Microsoft has a long and illustrious history of operating system sales. The model has served the company well on the PC, but if it wants to make money in the phone market, it needs to start thinking like a consumer electronics company. That means selling Microsoft phones.

Microsoft revolutionized the operating system market back in the early 1980s. Indeed, Microsoft created the operating system market back in the early 1980s. Back then, when you bought a computer, it normally had its own special operating system that the vendor bundled (or even sold at extra cost).

Sometimes those operating systems were written by third parties and just rebranded and customized by the hardware vendor; other times they were written from the ground up by the manufacturer. But the idea of an operating system that you could just go out and buy and slap onto any machine was a novel one.

With the advent of MS-DOS and the dawn of the IBM PC clone market, this changed. One operating system could work on machines from IBM, Compaq, Dell, Hewlett-Packard, and every other clone maker. Microsoft's great innovation was to sell the operating system as a valuable program in its own right, and in so doing the software maker all but eliminated the differences between different vendors' systems. The hardware became an almost irrelevant commodity—the only thing that mattered was whether it could run DOS, and later, Windows.

Many other companies stuck with the old hardware plus custom operating system package. Most fell by the wayside; the Amigas and Ataris of this world went out of business, unable to withstand the onslaught of cheap commoditized hardware with a separate operating system.

The custom operating system model lives on in the world of mainframes and, to some extent, commercial UNIXes (though Sun tried to break Solaris out of this niche), but in the consumer space there's only one company still standing: Apple. As the Mac OS X license agreement stipulates, Mac OS X is only allowed on Apple-branded hardware.

Commodity hardware, or vertical integration?

Microsoft is a firm believer in the model of commoditized hardware with a third party, hardware agnostic operating system (just as long as the operating system is bought from Microsoft, of course), and it's true that the model has worked very well for the company over the years; 175 million Windows 7 licenses is nothing to be sniffed at.

But this model hasn't always worked out so well for Redmond's other post-PC efforts. The company tried a similar tack with its ineffective attempts to get a toehold in the portable music player market. The approach here was a little different, but the aims were broadly the same: Microsoft wanted to sell its own scheme for DRM-protected audio, PlaysForSure, to a range of hardware vendors and online stores. In this way, Microsoft would take a cut both from each hardware device sold (as vendors had to license the ability to play back PlaysForSure-protected files), and from each PlaysForSure-protected song sold.

It didn't work out very well; the value of the iPod was that it offered a unified hardware, firmware, and store experience that all worked well together, and the piecemeal PlaysForSure system could never replicate this. Belatedly the software giant recognized this and produced the Zune and later the Zune HD. Both of these offered the end-to-end integration of the iPod—hardware, device interface, PC software, and online store—something that PlaysForSure had never achieved.

This move aggravated the PlaysForSure partners—Microsoft was now competing with them head on, with an integrated offering that wasn't even PlaysForSure compatible, but gave Microsoft a much better product. The problem was that it was just too late; the iPod was deeply entrenched, and for reasons best known to Redmond, the company decided to only sell the Zune HD in the US—that is to say, the market where Apple's presence was strongest, and the market in which Zune HD was least likely to make an impact.

The first-generation Zunes were not entirely inspiring, as they were rush jobs based on existing Toshiba MP3 players. But the Zune HD was an all-new design, and it was a high-quality, attractive, well-designed piece of hardware. If nothing else, it demonstrated that Redmond can, in fact, produce decent consumer electronics devices, with a look that appeals, an interface that works well, and attractive PC software.

The Xbox 360, for all its hardware problems, makes a similar case. The red ring of death flaws certainly detract from the Xbox 360 as a piece of design. But ultimately, it's a well-liked, well-designed appliance, and it shows off the benefits of vertical integration. As with the Zune HD, the Xbox 360 shows that Microsoft can build a tightly integrated combination of hardware, software, and online services. Though it may not ever make much money, for various reasons, it nonetheless serves to demonstrate that Redmond can do the consumer electronics thing properly.

Still, there are other areas where Redmond is persisting with its licensed operating system model. Phones are, of course, the big one. Windows Mobile is sold to OEMs to stick on the devices they build, and it's up to the manufacturers to produce elegant, attractive hardware. Windows Mobile is also highly customizable, and many handset manufacturers exploit this to add their own custom front-ends to make up for various flaws in the standard Windows Mobile user interface.

Microsoft has had a little success with this model, but that success has been waning. The introduction of the iPhone was the turning point; it offered the same end-to-end integration that the iPod had, and it brought it to the phone. A strong user interface, compelling industrial design, integration with an online music store, and an easy-to-use application store, all of which showed the value of vertical integration in a smartphone. Consumers liked what they saw.