Microsoft's Second Rite of Passage

Responding to a wave of change on the Internet, Microsoft(MSFT) is charting a new course that could ultimately determine whether the software behemoth once again sinks its rivals or is swept away by more agile competitors.

Recent memos from two top Microsoft executives revealed just how seriously the Redmond, Wash., company is taking the latest evolution of the Internet -- dubbed Web 2.0 -- into an ad-supported application platform.

But the jury is still out on whether Microsoft, widely viewed as a lumbering barge these days, will be able to navigate nimbly enough to be a leader in this next iteration of the Net.

"Microsoft is facing the greatest challenges that it's faced at any time in the history of the company," says Paul Saffo, a director at the Institute of the Future, a forecasting think tank in Palo Alto, Calif. "But I wouldn't be writing Microsoft off just yet."

Saffo ticks off a confluence of factors that have created the challenges, including its aging Chairman and Chief Software Architect Bill Gates and the company's difficulty hiring and retaining employees amid competition from Silicon Valley highflyer Google(GOOG).

On a technology front, Saffo says that Web 2.0 represents a big change in the competitive landscape for Microsoft.

"In this case, it's really true the competition is in cyberspace," Saffo says, calling that a shift in the "intellectual design model" for Microsoft. "That's a big shift for a company that has gotten rich selling operating systems and shipping applications."

Saffo is referring to the movement of applications off of a user's desktop onto the Internet. Salesforce.com's(CRM) hosted software is the most successful example of this, but start-ups and established players such as Yahoo!(YHOO) are getting into the act, using technology that lets Internet applications operate more like desktop software.