Your explanation lays out Bill Gates strategy rather well (in 1984, he told Forbes magazine how he would build Windows to increase the functionality of the OS and take command of the interface), but fails to account for demand side externalities - the fact that, at least for office applications, the quality of the applications themselves is less important than who else has them. People use Word, for instance, because everybody else does - the fact that there may be other (perhaps better but not interoperable with Word) applications out there)

So, if Microsoft hadn't taken the dominant position, someone else would. In esatblishing markets, there is a role for a dominant proprietary player - who sets standards and handles interoperability for a while. As the market gets more established, innovation happens at different rates in each layer of functionality, and the competition between proprietary/integrated vs. open solutions is on.

For some excellent discussion of this, see Neal Stephenson's "In the beginning.....was the command line" at www.cryptonomicon.com, or Clayton Christensen's "Skate to where the money will be" from Harvard Business Review, November 2001.