The talks broke down as Microsoft is rushing to complete the final coding for Windows XP, a version of its operating system that's in the final stages of user testing. The product is on a tight production schedule so it can be released on Oct. 25, just before the start of the crucial holiday shopping season.
Microsoft has said it plans to bundle Windows XP with an Internet phone, video conferencing program and instant messaging software. It will also enable computer users to send messages from PCs to cellular phones and hand-held computers.
The negotiations exposed deep differences between the world's No. 1 software maker and the media giant.
Besides the dispute over digital media formats, Microsoft also sought a guarantee that AOL-Time Warner wouldn't lobby lawmakers, complain to antitrust enforcers or bring legal claims alleging that Windows XP violated antitrust laws, according to people familiar with the talks.
The partnership is breaking down at a time when Microsoft is developing new services on the Internet under an initiative that it's dubbed ".Net" The .Net strategy will boost competition between Microsoft and AOL-Time Warner as they race to exploit the potential of electronic commerce on the Internet.
Microsoft has developed Windows XP based on the assumption that that a US appeals court won't restrict its ability to bundle new features into the PC operating system.
Microsoft appealed a federal judge's order that it be broken into two companies for illegally defending its Windows monopoly.
It also appealed US District Judge Thomas Penfield Jackson's finding that it violated antitrust laws by bundling the Internet Explorer web browser into Windows to foil competition from Netscape Communications Corp, now part of AOL-Time Warner.
The appeals court, which previously ruled in Microsoft's favor on the bundling issue, could issue its ruling any day.
Among the issues in the talks was Microsoft's demand that AOL-Time Warner give up its right to sue the software giant for damages to Netscape. Jackson had found that Microsoft sought to push Netscape's Navigator Web browser out of the market by bundling a free copy of Internet Explorer into Windows.
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