Microsoft: We're in 'fighting shape'

newsmaker Bill Gates and Steve Ballmer tell why Redmond is no pushover--and what they're playing on the Xbox.

LAS VEGAS--Microsoft has some catching up to do.

It's not a phrase you hear every day. But whether it's Apple Computer's iTunes-iPod combo or Google's advertising engine, the software maker's top executives readily admit that they are coming from behind.

In a rare joint interview ahead of the Consumer Electronics Show here, Microsoft Chairman Bill Gates and CEO Steve Ballmer outlined their plans to catch their rivals and discussed why it's Sony that will have to play catch-up in the video console wars.

On the Windows side, Microsoft's dynamic duo ticked off several reasons why they think consumers won't want to skip Vista, the next version of Windows. And while some software may shift to an ad-supported model, Microsoft's honchos cautioned that Windows is not likely to become a free download anytime soon.

On a lighter note, the two also shared the inside scoop on what they--and their families--are playing on the Xbox 360, Microsoft's game console.

Q: Obviously, with any release of Windows, one of the big challenges is, how do you convince the average consumer that this is something they're going to want? What are the things in Vista that you think will kind of hit home for that initial sale?
Gates: Well, Vista will be pretty strong in that respect. (It's) just the way we've integrated the search pervasively in the user interface; the way you can tag things easily and find them--tag photos, tag music, rate music and photos; the zippiness of the user interface, taking advantage of the DirectX advanced graphics capability.

You know, we've always had a mix of new Windows OSes, of people who get it when they buy a new machine. Because if we do our job right, we get manufacturers to shift over and have that very quickly on all the new machines, and we get people upgrading into the existing machines.

Ballmer: And that will certainly happen this time in terms of people--the (computer makers), consumer OEMs (original equipment manufacturers) will have that thing day 1.

You could say we've gotten into fighting shape by fighting a worse competitor, i.e., a tougher competitor, true free versus ad-funded.

With previous releases, the upgrades were mostly new computers sold with the latest version, correct?
Ballmer: Numerically, that will be the dominant factor this time, too.

Gates: Because in the installed base, it's the most active 20 percent who are willing to upgrade an OS. For a lot of people, that new machine is when they do (upgrade).

You know, you could get 40 percent of the features of Vista, if you went out and got our Windows desktop add-on and latest IE add-on, the latest Media Player add-on and Defender add-on, and all that. You could cobble it together. There are a few people who have, but it's a very small percentage.

Windows Live and Office Live--those complement what Microsoft already sells or repackage some of the online stuff you already do. Do you see a need or a desire to have ad-supported versions of the kinds of software you're best known for, things like Works or Money?
Ballmer: You get a hybrid thing happening with Money. Money is a good example today. This is a packaged product which is not ad-funded. There's an online site, which obviously has advertising as a mainline ingredient.

I think what we'll get is a combination of rich client experiences and service experiences and a mixture of advertising, subscription and transaction--traditional bought stuff. I don't see our business customers rapidly moving to having us read their e-mail and read every document. I just don't think that's going to happen.

I think that there will be elements of advertising certainly in the Office Live and Windows Live experiences, but I don't see us evolving Windows from a product that gets bundled on hardware to something that gets downloaded, (that) locks you into certain Internet experiences and feeds you ads. But it will be a mixture of these things that will be important.

There will be things where subscriptions make the most sense, there will be things where advertising makes the most sense, and there will be times you just want to own the damn thing.

It seems like the question mark is consumer-packaged software. Will the low end of that market become ad-supported?
Ballmer: There are certainly many things which have been consumer--take games, already. I don't know that a lot of traditional games have gone to be ad-funded, but a lot of gaming now on the PC is done online in ad-funded experiences, and so what it has done is create pressure that the games that do run on PCs and that you pay for be richer (graphically). It's hard to sell low-end, cheap, not very good PC games when there are ad-funded online experiences. So you get a little bit different mix, in terms of what's going to be charged for traditionally, ad-funded, etc.

Do you see competitors--both upstarts and the Googles of the world--trying to offer ad-funded versions of the kinds of software that you guys have traditionally sold in a packaged way?
Ballmer: Sure.

Gates: Yeah, but in some ways that's a red herring. We compete with truly free software--free software that doesn't stick ads in your face--and we compete extremely effectively by having reliability, innovation and the software that you want to use every day for hours a day. Somebody that's ad-supported is more expensive than just the pure free guys, and we do super well against the pure free guys.

Ballmer: Is Open Office with ads better than Open Office?

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