Microsoft is under attack by a bevy of competitors. But is the software giant really at its "most vulnerable moment in history"?
By Tim Weber
Business editor, BBC News website
In the second part of our report we examine how Microsoft hopes to beat its rivals.
Microsoft has plenty of headaches.
HQ: Redmond, Washington
Sales: $36bn (2004)
Profits: $8.2bn (2004)
Chairman: Bill Gates
Chief executive: Steven Ballmer
A raft of companies is newly emboldened to challenge the software giant in every market: music, messaging, mobile phones and more.
"Open source" projects - developed by legions of volunteers - undermine the firm's business model.
To make things worse Microsoft's developers are struggling to close the security holes in their software.
And as long as consumers don't trust the Microsoft world, they are unlikely to buy into the digital lifestyle vision of company founder Bill Gates.
But despite what rivals may say, the software giant is not on the ropes just yet.
Microsoft has a multi-billion dollar pile of cash ready to invest, and Bill Gates has a strategy to fight his rivals.
First battle: Sort out security
"Security will always be on top of the [Microsoft] agenda," says Mr Gates, who is ready to admit that consumers are worried about security.
Already Microsoft is spending 30% to 35% of its research and development budget on security issues, he says.
His promise: Longhorn, the next version of the Windows operating system, will make malicious software (malware) that gets onto computers without the users' knowledge "a thing of the past".
Longhorn works, explains Microsoft UK boss Alistair Baker, because "security needs to be part of the design, not a bolt-on".
It took Microsoft a long time to discover this.
The design and defaults for Microsoft's older software seem to have been written for a kinder, gentler age - without hackers, internet connections or computer viruses.
Now Microsoft is racing against time to secure its users.
Windows users have suffered numerous virus attacks
The more connected we get, the more people with old Microsoft software switch to always-on broadband connections. As they do, security risks rise.
But Longhorn and its security benefits are much delayed; it will ship at the end of 2006 at the earliest.
Microsoft also tries to play down expectations for take-up.
"We don't expect a rush to buy," says Mr Baker, not least because Longhorn is likely to run on high-spec computers only.
Critics suggest a simple solution: use Apple or Linux to be safe and sound.
But Linux (and Unix) systems have been hacked before, and Apple's brand-new Tiger operating system has already been fingered for a security flaw.
Yes, Microsoft's software has security holes, but hackers mainly love it because there are so many Windows PCs out there. Write one virus and 90% of the wired world could be yours.
So if Microsoft comes good on its promise to get Longhorn's security right, it lays the foundation of future success.
Second battle: Get into the living room
Think of Microsoft products: What do you see?
A moderately colourful computer screen, a word processor, maybe a weirdly shaped keyboard?
Whatever it is, it probably reminds you of work.
Can you spot the Windows XP logo?
Now take a look at this sleek DVD player/recorder. It doubles up as a digital TV set-top box, comes with surround sound and has a 200 Gigabyte hard drive.
But have you spotted its tiny Microsoft Windows icon?
The hifi exterior hides a fully-fledged Windows XP personal computer running Microsoft's Media Center software.
Welcome to your personal video recorder, picture archive, juke box, internet access, music download service, wireless media streaming hub, control box for your home's lighting and heating ... oh, and personal computer as well.
Not content with dominating office life, Microsoft wants to enter our living rooms.
Paul Randle, Windows product marketing manager in the UK, admits it will be tricky: "How do we jump from the PC aisle to the consumer electronics aisle?".
It's a question of cost, admits Mr Baker, who says "the Media Center will move into the mainstream... in about three years".
More worryingly, in some countries the cable networks and satellite broadcasters like Sky control the software in set-top boxes.
And how many consumers will be confident enough to integrate their old audio and video equipment with Microsoft's hi-tech box?
Microsoft hopes that home users planning to replace their old PCs will opt for Media Centers instead.
And it bets that once the digital lifestyle reaches our mobile phones and MP3 players, consumers will clamour for an entertainment hub to pull all content together.
Third battle: Get them young
Thursday is a red letter day for fans of video games.
Microsoft launches the second generation of its Xbox console.
Mr Gates says the new Xbox will show that Microsoft "is hardcore about gaming".
The first Xbox established Microsoft's gaming credentials
Internet rumour suggests it will be called Xbox 360, is either white or silver and has an unusual concave shape.
More interesting, though, is what's inside.
I am not talking about its microprocessor or whether it delivers a better experience of playing Halo 2 or Perfect Dark Zero.
Switch on the new Xbox and according to Bill Gates you will see something very similar to the userfriendly 'this-is-not-really-a-computer' interface of the Windows Media Center.
So if the media center fails to sneak into your living room, Microsoft's Xbox is likely to succeed - and make a whole new generation comfortable with using Microsoft.
Fourth battle: Go mobile
"We've never been afraid to work on any platform out there," says Bill Gates.
In the market for handheld computers, though, it took Microsoft three attempts to challenge Palm.
Bill Gates is pushing Microsoft into the mobile space
With mobile phones Microsoft fared worse.
Most handset makers are pushing their own software, while upstart Blackberry is grabbing marketshare among business users that want a phone-cum-organiser.
Adding insult to injury, old rival Apple delivered a double-whammy with its iPod music player becoming industry leader in both the music download and MP3 player markets.
The endgame, however, is yet to come.
Mobile phone giant Nokia and Microsoft recently announced a "long-term collaboration" on mobile media software.
Phones with massive storage, like Nokia's brand new N91, could prove to be iPod killers.
And on Tuesday Microsoft released Windows Mobile 5.0, which brings together its Smartphone and PocketPC software and supports iPod style devices with massive hard drives.
"In the portable space... the phone sort of trumps everything. It trumps media players, it trumps cameras, it trumps GPS-mapping devices, digital wallets, and even entertainment. And obviously we're in the phone software space," Bill Gates told gizmo website Engadget.com.
Microsoft's assault on the mobile space has just begun.
Fifth battle: Serious software
But what about Windows and Office, Microsoft's real cash cows?
Aren't they challenged by Linux, OpenOffice, a revitalised Apple and many others?
Time for a reality check.
More copies of Windows will be sold this year than there are Apple Macs in the whole wide world.
Apple's iMac computer was revolutionary, but no Windows killer; its new Mac Mini won't achieve that feat either.
Bill Gates hopes Microsoft can retain corporate customers
OpenOffice may be efficient, but how many IT managers will be bold enough to go to their bosses and propose dumping the office software used by most major corporations.
Tidying up at the edges, Microsoft is tackling firms like Skype by integrating Voice-over-Internet telephony into its Messenger software.
Which leaves Linux, the great hope of Windows critics worldwide.
Yes, Linux is powering more and more corporate servers, but so is Microsoft's server software.
And it takes a fairly computer-literate user to install and maintain the open source operating system on a personal computer.
"It may take another 10 years until Linux becomes a consumer product," admits Stuart Cohen, the chief executive of Open Source Development Labs, an industry group that helps businesses go Linux.
And there is the weight of numbers: the majority of developers writes software for the Microsoft world, because most PCs run Windows.
Microsoft is not yet in the clear, though.
Government officials in China, Japan, South Korea and Brazil are actively pushing for Linux solutions.
If they get serious, the balance of power could shift quickly.
Sixth battle: Open source
Microsoft executives, meanwhile, are trying their best to diss open source software, with its volunteer developers and 'general public license' copyright.
Such software, Bill Gates tells customers, might not be "interoperable" and could be more expensive to run than Windows "if you look at the entire software stack".
Microsoft has come a long way - and is determined to stay
And "do you really want to have your security issues discussed by the Linux developer community on a public bulletin board," queries Alistair Baker of Microsoft UK.
With the likes of IBM backing Linux, such assertions may be questionable.
But that's not an issue, as long as Microsoft manages to sow enough doubt.
So what about Firefox, the hugely successful open source browser that has grabbed a 6% market share in less than nine months (disclosure: the author's default browser is Firefox).
Startled by its success, Microsoft brought forward the launch of Internet Explorer 7.0 to this summer.
Watch out for Firefox hallmarks like tabbed browsing, better security, integrated RSS feeds.
The final push: Convergence
It is competition - from Apple to Linux - that has forced Microsoft to raise its game and sharpen its vision of the future.
As Bill Gates tells it, we are set for a wonderful life where software is user-centric and your digital world accompanies you wherever you go - in the office, at home and on the road.
Mr Gates calls it "convergence", and says: "We need someone who creates an architecture, need someone who puts that into a framework."
Soon, he implies, soon Microsoft could be everywhere.