Software Notebook: Gates picks challenging year to leave Microsoft

Just as Microsoft's past year was characterized by launches, the next will be defined by a departure.

But even as Bill Gates leaves his full-time executive role, the company will be grappling with some of the biggest competitive challenges in its history, particularly on the Internet.

Here's our annual look at what to watch at the company in 2008.

GATES LEAVING, SORTA: The Microsoft co-founder is slated to end his day-to-day executive duties at the end of June, but he will remain chairman, and he's expected to continue working on selected projects.

Microsoft has been preparing for Gates' full-time shift to philanthropy since 2005, when the plan was announced, and it has already installed executives Craig Mundie and Ray Ozzie to fill his roles in the business, working with Microsoft Chief Executive Steve Ballmer.

"I don't think the departure will be too disruptive -- it's not like it's a complete severing of the relationship," said Dwight Davis, an analyst with the Ovum research firm. "But nonetheless, that's going to be a notable milestone in the coming year for Microsoft -- one that will alter the company's profile in a fairly significant way."

ONLINE STRUGGLES: Microsoft tried to gain traction online in the past year, most notably through its $6 billion acquisition of online advertising company aQuantive. But it continued to struggle against Google in the Internet search business, with some studies showing the search giant widening its already substantial lead in U.S. market share.

Microsoft has been making progress in online display advertising, through deals with big names such as Viacom and Facebook. However, the overall online unit remains unprofitable due to the company's big spending on data centers and other projects.

"The amount of money they have thrown at it has not been sufficient" to make a difference in the search-related ad market, said Rob Helm, director of research at the independent Directions on Microsoft research firm. "The thing to look for in 2008 is whether they can actually turn it around."

WINDOWS VISTA: Launched with considerable hype at the beginning of 2007, Microsoft's latest PC operating system has been met with a shrug by many consumers and businesses. Among other challenges, Vista's steep hardware requirements have limited the ability to upgrade older machines to the new operating system.

Vista "really has not won hearts and minds the way it should have," said Michael Gartenberg, an analyst with Jupiter Research. The question, he said, is how Microsoft will change its approach to Windows from both technical and marketing standpoints.

The first service pack for Windows Vista is due out in the next three months. Traditionally, that big bundle of updates and fixes has led businesses to feel more confident upgrading, but analysts say the hardware requirements will be an obstacle this time around.

The next version, known internally as Windows 7, is due sometime in 2010. Microsoft has so far been tight-lipped on what that version will offer.

WEB-BASED SOFTWARE: Microsoft's partners and rivals will be watching closely to see how far the company strays from its traditional PC-based software to offer programs and features over the Internet -- funded by advertising or subscriptions, rather than a traditional licensing fee.

The company is already going in that direction with an online version of its Dynamics CRM customer-relationship management software, trying to counter Salesforce.com. More of Microsoft's business software is expected to follow suit.

The company also has edged its Office suite further online, with an Internet-based file-sharing and collaboration service called Office Live Workspace. But so far, it isn't offering full-fledged online document creation and editing.

SERVER LAUNCHES: Microsoft's Server and Tools business has been a big contributor to the company's bottom line in recent years, and the company will be launching new versions of the Windows Server and SQL Server programs in the coming year.

However, Windows Server 2008 will initially be missing a key technology to enable virtualization -- the increasingly popular practice of running more than one operating system on a single piece of hardware. Microsoft won't be coming out with the final version of that technology until later in the year, and it will face stiff competition when it does.

XBOX: The coming year will be pivotal in the video-game console industry, where Microsoft's Xbox 360 is competing against Nintendo's Wii and Sony's PlayStation 3. Entering the past holiday season, the Xbox 360 and Wii were neck-and-neck in worldwide market share, with the PlayStation 3 trailing.

Microsoft has said it wants its Home and Entertainment Division, which includes the Xbox business, to reach sustained operating profitability in the company's current fiscal year, which ends June 30.

HARDWARE AND DEVICES: Microsoft's Surface tabletop PCs are expected to start appearing in commercial venues in the spring -- behind the original schedule, which had them coming out last month.

Microsoft isn't expected to release a new full version of its Windows Mobile software for hand-held devices in the coming year, but it is planning incremental updates to the software, and a variety of new devices are in the works for the current Windows Mobile 6.

The company's Zune music player is continuing its uphill battle against Apple's iPod.

LEGAL ISSUES: Microsoft continued to clear its legal docket in 2007, making a series of settlements and dropping its European antitrust fight after losing a pivotal court ruling. One case that will bear watching in the coming year is the new antitrust challenge filed by Opera Software in Europe over Microsoft's bundling of Internet Explorer with Windows, and the relative lack of support for Web standards in the browser.

INTERNET EXPLORER: Speaking of the Microsoft browser, the company is promising to release a preliminary version of the next one, Internet Explorer 8, in the first half of 2008. The company is promising better support for Web standards.

ACQUISITIONS: Another huge deal along the lines of the aQuantive acquisition isn't likely. But Ballmer recently said the company expects to make about 20 acquisitions a year for the next five years, at individual values ranging from $50 million to $1 billion. That's roughly in line with the number and size of acquisitions made by the company in recent years.