Gates memo warns of 'disruptive' changes

"This coming 'services wave' will be very disruptive," Gates said in an October. 30 e-mail to top Microsoft employees. "We have competitors who will seize on these approaches and challenge us." [Read the full text of Gates' e-mail here.]

In the memo, Gates cites an earlier missive from Ray Ozzie, outlining the importance of tapping online advertising and services as new revenue sources. [Read the full text of the Ozzie e-mail here.]

"It's clear that if we fail to do so, our business as we know it is at risk," Ozzie wrote. "We must respond quickly and decisively."

Ozzie's memo, which was also seen by CNET News.com, includes a laundry list of missed opportunities for the software maker, citing competitive threats from rivals such as Google, Skype, Research In Motion and Adobe.

Ozzie notes areas that Microsoft could have led, such as Web-based applications, but where other companies are instead more heavily focused.

"We should've been leaders with all our web properties in harnessing the potential of Ajax, following our pioneering work in OWA (Outlook Web Access)," Ozzie wrote. "We knew search would be important, but through Google's focus they've gained a tremendously strong position."

In the memo, Ozzie talks about Google as Microsoft's most prominent of the emerging competitors, but also makes reference to Yahoo and Apple Computer.

"Google is obviously the most visible here, although given the hype level it is difficult to ascertain which of their myriad initiatives are simply adjuncts intended to drive scale for their advertising business, or which might ultimately grow to substantively challenge our offerings," Ozzie wrote. "Although Yahoo also has significant communications assets that combine software and services, they are more of a media company and--with the notable exception of their advertising platform--they seem to be utilising their platform capabilities largely as an internal asset.

"The same is true of Apple, which has done an enviable job integrating hardware, software and services into a seamless experience with dotMac, iPod and iTunes, but seems less focused on enabling developers to build substantial products and businesses," Ozzie wrote in his memo.

He also makes reference to smaller, emerging companies that are developing software and services that use the Internet, rather than Windows, as their base platform.

"Developers needing tools and libraries to do their work just search the Internet, download, develop and integrate, deploy, refine," Ozzie wrote. "Speed, simplicity and loose coupling are paramount."

At the same time, Ozzie sees an opportunity if Microsoft can create a Web-based development platform.

"The work of these startups could be improved with a 'services platform'," Ozzie said. "Ironically, the same things that enable and catalyse rapid innovation can also be constraints to their success. "

Microsoft has talked of a developer platform in conjunction with Windows Live, but the company has offered few details of how third parties will be able to build on top of Microsoft's work.

Microsoft has already reorganised the company and outlined some of its plans, but the two memos make clear the urgency and importance that the company is placing on this effort.

The company announced in September that it was reorganising itself into three units and tapping Ozzie to lead a companywide services push. Last week, Microsoft announced the first fruits of that effort--products called Windows Live and Office Live. Windows Live combines many of Microsoft's existing MSN services into an advertising-supported product for consumers, while Office Live is a set of services, some free and some paid, aimed at small businesses.

He also points to the fact that although Microsoft's Office is ubiquitous, it is Adobe's PDF file that has emerged as the key means of sending formatted documents on the Web. Microsoft is proposing its own rival to PDF, known as Metro, with Windows Vista, its new operating system that is due out next year.

Gates says that despite the threats, "the opportunity for us to lead is very clear."

"More than any other company, we have the vision, assets, experience, and aspirations to deliver experiences and solutions across the entire range of digital workstyle & digital lifestyle scenarios, and to do so at scale, reaching users, developers and businesses across all markets."

Details of the memo were reported earlier Tuesday by the Wall Street Journal.