http://www.nytimes.com/2001/06/18/technology/18SOFT.html?pagewanted=print
THE NEW YORK TIMES

June 18, 2001

AOL-Microsoft Talks Ended by a Growing Rivalry

By JOHN MARKOFF

The collapse of talks between Microsoft and AOL Time Warner this weekend was
rooted in
 Microsoft's strategy of making its new operating system the tool to provide
a wide range of
tightly integrated services directly to computer users, an area AOL has
dominated for years.

The dispute, over how their software would be combined, shows how rivalry in
the computer
industry has shifted from individual pieces of software, like Web browsers,
to control over whole
systems that govern how consumers use computers.

The breakdown in the companies' alliance complicates Microsoft's future in
two ways: Just as
Microsoft awaits an appeals court decision about breaking the company into
two parts, the
breakdown raises the prospect of new antitrust challenges concerning
Microsoft's new operating
system, Windows XP. And it creates a risk that opposition from AOL and its
30 million users will
hinder the introduction of Windows XP this fall.

In Windows XP, Microsoft is trying to closely link its programs to a range
of consumer activities,
including financial services, shopping and entertainment, via the Internet.
Its new, more
encompassing strategy gives AOL's latest version, which already performs
most of the same
tasks in an integrated fashion, its most direct competition yet.

For that reason, the collision may have been inevitable, according to
industry executives. With its
new ".Net" Internet strategy, Microsoft is increasingly moving into markets
that are crucial to
AOL. The consequence, industry analysts warned, may be the fracturing of the
computer industry
at a time when it can least afford it.

"This is an industry that is already in decline, and there is a chance that
it could be sent reeling into
a depression," said David Readerman, a managing partner at Thomas Weisel &
Partners in San
Francisco. "Is this just about C.E.O. egos? It seems the greater good, not
only for the industry
but for Microsoft, would be broad consumer enthusiasm for Windows XP."

Annual sales in the United States personal computer industry are projected
to decline for the first
time in memory, he said, and the Windows XP operating system, set to go on
sale in October,
has been one of the few bright spots that might lead consumers to upgrade
their computers.

Until now, Microsoft has presented computer users with the parts that
performed critical
computer tasks: the dominant Windows operating system, on which programs -
including AOL
- run; MSN, the network that connects users to the Internet; the Internet
Explorer browser,
which enables them to reach sites on the Web; and the Windows media player,
which permits
them to use audio and video.

But AOL has presented users with many of these same services as a package,
with far fewer
installation problems, in an environment that has attracted 30 million
users.

Now Microsoft is developing a new system called Hailstorm that will link a
wide range of
services, from financial to entertainment, in a way that critics assert will
leave no room for
competitors such as AOL.

Still, squabbles over the control of standards have long been a hallmark of
high-technology
industries, and the failure of the talks between Microsoft and AOL was
viewed as part of that
tradition.

"I'm surprised that the talks got this far," said Richard A. Shaffer,
founder of Technologic
Partners, a computer industry publishing and conference firm. "Having
several instant messaging
and digital media player standards accomplishes nothing for the consumer.
The problem is that
everyone wants to be the standard."

Over the weekend, the companies disagreed about why the talks had foundered.
AOL officials
said they thought all of the issues had been resolved with the exception of
the role of
RealNetworks' RealPlayer, a competitor to Microsoft's Windows Media Player.

Microsoft executives angrily disputed this, saying there were still a range
of unsolved issues on the
table when Jim Allchin, the head of Microsoft's operating system business,
and Ray Oglethorpe,
president of AOL's online unit, agreed to end the talks in a phone call on
Saturday.

Will Poole, vice president of Microsoft's digital media division and one of
the company's
negotiators, said that AOL threatened to sue Microsoft on antitrust grounds
in the absence of an
agreement. "In the end, AOL asked much, offered little and told us they
wanted to sue us over
XP," he said. "AOL didn't propose a win-win deal. They proposed an
I-win-now-you-lose-later
deal."

Accounts of how the talks progressed and then broke down suggest that, at
the least, Microsoft
has become vulnerable to accusations from AOL and other competitors that its
behavior has
changed little since last year's bitter antitrust trial. That trial
concentrated on Microsoft's decision
to bundle its Internet Explorer Web browser with its Windows operating
system, which already
dominates the market. A federal court decided that this action amounted to
an attempt to extend
market dominance in ways that harmed Netscape, the rival browser, and
recommended
Microsoft's breakup.

Several executives of rival companies say that Microsoft was repeating the
pattern by trying to
exclude RealPlayer from Windows XP, an accusation that Microsoft strongly
challenges. But
then, AOL Time Warner has been accused of being a multimedia bully itself.

As AOL officials described it over the weekend, the talks came close to a
successful conclusion
on Friday. AOL negotiators thought they were within reach of a deal in which
they would agree
not to sue Microsoft, and Microsoft would agree to include AOL's software in
Windows XP.

During the week, as the negotiations proceeded, AOL executives said that
Microsoft began
raising objections to adding RealPlayer to the AOL software that would be
included as part of
Windows XP. RealNetworks, which is negotiating a closer alliance with AOL
Time Warner,
which owns AOL, is ahead of Microsoft in striking agreements with record
companies to put
their music online.

AOL officials said they thought they had solved several of the legal issues
Microsoft had raised.
But later in the week, the AOL officials said, they heard another Microsoft
objection: the
RealPlayer software that AOL planned to provide would not run correctly with
Windows XP.

In several proposals last week, AOL executives said, Microsoft asked that
the company provide
the 5.0 version of AOL software, which does not include RealPlayer, rather
than the current 6.0
version.

Microsoft executives disputed the AOL account and said they merely tried to
persuade AOL to
drop its exclusive relationship with RealNetworks and give consumers a
choice of digital media
players.

The companies are also at odds over making their instant messaging systems
compatible.

Several analysts said that the breakup of the talks showed AOL's growing
confidence in
competing with Microsoft's MSN Internet service. With more than 5 million
customers, MSN is a
distant second to AOL.

Even with a deal, the AOL program might have been buried two mouse clicks
deeper than it is
now, and therefore be more difficult for Windows XP users to find.

Microsoft might allow hardware manufacturers to include an AOL icon in a
"start" menu that will
pop up from the lower left-hand corner of the screen in Windows XP.

AOL executives said they no longer needed Microsoft to provide it with
visibility, because they
advertise heavily, distribute their software widely on compact discs and
have computer makers
load their software on new machines.

But AOL executives are widely reported to have intensely debated the
seriousness of the threat
of Windows XP and Microsoft's new Hailstorm Internet strategy. Some
Hailstorm features are
viewed by some industry experts and rival executives as a way to lock
customers into Microsoft's
products and services.

Earlier this year, AOL planned to sell an AOL personal computer that would
be based on the
rival Linux operating system. Several people familiar with the program said
it was scaled back
after AOL's chief executive, Robert Pittman, decided not to confront
Microsoft so directly.

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