A Method to Microsoft's Zune Madness

Some say Redmond is crazy to take on Apple's popular iPodand crazier still to put limits on what Zune can play. Here's how the approach could work

When Microsoft announced plans to manufacture a media player nearly four months ago, many analysts thought the software giant was making a major mistake. After all, not even Walkman creator Sony (SNE) has been able to steal market share from Apple's (AAPL) dominant iPod. Criticism of Microsoft's decision has grown increasingly vehement as reviewers have had a chance to preview the Zune prior to the device's Nov. 14 launch.

Some early criticism: It's not sufficiently sleek, it's priced too high for a non-iPod, and the color isn't a cool chocolate like LG's (LPL) popular phone, but a boring brown.

Worst of all, critics say, Microsoft (MSFT) engineered the device to be incompatible with PlaysforSure, its own digital-rights management software used by Napster (NAPS) and Time Warner's (TWX) AOL Music, among others (see BusinessWeek.com, 11/20/06, "Microsoft Plays a New Zune"). In doing so, Microsoft likely frustrated not only past partners, but also those digital music consumers who were more likely to adopt Zune because they already were downloading music from sources other than Apple's iTunes store.

Despite the initial criticism and the potential cold-shoulder treatment from consumers, don't sell Microsoft—or Zune—short. Some analysts believe Microsoft's new approach to the digital player business just might prove effective in the long run. For starters, Microsoft is not just blindly copying Apple's business model of providing seamless integration between an individual music store and player, while walling off access to outside services and players. Instead, the software giant is also adjusting its business model to win over music and movie providers who have become frustrated with Apple's unwillingness to be more flexible with its 99¢-per-download pricing model (see BusinessWeek.com, 12/19/05, "Apple May Be Holding Back the Music Biz").

Buddying With the Industry

Witness Microsoft's recently announced revenue-sharing deal with Universal Music Group. In exchange for giving Microsoft rights to sell its music, Universal will receive a slice of Zune sales. While the seemingly generous move may have been influenced by Microsoft's weaker position in the space relative to Apple, it was also a strategic play by Microsoft to give content providers a stake in Zune's success. "It's clear that Microsoft is not only trying to win the hearts and minds of the consumers, but it is trying to reach the hearts and minds of the record companies as well," says Michael Gartenberg, vice-president and research director at JupiterResearch.

Close ties to the music industry could pay off for Microsoft in the short term with exclusive record industry deals. Companies such as Universal, for example, may grant Microsoft the rights to offer new releases earlier than rival services, says Gartenberg. Such deals would give Zune players an edge, which could translate into more money for the record and film companies. Solid relationships with content providers could also help sell Microsoft's technology and store to other music-player manufacturers—if it ever decides to give out the key to its walled garden. Microsoft executives were unavailable for comment.

Rob Enderle, principal analyst at San Jose-based Enderle Group, believes Microsoft will want to decrease the barriers for owners of rival music players to use its music download and subscription service.

"At the end of the day, Microsoft wants to sell the technology," says Enderle. "They are still a technology company and they want to demonstrate that [their store] can work."

Business-Model Test Lab

Proving to detractors that it can power a successful music download service may be a reason Microsoft decided to distance Zune from other PlaysforSure devices. Because a variety of digital music devices supported PlaysforSure, using the technology was not always seamless and had its share of glitches. In blogs and columns, the technology was criticized for not allowing music to play with certainty on all supporting devices.

"Right now the complaint with PlaysforSure is sometimes it doesn't," says Enderle. "And when there is a problem, the hardware guys point to the software guys and say, 'We did everything we were supposed to do, it's your problem,' and the software guys point to the hardware guys and say, 'We did everything, it wasn't us that screwed up.' "

Microsoft's approach to the digital music business this time gives it the control necessary to conduct a real-world test of the two supposed keys to Apple's success—seamless integration and an easy, 99¢-per download pricing model. Microsoft is offering the equivalent of a 99¢ download model as well as a subscription model in the vein of RealNetworks' (RNWK) Rhapsody service or Yahoo (YHOO) Music (see BusinessWeek.com, 9/05/06, "Meet the iTunes Wannabes"). Once it offers the same seamless experience as iTunes and iPod, Microsoft can monitor whether people gravitate toward the pay-per-download or subscription model, thereby making a better determination as to what pricing model consumers really prefer with all other things being equal.

Breaking the iPod Stranglehold?

If customers end up preferring the subscription model, Microsoft could have a real winner on its hands. But that's a big if. So far, only Apple seems to be making substantial profits from its service. Subscription networks have yet to truly take off. Napster, for example, has been losing money and is considering selling itself (see BusinessWeek.com, 11/21/05, "Online Music's Elusive Bottom Line"). Still, there's reason to believe that, given enough time, consumers could gravitate toward the music-rental model.

Subscription service has proven successful for the movie-rental and cell-phone industries, after all. However, it will take time to condition music lovers, used to either owning or sampling music for free over the radio, that music can also be rented like movies and other forms of media. How long it takes will depend not only on the willingness of music aficionados to change business models but also on the success of non-iPod players such as Zune.

Microsoft's biggest challenge, however, may not be solvable through offering more choices or even a better business model. The company must contend with the brand appeal of Apple's device that keeps its users loyal enough to keep buying upgraded versions. In other words, it must contend with the fact that Apple is the current king of cool, and the Zune is not yet hot (see BusinessWeek.com, 11/10/06, "Zune: Falling Down on Cool").

Interested But…

A great marketing campaign plugging Zune's special features such as Wi-Fi capability could increase excitement for the device. But even then, Microsoft would still have to win over potential customers such as Elizabeth Dye. The 23-year-old from Madison, N.J., says she is in the market for a new music player, having filled up her now-dated iPod mini with tunes.

She has read a bunch about the Zune, but doesn't think she will buy one unless Microsoft cuts the price. "The Zune sounds interesting, I like that fact that you can connect with other users," says Dye, "but I am just kind of used to the iPod and the iPod system."

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