Microsoft, The Entertainer?

Gates & Co. take aim at Apple's iPod -- but their first attempts could fall short

Since the dawn of the PC era, you would be hard pressed to find much that Apple Computer Inc. (AAPL ) CEO Steven P. Jobs and Microsoft Corp. (MSFT ) Chairman William H. Gates III agreed on. Now that Apple has reinvented itself as the king of the digital music world, Microsoft is trying to wrestle that mantle away with a new breed of iPod rivals, including ones that play color video as well as music. It's one more instance of clashing world views. "We don't think people have a burning desire to watch video on tiny little screens," Jobs said earlier this year. But Gates points to the growing phenomenon of kids watching videos during long car trips as proof that there is a market for small screens. "I guess Steve's kids just listen to Bach and Mozart," Gates quips. "But mine, they want to watch Finding Nemo. I don't know who made that, but it's a really neat movie." Of course, Gates knows: It was Jobs's own Pixar Animation Studios (PIXR ).

When the boss gets sardonic, you can tell Microsoft is getting serious about a market. On Sept. 2, the company is launching its most comprehensive foray yet into the digital media world. Portable video players, which run on Microsoft software and are made by Samsung Group and others, are just a piece of the tech giant's plan to steal Apple's rock 'n' roll mojo. Microsoft also is opening the doors to an online music store that includes a handful of popular artists that Apple's iTunes site doesn't have, such as Radiohead. More important, the company is rolling out an update of its Windows Media Player audio and video software that's designed to make it just as easy to purchase and manage music with Microsoft powered gear as it is with Apple's iPod and iTunes combo. "There's nothing that the iPod does that I say: 'Oh, wow, I don't think we can do that,"' Gates says.

The digital media push is aimed at helping Microsoft recapture a measure of its youth. The company has been wrestling with questions about maturity as its growth slows. Analysts expect that as the digital media market grows over the next few years it could contribute $400 million to Microsoft's revenues. While that's a fraction of its $36.8 billion annual take, the company is hoping over time to generate far more meaningful revenue for its MSN unit by jump-starting the sale of low-cost digital goodies. Once music shoppers give MSN credit card numbers to buy songs, Gates believes they'll be more willing to buy other products Microsoft is developing, from text-messaging services to digital characters that can be used as personalized icons for instant messaging. "There's a lot that has to be done to make it really comfortable and easy to spend small amounts of money online," Gates says. "Music is definitely one of the applications that's going to bootstrap that kind of consumer, lots-of-transactions-online e-commerce."

The new technologies are also key to Microsoft's march into the living room. If consumers get used to Windows Media Player and the portable video and audio players, they're more likely to use the company's technology as they shuttle digital content around their homes. Wide customer acceptance may help Microsoft persuade record labels and movie studios to wrap their music and video in its software. The idea is that the cycle could feed on itself, making Microsoft's media technology as ubiquitous as its Windows monopoly. "You don't have anybody investing more in bringing these consumer scenarios together," says Gates.

Yet for all the effort, Microsoft isn't going to displace Apple anytime soon. The stylish, simple elegance of Apple's iPod, together with its pioneering iTunes download service, has come to define digital music. It has sold nearly 4 million iPods and more than 100 million songs, and its momentum shows no signs of abating. By comparison, Microsoft hasn't shown the flair that's necessary in digital entertainment. It's relying on partners to gin up iPod killers, and to date, they haven't come close to Apple's allure. And even as Microsoft's partners are improving their designs, so is Apple, making its lead that much more difficult to overcome. "The iPod has transcended being a consumer device and become a cultural icon," says Jupiter Research analyst Michael Gartenberg.

With the iPod so strong in the digital music biz, Microsoft thinks that video-on-the-go may be its best chance to pull ahead long term. There, it sees a market that looks an awful lot like the digital music business did just five years ago. Back then, about 13% of Web-connected U.S. homes had music files on their PCs, according to Jupiter. That's roughly the same percentage as those who have digital video files today, according to tech research firm the NPD Group Inc. Now, 63% of Web-connected U.S. homes have music stored on their PCs. Microsoft's devices, which record video as well as songs, can untether prerecorded TV shows and movies so people can watch them wherever they want. The first devices, by Samsung, Creative Technology, and iRiver, will store 20 gigabytes of digital content -- about 80 hours of video or 5,000 songs. "Video is definitely the gee-whiz factor here," says Lisa O'Malley, a senior brand manager at Creative Technology Ltd. (CREAF )

The gadgets, though, aren't likely to kick-start a video revolution anytime soon. Their biggest drawback is simply that they're inconvenient. Users can copy video only from a PC, not directly from a television or DVD player. IDC analyst Roger Kay estimates that fewer than 1% of the world's computers have the TV tuner cards that are required to copy TV programming. Those can be bought for $70, but even then the only way to watch the latest episode of, say, The Daily Show with Jon Stewart on a Portable Media Center is to connect a cable jack to a PC, copy the show onto a computer, and then download it to the portable device. Although there are no restrictions on copying television shows now, broadcasters could impose them in the future. To avoid all the bother, customers will need to pay companies that have partnered with Microsoft to provide content directly from the Net. That presents another problem: Microsoft has lined up only two video content providers so far, Major League Baseball and CinemaNow Inc. and the movie site have less than 2 million monthly customers combined.


Copying hassles aside, the products are hefty and pricey, at $500 each. Adding video capabilities adds bulk and reduces battery life to at most seven hours while watching videos, vs. as many as 20 hours for music-only devices. Design is a big deal because, as Apple has proved, cool devices are the key to winning the digital media battle. Consumers pick a device first. Everything else is secondary. All of which likely will relegate the first generation of devices, about the size of a paperback book, to niche status. Especially since there already are viable alternatives for watching videos on the go. "There are a lot of them out there already. They're called notebook computers," says Mike McGuire, research director at GartnerG2 (IT ).

Analysts aren't willing to write off the long-term potential for portable video gadgets. Microsoft's partners could spiff up design, and Microsoft eventually will make video transfer more convenient. That could help the technology become much more popular toward the end of the decade, analysts say. "This is the first shot across the bow," says Jupiter's Gartenberg. "When it comes to Microsoft, the first shot is never the most important."

Microsoft's work in digital music holds more immediate promise. The new Windows Media software has mimicked iTunes, letting users buy in one click songs from MSN Music and a handful of other music retailers and have the tunes automatically added to music libraries. But unlike iTunes, MSN Music has agreed to carry music from artists who only want to sell entire albums online, instead of individual songs. That's a small number of artists, including Radiohead and the Dave Matthews Band, and may not prove to be much competitive advantage. Fans of the groups who prefer the iPod can always go to a retail store to buy their music. Still, Microsoft plans to add innovations over time, including letting users hover their cursors over names in their MSN Messenger buddy list to see what songs their friends are listening to.


Another big innovation is a feature that for the first time lets people who use music subscription services transfer their rented tunes to portable devices. That means customers of Napster Inc., for example, will be able to add as many songs from the service's one-million-song library as they can fit on their portable players. The technical breakthrough, to reassure the record labels, is that songs disappear from devices when the customer's subscription expires.

Still, the record labels are extracting a price for the newfound freedom. They want more money to let consumers put subscription songs on a portable device -- they believe, rightly or not, that customers who subscribe will spend less money buying music. Napster Chairman and CEO Chris Gorog says the company will hike the monthly subscription fee from $10 to at least $15 for the portable service. That's likely to limit the market, since $180 a year is a hefty tab for music that will vanish once the subscription lapses.

Gates has grand plans for how Microsoft can change the world of digital media. "Media today is so far short of what it can be," he says. But he'll have to do more work to get the company's strategy in tune with its ambition.

By Jay Greene in Redmond, Wash., with Peter Burrows and Cliff Edwards in San Mateo, Calif.

Before it's here, it's on the Bloomberg Terminal.