Microsoft celebrated the launch yesterday of Windows Server 2008, SQL Server 2008, and Visual Studio 2008 at an event in Los Angeles. After his keynote address to the gathered crowd of IT pros, InformationWeek had the chance to sit down with Microsoft CEO Steve Ballmer.

In a 25-minute interview, Ballmer discussed virtualization, Linux, the concerns customers might have about the Windows Server 2008 release, Microsoft's recent "openness" pledge, the forthcoming Yahoo acquisition (including the fate of Flickr), and even mainframes. Here's an edited transcript:

InformationWeek: I think you see VMware aggressively courting virtualization customers. Customers that I've spoken with are saying Microsoft is definitely coming from behind here. You mentioned it on stage here. There's Hyper-V's delay. Does Microsoft's entrance now into the virtualization space put it at a disadvantage in the virtualization world?

Ballmer: The choice is, you know, to be first to have share or not. I guess I prefer to be first to have share. Now, you've got to remember, this market has barely been scratched, less probably in the install base -- less than 5% of all systems run virtually. Virtualization is way too complicated, way too expensive today for people to take advantage of it, and it's way too isolated from the rest of everything that happens in application development to data center deployment and operations. That's not my way of criticizing, it's just if we're going to get -- if the phenomenon is going to fully take effect, then we've got to democratize it. That might be VMware, [but] they haven't shown moves in that direction. Somebody could argue it might be one of the open source alternatives. I like what we've got. I think we pay out on those problems.

That doesn't mean the other guys are going to go away. Obviously we recognize that fact and we provide good interoperability with VMware's virtual machine. But I don't think -- there's a simplicity with performance, with management, integrated management, with everything else, I think we're going to make a real difference. Sure, I wish we had everything we're announcing now and shipping this year a year ago, sure. Two years ago? Sure. But, believe me. We're going to make a big difference.

InformationWeek: One of the concerns I found that people carry over with them from -- certainly the Vista release and their past experiences with those operating systems, is the concern about application compatibility at the beginning. What kind of things is Microsoft doing today that it hasn't done in the past to assure customers that they can start moving fairly soon to Windows Server 2008?

Ballmer: Well, we've done a lot of work, obviously, even in the Vista context. We've done a lot of work on application compatibility. Some of that is work we've done in the code, but most of that is work that we were doing with the ISVs, with the application developers, with tools that help people get there, etcetera. And that doesn't mean that it'll be entirely zero work, but I think it's an area in which we have done a very good job and, in fact, the fact that Windows Server 2008 is a year after Vista actually helps the server release quite a bit.

So I think the thing ought to proceed fairly quickly. You know, if you look at it, only some of what happens in the server is about the sort of bespoke applications or ISV applications. A lot of what happens in the server, frankly, is about very standard applications. Are the databases all there or not? Are all the mail packages there or not? Are all the document management and collaboration tools and SharePoint there or not? You know, so I think a much higher percentage of the machines are accounted for by what we call standard applications as opposed to specialized applications. That doesn't mean specialized applications aren't important.

InformationWeek: So another thing is Linux. You've said you're gaining ground against Linux and some analyst reports have shown that. But still, a quarter of our readers have said they're looking to increase their ratio of Linux servers to Microsoft servers. How does Microsoft stay successful against Linux, and how do you convince that quarter that they're wrong?

Ballmer: Well, I think what we have to do rather than convince people they're wrong is we've got to convince people that the stuff that we do ship, that the partnership on top delivers real value. And that's what we've been doing a very good job of. I mean, the fact of the matter is, how do we beat Linux? The way you beat any other competitors: You offer good value, which in this case means good total cost of ownership, right? Because total cost is really, at the end of the day, the issue. And the fact that, quote, Linux is open source, therefore it appears to have a zero price -- that actually made it easier to shine a spotlight on the thing that always mattered anyway, which is total cost. We have a better proposition today, I would think, for total cost of ownership, and we have to offer better value where better value reflects the applications that are available, the quality of the tools.

Take something like SharePoint alone. It's a big deal. The quality of the databases, that's a big deal. The availability of tools, of Visual Studio and .Net and the ability to build bespoke applications, those are all part of the value and the total cost. And I think we've done a good job. In the areas where we haven't done a good job, we'd have less share. We have a smaller percentage of the market, for example, in high-performance computing. That's about 40% of Linux business. We really didn't enter the market with what I would call an engineered, high innovation, high-value-add offering until last year. Now that we're in the game, we're gaining share in the high-performance computing work load. So in a sense, the old formula: Keep the prices low, keep the innovation high, keep the total cost of ownership low.

InformationWeek: Does the interop stuff and the openness stuff and standards stuff play a significant role in that competition with Linux and open source as well?

Ballmer: Sure, it's helpful. It's sort of like all of these things. Interoperability is a two-way street -- the other guy takes share from you and you take share from the other guy -- and always will be. Everything that sort of starts with the word "interoperability" has that characteristic. Our customers benefit, which is a great thing. We go in thinking we have an opportunity to benefit, you're looking for risks, the risks I guess are that interoperability does more harm than good. I don't think that's likely, but nonetheless it's there for us and it's also there for the guys you interoperate with.

I used to always joke with IBM, you know, we were opening up the desktop to them, and they were opening up the mainframe and the data center to us. And who out-hustled who is a big deal in terms of who wins.

InformationWeek: Did you see the New York Times story yesterday with IBM saying that the mainframe's coming back?

Ballmer: I really don't think that's true. They may continue to sustain life and they may grow their revenue, that's a different story. But if you actually went to most of your readers and said the mainframe is actually coming back, I think you wouldn't find 25% who would agree with that statement.

InformationWeek: With every Windows release, you get people who say, "I'm waiting for Service Pack 1." Many of those do so because of perceived "bugginess" of an initial release. Microsoft has said that this version of Windows Server is among the most rigorously tested products that the company's come out with yet. What are some of your proof points there?

Ballmer: It builds off the Vista code base. So all of that testing plus another year. There's some enhancement and a lot of testing. We modified -- about three or four years ago now -- our development process to move to a secure development life cycle approach. Which if you just look -- the proof is in the pudding -- the products that have been released into that kind of development methodology have all shown reduced susceptibilities and reduced vulnerabilities, which I feel very good about and I 100% stand by that statement.

I think a lot of customers will say, "Good, I'm going to move forward." Some people will undoubtedly choose to wait for market feedback, or a service pack.

InformationWeek: Is there an expectation that the server deployments might take place over a longer period than the desktop?

Ballmer: The whole way servers get deployed is so different than desktops. People want to make it sound like they're the same. People replace or upgrade desktops. Mostly, people add servers. Occasionally, somebody will re-platform a server application that's working. But a server doesn't need to be re-platformed, mostly. You only have one desktop for one person, it's the whole environment. You either move it or you don't. You can leave the SharePoint workload on Windows Server 2008 and keep the high-performance computing workload on Linux and some other Web workload on Windows Server 2003 and the user doesn't have to know about that. So it tends to be servers get added and desktops get upgraded.

InformationWeek: In this age of server consolidation with virtualization being a next step to consolidation, Windows Server continues to be a growth engine for the company. What's accounting for the continued adding of servers?

Ballmer: Number one, virtualization is a very early stage, nascent phenomenon. I mean, I already said that less than 5% of servers have been virtualized. Number two, we have actually priced our Windows Server software in such a way that, in fact, even if the systems tend to be more consolidated, we have an opportunity to continue to participate financially, not by over-charging but by properly charging. We charge more for our enterprise and data center edition, and we give you greater numbers of virtual machines, effectively, that they run. We have some pricing which helps us continue to sustain value.

And then number three, the absolute demand, the absolute number of applications that people want to build and run is outgrowing any ability any of us seem to have to shrink workloads. Probably, number four is scale out, which is sort of more server-intensive per workload. The scale-out model is important for a lot of next-generation Web applications that are being run. Those are not getting consolidated, they're going the other direction. We can certainly see that at a place like Microsoft with MSN or Amazon or eBay or any of those. InformationWeek: Two of the main concerns I've heard about the Yahoo acquisition have been the major infrastructural differences between Yahoo and Microsoft and a lot of product redundancies. Craig Mundie actually mentioned it in a speech to the Goldman Sachs people yesterday. Why shouldn't customers and investors be worried about those two things?

Ballmer: I'm not sure what customer would think twice about that, honestly. I mean, customers here now are consumers and advertisers. And whatever is happening in the back room, that's kind of our problem to solve. So these are not enterprise customers. This is something we have to deal with, so I don't understand the customer point.

We've told shareholders, look, we think there's an opportunity to drive value, drive synergy in this combination, and that we have a number of ideas, we've talked about some areas to drive synergy. And at the same time, until we and Yahoo have a real discussion about it, it's just premature to be more specific.

InformationWeek: I guess the customer point was that customers might be worried about, for example, Flickr. Will something happen to it or is it going to go away?

Ballmer: Like I said, that would be our problem to solve. And, sure, there'd be some issues to think through. I'm not sure why a good thing like Flickr would disappear, I don't know why anybody would hypothesize that.

InformationWeek: The openness pledge you guys made last week, one thing that I didn't really get a better sense of is, do you feel like Microsoft is moving more toward embracing open standards than you have in the past? That's part one. And the second thing, what do you guys hope to get out of this increasing engagement with the open source community?

Ballmer: I think what we really worked to do last week is to systematize and formalize and make digestible to partners, industry participants, customers, etcetera, how we think about interoperability and standards support. We didn't say absolutely we don't do innovation. We didn't do that. We say when we embrace standards, we'll be transparent about how we're embracing standards. We're going to embrace a lot of standards, we're going to be transparent about how we embrace those standards. If we have deviations, we'll be transparent about the deviations.

We talked about what I would call a transparent and open involvement with industry standards, which I think is very good. I might even say I think it's sort of how we've been trying to get things done. Others would disagree, but rather than argue about it, why don't we lay it out as a principle. We're going to follow that principle both internally and with our customers.

In the case of open source, you know, we have many things that we're doing. There are all kinds of open source projects. Microsoft has always strived to be at the center of where innovative work is happening. If innovative work is going to happen in the open source community, I want it to happen on our platforms. We've always tried to get innovative work to happen on our operating system, and I want Windows to be the number one destination for open source innovation.

At the same time, some of our products have, themselves, open source competitors. The open source competitors we have, we're going to compete with and we're going to interoperate with, we're going to do, essentially, anything we would do with a commercial competitor. If it's announcing interoperability to get closer to Linux, you're talking about a value proposition and what we're trying to do to take share from Linux. In a sense, what you can say is Windows competes with Linux, Microsoft does not compete with open source, not in general. Windows does compete with Linux, SQL Server does compete with MySQL, etcetera.