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Google chase could trip up Microsoft

Analysts say Redmond's push into services is needed--but it risks rendering obsolete the company's ultra-profitable way of doing things.

Microsoft has talked about accelerating its business by offering services, but some analysts worry its race to compete with Google and others could leave Microsoft's very profitable business model in the dust.

Tuesday morning, Microsoft Chairman Bill Gates and services chief Ray Ozzie are expected to outline the company's new push to offer myriad online services on top of its existing software lineup.

Analysts say the move is probably necessary to help the company compete with rivals that threaten to offer online equivalents to some of Microsoft's cash cows, like Office. However, depending on how far Microsoft takes the strategy, it could also put the company in competition with its existing--and already lucrative--way of doing business.

"It's not so much about how you're going to beat Google," said Gartner research fellow Tom Bittman. "It's more about how you are going to beat the Google model. Microsoft is going to be forced to compete with Google, forced to compete with its own business model."

Bittman and others fear that any online offerings from Microsoft could potentially cannibalize sales of the company's shrink-wrapped software, like Windows and Office, which make up the bulk of the company's profits.

Historically, most of Microsoft's services have come from its MSN unit, which has been largely consumer-focused. But Microsoft sees a clear opportunity to offer online tools to businesses as well.

"For enterprises, I think we've just barely scratched the surface about which systems can...be brought into the cloud in some way, shape or form," Ozzie said at a technology conference last week.

Ozzie was put in charge of Microsoft's services push as part of a major reorganization of the company that took place in September.

In a September interview, Gates suggested that while many companies may continue to buy server-based software, some of those same software capabilities could also be delivered through services. Gates pointed to some of the early work the company has done with hosted versions of its Exchange e-mail software and its SharePoint portal software.

But, he said, most of the services that Microsoft has offered on its own have been rather basic--and often free--products.

"Our services have started out as very inexpensive but not feature-rich," Gates said. "Our servers are very feature-rich. So as we bring these things together, we give you the richness and also the choice of having it as server or as a service."

While Bittman believes Microsoft needs to do this, he questions whether the software maker can profitably make the switch.

"Can high-volume, high-margin software compete against high-volume, low-margin advertising?" he said. "It's the clash of two models."

But Microsoft sees services as a way to address two key challenges: One is to compete with Google and other online rivals like Salesforce.com. But the other, also important role that online services can play, is to offer a means of updating software more quickly than Microsoft can do with its traditional packaged software.

"We need to have service offerings associated with each of our products that allow us to feed innovations that are appropriate to the market on, let's just call it a six-, probably more realistically a nine-month cycle," Microsoft CEO Steve Ballmer said at October's Gartner Symposium/IT Expo.

The services push has been brewing for some time. At July's financial analyst meeting, several of Microsoft's individual business unit leaders discussed opportunities for services in their areas.

Eric Rudder, then head of Microsoft's server and tools business, pointed to the company's acquisition of FrontBridge as an example of how the company can sell services that are built on top of existing software--in that case Exchange. With FrontBridge, corporate e-mail is delivered to an intermediate server, which can strip out viruses, archive messages, and manage compliance issues.

"I think Microsoft can win, but in the end it means Microsoft loses, unless there is some other magic there we don't see."
--Tom Bittman, research fellow, Gartner

"So the opportunity to add value with services--not necessarily replacing the server, but complementary value streams--is quite significant, and I think you'll see us first grow in that area with Exchange," Rudder said. "But we're looking at how to complement hosted services to all of the server businesses."

Jeff Raikes, who leads the information-worker business, which includes Office, did not go into detail, but said services would be increasingly important as Microsoft attacks a bigger part of the business software market.

"Those show very little revenue now as a percentage of the overall IW business, but we see them as big opportunities," he said.

Even Windows is gaining a services component, of sorts. As part of its effort to combat piracy, Microsoft last year kicked off the Windows Genuine Advantage program, in which the company requires that any customer who wants access to most Windows downloads to prove that copy of Windows is legitimate. As part of that effort, the company has slightly expanded the range of online freebies that one can get as part of a Windows purchase.

The company also has looked at services for new markets, such as antivirus software, where the company is testing its OneCare program. The program is expected to become a paid service for keeping Windows machines healthy and virus-free.

One of the many questions that surround Microsoft's move is whether the company will offer more of these services on its own or if such products will continue to come mostly from outside partners.

Today, for example, Microsoft partners offer hosted Exchange, but the company does not offer the product directly. Ozzie said last week that he sees the strategy as "a mix" between Microsoft-provided services and those offered through partners. Ozzie noted that choosing to use partners would be more likely for products that require customization, such as for a particular region or industry.

Another question is: Will Microsoft offer services mainly as new tools that sit on top of its existing products or as packaged software that offers a new way to get things that companies and individuals have gotten in the past?

Bittman noted that in the areas Microsoft has chosen to enter, it has been able to hit the ground running.

"Microsoft has proven the ability to grab market share in the Web space as quickly as they enter," Bittman said. "Look at MSN Spaces and how quickly it became very, very strong."

Bittman thinks Microsoft could eventually outflank Google but, ironically, find itself worse off. "I think Microsoft can win, but in the end it means Microsoft loses, unless there is some other magic there we don't see."

Bittman pointed to the difference between winning market share and making a good business.

"There's a lot of money to be made in Windows and Office," he said. "Is there a lot of money to be made in an MSN platform? I think that's a real question."