Competitive Intelligence / Competitive Strategy, by Arik Johnson
by Arik Johnson

Clash of Titans Makes Strange Bedfellows -- What does the AOL-Netscape Merger mean for Microsoft?

Pop quiz! You're Bill Gates, Chairman of the absolute hegemon of the PC software universe, Microsoft Corporation. Two of your leading competitors, each one unique in its own strengths and the markets they serve have just joined forces and a third has strengthened a core competing technology in the process. What do you do next?

Don't know? Well, that's why you're not Bill Gates.

The $4.2 billion all-stock acquisition of Netscape Communications by America Online offered up recently has more than a few people guessing about the strategy behind such a move. While the merger both helps and hurts Microsoft on a number of competitive fronts, it proves that prediction is a fool's game in the Internet business. We now have a two-horse race - Microsoft versus AOL

Of the estimated 43 million active online U.S. adults, about 70% are users of AOL and/or Netscape products and services; with 25% of default home pages among Web users, AOL/Netscape would also control about 35% of the projected $1.3 billion in total 1998 online advertising revenues; and AOL/Netscape properties approach the most visited on the Net, with 72% in the home audience and 68% at work, their closest competitors are Yahoo! at 40%-home/49%-work and Microsoft sites have 39%-home/50%- work.

America Online is already the leader among companies selling access to the Net, with more than 13 million subscribers and control over half of all Web traffic. ISPs may have no choice but to fall into Microsoft's loving embrace. The search engines and other portals are also nervous. Excite has important deals with both Netscape and AOL, which means much of its traffic comes from one source. If the deals work, and drive lots of traffic to Excite that's great. But if they don't stay there, or if either AOL or Netscape decides not to renew their deals, the company could face problems -- which could make Excite a Microsoft acquisition target.

As a side deal, Sun Microsystems gets to distribute Netscape's entire line of enterprise products by paying AOL $350 million. Sun now has distribution rights to the middleware needed to enable business-to-business and business-to-consumer transactions. "If you want to play in the open commerce market, you've got to have middleware," says John Loiacono, Sun's Vice President of brand marketing. AOL expects Sun's back-end expertise to help the company draw business customers that might otherwise be anxious about betting their online endeavors on a consumer-oriented ISP. In return, AOL has agreed to buy $500 million worth of Sun hardware and services for its own use and for its e-commerce partners.

The deal cuts the legs out from under the government's antitrust case by offering convincing proof that when it comes to software, a formidable competitor can rise up overnight. This makes it unlikely Judge Thomas Penfield Jackson will exact tough punishment against Microsoft. States' Attorneys General, North Carolina being first, have begun to withdraw from the plaintiff's list in the two-month-old lawsuit that had threatened to turn the software powerhouse into a fragmented collection of "Baby Bills", broken into business units around applications, operating systems, and other technologies. Forget about a bundling of Netscape's browser with Windows or broadcasting Windows source code. Taking place against a clear win by Sun on its breach of license agreement for Java, Microsoft must now retool their browser engine and Java Virtual Machine (JVM) to JDK (Java Development Kit) compliance, then redistribute a revised browser; but Windows 98 will ship with an integrated Internet Explorer. Even the government's most damaging evidence against Microsoft -- that it conspired with Netscape to carve up markets -- is handicapped.

Although the threat of a monopoly breakup appears to be over, the timing was filled with fire and purpose on the part of AOL, Netscape and Sun. Why would Microsoft's rivals time this tripartite deal to sabotage an antitrust case when the government had Bill & Company on the ropes?

Because "they have shackles on," says William Kovacic, visiting professor at George Washington University School of Law specializing in antitrust, "the lawsuit itself served as a catalyst. One thing it does is give the partners a window of opportunity to create and implement this alliance. Jackson is going to issue a decision sometime in the spring. He'll impose some kind of order and the Microsoft appeal with take 12 to 18 months to decide. Starting today, AOL, Netscape and Sun have a 2-year window of opportunity to make it in the marketplace. And Microsoft cannot retaliate with the same ruthlessness that it could have."

Although the "Browser Wars" originally began as a race for marketshare they appear over. Microsoft saw Netscape's Navigator browser as a threat to their operating system dominance of Windows and acted to end that opportunity. "As far as I'm concerned they were a complete competitor to the operating system," Microsoft senior vice president Jim Allchin said in testimony taken in March. If computer programs could be made to run with Netscape's Web browser, no one would notice the operating system, precisely the intention of Marc Andreesen, former CTO of Netscape, as he declared in 1997. That threat is now greater than ever for Microsoft.

Although AOL's CEO Steve Case plans to stick with an Internet Explorer front end for his company's network, AOL will use Navigator for Netcenter and its expanding ICQ portal. AOL's greatest strength has been the ease-of-use and user-friendliness of its network. Supporting multiple clients will likely mean an easier standards fight, since AOL will want to provide the best environment for content providers and consumers on its multiple brands. But AOL bought Netscape primarily for its browser and portal properties, so the ultimate fate of its server software depends heavily on the side deal with Sun Microsystems.

Analysis points to increasing polarization. AOL and Microsoft will be the only competitors who own significant shares of content, commerce, access and software. Sun has shrewdly positioned itself to capitalize on the two potentially huge markets also sought after by AOL -- electronic commerce and embedded software -- while tapping into a major customer base for its Java technology.

IDC Research predicts that as many as half of all Internet users will be using something other than a PC early in the next decade and Netscape's effort to leverage the strategy of open-source applications development managed to harness the talent of thousands of developers around the world. The result is a lighter, faster browser engine named "Gecko" that might help AOL, Sun and Netscape win in the non-PC Internet device market, going far beyond the corporate network and home PC -- the real opportunity is in embedded software and network devices. AOL wants to dominate that market by selling "AOL devices" -- TV set-top boxes and handheld appliances. Ironically, everything old is new again - this was the original mission of Java -- to create a development platform for interactive television.

These devices would be powered by Sun's PersonalJava and designed to run on any OS, the user interface would use Netscape's Navigator client software. In return for providing the engine that propels the device, Sun will be able to introduce Java and Jini -- its technology designed to allow "spontaneous" network computing -- to AOL's millions. The motivation behind such an effort is clear -- with Microsoft extending its desktop power into other markets with WebTV, Windows CE, and the recent joint venture with Qualcomm to spur the market for wireless Internet services, the opportunity to establish early dominance in this sector is quickly diminishing.

The secret weapon in AOL's brand-centered strategy for a platform fight with Microsoft is that it doesn't have to win this battle to win the war. Microsoft wants new platforms into which it can sell operating systems and applications and so does Sun. AOL has always cared less about how its service is delivered as long as it is delivered to the greatest audience. The test case will be 3Com's new Version VII of the hugely successful Palm Pilot -- with wireless connectivity that links the device to branded content, users might sacrifice freedom for convenience. If it catches on, AOL will also speed up its efforts in the area.

On the server front, the Sun-Oracle "network computer" or "NC" initiative has received new life from application server technology and database advances that could help slow demand for Microsoft's Windows NT operating system. NT competes directly with Sun's own Solaris flavor of UNIX and if vendors can agree on the core JVM behind the server-side strategy, the NC could loom again as a serious threat to NT's eventual dominance. With Sun's preliminary win for "100% pure Java", Microsoft's strategy to do to Java what UNIX did to itself -- create varieties of Java "optimized" for each operating system platform - could lose its countervailing advantage against a "write once, run anywhere" user environment.

In the short term, businesses may drop Netscape's browser out of concern that the software will no longer be supported. Customers who have bought into Netscape's enterprise vision are skeptical that their interests will be protected over time. "I think they'll do it for awhile, but one of the fears I have is that the SuiteSpot server products may not evolve the way Netscape had planned," says Sergio Cortez, of Litton Industries. Many see Sun Microsystems' role in the pending deal as crucial to maintaining their satisfaction with Netscape.

AOL needs Sun to make sense of Netscape's software assets and Sun gets access to Netscape's browser software, experienced programmers and use of AOL's influence to try to turn its lightweight PersonalJava software into a popular platform. "AOL gets it," says John McFarlane, president of Sun's Solaris group. "They get Java, and together we have the products, platforms and technologies to put together an awesome portfolio."

The competitive threat against Microsoft is a real one that will certainly receive a response from Redmond - just not the one we might expect from the world's most powerful software company in light of its need to avoid the gaze of federal regulators. AOL and Sun are now poised to offer a serious alternative to Microsoft hegemony.

Arik R. Johnson is Managing Director of the Competitive Intelligence (CI) outsourcing & support bureau Aurora WDC. Learn more about Arik at his firm's Web site