Update: Gates memo puts services at the heart of Microsoft

Microsoft chairman calls on his company to focus more sharply on Internet services

Bill Gates has backed a sweeping plan to reshape Microsoft's development efforts to adapt to the threats and opportunities presented by the rapid growth of new Internet-based services.

In an e-mail to his top lieutenants dated Oct. 30, Microsoft's chairman and chief software architect proclaimed that "the next sea change" in computing has arrived and called on his company to focus more sharply on Internet services as it develops new products and technologies.

"Today the opportunity is to utilize the Internet to make software far more powerful by incorporating a services model," Gates wrote. "However, to lead we need to do far more. ... We will build our strategies around Internet services."

Gates e-mail was reported Wednesday by the Wall Street Journal newspaper. A spokeswoman for Microsoft in the U.K. confirmed the authenticity of the e-mail and the parts of it quoted by the Journal.

For businesses and consumers, the push from Gates will lead to more of the company's software applications being offered for use over the Web as services, supported by advertising or subscription fees, said Gary Barnett, a research director at U.K. analyst company Ovum.

Gates' e-mail draws heavily from an internal memo by Ray Ozzie, Microsoft's recently-appointed chief technology officer. In his memo, Ozzie talks of the emergence of a business model in which companies make money from Internet-based services supported by advertising. He also pointed to the success of online services companies such as Google and Skype Technologies.

"The model has the potential to fundamentally impact how we and other developers build, deliver and monetize innovations," Ozzie wrote.

He suggests that businesses can make more money by offering software and services supported by advertising than by the traditional software licensing model. If Microsoft does not respond to the changes, "our business as we know it is at risk," Ozzie wrote. "We must respond quickly and decisively."

The internal missives suggest the urgency with which Microsoft views the threat posed by emerging Internet-based services and applications. They also throw some light on Microsoft's announcement last week that it will offer some online services to complement its Windows and Office product lines.

The e-mails also highlight Ozzie's growing influence at Microsoft since he joined the company through an acquisition only eight months ago, the Wall Street Journal noted.

In September, Microsoft reorganized itself into three broad business divisions. Ozzie's role as CTO was expanded to include leading Microsoft's services strategy across those three divisions, Gates wrote in his e-mail. "We did this because we believe our services challenges and opportunities will impact most everything we do," he wrote.

In his memo, Ozzie called on the three business units to plan out their strategy for developing Internet-based services, and talks of appointing a top executive for each division by Dec. 15. He also called on Microsoft's MSN and Windows divisions to collaborate on a "next-generation Internet services platform" to spur innovation inside and outside the company.

This marks the third time that Gates has rallied his company in the face of challenges from a new type of computing. Most famously, in 1995, he pushed Microsoft to respond to the "Internet tidal wave" by developing software for the Web, resulting in Internet Explorer. And in 2000 he laid out Microsoft's broad .Net strategy for developing Internet-based applications.

As it gears up for this latest challenge, Ozzie talked candidly in his e-mail about Microsoft's successes and failures.

"Our products have embraced the Internet in many amazing ways. ... But for all our great progress, our efforts have not always led to the degree that perhaps they could have," Ozzie wrote.

Analysts weren't surprised by the company's decision to increase its focus on Internet services. In the mid-90s Microsoft was forced to adapt itself for the first, "narrowband" phase of the Internet, when most users had slow dial-up connections, Ovum's Barnett said. Now in the second, broadband phase of the Internet, the conditions are right for storing applications and data on the Web and accessing it through a browser, he said.

"The importance of having masses of data and software stored on a local drive becomes less obvious. This is the classic 'Google play' -- Google has convinced millions of customers that they can now keep their data online," Barnett said.

"I think Microsoft has caught onto this, perhaps a little late ... but they have caught onto it. What we can expect to see now is Microsoft being prompted into another phase of innovation, another phase of thinking about what is the interplay between the online world and the locally stored and attached world," he said.

Microsoft may not find it easy to extend its dominance from the narrowband world into the broadband world, Barnett said, but it is healthy for the company and its customers that it is being forced to compete in a new area.

Tony Lock, chief analyst at U.K. research company Bloor Research, said Microsoft is pursuing a familiar pattern: "They wait to see whether a particular strategy or solution will be accepted, and then when it reaches a certain level of success they say, OK this is looking good, let's really push it."

Its increased focus on Internet services will ultimately benefit customers, Lock agreed.

"This is a market where there are already some relatively well-known incumbents -- Skype for voice-over IP, Salesforce.com for online CRM and Google for search and other services. That means it won't be easy for Microsoft to dominate any one area, which is good from a competitive point of view," he said.

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