Microsoft Sings a New Zune

The MP3 player also-ran is being repositioned as a service for delivering content to game consoles, cell phones—even PCs

By Olga Kharif

Hindered by a failure to sell large numbers of digital music players, Microsoft is singing a new Zune.

A few weeks before releasing a new version of its MP3 player called Zune HD, Microsoft (MSFT) is taking extraordinary steps to court software developers to create applications for the device, which competes with Apple's (AAPL) hugely successful iPod and iPhone. One developer of a popular iPhone application for reading Twitter messages says Microsoft recently approached him about re-creating the software to run on Zune, with Microsoft footing the bill for development costs.

The programmer declined, but Microsoft's offer speaks to the company's legendary persistence at trying to make successes out of products that fail to excite customers the first or second time around. Along with Zune HD, Microsoft is making a Zune service available for delivering movies to Microsoft's Xbox video game console. A Zune-branded music service for the Xbox, cell phones, and PCs is in the works as well. "The business is entertainment," says Brian Seitz, group marketing manager with Microsoft Zune. "The mobile device or the MP3 player is just one screen that can use the service. To erase the iPod is not what the vision was. The business is the service."

A Seven-Year Project

Microsoft's dogged pursuit of success with Zune is a classic example of the company's willingness to keep investing in markets it sees as strategically important, even if early attempts to capture share fall short. Microsoft kept improving its Windows operating system for servers, SQL Server database, and Web search engine for years before having respectable products in those markets. Same goes for Zune, according to Microsoft. "When Zune was born, it was looked at as at least a seven-year project," says Seitz.

The project may pay dividends beyond the actual device. Microsoft considers Zune important to its foray into handheld computer games and other mobile software. It envisions an Internet-based Zune service that can deliver entertainment content to a wide range of devices, including those that don't bear Microsoft's logo. And Microsoft is still hopeful it can grab the quarter of the digital music player market that Apple doesn't hold, analysts say.

Sales of Zunes have been meager. Microsoft has sold about 3 million Zunes in the player's three years of availability. By comparison, Apple sold 10.2 million iPods between March and June of this year.

As of June, Zune commanded a mere 2% share of the MP3 player market, compared to 73% share for Apple's devices, according to market researcher NPD Group. Revenues in Microsoft's entertainment and devices unit, which includes the Xbox and Zune, declined 25%, to $1.18 billion, in the company's fiscal fourth quarter ended June 30. Revenues from Microsoft's "nongaming business" declined by $292 million, or 12%, "primarily reflecting decreased Zune and PC hardware product revenue," Microsoft said in its July 23 earnings release. The division lost $130 million in the quarter.

Taking the Focus Off the Hardware

Even the snazzy new Zune HD, which boasts features like high-definition video output to televisions, high-definition radio, and a touchscreen, is unlikely to shift that balance significantly, according to analysts. "If I were Microsoft, I'd just drop it," says Charlie Wolf, senior analyst at Needham & Co.

By repositioning Zune as an online service for a variety of devices, Microsoft hopes to reverse Zune's fortunes, and breathe new life into its handheld computing efforts.

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