Power Play: Aol Netscape Sun

The triumvirate of AOL/Netscape/Sun could become the crossroads of online business in the next century

In the folklore of the computer industry, the tale is told of how IBM foolishly underestimated the young entrepreneur on the other side of the table when it negotiated a licensing deal with William H. Gates III in 1980. The dweeby young programmer, by retaining control of the core software of the PC revolution, went on to build the most powerful company in the industry.

When the history of the next phase of the high-tech business is passed on--about how the era of E-business came about--a similar tale may be told. In this version, Microsoft Corp. is the giant and the underestimated rival is Stephen M. Case, CEO of America Online Inc. The giant's gaffe? Instead of pressing ahead with all its power to unseat AOL in online services, as it once intended to do, Microsoft entered into a marriage of convenience. In return for promoting Microsoft's Internet Explorer as AOL's featured Web browser in early 1996, Microsoft offered Case an immensely good deal: On each of the millions of copies of Windows shipped, AOL would be the featured online service.

IN-YOUR-FACE. At the time--when it seemed that Netscape Communications Corp. would run away with the Internet business--it may have seemed a cheap price for Microsoft to pay to get AOL on its side. But in the past two years, AOL has cleaned up its internal problems, bought up No. 2 online service CompuServe, and boosted its membership to 14 million. That has transformed AOL from the No. 1 proprietary online service to, potentially, Microsoft's most dangerous rival. That became stunningly clear on Nov. 24 when Case announced a $4.2 billion stock deal to acquire Netscape--and a far-ranging alliance between them and Sun Microsystems Inc.

Buying Netscape was impressive enough. But by bringing Sun into the deal, Case has pulled off a stunner that aligns some of the most powerful players in cyberspace. It plants a huge stake in the ground, pointing out the direction in which E-commerce may develop in the 21st Century. Over the next decade or two, vast chunks of the world economy will move into the electronic realm. What the new triumvirate suggests is that at some point, the online systems that connect companies to consumers, businesses to businesses, and networks to various parts of corporations will become part of a vast digital circulatory system.

The vision: To create a combination of services and products that lets companies do pretty much everything a company does--but on the Web. In the process, businesses could hope to get far more productivity out of the Web than they do now by setting up online stores. Thanks to its new alliance, "AOL becomes a conduit," says Josh S. Grotstein, a division executive in charge of E-commerce at Citigroup, which has strong relationships with Netscape, Microsoft, and IBM. "It helps communities that exchange information become business communities."

It is ambitious. And it couldn't be a more in-your-face move against Microsoft's Gates, who espouses a similar vision. "When a company with close to half of consumer Internet users embraces E-commerce with such a huge move, this could be the catalyst that could finally make E-commerce take off," says John W. Sidgmore, vice-chairman of MCI WorldCom Inc., the top supplier of Internet "backbone" service. Says Case: "With the success of upstarts like Amazon.com and its impact on book retailing and E*Trade with its impact on stock brokerage, every company has to have a major Internet presence."

How will the new cybertroika make that happen? When the AOL-Netscape merger is complete, probably next spring, AOL will get Netscape's popular Internet browser and a suite of software programs used behind the scenes to run Web sites and conduct business electronically. It will sell those to business customers and, as part of the deal with Sun, the workstation leader will sell the same set of tools to major corporations. Sun will pay AOL $350 million for licensing and other fees over the next three years. In return, AOL will buy $500 million of Sun services and equipment. "We believe Netscape software is right down the strike zone," says Case. "Sun's capability to leverage a huge sales force is important. Together, it jump-starts our whole E-commerce strategy."

The deal also makes AOL the biggest portal on the Web--the site through which the most people pass as they look for information or buy and sell things. Netcenter, Netscape's Internet site, has 9 million registered users, mostly at work, while AOL has 14 million subscribers--mostly consumers. And when you look at the number of people who visit the Netscape and AOL sites at home, you've got the most powerful force on the Net, with 50% more visitors than its closest rival, Yahoo! "Netcenter gives instant distribution to Corporate America, one of AOL's few weak links," says Kate Delhagen, an analyst at Forrester Research Inc. "Since many American consumers are using the Internet primarily at work, they really need the exposure." AOL already has a toehold in this market through its acquisition last fall of CompuServe Inc., which attracts small business users.

And by corralling consumers and businesses in the same virtual space, AOL has a huge opportunity to pump up the volume of electronic transactions. Crows Netscape CEO James L. Barksdale: "This is an awesome combination that lets us explode our vision of the networked economy over the next century."

For AOL and Sun, the timing couldn't be better. The acquisition comes just as consumers, small businesses, and major corporations are grappling with wrenching changes in the way they interact commercially. They are all scrambling to determine the smartest approach to rewiring for the next century, when every facet of business--from procurement, to billing, to human resources, to customer support--will be conducted over the Internet.

The troika is also well-positioned to address another major development in cyberspace--using all sorts of devices other than a personal computer to cruise the Net. Using Sun's Java programming language, Netscape's browser, and AOL's content, the team can create setups for sending E-mail via cell phone or downloading updated stock data to your TV screen through a digital set-top box. Sun's Java software will be used by AOL for future software development while Sun and AOL will use Java and the Netscape browser to develop a variety of Internet appliances such as handheld PCs, set-top TV boxes, and Web phones. Says Robert C. Fox, director of telecommunications services at Mercer Management Consulting: "A Sun/AOL group could be close to the center of that kind of business."

Sun, which has seen sales of its computers soar because of the Internet boom, now gets a chance to move to the center of the action. Until now, the company hasn't been able to provide all the critical software components that its corporate customers need for electronic business--the way IBM does and Microsoft aims to do. Now Sun will be able to tap Netscape for software to link Web sites to corporate databases and handle such tasks as managing relations with suppliers over the Web. Says Sun Chief Operating Officer Edward J. Zander: "This certainly puts a different face on Sun."

Microsoft isn't the only company likely to feel the effects of the new coalition. IBM, for one, loses some of its edge over Sun. What's more, computer makers Compaq Computer Corp. and Hewlett-Packard Co. may find themselves scrambling to bolster their Internet offerings by acquiring software skills or aligning with remaining independent Net players.

Even highfliers like Yahoo! and Amazon.com may have to make accommodations to the new reality. "You have the formation of two very clear axes of power [Microsoft and AOL] on the Internet," says Excite Inc. CEO George Bell.

While the deal may worry rivals, it helps assuage Netscape customers, who have grown wary of the company's ability to deliver on its promises of producing key software. "It's reassuring to us," says Charlotte Decker, a marketing manager with Visteon Automotive Systems, a $17 billion auto-components division of Ford Motor Co. based in Dearborn, Mich.

Even better--for the prospects of the new trio--Visteon applauds the idea of using AOL to broaden its E-commerce offerings. "Our vision is to be able to service the consumer," says Decker. "If we have car enthusiasts that need parts and they want to order on the Web, AOL would allow us to do that."

To be sure, this is new territory for AOL. Never a technology trailblazer, the consumer giant is now trying to seize the lead. With its successful acquisition of Mirabilis, an Israeli software company, AOL has proved it can fold in a high-tech startup without smothering it.

The question now is how effectively AOL can manage the acquisition of Netscape, a much larger software company that is in the midst of developing much more complex "enterprise" software. "Software is a bad fit for AOL," says Abhishek S. Gami, an analyst at William Blair & Co.

Case is aware of the challenge. AOL has to try to keep Netscape's management and technical team intact. Netscape CEO Barksdale will join AOL's board, assuring continuity of management. But the future of Marc L. Andreessen, Netscape's executive vice-president of products and the father of Netscape's browser, is up in the air. Andreessen is on sabbatical and plans to come back Jan. 1. In the meantime, he is in talks with AOL to decide what his position would be there.

There's also the nagging possibility that Case's decision to buy Netscape came too late. Once the runaway leader in the market for browser software, Netscape has faltered over the past two years as Microsoft grabbed market share and Netscape management flip-flopped on strategy.

As the company's earnings and prospects slipped this summer, Barksdale began shopping the company around. In fact, Netscape was close to consummating a deal with Internet portal company Excite two months ago. The deal got hung up on several issues, including Excite's reluctance to take on the Netscape software business along with Netcenter. Excite's Bell confirms the talks but says that what broke the deal were tax and accounting issues. Says Bell: "We got three-quarters of the way pregnant with each other, but didn't go all the way."

The AOL-Netscape deal could put Excite and other portals in play. Indeed, some investors figure that AOL, which already has a 9% stake in Excite, might buy up the rest. The Netscape sale has already put another leg on the Internet stock bull market: Issues such as Yahoo! and Amazon.com leaped by as much as 20% on one day.

The notion of another AOL deal isn't far-fetched. AOL has thrived mainly as a proprietary online service with millions of paying subscribers. But it is facing threats from fast-growing Internet portals such as Yahoo's that are free to anybody with an Internet access service. Those sites now offer news, chat, E-mail, and dozens of connections to content and services--essentially duplicating what Microsoft users get for their monthly fees. Over the next year, major portals such as Infoseek's Go Network, partly owned by Disney, and Microsoft's MSN.com will step up expensive marketing campaigns in their battle for eyeballs. "The door is closing on these portals in terms of how many can get out there and survive," says online consultant Gary H. Arlen of Bethesda, Md.

That, perhaps, is why AOL is pushing so hard to open a new door--onto the bigger world of E-business. And this is where Sun's involvement will be critical. As a partner with AOL and Netscape, Sun is now in position to challenge IBM, Hewlett-Packard, and others in developing the systems that will let corporations rebuild their businesses in cyberspace. The challenge for Sun CEO Scott G. McNealy will be to behave like the top-tier industry leader that this deal may finally make him (box). And he'll need to make sure that Sun not only talks like a good partner but behaves like one, too. In promoting Java as a standard, for example, Sun has sometimes come across as a bit too controlling, say other computer companies.

For now, AOL, Netscape, and Sun are basking in the glory of the moment. The three companies are focused on a common goal--E-business. And they have a common enemy--Microsoft. If they can keep it together, this could be the beginning of a new industry legend.

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