Microsoft-AOL war heats up over Net access

Microsoft Corp.'s continuing attempts to loosen America Online Inc.'s grip on millions of instant-messaging customers is the latest skirmish in what promises to be a long, costly war between the No. 1 software maker and the No. 1 online service.

Microsoft's next target: AOL's dial-up Internet-access business, the $21.95-a-month (£9.95 in the U.K.) service for more than 17 million customers that accounts for about two-thirds of AOL's revenue. Microsoft executives are laying plans to hasten the trend toward low-price, or even free, Internet access. The trend threatens AOL much more directly than Microsoft, which has only about two million Internet-access subscribers.

"We intend to be aggressive with access," said Brad Chase, vice president of Microsoft's new consumer and commerce Group and the point man for Microsoft's new strategy. "AOL might think about it as a profit centre. That's not how we think about it."

It is unclear whether Microsoft's latest attempt to tackle AOL will be more successful than prior efforts. In 1995, the Microsoft Network was launched as a proprietary online service to compete directly with AOL. AOL howled when Microsoft unveiled plans to bundle the service into its Windows 95 operating system; as it turned out, the tactic was ineffective. Microsoft eventually moved the service to the Web, where some online properties have found success, but has done little to dent AOL's lead.

Microsoft says it is more serious this time. Chairman Bill Gates and President Steve Ballmer have generously funded the new plan, formulated in the past six months, in large part as a protective measure for Microsoft's core software business.

AOL's dominance in online services gives it the opportunity to become an alternative software "platform," threatening the dominance of Microsoft's Windows operating system. Internal AOL documents disclosed in Microsoft's antitrust trial indicated that was exactly AOL's intention. AOL executives have distanced themselves from such statements, but Microsoft executives point to a recent comment by Steve Case, AOL's chief executive: "Windows is the past. In the future, AOL is the next Microsoft."

AOL executives say they are prepared for any Microsoft counterattack. "Microsoft has been very successful in being a big infrastructure player -- that's their strength," said Bob Pittman, AOL's president and chief operating officer. "Consumers are our strength."

The squabble between Microsoft and AOL over instant messaging shows how ferociously the online giant intends to defend its turf. Instant messaging allows users to conduct private online chats in real time, without the delays of e-mail. Microsoft last month introduced MSN Messenger to compete with AOL's Instant Messenger service, which has attracted 40 million subscribers; AOL's separate ICQ service has 38 million users.

Microsoft thought it could piggyback on AOL's success another way: by allowing users of MSN Messenger to exchange messages with users of AOL's service. The move outraged AOL, which quickly blocked Microsoft's efforts to let its chatters hook into AOL servers, the computer hubs that coordinate instant-messaging traffic. AOL said it never gave Microsoft permission to access the servers.

Microsoft, for its part, called the defensive measures hypocritical, since AOL has lobbied elsewhere for open access to cable-television and other networks. Microsoft has since rallied industry executives to push AOL's Mr. Case to open the company's proprietary instant-messaging service. According to AOL executives, the cat-and-mouse game has continued this week, with AOL jamming every workaround Microsoft created to get into its servers.

Although AOL admits the service isn't profitable, a closed instant-messaging system helps the company maintain a captive audience and build a platform for future audio and video services. "It's about loyalty," said Lisa Buyer, an analyst with Credit Suisse First Boston. "Clearly AOL is the one to beat," said David Readerman, an analyst at Thomas Weisel Partners, a merchant bank in San Francisco.

Microsoft has already launched its strategy to help drain profits from the Internet-access business. The company's deals with retailers and PC makers to offer customers bounties of $400 in return for three-year MSN service contracts has boosted sign-up rates by 50%, the company says. The company also has tested a price point of $9.95 a month and is considering offering free service to consumers who commit to a certain level of spending with Microsoft's electronic-commerce partners.

Microsoft also is pondering plans to consolidate the fragmented Internet-service market and broaden its cut-rate offerings. According to people familiar with the situation, Microsoft has discussed purchasing or partnering with a number of large Internet-service providers, including EarthLink Network Inc. and MindSpring Enterprises Inc., and partnering with PC makers such as Compaq Computer Corp. and Dell Computer Corp., which have launched their own access services.

To finance such efforts, Microsoft is considering the creation of a "tracking stock" to reflect its Internet-related businesses. Because the stock market has valued such stocks based on revenue, rather than profit, the tracking stock could absorb large losses without hurting the value of Microsoft's core businesses, said analysts.

Microsoft has used price cuts before, first to catch up to Lotus Development Corp. in the spreadsheet market, and later to overtake Netscape Communications Corp. in Web browsers. And the company has demonstrated its willingness to spend heavily. Executives say its $5bn investment in AT&T Corp. and $600m (£365m) stake in Nextel Communications Inc. will help the company gain a footing in the emerging broadband and wireless online-services markets.

But AOL executives insist even Microsoft won't be able to lose money on Internet access forever. "There are economics in the access business and everyone's got to play by economics," said Barry Schuler, president of AOL's interactive-services group.

AOL also points out that existing free-access plans and rock-bottom access prices from other service providers haven't slowed its own torrid growth. In fact, AOL last year actually raised prices for its unlimited-access plan to $21.95 from $19.95 and claims to be adding new subscribers faster than ever. "People don't buy on price," Mr. Pittman says. "They buy on value."