Everybody Wants A Piece Of The iPod

Apple's e-music dominance will be sorely tested as cheaper players hit the market

Apple Computer Inc.'s iPod MP3 player was an instant hit when it was launched two years ago -- the must-have gadget for music-loving digerati. The iPod was head and shoulders above its rivals: It was easy to use, elegantly designed, and, best of all, held 1,000 songs in a device no larger than a pack of playing cards.

The iPod has flown off shelves ever since and has allowed Apple (AAPL ) to pick up the single largest chunk of the MP3 player market. In August, says market researcher NPD Group Inc., 18% of all digital music players sold in the U.S. were iPods. Those sales -- and the iPod's lofty $300 to $500 price tag -- helped the Cupertino (Calif.) company power to a fiscal fourth-quarter sales gain of 19%, the biggest jump in almost two years. On Oct. 15, Apple announced net earnings of $44 million on sales of $1.72 billion, reversing a net loss of $45 million a year earlier.

Now Apple is angling to take iPod to a whole new level. On Oct. 16, the company was scheduled to announce a Windows version of the iTunes Music Store it launched in April for Mac users. The move follows the 2002 launch of a Windows-version iPod. Moving into Windows MP3 players seems like a no-brainer. It's Apple's most aggressive attempt ever to move beyond its core of Mac loyalists -- and for good reason. Apple badly wants to maintain its market share as the $35 billion music business moves away from CDs to digital downloads. By 2005, the portable player market is expected to reach $2.6 billion, up from $1 billion in 2003 -- so even with a 10% share Apple could reap dividends for years to come.

Still, the company will have to contend with a host of new rivals. By Christmas, a variety of iPod wannabes will hit the market, from Samsung Group's YP109GS to Dell Inc.'s (DELL ) Digital Jukebox, due on Oct. 28. A range of new gizmos also will join the party, from smaller, cheaper models like Rio Audio's 2-ounce Nitrus to devices that play movies on liquid-crystal displays. Meanwhile, say industry insiders, Apple has lost a key advantage: the exclusive use of the tiny Toshiba Corp. disk drive that made it possible for the iPod to store so much in such a tiny package -- even as other disk-drive makers put out their own diminutive products. "Any time you can get a full-year head start, it's awesome," says Kevin Magenis, CEO of Cornice Inc., which makes a tiny drive that will appear in a dozen or so players. "But there's going to be a lot more competition."

The risk is that Apple could end up where it has so often before -- with only a high-end niche of a market it pioneered. To keep that from happening again, it's betting Windows users will be drawn to Apple's trademark elegance and ease of use. Moreover, the emerging MP3 player business will remain highly fragmented, much like the early days of the PC market, when Apple prospered with an 11% share. In the short term, at least, the launch of the Windows Music Store is expected to galvanize iPod sales.

PRICE SENSITIVITY

The question is whether Apple will go far enough to win Windows users over the long haul. Microsoft Corp. (MSFT ) says Apple has not licensed its Windows Media technology or its copyright protection software -- both of which are used by many of the new iTunes-like services popping up. That means people who want to use the likes of Musicmatch, Napster 2.0, or BuyMusic.com likely won't be able to use iPods.

What's more, as cheaper players hit stores this fall, Apple may have a hard time persuading consumers to pay up to $500. "We've been positioning our products to [cost] 30% less than a competitive iPod," says Craig McHugh, president of Creative Labs Inc., which sells a range of players. The cheaper devices could force Apple to cut prices, pressuring margins now estimated at 20%-plus.

Another threat comes from below. Take the gadgets that use Cornice's 1-inch drive, which is the size of two quarters stacked up. Some are no bigger than a cigarette lighter and could cost well below $200 by next year. True, their 1.5-gigabyte drives hold just 800 songs. But that's more than enough for most people. For those who do need thousands of songs in their pocket, iPod will always be the cream of the crop. For everyone else, any of a slew of new rivals may be just as good -- at a fraction of the cost.

By Peter Burrows in San Mateo, Calif.

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