(FORTUNE Magazine) – Earlier this year Jeff Bezos, billionaire founder of Amazon.com, had a dilemma. He could join forces with Bertelsmann AG to expand his business. Or he could go it alone, knowing full well that the German publishing giant would turn to one of his competitors for help in building its online bookstore.

Bezos turned down the Bertelsmann offer--and sure enough, Bertelsmann announced Oct. 6 that it would pay $200 million for a 50% stake in barnesandnoble.com, the electronic arm of the retail bookselling chain Barnes & Noble. "This venture has one purpose--to compete with Amazon in the U.S.," says incoming Bertelsmann CEO Thomas Middelhoff.

Amazon.com's record is the one to beat. A virtual unknown only three years ago, Amazon offers millions of titles that brick-and-mortar bookstores can't afford to stock because of the overhead. Analysts expect Amazon.com to bring in as much as $500 million in sales this year--though profits aren't expected until mid-2000.

The arrival of deep-pocketed competitors has failed to slow Amazon down. Barnesandnoble.com jumped in last year. It has developed a decent Website and forked over cash for spots on leading portal sites, just as Amazon has. Nonetheless, according to an SEC document it filed in preparation for a planned IPO this fall, barnesandnoble.com sold only $22 million of books from Feb. 1 to Aug. 1. Amazon sold $203 million in the first six months of this year.

Now that Bertelsmann has logged in with cash, barnesandnoble.com has postponed its IPO. Meanwhile, the competitive environment has changed significantly for Amazon. For starters, Barnes & Noble may be able to start a price war by selling books from Bertelsmann-owned publishers like Random House at lower prices. And Bertelsmann should also help barnesandnoble.com in Europe, where the German publisher has enormous influence and a joint venture with America Online.

Bezos, too, longs to expand in Europe, and Middelhoff says he would have been happy to strike a deal; he thinks Bezos would have fit beautifully into the Bertelsmann culture. "He's a great entrepreneur. I admire him," Middelhoff says.

The Bertelsmann CEO pursued Amazon aggressively, at one point even sending a corporate jet to transport Bezos from Turkey, where he was on vacation, to Bertelsmann headquarters in Gutersloh, Germany. (Bezos' casual attire surprised Middelhoff's driver, who went to the airport with orders to pick up a billionaire. He found an unassuming thirtysomething toting a bright-yellow backpack.)

The deal between Amazon and Bertelsmann would have resembled the German company's joint venture with AOL, in which both companies have a 50% stake in a European entity they created together. Bezos says he met with Middelhoff four times to try to nail down a deal, but "we just couldn't make it work," he says, without elaborating. Middelhoff thinks the deal fell apart because Bezos wasn't ever convinced that Bertelsmann would truly focus on its new online store. "Jeff was nervous about giving up control," he adds.

Many analysts think Bezos didn't need Bertelsmann. "Amazon's reached the level of critical mass," says Derek Brown, senior analyst with Volpe Brown Whelan in San Francisco. "They have the cash to fund what they're doing, and they have the brand momentum." Brown thinks a deal with Bertelsmann might have made sense three years ago but not now.

Amazon.com is moving on with plans to expand on its own. It recently became a premier bookseller on many of Yahoo's World sites. The company also bought Bookpages, a smallish electronic bookstore in Britain; ABC Telebuch, a German Net bookseller; and IMDb, a movie database that will support Amazon's efforts to sell videos online.

Amazon is extending its operation in other ways too. It opened an online music store this summer; it's also offering DVD movies, sheet music, computer and video games, and audiobooks online. Videos are next, and sundries like soap and vitamins may follow.

Until the Bertelsmann announcement, pundits were all set to crown Amazon the Wal-Mart of the Net. Now, it seems, any number of players are in the running. The very same day that Middelhoff made his announcement, online music retailers CDnow of Jenkintown, Pa., and N2K of New York City confirmed that they were in merger discussions. Combined, the two would have as many as 1.2 million customers, analyst Brown estimates. The online video business is hot too; leader Reel.com was recently acquired by video rental giant Hollywood Entertainment. And four Internet retailers--CDnow, Cyberian Outpost, eToys, and Reel.com--just banded together to form what they call an "online shopping network."

Are these developments validation of Amazon--or portents of doom? The fans are still rooting for the online pioneer. "I am confident Amazon remains the company to beat in this space," says Peter Krasinovsky, vice president of Arlen Communications, a research outfit in Bethesda, Md. No doubt Bezos would say the same thing.

INSIDE: Microsoft and other techies ante up for the elections, page 230...A new angel investor, page 234...MarthaWare! page 236...Alsop on E-services, page 243