During last Friday's EU investigation into Microsoft's alleged monopolistic practices in Europe, it emerged that the company's operating system can function without Windows Media Player attached.

Three eye-witnesses who attended the closed door meeting revealed that RealNetworks had showed how Windows XP Embedded, a simplified version of the operating system which is licensed only for industrial use, can function as an operating system without Microsoft Media Player attached.

This could form the basis of a settlement to the long-running anti-trust case.

Microsoft has argued that removing Media Player would harm the way Windows works. It also says that Windows XP Embedded is not a full operating system.

"It is designed for single-purpose use, such as running ATMs (automated teller machines)," said Tiffany Steckler, a spokeswoman for Microsoft.

Rival bundle

In August, the European Commission told Microsoft that in order to restore fair competition among music and video players such as Media player, Real One and Apple's QuickTime, Microsoft must either extract Media Player from the operating system and sell it as a standalone product, or it must insert a rival player into Windows to sit alongside its own player.

The Commission referred to XP Embedded in the August statement, according to one person who has read the confidential document: "The Commission cited it when it refuted Microsoft's claim that Windows depends on Media Player," he said.

RealNetworks demonstrated how easily Windows XP Embedded runs without the media player before over 100 European competition regulators, opponents and Microsoft itself. It also showed how Real One Player, its own media player, worked on the specialist version of XP.

"It was a 'gotcha' moment," said one person present, adding: "Everyone was impressed; there was a lot of nodding heads and hands to chins."

He compared it to a similar moment during the antitrust case in the US, when a witness demonstrated how Windows can work without having the Microsoft browser, Internet Explorer, attached. "In that case, Microsoft insisted that Windows would be harmed by having its browser removed too," the person said.

Microsoft's lawyers made reference to RealNetworks' demonstration during their summing up at the end of the three-day hearing, another person present said. "Someone on the Microsoft team dismissed the demonstration as false, but they still acknowledged it as one of the more important points made during the hearing," he said.

Two versions

Settlement talks between Microsoft and the Commission are likely to begin in earnest from this week. After the demonstration on Friday the Commission is expected to push Microsoft towards offering to license two types of operating system to European PC manufacturers: one that contains Media Player and another that doesn't.

If Microsoft offered to license a stripped down version of Windows, such as XP Embedded, to the mass computer market to sell alongside its existing Windows XP, which contains programs such as Media Player, people at the hearing said there could be grounds for a settlement.

One version of Windows with Media Player and another without would allow PC manufacturers to offer their customers a choice: the Microsoft package or an a la carte package containing competitors' software.

"If the stripped down version is sold at a big enough discount to the bundled version to allow room for a profit margin for competing media players then that might well be enough for the European Commission," said a person present at last week's hearing.

RealNetworks and Microsoft were unavailable to comment. One person familiar with RealNetworks' position said that Microsoft has already tilted the market for media players so far in its favour that additional remedies may be needed.

In addition to selling a version of Windows without Media Player, Microsoft should carry a competitor's product alongside its own in the bundled version, RealNetworks is understood to be arguing.

There is also a question about marketing. Microsoft spends nearly $1 billion on advertising each year. If the bundled version of its latest Windows XP operating system continues to benefit from lavish ads, then the unbundled version should be promoted too, people argue.

All the hearing attendees contacted said they were doubtful whether Microsoft would willingly agree to license a second, unbundled version of Windows to the PC market. "Today Media Player is the issue. Tomorrow it might be Instant Messenger or Outlook (the email program). This sets too big a precedent, and creates, potentially, too great a challenge to Microsoft's plans for Windows," said one.

Meanwhile, more progress was made on the second competition problem the Commission has identified. In its August statement of objection, the Commission accused Microsoft of competing unfairly in the market for small servers of under $25,000.

Sun complained to the Commission in 1998 that Microsoft was giving its own server software an advantage over competitors by withholding information about Windows from them. Servers run networks of PCs. Microsoft has a 55 per cent share of the market for small servers in Europe, according to IDC.

One person in the hearing said Microsoft agreed to reveal enough about Windows to make it fully interoperable with rivals' server software. "Sun is likely to get what it wants," the person said.

Microsoft released a statement on Friday evening repeating assurances made by its senior counsel Brad Smith the previous day that it wants to settle the case before the Commission rules. It described the hearing as "a positive step towards a meaningful solution."