Updated from 4:41 PM EDT

Microsoft ( MSFT) is taking a page out of Apple Computer's ( AAPL) book with plans to launch an integrated digital media player and service by the end of the year.

Dubbed Zune, the offerings will include a Microsoft-branded, hard drive-based music and entertainment player and an online media store, representatives for the software giant said on Friday. The new player and service will be incompatible with Microsoft's PlaysForSure initiative, through which partners such as Creative ( CREAF) and Napster ( NAPS) offer devices and content centered on Microsoft's Windows Media encoding software.

"It's a similar model to Apple's iTunes ," said company spokeswoman Katy Gentes.

The move marks a risky step for Microsoft, which has been aggressively trying to diversify its revenue beyond its core Windows and Office software programs. Not only has Apple already entrenched itself as the dominant player in the space, but Microsoft risks alienating partners who have signed on to its Plays For Sure program.

And then there's the little matter of profitability. Despite the fast growth of the digital music industry, for most device makers and service providers other than Apple, profits have been hard to come by . That probably won't be music to the ears of Microsoft investors, who have seen the company lose millions of dollars on initiatives such as its Xbox game system and its MSN Web service.

The Zune effort has a chance to surprise and challenge Apple, says Rob Enderle, principal analyst with the Enderle Group, an industry consulting firm. Still, given Apple's dominance of the digital music market -- and Microsoft's poor track record with new initiatives -- the odds are still in Apple's favor, he says.

"We've certainly seen Microsoft try and fail with a lot of things," says Enderle. "This has the same potential upside , but it's also got a lot of downside."

He adds: "When you've got an entrenched vendor, you have to give the nod to the entrenched vendor."

Indeed, instead of threatening Apple, Zune likely poses the most danger to Microsoft's PlaysForSure partners, says Michael Gartenberg, an analyst with JupiterResearch.

"Creative, Iriver: They have a lot to be concerned about, as well as Microsoft's partners on the music side like MTV's Urge service," says Gartenberg.

In contrast, "this is a move that Apple's been expecting," he says. "I doubt that they've sitting around waiting for Microsoft to enter the market so they could give them a warm embrace. This is going be an intense battle."

An Apple representative declined to comment on the Zune announcement.

Although the new service will compete with the PlaysForSure initiative, Microsoft plans to continue to support the older service even while promoting Zune, Gentes said. "We think there's opportunity for both. The parallel offerings will provide additional choice," she said.

Gentes declined to say how much Microsoft will charge for the device, how much capacity its hard drive will have or what encoding format the company will use for songs and other media. Through the Zune service, Microsoft plans to offer music and is mulling whether to offer both games and movies, she said.

Key to a games effort could be J. Allard, the Microsoft vice president who spearheaded development of the Xbox, the company's video game machine. Allard is now helping direct development of Zune, Gentes said.

Also unclear is whether the company will offer content through a subscription service or a la carte as Apple's does with iTunes, Gentes said.

"We're looking at both," she said.

Microsoft plans to differentiate the Zune service from iTunes and other offerings by emphasizing community and social networking aspects, Gentes said. The idea is to allow music aficionados to connect with each other easily to share recommendations on music and other entertainment.

"People want to send a band up to the top of the charts ... in ways they haven't been able do before," she said.

Gentes didn't go into details on how the service would work. But according to Enderle, one of the ideas behind the service is to allow artists to set up their own song playlists that consumers could download, mix up and pass around. They'd be able to pass on the songs -- or, potentially videos or other media -- directly to other users over a peer-to-peer wireless connection, he says.

"This could be really cool; it's sharply different from what Apple's offering," he says.

But a key part of this vision -- and Microsoft's possible success -- is for Zune to be a subscription-based service, according to Enderle. That would help Microsoft to clearly differentiate Zune from iTunes, potentially allow them to convince those who might be reluctant to switch from iTunes because of a heavy investment in iTunes songs, and would allow consumers to pass around playlists with no extra charge, he notes.

Subscription services have long been touted by analysts as the eventual winning business model in digital music. However, to date, such services have found little traction with consumers.

As for the Zune hardware, Gentes offered few details on how Microsoft would attempt to distinguish it from Apple's iPod and other devices. As has been rumored , the company is planning on adding a wireless antenna to the device, she said. That could potentially allow users to download songs directly to the Zune device itself rather than having to sync their devices to a computer after downloading a song there. However, Gentes declined to say whether the first-generation Zune device will include a wireless antenna.

Although Microsoft plans to release a family of Zune devices over time, the company expects to have just one device ready by the holiday season this year, she said.

Arguably, the attractiveness of the Zune device could be the most important factor in determining the success of the initiative. Many observers believe Apple's success in digital music is largely linked to the cutting-edge fashion and ease of use of its iPods, as opposed to its iTunes service.

And the accessories that consumers have bought to outfit their iPods -- ranging from simple cases to external speakers and car-radio connectors -- could be another factor discouraging consumers from switching to Zune, says Gartenberg.

"This is a really tricky situation," he says. "If you own an iPod ... you're not likely to be in the market for a new player here. If you are, you're going to be looking at what Apple has to offer first."

Apple has long dominated the digital music space. Its iPod players have captured 75% of the retail market share for such devices in the U.S. and are the leading players worldwide, according to industry research reports. Meanwhile, the company's iTunes music service holds north of 80% of the market for digital song purchases in the U.S., according to Nielsen SoundScan figures quoted by the company.

Songs purchased from iTunes can only be played on Apple's iPods. Likewise, the iPods can't play songs encoded in Windows Media format.

Gentes said that Zune will work similarly, although she declined to comment on whether Zune devices would be able to play iTunes songs.

In contrast, songs bought from PlaysForSure-affiliated services will play on any approved device, no matter the manufacturer.