I can see the seeds of Microsoft's failure in Ballmer's response to the iPhone question. He talks about how the device can "do email" and "do web". They were check off items. Apple didn't say "our device can do email" they said "you can get your mail wherever you are." They weren't the first to offer that
by far but they talked about the customer: the end user.
Ballmer also talked about his customer: the enterprise CIOs (and for the phones, the carriers, not the end users).
Apart from the money-losing Xbox division I am not sure Microsoft really has ever had an end user orientation. Not surprisingly, given Ballmer's background, they are a 20th century industrial concern, more like a car company than anything else. That served them very well when the field was young and the companies that were computerizing needed all the help they could get -- and so were willing to be dictated to.
By the way I also liked the buffoonery of saying that they have a "respectable position" in the "high end" music player business. In another appearance he touted their strength in the "hard-disk based music player space." It reminded me of Steve Jobs claiming that NeXT was dominant in the "business workstation space". Let's define a niche and fill it...backwards!
(Ironically Zune did have a number of interesting features (dare I say "innovations") but the customer base was too smart to care about specs. By focusing on gimmicks they ignored the hard work of making a product that people actually wanted to use.