HolidayBuyer's Guide

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? Gates: Is it a better competitor once they stick ads in? That's the thing that's so goofy, I don't get it.

Actually, that was one of the few announcements in our industry that was sort of a fraud that actually was unmasked by the press; the first ever was that Sun-Google thing where people were saying, well, what the hell is this?

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

What about Google?
Ballmer: What's the expression? "To a man with a hammer, everything looks like a nail?" If you know how to sell advertising, everything is going to look like an advertising problem. I think people like to say the same thing about us. We know how to collect money, charge for software, so everything has got to--that's why in answer to your question I was very precise. 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.

One thing I will say, we have a big advertising business today. We're over a billion bucks in advertising, and we're going to grow the hell out of our advertising business, and we're going to grow the hell out of our packaged business, and--oh, by the way, subscriptions is a relatively small thing. We're going to have a big subscription business, too.

So we need to have all three muscles or we are vulnerable, but nobody else is even trying to have all three muscles.

How do you grow the advertising business, though?
Ballmer: It takes you awhile. First of all, advertising isn't all about search. Search is a good vehicle for advertising, but there are other good vehicles for advertising. We basically have held share over the last couple of years. Some other guys have gained a little share, but we've basically been relatively flat on share and growing nicely with the market.

How do you grow? You have exciting experiences that people want to participate in, whether those are communication or search or content.

Search is bad today. The average search takes five minutes. It doesn't really understand what's local versus what's not local.

We're going to continue to build out our experiences, and frankly, I think we can get smarter and smarter about how we monetize--smarter in two senses, smarter about picking advertising content that people want to see, as opposed to just the advertiser wants to see. I think there's a lot of work to do there, and I think we can be smarter about making our online experiences even more immersive than they are today, where people want to stay in them for a longer period of time, and the longer they spend, the more opportunity we have to deliver that relevant advertising.

Are there any ideas out there you're thinking of for search to actually make it more interesting and attractive?
Gates: Well, search is bad today. The average search takes five minutes. It doesn't really understand what's local versus what's not local. You know, you type in "pizza" it's going to tell you about someplace 1,000 miles away. It doesn't understand the context of are you trying to get advice for using the product or buying a product--Are you an expert? Do you want the historical data? Do you want the most recent data?--all of these things that can be done.

Ballmer: Half the searches don't give you an answer that you wanted anyway.

Gates: And so search is not personalized right now, and we've been making some advances. We've been driving our relevance up and up and up, and we have this way of really slotting in third-party expertise and letting you do some programmatic things against search.

In the months ahead, we'll be chronicling some of the business model changes, some of the software breakthroughs that we're going to have there.

We've got to get music in cars, music on phones, music throughout the house.

One of the things you are talking about at CES is music, and obviously you guys for a long time have said choice, big ecosystem will win out eventually. For the time being, Apple has got one family of players and one music store, but they seem to be cranking out stuff pretty fast, and consumers still seem to be going there. What do you think you guys and your partners have to do to change that?
Gates: Oh, we've got to get music in cars, music on phones, music throughout the house.

Ballmer: We do need a more consistent experience. That doesn't mean it's bad to have a variety of devices. I think that's great. But there are some things we need to make sure are more consistently delivered across the portable devices.

Let's face it, when it comes to actually using it on the PC, our stuff is still the most popular stuff out there. It's not true in the portable device space, and I think we have to do some stuff to simplify the experience across the portable device and the PC, and that's an important part of what we need to do. And we give credit--Apple has done some things right, and it's worked for them.

Do you guys need to go further into the hardware? I mean, obviously you don't generally get into the actual making, Xboxes aside, but could you do more reference designs?
Ballmer: We do need to have greater simplicity in the way the devices work with the PC, and we'll work with our partners on that in a variety of ways, including where it's appropriate for reference designs. But we do need to simplify the experiences. There's probably more we need to do with our partners in terms of the way things get presented, and peripherals get presented, and packaged and presented in stores.

You started that with PlaysForSure?
Ballmer: We started it. We've got a lot of work to do.

One of the areas that you've talked about a lot in the consumer side is Xbox, and really there is this kind of window of opportunity. You guys are out with the next-generation console; Sony is not going to be out for a while. The availability at launch wasn't necessarily what you wanted. What are you guys going to do, and what would you like to accomplish by the time Sony gets to the market?
Gates: Our availability was just great.

Ballmer: It's pretty good. We knew we were going to be short.

Gates: We are shipping faster than any videogame has ever shipped. The thing is just hot, and I spent over 100 hours playing with it over Christmas. It's fantastic. And it really draws you in because you get these awards, you meet people, you get into the contests. It's something.

Ballmer: It's accomplishing a lot of what we'd hoped to in terms of appealing to a broader demographic. We've got to make a bunch. We knew we would be in short supply, but we also knew we could build a lot. We've built a lot. We've sold a lot. We've got to keep building more, and as Bill says, we're on target for our roughly 5 million by the end of the financial year. I feel like everything is great guns on Xbox. I mean, yeah, every one we can make we're going to ship, but everything is great guns. I couldn't have laid out a much better place to be than where we are today.

How big a dent do you think you've put in Sony? ?
Gates: We know what it's like to go second. We've tried that. And that was last time. Last time was very different in that, if I bought a PS2 and you bought an Xbox, we'd go to your house and play PS2, we'd go to my house and play Xbox.

So it works, when it becomes this "Live" thing, that you're accumulating your achievements and all that, and anybody can play with anybody. (If) I bought an Xbox, when you go to buy a machine--whether it's 2006, 2007--if you want to play with me in Live, which is what the thing is all about, then you need to buy that same machine.

So we've got that leading-edge group, most of whom won't buy two machines--some will, but they're telling their friends, look, connect up to me, and that's done with Xbox. So going first was more important in this generation than in any generation there has ever been.

Ballmer: The Live advantage is...there's no Sony announcement for a Live equivalent type deal. We had, if anything, a cost disadvantage last generation. If anything, depending on what they do with (Blu-Ray disc support), we're not going to have a cost disadvantage this time.

Gates: Have you seen the basketball game? I think it's great.

Ballmer: Oh, have I seen it? Shall we say it's quite hot in the Ballmer house. My son comes up to me the other night, "Dad, the guys start perspiring in a few minutes...just the way they're supposed to; that is really awesome, Dad." I've got three boys, 13 on down, and unlike Xbox 1, my wife thinks it's a good addition to the house.