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David is a company that runs a successful website hosting business.

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Question;David vs.;Michael;Background;David is a company that runs a successful website;hosting business. It is one of the largest and most successful website hosting;businesses in the country. David?s key differentiator is that it has a very;well laid out website that allows its customers to upload their websites, edit;them and see traffic statistics. David?s own website is the so?called ?front;end? software that users see and is widely viewed as being one of the best in;the business. The ?back end? is the actual servers that host the customer;websites.;David was started in 1999 and each year since it;started has added about 30% more traffic to its web servers. David?s revenues;have not grown as quickly because the price it can get for hosting websites;each year has declined. So its revenues have grown at a more moderate 5?10%;rate with its profits showing year to year variation just depending on various;investments and costs. I have shown David?s traffic, revenues and profits in;the following table and graphs.;Traffic (mm pg.);2005;2006;2007;2008;2009;2010;2011;2012;2013;1,024;1,377;1,859;2,441;3,174;4,244;5,689;7,503;9,921;Revenues ($000);10,242;11,999;14,405;17,158;20,643;24,227;28,682;34,670;41,140;Profits ($000);1,599;5,780;10,603;9,763;18,495;514;16,907;8,072;12,940;David started out purchasing web servers ?;specialized computers that are customized to serve web pages ? but in 2007;decided to develop its own web servers. The servers it had been purchasing were;based on standard Dell computers but included some specialized web?serving;hardware components that had to be installed in slots in the Dells. Thus, these;servers were relatively expensive ? around $6500 each and at the time David had;over 100 servers. A single server was capable of serving around 10 million web;pages each year. What it hoped to gain from developing its own servers was;reduced costs. It wanted to eliminate the specialized hardware components and;increase the capacity of the backend servers. The plan was to replace the;hardware with new software it would develop based primarily on some other;software that it would license.;In 2008;David contracted with Michael to provide it with the software it would require;to develop its web servers. At the time, Michael was well known in the industry;as providing the best core web server software. Its software was used by around;30 large companies to manage their websites. David?s plan was to incorporate;Michael?s software onto the Dell servers along with a bit more software that it;would develop to make the whole package work smoothly and easily for customers.;The contract between David and Michael called for;annual payments of $300,000 per year. For this money, David would get rights to;use Michael?s software in an unlimited number of servers and get support from;Michael for any bug fixes. In addition, David would get any software updates or;upgrades that Michael might release over the term of the contract. The contract;specified that the term was for seven years (out through 2015) but that, even;after the end of the contract, David would have the rights to continue to use;the software in its products but it would no longer be entitled to any support;upgrades or updates.;In late 2009 David;completed development of its new web servers and replaced all 120 servers it;had at the time with 90 new servers for a total cost of $1.8 million. The old;servers were simply taken off line and stacked in a closet somewhere. No one at;David was able to testify what had happened to the old servers.;By late 2009, David was very confident that it;has the best web servers in the world and made statements to that effect. The;servers were fast and efficient. So David decided to add a line of business by;selling its web servers to other companies. It hired a couple of sales people;and started trying making sales calls. By 2010 David had sold 25 servers to;other companies and was continuing to pursue some other leads. By 2011, it;became apparent that other companies were not very interested in purchasing web;servers from David. While David made a few more sales, the other companies were;telling David?s sales people that 1) they weren?t comfortable buying from a;competitor, 2) the price David was asking was too high, and 3) they were more;likely to purchase webhosting services from Amazon than install their own;equipment. Thus, by the end of 2011, David fired its sales force and continued;to focus on web hosting as its business.;In 2010, Michael;received a buyout offer from MegaCorp for $30 million. MegaCorp was interested;in Michael?s technology for use in a product that wasn?t web servers but used;much of the same technology. Some time after the acquisition was concluded;MegaCorp did two things: 1) it sent notices terminating the agreements of all;the existing customers, and 2) it open?sourced almost all of Michael?s code.;With the lack of any ongoing support for;Michael?s code, many of Michael?s old customers decided to replace their;Michael?s software. The single biggest beneficiary of this was Michael?s;biggest competitor;? Eugene, Inc. Eugene was based in Germany and;had been selling software that functioned very similarly to Michael?s. Eugene;got a flood of calls from former Michael?s customers to get quotes on how much;it would cost to switch to Eugene?s code. The price ranged a bit, but the;biggest users were receiving quotes of $650,000 up front and then $80,000 per year;for maintenance and upgrades. There would be some transition costs ? the;companies would have to spend between $100,000 and $150,000 to revise their own;software in addition to paying Eugene. Some of the companies decided to go a;different direction and implemented the open?source version of Michael?s code.;This turned out to cost around $500,000 to implement. The advantage to this was;that the companies got full source code and;could customize it;to fit their needs. The disadvantage was that there was no support for any bug;fixes or future upgrades.;David received the letter terminating its license;with MegaCorp/David in July of 2011. In August of 2011, David sued MegaCorp;claiming breach of contract. Because of the suit, MegaCorp decided to continue;to support to David ? responding to its requests for bug fixes and giving it;some newly? developed software. The CEO of David continued to make public;statements to the effect that his web servers were better than anything else;out there ? including Amazon?s ? and David continued to run all of its growing;business on the web servers that included the Michael?s software.;The Complaint;In its complaint, David alleged that it had been;harmed in three ways;Insufficient;support. It claimed that the quality of support it received after the MegaCorp;acquisition of Michael was not as good as the support had been previously.;Furthermore, there were bugs in Michael?s software that David had repeatedly;asked Michael to fix that had never been fixed. The specific bugs went by the;names ACG, WNP and Speed. The ACG bug was in a feature that was rarely used;and, if turned off, allowed the software to run just fine. The WNP problem was;very rare and unpredictable. Michael?s engineers could never replicate it on;their own hardware, it only seemed to occur on David?s servers. In addition;David claimed that it had always expected to get 50% more speed from its;servers than it ever did.;Inability to sell servers. David claimed that, due to the purchase of;Michael it was unable to sell any more webservers because it could not;guarantee support for any servers it did sell.;Replacement cost.;It claimed that, due to the lack of support from MegaCorp/Michael it was going;to have to replace all of its servers. At the present time, MegaCorp had 500;servers and it viewed the only viable server replacement as buying new servers;for $7,500 each from BigBox, Inc. that included the old?style specialized;hardware components.;Dr. Vino?s Opinion;Dr. Vino offered four calculations. In his;deposition, Dr. Vino stated that he performed these calculations because they;were calculations that the CEO of David had asked him to perform.;1);The total;value of the hardware that had been replaced by David when it installed its new;servers incorporating the Michael software was $905 thousand broken out as;a. $450 thousand in computers;b. $225 thousand in specialized web server hardware;c. $230 thousand in maintenance and support for the;servers between 2004 and 2009.;2) The total cost to replace the existing 500;servers with BigBox servers amounted to $12.1 million broken out as;a. $6.5 million in computers;b. $1.0 million in specialized web server hardware;c. $4.6 million in support over the next five years;3) Loss in business value for David of $15 million.;Dr. Vino calculated this $15 million on the basis that, in 2009, CityCorp had;purchased a company for $20 million named Victor that competed with David both;for the provision of web?hosting services and sales of web?host servers. Dr.;Vino deducted the;tangible assets of Victor from the $20 million to arrive at an estimated value;of the goodwill and core technology of Victor of $15 million. He then opined;that, since Victor and David?s sales of web?host servers were similar, David?s;goodwill and core technology must also be worth $15 million and further, that;this was the value that had been destroyed by the breaches and termination of;the contract.;4) Total cost to fix the alleged problems with;Michael?s software of $165,000 broken out as;a. ACG: $25,000;b. WNP: $32,000;c. Speed: $108,000;Things to Consider;This is a breach of contract case. What are the;form of damages available for breach of contract?;Assume that all of the allegations are true ? how;has David been damaged?;o Additional costs?;o Benefits it didn?t receive?;o Lost Sales? (Both of servers and web?hosting;services).;What options are available to David to;replace its web servers without Michael?s software? The contract was a seven;year contract signed in 2008. It is now 2014 and the contract;terminates in 2015.;How does the fact that MegaCorp continued;to support the Michael?s code affect damages? What is the causal link between;each of Dr. Vino?s calculations and any harm suffered by;David?s.;What effect does ?partial performance? of the;contract have on any calculations of damages?;Assignment;Write a 2 page;report replying to Dr. Vino. Your opinion should address flaws (if any) with;each of his proposed calculations. While you don?t need to address each of the;?Things to Consider? from above, they will be helpful in your thinking. You;should also propose a damages calculation ? the number that you believe is most;appropriate assuming liability for breach of contract by MegaCorp / Michael?s.;Follow the discussion forum. Discussing this case;with me and your fellow students will help a lot in thinking about the;response.

 

Paper#38396 | Written in 18-Jul-2015

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