A Method to Microsoft's Zune Madness

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

by Catherine Holahan

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.