Microsoft: Live on Stage!

Microsoft's (Nasdaq: MSFT) Windows and Office practically own the operating system and productivity software markets. Yet the company is about to extend those products to a realm where the odds are decidedly not in its favor: hosted software. Yesterday, Microsoft announced Windows Live and Office Live, online-enabled additions to its top-selling software that will be offered free to users and subsidized by advertising.

It's not simply a coincidence that Microsoft would enter this particular fray. Mere weeks ago, Google (Nasdaq: GOOG) announced a team-up with Sun Microsystems (Nasdaq: SUNW) in a pact that would likely enhance the visibility of Sun's web-based offerings. It just cements what everyone has been speculating about for some time now: Microsoft's biggest current threat is Google, and it's not going to take the challenge lying down.

Microsoft doesn't intend to cannibalize its physical software sales. Windows Live, currently in beta testing, isn't an operating system replacement; it's an enhancement to Microsoft's existing platform of online offerings. At Live.com, Microsoft is integrating its Hotmail email service, MSN Instant Messenger, antivirus scanning, web-accessible browser favorites, and many other features into a single online product.

Office Live, with a beta test promised for early 2006, is perhaps even more compelling. It will be an online adjunct to Microsoft's existing Office software, providing entrepreneurs with their own websites, email accounts, and domain names, plus online project and document management tools, among other features. Many of these applications will run independently of Microsoft Office, and there will be some serious implications elsewhere if the ad-supported offering takes off. Depending on how things play out, this may impact smaller companies like Register.com (Nasdaq: RCOM), Network Solutions, GoDaddy, or Tucows (AMEX: TCX), which sell domain registrations and tack on hosting services.

If OfficeLive proves successful, Microsoft could enjoy some promising prospects for contextual advertising within free applications. What refinancing company wouldn't want the attention of someone working on a mortgage amortization schedule in an Excel spreadsheet? What travel company wouldn't want a shot at someone pecking out vacation plans for next summer? Some will crow about invasions of privacy, but by definition, consumers need to give something up to enjoy subsidized freebies.

It's a gutsy move by Microsoft, which will find itself on an unusually level playing field here. Hosted software stalwarts include Sun and Salesforce.com (NYSE: CRM), with Google and Yahoo! (Nasdaq: YHOO) entering the competition. Will Microsoft risk educating its more passive user base -- including 400 million global Office users -- only to lose them to Internet rivals? Perhaps, but ignoring this market could be potentially worse; it could leader to a slower but more certain rate of user defection.

Good luck, Microsoft. This is where the fun starts.

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Longtime Fool contributor Rick Munarriz is a fan of hosted software, and he will give Microsoft the benefit of the doubt. He does not own shares in any of the companies mentioned in this story. The Fool has a disclosure policy. He is also part of the Rule Breakersnewsletter research team, seeking out tomorrow's ultimate growth stocks a day early.