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Gates: "We're Early on the Video Thing"

Microsoft (MSFT) wants to steal some of Apple's (AAPL) thunder in the digital music business. On Sept. 2, it opens the doors to MSN Music, its online music store. At the same time, it will roll out a new version of its Windows Media Player, used to listen to music and watch video on a PC. And three partners, Samsung, Creative (CREAF), and iRiver, are launching portable media devices that play video as well as music (see BW Online, 9/1/04, "Microsoft, the Entertainer?").

Microsoft Chairman and Chief Software Architect Bill Gates recently talked about Microsoft's revamped digital media strategy with BusinessWeek Seattle Bureau Chief Jay Greene. Edited excerpts of their conversation follow:

Q: The iPod has become iconic for digital music. How can Microsoft redefine the market?

A: The basic idea of making it simple to get at the music -- there's still so much more that can be done. I'd say we have a lot to bring to this in terms of great software and the kind of flexibility we can give to people. We've always done things a little bit differently than Apple in terms of giving people choice. And we're more focused on software, not trying to get margin out of the hardware for ourselves. We leave that to people who can come in with variety and a maniacal focus on doing the best hardware piece.

Q: Do you think Apple is making the same mistake with the iPod, controlling both the hardware and software itself, that it made in the PC business?

A: Well, Apple is a successful company. They're pursuing the same strategy that they pursued in the PC business, and here they're likely to get an even higher share than they got in the PC business.... But there certainly are analogies between their PC strategy and their music strategy. Just like in our case -- here, we're doing software. We're working with lots of hardware partners. We're excited about what the hardware partners are doing.

It's great that Apple's in here. I think it's great we're in here. This is going to drive innovation at a pretty rapid pace. Is there an opportunity here for more than one company? Absolutely.

Q: Is their approach, though, likely to relegate them to the sort of niche they have in the PC business?

A: Obviously, they expect to do better than that. And they're always going to have the Apple position. Over time, the importance of choice, price-performance [comparison], some of the broad software things we do that they don't do, will give us the Microsoft position. I don't know what the equilibrium will be, but I think there's a significant opportunity for both of us.

Q: Why do you think digital music devices from Microsoft's partners haven't sold as well as the iPod?

A: Well, actually if you take the solid-state players and disk-based players, the majority of sales have been with our partners. But clearly the level of competition in terms of size and hipness is very strong, and our partners are having to step up to that competition. I'm very excited about what Rio announced with a couple of devices, particularly the Carbon [digital music player]. And we'll see more partner announcements between now and the end of the year.

Q: And what do you think is going to be different about it this time around? What is it about these devices that's going to get that cool factor going?

A: Rio and Creative actually created this category. They were in this space before others were in it. They need to drive for the size and ease of use that really advances the standard. I'm pretty excited about what they're doing. But it's a very competitive space, and they have to deliver on those things.

Q: Is there something that Microsoft and its partners need to do, specifically, to overcome that strength that the iPod, with its iconic status, has?

A: We need to have a set of capabilities that are a better choice for people. And that's the world we live in, whether it's buying a PC or choosing which online service you want to go to. It's easy to underestimate the importance of choice and innovation. And I think we're going to see some fantastic stuff.

In terms of what these devices need to do, we're pushing the state of the art in terms of what the software experience is, such as how these things connect up. There's nothing that the iPod does that I say, "Oh, wow, I don't think we can do that."

There's often, early in the new market, a few products that help get the category to critical mass. In the long run, people are going to buy what gives them the right price, performance, and capabilities. And does everybody want to have exactly the same thing? Probably not.

Q: Which new product or service from Microsoft do you think will have the most resonance with consumers?

A: This thing called Janus that lets you play subscription music on mobile devices. That's a real contribution. Now, we're not actually ourselves introducing the subscription music service, although we may in the future. But the work we've done with these device manufacturers to get them to build support for subscription music in, that's a big contribution.

Most consumers aren't going to hear the word "Janus." But there are a lot of people who believe that subscriptions will be a very, very important part of this market. And so we invested in enabling that for every company that wants to do subscriptions.

We've taken the Windows Media Player and done some very neat things to it. We've done this integration where, if you're an MSN Messenger customer, you can show show people the music you like and let them get a sample so they can buy it.

Our guys doing MSN Music are really excited about what they're doing. But I'd say overall, you really need to look at Windows Media Player, the new ways of delivering music, the new format, and the fact that video -- although at a much earlier stage and with some differences -- is coming into these media scenarios. We're laying the groundwork for that to happen this year.

Q: So what comes next?

A: We're going to ship a new version of the Media Center PC [which connects to a TV and a stereo to play both video and music] this year. It's interesting -- now these convergence devices are in the living room, [which] lets you do entertainment and communications and media stuff -- we're in that alone. It's not like the music space, where Apple and others are in there. That's classic Microsoft. We've always had things where we're out there alone, doing the innovation and defining the category. And we've had things where we're one of the companies in the category pushing it forward.

We see these things as connected. But this isn't the point yet where consumers see those things totally connected. Over time, a lot of the advances will come through the simplicity of how those work together.

Q: And what's going to get us to the point where consumers see that all interconnected?

A: The level of capability, the ease of connecting all these things up, the rights management -- it's really a many-year push to get to that nirvana that you walk into your living room and it's just obvious how you pick up the remote -- and not 5 remotes! -- and do 10 times what you can do with the five remotes that you have there today.

People are not happy with their current media situation. Media today is so far short of what it can be. And we're seeing with music, we're seeing with Media Center, a glimpse of what the next two years will bring -- the dream of digital media finally becoming totally mainstream.

Q: Do the new digital media products create incremental revenue for Windows and MSN, or are there new businesses for Microsoft to develop?

A: Oh, some of both of those things. Making it simple for the buyer who has that Windows PC or these partner devices, that's going to keep the Windows and the Windows ecosystem very strong.

We'll also bring in some new revenue sources, some of which will be margin on transactions and some of which will be advertising. As you help people search and find media and deliver those experiences, it creates a context where online advertising becomes a nice part of the financial possibilities.

Q: So that's incremental revenue to MSN as opposed to a new business?

A: The phrase "new business" is pretty dangerous there. Is MSN Music a new business? No, it's just MSN driving forward on their transaction vision and creating the first few e-commerce applications to get to critical mass in terms of consumers who trust us for that and having great infrastructure for that.

In MSN's vision of profitability, music is not a dramatic piece. But in terms of the vision of getting people to do e-commerce with MSN, we decided music was a very important piece.

Q: Is there a way to think about how much of a revenue boost Microsoft can get from these products over time?

A: No.... We're such a big company in terms of the Windows revenue base and the Office revenue base that it's always going to be hard for us. When things are in their first few years, they're never gigantic. Downloading music tracks will never, both because of size and margin, be a gigantic business. But the strategy of creating the foundation for e-commerce and more content for advertising, that's big. Advertising is already a measurable business even in the Microsoft scale.

Will this transaction stuff be a significant part of our business picture over the next five years? We're betting that it will be. But in order to make that true, we have to go way, way beyond just music tracks and have a variety of things that come through that infrastructure.

Q: Steve Jobs has said consumers aren't going to watch video on tiny screens. Is he wrong?

A: Yes. Ask kids in the back of a car on a two-hour trip, "Hey, would you like to have your videos there?" My kids would. I guess Steve's kids just listen to Bach and Mozart. But mine, they want to watch Finding Nemo. I don't know who made that, but it's really a neat movie.

So, yeah, we're early on the video thing. A video device costs somewhat more than just a pure music device -- up in the $500 range. But there's no problem with the screen. The experience for the kids sitting there watching that color LCD screen is fantastic. Getting the content providers to open up their broad libraries and making those things really easy to get at, we've put a lot into that.

But [video is] not where the music scenario is. So I'm very proud of what we're doing there, but the explosion of video will be based on the work we do this year.

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