Is Microsoft’s Zune Chasing
The Wrong iPod?
(Why Apple Must Build a MusicPhone)

By Avi Greengart
Principal Analyst, Mobile Devices
July 24, 2006

Microsoft has recently admitted that it plans to launch “Zune,” its own digital media player and music download service to challenge Apple’s iPod and iTunes. The logic behind the move is sound: Apple is increasingly making iTunes the gatekeeper to digital content, Microsoft’s partners haven’t made a dent in Apple’s market share, and some of the Zune details around social networking and content sharing are proven concepts on the web. However, Apple’s biggest threat is not another digital audio player, but the musicphone. Apple acknowledges as much, and promises it is “not sitting around doing nothing.” Is Microsoft chasing the iPod just as Apple is about to move on to musicphones?

Consumers are increasingly purchasing phones with music capabilities. While only a small percentage of music-playing phones are actually used for music today, this is changing as phone storage capacity reaches iPod nano levels – most consumers only need 1,000 songs. Nobody has created the perfect musicphone but the basic characteristics for success are not hard to define. Apple is rumored to be building an iPodphone because it would be far better to cannibalize its nano business on its own rather than let Nokia/Motorola/Samsung/Sony-Ericsson do it for them. With Zune, it appears that Microsoft is chasing after the wrong platform – today’s iPod, rather than the upcoming iPodphone. Ironically, Microsoft has strong assets it could deploy in musicphones if it marshaled those resources intelligently.

Microsoft has recently admitted that it plans to launch “Zune,” its own digital media player and music download service (separate from the recently launched MTV/URGE store) to take on Apple’s iPod and iTunes. Many of the launch details are still unknown, but the logic behind the move is sound: Apple is increasingly making iTunes the gatekeeper to digital content, disrupting Microsoft’s plans for the multimedia PC and its aims on the living room. Microsoft’s horizontal approach (creating platforms and DRM and letting multiple partners build devices and digital distribution points) has failed to dent market share of Apple’s vertically integrated system.

Furthermore, some of the Zune details that have emerged are intriguing – Zune players will have WiFi and will be architected to allow some level of music sharing. There may be ties to Microsoft’s Xbox Live, extensive video content, and possible efforts to buy users out of their iTunes library. Exploring the social aspects of media is definitely an area of differentiation against Apple today, and something that is a proven draw online, from customer reviews on amazon.com to music links on MySpace. The only similar product on the market today, MusicGremlin’s eponymous WiFi MP3 player, is intriguing, despite the bugs in our sample.

But even if the Zune’s implementation is flawless, the incumbent (Apple) can simply copy whatever works in the next generation of iPods. To beat Apple, Microsoft should be aiming at where Apple is going, not where it is today. Microsoft should know better than anyone that you don’t beat an entrenched competitor head-to-head; you win during platform shifts. (Have all of Microsoft’s Office veterans retired? Microsoft Word never would have overtaken WordPerfect if the shift to Windows had not occurred.) Microsoft doesn’t need to wait: there’s already a platform shift afoot, to the mobile phone.

While it is never a good idea to underestimate Apple’s ability to innovate in the iPod line, it does appear that the nano is played out. How much smaller can it get and still have comfortably sized buttons and a usable screen? Consumers have overwhelmingly chosen the iPod mini and iPod nano – even over the less expensive iPod shuffle – because they meet real-world storage needs of about 1,000 songs. Without a screen size large enough for watchable video, how much additional capacity does a nano need? However, there is one obvious area for improvement: while consumers universally carry phones, the nano is still a separate discrete product, and requiring a separate set of headphones as well.

Apple’s biggest threat is not another digital audio player, it is the musicphone. Music is the next victim of the voraciously converging mobile phone. Consumers are increasingly purchasing phones with music capabilities. While only a small percentage of music-playing phones are actually used for music today, this is already changing. Musicphones are now reaching those capacities, either with microdrives (for example, Nokia’s 4GB N91) or flash memory (SanDisk has a 4 GB Memory Stick Pro Duo that works with Sony Ericsson’s w810i Walkman phone). Today’s musicphones are not perfect, but Sony Ericsson’s Walkman line in particular is quite good, and the basic characteristics of a successful musicphone are easily described. If Microsoft’s efforts around sharing and connectivity are successful in the Zune, wireless carriers can add them to their already connected devices as well.

Apple acknowledges the threat, and promises that the company is not standing still. Apple has allowed Motorola to put the iTunes client on several handsets (though the number of songs on the device is artificially limited to 100), and is rumored to be building its own iPodphone to protect its nano business by cannibalizing it before a handset vendor does. At first, musicphones will not affect sales of large screen/hard drive iPods – or Zunes, for that matter. But, over the long term, whoever is the gatekeeper for this content may win the larger devices as well. Microsoft is chasing Apple by copying the vertical integration of the iPod and adding a few features, while Apple is moving on to musicphones. Ironically, Microsoft has strong assets it could deploy in musicphones if it marshaled those resources intelligently. Instead, it appears that Microsoft is chasing after the wrong iPod – today’s nano and iPod, rather than the upcoming iPodphone.

• Apple should build a music phone with an emphasis on “phone.” Despite strong competitors in Nokia and Motorola, basic voice is still an area ripe for differentiation. Apple should provide battery prioritization (so that iPod functionality does not encroach on the ability to make phone calls), highlight voice call quality, and utilize is vaunted UI talent to redefine ease of use for voice and text messaging. In the U.S., Apple should launch an MVNO to take the complexity out of voice and data plans; it already has the retail distribution it needs. In Europe, Apple should sell the iPodphone without contract at retail. Japan may be the only market where Apple can sell the phone through carriers and deliver its services using the standard off-portal revenue share model.

• Microsoft should focus its efforts on building media phones. Microsoft is making strong headway today against Symbian, Palm, and RIM in a relatively small market. Longer term, it appears that Motorola and Samsung are likely to go with Linux long term regardless. Therefore, Microsoft should buy HTC today.

• Regardless, Microsoft has a lot of work to do just to get its software house in order. The first step is to completely revamp mobile Windows Media Player. Next, separate versions of Windows Mobile must be consolidated. Finally, the mobile device universe is fragmented, but most music implementations are using Microsoft’s DRM solution at some level – and it PlaysForSure never works the same way twice. With few strong DRM alternatives, Microsoft must use its leverage to impose a single, consistent usage model across all Windows DRM devices, carriers, content types, and stores.

• SanDisk does not need to respond to Zune. Its microSD cards power mobile phones, and Zune is unlikely to change SanDisk’s key advantages in digital music players: retail distribution and pricing power (SanDisk should be able to win any price war, as it manufactures its own memory). iRiver and Creative – assuming that they aren’t pulling out of the DAP market altogether – will also have to continue working with Microsoft. At least Zune comes from a completely separate division at Microsoft: partner efforts out of the Windows Mobile and DRM groups are unlikely to be curtailed.

• Nokia, Motorola, Samsung, LG, Sony Ericsson, etc. must learn the lessons of what makes a good musicphone. True, carriers sometimes step in and impose their own warped vision. But there is no excuse for not having a perfect on-device music experience. Content acquisition is the other part of the equation; a great online music store is less important relative to a superior PC synchronization process.

• Given the limitations of storage, user experience, and cost, most mainstream consumers are still better served with separate music players and phones today. Users who are willing to trade storage capacity for access to iTunes’ best-in-class music management and synchronization should consider Motorola’s iTunes phones.

• Consumers looking for a dedicated digital media player should look first at Apple’s line of iPods, which still offer the best integrated media experience – from content discovery to playback. However, users who prize music discovery should investigate subscription options which require non-Apple players; Real’s Rhapsody is richly architected and SanDisk’s Sansa e series is a reasonable Rhapsody-compatible nano substitute.

• Consumers looking for a connected music experience should hold off on purchasing a dedicated media device at least until the fall. By then, Microsoft will have released full details on the Zune and Apple will have announced (and started shipping, if history is any guide) their latest iPods.