What Money Can't Buy

That's only partly true: Microsoft collects revenue for every copy of Windows, innovative or not, delivered with a new PC. But let Gates continue: "So, we wake up every day and say, 'Okay, what are the breakthroughs there [in Windows and Office]?' Workflow, business intelligence, integration with the phone. And [we] think, How do we drive those things forward?"

That's why, with its release of Office 2003, Microsoft added a new information-rights management feature -- pioneered by others -- that allows users to give sensitive documents expiration dates, after which no one can view or share them. It also created a "research and reference task pane," giving workers access to dictionaries and online search sites without the hassle of having to leave the programs in which they are working to, say, open a Web-browser window. (For either feature to work, customers must buy a $400 license to Windows Server 2003 software. That's two new sources of revenue for Microsoft!)

On one level, it's hard to fault Microsoft for pursuing a strategy that protects businesses that have served it so well. After all, Windows and Office provide close to 60% of its revenue and nearly all of its operating income. But Slywotzky and other outsiders believe Microsoft is spending more than it has to on defensive R&D. By Mundie's estimate, the company invested $6.1 billion last year in research to support existing franchises. But those categories produced revenue growth of only $2.7 billion. Wouldn't it be better off pursuing bolder new bets? "Microsoft has been too timid," says Howard Anderson, founder of YankeeTek Ventures and a lecturer at MIT's Sloan School of Management. "Are they spending enough? Clearly. But they either come to market late, after others have proved the value of a new product, or they [invest] in little fixes to products that they already have on the field."

To be fair, Microsoft has spent lavishly over the years on dozens of new opportunities. It just hasn't fared very well. Take the company's decadelong investment in interactive television. Gates really was in the vanguard when, in a 1992 speech, he predicted that television would one day be delivered over Internet protocol and enhanced with "rich software."

"I said, 'Hey it could happen any time.' Well, you know, about eight years went by and nothing happened," Gates admits with a chuckle. "[But] Microsoft was [still] spending over $100 million a year on research and development on that." In 1997, after investing half a billion dollars in its own technologies (none of which worked), Microsoft shelled out $425 million to buy the startup WebTV Networks. It made more investments in television through its satellite venture Ultimate TV, as well as in cable through AT&T (now Comcast). Together, these stakes cost Microsoft over $5 billion more. Both WebTV and Ultimate TV foundered and have since been folded into MSN.

Just Ahead of its Time

This is the central tension for Gates, and for Microsoft: Given a strict choice, it will nearly always be easier, and probably more fruitful, to plow research funding back into a proven technology. Sinking money into wisps of new ideas can be interpreted as bold and forward-looking -- but also, for a market leader, as strategically irrational and financially untenable. "Internally," Gates admits, again chuckling, "people give me no end of grief about things like TV."

Gates straddles this crucial fault line with apparent ambivalence. He makes a compelling case for his company's predominantly defensive research strategy. But when pressed, he proudly ticks off long-term product investments, where, he claims, Microsoft was either first or at least "resilient," meaning the time horizons were just as long as with interactive television -- and the bills nearly as big.

"We've invested 10 years in the Tablet PC" -- Microsoft's platform for pen-computing, which has won only modest adoption. "We were in there even before the fad came along and after the fad went away. . . . We've been working on speech recognition for a long, long, long, long time!" The Speech Server project began around 1995. It too has cost close to $100 million a year. "The SPOT Watch, we've been working on that for over 10 years." The SPOT Watch (for smart personal objects technology), is a tepid PDA-like wristwatch released last January.

While missing the biggest computing trends, Microsoft has sunk fortunes into technologies that proved either way ahead of their time or, simply, wrong.

This is par for the course at MSR. While missing the biggest computing trends, Microsoft has sunk fortunes into technologies that proved either way ahead of their time or, simply, wrong. Or, just as troubling, into innovations that most considered inconsequential. Even Lawrence Karr, whose decades-old patents for a method of transmitting data via low-grade FM radio are what make the SPOT Watch work, still seems dumbfounded by the attention Microsoft has lavished on his technology. "I never thought anyone would want this stuff," Karr says. "I never thought I'd be working on something this mundane."