How Tci's Malone Played Gates Off Against Mc Nealy

Microsoft and Sun Microsystems jockeyed hard to get their software into the guts of Amercia's cable-TV hookup

For the past nine months, cable moguls and technology barons have been engaged in an intricate mating dance. Each has something the other needs. The cable guys have a wire into nearly 70 million American homes. The computing gurus have the necessary technological knowhow and plenty of cash as well. The trick, as the players see it, is to stake out a position that will give each of them the most influence and the best strategic position in the coming world of digital convergence.

For a few precious hours on Jan. 9, one of those key players, Chairman Scott G. McNealy of Sun Microsystems Inc., thought that he had outmaneuvered his nemesis, Chairman William H. Gates III of Microsoft Corp. McNealy and his staff were celebrating that morning in a suite on the 28th floor of the Las Vegas Hilton, having just put the final touches on a deal with Tele-Communications Inc. to provide Sun's Java software for some, if not all, of the cable company's next generation of television set-top boxes.

VISIONARY. McNealy's euphoria was fleeting, though. Just 13 hours after he savored his win, Microsoft had a TCI deal of its own to crow about. The cable giant agreed to license a minimum of 5 million copies of Microsoft's Windows CE operating system for the set-top boxes. It was Microsoft's first-ever sale of software to the cable-TV business--and potentially a foot in the door for it to become the primary operating-system purveyor for the whole industry. Although TCI is no longer the largest cable company--that mantle is now worn by Time Warner Inc.--TCI Chairman John C. Malone towers over the cable business as its guiding visionary and its chief defender against the predations of the computer powers. Given that, "being selected by TCI gives us a good starting point," Gates says.

So who really won? Microsoft and Sun could probably debate that question until all the lights go out in Vegas. In the coming months, it will become clear who is best-positioned as application developers choose whether to peg their programs to Java or Windows CE. But the resounding near-term winner, by all accounts, was cable. "This keeps the cable guys in position to call all the shots," says Cynthia Brumfield, cable-TV analyst at market researcher Paul Kagan Associates. "Malone's very clever," she adds.

The TCI chairman is not gloating openly, though. "We're gratified by Microsoft's willingness to work with other software providers. This is an ecumenical process," he says mildly. But Malone's positioning could pay off handsomely for all the cable kingpins during the next half-decade or so, as tens of millions of American homes become wired for interactive cable--with its promise of jazzy new entertainment, information, data, and shopping services. "We have dreamed of doing this for years. Now, we have the technology and the economics to make it happen," Malone says.

To understand the full import of the mid-January deals, rewind to Apr. 10, 1997. On that day, Malone and a half-dozen other cable chieftains visited the Microsoft campus in Redmond, Wash., and heard Microsoft's offer to supply them with an end-to-end software package for the next generation of cable networks. The cable guys asked Gates to demonstrate his commitment to them by making an investment in the cable-television industry. That led to Microsoft's $1 billion investment in June in Comcast Corp. and to negotiations through the rest of the year with other cable companies--before which Microsoft was dangling offers of equity investments, equipment financing, and other incentives.

But for many in the cable and computer industries alike, Gates's Comcast investment looked like the first step in an effort to buy his way into dominance of cable. A Gates-wary Malone took the lead and adamantly refused to be pulled into Microsoft's orbit. He and other cable executives dictated an open standard for interactive cable systems and actively courted other technology companies, asking them to come up with products that would compete with Microsoft's. The gambit worked, as tech giants Sun and Oracle Corp. leaped into the fray.

ABUZZ WITH TALK. Rumors swirled that Microsoft was on the verge of making a $1 billion investment in TCI--yet nothing came of it. There was even more intrigue: The cable industry was abuzz with talk that Microsoft nudged Comcast to make a secret offer for 20% of TCI's voting stock controlled by the estate of founder Robert Magness. Nothing came of that, either.

Perhaps it was no coincidence, considering Microsoft's supposed maneuverings, that around this time Tele-Communications drew closer to Sun Microsystems and its Java product. On Christmas Eve, McNealy and lieutenants flew to TCI's Denver headquarters and reached an agreement in principle to supply TCI with Java. They even agreed on a price--which Gates now derides as just $1 per set-top box. Sun declines to say what it got, but McNealy was ecstatic. After high-fiving in the TCI elevator, the Sun team went to a nearby McDonald's drive-through for a lunch of cheeseburgers and fries.

Armed with an attractive proposal from Sun, TCI was in a position to squeeze Gates for concessions. And squeeze Malone did. Microsoft acknowledges that it gave up a bit on licensing fees, although no one will say how much Microsoft will receive for every cable box that contains the Windows CE operating system.

But to sweeten the deal further, Microsoft agreed to provide TCI's hardware suppliers at nominal cost with some key WebTV chip technology. Gates and Malone did the last-minute negotiations directly--Gates by airphone while he was en route to Houston on Jan. 9. "When it really comes down to it, these discussions are done with John," says Gates. Right up until the end, Microsoft attempted--unsuccessfully, it turns out--to convince Malone that Java was an unnecessary waste of computing resources.

THREAT ON THE HORIZON? Despite the high-level negotiating, Gates wasn't able to nail down his deal before McNealy announced Sun's coup at his Jan. 9 keynote speech at the Las Vegas Consumer Electronics Show. But Gates pressed hard to have his deal done in time for his own CES keynote the next morning. He was in a hurry to eclipse some of Sun Microsystems' glory. "I told John I didn't care about the PR," Gates recalls. "I just wanted to help make the vision a reality."

With the deals done, Malone departed for his vacation home in Maine. But it is time off that the TCI chairman can ill afford.

That's because computer titans aren't making cable television their only bet. With the ink barely dry on the TCI agreements, several leading computer companies are expected to announce at an industry conference that begins on Jan. 26 an alliance with five regional telephone companies. They have agreed on a common technology standard that will hasten the telcos' deployment of high-speed data services and Internet access via existing phone wires. The new, faster link to cyberspace could be widely available by the end of the year. Suddenly, the normally sluggish telephone companies are looking like real competition to cable for speeding access to cyberspace. Gates may well spend the coming months playing the two industries off against one another as expertly as Malone had done with Gates's industry. The dance is far from over.

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