Signs of the challenge came just days before the launch of Windows XP, when Yahoo released an upgrade to its service that effectively hijacks Microsoft's Internet Explorer browser.
Called "Yahoo Essentials," the add-on exploits little-known customization features in IE and the Windows operating system. It takes over searches in the browser address bar, switches the default e-mail client to Yahoo Mail, embeds its instant messenger within the IE window, adds a Yahoo toolbar below the standard IE menu, places a shortcut to Yahoo Mail on the PC desktop and offers to set the home page to Yahoo.com.
IE settings by default point to Microsoft services such as MSN Search and have served as key "hooks" to drive consumers to its products. Although knowledgeable users have long been able to tinker with the browser settings and choose rival offerings, there is little evidence to suggest large numbers of people have taken advantage of those features to date.
All of that may have changed Tuesday, however: Yahoo's aggressive move could turn the browser into a tool that drives millions of consumers to its own sites rather than to Microsoft's. If successful, copycats could emerge that also seek to take over IE, threatening to spark a renewed tug-of-war over the browser interface that could wipe out much of Microsoft's inherent advantage in controlling the underlying software.
"I think Microsoft is probably a little embarrassed," said John Corcoran, an analyst at CIBC World Markets. "They're typically the one in the driver's seat when it comes to this sort of thing. Microsoft has a lot of control with the operating system and the browser, but this shows that not everything was sewn up perfectly."
Renewed jostling over IE will require some deft footwork from Microsoft, which faces limits on its business after an appeals court upheld findings that it owns an illegal monopoly in desktop operating systems.
The company clearly hopes to use its dominance in the operating-system and browser markets to push services such as MSN, its Passport authentication service and its Hotmail Web-based mail service. At the same time, it has been at pains to prove its practices are consumer-friendly and that it supports an open environment for developers.
Customization in IE serves the second goal but could devalue its heavy investment in the browser--technology it has deemed essential for its long-term survival.
Microsoft would not comment on Yahoo's power play. Yahoo also would not comment on whether Yahoo Essentials intentionally exploits IE's ability to customize as a competitive move against Microsoft. The new service does not appear to alter other Web browsers such as AOL Time Warner's Netscape.
Rachel Rogers, the producer for Yahoo Essentials, said the company was simply responding to the wishes of its customers.
"This product answers the demand from our customer base and (gives) the best of Yahoo in one simple download," Rogers said.
But analysts predict Microsoft may quickly change its interface to limit competitors' ability to tinker with IE settings on behalf of consumers.
"It would not surprise me if all of a sudden those interfaces changed," said Carl Howe, an analyst at Forrester Research. Yahoo has "got to be careful when they go down this road."
From browser to Web site
Microsoft has always viewed the Web browser as a powerful platform that it needed to control. In the mid- to late 1990s, Microsoft engaged in its infamous battle with Netscape Communications, now owned by AOL Time Warner, which landed it in federal antitrust hearings. Netscape executives gave key testimony that alleged Microsoft used its Windows monopoly to take market share from rival technologies.
Microsoft, however, touted its ability to open its IE technology to other companies, letting them mold the browser to their own image. Even Microsoft's chief competitor, AOL Time Warner, has used IE as its default browser technology for years in its AOL Internet service, which has the largest number of paid subscribers in the world.
Microsoft also released versions of IE that let people change their settings. In IE 5.5, for example, people can change their default search engine to rivals including Yahoo, MSN, LookSmart, Lycos, AltaVista and GoTo.com. To do so, people must click the "search" button on the browser, and then click "customize" to scroll down a list of search engines. Once one is chosen, IE's address bar and its search button all yield results from the chosen engine.
Although the option to change it is there, being the default has its advantages.
"I think part of the power of owning the browser is that Microsoft was able to take advantage of consumer behavior, which is inherently lazy," said Mark Mooradian, an analyst at Jupiter Media Metrix. "That's behavior that ultimately nets Microsoft great numbers, and software like (Yahoo Essentials) eats into it."
Despite its overtures, Microsoft has not shied from exploiting the power of the Web browser, which is one engine in a network of software products that are becoming increasingly entwined.
Yahoo, which has been in close competition with Microsoft's MSN service for many years, is beginning to feel the effects of the software giant's practice of "bundling" various products. Recently, Microsoft began redirecting DNS (domain name system) error pages, which usually occur when a Web address is typed incorrectly into the address bar, to MSN Search pages. MSN also is prominently featured throughout Windows XP and its accompanying software applications, which all have links to the portal.
To show the success of such moves, Microsoft has launched a publicity blitz touting its traffic figures in comparison to Yahoo and AOL. This month, for example, Microsoft cited a Jupiter Media Metrix report that showed more people used its search engine than Yahoo's in September. Microsoft typically uses these numbers to sell advertising, but it also is anxious to show the world that an increasing number of people are using Microsoft's software for their entire Internet experience.
Through thick and thin
The browser remains a crucial part of Microsoft's plans to create a business that relies on subscription software services. That means adding more links to Microsoft-sponsored Web services through every bit of software created by the company.
Already, Microsoft has been taking steps to integrate IE more deeply with its other products and services. This past year, for example, the company has been testing an alternative version of the browser called MSN Explorer that is closely tied to its MSN Internet service and its Windows Media Player. MSN Explorer offers relatively little flexibility compared to IE, and analysts expect the company may push that browser more heavily following Thursday's release of XP and an updated version of MSN.
"Over the next two years we're going to see IE become less and less important to Microsoft," said Matt Rosoff, an analyst at Directions on Microsoft, an industry analysis group. "They're really pushing the idea of 'thick' clients as opposed to 'thin' clients."
In industry parlance, a thick client is software that has more offerings and services bundled into it. Thin clients, such as IE, act as industrywide tools rather than proprietary software.
That means Microsoft could simply dismiss Yahoo's maneuvers as too little too late. The question is whether the software giant will look forward or take action to protect its current product.
"I think the company first and foremost wants to be a technology provider and will do whatever necessary to fulfill strategy," said David Smith, an analyst at Gartner. "Their goal is profit. And when openness fits that goal, that's fine; and when it doesn't, it won't be."