How Microsoft will compete with 'free'

Guest post: Jean-Louis Gassée explains how Microsoft's future business model will borrow from both Apple and Google to compete with the free world of software. The essay was originally posted on Monday Note.

How do you compete with free? That's the question Steve Ballmer, Microsoft's CEO, is trying to answer every morning when he goes to work. On the server software side, Windows Server is doing well, especially with the Exchange e-mail server and the unheralded but very good collaboration server, SharePoint. These products have matured, they're relatively easy to set up and manage by IT organizations. The Exchange component is a spectacular success: it manages e-mail, contacts, calendars for hundreds of thousands of organizations all over the world. Even Apple finally embraced Exchange: the iPhone now syncs well with Microsoft's server and the next version of OS X promises "native" Exchange support. In plainer English: Apple's Mail, Address Book and iCal programs, for example, will sync with Exchange "out-of-the-box" just like the iPhone does. (This will be a relief to suffering Entourage users. Entourage is Microsoft's own Outlook sibling on the Mac, but it is a poor relative and lacks Windows' Outlook depth and polish.) Seeing that Windows Server generated more than $20 billion last year, one is tempted to think everything is going swimmingly.

Unix is the problem or, rather, the free Open Source implementations of its function set called Linux and FreeBSD, to name the best-known variants. While Windows Server and Exchange still reign for many Enterprise applications, tens of millions of Web sites run on Linux of FreeBSD software. Further, the Open Source nature of such software encourages sophisticated users to modify the operating system to fit their specific hardware configurations or applications requirements. For example, Google designs and manufactures (!) its own servers and customizes the Open Source OS they run. There's even a rumor they "roll their own" 10-gigabit Ethernet switches but I don't know vouch for that one. In any event, imagine how much the Google account would be worth to Microsoft if the Mountain View company used Windows Server? Knowledgeable readers will immediately object: Google running Windows Server isn't realistic. Not for price reasons but because Microsoft's server software isn't technically suitable for large "server farms" such as Google's. True. It'll be interesting to look at what Microsoft uses for its own Live cloud. In the past, Microsoft has had to resort to "other" server software for applications such as Hotmail. But, "scalability issues" (the ability to grow to serve very large server farms) aside, Microsoft is losing against free server software for the millions of simpler Web servers sprouting all over the world. And, as Linux and its cousins mature, they will inevitably make inroads in Enterprise applications where Microsoft still leads. Open Source competitors to Exchange do exist, they're not yet a strong threat but, if they keep improving, they will erode Microsoft very juicy server business.

On the desktop, Linux is trouble again, but much less so than in server farms. For consumers, as opposed to technically versed sysadmins, ease of use is still a strong plus for Windows. I bought two identical Asus EeePC netbooks, one running Windows, the other a Linux distribution. Windows is still much easier to use and update, Linux is still a little rough on normal humans. One example out of many glitches: the version I used didn't remember Wi-Fi access points and passwords. I had to re-enter everything each time I turned the machine on. This type of problem has prevented Linux from gaining much ground on the desktop.

But this could change: the success of netbooks, their large unit volumes could encourage a manufacturer such as Asus, Acer or Lenovo to invest in the needed polish to make a Linux-based netbook as easy to use as a PC or Mac -- or close enough at a much lower price. And the name, netbook, reminds us it might not need today's (or is it yesterday's?) full suite of robust desktop applications to succeed--it will run applications on/from the Cloud. Imagine a Google netbook.

Lastly, smartphones. Ballmer tries to change the subject by suggesting Apple ought to license its iPhone OS as opposed to keeping it all to itself. Let's skip over Microsoft's proprietary Xbox and Zune software and, perhaps, the upcoming Danger smartphone. Danger, the maker of the Sidekick PDA, is the company Microsoft bought earlier this year,. Microsoft has been selling Windows Mobile licenses for close to eight years now. In the licensing business, the iPhone isn't the real competition, Android is. How do you compete with a free smartphone OS, and a good one at that, which is supported by Google Cloud applications?

My guess is Steve Ballmer is working on a combined answer, one that is sketched before our very eyes already. Microsoft's Live services are but a rehearsal for a much bigger act, Microsoft's Cloud OS, sometimes called Strata. And, based on Microsoft's own Cloud services, we'll see a Danger-based smartphone, as proprietary as the Xbox and the iPod competitor Zune. Put another way, Microsoft's future business model will borrow from Apple and Google, it will have two components: proprietary devices and "universal" Cloud services. And like its models, it will attempt to extract extra profits by nicely tying both components together. For example: iPods are tied to the iTunes service, Android phones might (we don't know yet) better enjoy Google applications.

Interesting times ahead.

Jean-Louis Gassée is a general partner at Allegis Capital. Prior to his venture capital career he founded Be, Inc., which was sold to Palm in 2001. Gassée also held several positions at Apple Computer. He started Apple France in 1981, and in 1985 became president of the Apple Products Division. Earlier in his career Gassée as worked at Data General, Exxon Office Systems and Hewlett-Packard.