Microsoft Singing Its Own iTune

The software giant is poised to take on Apple with a music service and MP3 player all its own, abandoning its partner-oriented strategy

In mid-June, Jonathan Sasse, president of digital-music-player maker iRiver America, was making the rounds with the press, talking up his latest gizmo, the clix. His message was that this music player, unlike so many other iPod wannabes, had a chance to hit it big and maybe even take some business from digital music kingpin Apple Computer (AAPL).

His reasoning: The clix was created in close partnership with Microsoft (MSFT), which provided the underlying software, and engineers from MTV's Urge music service, another Microsoft licensee. Microsoft had approached iRiver the year before about working more closely to develop a product to give Apple a run for its money. For nearly four months staffers from the three companies had holed up in Microsoft's offices in Redmond, Wash., to make sure the product was glitch-free. "This time, it felt like all the pieces really worked together," said Sasse.


  But for all the partnership talk, it turns out Microsoft may have plans to take on Apple with an approach that doesn't rely on either iRiver or Urge. Four industry sources say that Microsoft plans to come out with its own device and an improved music service to go with it—possibly in time for the Christmas selling season.

It's a dramatic about-face for the software giant, but one that it may feel compelled to take since its partners have so little momentum in the music space. For the past half-decade, Microsoft has pursued a partner-oriented strategy, betting that scores of powerful collaborators such as Samsung, Wal-Mart (WMT), and Dell (DELL) would ultimately win out against Apple's go-it-alone approach. The argument: Even if Apple won the early innings with innovative, pioneering products, the Microsoft camp would ultimately prevail by driving down prices and blanketing every market segment.

That worked fine in the PC era. The only problem: In the Internet era, Apple hasn't faltered. As of May, Apple's iPod held 74% of the digital-music-player market—near an all-time high of 77% in March and far ahead of No. 2 Sandisk (SNDK), with 10%—according to NPD analyst Stephen Baker.


  If Microsoft plunges ahead with this new approach, the software maker is in for a tricky transition. For starters, sources doubt that Microsoft will fully drop its current strategy of embracing Apple's solo approach, where songs purchased at Apple's iTunes online music store will only work on its iPods.

Sources instead expect that Microsoft's device will be able to play songs purchased from other services built around Microsoft's Windows Media technology, such as Urge and (NAPS). And songs purchased from Microsoft's new, improved online music service will also likely play on devices made by longtime hardware partners such as Samsung, Creative Technologies (CREAF), and iRiver.

That could leave Microsoft saddled with a web of complex relationships and business models, in which it tries to go head-to-head with Apple—but without Apple's luxury of not having to worry about keeping its devices compatible with partner products.


  And to take a serious chunk out of Apple's market share, Microsoft will have to offer something Apple doesn't. Some industry insiders say that Microsoft's new service will let consumers buy music or receive streamed subscription services wirelessly, rather than forcing users to sit down at a PC to get new songs as they must with iTunes. But this wireless "mobile music" market may not be ready for prime time. One source familiar with Apple's thinking says Wi-Fi networks are not yet ubiquitous or easy enough to use to make wireless purchases a mainstream activity. If you have to go through a sign-up process and pay a fee for Wi-Fi access at the local Starbucks, Steve Jobs thinks most consumers are more likely to wait until they get home to buy music.

Then there's the device itself. As of early this year, Microsoft was debating whether to add video-game capability to the device to leverage its success with the Xbox gaming console. That's not likely to be part of the first version of the product, since it's probably too late to have games ready for Christmas. That creates a potential branding quandary, since it would likely preclude Microsoft from using its one hip brand—Xbox.

No doubt Microsoft has the financial resources to make a go of it. One music industry source says the company plans "to put a boatload of marketing behind this." Indeed, there's evidence that Microsoft is making a long-term commitment to make sure Apple doesn't parlay iTunes into a digital platform for the living room. The most compelling sign: The product's development is being run by J Allard, one of Microsoft's most respected executives, who is credited with spearheading the company's Web efforts in the mid-1990s and its gaming business with the Xbox a few years later. Says IDC analyst Susan Kevorkian: "They're in an analogous position to where they were when they got into the game market."


  With one exception: Microsoft had no game console partners at the time it launched the Xbox. Now it runs the risk of undercutting the digital music ecosystem it has worked to build in recent years. "They're going to go out there and piss off a lot of people they're supposed to be friends with," says NPD's Baker. "I don't think they're going to gain any share this way. All they're going to do is take share from their partners and cause them to be more focused on protecting their own market share. They all need to be focusing on Apple, not each other."

So far, Microsoft's partners are holding their breath and downplaying any threat. Matt Hutcheson, a spokesperson for MTV, says: "For us, it's very much business as usual." He says the network is excited about interest in the Urge music service in the two months since a test version was released, and that, "we'll be promoting the service heavily" as the holiday buying season approaches.

And Sasse says he remains unconcerned. He says Microsoft has given no hints that it's about to go into business against him. "At the end of the day, you only have so many assurances," he says. And even if Microsoft came out with its own music player, "I don't think it would be any death blow to the category."

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