(FORTUNE Magazine) – There was a time not long ago when Scott McNealy would have jumped at the chance to beat up on Microsoft. The CEO of Sun Microsystems, McNealy has long been known as the world's greatest Microsoft baiter, always ready with a nasty quip, delivered with the timing of a good stand-up comic. McNealy was the one who first described Microsoft's Windows operating system as a "giant hairball." He has called Steve Ballmer and Bill Gates "Ballmer and Butt-head." As recently as July, McNealy opened a speech at a packed technology conference with one of his classic anti-Microsoft broadsides. "They call it Hailstorm," he said of Microsoft's new set of Internet services, which are being bundled into Windows XP. "Have you ever been in one? I'm from the Midwest, and I know what it's like. It's billions of ice cubes raining down on you at escape velocity."

But ask McNealy to tee off on Microsoft today, on the eve of the XP launch, and he hedges. He'll talk to you eventually, but it takes prodding. And when he does talk, a lot of the old bravado is missing. Oh, sure, McNealy will lay out a dire vision of a Microsoft-dominated future, in which an unfettered Microsoft kills off every competitor from eBay to Merrill Lynch, just the way it killed off Netscape during the browser wars. But his tone is sober instead of brash--as if the doomsday scenario he is describing, which he once thought Sun could help fend off, is all but inevitable. The catchy one-liners are still there, but the vitriol has evaporated from the McNealy repertoire.

Indeed, about halfway through the conversation he suddenly starts sounding downright defensive. "Please don't say I'm bashing them," he says. "I don't care if you challenge my logic, but at least give me credit for having thought a lot about this. People say I'm Chicken Little, but they haven't seen what I've seen." Later he turns to a particularly painful subject--the disappearance of so many of Microsoft's old enemies. "They sent you to me because I'm the only one left," he says.

For Microsoft and its allies, the introduction of Windows XP is a time for rejoicing. The new operating system has received glowing reviews. Some commentators view XP as such a significant leap forward that they suggest its introduction could spur computer sales and possibly even the whole American economy. XP links Windows far more closely to the Internet, which is something Microsoft has been aiming at for years and which will certainly make life easier for users. And it incorporates a host of features and services designed to make Microsoft even more indispensable than it already is: XP has a Microsoft instant-messaging feature; photo- and video-editing capabilities; a media player that allows you to listen to, burn, and rip CDs; firewall protection; and on and on. In this view XP is so demonstrably a Good Thing that it's hardly worth discussing.

But to Microsoft's enemies, the launch of XP symbolizes something else entirely--the extent to which Microsoft remains an unrepentant monopolist, whose business model is based on using Windows to muscle into markets it covets. That, for them, is a very depressing thought. Many have spent years fighting Microsoft in one way or another: Sun's Java programming language, after all, was in no small part an effort to break the hegemony of Windows. Jim Clark and Marc Andreessen, the co-founders of Netscape, fought the browser wars. As CEO of Novell, Eric Schmidt spent most of his waking hours trying to ward off Microsoft.

And then there's the Microsoft antitrust case. Microsoft's enemies were largely responsible for instigating the lawsuit and were active behind the scenes in helping the government frame the charges and compile the evidence. Executives from Sun, AOL, Netscape, and other companies testified against Microsoft. Last year it seemed to have paid off when Judge Thomas Penfield Jackson ruled decisively in favor of the government and ordered that Microsoft be broken up.

And now? Now the breakup remedy is off the table, thanks to the court of appeals. Though the upper court upheld Jackson's finding that Microsoft abused its monopoly power, the case is back in federal court, where it seems to be on a treadmill to nowhere (see box). As Microsoft's critics see it, all the hopes they had invested in the lawsuit have been dashed. "I just don't think the remedies are going to be that substantial," says Charles Ferguson, who sold his company, Vermeer Technologies, to Microsoft in 1996--and then went on to become one of the software giant's loudest critics.

The launch of XP only reinforces that sense of hopelessness. After all, the antitrust case was originally brought because Microsoft had bundled its Web browser into Windows--and yet here comes XP, fairly bristling with newly bundled services and products that take dead aim at one competitor or another. The central belief today of those who fought the company in the 1990s is that, despite everything that has happened, nothing has changed. Microsoft is more powerful than ever. To them that is the real meaning of the XP launch--and it's what each of them is having to come to terms with, each in his own way.

The first thing you discover when you go back to the old Microsoft enemies is how few of them are even interested in talking about the company anymore. Dozens refused to return phone calls. Others took the call--only to end it abruptly once they discovered the subject of the interview. Take Gary Reback, for instance. He's the former Silicon Valley lawyer who was retained by Netscape to try to get the Justice Department to launch a Microsoft investigation. Wired magazine once called him "Bill Gates' Worst Nightmare." There were times in the late 1990s when Reback seemed obsessed with Microsoft. Today he says, "It's just not where my head is right now." He recently founded a company called Voxeo; that, he says, is where he wants to focus his energy.

Eric Schmidt? Few companies have taken the kind of battering over the years from Microsoft that Novell has. It basically invented the idea of the corporate PC network, but since the mid-1990s, when Microsoft bundled corporate networking into Windows NT, Novell has seen its core business wither to almost nothing. Schmidt, Sun's former chief scientist, came onboard in 1997 to attempt a turnaround. He was always willing to tangle verbally with Microsoft. Not anymore. He's the CEO of Google now, and there's no percentage in it. Talking about Microsoft, he says, has proven to be "bad for my health."

The second thing you discover is how many former enemies have become allies. That is especially true of the ex-Netscape crowd. Jim Clark's new digital-photography company, Shutterfly, has an alliance with Microsoft that gives it top billing in XP's online photo-printing folder. Marc Andreessen and Ben Horowitz--another ex-Netscape executive--run a company called Loudcloud that sells outsourced Website management. Microsoft is one of its biggest customers, and Horowitz can't say enough good things about the company. "Microsoft is one of our best partners," he enthuses. "We just expanded our relationship with them." Former Netscape marketing guru Mike Homer recently started a company called Kontiki, which makes software that speeds up Internet audio and video. "I'm their best and most supportive third- party developer," he says, offering no apologies for becoming a Microsoft ally. "It's really the only smart thing to do. It's just a bad business decision to do anything to compete with them."

One of Microsoft's more outspoken allies these days is Gateway Computer. Computer manufacturers such as Hewlett-Packard, Compaq, Dell, and Gateway are, of course, extremely dependent on Microsoft, whose operating system runs their machines; a new version of Windows, properly launched, can revive flagging PC sales. But over the years, it has become clear that not all computer makers are created equal in the eyes of Microsoft. Dell and Compaq, for instance, have extremely close relations with Microsoft, which in the past has gotten them preferential treatment and pricing. Gateway, on the other hand, has historically had a rockier relationship; Gateway even provided some of the strongest evidence used in the antitrust case.

It's possible that Gateway is singing its current tune because it has no choice. The company is having a tough time: It recently announced a quarterly loss of more than $500 million and has seen its stock fall 69% this year. It simply can't afford to get crosswise with Microsoft. Nevertheless, Gateway officials sound genuinely pleased at the current state of the relationship and claim that it's more Microsoft's doing than theirs. "I'm one of the world's biggest cynics, and I've been in the computer industry for nine years, so I've seen a lot," says Mike Ritter, a VP of marketing at Gateway. "And I've been impressed with the improvements I've seen [in Microsoft's behavior]." For example, Ritter says, Gateway has been pushing Microsoft to let it offer customers an icon-free desktop screen for a long time. With XP, Microsoft has finally given computer makers that option. It is also allowing boxmakers to cut their own deals with Microsoft competitors for desktop placement, something it used to fight vigorously. (However, any manufacturer that chooses to go that route must also put three Microsoft icons on the desktop.) Ritter also says that when Gateway wrote an application to introduce users to the various things the computer could do--and sold placements in that application to Microsoft competitors like AOL and RealNetworks--Microsoft didn't stop it. "The old Microsoft would have wanted to get in there and control it," Ritter says.

Part of the reason that Microsoft is giving computer makers more leeway may well be antitrust concerns. After all, the part of the case the company flatly lost had to do with the way it dealt with the manufacturers. On the other hand, the question of whether Microsoft can legally bundle new technologies into Windows is much less clear--it's one of the issues the appeals court threw back to the lower court. And as XP illustrates, Microsoft is showing no inclination to ease up on that piece of its long-time strategy. Indeed, XP includes new file-transfer features that compete with a product called PC Anywhere made by Symantec, a well-known Silicon Valley company. XP includes the Microsoft Network and Microsoft's instant-messaging service, which compete with AOL Time Warner (the parent of FORTUNE's publisher). And it has new, improved media player software--aimed at taking market share away from RealNetworks' media player.

For the companies that find themselves in Microsoft's sights, the question then becomes, How should they react? For those competitors who are veterans of the Microsoft wars--and especially those who have been successful in keeping the software giant at bay--the tone tends to be sanguine, above the fray, and studiously unworried. Here's AOL spokesman Jim Whitney, for instance, discussing recent gains made by Microsoft's MSN: "Sure they've added new members, but we've added seven million of our own in the past 12 months. We now have 31 million members, and our members spend far more time online. It's 65 minutes, compared with 11 minutes." RealNetworks, whose digital media player has about a quarter of the market (as does Microsoft's media player), sounds similarly unruffled. "Despite the fact that Microsoft has been bundling its media player for years, we have been able to consistently offer consumers better products, more content, and cutting-edge services that have been hugely successful," boasts Steve Banfield, the general manager of the consumer products division.

A more interesting case is Symantec, which in its 20-year existence has seen at least half a dozen of its products folded into Windows over the years. During the antitrust trial, Gordon Eubanks, the company's former long-time CEO, was called to testify--on Microsoft's behalf. His essential position was that Microsoft had the right to bundle anything it wanted into Windows, and companies like his just had to deal with it as part of doing business in the software industry. Today that's still Symantec's position--despite the fact that many of the functions of PC Anywhere are going to be included in XP. "Sure, we could play the legal game," says Joe Wang, a company vice president. "But we don't believe it would help us fight today's battle." Wang concedes that PC Anywhere's sales are off five to ten percentage points since the market became aware of the XP news. "Obviously we'd prefer that [Microsoft] didn't do something like this, but it's not something we have control over." He adds, "We expect sales to go back up once people discover the difference between our product and Microsoft's."

Not every company feels that way. Indeed, two of them seem particularly agitated about the potential effect of XP on their business--and are willing to say so on the record. One is a company called Intertrust, a pioneer in technologies that protect copyrighted items in digital form. After Napster's demise, digital-rights management has become increasingly important, because media companies want to be able to put digital content on the Internet without losing their ability to charge money for it. (Essentially the software attaches conditions to a piece of music or video and then controls what users can do with it.) Microsoft wanted to license Intertrust's technology exclusively--which would have made its media player more desirable--but the company declined to cut that deal because it wanted the freedom to license its software to all comers. So, it says, Microsoft simply took the technology and folded it into XP. Intertrust responded with a patent-infringement suit.

Ed Fish, the executive in charge of Intertrust's patents, says he's not eager to take on the best-financed company in the world but adds that his small company has no choice. Intertrust may not have billions in the bank like Microsoft, but it has more than enough cash to deal with the case, Fish says--somewhere around $160 million. And he expresses confidence about the outcome. "If Netscape had our patent portfolio," he says flatly, "they'd still be around." (For its part, Microsoft has responded with a patent-infringement suit of its own. "They seem to be on a fishing expedition, hoping to do discovery and get some kind of a deal," says Microsoft spokesman Vivek Varma.)

The second company that's openly upset about its treatment in XP is Kodak. For years Kodak worked alongside Microsoft to improve digital photography and to create standards for digital cameras so that any company's camera would work immediately when plugged into the back of a computer. But the two companies have also competed. Kodak is the photo company that backs AOL's My Pictures feature; rival Fuji backs MSN. More recently Kodak and Microsoft have started competing in the market for digital-camera software. And when early copies of XP started circulating late last year, Kodak discovered that Microsoft clearly viewed it as more of a competitor than a friend. In those early versions of XP, when consumers plugged in their digital cameras, only Microsoft's pre-loaded photo software appeared. It was only after Kodak took its story to the Wall Street Journal last summer that Microsoft decided to offer consumers a choice of software.

On the eve of the launch, though, a second issue still lingered. When computer users want to get digital prints developed, XP will offer three choices. Kodak rivals Fuji and Jim Clark's Shutterfly had nailed down two of the spots. Kodak wanted the third. The hang-up, says Kodak spokesman Anthony Sanzio, was that Microsoft wants a cut of every photo developed through its system, while Kodak wants the number capped. "The whole thing has been surprising to us, to say the least. Maybe Microsoft thought we would just go away. But that's not going to happen," Sanzio says. The night before the launch, word leaked out that Kodak had gotten the third spot; the terms were not immediately available.

At bottom, what most upsets Kodak is the realization that the company is being, as they say, "disintermediated" by Microsoft. In other words, whereas Kodak once handled every aspect of consumer photography--and made money at every step along the way--Microsoft is horning in and demanding a cut of the take. Certainly, the prospect of Microsoft inserting itself profitably into all kinds of business, from banks to brokerages to auto companies, has long worried many top corporations. In the latest edition of Windows, there is one feature above all that exacerbates those fears: Passport.

To hear Microsoft describe it, Passport is intended primarily to make computer users' lives easier. Without question it will do that. The feature allows the user to plug in his e-mail and postal addresses, a password, and other information such as credit card numbers, and then conduct transactions all across the Internet without having to rekey the data. To gain access to certain Microsoft sites, a user will need a Passport account. The company believes Passport will be so convenient and so useful that users will gravitate to it every time they want to enter a secure site or to make a credit card purchase online.

Many companies don't view Passport so benignly. As they see it, Passport will give Microsoft access to their customers--and thus the potential to know crucial information about their online habits. Consider mighty General Motors. One of the company's most important initiatives is to figure out ways to offer customers driving-related services over the Internet. In the calm, declarative way that only one of the largest companies in America can muster, GM says it believes that Microsoft has overreached with Passport and should back off. It wants Microsoft to make Passport completely "interoperable," and it wants it to join the Liberty Alliance, the 30-plus-company group Sun recently started to promote this view. "If GM wants to offer a Passport-like service of its own, it should be allowed to do so, and it should be able to interoperate with everything else out there," says Tony Scott, a top GM technology official.

"We don't think Passport is going to be a successful model at the end of the day," he adds. "We just don't think consumers are going to want to put all their eggs in one basket." Microsoft sounds as if it's listening carefully. In recent months the company has been saying that it will license Passport technology to anyone that wants it, and in recent weeks it has gone even further, talking about the possibility of ensuring that its system works with every other authentication system--and even bring in third-parties to audit (and protect) the consumer data Passport collects.

What it comes down to, of course, is power. More than its billions in the bank, more than its technical prowess, more than its hyperaggressive culture, raw power is the thing Microsoft has that everyone else fears. It's what causes people like Mark Eppley, CEO of Laplink--an old foe turned friend--to say bluntly, "Microsoft is the ocean. The rest of us are fish swimming in it."

And it's what causes Adobe CEO Bruce Chizen to remark, "They're the one competitor I think about every morning." Among Adobe's products is Photoshop, the dominant program for computer imaging and photo manipulation--a technology, it so happens, that Microsoft is not folding into XP. "If they decided they wanted to take on Photoshop and put us out of business, could they do it?" Chizen asks. "Yes. It would be tough. It might take a long time. But they could do it." Then he adds, "So I'm glad they're focused elsewhere."

REPORTER ASSOCIATE Noshua Watson

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