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An AOL-Microsoft Goliath? Don't Bet on It

By Jay Greene There's bound to be a lot of hand-wringing this week, as techdom studies the landmark settlement that AOL Time Warner (AOL) and Microsoft (MSFT) struck May 29. The deal calls for Microsoft to pay AOL $750 million to settle claims that it illegally leveraged its Windows operating-system monopoly to crush Netscape Communications, which AOL bought in 1999. More important for the rest of the industry, AOL Time Warner agreed to work with Microsoft's digital-media technology group, and potentially distribute its music and movies using Microsoft's technology over the Web.

There are those in the industry who worry that AOL Time Warner, now firmly run by Time Warner execs, has ceded a key battleground in the technical war that the AOL crew fought so fiercely. They worry that the company has become a valuable ally in Microsoft's bid to dominate digital entertainment the way it today dominates the PC world.

WARY OF REDMOND. It won't happen. No question, the deal clearly gives Microsoft momentum now for its Windows Media technology, which music and movie creators use to prevent piracy as they make their content available digitally. And landing AOL Time Warner, even if it's only to consider the technology, is a coup for Gates & Co.

Here's the catch, however: Microsoft still needs to convince AOL Time Warner to use its technology. The way the agreement is written, AOL is allowed to do that, but not required. And even if AOL Time Warner ultimately opts to use Microsoft's software, there are still several other movie studios and record companies that need to be won over. None of them wants to be beholden to just one vendor of digital-media technology.

It's easy to see how Microsoft's rivals could be unnerved. Microsoft Chairman Bill Gates and AOL Time Warner Chairman Richard D. Parsons were downright chummy as they announced the news, a stark contrast to the frosty relations with Microsoft when Stephen M. Case ran AOL. "The agreement we've reached marks a new phase of relationship between Microsoft and AOL Time Warner," Gates said of the deal in conference call.

The possibility of the software giant working closely with a digital-content behemoth should be daunting to those who want a piece of the action. But fears that Microsoft has gained some tremendous advantage because of the deal are a bit breathless.

END OF THE BEGINNING. As big as AOL Time Warner is, it's just one company in the vast sea of digital-content providers. It's unlikely that Sony (SNE), Universal, or any other movie and/or music creator will opt for Microsoft's technology simply because AOL Time Warner has done so. Indeed, they may be more likely to seek out alternatives, if only to ensure there's a balance of power among digital technology providers.

And there is healthy competition -- in some cases from companies that are already ahead of Microsoft in key markets. Apple turned heads with the quick uptake of its iTunes Music Store, which lets customers buy digital version of songs for 99 cents each. The company has sold 3 million songs since the service launch April 29.

Then there is RealNetworks (RNWK), which has built a base of 1 million paying subscribers who can listen to every Major League Baseball game live, watch CNN reports or tune into ad-free radio programs, all over the Web. Those companies aren't going to cede the market to Microsoft. And indeed, they may well stand to get more business as content providers fret over Microsoft's growing strength in the market.

There's no question that the settlement gives Microsoft's digital-media efforts a big boost. But this deal isn't the end game. It's just the beginning. Greene covers Microsoft from the Seattle bureau of Business Week

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