One outside expert in a unique position to assess Microsoft's prospects, following the withdrawal of its Yahoo bid, is Michael Cusumano, a professor at MIT's Sloan School of Management who has studied the company for years and written books on Microsoft and the software industry. Here are excerpts from a phone interview I had with him today.

Q: What are Microsoft's options at this point, if it wants to build the scale -- the volume of users -- that it needs to compete with Google in the advertising market?

Cusumano: Well, most Web entry is through search, and they've got to come up with a better search algorithm. If they can't do that, I think they just need to maybe leverage their applications. If they had a site offering Office over the Web, people would certainly go to that. In other words, other services, as compared to traditional search. Office Live, other applications, host files -- some of the things they've been doing, but that's about all I can think of. [Microsoft offers file-sharing and collaboration online but doesn't yet offer full-fledged, Web-based Office document creation and editing.]

Q: Are there other prospective acquisitions out there? MySpace, Facebook ...

Cusumano: Well, there's always new ones coming up. I guess that's another alternative. There's lots of startups in the social networking space. ... Ninety percent of those, maybe even 95 percent of those will collapse, never get anywhere. It's possible they could try to roll up some of those startups and try to make something of them. ... A lot of this is just a waste of money. They're trying to figure out, how could they waste more money. That's why, I had suggested a while back (they should) buy other software companies. The software industry is generally depressed. There's lots of product companies out there, even video-game companies. There's still a lot of money in the software business, if you can buy these assets cheaply.

I think they can still get some advertising from some sites where they deliver their software as a Web service. Lots of people still use Hotmail, and they can gradually try to build that up. It's possible they could have an aggressive campaign to get advertisers, but the problem with that is it's the network effects of these sites -- advertisers want to advertise where the most eyeballs are going, so there's an increasing return to being the biggest site, and it's really hard to dislodge that. I guess that's the logic of buying Yahoo, but I personally thought it was a dumb idea to spend that much money for Yahoo. It's an old-style Internet asset in decline, and they'd have to buy it at a premium. The action is in the social networking sites, it's not in these traditional channels that you have on Yahoo. If they could buy it at the market price, I'd say, sure, fine. You're just, again, buying eyeballs. ... Which is why I'm actually glad they withdrew their offer. I think Yahoo's got no future now. The stock is going to absolutely collapse, and maybe Microsoft will come back in and buy it for a more reasonable price. I think that's another option for them.

But I don't think Microsoft's future is really in advertising revenues on the Web, competing head-to-head with a Google-style firm. I think its strength is really as a software-product company, as a platform company, and it's moved into applications. It could have gone after a company like SAP. Could have bought a whole bunch of companies that Oracle bought in the last year. There still are some companies out there.

Q: Which of Oracle's acquisitions do you think might have fit most appropriately with Microsoft?

Cusumano: Could have bought BEA Systems. Just thinking of itself as a platform company, rather than a Windows company. SAP also bought Business Objects. Could have gone after Business Objects. (Microsoft) has its own analytics, but not as good as Business Objects, for business intelligence. These were pretty strong product companies.

Q: Do you think Microsoft has taken its eye off the software ball, as it were, in going after the advertising market?

Cusumano: I think so. I think they believe the future of software revenues is going to be mostly advertising. I don't actually see that in my own research. We see some companies doing that. But we see lots of variety in pricing models these days. So the traditional upfront license fee is under tremendous pressure, that is true, but different types of software-as-a-service programs, and subscription-type payments, those are becoming very common. Advertising is just a very tiny part of the funding for software companies. Now, of course, the Internet service companies like Google are a little bit different. Google and Yahoo. I don't see why Microsoft needs to try to play in that game. There's not going to be many successful companies there. I think Google's got it.

There are lots of little companies working on new types of search -- there are new ways of using search in different applications. Again, if Microsoft rolled up some of those companies, it might come up with something. They could buy a huge number of those little software companies, working on search technology, social-networking technology, video-game technology. For the amount of money they would spend on Yahoo, $40 billion, they could be the most powerful R&D funder in the world. There's a lot that they could do with that money, and wasting it on Yahoo -- which is barely worth what its pre-Microsoft-offer value was -- is not the way to go.

Q: What's your assessment of this moment in Microsoft's history? Where is the company right now?

Cusumano: I think the company is doing pretty well. The Windows desktop, Windows Server and the Office businesses are relatively strong, and they're very profitable. They just escaped wasting $40 billion on an old asset that's not worth very much. I think this is a new opportunity for Microsoft to think more carefully about how they're going to spend their money in the future, and not just act out of desperation. And I see the Yahoo acquisition as a desperate move. They just couldn't think of anything better to do. They've tried and tried, and that was what they finally came up with, but I think they need to think differently.

Q: If the company is to think differently, is Steve Ballmer the right person to lead that?

Cusumano: I'm happy with Ballmer where he is, because I think it's too disruptive to bring in an outside person to lead a company. I think they can continue to seed the company with people that think differently. Ray Ozzie is one of them, and I think they can keep going after some different people, as well, and younger people. But I think Steve is smart enough and strategic enough to take different advice. ... I think he's OK, but they need more people advising them and telling them different things. I don't know that they have that kind of advice in the company, or people in the company right now. It's not just Ballmer's fault -- it's the whole top cadre of executives there.