Microsoft wins in digital media

AOL Time Warner's settlement with Microsoft on Thursday brings the software giant a powerful ally in extending its digital media technology--part of Microsoft's plan to keep Windows the world's dominant operating system and to expand onto new devices.

The deal allows--but does not require--AOL Time Warner to use Microsoft's Windows Media 9 Series software and future versions of the multimedia technology, including its digital rights management (DRM) tool for securing music and video files from piracy.

Despite the open-endedness of the terms, the deal represents an important victory for Microsoft, which has tried for years to overcome reluctance from AOL Time Warner and other media companies to embrace its digital media technology over that of rivals, notably RealNetworks and Apple Computer.

"This is a huge win for Microsoft," Gartner analyst David Smith said.

The deal comes just weeks after Apple opened its iTunes Music Store, selling millions of downloads and putting Microsoft on the defensive.

While AOL Time Warner has announced no specific use for the Microsoft technology in the deal, analysts said it is likely just a matter of time before the company begins announcing products and services that rely on Windows Media--for example, in a digital music download store or in an Internet video-on-demand service. AOL Time Warner's Warner Music Group includes a group of record labels that together control one of the five largest collections of music rights in the world.

Broadly, the deal suggests that Microsoft and AOL Time Warner are untangling their competitive interests over technology. In the past, the two have clashed on a number of fronts in this regard, offering competing Web browsers, streaming media technology and instant messaging services, for example. Thursday's settlement lays the groundwork for cooperation in all of these once-contentious areas.

"This signals detente," said Matt Rosoff, analyst at Directions on Microsoft. "The companies are diverging. AOL no longer sees itself as a technology company. It will use whatever products make sense."

Microsoft has poured hundreds of millions of dollars into developing digital media security technology in a bid to convince media

		News.Commentary Setting the pace for digital media Consumers, not Microsoft or AOL, will drive digital media, despite the companies' blockbuster deal.

companies to adopt its formats for emerging entertainment products and services. The software giant has wooed customers using tried-and-true methods honed during the browser wars with Netscape, including bundling its technology with other products at no extra cost.

Still, it has taken years for the company to chip away at the lead established by RealNetworks in technology for distributing real-time audio and video, known as streaming media. Its Windows Media formats are still only a footnote in the world of music downloads, where the MP3 format rules supreme. And Microsoft has suddenly found itself playing catch-up to Apple in the race to develop commercially viable digital music services.

The AOL Time Warner settlement is the latest sign that Microsoft is gaining momentum in an arena that could ultimately reap enormous profits. These would come through sales of the server software used to encode and distribute music and video, as well as from licensing fees from hardware makers who agree to support those formats. In recent months, Microsoft's technology has increasingly found a foothold in DVD players, portable music players, home entertainment networks and other consumer-electronics devices.

Rich Gray, an antitrust attorney in Silicon Valley who's tracked Microsoft's antitrust battles, said the agreement opens up the possibility of an alliance with a major media company at a time when legal issues related to digital technology are still being hashed out.

"It will be interesting to see whether the arrangement about digital media is just a fig leaf or a meaningful alliance," he said.

Changing relations
AOL Time Warner had long been a Microsoft holdout, endorsing RealNetworks' technology and, more recently, developing its own internal streaming tools for its Internet radio services. But the alliance with RealNetworks has shown signs of stress as RealNetworks has established itself as an aggregator of paid online video content through its RealOne subscription service, which increasingly competes with new features in the broadband version of America Online's Internet service.

RealNetworks downplayed the announcement, saying AOL will continue to use its technology.

"We don't think it means anything for Real," said Dan Sheeran, vice president of marketing at RealNetworks. "What's important is not that AOL may support Microsoft technology because it's already there as part of the operating system. What's important is that they include us, which is what they're doing and what they plan to keep doing."

AOL has also been tightening its ties with Apple, giving the computer company a coveted berth in its instant-messaging network and raising the prospects of a possible AOL-Apple alliance on digital music--although Thursday's settlement now makes such a collaboration less likely. Apple declined to comment.

AOL has been stocking up on alternative digital media formats of late, including audio technology called Dolby AAC (Advanced Audio Coding), which is endorsed by the MPEG standards group, and video technology from start-up On2. Those deals, as well as its existing relationship with RealNetworks, could leave the company a back door if it begins to chafe under Microsoft.

In the meantime, AOL finally appears ready to cozy up to its longtime adversary.

"This agreement underscores both companies' deep commitment to developing solutions that expand consumer choice and access to high quality content and, at the same time, create new opportunities for content owners and promote innovation," said Will Poole, a senior vice president at Microsoft.

News.com's Lisa M. Bowman contributed to this report.