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Sent on Sunday to 'Executive Staff and Direct Reports; Distinguished Engineers', Bill Gates, Microsoft's Chief Software Architect, urged staff to assert the company's leadership position and take full advantage of the 'services wave.'

'This coming "services wave" will be very disruptive. We have competitors who will seize on these approaches and challenge us - still, the opportunity for us to lead is very clear,' he writes.

And he outlines Microsoft's plans thus: 'We will build our strategies around Internet services and we will provide a broad set of service APIs and use them in all of our key applications.'

What might also change is the way we buy and use Microsoft software and services in the future, with emphasis on Microsoft's ability to drive scale rapidly on broadly accessible Internet services. Gates wrote: 'Advertising has emerged as a powerful new means by which to directly and indirectly fund the creation and delivery of software and services along with subscriptions and license fees. Services designed to scale to tens or hundreds of millions will dramatically change the nature and cost of solutions deliverable to enterprises or small businesses.'

Microsoft has already started on that journey with the announcement of Windows Live and Microsoft Office Live which is supported with MSN adCenter. In short, contextual advertising will fund and drive rapid adoption of free versions of online services, which can be subscribed to for enhanced features.

What Microsoft appears to be doing is driving its client

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software online in the hope that its desktop dominance will elbow it more room to really take on the Internet service portals such as Google and Yahoo!. It's unlikely the former will be taken by surprise though, given the recent announcement that it will be working with OpenOffice.org on the free open-source office suite.

Gates attaches a memo from Ray Ozzie, CTO, which notes that the company has missed enough boats with Internet services. 'We must reflect upon what's going on around us, and reflect upon our strengths, weaknesses and industry leadership responsibilities, and respond. As much as ever, it's clear that if we fail to do so, our business as we know it is at risk,' he warns.

He writes that Microsoft was outdone by Google on search and by Adobe's PDF on the document format for the web. 'While we've led with great capabilities in Messenger & Communicator, it was Skype, not us, who made VoIP broadly popular and created a new category. We have long understood the importance of mobile messaging scenarios and have made significant investment in device software, yet only now are we surpassing the Blackberry,' he says.

Ozzie sees online advertising as an inevitable and significant source of revenues for software companies and doesn't want Microsoft left behind. 'Today's web is fundamentally a self-service environment,' he writes. 'Online advertising has emerged as a significant new means by which to directly and indirectly fund the creation and delivery of software and services. In some cases, it may be possible for one to obtain more revenue through the advertising model than through a traditional licensing model. Only in its earliest stages, no one yet knows the limits of what categories of hardware, software and services, in what markets, will ultimately be funded through this model. And no one yet knows how much of the world's online advertising revenues should or will flow to large software and service providers, medium sized or tail providers, or even users themselves.'

You can read the memos for yourself at Dave Winer's blog.