Microsoft's Big Bet On Small Machines They're proliferating like crazy--wee PCs, Web phones, game consoles, set-top boxes, and other gadgets packing software called Windows CE. Microsoft's mission: to drive its dominance far beyond the PC.
By Edward W. Desmond Reporter Associate Jane Hodges

(FORTUNE Magazine) – Judging from advertisements in magazines, you'd think Microsoft had jumped into the business of building miniature PCs. The typical two-page ad features an attractive model holding up a device with a small computer screen that looks vaguely like 3Com's wildly popular PalmPilot. It's not a PalmPilot, of course--if you look hard, you can see it's Casio's new Cassiopeia E-10, the Pilot's latest challenger.

The ad is not really about the E-10. It's about Microsoft Windows CE, an operating system Microsoft has designed for small computerlike gizmos. Like Windows 95 in personal computers, Windows CE sits on top of the microprocessor and acts as a control room, running the silicon beneath it and various application programs above it. Microsoft launched the advertising blitz because it wants you to think Windows CE when you shop for what are known generically as "intelligent appliances," devices that do bits and pieces of what a PC does without looking at all like a PC. Behind the ads is a burning ambition of Bill Gates': to extend his company's dominion far beyond the PC and weave its software more totally into your life.

You can find Windows CE in palm-top computers like Casio's E-10. You can find it in hand-held computers (slightly larger than palm-tops, with little keyboards) like the NEC MobilePro at right. CE is at the heart of a voice-activated "car multimedia" system that Japan's Clarion Corp. plans to launch this year. The unit, likely to cost around $1,200, manages a car's navigation and stereo systems, syncs up with a cell phone to download E-mail, and more. Windows CE is onboard Sega's Dreamcast game machine, due to go on sale this fall in Japan and next fall in the U.S. Cable TV giant TCI plans to use CE as the operating system in five million digital set-top boxes. The flood is only beginning: Look for announcements in the next few months declaring that Windows CE is in digital cameras, phones that let you connect to the Web, and other shrimp-sized gadgets that pack a lot of computing power.

On most of these you'll find the Windows CE brand emblazoned right on the plastic case. Microsoft wants consumers and businesses to think of Windows as ubiquitous--not just a figment of the PC screen. It wants people to see all Windows products as compatible--CE machines can talk to and swap files with their bigger brothers, PCs running Windows and servers running Windows NT. For consumers, the message is that you can, say, synchronize the calendar on your Casio E-10 with the one on your PC. Easy. For business, the promise is a relatively cheap, reliable way to ensure compatibility across a spectrum of devices, from giant servers to palm-tops in salespeople's pockets and hand-held controllers on the factory floor.

Microsoft expects CE to be a major source of revenue as sales volumes for intelligent appliances surpass PC sales, something most analysts believe will happen in the next five years. "On a world-market basis, we [meaning the industry] could be selling five to ten times as many of these inexpensive devices per year as we do PCs," says senior vice president Craig Mundie. "It's a challenge to figure out how many of those we [meaning Microsoft] can compete and win in."

Microsoft won't discuss its projections for CE; even a conservative analysis suggests sales will be big. Looking only at hand-held and palm-top computers, analyst Robert Enderle of Giga Information Group in Norwell, Mass., expects CE devices to account for 80% of those fast-growing markets within five years--possibly turning the PalmPilot into an also-ran. For Microsoft, that could mean $1.2 billion a year in sales, he figures, or roughly 10% of its total sales today. Should CE catch on in set-top boxes, phones, or other categories too, the numbers could be much higher.

Microsoft's goal is to replicate its immense success in the PC world. Dominance of the operating-system business helped the company capture key categories of applications with products like Word and Excel. That all led to fabulous profits and, eventually, trouble with the U.S. Justice Department. But trustbusters aren't complaining about Windows CE, because the market for information-appliance operating systems is highly fragmented--a frontier where Microsoft is racing to stake its claim.

"They have a powerful road map and are the most leveraged partner we could hope for," says Gene Wang, president of Photo Access, a Palo Alto startup making chips for digital cameras with Windows CE onboard. "It's typical Microsoft. They are fielding an excellent product that keeps getting better. It's like the tide coming in."

Software competitors like Wind River Systems, a fast-growing operating-system company in Alameda, Calif., say Microsoft's push has already lengthened the time required to make a sale, as customers pause to consider CE. "Who is going to tell their boss that they failed to evaluate the Microsoft product?" asks Wind River Chairman Jerry Fiddler. Nonetheless, he says, Wind River has lost only a few sales to Microsoft. In areas like digital cameras (despite Gene Wang's enthusiasm) and Web telephones, Windows CE is not yet a factor while Wind River, Integrated Systems of Sunnyvale, Calif., and other competitors are entrenched. Microsoft's perennial rival, Sun Microsystems, is pushing its Java programming language for a broad range of devices. In fact, beyond the hand-held PC market, most of the energy behind Windows CE is more potential than kinetic.

It's fair to ask the skeptic's question: Has the market for hand-held PCs, Web phones, and other brainy gizmos truly arrived? Remember the early 1990s, when Silicon Valley fell in love with the potential of "pen computing." Pen computers were hand-held devices on which you input data by tracing a stylus over a screenlike writing surface. The craze gave rise to Microsoft's WinPad, Go Computing's PenPoint, and Apple's Newton, among others. The projected multibillion-dollar market never materialized.

The market for smart portable devices then languished until the advent of the PalmPilot. In the two years since its introduction, the palm-top (the current version, Palm III, lists for $399) has sold close to two million units, making it one of the fastest-selling computer devices of all time. Its success, combined with the phenomenal rise of the Internet, has prompted analysts to conclude that there is a major market aborning for portable devices that tie some of what a PC can do to services like E-mail access, paging, and telephone service. In a recent report called "Death of the PC-centric Era," International Data Corp. of Framingham, Mass., argued that computing will soon shift dramatically away from the PC. Last year, 96% of devices hooked to the Internet were PCs, but IDC predicts that in four years, close to half the total will be appliances like videogame consoles, set-top boxes, cell phones, and palm-tops. By 2002, it forecasts, non-PC devices with Web capability will total 41 million, up from 3.6 million this year. That's a lot of potential Windows CE licenses.

Hard experience has left Microsoft poised to go after the new market. Even after pen computers failed, the company never gave up on the dream of what Gates calls the "wallet PC"--a powerful, networked pocket device that will even store digitized cash. Microsoft lost millions on failed projects to develop small-scale operating systems; even so, in 1995 Mundie launched a major effort that led to Windows CE. Some key features distinguish it from its Windows kin. It requires relatively little memory (as little as 512 kilobytes vs. 40 megabytes for Windows 95) and resides in read-only-memory chips, not in random-access memory, thus reducing the likelihood of a crash. Moreover, Windows CE is modular--a manufacturer can choose among some 120 options, mixing and matching the features a product needs. A camera maker, for example, might leave out the keyboard module and include one that makes a dial-up connection to the Web. To anyone used to coping with Windows 95, CE offers some appealing features too, like "instant on." Believe it or not, the little Casio E-10 winks right to life when you hit the power button. Try that on your laptop.

Microsoft believes that CE's biggest advantage is what programmers know of as Win32 APIs. Those are the building blocks that an estimated five million developers around the world use today to write software for Windows 95 and Windows NT. So, at least in theory, there is a huge reservoir of talent out there ready to write programs for Windows CE, and programs for other Windows systems can be quickly modified for CE. No competing system, not even the PalmPilot (which boasts 1,600 applications vs. 300 for Windows CE) or Sun's Java, rivals CE's potential breadth of support among programmers.

That edge is already evident in the market for hand-held PCs. Microsoft offers "pocket" versions of its Office suite of programs--Word, Excel, Outlook, and so on--to run on Windows CE. A Word document created on either a PC or a hand-held is easy to swap between machines. Says Roger Gulrajani, group project manager for Windows CE: "You can take a document from the desktop to the hand-held and transfer it back. Nothing beats what we can do. We have the applications." Windows compatibility is quickly transforming the hand-held PC into Microsoft territory. Sharp has licensed CE for its new Mobilon line--despite its success using its own operating system in its Zaurus hand-helds. Casio, Philips, Hitachi, and Hewlett-Packard, among others, are Windows CE licensees too.

In palm-tops today, the PalmPilot still rules. IDC says it accounts for 78% of the $980-million-a-year market. 3Com is licensing the machine's operating system as fast as it can to companies like IBM and Qualcomm in hopes of staving off the Microsoft juggernaut. To most other palm-top makers, however, Windows CE appears the smart choice. Everex Systems, a manufacturer in Fremont, Calif., decided to drop its proprietary operating system and adopt CE. Says executive vice president Peter Ow: "By the time of the Comdex trade show this fall, you're going to see 200 applications running on this thing. That's why we dropped our OS."

Rushing to Windows CE, however, may not do wonders for the profitability of Sharp, Casio, and the rest. Widespread standardization on CE is apt to help the hand-held market grow faster--much as Windows 95 helped boost demand for PCs. But it also means hardware makers must pay Microsoft a substantial license fee, as do software companies that make programs for those devices. So Microsoft will take away a big piece of the margin, the way it does in PCs today. Windows CE licensees "are helping Microsoft commoditize their business," says Brian Dougherty, an operating-systems expert and chairman of Wink Communications in Alameda, Calif. "They are setting themselves up to be sole-sourced to a vendor who can charge an arbitrary price."

Fear of monopolization by Microsoft has become so widespread that it undercuts the company's effort to promote Windows CE. In the cable TV industry, for example, giant TCI has been careful to ensure that Microsoft does not gain control of the digital set-top boxes General Instrument is building for TCI's next-generation system. TCI licensed Windows CE for five million of the up to 11.9 million boxes it plans to build; it is considering Sun, Microsoft, and other companies to supply the operating system for the rest. At the same time, TCI licensed Personal-Java from Sun for all its boxes. Java is software designed to sit on top of an operating system--Windows CE and a variety of others. Like Windows CE, it provides building blocks for programmers; its advantage, at least in theory, is that a program written once in Java will run on machines with different operating systems. TCI is pushing programmers toward Java and away from Windows CE because it wants to avoid a Microsoft dependency. "We are trying to keep the applications independent of the operating system and the microprocessor," says Bruce Ravenel, an executive vice president at TCI Communications. "We want to avoid a sole-supplier situation."

There are competitors, lots of them, and not just Sun. Technology powerhouses in Europe--Psion, Ericsson, and Nokia--recently announced a joint venture called Symbian. It will promote an operating system called EPOC, built by Psion, for cellular phones and other wireless devices that incorporate some of the functionality of a palm-top PC. Part of Microsoft's response to such looming competition is to use Windows CE to invent entirely new product ideas. Microsoft offers electronics companies what it calls "reference platforms," versions of Windows CE tailored for out-of-the-box products Microsoft thinks will work. The most dramatic example is the Auto-PC, a version of CE packed with features a maker of car-navigation and stereo systems might want, like a sophisticated radio tuner, support for wireless E-mail downloads, voice recognition, and more. Auto-PC is the basis for Clarion's car-multimedia system, but most analysts believe such products will take years to become hot.

Windows CE also has technological limitations that may slow its spread beyond the PC world. For example, the current release can't operate in what programmers call "hard real time." Translation: Windows CE is not well suited for managing activity that must be choreographed to the microsecond, such as the motion of the print head in an ink-jet printer. The fact that Windows CE is ill-suited to such specialized demands makes industry experts fume about the way Microsoft is leaning hard on every conceivable partner to sign up. At Sony, for example, engineers who designed the company's own elegant operating system were mightily annoyed when Sony licensed CE and announced it may include it in some future products. Sputters one: "Microsoft thinks it can bring its PC model into our world. If it works, okay. If it doesn't? Reboot it! They are so arrogant. They just don't get it."

Microsofties soberly respond that future versions of Windows CE will bring improvements. But Wind River's Jerry Fiddler contends that Microsoft's efforts to expand beyond its PC heritage will lead to trouble: "It's going to be tough for Microsoft. This isn't a one-size-fits-all market. Applications are specific, not standard like they are in the PC world. This world is chaos." Tom Rhinelander, an analyst at Forrester Research in Boston, chimed in recently with a report entitled "... Windows CE Falls Short." He predicted that equipment makers will realize that Microsoft's strengths in PC-dom won't translate fluently to all corners of the smart-appliances world. Bottom line: Look for Windows CE to do well, but the further the Redmond, Wash., giant roams from the realm of the PC, the weaker its hold is likely to be.