Microsoft

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lifted the curtain Tuesday on the newest version of its Media Center PC operating system: consumer-focused software with spruced-up features for listening to music, managing digital photos and recording TV shows.

Microsoft unveiled Windows XP Media Center Edition 2005 at a splashy launch event at Shrine Auditorium in Los Angeles titled "Digital Entertainment Anywhere" featuring Microsoft Chairman, Chief Software Architect and Co-Founder Bill Gates and singer Queen Latifah.

This third version of Media Center may finally be the one to make some inroads into the consumer market for combining PC use with mainstream electronics, analysts said.

"Today marks what we believe to be an important landmark for the PC industry," American Technology Research analyst P.J. McNealy wrote of Microsoft's announcement Tuesday. "We continue to expect the first mass-market generation of products to come to market this holiday, and 2005 will be a year where the vision of a networked home moves beyond the niche and toward mainstream as investors take note." (McNealy does not cover Microsoft but has a buy rating on

Sonic Solutions

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and a hold on

Roxio

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-- both of which he expects to benefit as homes become more networked. American Technology doesn't do investment banking.)

Analysts believe Microsoft reaps tens of dollars more on a PC equipped with its Media Center software than on those with standard XP operating system software, although Microsoft doesn't disclose that difference. But beyond just boosting sales, Microsoft's Media Center operating system is a cornerstone of a broader strategy of the world's largest software maker to ensure that it holds a central position in the move toward digital entertainment and convergence of digital media on multiple devices, analysts say.

But so far, Media Center PCs have been slow to take off. IDC expects about 550,000 media center PCs to ship worldwide this year, about a third of the research firm's previous forecast of 1.5 million. However, IDC believes that about 298,000 PCs shipped last year with Media Center software -- more than its earlier forecast of only 131,000 but still less than 1% of the worldwide PC market, said Roger Kay, vice president of client computing at IDC.

"The market is taking off more slowly than we thought it would," Kay acknowledged. He cited three reasons for the slower-than-expected adoption: software and hardware glitches; issues interacting with the rest of the "ecosystem," such as cable operators; and price.

In particular, Kay noted that at as high as $2,000, media center PCs have simply cost too much, especially considering that a

TiVo

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digital video recorder sells for about $200. By 2008, when IDC projects shipments for media-center-style PCs will reach 20 million, the price must fall to as low as $500, Kay said.

But Microsoft and PC manufacturers are headed that way, with some now selling media center PCs for just under $1,000.

Two factors allowing for a lower price are that so-called white-box, or unbranded, PC makers are now shipping with Media Center PC software, and that Microsoft itself is offering a version without a TV tuner, noted Joe Wilcox, a senior analyst with Jupiter Research who covers Microsoft. Consumers are more interested in the digital photo features and listening to music than in recording TV stations with their PC, Wilcox argued, noting that 52% of U.S. households own a digital camera and 70% of consumers listen to music on their PCs.

Perhaps surprisingly, Jupiter also found in a recent survey that two-thirds of U.S. households already have a PC in the living room, the area of the house that is the primary target of Microsoft's Media Center. "What that shows is that more consumers are treating PCs as sort of mainstream devices, like the television, like the stereo system that bellows in the living room," Wilcox said, acknowledging that this doesn't mean those PCs are necessarily connected to a TV or stereo system.

In fact, until now, Microsoft has faced at least one hurdle becoming the hub of those systems in the living room. "One of the problems of having a media-center PC is, do you want this thing with a bunch of fans humming next to your TV?" noted Sanford C. Bernstein analyst Charlie Di Bona. "It kind of ruins the mood." (Bernstein has an outperform rating on Microsoft, and his firm doesn't do investment banking, although its parent Alliance Capital holds Microsoft shares.)

Microsoft addressed that issue with the launch Tuesday of so-called Media Center extender devices, which enable users to connect their Media Center PC to any TV in the house. Microsoft also will launch a product to turn their Xbox video game console into a Media Center extender in time for the holiday season.

But the extender has some shortcomings too. First, its price is steep at $250. Second, while you can control your PC from the living room with the extender even if it's in a den, you'd still have to walk to the den to put a DVD in the computer to be played on a TV in the living room, noted IDC's Kay.

Ultimately, whether the third version of Media Center jump-starts sales will depend not only on Microsoft but also retailers, Wilcox said.

"I think that's where there has been a breakdown with the previous version," Wilcox said. "Retailers just put Media Center PC on the shelf with regular stuff and did not showcase the capabilities, and you saw many accidental sales where

consumers bought the PC for other reasons and, 'Oh, it had Media Center on it.'"

"Definitely, we remain bullish on Media Center," said Wilcox, whose firm believes the operating system will become the standard for midlevel PCs and desktop replacement notebooks over the next 12 months to 18 months. But "now it's incumbent on

Microsoft and hardware makers to work with the retailers to change that buying experience."