They also clearly missed the internet revolution, but managed to recover. Big companies have trouble adapting to new paradigms, but it's not impossible for them to do it, especially when they have so many resources at their disposal.
A similar memo would have done the most good in 2005, when it was becoming clear that we'd soon all have access to pretty decent wireless networks and high performance pocket computers, but also clear that WinCE and the PocketPC were lousy ways to take advantage of those facts.
I agree that trying to remake the PC space in the PDA and phone worlds was a strategic blunder for Microsoft. OEMs competing to build low-margin devices for a common OS worked for Google because they could afford to give Android away for free and the carriers and handset makers were terrified of Apple.
On hardware, Microsoft had a model to follow: XBox. Imagine if they'd built an "XPhone" in 2005 instead of playing me-too to Apple with the Zune.