More on Microsoft: A Window on the AOL/Microsoft Rivalry

Originally published July 4, 2001, Knowledge@Wharton

In 1996, America Online carpet-bombed the nation with 3.5-inch floppy disks in a battle to build its brand and grab more of the online services market. At the same time, Microsoft Corp. waged “the Browser Wars,” the media’s moniker for the struggle between established Netscape Navigator and upstart Internet Explorer.

In those days, the two companies were vicious rivals. AOL then helped sow the seeds that blossomed into the government antitrust suit against Microsoft. AOL Chairman Steve Case hammered Microsoft, demanding equal access to the consumer’s computer desktop, referring to it as the “dial tone” of the online services industry. Microsoft Chairman Bill Gates volleyed back, quoted as saying he would either buy AOL or bury it.

From this discord came an unlikely pairing: A partnership between Case and Gates, between AOL and Microsoft. The deal was simple: AOL got access to the Windows 95 desktop – and more customers – because Microsoft bundled AOL software with its operating system. This element of the deal came in spite of Microsoft’s efforts to establish its own proprietary online service, the Microsoft Network, and build it into the Windows desktop.

Meanwhile, Microsoft’s Internet Explorer became the built-in web browser in AOL’s consumer software – an immediate boost to Microsoft in the browser market. That deal point prevailed in spite of AOL’s existing partnership with – and later, its $10 billion acquisition of – Netscape.

“There was a high level of acrimony then as well as now,” said Dwight Davis, a vice president at Boston-based research firm Summit Strategies, but “both companies were being pragmatic then.”

If pragmatism carried the day in 1996, something else entirely was at work on June 16, when the two companies ended talks to renew the five-year deal. Their irreconcilable differences ranged from litigation immunity to audio software disputes. What was the difference? Why did two corporate enemies decide they needed each other 1996, but not in 2001? And what lessons are there in the discussion of then and now?

For some, the lessons are simply this: All’s fair in love and war – and business. Customer care is paramount, and if that means partnering with a rival, so be it. Furthermore, company strategists must always remember the goals of the partnership, evaluate that partnership and be prepared to end the partnership when the goals are met.

“Rivals should cooperate in domains where the value of cooperation complements company goals and where the downside is limited,” said Raffi Amit, director of Wharton’s e-business initiative. For AOL and Microsoft, Amit said, “There was lots of downside then – and now there’s more downside – but the upside was substantially, substantially higher then than it is now.”

Most agree the 1996 Microsoft-AOL partnership was a win-win for the two companies. In 1996, AOL claimed nearly 7 million members, compared to Microsoft Network’s 1.5 million. Meanwhile, Netscape claimed more than two-thirds of the browser market. Now, AOL membership has more than quadrupled; membership on Microsoft’s slimmed down MSN service has more than tripled to 5 million. Navigator is an also-ran to Explorer.

Each side got what it wanted. The question then becomes, do they still need each other? “I think the answer is yes,” said David Strom, an Internet consultant and author who has followed both companies as a consultant and tech writer for Forbes, PC Week and CNET. For Microsoft, Strom added, the upside of a new partnership is showing that it’s not a monopolist. For AOL, in spite of reporting membership of 30 million members this month, “they still need to get to 100 million. And they still need to be on the (computer) desktop – with the latest version.”

Presence on the desktop was high on the list of issues that a renewed partnership needed to resolve. Microsoft wants to slim down its desktop offerings and “start” menu options in Windows XP, its latest operating system, due in October. But AOL wants to maintain access to Windows users by seeking space in the “start” menu.

Another key issue: Microsoft’s demand that AOL users get equal access to the Windows Media Player for streaming audio and video. AOL has an exclusive relationship with RealNetworks Inc. to embed its RealPlayer in AOL.

Microsoft also wanted assurance AOL would not sue over any Windows XP issues it may consider anti-competitive. Two other unresolved issues included 1) continued incorporation of Internet Explorer into AOL’s software and 2) bridging the gap between dominant AOL Instant Messenger and Microsoft’s MSN Messenger Service, giving users of both the ability to chat across platforms. It was the lawsuit issue, however, that “may have been the poison pill on this deal,” said Davis, who follows Microsoft strategy in his research.

The landscape for the two companies has changed considerably since 1996. Both have struck out in different strategic directions. Back then, Microsoft held deeper aspirations for content and media plays, investing heavily in such ventures as Carpoint, Expedia and, eventually, its cable partnership with NBC television, MSNBC. Instead, Microsoft has invested heavily in its .NET strategy – a proprietary software platform for web services based on the XML formatting language.

Steve DelBianco, vice president for corporate affairs at the Association for Competitive Technology, a Washington-based lobbying organization, noted that “.NET is Microsoft’s attempt to return to its roots as a software company” which suggests that both companies aren’t as competitive with each other as they once were. Even Microsoft CEO Steve Ballmer, in a January speech, minimized AOL as a competitor. Ballmer told Morgan Stanley Dean Witter representatives that the open-source software phenomenon of Linux is “threat number one” to his core business. Oracle and Sun, Ballmer said, are companies he wants market share from. “I’d put AOL at that level or a half step down.”

Meanwhile, AOL always envisioned itself as something more than an online service. While its focus in the last five years has been on building membership and the quality of its online service, its merger with Time Warner firmly positions Steve Case as a media mogul. “AOL evolved into a very different company than it was,” said Ed Black, president of Washington lobbying group Computer & Communications Industry Association. “Microsoft has evolved in predictable ways.”

Typically, Amit said, rival companies can partner effectively where they have less competitive overlap. Cooperating in noncompetitive areas may help companies serve customers in the competitive areas. The AOL/Microsoft example seems to fly in the face of that conventional wisdom; in the 1996 deal and the proposed renewal, most partnership points involved areas of overlap.

Still, Black and DelBianco – on opposite sides of the Microsoft fan club – agree with a host of others in the media who saw plenty of good reasons for AOL and Microsoft to continue their relationship. [Black’s organization supports open-source software development and is strongly in favor of the antitrust judgment against Microsoft. Microsoft is a key member of DelBianco’s organization.] In the new Microsoft operating system, for example, “You’ll have to work hard to get to AOL,” Black said. “In fact, you’ll have to work to get anywhere Microsoft doesn’t want you to go.” That, combined with Microsoft’s desire to gain more market share – and potential revenue – from distribution of the Windows Media Player is reason enough for both to extend the partnership.

Microsoft has other issues to consider. Instant messaging software, for example, is a feature that can be incorporated into the Windows XP operating system – another reason for existing Windows customers to upgrade. But the value of that feature is diminished if MSN Messenger members can only chat within that network. Further, as Strom suggested, working with a company like AOL could diminish Microsoft’s reputation for being anti-competitive – a benefit in the marketplace as well as legal and political circles.

For AOL’s part, losing out on this deal may give MSN a boost as the sole service available from the new Windows desktop. “Earlier, Microsoft had de-prioritized MSN. Now it’s coming along like gangbusters,” Black said. The lingering question is whether AOL cares and whether the 1996 deal was sufficient to meet its goals.

“You go into a deal with a rival with eyes open,” said DelBianco. “Put time limits on them. Reevaluate them frequently to make sure they meet objectives. Once you’ve fulfilled those objectives, it might be time to move on.” It’s possible both companies felt they had done what they needed to do with each other.

DelBianco notes another lesson from the AOL/Microsoft partnership: Dealing with a rival on one playing field doesn’t mean you can’t go to war on another. AOL helped the government in its antitrust case against Microsoft, acquired Netscape Communications and acquired the ICQ instant messaging software – all during the course of the 1996 agreement. At the same time, Microsoft’s MSN hammered AOL during its history of service outages, rate changes and busy signals, seeking to grab a share of its customer base – most recently, this month, when AOL said it was raising its rates by $1.95.

The news that the companies had scuttled their talks had the definite ring of finality, but some issues are still unresolved. No word yet, for example, on whether AOL will strip Internet Explorer from version 7.0 of its software, due this summer. “It pays to be pragmatic, even if emotionally and institutionally everything your instincts say are to walk away and all-out compete,” Davis said. “You have to weigh the options and look for the good as well as the bad.”

Copyright © 2001, Knowledge@Wharton

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