Microsoft in the Zune

On Friday, Shares of Microsoft closed up 12 cents, or 0.4%, to $27.87. The stock has been down nearly 9% in 2007.

Microsoft has about a 10% market share in the hard-drive-based devices category, according to NPD. The company is on track for the target it had set last year of shipping one million devices by June, but it's still a very small fraction of the overall market for digital music players.

Flash memory-based players account for about 65% of the market, and Microsoft needs to have a product there soon to make a dent, analysts say.

So far, Microsoft hasn't materially affected Apple, whose iPod remains the market leader.

Zune's market share has come at the expense of smaller players in the category like Creative TechCREAF, says Rubin.

But a flash-based player would be a true rival to the iPod, says Samir Bhavnani, research director for Current Analysis. "I am predicting we will see the flash-based player by the end of the year," he says.

Reindorp couldn't confirm the company's plans, but admits Microsoft is clearly thinking about a flash-based device. "They are certainly popular amongst consumers -- and therefore, in the industry right now -- because of the cost, capacity and size benefits they bring with them, so yes, we are indeed considering if they might complement the Zune device family," he says.