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AOL, MSFT: Tense times?
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June 18, 2001: 3:31 p.m. ET
With distribution deal talks called off, analysts see a rivalry intensifying
By Staff Writer Richard Richtmyer
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NEW YORK (CNNfn) - Even though Microsoft and America Online have broken off negotiations regarding including AOL's software with the next version of the Windows operating system, industry observers on Monday said there will be very little immediate impact on either company's bottom line.
At the same time, some said that the long-running feud between the two companies could heat up in the coming months, and AOL may try to block Microsoft's efforts to integrate much of the online-service experience into its Windows XP operating system, due to be released in October.
On Saturday, each side walked away from the bargaining table, ending 10 week of strained negotiations between the two rival firms.
Microsoft – which included AOL's Internet software with its Windows operating system software from 1996 until their distribution agreement expired last January – said the two sides reached an impasse on multiple issues, including whether AOL's "Instant Messenger" service would be interoperable with Microsoft's equivalent technology and which Web browser would be used.
For its part, AOL, which currently claims more than 30 million subscribers, said the key sticking point was whether it would include Microsoft's streaming Internet media software, called "Windows Media Player," as part of its service. AOL currently has an exclusive agreement with RealNetworks, which currently is the leading provider of such technology.
Microsoft has poured substantial resources into developing its Media Player, which is a standard part of its Windows operating systems and has been aggressively pushing Web developers to adopt its streaming media technology over that of RealNetworks.
"These talks ultimately became about music and broke down over an issue that isn't about AOL and Microsoft but Microsoft's determination to control digital music on the Internet," said AOL spokesman John Buckley.
Buckley said Microsoft wanted AOL to abandon RealNetworks and not bundle Real's player in AOL software or use a version of the RealPlayer that wouldn't work as well as Microsoft's Media Player.
Microsoft spokesman Vivek Varma claimed the company never asked that its Media Player be used exclusively in AOL's software, and that AOL is "mischaracterizing the talks and trying to raise antitrust issues."
AOL was one of the most vocal in speaking out against Microsoft during its landmark antitrust trial. After ruling that Microsoft has violated U.S. antitrust laws abused its monopoly power in computer operating systems, a federal judge in June 2000 ordered the company split into two smaller companies to prevent it from violating state and federal antitrust laws in the future. The U.S. Court of Appeals is currently reviewing that order and is expected to hand down its decision sometime this spring or summer.
Windows XP is tied closely to Microsoft's ".NET" strategy, under which it is hoping to expand its Windows franchise into the age of the Internet. It has been designed with more emphasis on Internet and multimedia features, which have been integrated throughout the various elements of the operating system.
Rivalry, cooperation could shape the industry
But some analysts on Monday noted that AOL Time Warner, which also is the parent company of CNNfn, may try to thwart Microsoft's plans.
"As with previous versions of Windows, we believe that much of Microsoft's strategy with XP is to render 3rd-party software and services such as AOL) irrelevant," Merrill Lynch analyst Henry Blodget told his clients.
"We contend AOL Time Warner is powerful enough that it won't go gently into the night (unlike Novell, WordPerfect, Lotus, Netscape, et al). We do believe, however, that developments between the two companies over the next year or two will have significant bearing on the long-term direction of the industry," Blodget added.
AOL said it is not concerned about losing the distribution deal with Microsoft because it is assured distribution through agreements it has with all the top-tier PC vendors.
Several industry analysts on Monday supported that position.
"I think it's totally insignificant to AOL," Arthur Newman, an analyst at ABN Amro, told CNNfn.com. "At this point, Microsoft has more to gain from this discussion than AOL does."
"I don't think they really need Windows XP distribution," Newman added. "They already have deals with the four largest PC manufacturers, and that will give them the means of getting onto the desktop anyway, without having to do a deal with Microsoft."
Fred Moran, head of Internet research at Jeffries & Co., agreed that there will be no measurable financial impact of the breakdown in talks between the two companies.
"I think the XP issue is a rather small event in the big-picture rivalry between AOL and Microsoft," Moran said.
"There are a lot more heated issues, such as Instant Messenger, that are still looming," he added. "Competition between these two players will remain quite intense for some time, and it will remain hard for them to cooperate because of their adversarial history. I think AOL will remain as vocal as ever on the issue of fair and open access to competition on the Internet."
John Corcoran, an analyst at CIBC World Markets, said the only company that appears to have gained an advantage as a results of the breakdown in talks is RealNetworks, which is expected to remain the exclusive streaming media technology provider to AOL's 30 million subscribers.
Since AOL does not generate very much of its new subscriber growth from referrals through Microsoft's operating system, Corcoran characterized its distribution with Windows XP as a "nice to have" but not "'need to have" category for AOL.
At the same time, because each company is such a large player in the Internet and each plays a large part in the development of the Internet market in general, Corcoran said he expects the two companies will ultimately will have to come back and renegotiate other portions of their relationship.
"I don't think they're going to not talk to each other forever," Corcoran said. "What issues will be most important to them at that time, I don't know. But I do think that they will continue to have this tenuous balance of cooperating and competition in a variety of their businesses." 
-- CNNfn's Steve Young contributed to this report
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