I actually think this is a very positive development since it exposes that M$ knows that Linux has become good enough - so much so that it forces them to basically start giving away for free keys to their kingdom. As long as there was perception that Linux was not there yet M$ did not have to worry about it.
The downside of M$ giving away software is that they expect payback further down the line. Much like the "giving away" of IE and the illegal methods to exclude Netscape allowed them eventually extend their evil influence into the internet - just look at the number of ignorant online banking sites that mandate the use of IE. And billy boy said, with regards to software piracy in China, something along the lines of "we're happy as long as they're pirating M$ software, we'll get them eventually" - the implication being that let them get hooked on M$ crap, when China's economy matures and their enforcement of copyright infringement becomes more stringent those using unlicensed copies will eventually have to cough up. Reportedly (and naturally) the Chinese leadership weren't happy to hear that and prompted them to explore alternatives like funding the development of Linux.
The other shue to drop will be when they start giving away office and corporations start switching to open source on the front end
Not sure I follow your argument. If M$ starts giving away M$ Office how does that give incentive to corporations to switch to opensource (eg OOo)? FWIW the evidence so far is that the majority of organisations who make a big fuss of announcing that they're planning to switch to Linux do so in order to get a big discount from M$, and M$ obliges and then say it's another "win" for M$ over Linux - the discount given is taken from their marketing budget. The organisations who are serious about using Linux mostly just do so without making a big fuss out of it.
Open standards is the best way to break M$'s stranglehold. Draconian enforcement of copyright infringement would also help, as it would force people to take a good look at why they should pay good money for mediocre crap when they could be using something better, for free.