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Originally published October 12, 2005 at 12:00 AM | Page modified October 12, 2005 at 10:37 AM

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Microsoft makes the Real deal

After years of crosstown feuding that drove a wedge into Seattle's technology community, Microsoft and RealNetworks declared a truce yesterday...

Seattle Times technology reporter

After years of crosstown feuding that drove a wedge into Seattle's technology community, Microsoft and RealNetworks declared a truce yesterday to help them compete against Apple and Google and solidify the city's future as a center for digital media.

Real dropped its 2003 antitrust lawsuit against Microsoft, the last major suit stemming from the Redmond company's bullying tactics in the 1990s, and Microsoft agreed to support Real's digital-music and games businesses and give the Seattle company $761 million.

The lawsuits accused Microsoft of gaining an unfair advantage by tying its own Windows Media Player into the Windows operating system.

By working together, the two companies improve their odds of overtaking Apple Computer as digital music moves from a niche product to the mainstream over the next decade, said industry consultant Richard Doherty at the Envisioneering Group in Seaford, N.Y.

"It really does change from being Apple, Real and Microsoft to being Apple versus Microsoft-Real," he said.

The terms


Key elements of the settlement between RealNetworks and Microsoft:

Antitrust

• Microsoft pays Real $460 million; Real ends participation in antitrust cases in Europe and Korea.

• The companies will work together to improve performance of Real products running on Windows, and Real can take advantage of more media functions in Windows.

• Microsoft will make it easier for customers to access Real's products in Windows. The upcoming Windows Vista will direct users to a Web site where they can download Real software if needed.

• The companies will enhance interoperability between their digital-rights management systems, and Microsoft is giving Real access to its PC distribution channel.

Music and games

• Microsoft pays Real $301 million and provides services over 18 months to support Real product development, distribution and promotion.

• Microsoft may earn credits against the $301 million for subscribers it delivers to Real through MSN.

• MSN Messenger users will be able to share and play music — in a legal way using Real's Rhapsody software — while chatting online.

• MSN Search will use Rhapsody's music catalog to help users find and discover music, and the companies will work together to integrate MSN Search in RealPlayer.

• Links to Rhapsody will be displayed when users conduct music-related searches at MSN Search, and Real may buy MSN ads to promote Rhapsody.

• Both companies will promote the use of Real's Rhapsody to Go service with Windows Media portable devices.

• The companies will collaborate on "casual" video games such as Bejeweled, Scrabble and Solitaire. Real will develop casual games for the Xbox Live service and Xbox 360 console, and a subscription service for MSN Games.

The combination also challenges Google's search-engine business because Real and Microsoft's MSN group will work together on improving the way music is handled by MSN's search and messaging services.

If the partnership works as promised, it will benefit consumers by making it easier to find and play music in different formats on Windows-based computers.

In the Seattle area, there are personal dimensions to the settlement.

Real founder Rob Glaser, an intense New Yorker and co-owner of the Mariners, went straight from Yale to Microsoft in 1983 and worked closely with Chairman Bill Gates. Ten years later he left to start a company that, until recently, beat Microsoft in the field of streaming digital media over the Internet.

That history and the suit gave the competition between the companies the bitter edge of sibling rivalry. But employees are friends and neighbors in the Seattle area who have long struggled with the animosity between their companies, said Bob Kimball, Real's general counsel.

"We all live and work [here] and we all have spouses, friends, significant others in the two companies. There's all these ties that have always existed and this is always the unspoken topic — you can never raise the topic," he said. "Now I think it's really going to be great for people's psyches to know there's peace, and there could be prosperity as well."

Those personal ties also helped overcome the rift, executives said in announcing the deal at Seattle's Experience Music Project.

Talks began a year ago after Glaser sent an e-mail to Gates suggesting they work together on copy-protection technologies, known as digital-rights management. One motivation was to share technology so they could better compete with Apple, which uses a proprietary system to protect music sold by its iTunes service.

"I contacted Bill and said, 'Hey, I think this is a good thing for consumers. Consumers want openness, consumers want interoperability, consumers want choice,' " Glaser said. "It began a dialogue that was sort of the antecedent to the discussion that led to today's announcement."

Gates said relationships between him and Glaser and among people at levels below them "allowed us to get to where we are today."

Lengthy negotiations

Glaser's e-mail led to a series of meetings at Eastside hotels.

After internal discussions, Gates, Glaser and their lawyers met in February for a dinner at the Woodmark Hotel in Kirkland. Talks continued through the year, but it took a marathon session last weekend to work out the details.

"The two companies effectively took over the fourth floor of the Bellevue Hyatt last weekend," Microsoft General Counsel Brad Smith said. "We were using five different conference rooms with a negotiation taking place in each room until two or three in the morning each night."

Smith and Kimball characterized the partnership as a benefit for the region and for their companies. Kimball said it will "form a new center of gravity for digital media in Seattle" and Smith said they've built a "third bridge" across Lake Washington, referring to Microsoft's headquarters in Redmond and RealNetworks' in Seattle.

"That third bridge probably won't do much to alleviate traffic congestion, but it should certainly bring more-exciting digital entertainment to consumers around the world, and that is good for Seattle," Smith said.

Real stock soared after the morning announcement, largely because the cash infusion is roughly three times its annual sales. Last year, the company had $267 million worth of sales and $363 million in cash. The stock was the biggest gainer on the Nasdaq Stock Market yesterday, where it closed at $7.70, up 34 percent. Microsoft was flat, closing at $24.41.

Impact on EU case?

Real's case against Microsoft was based on U.S. court rulings that found Microsoft liable for anticompetitive business practices in the 1990s. A series of companies then sued and settled with Microsoft on terms similar to Real's: large cash payouts together totaling about $7.5 billion, plus improved access to Microsoft's platform and partnership arrangements. Still unresolved are smaller cases brought by Novell and Go Computer, but Smith said "I put those in the category of issues that don't keep me up at night."

RealNetworks in brief


Headquarters: Seattle

Founded: 1994, as Progressive Networks

CEO: Rob Glaser

2004 sales: $266.7 million

2004 loss: $22.5 million

Employees: 915

Notable events

February 1994: Rob Glaser founds Progressive Networks to distribute politically progressive content. It evolves into a distribution company for audio broadcasts online.

April 1995: Introduces RealPlayer, pioneering software to stream audio online.

July 1997: Announces a broad agreement with Microsoft to share technology and work together. Microsoft invests $30 million in RealNetworks.

September 1997: Changes name to RealNetworks and files with the Securities and Exchange Commission to become a publicly traded company.

November 1997: Holds initial public offering.

July 1998: Glaser testifies before U.S. Senate regarding Microsoft's competitive practices.

November 1998: Microsoft announces it will sell its stake in RealNetworks, saying their competing visions for streaming technology mean the investment "no longer makes sense."

August 2000: Launches RealPlayer GoldPass, the first subscription service to charge users for access to specialized audio and video content.

July 2002: Introduces new platform technology called Helix, which delivers audio and video files in any format, including Microsoft's Windows Media.

April 2003: Buys San Francisco-based Listen.com, which forms the basis of Rhapsody, RealNetworks' music-subscription service.

December 2003: Files $1 billion antitrust suit against Microsoft, claiming its giant software rival is a predatory monopolist.

March 2004: European Commission rules that Microsoft violates antitrust laws. RealNetworks is one of the chief complainants.

May 2004: Glaser tells analysts in New York that his company has shifted focus to music and online games.

October 2005: Settles suit against Microsoft in deal worth $761 million.

A bigger question is whether the Real settlement will help Microsoft in its ongoing European antitrust case. After hearing from Real and other competitors, regulators found that Microsoft had abused its monopoly on PC operating systems. Last year the European Union fined the company, ordered it to share technology and mandated that it sell a version of Windows stripped of Microsoft's own media player. Microsoft is appealing, and the Real settlement should help, Smith said.

"This certainly won't hurt our appeal, let me put it that way, but government officials and judges will obviously make up their own minds," he said.

A lawyer for other Microsoft competitors said the Real settlement is too late to have much effect. Real's complaints remain part of the written record in the case against Microsoft, and the settlement validates the concerns of the European Commission, the regulatory arm of the European Union, said Thomas Vinje, an attorney in Brussels.

"In other words, exactly what the commission predicted would occur as a result of Microsoft's illegal bundling behavior has occurred: Real has been marginalized," Vinje said via e-mail. "The lesson is that the commission is right to have found Microsoft to have engaged in illegal conduct, but that it erred in taking so long to decide the case and in imposing an ineffective remedy."

Wait-and-see on Wall St.

Wall Street will continue to focus on Microsoft's European case, said analyst Charles Di Bona at Bernstein & Co. in New York.

"I think there's still a wait-and-see perspective," said Di Bona, who doesn't own stock in either Microsoft or Real.

Di Bona said the partnership strengthens the competitive positions of both companies, especially their digital-rights management franchises, but it remains to be seen who will prevail in the digital-media business.

"I don't think any one domino falling is going to be enough," he said. "They're going to have to get a lot of people lined up behind it. Apple is a juggernaut in music but really only music — there's a lot more content in the world other than songs."

Apple has sold about 25 million iPods, compared with fewer than 8 million Windows-based devices, but only a fraction of the market has been tapped, said Doherty of the Envisioneering Group. He expects 500 million devices will be sold by the end of the decade, and Microsoft and Real have a chance to claim the vast mid-market.

"If you look at BMW and Mercedes and Ferrari and Lexus, altogether they aren't even 5 percent of the world's car output," Doherty said.

"Apple may remain a truly attractive premium product for the next few years, but we think there are going to be a lot more Toyotas, Chevys and Nissans sold."

Spokesmen for Apple and Google did not immediately respond to requests for comment.

Brier Dudley: 206-515-5687 or bdudley@seattletimes.com

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