Microsoft is a major software company, while Google has great online apps. They only need to expand and make their sites more user-friendly, quick to load and improve the navigation bars. This way they could get a bit closer to Google.
I guess Microsoft realized the potential too late. They started realizing when Netscape was getting the lion share of the Browser pie. That got them started on battling Netscape. It seemed that all their concentration was on the browser wars but not on search engines and portals, Google and Yahoo came along, with first mover advantages. When Microsoft wanted to get onto the band wagon, Google and Yahoo proved to be too difficult to dislodge. I guess what Microsoft could do would be to integrate as much as possible their desktop applications to the web, but then they need to be very mindful of the anti trust laws.
If they open their advertiseing program to publishers it would help give them a better like-ing in the webmaster world.
Microsoft just needs to allocate more resources to it's online focuses, it is probably not profitable enough if they where to allocate their resources some where else
That is the problem, huge companies are less flexible, therefore they are less able to adapt to the current situation fast enough. But once they focus their might onto the search engine, they could be the one Google have to contend with.