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Economy's 'fundamental reset' hurts Microsoft earnings, future

Microsoft reported disappointing earnings Thursday. The company needs to make some fundamental changes to survive and thrive.

Microsoft CEO Steve Ballmer probably wishes his prediction of a "fundamental economic reset" wouldn't have proved so prophetic as the company Thursday reported "disappointing" earnings, with net income plummeting 17 percent, online ad sales down 14 percent, and overall sales for the year down 3 percent.

Disappointing? That's generous. The results are traumatic and point to the need for a "fundamental reset" in how Microsoft does business. Fortunately for the company, its SharePoint business offers some clues as to how it can revive its fortunes.

Despite the occasional base hit in its Xbox business and a solid line drive with SharePoint, which helped to prop up the Office business, Microsoft has been consistently striking out in its attempts to guard its Windows hegemony.

In part this is because Microsoft has failed to deliver compelling, new value to Windows customers. Vista was a disaster and the Windows 7 upgrade path for most customers, as Walt Mossberg writes, is so painful as to almost be unthinkable for most customers.

Microsoft points to a global weakening in personal computer demand as one reason for its Windows decline, but this same weakness isn't having the same effect on Apple, which showed growth in its Mac shipments and dominates the "premium" computer market, now claiming a whopping 91 percent share of all personal computer retail purchases above $1,000 in the U.S., according to NPD Group data.

Apple is winning in this market because customers really like its technology. Microsoft has failed to "wow" its prospective and existing customer base.

With both Intel and Apple reporting somewhat rosy earnings in the face of the harsh economic climate, it's clear that the problem really isn't with the industry, which is soft but not terminal. No, the problem is Microsoft.

Microsoft hasn't figured out premium value, even as Linux-powered Netbooks eat at its ability to compete profitably in the economy PC market. Its Web strategy is still disjointed and frail.

Microsoft is stuck zealously guarding its past successes at the expense of its future. The company needs Game Plan 2.0.

Microsoft CFO Christopher Liddell says, "There are some signs that we have at least seen the worst." The problem is, that "worst" (Apple, Netbooks, open-source price pressure, etc.) isn't going to leave Microsoft alone anytime soon.

It's easier said than done, but Microsoft needs to accelerate its experiments with open source. It needs to figure out new ways to reach customers, and to upsell them with more than repackaging of the same product. (Spoiler: Windows 7 Titanium Edition won't work.)

In short, Microsoft needs to reset itself to compete in the 21st Century, which promises to be the most painful thing it has done in its decades-long existence.

If it's any consolation, the company seems to be doing this with SharePoint, which continues to boom because of and not despite a weak market. SharePoint does several things right.

First, Microsoft SharePoint combines wide distribution of a basic and free product (SharePoint Services) that seeds a market for the paid version (SharePoint Server 2007).

Second, SharePoint helps companies bridge their investment in client-side Office to server-side services. This allows Microsoft to tie its strength in the client to a growing strength in the cloud.

Third, Microsoft has effectively (though still in limited fashion) used open source to augment SharePoint's value without undermining its pricing power, e.g., SharePoint Learning Kit. In other words, Microsoft is fostering open-source complements for the proprietary SharePoint core.

In these three ways, among others, Microsoft is showing that it can bridge the gap between its past and its future. But it needs a lot more SharePoint-esque strategy, and a lot less hubris. Microsoft's claims around the iPhone and other competitors have lately fallen flat.

Unless it learns from these experiences, Microsoft, too, will fall flat.

Follow me on Twitter @mjasay.