Will AOL miss the window for Windows XP?

AOL Time Warner may miss the chance to bundle its online service software with Windows XP, according to sources close to negotiations between the media giant and Microsoft.

Meta Group says as computing becomes more widely connected, Microsoft and AOL are wrestling for control of the user experience, not the user interface per se. see commentary

Each company has different reasons for wanting to see the AOL software ship with Windows XP, as it did with earlier versions of the operating system. But one source close to the negotiations described the positions as "far apart" and warned that "time is running out."

The problem is meeting Microsoft's development schedule for Windows XP, which is slated to go on sale at retail stores Oct. 25. Microsoft will deliver another test version of Windows XP this week featuring the new Windows Messenger technology announced Monday. The first release candidate--or nearly final code before release to manufacturing--is expected later this month.

Because there are still technical issues to be worked out to ensure the AOL software is compatible with Windows XP, the two companies must resolve their differences soon, said sources close to the negotiations. Resolving the technical problems would be contingent on reaching a broader business agreement, the sources said.

Microsoft and AOL Time Warner are engaged in talks to renew a five-year bundling arrangement that expired in January. That agreement made Microsoft's Internet Explorer the default browser for the AOL service while guaranteeing the online software prominent placement on the Windows desktop.

But increasing tension between the two companies' business objectives, changes to how Microsoft regards the Windows XP desktop, and differences over instant messaging and media player software have jeopardized the negotiations.

"We're pleased to be back at the table, and if it's possible to have a developing, mutually beneficial agreement we would be pleased to do so," said Microsoft spokesman Jim Cullinan.

AOL Time Warner refused to comment on the negotiations.

Sources close to the discussions said the companies agreed to several meetings over 30 days with an initially planned conclusion date of June 1. Discussions took place in Dulles, Va., where AOL Time Warner is based, and in Redmond, Wash., where Microsoft is located. More recently, the two companies have been meeting in Denver.

At this point, the discussions do not involve senior executives, said sources familiar with the negotiations; technical, legal and business teams are working through issues dividing the companies. Given the level of the discussions and continuing delays reaching an agreement, negotiation sources said it will soon be too late technically to get the AOL software ready to be included with Windows XP.

Both companies have much to lose should a deal fall through, warn analysts.

"There are obvious benefits for both companies here," said Gartner analyst Neil MacDonald. "But we have ongoing battles on multiple fronts. This one gets all of the attention because of the bundling issues with Windows XP and because of the time constraint."

Renewal of the agreement would mean Microsoft would continue to ship AOL Time Warner software with Windows, putting it on equal footing with MSN Explorer. Microsoft would benefit from access to nearly 30 million AOL subscribers, all of which are potential Windows XP customers.

During a meeting to discuss Microsoft's Windows Messenger technology, Shawn Sanford, Windows group product manager, addressed AOL and Windows XP.

AOL is an "extremely important" software developer, he said. "From the product team and the development team, we spend a lot of time to ensure that AOL users have a great experience with Windows XP. So from (development) and test engineer stuff, we are continually working with AOL to make sure their client and their technology works on Windows XP."

Tit-for-tat spat

Neither side appears to be giving much ground--at least for now, said negotiation sources. Sources on both sides of the discussions indicated the other seemed less than serious about reaching an agreement.

Still, some analysts did not rule out the possibility of a last-minute deal.

"Microsoft is playing hardball, which is typically what they do in contract negotiations," MacDonald said. "So I would not rule out their reaching an agreement just because both sides appear divided."

For its part, AOL Time Warner contends Microsoft violated the original 1996 contract and has no grounds to negotiate new terms. The Internet and media giant also would like prominent placement on the Windows XP desktop. In previous consumer Windows versions, a link to AOL software appeared in the folder "Online Services," which was placed on the desktop.

But with Windows XP, Microsoft is trying to reduce icon clutter on the desktop. In Windows XP Beta 2, for example, only three icons appear by default on the desktop: a link to run software in compatibility mode for older Windows versions, another to submit a bug report, and the "Recycle Bin" for deleted files. In the past, five or more icons typically appeared on the desktop after a Windows installation.

Microsoft's problems with AOL Time Warner are not new. One hot-button issue is the interoperability of IM clients. AOL Time Warner has effectively blocked Microsoft's MSN Messenger and other competing products from connecting with AOL Instant Messenger (AIM).

Although sources closer to AOL Time Warner said both sides agreed to defer IM interoperability to a later time, other sources insist this remains a major stumbling block to any agreement.

The software giant also wants AOL Time Warner to back off lobbying regulators and trustbusters in Washington, the 50 states and the European Union to further their legal attacks against Microsoft.

"These guys are going to regulators in D.C. and abroad lobbying against the same product they want distribution with," said one source that asked not to be identified. "Is this the foundation on which you build a new partnership?"

The companies have made some progress in addressing technical hurdles in bundling the two products, however. At one point, for example, there were concerns that there was not enough room on the Windows XP installation disc for AOL's software, an issue that one source familiar with the talks said is no longer a problem.

Several larger issues remain.

One of the most serious, according to people familiar with the negotiations, concerns AOL Time Warner's choice of media player. With Windows XP, Microsoft is taking a more aggressive position with Windows Media Player. Version 8, which offers new CD burning and DVD playback capabilities, will be available exclusively with Windows XP, according to Microsoft.

But the AOL software exclusively uses RealNetworks' competing RealPlayer for media streaming and viewing. Sources close to both sides said Microsoft does not want to distribute a competitor's software and wants AOL Time Warner to at least offer support for Windows Media file formats.

"AOL granting Windows Media is hugely valuable for Microsoft, and Microsoft offering distribution for AOL--like it or not, Microsoft has a dominant place on the desktop and can potentially be incredibly valuable for AOL in terms of distribution," said Mark Mooradian, an analyst at Jupiter Media Metrix. "You have to believe that distribution of AOL through Windows is still pretty important" for AOL.

But other sources suggested Microsoft wants more: to see RealPlayer replaced with Windows Media Player. With an appeals court ready to rule on Microsoft's antirust case any day, that appears to be a bold move.

But maybe not, said Andy Gavil, antitrust professor at Howard University School of Law.

"It really comes down to some very specific facts," he said. "There is nothing wrong with AOL making a business judgment they want to replace one software with another software, even if it comes from Microsoft. That would totally be legitimate competition."

But he cautioned, "The devil is in the details. The question is: Are they in any way having their arm twisted to take a product that is in fact not as good as the RealNetworks product because of Microsoft's dominant position in other markets? That may not be as clear as it would seem."