Digital media hottest turf on Internet

"The big battleground in software is going to be the media player itself. The media player will become a more important link to own than the browser, and Microsoft recognizes that."

Chris Charron, an analyst for Forrester Research

The corporate armistice declared last week between Microsoft and AOL Time Warner reflected two companies moving from the past to the future.

The abandoned past included a last lingering vestige of the Internet browser wars of the 1990s, a civil antitrust suit that Microsoft has now agreed to pay AOL Time Warner US$750 million to settle.

The future involves using the Internet to deliver commercial program content, mainly movies and music, to consumers who are equipped with a growing array of digital devices to receive it, from personal computers to digital televisions to smart mobile phones. And the two companies must do so in a way that is convenient for users and profitable for media companies, while keeping digital piracy to a manageable minimum.

Bill Gates, the chairman of Microsoft, and Richard Parsons, his counterpart at AOL Time Warner, spoke last Thursday about how their collaboration could accelerate the adoption of digital media for the Internet while maintaining copyright protection.

Rich media

The central technology in pursuit of that goal is the software for handling and protecting digital media. And last week's pact included a long-term, nonexclusive license agreement allowing AOL Time Warner to use Microsoft's Windows Media software for distributing and playing back digital media.

The media player is the crucial piece in the puzzle. It resides on the user's computer or other device and opens a portal to what the industry calls rich media -- movies, music, video -- delivered over the Internet, just as the browser is a portal for viewing Web pages. The media player takes on additional importance because it seems to be the likely vehicle for some of the vital technology in the emerging field of digital rights management -- a fancy name for piracy protection.

"The big battleground in software is going to be the media player itself," said Chris Charron, an analyst for Forrester Research, a computer industry research and consulting company. "The media player will become a more important link to own than the browser, and Microsoft recognizes that."

Can Microsoft dominate the market for digital media distribution software as it came to dominate the browser market?

The media-player market today looks quite similar in some ways to the browser market in, say, 1997. An early media-player leader, Real Networks, is under pressure from Microsoft, just as the commercial pioneer of the browser market, Netscape, was then.

Microsoft its digital media software with its Windows operating system, a monopoly product running on about 95 percent of all personal computers. As for user acceptance, at the moment Microsoft's player is neck and neck with Real Network's Real One Player, with each having more than 300 million registered users.

But Real Networks, founded in Seattle in 1995 by Rob Glaser, a former Microsoft executive, is an embattled challenger. It lost US$2.8 million on revenue of US$47 million in the first quarter of this year, bringing its cumulative loss since it started to US$261 million. A former highflier on Wall Street that raised a lot of money early, Real Networks still has US$320 million in cash, so it has financial staying power for a while, but it must find a way to make money.

Yet there are significant differences between the markets for digital media software and browser software. One is simply the legal legacy of the browser wars. A federal appeals court has ruled that Microsoft repeatedly violated antitrust laws in its campaign to thwart the challenge that Netscape at one time seemed to pose to Microsoft's desktop monopoly. Last week's US$750 million payment was to settle a related civil antitrust suit brought by Netscape, which AOL purchased in 1999.

In a criminal antitrust settlement last year with the government and several states, Microsoft agreed it would no longer bully industry partners and others to choose its software over competitors' offerings. So some of the tactics Microsoft used in the browser battle should no longer be in the Microsoft arsenal.

Less monopoly power

More importantly, the nature of the market for media software is different. For a browser maker, the crucial relationship -- and channel of distribution -- was with the PC makers, who were beholden to Microsoft because of its Windows monopoly. In digital media software, by contrast, the crucial relationship is with the owners of the content, the big media conglomerates, who have plenty of independent power and are not beholden to Microsoft.

Significantly, the long-term licensing deal included in the cooperation pact last week between Microsoft and AOL Time Warner was not exclusive. AOL Time Warner has been working with Real Networks for some time and will continue to do so.

The chances that AOL Time Warner will adopt Microsoft's technology are a lot better today than they were a week ago.

"It's hard to be a partner with someone who is holding a gun to your head in court," said Will Poole, a Microsoft senior vice president responsible for Windows and its digital media software.

But the agreement is by no means a guarantee that Microsoft will become AOL Time Warner's preferred media software supplier.

"We don't ask for exclusive deals in this space," Poole said.

Indeed, most major media companies are expected to deliver their movies and music formatted for both the Real Networks and Microsoft media players. For example, Movielink is a movie service set up last November by five Hollywood studios, including Warner Brothers. It charges US$3 to US$5 for movies sent over the Internet, and uses both Real Networks and Microsoft technology.

Though Real Networks and Microsoft are the leaders, there are other competitors in the field, and some big potential entrants. Apple Computer offers QuickTime media software, and with the recent introduction of Apple Computer's iStore online music sales service, first for Macintosh computers and later for Windows PCs, the company is becoming a more serious competitor.

Big electronics companies like Sony, Phillips and Matsushita are also working on some software elements, like the MPEG-4 digital movie standard. Sony is also building up its capabilities in the digital rights management area; it created a stir in the software industry last year when it paid US$28.5 million to license digital rights software and patents for InterTrust, a struggling startup.

It seems doubtful that either the major media companies or the consumer electronics makers would allow themselves to become overly dependent on Microsoft technology.