Battle lines drawn for control of Net

The battle lines for control over the Information Age are being drawn in the hyperspeed of Internet time.

Word of Microsoft's $5 billion stake in AT&T sent a chill throughout the rapidly converging worlds of communications, computing, and television. Although relatively small by today's megamerger standards, the investment marked a monumental shift overnight in the balance of industrial power.

On one side looms the potential for a historic new axis formed by AT&T, Microsoft, and cable operators such as TCI and MediaOne that could dwarf the Wintel duopoly of the computing business. On the other is a loose band of rebels including America Online, Sun Microsystems, Netscape Communications, and the Baby Bells. Yet to declare their allegiances--and weighing whether they need to at all--are such key players as Yahoo, Intel, Compaq, Sony, Disney, Time Warner, and the TV networks.

Although the dynamics of such relationships can change in an instant, the AT&T-Microsoft deal as it now stands "signals the beginning of the way Web services will be delivered to consumers" in the future, said Jupiter Communications analyst Abhi Chaki. "If you look at it across the spectrum--the semiconductor industry, the entertainment industry, the advertising industry, consumers--there's a huge impact this could potentially hold."

Still, AOL could have a secret weapon in its arsenal, albeit a long shot for the long term, in Linux. Sources say the alternative technology could be used as an operating system for television set-top boxes, bypassing Windows--and therefore Microsoft--altogether.

As all this unfolds, federal regulators have been curiously tolerant as huge chunks of the economy are bitten off by new media conglomerates. Other than Federal Reserve chairman Alan Greenspan, none seem anxious to take on the unenviable role of economic naysayer the year before a presidential election. But in their defense, no one could have imagined the scope and pace of change the Internet has created in the last year alone.

"AT&T seems to be doing the same thing in a number of ways. They're trying to get into consumers' homes in a way that won't attract the attention of regulators," said Nancy Kaplan, vice president of business strategy for Renaissance Worldwide, a Boston-based business and technology management consulting firm. "The deal with Microsoft gets them into the box right on the TV. To me it's just a variation on the play they just made with MediaOne."

The corporate alliances that have already emerged, though never seamless in this era of "co-opetition," show how quickly things can change in today's frenetic landscape. Only last year, Microsoft was haggling with Tele-Communications Incorporated over an agreement that would put a Windows operating system into its TV set-top boxes--a deal that TCI chief executive John Malone called an "arm's length" arrangement--at the expense of competing Java technology from Sun. Like their counterparts at the broadcast networks, cable executives have always been wary of encroachment by computer companies as their technologies converged, well aware of how Microsoft does business.

Among the online leaders, clear divisions began only a few months ago with AOL's buyout of Netscape and its new alliance with Sun. The triumverate presented a formidable opponent to the Microsoft empire's expansion through the Net.

That deal, on its surface, seemed to make sense: AOL would take over Netscape's content operations, namely its Netcenter portal, and use Netscape technology in a new partnership with Sun to strengthen its e-commerce ventures. But the three-way alliance needed a pipeline partner that could carry AOL into its projected future, where it could become the Web portal of choice on any electronic device used in any medium.

AT&T reportedly could have been that partner last summer, but only through an acquisition--a price that AOL refused to pay. AT&T bought TCI for $48 billion a week later, leading some in the industry to question the wisdom of AOL's insistence to remain independent. AOL suffered another broadband blow when cable portal and TCI partner @Home merged with Excite this year.

"One of the things we did see is the importance of becoming very closely tied to the broadband platform," Excite chief executive George Bell said. "The events of the last week couldn't have turned out better for Excite and @Home."

Seemingly all but shut out of the cable industry for the moment, AOL has little choice but to hitch its hopes to the Baby Bells and their competing high-speed technology. It has become "AOL and ADSL technology vs. AT&T and cable modems," said cable analyst Michael Harris, president of Kinetic Strategies, a broadband market research firm.

No one knows that better than Microsoft, which had been exploring partnerships for high-speed Internet connections through leaders in both cable and the rival DSL technology advanced by the Baby Bells. Although Microsoft is sure to hedge its bets with other bandwidth technologies, it has long sought a place in the future of small cable boxes that sit atop television sets as the traditional PC market has become saturated for its Windows software.

"The real issue is access to content," said Clay Ryder, vice president and chief analyst for Zona Research, an Internet market research firm. "Microsoft is very much a content provider and with an investment in AT&T, and its role in cable, it does seem to smooth the path for delivery of Microsoft content to consumers."

That raises questions for all the portal players, which fear that Microsoft eventually could control the first screen seen by TV set-top box surfers in the same way it has come to dominate the PC real estate with its Windows operating systems. Caught in the middle are the companies that make these boxes and the chips that power them, which are preparing for a war of their own between the hardware manufacturers of the computing and consumer electronics industries.

As the battlegrounds of this new world order move increasingly from R&D labs to corporate suites, however, a decidedly old-media solution continues to be as effective as ever before: money.

Both Microsoft and AT&T had been criticized for their slowness to accept the Internet, and both have played effective catch-up with major mergers and investments. Microsoft's buying power is further enhanced by its special relationship with billionaire financier and company cofounder Paul Allen. That could make for some long odds against the AOL-Sun-Bell camp where financing is concerned.

"This is all part of Microsoft's strategy to get involved in all the layers, not just their traditional markets," said Matt Page, director of Internet consumer research for Strategis Group, a telecommunications consulting firm.

AT&T, however, has yet to prove that it can master the Internet market. Its WorldNet ISP service, once thought to be a natural winner because of the telecom giant's consumer base, has never lived up to expectations. And historically, AT&T's track record in mergers has been nothing to brag about.

Specifically, AT&T's attempts to unseat AOL in the past have been poor, said Abhishek Gami, an Internet analyst at William Blair. The phone company offered neither better services nor features, he said.

It is also important to remember that the medium AT&T is most focused on right now is the telephone, not the Web. The quickest way for the long distance giant to get back into local phone service is through two-way cable technology.

"The No. 1 priority of AT&T, exponentially, is local telephony. By the year 2004, AT&T's local telephone customers, and associated revenue, are expected to outnumber broadband Internet customers by a factor of 4 to 1," said Harris of Kinetic Strategies. He said AT&T plans to launch a trial of telephone service over cable lines in the next month in Fremont, California.

Nevertheless, the addition of Microsoft to the AT&T-TCI camp has instantly created a number of issues with profound impact for the Web: Where will Microsoft Network fit into the portal question? Will it be possible for @Home and Excite, through the newly merged company's close relationship with TCI, to cut off the other portal players? Will the branding of such PC online stalwarts as AOL and Yahoo be as powerful with new Web surfers using digital cable TV boxes?

"It's a question of who will get to be the front-end for the customer," Gami said. "Customers will probably break into two camps: Ones who are looking for faster speed or ones who are looking for better ease of use and service."

Publicly, the leading Web portals play down the AT&T-Microsoft deal and the potential divisions it implies. But such questions are clearly not far from their minds.

"From our perspective, it doesn't change the landscape," Yahoo president Jeff Mallett said, adding his company's customer loyalty is much stronger than that of any telecommunications usage. "I say it's a deeper relationship because it's a media relationship."

Forrester Research analyst Bruce Kasrel believes that AOL will flourish because of its lead in paying subscribers. "Eventually cable companies are going to say, 'We've ridden cable modems long enough--it's time to start looking at AOL's customers."

AOL, not surprisingly, agrees. "We have a brand name, and AT&T isn't as recognizable," chief financial officer J. Michael Kelly said. "Yes, they have a brand in telecommunications, but I'm not so sure it's transferable to TCI and MediaOne for the Internet space."

Of course, it doesn't hurt that AT&T owns both those cable companies--a situation that makes partnerships with the Baby Bells and their rival DSL high-speed technology all the more important for AOL and other portals. But that may be easier said than done.

Although AOL views itself as a potential catalyst to bring the Bells together for a single broadband coalition, Kelly said the task has been more difficult one than for the cable operators. "US West and BellSouth have national aspirations of their own. The cable companies don't," he said. "I think the [telcos] act more like natural competitors than allies."

Which is exactly what was supposed to happen under telecom deregulation. But the same laws that freed up this market also allowed AT&T to go on its merger rampage of the last year.

That's why many analysts believe that the new world will be mapped largely by the massive infrastructure needed to carry its content. Whether today's alignments will last even until tomorrow is anyone's guess but, at least on paper, the advantage seems to be weighted decidedly in favor of the AT&T axis.

"These are the No. 2 players being opposed by the No. 1 players," Ryder said. "What else is new?"

News.com's Jeff Quan, Dawn Kawamoto, Jim Hu, Beth Lipton, John Borland, Corey Grice, and Aimee Male contributed to this report.