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Apple + HP = iPod Forever

By Alex Salkever As expected, Apple's (AAPL) iPod music player dominated the spotlight at the MacWorld San Francisco Expo last week. CEO Steve Jobs unveiled a smaller, lighter, and slightly less expensive version of the wildly popular digital-music playback and storage device (see BW Online, 7/7/04, "A maxiPrice for Apple's miniPod"). He also trotted out impressive stats showing that iPods are getting about 55% of the gross revenues from sales of all digital-music players. Few anticipated, though, that the iPod would also steal the limelight at the much larger and broader Consumer Electronics Show (CES) in Las Vegas.

Jobs managed to accomplish this with an announcement that Apple would start shipping Hewlett-Packard-branded iPods at some point in the summer of 2004. Equally important, HP CEO Carly Fiorina said the No. 2 PC maker would install Apple's iTunes Music Store software and put the shop's icon on the home screen of HP's (HPQ) consumer machines.

A SLAP AT MICROSOFT. This surprise was the talk of CES, the biggest consumer-electronics expo in the U.S. "What this announcement says is for the first time one of the biggest manufacturers of Windows-based PCs is adopting as a standard an Apple platform. If I were an Apple shareholder, I'd be as happy as a kid let out early from school," says digital-media analyst Phil Leigh.

The deal stipulates that Apple won't co-brand iPods for any other PC company. But Apple will gain powerful distribution through HP's extensive retail network, a development that likely will fuel a new wave of iPod purchases and a steady stream of people buying music through iTunes Music Store.

It's also a rebuke to Microsoft (MSFT) from a particularly important customer. Redmond is eagerly promoting its own Windows-based audio-file standard (Windows Media Audio, or WMA) and digital-rights-management schemes for music downloads. A host of other groups are pushing their own formats, including an upcoming offering from music and consumer-electronics giant Sony (SNE). Apple chose a format known as Advanced Audio Coding, and it's teamed with an antipiracy scheme dubbed FairPlay. But Apple has set the DRM so that AAC-encoded tunes downloaded from iTunes Music Store won't play on any other devices.

"PRETTY MUCH GOLDEN." At the moment, Apple has over 70% of the market for the digital-music downloads, so the only real competition is between Jobs and Bill Gates. And Jobs is winning: The HP deal underscores that he's the go-to guy for the music industry.

"He was smart enough to go do something that was beneficial to the music industry in creating a paid environment that protects their interests. He's pretty much golden in terms of getting deals with the labels," says Tim Bajarin, CEO of consultancy Creative Strategies. That Jobs could become the most powerful guy in digital music from a platform with a mere 5% or less of total market share is like Houdini pulling a Hummer out of his hat.

Step back, though, and the strength of Jobs's position becomes a bit less clear. Apple has decided to keep a close hold on the hardware by making the iTunes store compatible only with iPod players and Apple's audio-coding format. You can't import iTunes-formatted songs to a Dell (DELL) Digital Jukebox or any other player not made by Apple.

DEJA VU? Apple's tactic differs from the longstanding Microsoft strategy of licensing its software to work on any hardware, which started in operating systems and continues in the world of digital music. Microsoft has licensed its WMA digital-audio format to dozens of companies, and it's compatible with over 500 different types of digital players. And WMA files work on desktop software jukeboxes by MusicMatch, Roxio (ROXI), Yahoo! (YHOO), and Real (REAL).

It all sounds a lot like the circumstances under which Apple lost its market dominance in the personal-computer industry to a host of hardware makers sporting code by Bill's boys. This leads to a few questions:

Apple is the force majeure of music right now, but has it chosen to reboot an already discredited strategy by refusing to let other music standards play on iPods, and not letting iTunes songs be uploaded to digital-music players made by other companies? Has Steve lost his marbles? And will Gates slowly and steadily reel Apple in to take over digital music and force the iPod into the unwelcome role of fetish item for Macheads?

DIFFERENT STORY. That's the scenario painted by many iTunes and iPod competitors. "Apple can maximize their short-term profitability by keeping the system closed and proprietary. But three years from now, if they continue to do this, their share will be at a very small level -- far smaller than if they had agreed to license more broadly," says Dennis Mudd, CEO of music-download service and software outfit MusicMatch.

That may be. But I think Jobs has this one right, and Apple will continue to make headway. Times have changed, and the music market is different. For starters, Apple is building a captive audience for iTunes Music Store. Every 99-cent download represents an investment for a music lover and an additional disincentive to ditch their iPod and go with, say, a Dell Digital Jukebox. Converting an entire collection into MP3 format and burning it onto disks would be a major hassle. And no one wants to go out and replace their music collection every time they switch players.

So as more and more people download tunes from iTunes, the Apple music format becomes harder and harder to dislodge as a prominent standard. In a nutshell, I think this is also the reason why Apple had so much trouble getting people to switch computing platforms: The cost and inconvenience of switching not just hardware but software is prohibitive.

ME AND MY iPOD. I also think the music-player business and the PC business differ in terms of the cool factor. Apple and Sony are the only PC companies that build machines to appeal to design freaks. That's because few view a PC as anything but a machine. It's a giant paper weight that sits on your desk, not a thing of beauty and a joy forever.

A music player, on the other hand, is a fashion accessory. Sure, plenty of folks don't care what their player looks like. But the majority will view their iPod as an extension of themselves and their image: Hip, sleek, and cutting-edge. And no one disputes Apple's stellar track record for building things that are just plain cool.

Other cool music players may emerge, but it's not that easy to build cool products, as HP seems to have acknowledged by abandoning its own efforts to build an iPod killer and throwing in with Apple. And when has Dell ever been associated with cool? Um, next question.

CHOICE CUTS. Finally, content choice is an issue. I think it's a far bigger deal in the PC business than it is for music players. For PCs, software is content, and Apple has suffered its lack since many software makers have Windows but not Mac versions of their products. After all, it costs additional money and manpower to create dual versions of essentially the same product.

No such problem exists in music. A song is a song is a song, regardless of the digital format it comes wrapped in. And basically it doesn't cost extra to make songs available in multiple formats. Apple's iTunes music software will always be able to play songs just as well as MusicMatch or RealJukebox.

The only real issue with choice is when one music-download site can't offer the songs that users want. As long as Apple maintains the good graces of the music industry, it probably won't face that issue. Add these factors up, and the digital music game, for the next couple of years at least, is Apple's to lose. Salkever is Technology editor for BusinessWeek Online. Follow his Byte of the Apple column, only on BW Online

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