• Chart: The Antitrust Price Tag

RealNetworks has dropped all legal claims against Microsoft, including its private antitrust lawsuit and participation in the European Union (EU) antitrust case, and the two companies will cooperate on marketing and technology in several key areas, including online music services, digital rights management (DRM), and gaming. The settlement will help both companies compete against Apple in the digital media space. Equally important, Microsoft removes its last nongovernmental antitrust opponent, while RealNetworks no longer faces the prospect of lengthy litigation against an opponent with virtually unlimited funds.

In other legal news, the United States Patent and Trademark Office (USPTO) has rejected efforts to invalidate a controversial patent on Web browsing technology held by Eolas and the University of California. This renews the threat that Microsoft will change Internet Explorer (IE), forcing Web developers to alter their Web pages or subject users to numerous prompts, and could open the creators of other Web browsers to similar lawsuits.

RealNetworks Truce

RealNetworks filed a private antitrust lawsuit against Microsoft in Dec. 2003, basing its case on findings and legal rulings in the U.S. Department of Justice (DoJ) lawsuit against Microsoft. RealNetworks alleged that Microsoft took illegal steps to dominate the digital media market, including tying its streaming media player (the Windows Media Player) to its monopoly Windows client OS; using contractual restrictions and other arrangements to convince OEMs to favor the Windows Media Player and other Microsoft digital media products over RealNetworks products; and withholding certain information about Windows that RealNetworks could have used to make its products more accessible to users. RealNetworks asked the court for numerous remedies, including forcing Microsoft to unbundle the Windows Media Player from the Windows client OS and to unbundle Windows Media Services (a streaming media server) from Windows Server. RealNetworks also sought unspecified damages that a spokesperson estimated could top US$1 billion.

In addition, RealNetworks has been an active participant in the EU's antitrust investigation since 2003, and its testimony was probably the main reason that the European Commission (EC, the government body that handles competition law for the EU) found Microsoft guilty of illegally tying the Windows Media Player to Windows and ordered Microsoft to ship a version of the OS without the Player. Microsoft met this requirement in summer 2005 with a new edition of the OS called Windows XP N, but this remedy appears ineffective: most major OEMs are not shipping the OS, citing no customer demand. (The EU case also involved server protocols, but RealNetworks was not involved in that portion of the case.)

Most recently, in Aug. 2004 RealNetworks filed a complaint with the South Korean Fair Trade Commission, which was already investigating Microsoft for unfair trade practices over bundling its instant messaging client into Windows.

Terms of the Settlement

In Oct. 2005, the two companies announced that they had settled all legal claims. RealNetworks has withdrawn its private antitrust lawsuit and will no longer participate in the EU and South Korean antitrust investigations. Microsoft paid RealNetworks US$460 million in cash to settle the lawsuits and an additional US$301 million in cash for marketing deals, for a total of US$761 million. Some of this will be counted against Microsoft's next-quarter earnings, but Microsoft has not yet revealed exactly how much (the company may pay part of the settlement from reserves set aside in prior quarters).

Aside from the financial payout, RealNetworks will get a boost for its consumer subscription services, particularly its Rhapsody music service. Such services are now RealNetworks' most important business, accounting for almost 60% of the company's revenue in the quarter ending June 2005.

Following a template similar to Microsoft's June 2003 settlement with AOL Time Warner and Apr. 2004 settlement with Sun Microsystems, the companies agreed to cooperate in several areas, as follows:

Rhapsody promotion. Microsoft will promote Rhapsody, an online music service that RealNetworks acquired in 2003. Unlike MSN Music or Apple's popular iTunes Music Store, which only offer downloads, Rhapsody offers subscription services that let users stream, download, and transfer songs to portable devices (depending on the user's subscription level). It boasts more than 1.15 million subscribers, many of whom have come to the service through promotional deals with ISPs such as Comcast. Unlike some other RealNetworks services, Rhapsody uses Microsoft's Windows Media technologies to encode and apply DRM to its library of more than 1 million songs.

MSN Messenger users will soon be able to download an ActiveX control that integrates Rhapsody into the Messenger client, and this control will be shipped as part of the next revision of MSN Messenger. After the control is installed, MSN Messenger users will have access to the free level of Rhapsody, which allows them to stream (but not download) 25 songs per month, and will be able to share songs from Rhapsody while chatting, although a Rhapsody subscription might be required for this function. (Microsoft offered similar music-sharing in a beta IM client called threedegrees and has been expected to incorporate this function into MSN Messenger for some time.) The incorporation of streaming music could help MSN Messenger increase its user base, while RealNetworks gets the opportunity to promote Rhapsody to MSN Messenger's approximately 185 million (according to Comscore) global users.

Microsoft will also promote Rhapsody in several other Web sites and software, including MSN Search (where searches for musical artists will return links to information and songs on Rhapsody), the MSN home page, the Windows Media Player, and WindowsMedia.com. Finally, MSN Web sites and services will not advertise or promote any other subscription-based music service for six months and will give Rhapsody equal placement to any other subscription-based music service for the following year.

The deal calls into question the future of MSN Music, which was widely expected to launch a subscription service in fall 2005. According to media reports, Microsoft was unable to reach a business arrangement with music content owners and subsequently scrapped the idea. (MSN independently confirmed that it was no longer planning a subscription music service for launch in the fall but did not confirm the reason.) Microsoft has never viewed selling music as a major future source of revenue, but rather built MSN Music to stave off a platform challenge from Apple, whose products dominate the digital music market but do not use or support Microsoft's Windows Media technologies. Given these strategic considerations and the Rhapsody deal, further investment in MSN Music is unlikely for the next year.

Casual games. RealNetworks will offer a new gaming subscription service through MSN Games and develop new games for the Xbox Live Arcade, a portion of the Xbox Live service that allows users to play casual games.

Microsoft will pay RealNetworks US$301 million for the Rhapsody and gaming portions of the agreement and support product development, distribution, and promotions for these ventures for 18 months. RealNetworks will eventually credit a portion of the US$301 million back to Microsoft based on the number of new subscribers that it obtains through these deals.

Other cross-promotions. The two companies will develop a plan by which the MSN Search interface can be incorporated into RealNetworks' RealPlayer and jointly promote portable devices that are capable of playing subscription-based files from the Rhapsody To Go service.

Technology and OEM cooperation. Microsoft will give RealNetworks long-term licenses to use certain Windows Media technology, as well as more access to technical information about Windows. For instance, Microsoft says it will develop and share new interfaces to allow future RealNetworks products to take advantage of new media functionality in Windows, make it easier for consumers to choose RealPlayer as their preferred media player, and work more closely with RealNetworks to ensure interoperability between the two companies' DRM technologies. In addition, Microsoft says it has contractually assured RealNetworks' access to the OEM channel.

However, as with Microsoft's prior deals with AOL and Sun, it's not clear how far the companies' cooperation will go. Microsoft will continue to develop and promote its own digital media technologies, ship the Windows Media Player and other digital media software (such as Movie Maker and the Media Center interface) as part of the Windows client OS, ship Windows Media Services as part of Windows Server, and operate MSN Music. Therefore, competition between the companies will remain, and end users may continue to experience frustration with overlapping applications and technologies from the two companies.

Why Microsoft Settled

Given the tense relations and longtime competition between the two companies (RealNetworks CEO Rob Glaser is a former Microsoft executive), it seemed possible that Microsoft would drag this court case out to drain RealNetworks' resources. However, several factors probably inspired Microsoft to reach an agreement.

Apple. Microsoft's consumer strategy is set on establishing the PC as the center of home entertainment. One key tactic in this strategy has been the Windows Media platform, a set of Microsoft tools and technologies that ensures that digital audio and video can be played on a PC without forcing Microsoft to pay royalties to third parties. However, Apple, which does not use the Windows Media platform, has established a significant lead in the market for portable music players and online music downloads. If Apple can leverage this lead into other areas, such as video—exemplified by its new video-capable iPod and a deal with Disney's ABC television subsidiary to offer popular TV shows for download a day after they first air—then Apple could establish its own technologies as the de facto standard, making the Windows Media platform irrelevant and enabling other devices (including Macintosh PCs) to take the central entertainment role that Microsoft has envisioned for the PC. Rather than continuing to expend resources fighting RealNetworks, which supports the Windows Media platform in at least some of its products, Microsoft can now focus on its main competitor.

EU. Although Microsoft may have been able to outlast RealNetworks in the private antitrust lawsuit, government agencies are another matter. As long as RealNetworks was able to intervene in antitrust suits brought by these agencies, it could have pressed for remedies that hurt Microsoft's consumer strategy.

In particular, Microsoft is threatened by the precedent set in the EU antitrust case, in which a government body dictated the feature set for Microsoft's most important product, the Windows client. Although Microsoft complied with that dictate, it is also appealing the decision, and removing RealNetworks from the picture increases the likelihood of an eventual settlement that's more favorable to Microsoft. At the very least, RealNetworks will not be able to complain that the current remedy is ineffective, which could have led the EU to impose harsher remedies, such as forcing Microsoft to unbundle the Windows Media Player from all versions of Windows sold in Europe.

A clean slate. Uncertainty over the financial effect of antitrust litigation is possibly one reason that investors have turned away from Microsoft's stock, whose price is currently at 1998 levels. (For an estimate of how much Microsoft has paid to settle antitrust lawsuits, see the chart "The Antitrust Price Tag".) Microsoft's eight-year antitrust ordeal has also affected employee morale and partner relationships and distracted the company from innovating and meeting new competitive threats. Now that the last fallout from the DoJ antitrust case has been cleared, Microsoft can close this chapter of its history and focus on the future.

Patent Decision Could Affect Web Developers

In Sept. 2005, the USPTO issued notice that it would uphold patent 5,838,906, which was granted in 1998 to Eolas and the University of California. The patent covers the ability of a Web browser to automatically launch other applications in order to support interactive elements, such as ActiveX controls and digital media files, embedded in a Web page. Microsoft has warned Web developers that it might have to change IE so that users would be prompted to download the necessary supporting application whenever they encountered a Web page with such interactivity. This would skirt Eolas's patent (in Microsoft's opinion), but could mean a degraded user experience, because users would encounter multiple dialog boxes on Web pages with interactive elements. To avoid this, Web developers would have to redesign their Web pages, either embedding interactive data directly into them or adding scripts to launch the supporting applications.

The USPTO agreed to reinvestigate the Eolas patent in Mar. 2004, following a jury decision that Microsoft's IE violated the patent. The presiding judge in the court case said that Microsoft did not have to make any changes to IE until this reinvestigation was complete. In Mar. 2005 an appeals court vacated the original jury verdict and instructed the lower court to retry the case, this time looking at Microsoft's claim that a "Viola" Web browser created by Pei-Yuan Wei in 1993 constituted prior art and thereby invalidated the patent.

However, now the USPTO has reaffirmed the patent, and specifically said that the Viola browser did not constitute prior art, making it unlikely that Microsoft's prior art claim will succeed during retrial.

Web developers should wait before rushing to change their Web pages. In all likelihood, Microsoft will not abandon its case until it has appealed it further, a process that should take at least another year, and the company will change IE only if it loses these appeals. Alternatively, Microsoft and Eolas might reach an agreement that allows IE to continue using the patented technology. Nonetheless, the USPTO's decision forces developers to monitor the situation.

The ruling also means that other companies or organizations that potentially infringe upon the Eolas patent, including Apple (which makes the Safari browser) and the nonprofit Mozilla Foundation (which makes the Firefox browser), could face similar infringement lawsuits from Eolas.

Resources

RealNetworks' antitrust lawsuit against Microsoft is detailed in "RealNetworks Files Antitrust Suit" on page 27 of the Feb. 2004 Update.

For more details on the proposed changes to IE and their effect on Web developers, see "Lawsuit Drives Browser Changes" on page 7 of the Nov. 2003 Update.