A Cold War in Cyberspace?

The growing rivalry between AOL Time Warner and Microsoft is spawning a web of deals and alliances, which could mean good news for consumers

Two titans are left standing in the wake of the dot-com collapse. There's AOL Time Warner (AOL ) spanning media, Internet access, and cable television. Equally formidable is Microsoft, cutting its impressive swath through the software world. Talks between the two recently broke down over how Microsoft's much-anticipated XP operating system would interact with AOL's Internet services. That has fueled much speculation over which company will emerge victorious in the battle for the loyalty of a new generation of Netizens.

Billed as the ultimate cyberwar, it's likely to be a complicated affair with a lot of Cold War sparring, alliance-building, and grabbing of strategic tech territory. While Microsoft and AOL compete directly in such areas as dial-up access, instant messaging, and interactive TV, there are many others where they don't. For instance, AOL doesn't have an operating system, and Microsoft isn't a media company. It's in these no-contact zones where the Cold War is most active.

Both giants are busy forming alliances to create new spheres of influence. And the propaganda is hot and heavy, too. "We fundamentally don't think that consumers should be left with the same choice in music players or anything else that they're left with in spreadsheets, [word-processing] programs, and other...software. That's a choice of MS or nothing at all," argues John Buckley, AOL Time Warner's vice-president for corporate affairs.


  Do consumers stand a chance in a market carved up by two corporate superpowers? Surprisingly, the answer may be yes. For the first time in a decade, AOL and Microsoft each face an adversary with real clout. Ultimately, an unwinnable war may keep competition healthy in important emerging markets, such as digital media, electronic games, and cable.

Witness the battle over streaming-media technology. AOL doesn't make a media player -- but it wants to make sure that someone besides Bill Gates and Steve Ballmer does. So it's building a strong alliance with RealNetworks, Microsoft's competitor in streaming technology. The Seattle-based company is the market leader, with more than 200 million registered users. But RealNetworks, founded by former Microsoft employee Rob Glaser, has had a tough time spinning cash from those users. That's particularly true since Microsoft gives its similar Windows Media Player away free as part of its ubiquitous Windows operating system.

AOL is giving RealNetworks maximum backing. Last July, AOL announced that it would bundle RealNetworks' RealPlayer into the newest version of AOL, 6.0, giving RealNetworks access to AOL's 30 million-strong subscriber base. On Apr. 2, AOL chose RealNetworks as a partner for its upcoming music-subscription service, MusicNet.

The service, a partnership between Time Warner Music, EMI, and BMG, will offer a wide collection of downloadable and streaming music backed by RealNetworks' technology. "Whether it's a portable device, a game machine, or something else, if you don't want to be sucked into the world of Windows, you need another alternative," says one digital-media expert. "Clearly Real is becoming a tool of companies that don't want to do everything with Windows."


  Online gaming is another area both AOL and Microsoft covet. Once video games are routinely connected to the Net, the console becomes a valuable platform, much like the PC, from which ads, music and, of course, video games can be sold. On May 15, AOL struck a deal with Sony to include its e-mail and instant messaging programs in the next version of PlayStation 2.

In exchange, Sony will build an adapter into the game console that allows consumers to access AOL Internet features and play Net-enabled games. By yearend, Sony also will include RealNetworks' RealPlayer and RealJukebox software on hard drives that can be added to PlayStation 2 consoles.

The furious dealmaking by AOL is all aimed at blunting Microsoft's steady move into the market. On Nov. 8, Gates & Co. will launch the new Xbox game system in a $500 million marketing blitz that is sure to cause damage. Gaming "isn't a core area for either AOL or RealNetworks, but neither wanted to cede it to Microsoft," says John Corcoran, an analyst at CIBC Markets in Boston.

Microsoft is likewise making defensive alliances in areas of AOL strength, such as cable TV, though it plays down the notion that keeping AOL in check is of strategic importance. "We're moving ahead with a strategy that relies a lot on third-party support. But it's up to AOL to decide how they want to partner with Microsoft," says company spokesman Jim Cullinan. Since 1997, Microsoft has invested $1 billion in Comcast (CMCS ) and $5 billion in AT&T (T ) to ensure that it keeps a big hand in the development of interactive TV.

"Microsoft is working hard to become a player in the cable industry. And the industry has anointed Microsoft as one of the two players in the interactive-TV space," says Michael Goodman, a cable analyst at the Boston research firm Yankee Group. While such investments don't directly undermine Time Warner cable properties, they help keep rival cable operators on the digital edge.


  Meanwhile, AOL is keen on building solidarity with other companies in the anti-Microsoft camp. In January, AOL gave Microsoft archrival Sun Microsystems (SUN ) a big boost in a time of slumping sales by purchasing $400 million in products and services. That's on top of the $500 million worth of equipment it AOL bought in 1998. AOL now uses more than 4,000 Sun servers.

More recently, Microsoft moved to test the loyalty of AOL's 30 million dial-up network users. When AOL hiked its prices by 9% in May, MSN's prices stayed flat, and it offered three months of free service to new customers. Gates & Co. also spent $50 million in the market push. So far, AOL claims the price hike hasn't hurt it.

Clearly, a digital world dominated by these titans is a long way from the wide-open markets that many analysts were predicting only 18 months ago. The not-so-bad news is that the new battle for the Net is between two well-oiled machines, with lots of cash and plenty of incentive to innovate and keep their competitive edges sharp. Without AOL, RealNetworks might have gone the way of Netscape. Microsoft's deep pockets keep AOL from dial-up domination. While neither superpower may win, the consumer just might.

By Jane Black in New York

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