What a month for Microsoft. The stiff fine and tough new measures imposed by the European Union last week were merely the capper in a series of setbacks to hit the company in recent weeks. Microsoft revealed that key products have fallen behind schedule, including patch-management software that's central to its security push. And its next-generation Windows operating system, code-named Longhorn, may be getting bogged down, too.

In addition, Microsoft continues to wrestle with the encroachment of Linux and other open-source products. "A lot of different forces are coming to bear on Microsoft," says Michael Cherry, an analyst with Directions On Microsoft.

On March 22, only 36 hours before the European Commission's crackdown was announced, and knowing what was coming, CEO Steve Ballmer insisted that Microsoft is on the right track. "We think we have all the opportunities in the world," he said during an interview at Microsoft's headquarters.

Ballmer argues the EU has gone too far with its mandate that Microsoft create a version of Windows with its media software removed, disclose Windows server APIs, and more. Microsoft has been down this path before, and Ballmer maintains that the antitrust agreement reached 18 months ago with the Justice Department should be enough to regulate the company's actions at home and abroad. "The question is, will the standards be different outside the United States than inside the United States?" Ballmer says. "We went through a long and arduous process in the United States. We think it's quite an adequate framework."

On March 16, Ballmer flew to Brussels with Microsoft general counsel Brad Smith in an effort to reach a compromise. After two days of negotiations--and a visit to the grammar school he once attended there--Ballmer left without a deal. The talks broke down when EU negotiators insisted on guidelines that would have restricted how Microsoft packages future products.

The EU's verdict that Microsoft must pay a $613 million fine and create a Media Player-free version of Windows, while opening its closely guarded server APIs, cuts at the heart of Microsoft's ability to keep adding new features to its operating system. Microsoft plans to appeal the EU's decision. But if the sanctions stick, they could limit the company's product decisions and embolden competitors to register new complaints, says analyst Dwight Davis at Summit Strategies.

All this comes at a time when Microsoft itself is trying to figure out what features to include in future releases of Windows. In recent weeks, Microsoft product managers have begun talking about fuzzy concepts called "Windows XP Reloaded" and "Windows Server 2003 Update." The company is looking for ways to deliver new Windows features before Longhorn's release, but it's unsure how to package them.

That Microsoft is mulling these options at all is a sign that Longhorn's development is taking longer than expected, which Ballmer confirms. "We have more in our initial Longhorn conceptualization than we probably need," he says. "We've probably got more work than we wanted."

That means Microsoft may "cut back a little bit on the boldness" of Longhorn--the centerpiece in the company's future product line--to get it done more quickly. Even then, Ballmer says, "the Longhorn release that comes out will probably still be a little bit later than I would have hoped initially." Microsoft officials still aren't saying when Longhorn will ship, though some analysts estimate it will be 2007 or later.

Ballmer says there's no plan for an interim PC operating system between now and Longhorn. However, a pre-Longhorn server release remains a possibility.

Freedom to design Windows the way Microsoft wants is especially important as it builds technology into Longhorn. For example, the Speech Server 2004, introduced last week in San Francisco, could lead to future products hitched to Longhorn's development. "Eventually, we'll think of the PC and the phone as devices we can talk to," chairman Bill Gates said at the product's introduction. "The screen and speech shouldn't be separate worlds." During a March 24 teleconference to discuss the EU decision, Ballmer said Microsoft's long-term product strategy won't change as a result of the ruling. But its product road map is anything but static. Upgrades to the company's database, developer toolset, and patch-management system have all been bumped into future quarters. The shifting dates, along with uncertainty about future Windows releases, make planning difficult.

"Their road map seems like a moving target," says Tim Stettheimer, VP and CIO at St. Vincent's Medical Center, a hospital in Birmingham, Ala., with about 1,500 Windows PCs. "We're scratching our heads."

Damien Bean, VP of corporate systems at Hilton Hotels Corp., says, "They have to tell me what building blocks I can rely on."

The delay in Microsoft's Windows Update Services, which promises to make it easier for businesses to download and install Microsoft-issued software patches, was a big miss, given the high priority the company has placed on improved patch management.

But Ballmer touts what Microsoft has accomplished: monthly patch distributions that make life more predictable for systems administrators and an almost-ready security update for Windows XP. "I think we're doing a very good job on the [security] action plans we laid forward," he says. Ironically, the Windows XP work is partly to blame for the Windows Update Services delay; Microsoft deemed Windows XP a higher priority and shifted its resources there.

As Microsoft confronts the growing open-source threat, it's also paying closer attention to how it might turn things to its advantage in China, which has open-source initiatives under way. China is "getting more and more comfortable with Windows as part of their infrastructure," Ballmer asserts. Microsoft last year hired Tim Chen, the former head of Motorola Inc.'s Chinese operations, to spearhead its work there. Ballmer points to a recent deal with the China Ministry of Information Industry to establish technology labs equipped with Microsoft software as a sign of progress.

With pirated versions of Windows widely available in China, Ballmer jokes that the acquisition costs are comparable to Linux. And illegally acquired software gives Microsoft a wide base from which to grow. "Our market share relative to Linux is better in China than almost any other country in the world," he says.

So much for bowing to the pressure. Rather than set Microsoft back, analyst Cherry says hard-to-solve problems tend to fuel the company's competitive drive. "I think they see these challenges as an opportunity," Cherry says. "If you solve these challenges, then there's unlimited opportunity ahead of you."

Among the opportunities Microsoft wants to seize are more deals with manufacturing companies. It's sketching out plans to create sales teams that target the aerospace, chemical, consumer packaged-goods, high-tech manufacturing, and oil and gas industries. It also intends to deliver more job-specific software for employees in finance, sales, and other roles.

But first, Microsoft has to get past the current mix of challenges. And that's going to require more than Ballmer's can-do attitude.

-- With Aaron Ricadela

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