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Microsoft is turning to search, services, and the cloud, but what the company really needs is a game changer.

Paul McDougall

December 21, 2009

8 Min Read

The year 2009 was a tough one for Microsoft. Overall sales slumped, and core franchises like Office and Windows were hit doubly hard. Sure, the economy was bad, but a handful of other tech vendors managed to hold up significantly better.

Redmond's problem is that CEO Steve Ballmer and other top executives continued to operate as though it were 1989 -- when the personal computing industry was new and Microsoft could dictate prices and practices. In reality it's two decades later, and Microsoft has numerous new rivals, computing is moving from the desktop to the Internet, and the company is having trouble keeping up.

Windows 7 screen shot (Click for larger image and for full photo gallery)

Here's what Microsoft must do over the next year to get back in the game.

1. Cut Windows Prices

Windows has gotten too expensive to compete with virtually free offerings from Linux vendors like Ubuntu, which is gaining ground in the ultra low-cost netbook space.

Dell, for instance, now offers the Ubuntu-based Inspiron Mini netbook starting at $299 -- a price that is less than what one copy of Windows 7 Ultimate costs. The fact is, most consumers no longer care what OS their PC uses, as long it's priced right and they can reliably send e-mail, surf the Web, and get to their Facebook page. Meanwhile, nascent powerhouse Google appears willing to use its use Android OS as a loss leader to establish a beachhead in the netbook market.

The upshot of it all: Windows sales were down 13% in Microsoft's most recent fiscal year.

To stay competitive, Microsoft needs to slash Windows prices by 50% or more, or the market will continue to move toward alternative operating systems. Microsoft would also do well to banish the memory of Vista, the most reviled OS in its history, by giving all users a free upgrade to Windows 7.

Sure, Windows still represents a $15 billion annual cash cow for Microsoft -- but business history is replete with examples of companies that tried to play it conservative in the wake of profound change -- and got run over by the disruptors. Eastman Kodak, for instance, tried to protect its film business for far too long, and was late to the game when the photography world went digital.

2. Forget Willy, Free Office

On a similar note, Microsoft needs to produce a full, consumer version of Office that sells for no more than $20. The company is releasing a no-charge Web edition with Office 2010 next year, but that offering lacks the bells and whistles of the pricier desktop version, which starts at $80.00

IBM's Lotus Symphony is robust and free, and can do about 80% of what the full version of Office does. That's good enough for most users on the consumer side. Microsoft needs to respond, or it will see Office sales to consumers, off 34% in the most recent quarter, continue to suffer double-digit declines.

Microsoft must also trim pricing on the enterprise editions of Office and Exchange Server, as, again, rivals like Google are moving in with cloud-based products that are fully functional but much cheaper. Want proof? The cities of Los Angeles and Washington, D.C. recently ditched their Office environments for Google Apps, and stand to save tens of thousands of dollars on desktop software. More government agencies and businesses will follow suit unless Microsoft responds with some price elasticity in the current economic climate. 3. Go Deeper Into Services

If Microsoft can't continue to make fat profits selling software, where can it turn for income? The answer should be clear given the mergers and acquisitions activity of the past year. Hardware makers Dell and Xerox, faced with similar commoditization of their product lines, stocked up on tech services companies.

Dell took out Perot Systems for $3.9 billion, and Xerox bought ACS for $6.4 billion. IBM, meanwhile, went down this road several years ago by divesting low-margin products and focusing on outsourcing. HP followed suit in 2008 with its $13.9 billion buyout of Electronic Data Systems.

Services are hot because they provide an ongoing source of revenue, rather than just one-off purchases. And while software is getting cheaper and cheaper, it's not getting any simpler to use, maintain, or integrate with other systems. Consumers and businesses are always going to need ongoing support for their tech buys, meaning continued strong demand for services.

Microsoft to date has been a bit player in the services market, choosing to participate mostly through its Avanade joint venture with Accenture. Yet 2010 must be the year the company puts its $37 billion cash reserve to work in aid of becoming a larger participant. Buyout candidates include Computer Sciences or a mid-tier offshore vendor.

4. Ditch The Zune

Microsoft needs to stop spending time and effort, not to mention money, in markets where it's already lost the battle. The best example of this is in the MP3 space, where Apple rules with its iPod, and everything else, including the Zune, is an afterthought.

Despite a bevy of promotional and marketing efforts -- such as custom designs and an HD unit that shipped in August -- Microsoft continues to play the role of also-ran in the MP3 market and that's not going to change, ever. Sales of Zune and related products were off 14% in Microsoft's most recent quarter, and market share was insignificant compared to the iPod. Microsoft needs to admit Zune was a failure, cut its losses, and get out.

5. Buy Yahoo

On the other hand, Microsoft needs to go all-in with Yahoo and just buy out the company already. Redmond is having only marginal success building out its Bing search brand, with a global market share of just 3.26% in December. That's not because Bing is not a decent search engine -- it is. Rather, it's due to the fact that Google, with 85% percent of the market, has become far too entrenched in consumers' minds as synonymous with Internet search. Even a Microsoft executive recently told attendees at the Interop tech conference to "Google" his contact info, rather than "Bing it."

Yahoo is still the leading Web portal and is the richest site for general interest content on the 'Net. Adding the Bing search tool to Yahoo's pages would bolster search traffic considerably. True, Microsoft's current alliance with Yahoo calls for just that, eventually. But the deal involves complex revenue sharing formulas, dicey traffic guarantees, and technical integration challenges sure to hamper execution. Six months after its announcement, the companies still haven't closed the deal and it's unclear when that will happen.

Yahoo shares are currently priced at about $16.00; it's time for Microsoft to tear up the old deal and go hostile, if necessary. 6. Shore Up The Executive Suite

Steve Ballmer has said he plans to remain at Microsoft until roughly 2018. The question is whether he should wait that long. The company's performance under Ballmer's watch has been decidedly mixed since he assumed the CEO's slot from Bill Gates almost a decade ago.

Core franchises are hurting, few gains have been made in key, new markets, and in many respects the company has seemed adrift in recent years. Still, Ballmer has been a tireless champion of Microsoft and few executives spend as much time on the road as he does, meeting with major customers and talking up the company and its products at industry events and confabs. Ballmer is a tireless, passionate pitchman.

But if 2010 isn't the year for a change in Microsoft's corner office, the company's board must at least start to map out a transition plan and identify strong, young talent that can lead the company in the 21st century. It's a critical time, as Microsoft needs to adroitly navigate profound market changes, none more significant than the industry's shift to cloud computing. One individual to watch is senior VP Amitabh Srivastava, who was recently appointed to head a new server & cloud unit devoted to developing and marketing Microsoft's Azure cloud OS.

7. Launch A Game-Changer

Finally, Microsoft needs to release a new product in 2010 that will set the industry abuzz. The fact is, the last significant new launch from the company to garner a respectable level of attention, and demonstrate some staying power, was the Xbox. That was 10 years ago.

Microsoft must set the agenda again and steal some of Apple and Google's thunder by developing a game-changing product. Whether it's a phone, a tablet computer that really works, an e-reader, or something completely from left field, Microsoft needs a hit. Windows and Office are tired franchises, and the company must get the tech world talking about Microsoft again. Why let Steve Jobs have all the fun?

If Microsoft can accomplish even a few of these goals in 2010, it could put itself on the road to redemption. But if it stays on its current, middle-of-the-road course and rejects bold moves, next year will be another tough one in Redmond.

For Further Reading

Microsoft Data Center Strategy Vital To Azure

Less Client, More Cloud For Microsoft After Windows 7

What CIOs Think About Windows 7 .

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About the Author(s)

Paul McDougall

Editor At Large, InformationWeek

Paul McDougall is a former editor for InformationWeek.

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