Discussions between AOL Time Warner and Microsoft over whether AOL's online service software would be bundled with Windows XP collapsed on Saturday. During a phone call, Microsoft Windows group Vice President Jim Allchin and America Online Time Warner President Ray Oglethorpe agreed they could not resolve the key issue that had stalled discussions, said sources familiar with the matter. An agreement would have guaranteed the AOL software would ship with XP as it has with every other version Windows released in the past five years. AOL Time Warner and Microsoft had been deeply divided over a number of issues, but most had been worked out, said AOL Time Warner spokesman John Buckley. The inclusion of RealNetwork's RealPlayer with the AOL online service was the issue that tripped up negotiations, he said. "All the major issues between AOL and Microsoft had been largely worked out when the talks foundered on an issue that really isn't about AOL and Microsoft," Buckley said. "It was Microsoft's desire to try to have as much control of music on the Internet as possible." But Microsoft spokesman Vivek Varma said no single issue led to the severing of negotiations. "We're disappointed the discussions between AOL and Microsoft ended without an agreement on a broad range of issues between them," he said. "While unable to conclude a broader view, we will continue our work to ensure the AOL service runs well on Windows XP." Varma emphasised, "The discussions have ended. We're always open to discussing partnership possibilities, and we hope to have discussions with AOL Time Warner in the future." Sources close to the negotiations painted differing pictures for the cause of the talks' collapse. Microsoft had wanted the AOL Time Warner service to offer support for Microsoft's Windows Media Format. Content is largely available only for RealNetwork's RealPlayer, and the program is the default media player for the AOL service. Sources said AOL Time Warner would have been willing to give some ground on the media format issue. But Microsoft, apparently, had manoeuvred to get AOL Time Warner to disable or boot RealPlayer from its online service. One source insisted Microsoft, which had used a number of technical and legal arguments supporting its position, "choked on the inclusion of RealPlayer". AOL Time Warner's resistance to opening its instant messaging network to rivals also may have played a role in the negotiations' collapse, said one source. But another discussion source insisted the messaging issue had been put aside for a later time and had little or no effect on the talks' ending. The inclusion of Windows Messenger with Windows XP was not an issue during the discussion, said negotiation sources. Microsoft added the communications console -- offering instant messaging, videoconferencing, application sharing and telephony -- to the most recent testing version of Windows XP. The feature replaces MSN Messenger. Microsoft and AOL Time Warner had not fully resolved differences over legal issues. Microsoft wanted both sides to agree not to go after the other. In the case of Microsoft, the company would have agreed to back off regulators and trustbusters about AOL Time Warner's closed instant messaging network. AOL Time Warner would have agreed to back off its antitrust campaign against Windows XP. But some differences remained between the sides when the talks collapsed, sources said. Another minor issue, which had largely been resolved, affected how the AOL service would be bundled with Windows XP. In early versions of Windows, a link to AOL's online service appeared on the desktop in the "Online Services" folder. But in Windows XP, Microsoft wants the desktop to startup with as few icons as possible. In the most recent testing version of Windows XP, for example, only three icons appear on the desktop compared with seven or more in earlier versions of the operating system. Apparently, AOL found the more limited advantages of being included with Windows XP but not placed on the desktop not worth concessions Microsoft had asked for. Both companies could stand to lose much from the negotiations' collapse. Microsoft has bundled its MSN online service and instant messenger service with Windows since version Me. Inclusion with Windows XP would have assured wide distribution of AOL's service, which already commands significant market lead over Microsoft's competing service. For Microsoft, AOL's large base of instant messaging and online service customers also are potential Windows XP upgraders and converts to the MSN Explorer and Messenger services. Have your say instantly, and see what others have said. Click on the TalkBack button and go to the ZDNet news forums. Let the editors know what you think in the Mailroom. And read other letters.