To Market, to Market, to Buy a Fat B.O.B.

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SAN JOSE, Calif. -- If a rich, powerful and possibly dangerous man with a squeaky voice and bad hair asked you to dance -- and he was the only man left on earth -- would you say yes?

That was kind of the dilemma facing companies in the electronic software distribution (or ESD) business here at the

Software Publishers Association

conference two weeks ago: Dance with

Bill Gates

or go home alone. Because as the show wound up, a consensus had emerged: Electronic software distribution is the Next Big Thing, and

Microsoft

(MSFT) - Get Report

knows it.

Can you hear the ESD knees knocking?

ESD technology can best be described as software for selling software. It consists of odd, complicated little programs such as "key encryption" and "wrappers" that enable a distributor to "unlock" a piece of software once the customer has purchased it. Thus, the purchased "bag of bits" -- or B.O.B., as it's known in ESD parlance -- can be conveniently sent to the customer over an electronic network rather than packed in a box and shipped.

Microsoft has so far said only that it will use ESD to sell its own software on its own Web site -- an alarming enough prospect as far as resellers like

CompUSA

(CPU)

and

Egghead Software

(EGGS)

are concerned -- but ESD executives here are convinced the company's real intentions are to become a seller of ESD technology. (In other words, Microsoft would add ESD to its lineup of e-commerce products.)

The bet is that Microsoft will pick one or two ESD companies from the pack, license their product and eventually buy them out. Or Microsoft will use the knowledge gained from such a partnership to refine its own product, making the partners obsolete. Those who aren't chosen will be left to fight over the crumbs of business Microsoft leaves behind. The upshot? Microsoft is sort of a competitor, sort of a partner, and sort of someone you don't want to badmouth to a reporter at an industry conference.

Last week, Microsoft confirmed that it is developing its own key-encryption management server for delivering its products to customers, but could not say for certain whether it plans to turn the server into a commercial product. And the CEOs and marketing vice presidents casually chatting in the white halls of the San Jose Convention Center, said Microsoft has been phoning them up and asking to kick the tires of their wrapper technologies.

"Someone at a session here said Microsoft is investing heavily in ESD and you better get ready for it," said consultant Darrell Monda of Campbell, Calif., as he pawed through product literature in the lobby, trying to figure who the likely targets would be.

Across the lobby,

Marimba's

much-photographed

Kim Polese

was bouncing on her stylish four-inch heels as a small crowd quickly gathered around her. Oh, no, Marimba doesn't compete with Microsoft, she said. "Microsoft has not actually made any announcements in this area of application management over the Internet," clearly playing it safe lest anyone think Microsoft has it out for her newly reinvented company. (After the death of "push" last year, Marimba was reborn in the already well-established area of application management and has partnered with dominant player Tivoli.)

The ESD market is still in its infancy and none of the big ESD players are yet public. Market research firm

International Data Corp.

of Framingham, Mass., estimates that less than 10% of all software is sold by electronic distribution. But according to IDC analyst Steve Graham, ESD will grow fairly quickly in the next few years, taking off first in the corporate market where users have high-speed lines and then in the consumer market for small patches and upgrades (slow modem speeds won't hamper such products).

Outside the SPA conference, on a blindingly sunny patio, three guys in dark suits from

Digital River

of Edina, Minn., sounded a familiar refrain: They entered the market in 1994, are growing at 20% to 40% a month, and plan to go public later this year. Are they worried about Microsoft wanting some of the action?

"We actually have a potential client relationship with Microsoft," said Mike Grandchamp, Digital River's vice president of marketing. "We have many little ins and outs with them; we're another channel for them," he said, wiggling his fingers in front of his chest as though plotting the takeover of the universe.

Not long ago, anti-Microsoft sentiment ran deep, when the SPA drafted its infamous

principles of competition

earlier this year, which talked in general terms about "any company" exploiting a "hypothetical" monopoly position in software. Was everyone suddenly too scared to say anything critical of Microsoft? Wouldn't little fish like Digital River admit Microsoft could be a shark?

"Maybe. Yeah, we kind of had a feeling here and there." Grandchamp turned to his suited colleague. "What's your feeling?" he asked, clasping his hands in front of his chest. "Did I put it accurately? We're still working on a deal with Microsoft ourselves," he said again.

The second suit, more politic, said "I think everybody still thinks they have a shot."

Grandchamp recovered: "This is a wonderful, dynamic, changing Internet industry and everything that happens now is a unique opportunity for partnership even with competition."

There was a pervasive sense that the glass was half-full. One CEO pointed out that Microsoft's entry validates the embryonic category and will help it grow in size. But others said Microsoft could put them out of business. "There will be a couple of us left when all is said and done a couple years from now," said Jeff Tremaine, director of sales and marketing for tiny

PACE Anti-Piracy

of San Jose, another ESD company. "But I don't want Microsoft in my space unless they're going to buy me."

Cate T. Corcoran writes about technology, business, culture and media from San Francisco. Her work has appeared in the San Jose Mercury News, Salon, CNET, Wired News, Byte and many other publications.