San Francisco (CNN) -- Remember when Hotmail was hot?
Dick Craddock, who manages the group responsible for Microsoft's Web-based e-mail service, can still recall the day of celebration in 2004 when the Hotmail division had just posted a stunning financial quarter. Craddock, along with other Microsoft execs and developers, convened to relish in the victory.
The triumph was short-lived because soon after, Google launched a competing Webmail service called Gmail, and like in the short time it takes Google to call up a search query, Hotmail instantly looked dated.
Gmail gave users a gigabyte of file storage for free, while Hotmail presented a few megabytes and required users to pay for more. Gmail was fast, spam-free and let people attach files several times larger than that of Hotmail. And Gmail only showed small text advertisements, while Hotmail's pages were covered in ads, which is why the site was able to exceed financial goals during that quarter in 2004.
After evaluating the options, "it wasn't hard to pick Gmail; it just wasn't hard," Craddock said in an interview on Monday. "It was a great learning experience about what really matters."
After a few years of lightning-fast growth for Gmail following its launch and at the expense of Hotmail, Microsoft reversed course. "We set out to really invest in Hotmail and really, to rebuild it from the ground up," said Chris Jones, a vice president who oversees several of Microsoft's Internet applications.
The Hotmail team eventually got the green light to dial down the ads while increasing development on features made available to nonpaying users.
Making money directly from Hotmail "is not the most important thing for us to optimize for," Jones said in an interview. "The lesson from some of the most successful Internet companies is they build something valuable and durable."
That is a notion, Jones said, that Microsoft learned from a rival, Google, and from a partner, Facebook. It is not conventional wisdom for Microsoft, which makes most of its revenue from software sold for hundreds of dollars a package in brick-and-mortar stores.
The people who write the history of technology tend to take shortcuts. Accounts of Friendster's, Myspace's and AOL's fall from grace are often summed up as: they just stopped being cool. In fact, they were less reliable and less capable than their scrappier competition. The same was true of Hotmail, but Microsoft is fighting back.
The Redmond, Washington, company gathered reporters together here at an art gallery in San Francisco on Monday to show PowerPoint slides that demonstrate how Hotmail is just as feature-rich, if not more so, than Gmail. Microsoft is putting muscle behind features such as granular controls over daily-deal messages and newsletters, automatic filtering and various new functions that launch in the next few weeks.
These changes are already being touted to current users of Microsoft's e-mail service in a banner that urges them to look out for "the new Hotmail." It's a part of a campaign to improve the brand's image, so that people aren't embarrassed to say their e-mail address ends in @hotmail.com.
"For a lot of folks, Hotmail was their first Webmail address," Jones said. "Now the challenge that we're fighting, frankly, is mostly one of perception."
Hotmail still holds the highest market share worldwide, followed by Yahoo Mail and then Gmail, according to research firm ComScore. In the U.S., Yahoo is the leader, and this year, Gmail surpassed Hotmail and maintains faster growth, ComScore says.
The options for free e-mail are poised to increase, with other tech giants making bids for the space that follows your name and the "at" symbol.
Apple will discuss its iCloud service at a news conference on Tuesday, which is the first time the company will give out free e-mail access, in this case, an @me.com address, to customers. Facebook recently gave each of its 800 million users an @facebook.com alias, but few people seem eager to use them.
Microsoft is hoping to regain some cool in the hopes of hanging onto the friends it still has -- and to make new ones, before the new kids take over the block.