Commentary: Why Microsoft Can't Be the Bully on This Block

To the outside world, Microsoft Corp. and AOL Time Warner (AOL) Inc. were bitter enemies -- duking it out in the marketplace and courtroom -- right up until a surprise detente at the end of May. But a sort of peace began in March, when a handful of senior executives from both sides dined at New York's tony 21 Club. The execs mapped out a plan to settle their differences, even agreeing to explore opportunities in the fledgling digital-media market together. AOL execs, according to those at the dinner, picked up the tab.

On May 29, Microsoft's turn came to pick up the check. The software giant agreed to pay AOL $750 million to settle claims that it illegally leveraged its Windows operating-system monopoly to crush Netscape Communications Corp., which AOL bought in 1999. As part of the deal, AOL agreed to consider using Microsoft's digital-media software to distribute movies and music from its trove of content.

Microsoft Chairman William H. Gates III and AOL Time Warner Chairman Richard D. Parsons said the deal could spark a revolution as digital versions of music, TV programs, and movies start to flow over the Web. "The agreement here with AOL Time Warner advances the time that will happen quite significantly," Gates said on the day the deal was announced.

Gates wants Microsoft's technology to become a standard in the digital-media industry -- and he's hoping the AOL Time Warner deal will be a giant step in that direction. The big prize: selling secure software for the servers that dish up digital content. The music industry has seen pirates siphon off billions in revenue as they swap songs over the Web. Without copy protection, the movie studios fear a repeat performance in their business. As they roll out digital programming on disks, over the Web and through set-top boxes, they must include tough antipiracy features.

But Microsoft has a long way to go before it can call itself king of this hill. True, it provides antipiracy technology to two leading services that let users download movies to their PCs -- Movielink LLC and CinemaNow. The technology is also used by pressplay, an online music-subscription service. But the media industry is determined to keep its options open.

AOL, for one, has only licensed Microsoft's technology. It hasn't agreed to use it. And AOL already uses competing digital media technology made by Microsoft rival RealNetworks Inc. AOL Time Warner Executive Vice-President Olaf Olafsson, who helped negotiate the settlement, says the agreement is not exclusive because "we wanted to make sure other products don't get shut out."

Hollywood is leery of sharing the spoils of the digital-content market -- whether from its DVD sales or fledgling Web download business -- with the likes of tech heavyweight Microsoft. If it gets too much power, media outfits fret that the company could dictate licensing terms. "This is all about how large a toll we're going to have to pay to Microsoft," says one top studio exec.

What's more, Microsoft's grip on the PC market won't be nearly as useful in securing a lead in digital-content protection as it was in winning the browser wars. In that showdown with Netscape, Microsoft created links between its Windows operating system and its Internet Explorer browser to surpass Netscape. This time, media companies are in the driver's seat. Says Larry Gerbrandt, chief operating officer of Kagan World Media, a research and consulting firm: "It's going to be up to Hollywood to decide."

Microsoft's rivals have made some inroads. Thanks to a feature that prevents songs from being copied more than three times, Apple Computer Inc. convinced every major music label to make part of their catalogs available for sale at its iTunes site. Some major record companies are also developing software on their own that could freeze the PCs of music pirates. "Media companies hold all the cards, and the last thing they're going to do is let themselves become beholden to Microsoft," says Dan Sheeran, Real's vice-president of marketing.

The AOL deal may still open some doors. "We've eliminated a barrier to success," says Will Poole, a senior vice-president at Microsoft who helped cut the deal. Maybe so, but Microsoft has plenty of hurdles to leap. By Jay Greene

With Tom Lowry in New York and Ronald Grover in Los Angeles

The Good Business Issue
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