2 things I think they need to do:
1) Make Silverlight *the* platform for app dev on Windows Phones
2) Leverage Windows Live (which is soon to include the sync platform previously known as Live Mesh)

1) Embed Silverlight in as Jamie noted
2) XBox Live integration (be able to play games purchased through arcade on your phone)
3) Windows 7 includes Remote Access through Media Player and this should be extended to Windows Mobile so that you can play music (including Zune) and video (including Zune, Divx, etc), Media Center DVR'd material, live TV through MCE seamlessly through a Windows Live account. Basically make my media available to me easily!
4) Integrated calendar for both exchange as well as other email accounts (Gmail, Live, etc.)

MS has an infrastructure that Google and Apple can't compete with in terms of market penetration with games machines and computers. They must use that to their advantage by allowing people to access their content.
They do that and I'll drop my Droid (its OK but certainly could be better).

1. Bring Zune Interface to Windows Mobile 7
2. Integrate Xbox, Xbox Live
and more..

I am sure Microsoft has the knowledge and best talents to make it better.

Focus on simplifying all experiences built into the phone. Dead easy to use aps, dead easy to browse the web, etc. But protect the phone experience above all else. The hardware and the OS need to be fast. Nothing more aggravating than being unable to answer the phone because it's seized up trying to respond.

Microsoft needs a new mobile OS. Not more window dressing on the old Windows Mobile 6.x, which is now dead in the water.

Microsoft needs to sever compatibility to previous operating systems, and make it totally new, as keeping interface compatibility with older applications is part of the problem.

Microsoft needs to use an open-source base to its operating systems. The day after Steve Ballmer is sacked is the day that Microsoft will embrace open-source. First will come a Microsoft Webkit browser. Then it needs an open-source base to its mobile OS, as Microsoft was incapable of dealing with the proprietary nature of Windows Mobile and incapable of updating it in a reasonable time frame. It loses money on Windows Mobile anyway, so it may as well open-source to attract developers and stay in the game.

But all indications are that Microsoft is still on the wrong course with mobile, so I think all its mobile ambitions (including the aging Windows Mobile) will collapse later in 2010.

Add Live Meeting, web conferencing feature
Incorporate some of the ZUNE HD's features into the product.
Make it DNLA compliant
...

1) wm7 sdk for visual studio express. not all developers can afford full version of vstudio.

2) flash and silverlight and youtube is must.

i have been a user of windows mobile for nearly a decade, and i may remain so, but recent events have put that into doubt.
i have recently upgraded my phone to an htc touch hd, their flagship 6 months ago, expecting it to be on the upgrade list when winmo 6.5 was released. it is not on this list. manufacturer, network provider and software developer all blame each other. the bottom line is windows mobile users want to be able to upgrade their software in the same way we upgrade our computers. i have been running win 7 r/c on 3 laptops with great success. i would like to use upto date software on my phone, but now im stuck for anoth 18 months with software that is out-of-date because it cannot be upgraded. i am not a happy windows mobile customer right now, and unless something changes at development, it will change in my buying trend.

* Making Internet Explorer for WinMo nicer
* Support gestures in more situations
* Making the difference between mobile applications and Windows applications less noticable.
* Allowing us to use 'Desktop applications' that runs on Microsoft Server (as sample the Azure Platform) using the Web as communication platform)

The IPhone succeeded because it 'shrunk' the Mac mini experience into a phone. Windows 7 mobile must shrink the netbook experience into a phone. Must be smooth, lightweight, frustration fee.
1) Include a killer version of Office Mobile for free
2) Provide free space on Azure, for data. Allow two way downloads. Maybe even your own portal such as WHS.
3) Games. Start porting the most successful Xbox franchises, such as Halo.
Give free games and/or additional content to Xbox Live Gold members. Support XNA and tap into the developer community.
4) Start writing some software. Mobile is way behind on apps. Microsoft must do what it does best. Find great apps, such as googole gps, and copy/improve on them. Encourage 3rd party dev, but don't rely on them. For them to come around they need confidence in the future.
5) Include Twitter, Facebook, Bing, GPS and Kindle apps right out of the box.
6) Media, first class music and video with a download service.
7) Security, don’t forget it. The last thing users want to worry about on a phone.

A few suggestions:

*get rid of the hexfield start menu, and make it a default 3, 4, or 5 icon-wide screen (user preference)
*make the start menu fully editable, so I can drag around my icons wherever I want.
*Zune interface for media playback
*support for mkv, flac, ogg, avi, mpg, divx, xvid, and Digital Copy wmv on the device in addition to mp4, mp3, wma, wmv
*When I think start menu, I want to press start, and get a list of all apps, swipe right once, get games, twice, get my news apps, etc. When on the games page, I can scroll down a few swipes to find my desired game. It's different from the iPhone, which does not really organize apps like this, but introduces some needed organization to the Start menu from 6.5
*swipe left once to get to the Office Mobile apps
*give 4 persistent apps at the bottom while in the menus- a quicklaunch area, with the middle button being the Start Button.
*make the phone's default apps when you first turn on: Bing Maps, Youtube, Stocks, Calendar, Contacts, WinLive Messenger, Office Mobile, IE Mobile, Phone, MyPhone, Solitaire, Freecell, Hexic, Sudoku, Calculator, Facebook, Twitter, MS Reader for e-books, Zune and Zune Marketplace.
*make the address book as easy as the HTC version - store all my conversations with a contact there for easy reference, and make it easy to 'map to contact's house' with a single click, call, e-mail, and text with a single click. Also integrate a person's facebook profile to see 'status updates' and also have the option to 'fill in information from facebook' for address, birthday, etc. if it's on FB.
*keep churning out quality first and third-party apps for the WinMobile platform. That's the battleground - choice of apps.
*Look at HTC's skinning for the WinMobile 6.5 devices they release, and adapt some of those ideas for use in WM7, along with Apple and Android. Make sure that the interface is tight, integrated, smooth, and has NO LEGACY screens whatsoever. Everything has to feel logically put together from the user perspective, not the R&D's perspective.
*Make all OS updates a strictly over the air item, that is pushed directly to the user. The carrier cannot and must not dictate whether we as consumers can update our OS. That doesn't work for Windows 7, and it should not work for our phones either.

Save me money.
While I agree that impressing consumers might end up selling more phones, everyone knows that's a high risk R&D strategy. Apple does it well, but it doesn't often work out well. While it clearly has to catch up to and maybe beat iPhone UI features, what if a Windows Phone could help save money somehow? It's just a thought and has its downsides, like targetting a demographic that inheritly spends less money.
Seemless switching from cell phone to VOIP to save minutes. Metering data plan usage and obviously seemless switching from 3G to WiFi when possible. A network of WiFi, like Microsoft and Google both did in airports this holiday season, to move more data transfer off of 3G. Bypass SMS and use data instead by adding some sort of smart redirection if my cell phone plan has a data plan (because SMS still costs a stupid amount of $).
There are lots of ideas.
What if you could see a snazzy Windows Phone ad showing off multitouch, AGPS, proximity and others sensors. Then it ended with 'Did we mention yet that it can save you $100 a year?'

I have owned a Blackjack II for two years and besides the phone being slow Samsung has yet developed drivers that will work with Win7. Never never never will I own a MS Windows based or a Samsung phone again.

Windows Mobile 7 should take a lesson from the company that started this whole app thing- Palm. Make the sdk free, and people will develop apps for you. Long before Apple's move into this arena, Palm had a dedicated community of apps developers and not one but several "app stores" where some apps were available free, most were available for free trial, and some were actually useful...

Microsoft should focus on the kernel and system services and partner with another company such as HTC for the user interface. HTC knows the platform and did a spectacular job with the HD2 even with Windows Mobile 6.5 as its base OS. It's better to use their expertise rather than try to play catch-up this late in the game.

One of the mistakes that these comments make is that they describe how Microsoft could make their future product competitive with Apple and Google products that are in the market today. The problem is that by the time Windows Mobile 7 products are in our hands we'll also have iPhone 4.0 and Android 3.0

And even if Microsoft met the capabilities of those platforms they'd still not have a world beating product -- the key for them is to actually surpass Apple and Google -- they have to be 500% better to break out of the downward spiral they are in.

The first bit of work is to take the set of advantages which Apple and Google are wielding and make them common (everyone has them). This includes a robust third party applications market (where developers make money) and a solid cloud strategy for data and services.

But the more important work is to reinvent the input, output or form factor of the device. Augmented reality is one interesting direction, but there are a dozen ideas like this one that need to be pursued. The "jaw dropping" which Nicholas asks for in this article has to come from some critical re-envisioning of the mobile experience.

We know that processor power is increasing, battery life is improving, local storage is getting larger, and network speed is accelerating. What else can you give us? Can Microsoft create a more seamless interaction between mobile and computing platforms? Can they give us a display option that includes picoprojection in a practical format? Voice control that actually works (although Google's voice search is getting darn good)? A better model for syncing with a wide variety of third party hardware -- alternate keyboards, screens, sensor networks...

Microsoft has always been better at copying innovation than introducing innovation themselves. But in my opinion to get back into the mobile game (and in the long run computing) they absolutely have to become innovation leaders. I am not sure they can do that from the center of their empire in Redmond. Do they even know that their empire is collapsing? Or like the Romans are they so isolated in their world that they are completely out of touch with why they are failing?

I agree with everyone here about the additional features. As a mobile device developer below are my thoughts.

Silverlight (or full fletched WPF) needs to be the developer platform. I think this is a no brainer and it's the only logical direction, so I expect this will certainly happen. Other frameworks like XNA support would be great as well.

Performant and fluent (touch) user interface over features or any other aspect of the phone OS is a must. This is where I think Microsoft is losing the battle with Mobile. I've been using many WinMo devices for close to a decade and almost nothing on my WinMo device is as fluent as I think it should. There is a constant presence of what I can only describe as "jitter".

Give me convention over configuration and a well thought out set of feature rich controls! This is by far my number one request! My nightmare is a frenzy of Silverlight application in Windows Mobile 7 all working inconsistently. This is where Apple gets it and Microsoft trails. Being an iPhone developer I can tell you I get most of the fluent user experience tidbits for free with well thought out set of controls. Also being a WPF developer I can tell you that you get almost none of the extra user experience flares for free. As a matter of fact you have to invest in what Microsoft calls their "Designer Tool", Expression Blend for the extras. (granted you can do it all in notepad with xaml if you had to, for all three developers out there who can manage that while not being distracted by focusing on your application logic). Even if you were to invest in Expression Blend the learning curve is steep and I only know a few developer/designers who can use it to create well formed interfaces.

Also do not forget about the small perceived performance aspects. Example: Apple lets you include a default image in your iPhone app that is meant to display your initial screen's key elements and background. This is then shown in a matter of milliseconds while your application takes a second to load. Your app is no faster ready to use, but that perceived performance gives the user a fluent feel. The cocoa touch framework is full of these nifty features.

A light, fast, speedy interface with apps that have apps.

I learned my lesson. I will not use Microsoft - I will support competition, and support choice with my money. I have Android now, and I'm very happy with it. If I was going to choose an evil OS, then I would go for Apple.

If Microsoft goes down to a 25% market share in desktop and mobile, then I might possibly consider them again - but for too long they have abused their power and screwed people out of a good competitive market by fixing it.

There are good reasons that the EU are on Microsoft's case - and it's a shame they can't go further.

Improved touch.
Friendlier interface. As said before zune like.

INTERGRATE ZUNE SOFTWARE A zune phone would be great.

Continued support and development of the marketplace.

Microsoft is so far out of touch with reality I can't imagine them coming up with anything remotely interesting to users. The only thing keeping them in business is inertia.

If I were them and wanted to be in the mobile OS business, I'd start another development company. Finance them heavily, give them the Windows mobile source on the off chance there's anything useful in it, but otherwise just let them go on and create/market a mobile OS and infrastructure. License it to a hardware company who's got the balls to release YASP (Yet Another SmartPhone). Let the cash roll in.

I agree Jiles that Microsoft needs to develope a new OS for mobiles, not just upgrade the old one.