Real's reality

 
Microsoft just one factor in Net pioneer's chaotic history

By Stefanie Olsen and Mike Yamamoto
Staff Writers, CNET News.com
March 4, 2004, 4:00 AM PT

The message in RealNetworks' antitrust case against Microsoft is clear: "Predatory conduct" by Microsoft is responsible for lost business that could exceed $1 billion in damages to the digital-media company.

Regardless of the lawsuit's merits, however, Microsoft's opposition is only one of a remarkable string of hardships faced by RealNetworks. The Seattle-based Internet pioneer has endured years of internal and external challenges, including new technologies, strategic mistakes and old-fashioned bad luck, that weren't caused by its crosstown rival.

Wireless technology may represent RealNetworks' best hope of becoming a digital media powerhouse.

RealNetworks has raced ahead of its competitors in making important deals with equipment makers and carriers to deliver content using wireless networks. In a recent report, researcher Strategy Analytics predicted that the mobile video market will be worth $5 billion a year by 2008.

RealNetworks has partnered some 26 mobile operators, including U.K. wireless giant Vodafone, O2, Telecom Italia, Telefonica and Wind. In the United States, the software maker has established partnerships with vendors Sprint PCS and AT&T Wireless. RealNetworks also has deals to build its digital media technology directly into mobile handsets manufactured by Ericsson and Motorola.

No one would be shocked to find that Microsoft--never a stranger to strong-arm business tactics--has stunted RealNetworks' ability to compete. But the extent of such antagonism is difficult to gauge when the claimant is a rare survivor of the dot-com implosion and has been forced to remake itself repeatedly to ride out one of the more extraordinary boom-bust cycles in economic history.

"First it was about getting its player out, then its premium player and server software, then middleware and a subscription business. Now it's in the games and music business," said a former RealNetworks executive who asked to remain unnamed. "Real's never had the luxury of time to let a business develop. Microsoft is playing a game 10 years at a time; Real is playing it three months at a time."

An inevitable byproduct of this mad rush to stay ahead of the competition is the exposure of dangerous blind spots in its strategic maneuvers. The most damning oversight for RealNetworks, critics say, was its underestimation of the boom in digital music downloading and file swapping.

The live-streaming technology long championed by the company was quickly eclipsed in 1999 by tools that enable people to share digital music across the Internet, to store songs on personal computers and to burn custom CDs. The surge in file swapping was fueled even further by significant advances in the broadband industry, which made fast Internet connections widely available.

Although streaming audio is still popular for sports and other live events, the Napster phenomenon replaced RealNetworks' signature technology as the leading online music medium--seemingly overnight. But instead of immediately joining the new trend, RealNetworks tried to develop a streaming network aimed at improving the efficiency of multimedia distribution over the Internet. The business never took off.

The company eventually started its own music subscription business in 2001: a joint venture with three major record labels, called MusicNet. But the service was hampered by poor licensing deals that sharply limited content and placed severe restrictions on what customers could do.

More recently, RealNetworks has reported success with another music service, a subscription-based streaming business called Rhapsody. It acquired Rhapsody in its purchase of Listen.com last year for an estimated $36 million in cash and stock, buying the company just weeks before Apple Computer rocked the industry with the launch of its iTunes Music Store.

Given that RealNetworks had long been the leader in online music, it can be argued that the company should never have needed to make a multimillion-dollar buy to play catch-up with rivals from the computing and electronics industries.

"The popularity of Apple's iTunes and its impact on Listen.com could be playing a role in its strategy," said Peter Harter, an entrepreneur and former executive at Netscape Communications and eMusic. "A lot of people are competing to have control of this market."

Caught on video
At least part of RealNetworks' miscalculation in music may be attributed to its emphasis on Internet video, a medium that remains practically dormant in comparison. Some industry veterans blame Hollywood for the lack of progress in the online video market, because the major studios are reluctant to allow the digital distribution of movies, having witnessed the devastating effect of online music on the recording industry. But others, including digital media evangelist Steve Jobs, say the quality of Internet video is simply too poor for mass consumption at this time.

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The streaming business has been undercut further by Java technology, which gives browsers the ability to play videos directly on a Web page, obviating the need for a separate media player such as RealOne. More significantly, such built-in video can be run from regular Web servers, cutting out the special back-end streaming technologies sold by RealNetworks.

"It's not clear to investors what RealNetworks' business model is, long term," said Stewart Barry, an equity analyst at investment firm Delafield Hambrecht. "They have some big potential markets, but how do they compete, and how do they capture value, as these markets emerge?"

Moreover, the demand for video and audio subscriptions may have been overestimated by RealNetworks in some key areas. As suggested by the recent collapse in negotiations for RealNetworks to power Major League Baseball's Web coverage, consumer demand--even for highly popular events--does not deliver enough revenue to pay for expensive licenses. Sources say MLB representatives were seeking a substantial increase to the $20 million the league received under its last three-year contract with RealNetworks.

As if such setbacks weren't enough, RealNetworks and the rest of the online media industry were hit disproportionately hard in the collapse of the so-called New Economy. Many of the companies that succumbed to the dot-com bust were start-ups dedicated to developing content and technologies that would have expanded the digital media market and would thereby have created more demand for RealNetworks' products and services.

The federal civil suit filed by RealNetworks against Microsoft last December mirrors the antitrust charges under investigation by European authorities, which are scheduled to issue a decision as early as March.

If Microsoft is found guilty of illegal behavior in the European Union case, the company could be forced to separate its Windows Media Player software from the Windows operating system. RealNetworks' suit "is a sideshow and largely reflects what the European Union is pursuing against Microsoft right now," said Steve Frankel, an equity analyst at Adams Harkness.

"It just became more expensive for them to continue using Real," said Rags Gupta, the chief operating officer of Live365, an interactive radio services company. Gupta pointed to Microsoft's essentially free media server as an easy choice for many companies.

Other partnerships have disappointed RealNetworks for different reasons. America Online, for example, backed away from its long-standing use of RealNetworks' products for digital media, as it developed its own technologies. In May 2003, AOL switched to Dolby AAC as its preferred audio-streaming technology for online radio products. Later, AOL raised the possibility of using Microsoft technology when it settled its antitrust case against the software giant.

Such an arrangement would be particularly stinging to RealNetworks because it involves issues at the core of its own antitrust case against Microsoft. Key to the lawsuit is RealNetworks' claim that Microsoft has competed unfairly on the server side of the digital media business by offering free products to customers and by bundling that software with its dominant Windows operating system. RealNetworks says sales from software licensing accounted for 25 percent of its business in the fourth quarter of 2003, down from roughly 40 percent a year earlier.

Microsoft's actions in the digital media market are also the subject of a European Union antitrust investigation that is separate from Real's lawsuit. The EU could issue a decision in its case as early as March.

In a tacit acknowledgement of the market shift, RealNetworks in 2002 released a new version of its server software, dubbed "Helix"--a new name aimed at highlighting the sharp break with past products. Helix is capable of supporting most major competing streaming media formats, including Windows Media. Although RealNetworks had already licensed Microsoft's formats for use in its media player, it didn't have Windows Media licenses for its server technology. Undeterred, the company found a way to essentially replicate the Windows Media code, trumpeting its new software as the Internet's first "universal" streaming system.

"It's an admission of RealNetworks that it's important for them to support Windows Media and that we're now the leading player among home and work users," Michael Aldridge, the lead product manager for Microsoft's Windows Digital Media division, said of the move at the time.

With the Helix release, RealNetworks revealed portions of its source code--the basic instructions underlying the software--in a bid to attract programmers to develop their own media players based on its technology. The plan closely resembled moves made by Netscape to defend itself against Microsoft.

Some say RealNetworks should have abandoned this software "platform" part of its business long ago, regardless of Microsoft's actions, and have concentrated instead on content opportunities, which have far more potential. The platform market is difficult: Microsoft itself has yet to turn a profit in digital media operations, despite its massive resources and industry influence.

"There are precious few companies that have ever been able to exploit the 'synergy' between owning the platform and the content," said David Card, a senior analyst at Jupiter Research. "It's the same as Netscape. Netscape tried to do both and failed at both."

Staying afloat in streaming
Nevertheless, RealNetworks is to be credited for its resilience and uncanny ability to evolve quickly. Even more impressive, for a dot-com enterprise, it has managed to maintain a cash reserve of $374 million--a sizeable war chest that RealNetworks can tap as it expands into its next field, delivering content through wireless networks. It also has $100 million in debt.

Even those who criticize RealNetworks, which celebrated its 10th anniversary two weeks ago, say it deserves praise for weathering changes and numerous attacks for so long. Friends and foes alike of RealNetworks founder and CEO Rob Glaser say he has done an amazing job in turning the company on a dime to stay ahead of competitors, market trends and the whim of the economy.

Glaser, who served as one of Bill Gates' lieutenants for a decade at Microsoft, has denied that RealNetworks is defined by its competition with the Windows empire. But those who know him well have said the opposite is true: Beating Microsoft has been a long-standing goal that, at times, has bordered on an obsession.

The result has been a bunker mentality at RealNetworks that has served as a source of alternating frustration and determination for its battle-hardened executives. In the face of monumental odds, the company has consistently refused to allow its opponents any quarter while defending its pledge to be "the leading creator of digital media services and software."

Yet this stoic front, admirable as it may be, belies the difficult question facing RealNetworks as it pursues its legal action against Microsoft: How much can it trumpet its successes to attract new business and all the while claim that it has been a victim of widespread abuse?

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Microsoft seized on this point in its rebuttal to RealNetworks' charges. "This is a case where a leading firm is seeking to use the antitrust laws to protect and increase its market share," it said in a statement issued recently from its headquarters in Redmond, Wash.

RealNetworks, for its part, said Microsoft is just trying to divert attention from the facts of the case. "That we've been able to succeed in the face of illegal conduct should not be grounds for the illegal conduct going unaddressed," said Dan Sheeran, RealNetworks' vice president of marketing.

Larry Jacobson, RealNetworks' president, credited the company's alliances for its success. "Our philosophy has always been, given our position of leadership, to be focused on creating strong partnerships in the content industry and technology industry," he said. "We have a long list of successful wins. That makes us unique. It's hard to do this all on your own."

That may not get much easier as its fight with Microsoft escalates. RealNetworks has made its share of enemies, which have taken issue with its aggressive business practices.

During its unbridled drive to expand its music business in the late 1990s, for instance, RealNetworks drew heavy criticism over the controversial practice of monitoring customers who used its RealJukebox product through unique identification numbers assigned to the software.

"The thing that's interesting will be the witness list. A lot of the people who have relative information don't work at the company anymore but didn't leave with great feelings," another former RealNetworks executive said.

"Nobody feels like they owe Rob much." 

CNET News.com's Evan Hansen contributed to this report.