CARLSBAD, Calif. -- Walt Mossberg asked Steve Ballmer a question that a lot of Microsoft watchers have been thinking about lately: Why is the company manufacturing hardware like the Zune and the new Surface computing table, after insisting for years that it made software and left hardware to partners?

Ballmer said "modern consumer electronics" is one of the new "muscles" the company is trying to build, along with digital advertising. He also said people shouldn't write off Microsoft after seeing only its initial forays:

"We're trying to build these two new muscles, one in advertising and one in modern consumer electronics and we're going to keep coming and coming and coming just as we did in enterprise and just as we did in phase one."

Ballmer said the company will pick and choose where it builds hardware in businesses such as media players that are becoming largely software and services businesses. "How much hardware we have to offer is always variable," he said, adding:

"If we're not willing to grow and adapt and build up new business muscle in addition to new technology muscle ,we won't succeed."

Microsoft doesn't plan to build its own mobile phones, however, saying "No, I don't think it will make sense for us to do a phone."

Ballmer said that while RIM and Apple may build "nice smaller positions," he's more interested in the bigger opportunity presented by the overall phone market, where 1.2 billion devices a year are sold.

The broader market is also where Microsoft is getting traction, selling "tens of millions" of copies a year of its mobile software platform to phone manufacturers.

"We would love to have a high share of phones," he said.

Mossberg also asked why Microsoft continues to lose search market share to Google after all its effort.

Ballmer clarified that the company hasn't lost share as much as "we've wallowed around the same spot."

As for the lag, Ballmer said Microsoft had to launch its own search product, enter the market and get experience:

"I can say we're in the game now."

They didn't get specific about the aQuantive acquisition, but Ballmer explained how Microsoft sees all media being delivered via networks within a few years. Much of the software used by consumers will also be ad-funded, he said, in a particularly striking comment.

Microsoft needs to be in the platform layer that's delivering ad-supported services. It needs to be a player in the portal layer, where Web search is done, and it needs to partner with publishers providing the content.

Ballmer was reluctant to use the word "Google" and instead referred to it as "the market leader, because the market might change. With patience and determination and hard work, hopefully it will change sooner than later."

But he did mention Google by name later, around the time that he brought up antitrust concerns about one company dominating digital advertising. He also acknowledged the irony, but didn't mention that Microsoft's complaints about Google's DoubleClick merger are getting traction with an FTC review, which was confirmed Tuesday.

"I think it's important in fact that there be good competition. I've gotten that line thrown at me. I'll throw it back at the market leader here."

Mossberg also pointed out that Microsoft hopes to sell a million Zunes by June, while Apple is selling up to 20 million iPods per quarter. Will Microsoft stick with the Zune?

Ballmer's reply:

"Sure, we don't drop things. There's a very short list of things we have started that we haven't continued. ... We're very committed to Zune."

Ballmer also acknowledged that the Zune hasn't blown away techies. He said the company weighed whether to wait to develop a spectacular device, or get into the market "with a product that's good but not revolutionary compared to Apple." It opted for the latter, but Ballmer told Mossberg to stay tuned.

"We'll have a lineup this Christmas that's more exciting."