Microsoft and AOL duel for the Internet crown

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In an internal document distributed recently to key members of Congress, AOL Time Warner articulated one of its greatest fears: an "all-Microsoft future."

Unless the software giant is stopped, "consumers will use Microsoft software to view Microsoft-created content served on Microsoft networks," AOL said in the March 21 document.

Microsoft has a similar concern about AOL, the world's largest media company. But that is the only sentiment they share.

The two behemoths of technology are taking different approaches to the wired world: Microsoft's strength is software; AOL emphasizes media content. But they are both pursuing the same future: supremacy on the Internet, whether by desktop, cell phone or a device as yet unimagined.

"An area where we are competing is kind of the heart and mind of the consumer experience over the Internet, and in that area we're having fantastic competition," said Yusuf Mehdi, a Microsoft vice president.

The two companies have been competing for years in various markets, including Internet access, instant messaging and interactive television. But the clash between AOL and Microsoft has come to a head, with the two locked in heated negotiations over a proposed software deal.

An agreement would give AOL software for Internet access a prominent display on Microsoft's Windows XP operating system that debuts Oct. 25. In exchange, AOL would use Microsoft's Internet browser in its software.

But the terms of the deal are a sidelight to the real issue: Who will rule the Internet?

The question has gained immediacy because both companies have benefited from the latest tech shakeout, which helped them fend off capital-starved upstarts and rein in former rising stars such as music-sharing service Napster.

"Frankly, I don't have sympathy for either one of these in this battle," said Drew Brosseau, a Boston-based analyst at SG Cowen Securities. "Both are trying to protect and extend their franchises. When those franchises collide, sparks fly."

The sparks are flying more now because both increasingly find themselves squaring off over the same customer, accusing each other of creating a powerful network of products and services - an all-inclusive digital world - to box out the competition.

AOL "has erected a walled garden of captive users, and their strategy is to force-feed them Time Warner content," said Microsoft spokesman Vivek Varma.

"I would argue that what Microsoft is trying to do is to become the operating system for the Internet," said Barry Schuler, chairman and chief executive of America Online, the Dulles, Va.-based online unit of AOL Time Warner.

Caught in the middle are consumers who fear that whichever one wins may constrict the choice of goods and services.

"The danger of these two giants is that they're building fortresses around their own territory that may make it easy to stay within the wall but make it difficult to pick and choose selective services that each company is offering," said Gene Kimmelman, co-director of Consumers Union, publisher of Consumer Reports magazine.

Microsoft, however, argues that what it is trying to do is build a business based on its bread-and-butter strength, technology. Meanwhile, AOL's approach has been driven by content, especially since its acquisition of Time Warner in January. For example, AOL has been using its online service to peddle subscriptions to Time Inc. publications.

"The biggest difference between the two companies is that we are a consumer company that has been razor-sharp focused on consumers and have really specialized in taking complex technologies and making them easy ... and Microsoft is a business-to-business company," Schuler said.

Lately, Microsoft has been pushing hard to use its technology to become more of a consumer company and has made aggressive moves in the Internet-access business, which AOL leads. Microsoft recently launched a $50 million marketing campaign to lure AOL members to its own MSN service, offering three months of free access to those who defected.

Microsoft has done even better with its Web sites, which attracted 114 million consumers worldwide in February, ranking it first, ahead of Yahoo! and AOL, according to Jupiter Media Metrix, a New York research firm. "From MSN's perspective, we've really been giving AOL a run for its money," said Mehdi.

AOL's view? "They're trying to play catch-up," Schuler said.

AOL's immediate problem, and that of other rivals, is the imminent arrival of Windows XP. The operating system comes with a lot of new bells and whistles, which Microsoft says are meant to enrich the user's experience. Software such as an instant-messaging service are among the additions.

Alarmed AOL executives worry that Microsoft will gain ground on their own AOL Instant Messenger, the No. 1 such service, with more than 80 million registered users. On the surface, instant messaging allows computer users to exchange rapid-fire text-based notes over the Internet. But what's at stake is an emerging communications platform that may one day compete with the telephone.

As a result, AOL has been raising questions about Windows XP and how it is embedding such features as instant messaging. Its campaign is aimed at getting lawmakers to pay closer attention to Microsoft's new operating system at a time when the software maker is appealing a court-ordered breakup. That case also happens to involve Microsoft's strategy of embedding software.

In the mid-1990s, Microsoft incorporated its Internet browser, a software product that enables the user to view Web sites, into its Windows operating system, which runs on about 90 percent of all PCs. By the late '90s, Microsoft's browser had surpassed all others, including one made by Netscape Communications, a company AOL now owns.

Last year, U.S. District Judge Thomas Penfield Jackson found that Microsoft had broken antitrust laws by tying its Internet Explorer browser to Windows. This year, AOL thinks it sees a replay of events with Windows XP.

Microsoft has countered AOL's campaign by approaching many of the same lawmakers with its defense of XP.

But for all the strife between the two companies, they still depend on each other. Which leads to their present dispute.

AOL insists it no longer needs the distribution that it would get by being placed on the Windows operating system; it gets most of that through other means - by striking deals with computer makers that preload AOL's software and by giving away free compact discs, its staple of direct marketing.

AOL, however, does depend on Microsoft to the extent that it needs its rival's software to run smoothly with Microsoft's operating system.

Microsoft needs AOL, too. The company wants a provision that would require AOL to make its popular instant-messaging system compatible with its own.

Microsoft also wants its rival to use its Windows Media Player, software that allows PC users to play music and video. AOL, which has a multiyear deal with Seattle's RealNetworks to use its RealPlayer software, has refused.

AOL and Microsoft have come a long way since they struck their original five-year bargain, which expired in January. Then, Microsoft was in a pitched battle with browser rival Netscape. Microsoft made a deal under which AOL agreed to use Microsoft's browser. AOL gained a key distribution channel on Microsoft's Windows operating system.

It worked for both. Microsoft won the browser war, and thanks in part to the Microsoft distribution deal, AOL is the world's dominant Internet provider.

"We're not the little scrawny kid who the muscle-bound guy on the beach kicks sand on," said Kenneth Lerer, an AOL Time Warner executive vice president. "These days, big companies have to learn to live together and have to learn to compete at the same time. Those are the new rules of business."