Having gone up against the iPod with Microsoft’s (MSFT) MP3 player and failed to make much of a dent in Apple’s (AAPL) dominant share of the portable digital music market, Gates seems to be conceding the field for all-in-one devices to the iPhone.

Thompson Financial reports today that in an interview with a German newspaper, Frankfurter Allgemeine Zeitung, Microsoft’s chairman said he did not intend to make a combination cell phone/music player.

“No, we won’t do that. In the sector of such smartphones, we are purely concentrating on the software with our programme Windows Mobile.” (link)

That’s a strategy that will put Microsoft in competition more with Google’s Open Handset Alliance than with Apple’s iPhone.Of course, licensing high-margin operating systems and application software, and letting others duke it out in the cut-throat hardware markets, is how Microsoft made its first billions.