Microsoft phone system hits reset on digital music

Microsoft's CEO Steve Ballmer gestures during the 'Windows Phone 7' presentation at the Mobile World Congress in Barcelona February 15, 2010.

DENVER (Billboard) - It's been more than six years since then-Microsoft CEO Bill Gates admitted that Apple caught the company "flat-footed" in the digital music market and directed his team to make up for lost ground, according to recently surfaced internal e-mails.

To date, Microsoft's effort to address the digital music market has largely focused on its Zune player and Zune Pass subscription service, which have won favorable reviews but few customers. But with the recent unveiling of its Windows Phone 7 Series operating system at the Mobile World Congress conference in Barcelona, Microsoft hopes to reboot its struggling digital music strategy.

Even the well-received Zune HD device, introduced last fall, hasn't been enough to convince music fans to convert to the Zune Pass. The company says it has sold only 3.8 million players since 2006, and NPD Group estimated in November that it has a 2 percent share of the U.S. portable media player market, compared with 70 percent for Apple's iPod.

So Microsoft has made it a priority to expand the Zune service to other platforms. In November, it added the Zune's video service to its Xbox Live network, consisting of more than 20 million worldwide users of the Xbox 360 gaming console. Since then, Zune communications director Jose Pinero says the number of daily HD video downloads and streams has doubled. Now, Microsoft plans to use its Windows Phone 7 platform to bring Zune to mobile customers.

"Anybody who gets a Windows Phone 7 Series phone is going to get a Zune within that device," Pinero says.

INTERNATIONAL PUSH

The most immediate impact this has is to expand the Zune service to countries outside of the United States and Canada, which are the only markets where the Zune is sold. While Microsoft will continue to sell the original Zune player in the States, Pinero says it doesn't plan to expand it to other countries, instead relying on the mobile phone software to bring the Zune service to those markets.

For this strategy to work, Microsoft will have to turn around its equally struggling mobile phone business. According to technology research and consulting firm Gartner, Windows Mobile handsets rank fourth in worldwide smart-phone sales, at 7.9 percent, as of third-quarter 2009, down from 11 percent a year earlier and behind Nokia, BlackBerry parent Research in Motion and Apple.

But those rankings remain fluid, as analysts expect global smart-phone sales to double in the next three years.

"There's certainly opportunity for Microsoft and other players in this market to grab share in the smart-phone space," says Sue Kevorkian, an analyst at tech market research firm

IDC.

Early reviews of Windows Phone 7 have been positive, with its simple interface and clean design winning high marks. But handsets featuring the new technology aren't expected to hit the market until the 2010 holiday season. By that time, Apple is expected to release an updated iPhone.

Zune will need to do more than piggyback on an innovative new mobile phone platform to generate the kind of momentum needed to elevate itself from the status of also-ran. It must compete with rival mobile music services sure to be created for handsets using Windows Phone 7, and the company hasn't yet detailed how developers will be able to integrate Zune functionality into their applications, if at all. Answers to those questions are expected in March at Microsoft's annual Web developer conference, Mix.

Zune will also need to increase its footprint to encompass more than mobile technology. That includes adding the music service to the Xbox Live network, as well as taking a larger stake of the subscription market and expanding that lackluster model beyond its current state.

Forrester Research analyst Sonal Gandhi estimates the entire U.S. music subscription market totals just 2.5 million users, and that includes not only Zune, Rhapsody, Napster and MOG, but also eMusic and those paying for the premium tiers of such streaming services as Pandora and Live365.

While Microsoft's recent moves may lend an important boost to Zune, the company will have to look beyond the subscription model if it is to have much of an impact on overall digital music revenue.