Software giant needs to perfect strategy and execution in 2006 if it wants to beat competitors ranging from Sony to Google.

Bill Gates is betting big on 2006. After years of development and hype, Microsoft will launch its biggest lineup of products ever while also challenging Sony’s dominance of the video game market and Google’s lead in online media.

The world’s largest software maker will ship two critical products: Windows Vista, its next-generation operating system; and Office 12, a package that includes updated versions of Word, Outlook, PowerPoint, and Excel. Its Xbox 360 is already on store shelves worldwide, albeit in short supply, and gamers who bought the consoles will now expect a steady flow of thrilling new games.

Amid all that, Microsoft will have to see if its attempts to streamline the company’s organizational structure have been successful.

Red Herring.com offers seven critical areas to watch in the year ahead.

Executing Product Transitions

The biggest challenge for Microsoft will be to successfully shift customers to new versions of established products without disrupting its revenue stream. Microsoft plans to ship Windows Vista and Office 12 in late 2006. The first two quarters, when Microsoft does not have any new product releases, will be particularly tough, said Richard Williams, an analyst with Garban Institutional Equities, a brokerage firm based in New Jersey.

“2006 is a product launch year and not a revenue contribution year and that leaves Microsoft in the difficult position of having to find ways to keep growth up even as they accomplish the difficult task of executing on their upcoming product line,” he said.

Vista and Office are the company’s cash cows and if Microsoft fails to convince a larger percentage of users to upgrade quickly to its new products, it risks losing market share to increasingly strong competitors, especially in open source.

“Microsoft cannot afford to lose the mindshare and dominance of the market,” said Carmi Levy, an analyst with Info-Tech Research Group, an advisory services company focused on midsize firms. “If it does, funding for everything else will be threatened.”

Pushing Vista to Enterprises

With Vista, the challenge for Microsoft will be in convincing customers to give up on their existing Microsoft products and move to a newer version. Windows Vista will be particularly difficult to sell to businesses, said analysts.

So far, Microsoft has focused on the security features of Vista which are far less important to businesses. “Getting corporate appeal for Vista is a huge challenge,” said Rob Helm, an analyst at Directions on Microsoft, an independent Microsoft-focused consultancy firm. “The Windows operating system is Microsoft’s biggest business and I am hoping early in the year they will nail down the feature set so they can better market the product to businesses.”

Pulling this off is critical because newer versions of its products are more highly integrated with one another. “Microsoft has embarked on a very aggressive integration strategy,” said Joe Wilcox, an analyst with JupiterResearch. “So if enterprises don’t move to the newest version, it creates problems for Microsoft because of the cross-dependencies it has built into the product.”

Winning with Xbox

Microsoft has said its Xbox business will become profitable in fiscal 2007, which begins in July 2006. Right now, Microsoft loses money on every Xbox 360 console it sells but the company has said that a strong presence in the entertainment segment is crucial to its future (see Xbox Loses Money). Overall, Microsoft is believed to have invested $4 billion in the Xbox franchise without a penny to show for it.

Microsoft has a few things going for it here. Despite facing a strong competitor in Sony, Microsoft has been able to build a buzz around the Xbox 360. It has more than 2 million paying customers for Xbox Live, its subscription-based online gaming service.

Overhauling Security
Microsoft is giving itself one more chance to prove its ability to create a secure and reliable product. The company has long been criticized for the poor security features in its operating system and other products. And it has been working to slowly strengthen security.

Vista will be the test that will determine if Microsoft is capable of creating a secure system, a test Microsoft must pass.

“Microsoft has the challenge of delivering an operating system, a browser, and an Office application that are fundamentally and architecturally more secure than its current generation of products,” said Mr. Levy.

Microsoft also needs to prove it can handle issues arising from its partners, such as in the recent Sony “rootkit” incident. The music giant had embedded software into its music CDs ostensibly to protect its copyright, but critics assailed the company for using technology that could be exploited to install malicious software on users’ computers.

However, Microsoft, which recently launched its anti-spyware tool for home users, took about two weeks to respond to the problem. Only after the outcry against the rootkits had reached a crescendo did Microsoft decide to update its Windows AntiSpyware and the online scanner on the Windows Live Safety Center to detect and remove the software.

Microsoft’s slow reaction could be symptomatic of how it would respond to security concerns created by partners. “Microsoft’s size, position, and interest create conflicts that may undermine its ability to offer truly aggressive security products,” said Mr. Wilcox

Creating an Agile Organization

Microsoft has revamped itself twice this year. The company has been criticized for its slow product development cycle, lack of agility, and inability to capture emerging market opportunities

On Thursday, Microsoft said it plans to reorganize its entertainment division to compete more effectively with consumer products beyond gaming

All of this is essential if Microsoft needs to grow through 2006, said analysts.

“Agility, responsiveness, and speed to market are the key issues here,” said Mr. Levy. “Microsoft needs to encourage more entrepreneurial units within the company’s overall structure so products like operating systems don’t take years to develop.”

2006 is when some analysts hope to see some results of the reorganization. “Microsoft needs to sell better and code better,” said Mr. Williams.

Refreshing Its Online Strategy

On the online services front, Microsoft faces its most formidable competitor in nearly a decade: Google. In 2005, the company created the “Live” brand to take on Google, but is still light years behind in advertising dollars.

It doesn't help that Google plans to strengthen its existing ties to AOL.

“Microsoft fears Google because it could interfere with its plans to create a web channel,” said Mr. Williams. “In 2006, Microsoft will have to work to defend its turf.”

Microsoft has to create a search product that can take on Google and scale up its MSN infrastructure, said analysts.

If Microsoft doesn’t catch up in 2006, it is liable to not just lose revenue to Google, but to find itself in a position where its core products—its operating system, browser, and applications—could be threatened.

Microsoft is facing potential competition to its platform from Google. “Just as Xbox has squeezed Sony’s profits, Microsoft needs to refresh its online strategy to be able to beat Google,” said Mr. Helm.

Revamping Its Brand

Microsoft’s marketing and branding machine will have to be stronger than ever. The Redmond giant has already stumbled on this front, especially by talking about its products—often through unidentified “spokespersons” or jargon-ridden boilerplate—long before the company is in a position to ship them.

“Microsoft often talks about stuff before it releases it as a competitive tactic when a competitor is about to release something,” said Mr. Wilcox. “But then it seems like Microsoft is reacting to competitors rather than talking to consumers about the benefits its product can bring.”

Microsoft’s attempts at naming its products too have caused considerable confusion in the past. For instance, Microsoft changed the name of its business messaging and collaboration product more than three times. Initially, launched with a codename, Greenwich, the product was renamed to Real Time Communications Server 2003, then changed to Office Real Time Communications Server 2003, and finally Office Live Communications Server.