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Microsoft is on a roll: Its newly launched Windows Phone 7 is gaining momentum, and Kinect, its motion controller response to the Wii, could very well sell out before the end of the year. If there was ever a time for Microsoft to get back on its feet and stand shoulder to shoulder with Apple and Google, this would be it.

This positive buzz comes at a time when Microsoft sorely needs it. Microsoft’s major source of power and revenue –  the Windows operating system –  is under an unprecedented threat on several fronts. First, as mobile phones become smarter, the Windows franchise will lose its dominance unless Microsoft can find a way to compete with Apple’s iPhone and Google’s Android. Second, as operating systems find their way into other connected devices such as Internet TV, Google’s Android and Apple’s iOS are getting all the buzz. Third, as the Internet becomes speedier and demand for cloud-based storage increases, web apps will become even more popular, making the Windows operating system even less relevant.

So what’s Microsoft doing to regain footing on these three fronts?

Despite arriving late to the party, Windows Phone 7 has received strong reviews so far, and while there are a few glaring omissions (such as the missing copy/paste function), on the whole it is a great leap forward from the antiquated Windows Mobile platform.

It’s too early to tell whether Windows Phone 7 can catch up in a market dominated by iOS and Android, but it has some clear advantages. Tighter integration with Microsoft Office, still the most dominant productivity suite, is one of them. Gaming is another.

Gaming remains the most popular category in the iPhone app store. It’s no surprise then that most of the top 10 Windows Phone paid apps are XBox Live games. With most third-party mobile game developers already committed to iOS and Android, Microsoft has had to develop several games in-house to kick start Windows Phone’s marketplace. This was essential to circumvent the chicken and egg problem: Users would not like the Windows Phone unless there were enough apps, and developers would not write apps unless they thought there were enough Windows Phone users. As more users start using mobile apps on the Windows Phone, it will be easier for Microsoft to convince developers to build apps for the platform.

Games on the Windows Phone do have a notable advantage over iPhone and Android games. Users will soon be able to play games with players on other platforms such as XBox 360 or the PC. Microsoft already has a passionate following on XBox 360, and these XBox gamers are more likely to be attracted to Windows Phone 7 because of its tighter integration with XBox Live. The risk, however, is that the Windows Phone might not win over casual gamers. Casual gamers who indulge in games like Angry Birds easily outnumber hard-core gamers who revel in the likes of Halo on XBox.

Strategically, Microsoft’s Windows Phone is more open than the iPhone, but less so than the Android. This semi-openness could prove vital as more hardware manufacturers embrace the Windows Phone (Samsung, for instance, will focus on the Windows Phone in the coming year) and therefore help it catch up with the iPhone. At the same time, Microsoft is keeping tighter control of phone specifications than the Android. This could result in a higher quality and more stable platform.

Internet TV
Operating systems are no longer housed by just PCs and mobile phones. Home devices are the next front for innovation and opportunity, and the Internet TV market is of utmost strategic significance. Not surprisingly, Google and Apple are making big plays there.

Apple and Google are both leveraging their success in the mobile operating system market to propel their operating systems into homes as well. The new Apple TV, for example, uses iOS, Apple’s operating system behind the iPhone, iPad, and iPod Touch. However, despite rumors, Apple hasn’t launched iOS apps on the Apple TV yet, and Google TV has not launched full-blown Android apps and games either.

While Apple and Google try to enter a market that has traditionally been tough to crack, Microsoft already has a passionate base of users with XBox consoles at home. In addition to games, XBox already offers popular apps such as Netflix and If marketed well, there is no reason why XBox cannot be an alternative to Apple TV or Google TV. Indeed, rumor has it that Microsoft is planning to launch television service on the XBox 360.

In addition, Microsoft’s recent push to hire Silverlight app developers for the XBox 360 and XBox Live’s integration with the Windows Phone indicate that Microsoft is serious about bringing Windows Phone apps to the XBox. Microsoft has a large existing developer base familiar with its development tools and technologies. If it can convince developers to write apps for the Windows Phone (more than 15,000 are already on board), and if their apps can be easily cross-deployed on XBox, Microsoft will have a leg up in the Internet TV market.

Unlike Google TV, which any manufacturer can license for TVs and set-top boxes, XBox is currently only manufactured by Microsoft. In order to make further inroads in the home entertainment market, Microsoft might be better off taking a similar strategy to its Windows Phone model by letting independent manufacturers license its operating system for their TVs and set-top boxes.

Web-based apps
Google, which makes more than 90% of its revenue from advertising and gives away things such as productivity applications (Google Docs) and operating systems (Android and soon Chrome OS) for free, continues to be a headache for Microsoft. Almost all of Google’s applications are web-based; users do not need to install Google software on their laptops to use the applications. Contrast that with Microsoft, which earns the majority of its revenue from Windows and Office, both of which are expensive, take up a significant chunk of the hard drive, and must be installed to achieve full functionality.

This is a precarious situation for Microsoft. Unlike Google, Microsoft has little expertise in developing web-based apps, and even if it did, its web-based apps would cannibalize its desktop software.

Another challenge for Microsoft is presented by the trend towards proliferation of new form-factor devices such as tablets, e-readers, and Internet TV boxes.

Moore’s Law, which says that processing speed and memory capacity are improving at roughly exponential rates, means that smaller devices like phones will become more powerful. This has led analysts to predict that several devices such as PCs, mobile phones, digital cameras, and PDAs will eventually converge into a single device – a phenomenon known as digital convergence.

However, an unexpected consequence of Moore’s Law has been multiplication (and not convergence) of specialized devices. As processors become more powerful and as technologies advance, newer applications emerge, resulting in the aforementioned specialized devices.

This phenomenon, along with increased consumer mobility and media consumption, has resulted in increased demand for storage and accessibility. Google’s web-based apps provide a solution for both. Since most of its user content is synced with the “cloud” and thus can be accessed from any Internet browser, users benefit from better accessibility and less need for local storage. Google contacts, documents, and email are prime examples.

Apple, on the other hand, has the weakest web-based portfolio of the three tech giants. This is partly because Apple believes in the quality and power of native apps, and partly because Apple makes money from local-storage-based phones, iPods, and laptops. This is also why I don’t think Apple will launch a “cloud based” iTunes anytime soon despite the rumors. It almost doesn’t have to. If it can make the syncing between devices wireless and seamless, it will continue to attract users.

Microsoft’s response to the threat has been again to opt for the middle road. Unlike Google, Microsoft’s offerings are not purely web-based. But Microsoft doesn’t have as tight an integration between its devices and software as Apple does.

Microsoft continues to offer its powerful native Office software but now also offers a free but limited version online. This is imperative to compete with Google, whose free Google Apps continue to lure users away from Office. Will online Office cannibalize some of Microsoft’s revenue? Perhaps. But it could also entice users to buy a more powerful Office suite and keep them from switching to Google Docs at the same time.

The newly launched Windows Phone and its integration with Office and XBox Live presents another opportunity for Microsoft to keep its users hooked to its devices. If Microsoft can offer seamless syncing between its devices – Windows Phone, XBox, and Zune – it can retain its user base.

While Microsoft can now claim to have web-based offerings comparable to Google’s – the portal, online Office, Hotmail, and inline Messenger are some examples – its offerings still seem like works in progress and are not as seamlessly integrated as Google’s. Moreover, while Hotmail has a sizeable following, most of its user base is “pre-Gmail”, and it will be a challenge to win over Gmail users and the younger generation that has grown up in Facebook and Google times.

Bottom Line
Even putting aside the fact that the younger generation is generally more attracted to Google, Facebook, and Apple, Microsoft has a hard battle ahead. Its weak market share in the mobile market and loose integration and generally slower performance of web-based apps are handicaps that will be hard to overcome.

Additionally, its middle-of-the-road strategy – its mobile phone OS is not as open as Google’s but not as closed as Apple’s, and its software is not as device-centric as Apple’s but not as web-based as Google’s – could position the company as a “jack of all trades, master of none.”

But most importantly, Microsoft needs to stop playing catch-up and start leading. To give it due credit, Microsoft introduced tablets several years ago, even though its tablets never took off. It has also brought innovation to console gaming by introducing XBox Live (with the ability to play with other gamers around the globe) and is now leading again with the introduction of Kinect, a gesture- and motion-based sensor. However, Microsoft has been too late to market in several areas where it matters most – mobile computing and apps.

2010 could go down as one of the most exciting times in Microsoft’s recent history. If Microsoft can keep up the momentum behind its Windows Phone, XBox, and Windows 7, and attract a sizeable user base to its web-based apps, it has a real shot at staying strong and relevant for a very long time.

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