Microsoft, AOL headed for final showdown

By Jim Hu
Staff Writer, CNET News.com
October 19, 2001, 4:00 a.m. PT

At an America Online staff meeting in 1994, then-President Ted Leonsis wheeled out a wooden cutout of a bare-fanged Tyrannosaurus rex meant to symbolize the company's most menacing enemy: Microsoft.

Leonsis' representation was both right and wrong. The software giant indeed presented a major threat at the time--the eve of the launch of its Microsoft Network--but its battle form would come to resemble a multiheaded Hydra more than a prehistoric monster. Rather than full-frontal assaults, Microsoft would attack from many directions simultaneously and regenerate appendages whenever they were severed.

"That's the way you win a war; you don't do it with monster battles unless you're sure you can win them," said Carl Howe, an analyst at Forrester Research. "You do it by finding weaknesses in the enemy's lines before you mount your big attack."

Although shorter-sighted thinkers initially viewed the companies as disparate media and software businesses, executives at AOL, now a division of AOL Time Warner, have long known that their counterparts ensconced in Redmond, Wash., had the same goal: to "own" the Internet user, absorbing his or her identity into a virtual world where cybercitizens travel, purchase, communicate and plan their daily lives. That concept became increasingly important as companies and Web sites began charging for content and services to survive.

AOL's route to this destination has involved drawing in consumers with dial-up Internet access, then guiding them through the rest of its features. Now Microsoft, with vaguely defined .Net strategies that will launch with its Windows XP operating system, is pursuing a similar kind of recruitment and retention, with services offered for monthly subscriptions rather than through the traditional one-time purchase of its software either directly or via computers already loaded with its products.

Windows XP and .Net are "clearly an effort by Microsoft to emulate the subscription model that has been quite successful for AOL Time Warner in all of its component parts," said John Buckley, an AOL Time Warner spokesman. "But the question is--even with their monopoly--whether they'll be more successful in their effort than they have been previously. We have a significant advantage in this space."

Another question, though, is how long that upper hand can be held.

It is true that AOL is the clear leader in dial-up Internet service, with 31 million subscribers--a total more than four times greater than that of second-place MSN. But Microsoft has managed to make significant inroads with popular technologies such as instant messaging. Windows XP promises to escalate the competition with more services in communications, multimedia and other areas that will challenge AOL on several fronts.

Moreover, for all the controversy over Microsoft's technology monopolies, AOL has been cast in the unusual role of media bully to the software company. Ever since it blocked MSN Messenger subscribers from communicating with its own IM network, AOL has been accused of thwarting efforts to devise an industry standard that would allow all chat technologies to work together.

That domineering image apparently does not sit well with the public. A survey by research company Gartner released in August indicated that consumers distrust AOL more than they do Microsoft in the handling of personal and financial information. This kind of credibility gap could become a crucial factor in the next major confrontation between the two online superpowers: the fight over so-called authentication technologies.

Controlling identities
Far more significant than any single feature of Windows XP is the broader technological architecture it will begin to test--Microsoft's .Net My Services project, formerly known as HailStorm. The "foundation service" is designed to organize all manner of personal information, from calendars to credit card numbers, while easing such online transactions as banking and shopping.

A cornerstone of .Net My Services is an authentication key called Passport, a kind of universal identification tool. It allows people to sign in to multiple sites with the same password and store such personal information as credit card numbers for online purchases at stores that agree to use Microsoft's security technology.

"Passport represents a critical control point of the Internet of the future, the place where identity will be managed on the Internet," said David Smith, a Gartner analyst. "Identity leads to all kinds of information about people. It's the keys to the candy store."

AOL is combating Passport with a similar ID mechanism called Screen Name Service. Both companies are racing to sign up leading Web sites and companies to use their respective technologies.

Some analysts say Microsoft could benefit in this area from a hesitation among many content companies to partner with AOL Time Warner. Some companies fear the media conglomerate already has too much control of distribution and could dictate absolute terms.

"Now that AOL owns Time Warner and many properties in its various vertical genres, I think media companies are far more likely to look for an agnostic distribution partner that's not invested in vertical content," said Mark Mooradian, an analyst at research firm Jupiter Media Metrix. "Microsoft can use to its advantage the fact that AOL is in every respect a media company and downplay their own 'medianess' to position themselves much more as a technology enabler and a software company."

The content conundrum
In some ways, the campaign to strike content partnerships brings Microsoft full circle to its strategy to secure exclusive access to popular Web sites. Five years ago, the company struck deals with Walt Disney, Viacom's Paramount Pictures, Dow Jones and other media companies for content accessible only through its Internet Explorer browser or MSN, only to back away from many of those arrangements under antitrust scrutiny.

Microsoft also retreated from many high-profile experiments with its own content, including the Sidewalk chain of city guides, the Expedia travel site and various MSN sites such as MoneyCentral.

Ironically, the move from content may end up helping Microsoft against AOL by returning the software company to its roots: the long-held philosophy of owning the underlying architecture needed to use applications, services and content, allowing the company to collect the equivalent of toll fees for access.

"Applications are Microsoft's greatest strength," Mooradian said. "When it started getting involved in Expedia and MoneyCentral and CarPoint, it realized that."

While AOL Time Warner hopes to attract and maintain subscribers with its family of publications and other properties, Microsoft is focusing on the convenience of its technologies. Microsoft says .Net My Services and Passport can be used through any device with access to the Web, whether it be a desktop PC or a cell phone, in direct competition with the "AOL Anywhere" initiative.

"Windows XP is an end point for .Net services," said Jim Cullinan, a Microsoft spokesman. "Windows XP is the first offering that will at the base level show a twinkle of what Web services might look like in the future."

That future, as defined by Microsoft, could bode ill for AOL's ability to expand its subscriber ranks. If Microsoft links all its software and services through .Net, it could gain a significant advantage over AOL's exposure to potential new customers.

Discs vs. the desktop
AOL walked away from negotiations to package its service's software with Windows XP this summer, maintaining that the PC desktop offers only limited opportunity to acquire new subscribers. That means AOL must rely more heavily on alternative marketing strategies such as the mass-mailing of CDs--tactics whose success is anything but guaranteed, even with the vast cross-marketing power of the Time Warner division's magazines, books, music and TV programming.

For now, Microsoft and AOL are battling one deal at a time. Each company is trying to piece together its own version of the Internet based on its authentication technology, presumably for a regular fee to subscribers.

In July, AOL invested $100 million in Amazon.com, a deal that required the online retailer to use Screen Name as its e-wallet technology instead of Microsoft's Passport. The arrangement was considered a major coup for AOL because a partnership with the Web's largest retail company could plant a significant stake in the ground against Microsoft's advances.

The software giant has responded with its own high-profile partnership. This month, it struck a deal with Disney's ESPN.com that gives MSN exclusive rights to the sports site's content in exchange for a toolbar link on ESPN's home page to other Web services. ESPN will eventually incorporate Windows Media streaming technology and adopt Passport as one authentication option.

The arrangement is reminiscent of deals in years past that have drawn antitrust objections from competitors.

"It's nothing new for Microsoft to leverage off its monopoly into other businesses," AOL Time Warner's Buckley said. "It's at the heart of the antitrust problems they have and the core of the prosecution of Microsoft by antitrust regulators in the United States and Brussels and beyond. It's also nothing new for Microsoft to desire to play in AOL's space."

Yet AOL Time Warner faces antitrust questions of its own, a concern that Microsoft has raised repeatedly. During the federal government's review of the AOL-Time Warner merger last year, Microsoft pointed to its adversary's previous moves to keep other chat networks from working with AOL Instant Messenger.

Microsoft Chairman Bill Gates himself met William Kennard, then chairman of the Federal Communications Commission, to complain about AOL's dominance and the need for interoperability. Instant messaging will remain a major point of conflict between the two companies after the launch of Windows XP, which will offer a new version of the technology that has audio, video and text collaboration features embedded in the operating system.

Still, AOL is well aware that two can play the antitrust game, and it is more than willing to turn the tables on Microsoft. Already, sources on Capitol Hill say AOL lobbyists have begun analyzing .Net and .Net My Services for possible competitive concerns.

In addition, some in the industry believe Microsoft might face a backlash in charging subscribers, developers and Web sites for use of .Net My Services--a possibility that could tip the scales in AOL's favor.

"Microsoft is kind of breaking the rules and saying, 'We're going to charge everybody for everything,'" Howe said. "AOL's opportunity is to use a pure media business model for their services, to do a pure subscription model for other services, and not to go do the charge-everyone-for-everything pass."  

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