AS LAWYERS FOR Microsoft met last week with Department of Justice officials to discuss settlement terms in its landmark antitrust case, sources close to the government say antitrust chief Joel Klein is already concerned about a new front of possibly predatory behavior on the part of the software giant. Over the past six months, as attorneys have bickered in court over three-year-old e-mail and videotaped demos, Microsoft has quietly fixed its corporate war machine on a former partner: RealNetworks. In an overlooked portion of his infamous Justice Department deposition, Bill Gates called RealNetworks CEO Rob Glaser a liar and—even worse—”a competitor.” In November, Microsoft announced that it would pull out of its $30 million investment in the company. And most significantly, three weeks ago, Microsoft launched the latest version of its Internet Explorer Web browser with few new features save for a free, fully integrated alternative to RealNetworks’ flagship media player. “Microsoft has built its media player directly into the user’s browsing experience,” explains David Kerley, an Internet analyst for Jupiter Communications. “It’s a direct spank on RealNetworks.”

Yet the undisputed leader in software for receiving audio and video broadcasts over the Internet hasn’t blinked. According to RealNetworks product unit manager Dave Richards, Microsoft is a “friend.” He’s “glad” Redmond has targeted the Web broadcasting market, which RealNetworks has ruled singlehandedly for the past three years. “Microsoft’s sending a message that streaming media matters,” Richards says. “Wow—that’s cool.” Added another spokes-man, with notes of both defiance and dread in his voice: “I hope this isn’t going to be a ‘RealNetworks is dead’ story.”

Since its founding five years ago, RealNetworks has maintained an unusual peace with Microsoft. Glaser himself worked there for 10 years and ultimately became one of Gates’ top lieutenants—vice president in charge of multimedia systems—before leaving to launch his own company in 1994. Two years ago, Microsoft purchased a 10 percent stake in Glaser’s venture, which had already sprinted to the lead in file compression technology enabling large audio and video files to be streamed over the Internet. (Before RealNetworks, users had to download entire files, then play them back.) The relationship became an industry case study in “cooptition,” in which two companies with competing interests cooperate to the mutual benefit of both. Glaser seemed to have forged a remarkable partnership with the Redmond giant.

Then, last summer—on July 23, to be exact—everything changed.

“I’m here today because I believe Microsoft is taking actions that create obstacles to the freedom and openness of the Internet,” Glaser announced at the beginning of his surprise testimony before a US Senate committee investigating competition in the software industry. “Microsoft asks consumers in its advertisements, ‘Where do you want to go today?’ But if Microsoft continues on its present course, consumers will increasingly be asking, ‘Is there anywhere I can go except where Microsoft wants me to?'” Glaser went on to testify that he “loved” his time at Microsoft and that he has tremendous respect for Gates and right-hand man Steve Ballmer. “Thus, it is with great personal sadness that I report that Microsoft is beginning to inject other factors into the dynamic—using its market power to unfairly impair free competition. Specifically, Microsoft recently released a new product called the Windows Media Player that breaks RealNetworks’ products.” Glaser claimed that Microsoft software intentionally disabled RealNetworks’ players in certain scenarios, substituting the Windows player in its place. A ferocious technical and public relations battle ensued as Microsoft vehemently denied Glaser’s sabotage charges. To this day, both companies maintain that the other misled the public and fudged technical trials. Independent observers have weighed in on both sides.

WHATEVER THE MERITS of Glaser’s charge, the public attack may not have been the wisest strategy for dealing with Microsoft. David Yoffie, a Harvard Business School professor and co-author of Competing on Internet Time: Lessons from Netscape and Its Battle with Microsoft, says that Glaser broke Rule No. 1: Don’t moon the giant. “Part of what Netscape did wrong was that they did everything they could to antagonize Microsoft, which only maximized their response,” explains Yoffie. Indeed, Microsoft retaliated with remarkable might—some say monopolistic might—by bundling a Microsoft Web browser into a Windows operating system that comes pre-installed on nearly every PC sold. Netscape’s market share plummeted, from more than 85 percent in 1995 to less than 50 percent by December 1997.

Today, RealNetworks faces a remarkably similar marketscape. More than 85 percent of all Internet audio and video currently streamed over the Web relies on RealNetworks software. Every day, 260,000 users visit RealNetwork’s Web page and download its free player, in order to receive Internet broadcasts. Audio and video content providers then buy RealNetworks servers to stream broadcasts over the Web to this vast audience. It’s a very impressive position, but the numbers are eerily reminiscent of the Netscape experience—and so is Microsoft’s reaction.

With the release of Internet Explorer 5.0, Microsoft offers the media-streaming equivalent of its Web browser—an operating-system “feature” that obliterates the freestanding product of a competitor. Although Microsoft has offered streaming media products for several years, with little success, the new Radio Tool Bar in IE 5.0 is so seamlessly integrated into the browsing experience that audio controls simply drop down from the address bar with a volume tuner and links to online radio broadcasts. The Microsoft Radio Tool Bar can even receive broadcasts using earlier versions of RealNetworks’ streaming protocol. “Ease of use is a top initiative here at Microsoft,” Gates explained during the launch ceremony for IE 5.0. “I really see this as the highest priority for Microsoft right now.”

According to Gary Schare, Microsoft’s lead product manager for Windows streaming media, it wasn’t until Glaser testified before the Senate that Microsoft brass redoubled their efforts in streaming media. “Frankly,” Schare says, “it was very difficult to change some thinking as to whether we were friends [with RealNetworks] or competitors. Then, all in one day, that problem went away. It helped me do my job.” In his Department of Justice deposition, Gates testified that he was surprised and angered by Glaser’s Senate appearance: “He went out of his way to lie about us. . . . I sort of thought, hmm, he must be a competitor.”

Despite the tough talk from Microsoft, RealNetworks maintains that the companies have a productive working relationship and that they can peacefully coexist. “We don’t consider them a competitor,” says RealNetworks’ Richards, in striking contrast even with Glaser’s Senate antics. “We actually like Microsoft’s Radio Tool Bar. . . . It’s a very large market.” He explains that RealNetworks has borne the cost of being sole evangelizer of streaming media, and that Microsoft lends marketing muscle and “credibility” to a growing market.

In fact, RealNetworks is taking advantage of a separate new feature in IE 5.0 that allows content providers to display their own offerings more prominently in an inset window along the bottom of the screen. RealNetworks took the opportunity to reorganize thousands of Web sites that broadcast via RealNetworks servers into the RealGuide, which offers one-click access to Web feeds from more than 1,700 radio and television stations. The intended effect is to funnel IE 5.0 users to broadcasts from RealNetworks servers. (By comparison, Microsoft offers access to some 700 stations through its Radio Tool Bar.) “Microsoft will help educate the market,” says Richards, “but when you really want to listen to stuff on the Net, you’ll go to Real.”

Not cited by Richards is the rather long list of companies that went up against Microsoft with a massive market share and even arguably superior products, only to end up beneath the treads of the Windows juggernaut. Small wonder that the Justice Department is keeping a watchful eye as Microsoft trains its sights on that infuriating RealNetworks moon.