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Finally, Gates and Real Make Nice

By Jay Greene The tech industry has a way of turning friends into enemies. And sometimes those enemies become friendly again. That seems particularly true when it comes to Microsoft (MSFT). A year and a half ago, Microsoft CEO Steven Ballmer made up with long-time foe Scott McNealy, CEO of Sun Microsystems (SUN), settling a bitter lawsuit between the two companies. Long before they were rivals, though, Ballmer and McNealy were high-school acquaintances in Michigan.

A new fence-mending came Oct. 11, when Microsoft Chairman Bill Gates clasped hands with RealNetworks (RNWK) CEO Rob Glaser. The two outfits settled a lawsuit filed by Real in December, 2003, which accused the software giant of illegally leveraging its Windows monopoly to win customers in the digital-music business.

STORMY SAGA. Microsoft will pay Real $460 million to settle the antitrust claims, and another $301 million in cash and services to promote and distribute Rhapsody, Real's online music subscription service.

"We're ending one chapter and opening a new chapter in our relationship with Microsoft," says Real CEO Rob Glaser. The previous chapter wasn't a pretty one.

Seven years ago, Glaser testified before Congress that Microsoft's Windows disabled Real's digital-media technology, accusing Microsoft of using its clout to prevent competition. In addition to that lawsuit, Real also provided evidence to European regulators investigating Microsoft. That ended with the EU fining the company $612 million, in part for abusing its dominance to thwart Real.

Long before the enmity between Gates and Glaser, though, there was a friendship. It started 22 years ago, when Microsoft hired Glaser and he rose to the highest levels at Redmond. He was close enough to Gates that he even attended the boss's bachelor party in 1993. "We were good friends then," Gates said of their time together at Microsoft.

FRONT AND CENTER. The new agreement is much more than a personal reunion, though. In fact, it's a crucial deal for Rhapsody, which is now the leading online subscription music service, but faces tough competition from Napster (NAPS) and Yahoo! (YHOO). Though critically acclaimed and a market leader, Rhapsody has just 1 million subscribers. While Real recently cut a deal to put Rhapsody in front of Web-access giant Comcast's (CMCSA) customers, it still needs more visibility to develop into a business with long-term viability.

This agreement gives Real just that. Microsoft's agreed to broadly market Rhapsody for 18 months in key spots on its widely used MSN service, starting early next year. When users go to MSN Search and type a music artist's name -- the Rolling Stones, for example -- Rhapsody's service will pop up among the results, giving users the option of hearing a song from Mick and the boys.

At MSN Music, Rhapsody's service will be featured prominently. And users of MSN Messenger, Microsoft's instant-messaging service, will be able to let buddies hear the song they're listening to over Rhapsody.

REDMOND'S COST. For Microsoft, the deal was more about resolving long-standing litigation than achieving much in the way of digital-media advantage (see BW Online, 7/15/05, "Microsoft's Lengthy Legal Ledger"). At best, Microsoft has strengthened a company that shares its rivalry with Apple Computer (AAPL), whose wildly popular iPod players and iTunes song download service have given it a huge lead in the nascent digital music market.

Apple rebuffed Real's efforts to work together a year ago, and CEO Steve Jobs has consistently belittled the subscription music business (iTunes users pay by the song or album). Now, Microsoft has lent a huge marketing and distribution hand to the leader of that business.

In fact, the agreement appears to have come at some cost for Microsoft. It had been considering launching its own subscription service, but about two weeks ago, called off talks with a handful of music labels to license music for subscription customers.

NO OBSTACLE TO APPLE. The pending deal with Real may have led to that decision, though Brad Smith, Microsoft's general counsel, says the two moves weren't so closely linked. "It would be going too far to draw a direct line between the two," Smith says.

And while Microsoft hopes the Real partnership will help it better compete against Apple, it's hardly enough to matter. "This is a big deal for Real. It's a medium deal for Microsoft," says Jupiter Research analyst David Card, adding: "It's hardly enough to dent Apple's momentum." Microsoft and Real may have buried the hatchet, but it will take more than this deal to bury Apple.

Greene is BusinessWeek's Seattle bureau chief

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