitled to have the software provided to users at no charge [FCW, Sept. 22, 1995].

Although the contractors disagreed, citing the manufacturer's assertion that Windows 95 and Office 95 were new products, the Air Force directed the contractors in a letter dated Nov. 27, 1995, to distribute the software within 45 days. On Jan. 5, 1996, the Air Force reiterated its demand and cited contract penalties.

Pat Gallagher, ZDS' sales vice president, said furnishing the software free would cost the company "multiple millions of dollars."

ZDS sued its application software supplier, Electronic Data Systems Corp., which has been unwilling to supply the software at no charge.

Filed in federal court last week, the suit aims to force EDS to provide the Office 95 software at no cost.

Fred Geldon, counsel for EDS' Government Services Group, said his company's agreement with ZDS explicitly excludes Office 95 from the Desktop IV contract. ZDS "went to court to recover damages they might suffer," Geldon said.

GTSI declined to comment on the financial impact it would experience from furnishing the free software to its Desktop IV purchasers.

Industry analysts and other federal computer vendors estimated it would also cost GTSI millions of dollars to ship the free software.

Exactly how both companies plan to distribute the software has not yet been resolved. An internal Air Force message obtained by FCW said, "GTSI will distribute [the software]...on CD-ROM.... A post card will be included with the software for those who cannot upgrade with the CD-ROM to receive [it]...on floppy disks."

ZDS' Gallagher said, "We have a series of proposals in to the Air Force on how to distribute the software."

The Air Force's Standard Systems Group (SSG) has given the vendors very clear direction, Gallagher said. ZDS has sold 205,000 PCs, of which 122,000 were purchased with office automation software, which entitles all users to a free Windows 95 upgrade. The 122,000 office automation buyers, according to Gallagher, will receive a free version of Office 95, along with 29,000 buyers who purchased the office automation package only.

The internal Air Force message shows that GTSI will have to ship upgrades only to "registered" Desktop IV purchasers—that is, buyers who sent back registration cards to the company after receiving their PCs. The message added that any orders accepted by GTSI between Dec. 19 and Feb. 1 would be considered registered.

GTSI refused to provide any details on how many Desktop IV registrations it has received or how many free software packages it plans to ship. SSG also declined to provide details. But sources close to GTSI estimated that 365,000 systems have been sold on the Desktop IV contract—some 160,000 by GTSI. If GTSI's orders follow the same pattern as those of ZDS, roughly half—or 80,000—of those orders for systems came with the office automation package.

Bob Guerra, vice president of Sysorex Information Systems Inc., estimated that "about one-third of all buyers send in a registration card."

If that formula holds true for this market, GTSI will end up shipping about 53,000 free copies of Windows 95 and 26,000 free copies of Office 95 at a substantial collective cost, even if heavily discounted by Microsoft. However, whatever the cost to GTSI, it will be far less that ZDS' bill.

ZDS will upgrade 100 percent of its users to Windows 95, meaning a $15 package price (half the lowest schedule price of $29.95 for Windows 95) would hit ZDS with an extra $3,075,000 charge. Knowledgeable industry sources pegged the cost to dealers of Office 95 at $90 a package, meaning it could cost ZDS $14 million to upgrade its 122,000 Desktop IV office automation buyers.

GTSI could get off much lighter, due to its registration requirement. At $15 a package, GTSI would have to absorb a $795,000 cost to distribute 53,000 free copies of the operating system and $2.3 million to ship 26,000 packages of the office automation software. This would put total costs for the free Desktop IV upgrades to GTSI at slightly more than $3 million.

Anything much higher would cause concerns in the financial community about the publicly traded GTSI.

"Five million dollars is a significant hit, but it is not going to kill GTSI," said Bill Loomis, an equity analyst for Ferris Baker Watts Inc. "If they are going to have to do it, they might as well put it behind them now," he said.

Loomis added that the Air Force's decision to push for free Windows 95 upgrades could pose serious problems for other resellers in the federal market.

"There are a lot of big [contracts] out there," said Cromwell Coulson, a general partner at C.C. Partners Ltd. "If Microsoft takes a hard line on this, and every other site license is going to get this [upgrade] too, that could affect all of the resellers."

GTSI and ZDS could refuse to ship the products and be found in default, but that move would surely sink their bids on Desktop V, Guerra said. "If you are found noncompliant with Desktop IV, how do you have a chance to win Desktop V?"

This quandary is important, given that more agencies are emphasizing past performance when awarding new contracts. "One of the downsides of past performance is that it can be used as a coercive technique to force vendors to deliver things that weren't in the contract," said Bob Dornan, senior vice president of Federal Sources Inc.

GTSI's predicament has certainly gotten the attention of the reseller community. "It is going to alert all of the bidders on upcoming contracts not to get caught in this bind," Dornan said. That could mean writing contracts to exclude upgrades or writing contracts that pass responsibility along to software suppliers. "The pass-through requirement has to be absolute and well-covered," he said.

Regardless of which means vendors use to protect themselves, the word "upgrade" needs to be more clearly defined. "A better definition of what is an upgrade is essential," Dornan said.