Microsoft's Online Store More Buzz Than Music

Analysts say the company's music store debut is still very much about sustaining Microsoft's dominance.
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Microsoft (MSFT) - Get Report is once again playing the role of the late 800-pound gorilla in a crowded-but-nascent market. This time it's online music, and Microsoft's launch of a Web-based music store Thursday is expected to initially play backup to longtime rival Apple's (AAPL) - Get Report hugely popular iTunes site.

But while iTunes has been instrumental in selling Apple's iPod portable music player, and consequently the revival of Apple shares, MSN Music, Microsoft's long-anticipated music store, is actually far less important to the world's largest software maker than recent buzz suggests.

According to analysts, other upcoming music-related software launches by Microsoft are far more important to the company's long-term goal of extending its dominant Windows operating system from the office into the home and even while mobile. The product launches are:

  • Windows Media Player 10, a beta version of Microsoft's next media player software, expected to launch later this week along with the MSN music store.
  • Janus digital-rights management software, which will enable users of online music subscription services to listen to songs on portable players for the first time. Janus is expected to debut this fall.
  • Portable Media Center handheld devices that use a version of Microsoft Windows to play recorded TV, movies, home videos, music and photos transferred from a PC with Windows XP. They are expected to debut this fall.

"Clearly again, this issue is about Microsoft expanding its technology base to both PCs and portable devices," said Mike McGuire, research director in the media group at Gartner G2.

That has been a goal of the software behemoth for the past several years. Through its money-losing Xbox video-game console, its more recently launched Media Center PC and its upcoming release of portable players, Microsoft is trying to make its operating system as ubiquitous in the home as it is in the office. And with consumers increasingly focused on digital entertainment in the home -- from photos to music to movies -- controlling digital media is a logical next step for Microsoft.

"Basically, in the next 10 years the technology for home entertainment is going to be turned upside down," said Piper Jaffray analyst Gene Munster, who has an outperform rating on Microsoft. One way for Microsoft to make sure it's part of that transformation is to provide content behind the technology, Munster said. (His firm hasn't done banking with Microsoft.)

"This idea of consuming and using music on your desktop is becoming a significant part of what people do on their computers, and Microsoft doesn't want to be left out," added Josh Bernoff, a principal analyst with Forrester Research. But "it is far more important that Windows media becomes standard than their music store becomes the leader, because controlling the future of digital media ... is probably one of the top forward-looking objectives of the Microsoft Corporation."

Meanwhile, in a note last month, Citigroup Smith Barney analyst Tom Berquist suggested that Microsoft's online store also may be a move to protect its PC franchise against Apple's recent success.

"Microsoft's real ambition may be to hurt Apple on the PC side," Berquist wrote, noting that Apple recently exceeded Gartner PC unit estimates. "By providing a technology that enables competing music services to compete more effectively with iTunes, Microsoft may ultimately be seeking to enhance its own competitive position in desktop

operating systems vs. Apple." (Berquist has a buy rating on Microsoft, and his firm has done banking with Microsoft.)

Still, that's not to say the online music market doesn't hold some promise of growth. Research firm Gartner presages that online music will balloon to a $1 billion market in 2008, compared with $170 million in 2004.

With its enormous marketing muscle, Microsoft should be able to vault to the No. 1 spot among Windows-based music services, ahead of such smaller competitors as

Roxio

(ROXI)

, Napster and Musicmatch, Bernoff said. Microsoft is expected to push the new music store on its MSN Web site -- which counts nearly 115 million unique visitors a month in the U.S., according to comScore Media Metrix -- as well as its new Windows Media Player.

In addition, unlike Apple's proprietary approach, in which iTunes music plays on its iPods, Microsoft's music store will offer music downloadable to a multitude of players from different manufacturers. Microsoft's store initially will sell music a la carte -- downloadable per song or album -- with prices expected to match its competition at 99 cents a song and $9.99 per album.

In anticipation of Microsoft's launch, longtime Microsoft rival

RealNetworks

(RNWK) - Get Report

recently launched a special promotion selling songs at 49 cents each and offering a 50% discount on albums. Excluding that special offer and the free file-sharing sites,

Wal-Mart

(WMT) - Get Report

, not surprisingly, is the low-cost leader in online music, selling songs at 88 cents each and albums starting at $9.44.

In addition to the launch of its Janus technology this fall, Microsoft is also expected to eventually offer a monthly subscription music service. Janus will enable subscribers to download their music to portable devices for a set period of time.

As well as eventually enabling both downloads and a subscription service, Microsoft's technology offers more choices than Apple among portable players at a greater range of prices, noted IDC senior analyst Susan Kevorkian, who covers digital audio technologies.

Despite such advantages, however, Microsoft still is expected to end up playing second fiddle to Apple -- at least initially. "The huge player in this market is Apple, and I think

Microsoft is going to find it a whole lot harder to displace Apple because the Apple experience -- the iPod, the music store, the application -- is so well-designed and pleasing for people to use," Bernoff said.

Piper Jaffray's Munster sang even more praises about future Apple sales. "This Christmas is going to be pandemonium around the iPod. ... Last year it was kind of a buzz, but this year is when everybody gets one," he said. "We've seen the other devices out there, and they're just not that compelling."

For now, iTunes accounts for 70% of legal music downloads, according to Forrester. And Apple's iPods accounted for 72.1% of the hard drive disc player retail sales -- excluding direct sales by Apple -- in the 12-month period ending in June, according to NPD Group. The percentage was even higher -- at 78.4% -- in just the month of June, the latest figures that are available.

Despite Microsoft's efforts, Apple's share of the market stands to grow with

Hewlett-Packard's

(HPQ) - Get Report

launch last week of its own iPod and

Motorola's

(MOT)

launch next year of cell phones that can download iTunes songs.

The idea that music subscriptions could lure enough customers away from iPod looks unlikely, given that downloads are expected to account for two-thirds of the approximately $300 million expected to be spent on online music this year and that only one-third is expected to be spent on subscriptions, according to Forrester.

The other remaining wild card is the free peer-to-peer file-sharing from successors to the original Napster, which was shut down by a court order in 2001. Although record labels have been suing individual users of free peer-to-peer sites and lawmakers have introduced legislation to clamp down on the sites, the most popular one, Kazaa, still attracted 16.4 million unique visitors in May, the latest date for which figures were available from comScore Media Metrix. And a recent appeals court ruling in favor of file-sharing Grokster and against plaintiff

Metro-Goldwyn-Mayer Studios

(MGM) - Get Report

assures that such file-sharing sites will survive for some time to come.

Despite the millions of visitors still using the free sites, Forrester estimates that 90% of the market still has yet to sample online music. The entry of big names such as Microsoft -- to be followed later this year by

Yahoo!

(YHOO)

, Virgin Records and MTV -- may finally entice more consumers to test the online music waters.

Of course, they'll have to execute with services that are as easy to use as Apple's. But in Microsoft's case, it may not be the first time that getting it right at the start won't matter much.

After all, the first versions of Windows and Internet Explorer were nothing to fawn over, yet later versions displaced early innovators such as Apple and Netscape Communications, Forrester's Bernoff noted. "It's always a mistake to underestimate Microsoft," he said.

"They always do win," he added. "It just sometimes takes many years."