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Microsoft is gearing up to take on rival Apple in the smartphone market.

The Wall Street Journal reported Monday that Microsoft is getting ready to launch an online marketplace akin to Apple's App Store. In August, Microsoft had started looking for people to head up the new application store. Microsoft is also readying a more sophisticated version of its mobile operating system called Windows Mobile 6.5, the Journal reported.

Smartphones are sophisticated mobile phones that offer users access to the Web and e-mail, as well as, provide phone calling and all kinds of other messaging options. This category of device is the hottest thing going in the mobile market and is seen as the biggest growth engine for mobile devices over the next few years.

Microsoft, which only makes the operating software for these devices, holds third place in terms of worldwide market share, according to research firm IDC. Symbian, which powers Nokia's smartphones, is by far the leader, followed by Research In Motion with its BlackBerry devices. Even though Apple seems to be the most talked about smartphone on the market these days, it's only in fifth place in terms of overall market share for 2008, IDC said.

But Apple is quickly gobbling up market share and has become a serious threat to Microsoft and every other company competing in the smartphone market. With the release of the iPhone 3G last summer, Apple has tripled its market share from 3 percent in 2007 to 9 percent in 2008, according to IDC. Meanwhile, Microsoft only grew from 11 percent market share in 2007 to 12.3 percent in 2008.

Microsoft is facing several challenges as it tries to catch Apple's growth rate. For one, the company's business model is based primarily on licensing software to hardware vendors. While this business model worked fine just a couple of years ago, it's difficult to justify now given that device makers can get free software from Symbian, Google Android, and Linux.

The second problem that Microsoft faces is that the company has been almost exclusively focused on business customers. Over the past year, smartphone users have gravitated toward more consumer applications. In addition, to their work e-mail, they want multimedia functionality and social-networking applications on their phones.

"Microsoft is in a really tough spot," said Ryan Reith, an analyst with IDC. "It has to change its value proposition. And a big part of that is refreshing its user interface and making the device more consumer-friendly."

Reith believes this is why it's critical for Microsoft to develop an application marketplace that can compete with Apple's App Store. The App Store went live last summer and offers thousands of applications for the iPhone and iPod Touch music player. The store has been very successful with users downloading thousands of free and fee-based applications.

Microsoft already has a developer community creating applications for Windows Mobile devices. But the problem is that many of these applications have been geared toward business users. And there is not a single destination that makes it easy for users to discover and download different applications.

"Clearly smartphones are not just for business users anymore," Reith said. "Microsoft needs to work with the developer community to get more consumer applications out there."

Microsoft's executives have gotten the message that consumer functionality is hot. And Andy Lees, head of Microsoft's mobile business unit, told the Journal that the company is about to put more emphasis on multimedia and other consumer functions like music and photos.

Microsoft is expected to unveil its new offerings next week at the Mobile World Congress trade show in Barcelona, Spain. Chief Executive Steve Ballmer will be delivering a keynote speech there on February 16. I will be there next week covering the news from the show, as will my CNET Reviews colleagues Bonnie Cha and Kent German.

But even with these enhancements, Microsoft has a tough road ahead of it. Competition in the smartphone market is increasing. And several competitors, including Android and RIM, are launching their own version of an application store.

On the handset and operating system side, new devices are coming to market that could provide stiff competition for Windows Mobile devices. For example, smartphone pioneer Palm is coming out with new mobile software and a device called Pre later this year. And even though critics have been writing the company's obituary for the last year, the new device, which was unveiled last month at the Consumer Electronics Show in Las Vegas, has been getting a lot of buzz.

But Microsoft thinks it has the right enhancements lined up to take on these competitors, especially Apple.

The Journal also reported that Microsoft is talking about a new synchronized data storage service called My Phone. This new service is supposed to make it easier for people to back up their mobile contacts, calendar appointments, photos and text messages, to a Web site. The service is similar to a service that Apple calls MobileMe. The biggest difference will be that Microsoft will offer My Phone for free whereas Apple charges $99 a year for MobileMe.

It's too soon to know how Microsoft's new software and application store will stack up against Apple's offering. But one thing is certain, Apple isn't sitting still either. And if Microsoft or any other competitors want to hasten Apple's rise in this market, they'll have to leap-frog Apple with something truly revolutionary.