Last week, during an annual Strategic Update meeting with Wall Street financial analysts in New York, Microsoft CEO Steve Ballmer laid out his assessment of the coming year and Microsoft's plans for coping with what is clearly an historic economic downturn. Ballmer's talk was hopeful at times, but more tellingly it offered a pretty brutal overview of the problems facing the software giant as some of its traditional core products are beginning to flat-line for the first time. Looking at the state of Microsoft's businesses and ahead to the coming year, however, one thing becomes clear: The software giant still makes most of its revenues from businesses, not consumers.

In his talk Ballmer described Microsoft's seven core businesses: Windows, Windows Mobile, Desktop Productivity, Server, Enterprise Software, Search and Advertising, and Entertainment and TV. Of those seven, five are directly related to IT/business. And when you look at an eighth "other businesses" category, you'll see that two of the four emerging Microsoft businesses, Dynamics and Enterprise Services, are also IT/business related.

Microsoft is very clearly in the midst of an enormous push into consumer software solutions but its business sales remain its primary source of revenues. And from a mile-high view, all of Microsoft's IT-related businesses are profitable or highly profitable, with the exception of Windows Mobile, which Ballmer described as "somewhat unprofitable." Microsoft's consumer-oriented businesses, meanwhile, are doing notably poorly, almost across the board.

Let's take a look at each core business.

Windows

For Windows, Microsoft is ramping up operating expenses and marketing this year, both to stem the tide of bad publicity about Windows Vista and, in the future, to promote Windows 7. The Windows business has been hit hard by the economic depression. What's odd is that Windows sales are still as strong as ever. It's just that a higher percentage of them are going to low-cost netbook computers that include a low-end version of Windows XP for which Microsoft receives a much lower licensing fee. Microsoft also sees a slowdown in IT spending for 2009, which makes sense given the economy.

From a competition perspective, however, Windows has no real competition today beyond pirated copies of Windows. Even on netbooks, over 90 percent of installs are Windows. But Microsoft sees Linux being more competitive on the PC desktop going forward because it believes that Google will port its Android mobile OS to the PC. (An increasing synergy between phone and PC is a theme of Microsoft's planning going forward.) As for Mac OS X, Microsoft says that they barely register, and the actual market share figures I calculate each quarter bear that out: In the fourth quarter of 2008, the Mac controlled just 3.2 percent of the market worldwide, and less than 5 percent in the US.

My take: People have always misconstrued the real market forces that are eating away at Windows. This has nothing to do with the Mac, which remains a niche player in yesterday's market. The future of computing is online, and as the box you use to get there becomes less important--or becomes a smart phone--Windows matters less. Netbooks, of course, are a real issue for Microsoft. It's strength in this market is key for the future. But it's a smaller future, from a revenues perspective. That's true across the board, and not unique for Windows.

Windows Mobile

Windows Mobile is a bit of an enigma. Microsoft is number three in the smart phone market worldwide following Symbian and RIM, and ahead of Apple. But that's a temporary condition, and we can expect Apple's iPhone to surpass Windows Mobile this year, thanks to its consumer-heavy sales. Ballmer says that Microsoft will not build its own phone, suggesting that the company is ready to concede the consumer market to Apple. But the company is strongly positioned in the business world and should remain a RIM contender in that space. Ballmer says that the smart phone market will continue to grow despite the economy and that the low price of some Windows Mobile phone offers will help.

My take: Windows Mobile is in trouble. I see no bright future there, thanks to Microsoft's reliance on slow-moving hardware maker and wireless carrier partners. One possible exception: Microsoft takes control of its future in the mobile space and makes its own phone.

Desktop productivity

Desktop productivity is now Microsoft's strongest business by far, and it accounts for the largest slice of operating expenses as well as a result. Here, the software giant's long-term customer licensing agreements will help Microsoft offset some of the more damaging aspects of the economic downturn. But this business is not immune to challenges, Ballmer notes, and the low-priced Home and Student version of Office 2007, for example, is already the best seller (number-wise). That said, Microsoft derives far more revenues from its enterprise Office users that it does from consumers, so once again the company's dedication to IT is paying off. Looking ahead, Office 14 will ship in 2010, not this year, and will be accompanied by Web-based versions of popular Office applications.

My take: Web-based Office can't happen quickly enough, and I hope to see these Office Web Applications appear much more quickly than 2010. The time to take on Google is now, when the majority of desktop workers are still familiar with--and expect--Office. This is a market Microsoft could lose if it gets too complacent.

Server

Microsoft's Server business is going gangbusters thanks to a strong product lineup with an incredible range of functionality and manageability. Linux remains a key competitor in Web and scientific computing workloads, but Microsoft owns more lucrative desktop infrastructure and IT infrastructure workloads. To address the financial needs of emerging markets and cash-strapped smaller businesses, it will release a Foundation Edition of Windows Server 2008 R2 this year. Ballmer called it a netbook-type release for servers.

My take: Microsoft's Server business is in great shape, and poised for future growth.

Enterprise software

Microsoft's enterprise offerings--Exchange, SQL Server, and the like--typically dominate most of the markets in which they compete from a market share perspective. But it's light on the revenues side because of its low prices. Microsoft accounts for only 16 percent of revenues in the enterprise, for example, but has higher market share than the companies, like Oracle, that earn higher amounts. Ballmer called this a double-edged sword, suggesting that the worsening economy might actually help it pick up some new accounts from customers tired of competitors' higher prices.

Looking ahead, Ballmer pointed to an amazing set of releases coming in the next year, including the Windows Azure cloud computing platform, new versions of System Center (IT management), SQL Server, and other servers, and of course Microsoft's hosted online services (Microsoft Online Services, or MOS).

My take: Oddly, MOS and Microsoft's other online services are still considered "other businesses" as they are nascent at this time. I feel that MOS and services like it will largely replace onsite server installs as the mass market enterprise offerings of the future. As such, Microsoft is poised to take its strength in the enterprise to the next generation.

Search and advertising

Almost comically, Ballmer admitted that, with search and advertising, Microsoft "is a small share." That's for sure: Worldwide, Microsoft's search engine accounts for a piddling 1.7 percent of searches, compared to 2.5 percent in April 2008. And in the US, Live Search manages just an 8.5 percent share, down from 9.4 percent in April 2008. These aren't just bad numbers, they're dropping, and steadily.

Ballmer's take on this is surprisingly hopeful. "This is a huge opportunity," he said. "You give up, you can't get back in the game. " On the flipside, of course, is the problem where Microsoft continues to be a complete non-event, despite years of R&D and billions of dollars spent.

Yahoo! is, of course, a wild card. Ballmer says he's still open to buying the company's search business. And rumor has it that they're talking.

My take: It's not clear to me that Microsoft will ever own a significant share of the Internet search market again. If they do buy Yahoo! Search, that will change, but probably only for temporarily.

Entertainment and TV

This market is very interesting because there's a lot of upside and Microsoft, like others, is convinced that owning a part of the living room will one day be as lucrative as its current share on the PC desktop. Of course, Microsoft has been taking on the living room for almost a decade and has precious little to show for it. The Xbox 360, for example, has been reasonably successful, assuming we pretend that the Nintendo Wii doesn't exist and forgive it several billion dollars in R&D expenses that will never be paid back.

Of course, Microsoft's living room strategy isn't just about the Xbox: It has Media Center (PC-based) and Media Room (set-top box software) today--neither of which has any serious traction, and, looking forward, what Ballmer described as "new appliance devices that we or others design that sit next to a TV." These new devices, he said, would bring online TV and movie services, common on the PC, to the television.

And let's not forget Zune. While Microsoft's Zune devices will never offer viable competition for Apple's iPod, the company isn't giving up and its plan to move the excellent Zune software to the Xbox 360, Windows Mobile phones and, possibly, the aforementioned pie-in-the-sky set-top box is a good one.

My take: Give them credit for one thing here, they keep trying. None of Microsoft's living room solutions have ever been legitimately successful, but the software is all excellent. Microsoft deserves to be successful in this market. It never has been, not really.

Final thoughts

Microsoft's product line-up is in a transitionary state this year as its customer base begins the long and probably painful move to cloud computing on both the desktop and server. This will be difficult for the software giant, because its bread and butter products--Windows, Windows Server, and Office--are very much traditional software products. But it is taking the right steps to position itself for this change, with Windows Live on the desktop and MOS on the server.

Windows Mobile's future is uncertain. I don't feel that this year's 6.5 release will accomplish anything, but its services-oriented offerings, My Phone and the Windows Mobile Marketplace, will position it for the future. Apple will eat Microsoft's mobile lunch this year and for the foreseeable future.

On the entertainment side, I'm curious to see if Microsoft can overcome endemic Xbox 360 reliability problems and antipathy about its Media Center, Media Room, and Zune solutions. Here, Microsoft has very clear and very powerful competition: Nintendo in the video game front and Apple on the digital media/living room side. Apple's digital media lineup is particularly strong, though it should be noted that even that company has been completely unsuccessful in the living room.

Whatever happens, one thing is clear: This year is going to be tough on everyone, including Microsoft. If you have opted for Microsoft's solutions, especially in business, it looks like you've made a good decision. The issue here, of course, is whether your existing infrastructure can be stretched for a few more years: Microsoft isn't the only company that will be riding out this storm. On the consumer end, you've got a lot of decisions to make. Microsoft offers increasing levels of integration, but the competition almost always offers superior products.

Edited portions of this article appeared in the March 3, 2009 issue of Windows IT Pro UPDATE. --Paul