Everybody else was adding a free browser to their OS and it was obviously going to become a requirement, as it is today with smartphones. It would have been foolish for Microsoft not to do it, and it was foolish of the US DoJ to think otherwise.

Otherwise, Microsoft rewrote the browser so that the components could be used by other programs and by outside developers, so it wasn't a bundled product, it was integrated into the operating system. This might have been a mistake (or not), but it was required because Microsoft had already signed a consent decree with Janet Reno that stated that Microsoft was allowed to add to the OS but not to tie separate products.

Life is hard when politicians interfere with software design.

Componentizing IE resulted in it being a better browser than Netscape, and made it much easier for third parties like AOL to adapt it using the SDK Microsoft provided. Netscape couldn't offer that, though it probably wouldn't have: Netscape prevented third parties from changing Navigator, and it could only be downloaded from Netscape.

Netscape finally lost for a lot of reasons. One was because it decided to rewrite its crap code just as Microsoft had done. That meant it stopped shipping new browser versions with new features. Its market share plunged and AOL, which had bought it, decided to make it open source, which is where Mozilla came in....

Incidentally, Microsoft didn't run into the same problem because it had two browser development teams working in parallel, one on the old version and one on the componentized version.