So what is Microsoft to do? In most markets, if your competitor puts out a better product than you, you have only a couple of options: lower your price to make your product more attractive, or build a better product. Well, you can’t go lower than "free", and building a better browser than the competitors is *hard*, especially when you have the baggage of seven previous versions of Internet Explorer. But in this case, there’s actually a third option: take your competitor’s product and add value on top of it. That’s what Microsoft is doing with jQuery, and that’s what they should be doing with Firefox. They could put a custom skin on top of it, maybe throw in some add-ons to allow it to switch easily to IE7-mode in order to maintain backwards compatibility, integrate it strongly with Microsoft Live… who knows, but I’m sure they could come up with some cool ways to make the Microsoft version of Firefox a compelling choice.
Microsoft is in real danger of falling behind on several fronts right now. Internet Explorer is a mess; Open Office (and their widely-supported formats) are a threat to Microsoft Office; and Linux and Mac OS each have strengths (and weaknesses) that Windows doesn’t have. Instead of trying to compete so fiercely with open-source, why not try to leverage it to build better products?