Microsoft's Internet Do Or Die

Can Microsoft get its online services strategy right? To stay relevant, it has to.

April 16, 2007

15 Min Read
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In the summer of 1998, newly promoted Microsoft CEO Steve Ballmer told industry analyst Rob Enderle that Microsoft's long-term future would be in Internet services. At that time, however, Ballmer said the technology wasn't sufficiently developed--and the world wasn't ready--for an Internet services revolution.

That was then. Now, with the increasing use of Web tools like Ajax, JavaScript, Flash, and XML, the technology is ready. The popularity of application services such as Flickr, Google Maps, and iTunes on the consumer side and with businesses suggests that the world is ready, too. The remaining question: Is Microsoft?

"Our business is at risk," wrote chief software architect Ozzie in a red-flag e-mail over the challenges Microsoft faces from Internet-oriented computing

Photo by Kim Kulish

Today, the company faces one of the biggest challenges of its 32-year existence: Risk disrupting a massive installed base of users and developers--and cannibalizing its primary revenue source--by spending most of its energy and resources developing Web services, or get left behind as the world embraces Internet-oriented computing.

Microsoft, of course, wants to eat its cake and have it, too, calling its vision "software plus services," a convenient reworking of the "software as a service" phrase. That Microsoft has done a poor job of articulating that hybrid strategy is evidenced by the fact that even developers close to the company don't understand it. "I'm trying to get my arms around this," says Tim Huckaby, CEO of application development firm InterKnowlogy and a Microsoft MVP. "If I can't understand, and it's my job to understand, then CIOs are going to have a devil of a thing with this."

Some light may be shed at a sold-out conference in Las Vegas at the end of this month called Mix 07. Billed as Microsoft's conference for Web designers, developers, and decision-makers, it features sessions such as "Accessing Data Services In The Cloud" and "Front-Ending The Web With Microsoft Office." The keynote speaker and the exec charged with piloting Microsoft into the wild blue yonder of Web services is Ray Ozzie, chief software architect since Bill Gates turned over the title to him last year. Microsoft won't comment on what Ozzie plans to talk about at Mix 07. In fact, Microsoft representatives repeatedly tried to talk us out of running this story, at least until after the conference.

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Ozzie hasn't been talking much, at least publicly, in the two years since Microsoft bought his company, Groove Networks, but it's clear he's serious about the effect online services will have on Microsoft's business model. In an October 2005 e-mail to employees titled "The Internet Services Disruption," Ozzie expressed the same urgency Gates did in his famous 1995 "Internet Tidal Wave" e-mail. "We must respond quickly and decisively," Ozzie wrote, or "our business as we know it is at risk." But he also was optimistic that "with such a broad variety of products and solutions, we are well positioned to deliver seamless experiences to customers, enabled by services and service-enhanced software."


Microsoft's strategy for maintaining its dominance in an increasingly services-oriented environment is emerging slowly, in pieces, and in very general terms. "Sometimes people think about this just at the application level," Ballmer said at a financial analysts' conference in February. "But we think about [it in terms of] core infrastructure for storage, for transaction processing, and computation." Ballmer talked about providing "foundation services" such as directory functions and network protocols, "just like we have in Windows Server." And the fact that Microsoft's online application services will be key: "There will be application services for things like electronic mail, instant messaging, that people can build on."

At the center of Microsoft's online services drive is its 2-year-old Live brand. Despite the nomenclature, Office Live isn't an online version of Office but, rather, a set of tools for small businesses to help with Web hosting, online storage, e-mail, and Web analytics. Similarly, Windows Live is a collection of online services such as e-mail, file synchronization, security, messaging, search, and maps. Several of the Windows Live options are rebranded MSN services, and future products include an online clipboard, a collaboration tool code-named Tahiti, and a storage service known as Live Drive.It doesn't sound impressive. But remember, Windows wasn't very impressive when it came out in 1985.Microsoft sees its role as helping developers create online services with a common underpinning. "Our job is to provide a platform that allows people to get the infrastructure off the shelf and then build things that really differentiate them above the platform," says Charles Fitzgerald, Microsoft's general manager of platform strategy.

But Microsoft may have something more radical up its sleeve. "Once the realization was made by different groups that every product would have a services component, you go back to the company's platform roots and figure out what kind of platform treats the services layer as a system," Ozzie said at a Goldman Sachs conference in February.

Huckaby can't understand Microsoft's services strategy--and he's paid to

Ozzie may have been referring to a hush-hush project identified as Windows Live Core. Over the past 18 months, Microsoft officials have let slip tantalizing references to development of a "cloud OS" (Microsoft calls the Internet "the cloud"), which could be a full-blown operating system or some combination of distributed low-level services that largely exist on the Web. From a peek at Microsoft's organizational chart, Windows Live Core is being worked on by the company's heaviest hitters, all of whom report to Ozzie (see box, above). Another big name connected to the project: Dave Cutler, a Microsoft technical fellow who led the development of Windows NT in the early 1990s and before that the VMS operating system for Digital Equipment Corp.

Though Microsoft isn't saying much about Windows Live Core, an effort by a Swedish company, Xcerion, may provide some insight. Backed in part by former Microsoft execs (including an ex-CFO), Xcerion will debut later this year a Web-based operating system developed in XML and Ajax called XIOS. It will include a virtual file system, transaction-processing capabilities, a task manager, and a desktop-like graphical user interface.

SEVERAL MODELSOne of the criticisms leveled against Microsoft is that it hasn't responded fast enough to the threat represented by online productivity apps from Google, Zimbra, Zoho, and others. "The software industry is going online and Microsoft hasn't innovated," says Salesforce CEO Marc Benioff. "They don't have any multitenancy, on-demand application-sharing strategy."

There are several delivery models for online services. They can be free, as with some of those from Google, which are supported by revenue from advertising. With more sophisticated services, such as Salesforce's, users pay monthly or annual subscription fees. Microsoft "hosts" its services in its data centers, and it licenses software to third-party service providers for them to host.

It's a shifting landscape. "The world's trying to figure out where hosted services are good, where hosted services are bad, what's the limit," says Microsoft's Fitzgerald.

Whatever the limit, Microsoft wants its share. Later this year, it will offer Live CRM, a Microsoft-hosted, subscription-based version of its customer relationship application, part of its Dynamics line of business apps. Microsoft has hinted that it will offer its Dynamics ERP apps online and says new versions of the shrink-wrapped products coming out this year will feature links to Microsoft-hosted online communities. The first, a social network for financial professionals, will feature blogs, discussion boards, wikis, and the ability to create personal profiles, à la MySpace.

Services' Thin Slice Of Microsoft's 2Q RevenueBallmer said in February that Microsoft is planning "a service that will help host" Exchange, SharePoint Server, and Live Communication Server for its large accounts. "How quickly and how big the impact, a little less clear visibility," Ballmer said. "But [it's] a very important opportunity for us of a subscription nature."

Asset Matrix, which Microsoft acquired last year, has an online service that identifies software running on a company's networks. A presentation tagged "Microsoft Confidential" found on the Web site of another recent Microsoft acquisition, Softricity, mentions something called System Center Live--an online version of Microsoft's System Center as well as services attached to a desktop component, including catalog updates, additional online reports, and the ability for admins to identify and categorize unknown apps.

The physical manifestation of Microsoft's commitment to offering online services is its plans for building massive new data centers, starting with one along the Columbia River in Quincy, Wash., which opens this week. That data center will host Live CRM, among other services. Microsoft said in January it would spend $550 million on a data center in San Antonio, reported to be operational in about two years. And Microsoft may have a more radical plan for scaling online capability quickly: An architect on the Windows Live Core team recently gave a presentation demonstrating how modular data centers could be assembled, Lego-style, from shipping containers housing self-contained computer systems. HYBRID ADVANTAGE

Software plus services is, as it suggests, a hybrid model that seeks to leverage Microsoft's ubiquitous desktop and server products into an online advantage. Microsoft says it's been working on that strategy for some time, often pointing to its Windows Update service as an early example. A better example today is its e-mail server, Exchange. On the back end, Exchange can be installed on premise or hosted by a third party. On the front end, the Outlook client lets users take e-mail access offline; Outlook Web Access allows e-mail access via the browser; and Outlook Mobile runs on mobile devices such as cell phones and PDAs. Exchange 2007 even gives users the option of accessing e-mail via voice prompts on the phone. Add to that Exchange Hosted Services, which runs in Microsoft's data center and stops spam and checks for viruses before e-mail hits corporate servers.

There are numerous examples of Microsoft's applications leveraging online services. A feature called PowerPoint Slide Libraries in SharePoint Server 2007 lets users store PowerPoint slides online and get RSS notifications whenever they're checked out or changed. When a user searches for templates in Microsoft Word, the application pings Office Online, where contributors have uploaded custom-made templates and others have rated their quality. The user can then choose from those templates as well from the desktop software. That capability has been available since Office 2003, though it has flown under the radar, says Microsoft VP Chris Capossela.That's the essence of software plus services, technically and philosophically. "What we find is that customers don't pick one type of computing. They pick a mash of those things," Fitzgerald says.

Microsoft has one of the biggest partner ecosystems in the industry, and it needs to keep software vendors and service providers on its side. Last fall, the company announced a change in licensing policy that lets online service providers offer its Dynamics apps. And Microsoft continues to enhance its tools for small-business service providers, such as the Microsoft Solution for Hosted Messaging and Collaboration Version 4.0. This week, it will introduce the Microsoft Incubation Center, a program to bring together ISVs interested in developing online software with service providers interested in hosting it.


Microsoft needs to persuade its large developer community to stick with it through this transition--especially those in the dark about its strategy. The Mix 07 conference should address some of those concerns.

Microsoft publishes programming interfaces for some Windows Live apps, such as Live Search Maps. Its ASP.Net toolset helps developers build Web sites. And its .Net Framework 3.0, shipping with Windows Vista and eventually with Windows "Longhorn" Server, has the Internet in mind with features such as Windows Communication Foundation, which helps in creating distributed applications, and the interactive user-interface technology Windows Presentation Foundation.

To succeed with its software-plus-services approach, Microsoft must ensure a rich out-of-browser experience for Web-connected apps. "Programming in the browser is like programming with one arm behind your back," says InterKnowlogy's Huckaby. Windows Presentation Foundation was used to develop the New York Times Reader, which separates the online version of the Times from the browser and presents the reader with content that looks very similar to the printed newspaper. A small company called Thirteen23 has built client applications on top of WPF that provide out-of-browser experiences for popular Web services including Cine.view for Netflix and Nostalgia for Flickr.

Browser programming is still a critical piece, and a new technology from Microsoft called Silverlight--formerly known as Windows Presentation Foundation Everywhere--may help. A competitor to Adobe's Flash, it's a 2-Mbyte plug-in that runs inside the browser, even the Mac's Safari browser. Future versions will support C# and Visual Basic programming.SEARCHING FOR REVENUE

"Buy more software" is always Microsoft's strategy, says Benioff

So far, Microsoft's services record has been decidedly, well, mixed. The MSN Web portal has had more makeovers than Madonna. Though Microsoft essentially created Ajax as part of its Outlook Web Access product, and it led the development of satellite mapping with TerraServer, it let others capitalize on those areas, notably Google. A planned online productivity suite called NetDocs was shelved five years ago because of immature technology and concerns it would cannibalize Office.

Online services are only a small slice of Microsoft's overall revenue pie. Its adCenter online advertising business generated $462 million in the quarter ended Dec. 31--respectable but paltry compared with Google's staggering $3.2 billion in the same period--and its search engine has been steadily losing market share. Two key Live executives--Live Search VP Chris Payne and Windows Live platform engineering exec Blake Irving--recently left the company.

To jump-start online advertising and search, Microsoft is breaking them out from the Live organization with a new leader, former business app head Satya Nadella, who will report to Kevin Johnson, president of the company's platform products and services division. A new version of adCenter is in development, and Microsoft is integrating search technology into many of its products and targeting vertical, segmented search markets.

Still, where online advertising figures into a software-plus-services environment isn't entirely clear. Ozzie said in February that ad support won't be the predominant way Microsoft generates revenue from its online enterprise software--volume licensing or subscriptions are more appropriate--and it will play a mixed role in its small-business services offerings.To succeed in the online environment, Microsoft will have to accommodate it. Web users highly value the ability of a service provider to implement quick, incremental updates, but that's not part of Microsoft's historical culture. Steve Berkowitz, senior VP of Microsoft's online business group, admitted at a conference last week that the company hasn't been "nimble enough or creative enough or bold enough" to exploit the technology innovations it has in development, and he promised that would change. "You're going to see us bring these technologies to the forefront in ways that we haven't before," he said.

Asked in February about the potential for online services to cannibalize Microsoft's traditional software business, Ozzie admitted there was a small chance, in certain markets, but that overall services would generate more business, not less. "Whenever there's a big technology shift like this," he said, "it tends to be more additive to the business net-net than significantly deleterious."

That's what Microsoft hopes, at any rate. Because if there's a company that might find the shift to online services significantly deleterious, it's Microsoft.

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