Watson was appointed Everton manager in March 1997 for the remainder of the 1996–97 season following the resignation of Joe Royle, but reverted to his playing duties in June 1997 when Howard Kendall was appointed manager for the third and final time. Watson's first-team opportunities gradually faded, but he made one appearance for Everton during the 2000–01 season, before finally announcing his retirement as a player at the age of 39, and moving into management with Tranmere Rovers. His key objective at Tranmere was to regain their Division One status which had just been lost, but he failed to achieve that goal and was sacked after just one season at the helm. He later became a scout for Birmingham City before joining Wigan Athletic as their youth-team coach on 23 April 2008.