The disquiet within Microsoft at its failure to exploit the internet has been made clear through a leaked internal memo in which Bill Gates says the world's largest software company "is at risk" from more innovative competitors such as Google.

In a memo to senior staff, Microsoft's billionaire founder quoted Bill Ozzie, the internet guru recruited by Microsoft earlier this year to bulk up its web-based business.

"We knew search would be important, but through Google’s focus they’ve gained a tremendously strong position," the document said.

"While we’ve led with great capabilities in Messenger and Communicator, it was Skype, not us, who made [Voice over Internet Protocol] broadly popular and created a new category."

In the document, Mr Ozzie said Microsoft "must respond quickly and decisively ... It’s clear that if we fail to do so, our business as we know it is at risk."

Mr Gates also compared Microsoft's current position to two previous crisis points - the initial appearence of the internet, described as "the Internet Tidal Wave" in a 1995 memo he wrote, and a shift five years ago to internet-focused software development.

The latest leak is the most recent in a string of sources suggesting that despite Microsoft's public denials, it is seriously concerned that it could lose its leading position in the IT market.

In September, Steve Ballmer, Microsoft's chief executive, allegedly vowed to "kill" Google, according to documents presented in a legal hearing over Google’s hiring of a Microsoft employee.

According to sworn evidence from a former Microsoft engineer, Mr Ballmer said of the Google chief executive, Eric Schmidt: "I’m going to f****** bury that guy, I have done it before, and I will do it again ... I’m going to f****** kill Google."

After the release of the court documents, Mr Ballmer described the former Microsoft engineer's recollection as a "gross exaggeration".

However, there have been other signals that Mr Gates feels Microsoft must up its game. The internal memo revealed today was written shortly before the launch last week of Microsoft's next generation of web-based services - Windows Live and Office Live.

Analysts said the products, described by senior executives at the company as the "biggest announcement we have made in a decade", were a positive move. But it was widely felt that Microsoft had been pushed into the announcement, which was criticised for being short on detail, rather than leading what was hailed as a step change in the industry.

Microsoft "clearly gets where the focus of the competition needs to be," Tim O’Reilly, the publisher and software design guru, said on the day of the Live launch.

"There are going to be some fabulous new services. But whether they are built by Microsoft or by Yahoo or Google or Salesforce remains to be seen," he added.

Competitors who already provide web-based software services branded the move inevitable. Marc Benioff, the chief executive of Salesforce.com, a leading web-based software provider, said: "Bill Gates is still trying to prove Microsoft’s relevance in the age of the internet.

"The real innovators ... have all succeeded because Microsoft has let us down on innovation," he told Times Online.

Groups such as Salesforce.com have grow rapidly by providing business owners with internet-based applications for tracking customer relationships and managing back-office functions.

"It’s the Day of the Dead," Mr Benioff said. "Bill Gates and Ray Ozzie announced a series of 'internet-based software services' with 'Live' appended to some familiar names: Windows Live, Microsoft Office Live, Windows Live Messenger, and so on.

"The clear implication is that their current product line should be renamed with similar zeal: Windows Dead, Microsoft Office Dead, and Windows Live Messenger Dead."

However, Gillian Kent, managing director of MSN UK, Microsoft's British internet portal, said that it was "totally not the case" that Microsoft had been slow to spot the internet's significance.

Microsoft recently radically re-organised its business - slimming down its divisions from seven to three - in a move designed to make the group more nimble.

Read the Wall Street Journal's report of the Gates memo - free this week for Times Online readers - here.

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