When the last great hacking scandal broke in February, there were gloomy predictions in the United States about the vulnerability of companies to such attacks. Time magazine reported that the government was fearful of "some future electronic Pearl Harbour".

Philip Bobbitt, the former national security council senior director for infrastructure protection, warned ominously: "We're entering a period when a very small number of persons can do greater damage to our American infrastructure than all our previous wars combined."

Mr Bobbitt was speaking before the latest electronic break-in at Microsoft, but what has happened bears out the fears - if in slightly less apocalyptic terms - that industrial espionage at such key companies as Microsoft is becoming a reality.

Gaining access to Microsoft's source code would be like obtaining the secret ingredients of Coca-Cola. It is the fount of Microsoft's huge success and monopolistic grip on world computers, more than 95% of which have an operating system (mainly Windows) designed by Microsoft.

The company's policy has been to integrate its operating system with other popular applications such as the Excel spreadsheet and Word wordprocessing package (also providing Microsoft with a market share of around 95%) to expand its firm grip on the market.

Critics complain that Microsoft's integration of applications with its operating system stifles competition because a rival company could not invent a new spreadsheet and give it away free - in order to be successful, it would have to displace Excel, which has become a world standard.

In recent years Microsoft has been using versions of its operating system to expand into other fast-growing areas such as cable television (where it has been buying minority stakes), palm-top computers and mobile phones. In Europe, its chief competitor in the mobile world is Symbian, part owned by Britain's Psion which yesterday warned that its profits would be well down on market expectations.

Another success for Microsoft is Internet Explorer, which has long since dis placed Netscape Communicator as the leading internet browser.

At the heart of Microsoft's success is the intellectual property rights it asserts over the source code to its operating system. Its main rival is Linux, the operating system devised by devotees around the world which can be downloaded for free from the internet. Although it has had some spectacular successes in professional applications (particularly running servers), it has never made any impact against Windows run on personal computers.

Microsoft's dominating position, its often arrogant attitude and its claims to have a high level of security have made it a prime target for hackers. In the past 12 months its Hotmail subsidiary, one of the most successful emailing companies, was subjected to a spectacularly successful hack, and its Explorer browser was exposed as having security holes.

But the most worrying aspect of this is undoubtedly the fact that it has happened on this scale at all. If a company such as Microsoft - which probably has the densest concentration of intellectual firepower of any large company - can fall prey to hackers, can anything be safe? The answer, in a word, is no.

The break-in could not have come at a worse time for Microsoft, still embroiled in its long-running and expensive anti-trust battle with the government. The battle has even had ramifications on the presidential election, with Al Gore visiting Microsoft's home state of Washington to try to woo back the company's workers and families who feel bruised by the way the government has behaved, thus helping to turn the normally Democrat state into a marginal.

It was only on Wednesday that Microsoft's lawyers and those representing the US government joined in raising concerns about plans to conduct a computer seminar for the US appeal court judges who have to sit in judgment on the break-up of the company.

Microsoft and the government have both requested a preview of what the instructor, Michael Hites, a computer technician from the Illinois Institute of Technology, intends to tell the court, fearing that Mr Hites might unintentionally stray into some of the key appeal issues.

But the greatest concern to Microsoft is the implications of the break-in. Previously, the hacker as a figure had been regarded mainly as a nuisance, albeit a disruptive and costly one. Many of the most spectacular acts of hacking have been aimed at proving a point and have not been done as acts of commercial theft.

"The media's obsessive focus on computers and the extraordinary growth of electronic commerce on the internet has led to a 'dumbing down' of the terms used," Kevin Mitnick, the world's most celebrated computer hacker wrote in the Guardian earlier this year. "The media now uses 'hacker' to describe crimes using computers and 'hacking' is now a pejorative used to label those crimes."

Mr Mitnick spent four and a half years in jail for his hacking activities, although none of them were for commercial gain. He has always argued that the FBI and government have concentrated their attention on the wrong targets and the latest break-in might prove his point.

Microsoft yesterday confirmed the hackers had accessed its source codes but denied that they had tampered with them.

A British security expert said yesterday that the hackers may well have needed inside help. Former det supt Graham Satchwell, Microsoft's senior investigator in Europe, the Middle East and Africa until last month, said: "If this was not a case of a 17-year-old hacker getting lucky and actually a case of organised crime then they would need someone on the inside."

So, just when Microsoft would have wanted to be using its fire-power in its legal battle, it is having to mount a public relations exercise to deal with the damaging implications of commercial espionage.

The great irony is that the hackers have accomplished what the US justice department has been unable to do: get access to the company's source code. The other irony is that Microsoft will have to work the FBI at a time when it is crossing swords with a different branch in its anti-trust case.

The fact that the presidential campaign is at its height may prove a blessing - diverting attention from Microsoft's current embarrassment.