Microsoft is between a rock and hard place. The Redmond software giant made an enviable $17.6B in profit last year (see MSFT for more details) but the stock is down from its bubbly peak and has been stagnant for almost a decade. Competitors that once cowered in the corner are now nipping at the company’s flanks. Perhaps most threatening of all, Microsoft has become what it once overpowered– a vast, internally focused bureaucracy, more like the IBM of old than the Microsoft of old. Windows Vista was a debacle. Rather than rushing to purchase the latest and greatest, customers demanded access to older software, specifically to avoid the latest and greatest.

Despite these problems, Microsoft’s earnings have continued to climb, driven in part by savvy segmentation and pricing, which meant that almost alone among companies supplying computer “parts”, whether physical or virtual, Microsoft has been able to maintain and even raise unit prices.

However, Apple has eaten a chunk of the high end personal computer business. Linux made its deepest inroads in the “netbook” segment of cheap laptops, while Google and others threaten to move computing off the desktop and into the cloud (finally fulfilling Netscape wunderkind Marc Andresson’s arrogant if prescient quip that the browser would reduce Windows to a “poorly debugged set of device drivers”).

Microsoft has seen threats before, from IBM’s OS/2, AOL, Netscape, Sun, and others. But Microsoft’s response to the latest onslaught has been weak. Now, Microsoft is going on the offensive again, with a line of ads attacking Macs as too expensive, and a new pricing attack against Linux that has reversed market share losses in the netbook segment (see How Microsoft is fighting back (finally) at Business Week).

The problem is that Microsoft can only complain so loudly that Apple is too expensive before the obvious comparisons between Microsoft and open source solutions like Linux and Open Office make Microsoft appear over-priced. For most consumers, Linux netbooks are perfectly adequate from a software perspective (personally, I need a fullsize keyboard a decent screen– even the Macbook Air doesn’t qualify for the screen).

Allowing OEMs to ship Windows 7 at $15 per copy for the most basic version will help head off Linux, at the cost of the tremendous margins Microsoft has typically enjoyed. However, it’s better to cannibalize yourself than let someone else do it for you. Without a way to actually grow profits, though, Microsoft stock will continue to languish, talented and ambitious employees will leave, and Microsoft will lose its place as the industry’s dominant player and join IBM as another powerful behemoth.

Is the company that changed the computer industry, partly by audacious bundling (I’m talking about practically giving away Office productivity applications by 1980s standards, not the later bundling of programs with Windows), doomed to irrelevance? In a follow-up post, I’ll talk about what they could be do to regain their mojo.

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