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Fast Forward
February 22 2008: 4:57 PM EST
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Microsoft is finally growing up

With a new move to make its products work better with open source and its effort to buy Yahoo, Microsoft shows it wants to move into the present.

By David Kirkpatrick, senior editor

Take it or leave it, Yahoo!
Fortune's Andy Serwer discusses Microsoft's rejected bid for the search giant, and whether Bill Gates plans to sweeten the deal.

NEW YORK (Fortune) -- Microsoft is at a critical moment in its history and is taking brilliant steps to remake itself. Thursday's announcement that it would open itself up to far greater interoperability with other types of software, including open source, is the latest big move. But the bigger step is its $44 billion bid for Yahoo.

The crisis Microsoft (MSFT, Fortune 500) faces is multi-part: Google (GOOG, Fortune 500) continues to grow, lapping up the majority of revenue created by online advertising. Since such ads may someday be the primary source of revenue to pay for software, especially for consumers, that part of the crisis is grave. Microsoft has failed to build a massive online advertising business and has fared poorly in creating online services that capture the imagination of customers.

On the enterprise side, open source alternatives to Microsoft software, particularly in the back end of corporate infrastructures, have clearly diminished revenue growth. Finally, founder Bill Gates retires from his management role this summer, remaining part-time chairman of the board. But for all those challenges, the company remains a money factory, with 2007 net profits of $14 billion on revenues of $51 billion - a net margin of more than 27%.

So Microsoft needs to move beyond Gates and maintain profits, while segueing into a world filled with new and mostly unfamiliar competitors.

This week's move was a very canny step to neutralize the ability of open source to pull more business away from Microsoft.

In November 2006, Microsoft and Novell (NOVL) announced a historic partnership that aimed, among other things, at making Windows-family products work better with Novell's open-source SUSE Linux software. It was in part a response to customers outraged with how hard Microsoft makes it to get its products to interoperate with open-source software. A few months prior to the Novell deal, Microsoft had set up a Interoperability Customer Executive Council to placate big customers.

The Novell deal has been a success. Microsoft executives learned they can actually sell more products once it is easier to dovetail Windows with Linux.

This week's announcement takes the logic of the Novell deal to the next stage. It makes it easier for Microsoft's customers and competitors to modify its products for their particular needs - a longtime lure of open-source alternatives -as well as to more easily connect other sorts of software to Microsoft products.

So look at it as a canny response to market realities. It's a pragmatic realization that the days of true monopoly may be over, even as the company seeks to ensure that the days of dominance are not. (The deal is also, of course, a response to the continued prodding of never-satisfied regulators in the European Union.)

As recently as 2004, Microsoft Chief Research and Strategy Officer Craig Mundie was telling me open source was "socialism." But by the time I wrote a piece in Fortune two years later about the rising influence of new Chief Software Architect Ray Ozzie, it was apparent the company was moving in new directions.

That article explained the urgency with which Microsoft was treating the challenges of advertising and moving to the Web. "Put simply," I wrote, "Ozzie's assignment is to Webify everything: To intertwine Microsoft's entire product line - software for consumers, software for businesses, Xboxes, all of it - with the vast and ever-growing power of the Net."

Bill Gates did not participate in the announcement this week about openness. CEO Steve Ballmer spoke along with Ozzie, server head Bob Muglia, and General Counsel Brad Smith. I doubt that if Gates were still in charge of Microsoft it would be making such moves. He created the old world of "shrink-wrapped" software with superb success. The new coexistence with open source and the move to the Web present fundamentally different challenges.

Think of this week's opening up of Microsoft's proprietary software alongside its effort to buy Yahoo (YHOO, Fortune 500). That deal is intended, I believe, as much to prod Microsoft's culture toward a Web-centric mentality as to acquire powerful new advertising properties. Ozzie has had trouble getting the company to move as quickly toward the Web as he said it should in 2006. Spending more than $40 billion dollars signifies the company's seriousness much more than exhortations ever could. I suspect it will work. And recent alarms raised by Google execs suggest they worry it might.

Open source and Web software are Microsoft's two major challenges. As Gates departs, both are being addressed by the company's new leadership with creativity and deftness. The monopoly mentality no longer works. But Microsoft can still thrive in a world of cooperation. To top of page

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