Microsoft’s failure to close the Yahoo deal, despite all kinds of loud talk and machinations, makes the Beast of Redmond look increasingly weaker. They may still pull it off, but even then the question is why do they need Yahoo so badly? The answer is that their dramatic failure with Vista took away their normal playbook.

This article in ArsTechnica is a good summary of current state of Vista. The part that jumps out is “Only 8 percent of developers are targeting Windows Vista”. That is less than the 13% targeting Linux. 49% are sticking with XP. Microsoft’s future depends on their developer ecosystem.

Microsoft new release adoption has always had that “resistance is futile” sense of inevitability, but this time customers are saying, “no thanks”. It no longer feels inevitable and XP looks just fine as a stop-gap. Cloud computing feels more inevitable. The browser is all that matters, maybe Silverlight, Gears and other ways to tie the PC to the cloud. So Firefox goes from strength to strength, Apple is on a roll and Google Apps get taken seriously.

Mozilla, Apple and Google all executed brilliantly, but they would have had a much harder time if Vista had been on track.

Vista has some cool stuff under the hood. But that’s like saying telling people your car has a revolutionary new carburetor when the engine keeps stalling and the back wheel just fell off.

Specifically, Vista has all the network stuff that Ray Ozzie needs to make his P2P vision (re-drafted as Mesh) into a reality. Vista adoption would also drive IPv6 and that enables P2P at a totally different level. P2P matters because it puts PC horsepower back as the driver and that of course makes the OS the driver again. P2P search for example could disrupt Google. P2P video could disrupt YouTube.

But those are all pipe-dreams if Vista stumbles and falls coming out the gate. And Vista seems to stumble and fall all the time. Back in November 2007, financial analysts were saying MSFT stock would recover when SP1 hits the market. But then in July we get lovely stories like this one. When you need to download 56mb and re-boot to get a few more words into a spell-check dictionary, entropy has reached a new level.

Thousands of firms are dependent on Vista success. Everybody gets to sell upgrades when a new release becomes essential. The level of skepticism in this Windows ecosystem has now reached the level where they are increasingly looking at alternatives, whether they are cloud based or Apple or Linux. if Microsoft loses the confidence of this ecosystem, they have a serious problem.

Without the massive leverage from the OS, Microsoft has to play catch-up on a field that is tilted in the wrong direction. That must be a very uncomfortable feeling and a new one for them. Combining # 2 and # 3 in search is not by itself a smart play. It does not do anything to grow the search volume or disrupt the # 1.

Most of the commentary has been about Yahoo’s problems. Microsoft’s Vista problems might be worse. Looking at the 6 month stock chart for Microsoft vs Yahoo vs NASDAQ implies that investors see it this way. YHOO is actually a tad above NASDAQ and MSFT is way below. 6 months is an eon to the funds that make the call on this.

Yahoo shareholders are being asked to accept a mix of cash and Microsoft stock. How comfortable should they be that Microsoft really has the Vista problem licked? If they have big doubts on that score they might be better sticking with an independent Yahoo.