As the year winds down, financial analysts are predicting that Microsoft will pre-announce negative earnings for the first time since 2000 because of a flat PC market. But all things considered, 2008 was a pretty good year for the software giant.

Windows is still used on 90% of computers and Internet Explorer on 70%. Despite growing Web-based competition, Microsoft Office saw 20% growth in Q1 of fiscal 2009 and the company’s server and tools division grew by 23% in Q1 2009.

On top of that, research from NPD Group this week shows that November retail sales for Macs fell 1% year over year while Windows PC sales grew 7%.

Under new cloud-minded chief software architect Ray Ozzie, Microsoft has been adapting to a changing Web 2.0 world. Cloud computing operating system Windows Azure, Windows Live, Live Mesh and Office Web Apps are a few examples of Microsoft’s focused attempts to stay innovative.

But even though its finances are stable and its eyes are on the future, Microsoft executed poorly in some major areas in 2008.

Here are three Microsoft stumbles from the past year that will put more pressure on the company to survive and thrive in 2009.

The real tragedy of Windows Vista, especially after service pack 1, is that it’s not as bad as its reputation. But Microsoft did not do enough in 2008 to let people know that. It got caught in the crosshairs of bad Vista perceptions and unrelenting anti-Vista marketing from Apple .

But bad perceptions don’t appear out of nowhere. Compatibility and performance issues plagued Vista from the start. It was a vastly different OS from Windows XP and there were major changes to security features and the graphics system that created usability problems. These changes may have been necessary, but adapting to them led to chaos.

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Michael Cherry, an analyst at Directions on Microsoft, says that Windows Vista isn’t as bad as Microsoft has convinced us it is. By remaining silent on Vista, he says, Microsoft did more harm than good.

The biggest misstep was not using Vista SP1 [released in February] as an opportunity to show customers that Vista is a stable and reliable system. especially now that most device manufacturers have updated their drivers, he says.

Cherry said Microsoft missed an opportunity to illustrate why the security changes in Vista are so important, to promote security features like UAC and BitLocker, and to help people purchase machines that can best utilize Vista SP1.

Microsoft’s self-consciousness about Vista in 2008 was glaring, and it led to timid or non-existent marketing.

Letting the Apple Momentum Build

For most of 2008, Apple relentlessly lampooned Microsoft in its ubiquitous I’m a Mac, I’m a PC TV commercials. The ads were often funny and effective in pointing out Vista’s flaws in ways that everyday people could understand.

America waited for a response from Microsoft. and waited. and waited.

Finally, towards the end of the summer we got. drum roll. a response. Jerry Seinfeld and Bill Gates hanging out in a mall talking about shoes? Huh?

Putting a beloved comedy legend in your ads is a great idea on paper, but it was as if the ad was completely improvised, and not in a good way. Gates had a capable deadpan delivery and Seinfeld was being Seinfeld, but the ad was flat, and there was no mention of Microsoft or any of its products. Viewers were confused.

The follow-up ad where Jerry and Bill move in with a family in the suburbs was longer and even more out there. It worked as a quirky and amusing short film, but not a TV commercial and the campaign was cancelled.

Microsoft rebounded fairly quickly with the I’m a PC/Life Without Walls ads that included celebrities and everyday people from around the world talking about how they are proud PC users. It was a much more effective ad about how PCs connect people and cultures.

But it may have been too little too late. The ad, though earnest and inspirational, did not mention Vista. Apple seized on this with a clever commercial about how Microsoft is pouring money into advertising rather than fixing Vista. Again, Vista was Microsoft’s Achilles’ Heel.

Roger Kay, president of consulting and research firm Endpoint Technologies, says Microsoft let Apple get the best of them in 2008 and should have played more aggressively in the marketing game.

Letting the momentum from the Apple campaign gather for too long before intervening was a big mistake, Kay says. Microsoft should have started punching back much earlier.

Microsoft’s efforts to buy all or some of Yahoo dominated the headlines for most of 2008. Ultimately, nothing concrete came out of it (not yet at least), but there was no shortage of drama. And the drama should continue into 2009: the latest speculation is that Microsoft is lining up to buy Yahoo’s search business.

The saga began in February when the software giant offered $44.6 billion for Yahoo so Microsoft could beef up its struggling online search and advertising portfolio.

Criticism arose that Microsoft was not up to the task of integrating both the technology and the culture of Yahoo into the more corporate, proprietary world of Redmond.

And then a funny thing happened: Yahoo said no. It rejected the 44.6 billion offer. Most people were expecting Microsoft to either do a hostile takeover or purchase part of Yahoo. But then another funny thing happened: Microsoft dropped the bid entirely and walked away. It was around this time that the economy and Yahoo’s stock price went downhill.

A clumsy courtship where the two companies almost get together and then break it off continues to this day. Recently, billionaire investor Carl Icahn invested his way onto Yahoo’s board and pushed for a Microsoft deal. Yahoo CEO Jerry Yang, who repeatedly resisted the Microsoft offer, was ousted in November. Many thought Microsoft would strike again, but a day after Yang stepped down Microsoft CEO Steve Ballmer declared: We’ve moved on.

All this Microhoo noise just makes Microsoft look bad and unsure of itself, says Kay. I would put Yahoo at the top of my list of Microsoft missteps, he says. It was just badly handled with time and money wasted, not to mention the bad publicity and the lost momentum.

These days Microsoft seems intent on hiring every top executive away from Yahoo until there is no Yahoo. The latest high-profile hire for Microsoft is former Yahoo search chief Qi Lu.

Ballmer says that Microsoft has no interest in buying all of Yahoo, but remains interested in discussing a deal for Yahoo’s search business. If such a deal goes down in 2009, it will have been one long, strange trip getting there.

2009: A Pivotal Year

The coming year will be a busy and crucial one for Microsoft. Windows and Internet Explorer still dominate their markets, but both took unprecedented market share hits in November. The pressure is on Microsoft in 2009 to compete more effectively against Apple, Google and Mozilla with the expected releases of Windows 7 and Internet Explorer 8.

The software giant needs to build anticipation for Windows 7 without allowing Vista to fade off into obscurity. No easy task. It must also chase Google in the cloud and speak up more about the timetable for that other massive money-maker Microsoft Office, both the Web-based and desktop versions. As of now, not much is known about Office 14 or Office Live.

Microsoft needs to do all this and more in 2009. And some better TV commercials wouldn’t hurt. But please, let Seinfeld stick to stand-up comedy.

This story, Microsoft’s ’08 Mistakes: The Software Giant’s Big Errors was originally published by CIO .

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