Last week, Microsoft officially announced details of its new Zune consumer brand. The September 14th announcement came two days after rival Apple announced a refreshed iPod family, updated iTunes software for Windows and Mac OS X, and a revamped iTunes Store (now the ITS; it is no longer ITMS, as "Music" has been dropped from its name) that now supports movie downloads. The verdict? The soon-to-arrive Microsoft device and its accompanying Zune-branded ecosystem will not slow the iPod juggernaut. Zune, in its initial 1.0 incarnation, will be a dud.

Note: When we say iPod in this research note, we mean the hard-drive, video-capable model of the iPod line; otherwise we will use the specific model name, such as Nano or Shuffle, or use the term iPod family which will denotes all iPod devices.

The online Zune-iPod battle royal of fanboys, astroturfers, trolls, and other interested parties

In the often emotional community of tech-centric blogs and community sites, such as Slashdot, Ars Technica, Engadget, and Gizmodo, there is fierce debate over Zune. Some of the comments are relatively superficial, for example, the discussion about whether brown is a good choice for a consumer electronics (CE) device, while others dig deeper into the capabilities and business models of the Zune ecosystem components (a digital content ecosystem includes a CE device, PC-based content management software, and an integrated online store). And as with any Apple/Microsoft and Mac OS X/Windows discussion, there are rigid divisions between the vendor loyalists who discount any of their counterparts' arguments as blind "fanboy" support. And of course, in the Internet age, you can never discount the possibility that some posters are astroturfing (trying to create a false sense of grass roots support or rejection of a product) or simply trying to incite the emotionally involved (trolling).

But despite the often low signal-to-noise ratio, these discussions are important. These vocal technophiles are likely to be early adopters and to influence the buying behavior of other, less technical consumers, such as friends and family members. Creating and nurturing support for Zune at this pre-launch stage will be critical for Microsoft's success, and since Apple is so dominant in the digital download market today, any mention of Zune is a minor victory for the new ecosystem. In addition, finding the handful of nuggets of value in these types of discussions -- for Microsoft, Apple, and others -- can be of value for future product iterations (see this New Rowley research note about the value of the vocal tech community).

What we know about Zune from Microsoft

To evaluate the success of Zune, version 1.0, we need to analyze what we know of the offering. From recent Microsoft announcements, PR images, and comments from Microsoft executives, we have an incomplete glimpse of the Zune offering. The lack of solid information on certain issues, such as the device price, and confusing or contradictory information, such as the relationship between Zune's and Microsoft's existing PlaysForSure digital rights management (DRM) systems, illustrate how either Microsoft has still not worked out certain details or is refusing to divulge aspects of the Zune ecosystem for marketing purposes. That said, here's what we know so far:

• Zune is a brand, not a single product. As Microsoft puts it, Zune is part of its Connected Entertainment vision. But Zune is not just a brand designed to wrestle the digital music content market from Apple. Zune pointman J. Allard is quoted in the press release: "With Zune, we are not simply delivering a portable device, we are introducing a new platform that helps bring artists closer to their audiences and helps people find new music and develop new social connections."
  
  
• Zune will rely on a three-part ecosystem similar to the iPod. The ecosystem includes a forthcoming device, Windows software, and an online store called the Zune Marketplace. As of this moment, the device has no identifying name or model number. The Zune-centric Windows software does not have a name yet, either. The assumption, with lack of evidence, is that it will not simply be a re-badged or themed Windows Media Player 11, but an enhanced version of that software that will play Zune DRM files (see below for further discussion on the DRM issue). From an available screenshot, the software with integrated store offers three sections for music, video, and photos. We do know Zune solutions will work on computers running Windows XP as well as the forthcoming Vista operating systems.
  
  
• The Zune ecosystem will be available this holiday season in the US market. The actual release date is unknown, but it will have to be relatively soon to enable retailers to promote the Zune brand to consumers shopping for the holidays. There is no word on when non-US consumers can buy into the Zune ecosystem. Given that Microsoft is known for delayed releases -- see Windows Vista -- Zune could arrive late in the year or in the beginning of 2007.
  
  
• There will be one wireless-enabled Zune device at launch. The feature that Microsoft has touted the most is built-in WiFi wireless capability. The wireless technology is initially for only Zune-to-Zune connectivity (see below for a more in-depth discussion of this attribute). We also know the device will be available in white, black, and brown and will be manufactured by Toshiba. Like a video-capable iPod, it will rely on a hard drive for storage (the iPod Nano and Shuffle rely on Flash memory). It will include a three inch video screen (the iPod screen is 2.5 inches; both are QVGA, and both offer 320x240 pixel resolution) and will play Microsoft's own WMA (audio) and WMV (video) files and most likely files that rely on Zune-specific DRM. It will also support AAC audio (iTunes' native audio format) and H.264 video (i.e., it will play iPod-formatted video files). Despite this latter support, the device will not be able to play audio or video files that use Apple's FairPlay DRM, which includes all ITS content.
  
  Additional features include up-dateable firmware to enable future functionality enhancements (Microsoft says this "future proofs" the devices, a statement that is not credible as almost any PC or CE device, including iPods, at some point does not have the hardware to support future features), support for Zune Marketplace music subscriptions, a customizable user interface (users can change the device wallpaper, etc.), and a built-in FM radio tuner.

What we don't know

Despite the information detailed above, we still don't know several critical details, or they are unclear. These include:

• The device price. We can assume the digital content pricing will be inline with existing music services from Apple and current Microsoft partners, but what about the device? For comparison, the 30GB, video-capable iPod sells for $249. It would be hard to imagine the Zune device would be sold for more, even with its extra features, like wireless, that are so far unproven in the consumer market.
  
  
• Battery life. Wireless use could drain the battery, and video takes more energy than audio. What we need is an overall battery life for just playing music -- in the preferred Zune DRM format -- as well as a scenario for occasional wireless sharing. If sharing kills battery use, you can imagine most users will forego that activity except in rare cases. Since Toshiba is making the Zune device, it might be helpful to look at specs of a Toshiba gigabeat with a 30GB hard drive. Toshiba says the S30 model, which has a 2.4 inch QVGA display with a 320x240 pixel resolution and an FM tuner, has 12 hours of battery life for straight audio playback and 2.5 hours for video playback. For comparison, Apple's latest video-capable iPod claims up to 20 hours of battery life for audio use and up to 6.5 hours for video.
  
  
• The relationship between Zune and PlaysForSure ecosystems. For years, Microsoft's digital music strategy was to rely on partners to offer both devices and online digital music stores -- the vendor's job was to develop and license the underlying technology, including the DRM. PlaysForSure was an attempt to make this multi-partner-based ecosystem function as seamlessly as consumers expected and Apple delivered. But Zune apparently breaks that mold. The press release describes Zune as "Microsoft’s music and entertainment platform that provides an end-to-end solution for Connected Entertainment." If Zune is the company's platform, what does that mean for all the other vendors who are not part of Zune? For example, Microsoft and MTV's URGE was announced with much fanfare, but does not seem to be part of the Zune world (see this New Rowley research note on the URGE announcement).
  

Exploring the Zune/PlaysForSure mess 

According to an Engadget interview with Allard, the situation for PlaysForSure partners looks grim:

"The PlaysForSure is still a program we're going to invest in, we still have a lot of partners there, and for a class of consumers that want to have a hand-crafted media media experience and maximize their choice, we have an answer. There's another class of consumers that just want to get digital media, and they just want to be able to go to one store and have it all just plain, dead simple, and don't want to know what a codec is."

And according to Bryan Lee (note this link is to a .doc transcript download), speaking at a Citigroup Tech Conference on September 5th:

"Our PlaysForSure compatibility program is still out there... The core underlying DRM, a bunch of the technologies are all shared" but "focusing on compatibility with other services or other devices is not really something that we're after right now."

Not being part of Zune will make life even harder for other device manufacturers and online music stores, as they now must compete with Apple's and Microsoft's closed ecosystem. No matter how Microsoft tries to spin it, Zune looks like a betrayal for those that bought into the PlaysForSure vision. Already, we saw earlier this week that Zune has driven device maker SanDisk into a deal with RealNetworks, as the two companies plan to offer an alternative to the Apple and Microsoft ecosystems based on Real's Helix DRM.

The potential differentiator is wireless, but that won't be a hit for at least some time

In the Engadget interview, Allard said, when talking about Zune, "it's really about proximity." Microsoft is betting that wireless music sharing will enable the Zune device to stand out from the iPod family. But the wireless capability faces many hurdles that will hinder its consumer appeal because:

• It has restrictive rules. It is only Zune-to-Zune for now, and those that receive a music file can only listen to the song three times in a period of three days. Sharees also cannot share this file with someone else. Subsequent use or sharing will require the sharee to buy the song using the Zune PC software.
  
  
• It relies on the network effect. At the conference, Lee said, "We think of the idea that my experience gets better because you have one, because I have one, because Joe has one, that we can learn from each other, that the device can learn from me and it can learn from each of us." That may be right, but the challenge, of course, is how to get all those people on Zune. If you are the sole Zune user in your dorm common room, or don't like the musical taste of the other Zune user in the courtyard, wireless sharing will remain a novel but useless feature.
  
  
• We don't know sharing's impact on battery life. As mentioned above when discussing the device's battery life, we don't know what the impact of wireless connectivity will be. From the online video demos provided by Microsoft's PR firm, the process of sharing looks cumbersome and is not instant. If sharing consumes too much battery life, even Zune fanatics will be hesitant to embrace the device's key differentiating feature.
  

Other Zune challenges

Besides the hurdles related to wireless, there are other issues that will impact Zune's appeal, including:

• Only a single model. The first Zune device comes in one size. Microsoft is not talking about other form factors. There is no Zune device model similar to either an iPod Nano or the ultar-portable iPod Shuffle, so there is no non-hard drive offering that would be suitable for activities where size, weight, or harsh climates must be considered, such as going to the gym, jogging, or hitting the slopes.
  
  
• A retail sales challenge. Apple can showcase the iPod family in its growing stores and its own online store. Microsoft will most likely rely on resellers like Best Buy and PC makers like Dell. But will those companies: a) sell both PlaysForSure and Zune devices; and b) if so, can they explain the differences to potential buyers? Imagine the conversations at Circuit City where a store employee tries to explain to a consumer how Zune and PlaysForSure offerings are different and what that means for digital content and online store use and choices.
  
  
• The lack of cool, unique offerings like the Nike + iPod products and related site. The Microsoft press release mentioned that a Zune Car Pack, Home A/V Pack, and Travel Pack will be available at launch, and it lists 14 accessory makers that will "customize and personalize [the] Zune experience." But there are currently no creative, out-of-the-box after-market products to set the Zune apart.
  
  
• A Zune Marketplace with no current customers. On its Windows Media section of its site, Microsoft proclaims, "With Windows Media, you have the largest selection of stores to find the music and video you love." It lists 25 stores in the United States that are compatible with its existing Windows Media technologies. Fourteen are touted as being compatible with the Windows Media Player 11 beta software (note the special place for URGE). If we assume Zune devices can play PlaysForSure songs, but PlaysForSure devices can't play Zune songs and PlaysForeSure stores can't sell Zune DRM content, then all of these relationships mean little. At launch, Microsoft will have zero Zune Marketplace paying customers. The Zune Marketplace will have to grow its market-share by luring customers from other Microsoft technology-enabled stores, such as Napster and Amazon (Unbox), steal customers from Apple, or attract consumers new to digital downloads.

Conclusion: Once again, Apple doesn't have to do much to win this round

Why so harsh on Zune? Outside of the anti-Apple crowd, Zune will have a hard time convincing consumers to switch from the iPod to Zune ecosystem based solely on its most obvious differentiation -- wireless sharing.

To succeed, Lee says Microsoft has to be, "as good as Apple in the core functionality, we've got to have that simple end-to-end elegance, we've got to have a good sexy physical design for the device, we've got to have a cool brand." Certainly the Zune device shown is acceptable from a design standpoint, though it won't win any awards for being sexy -- even in brown -- and the integrated Zune software and Marketplace also appear functional and similar to iTunes/ITS. But with so many iPod users already invested in Apple's DRM content, switching will be a difficult task (Apple DRM can be removed from ITS audio files easily, but not from video files). Unfortunately for Microsoft's existing PlaysForSure partners, Zune consumer adoption will be largely at their expense.

Competing on experience

While Apple and its loyalists tout the industrial design of the iPod family as a key differentiator, device design is only a secondary motivation for Microsoft. Lee commented, "The reason that we have become a hardware company is actually less about an aspiration to do it and more a necessity of the business model."

Whether Microsoft can excite the masses with its future device designs will have to be seen, but more important will be the seamlessness of the entire Zune ecosystem. Any experiential hiccups will only add to the problems that start with the market confusion between PlaysForSure and Zune.


Hoping for relevance

So, what's the near-term metric for Zune success? Lee mentioned he doesn't expect to take the market share lead from Apple within a year. What he hopes to achieve is relevance. Relevance is certainly a tough metric to measure, unlike device or digital download marketshare and profits. If relevance is all that is required for a successful Zune launch, a massive Microsoft marketing campaign this holiday season may accomplish that soft goal.

With so many Zune issues, Apple will be its own worst enemy in the near term

New Rowley still believes that eventually Apple will have to either license its FairPlay DRM technology or adopt an industry-wide DRM solution. It's unrealistic to believe in 10 years Apple will be the dominant, global provider of digital music, TV show, and movie downloads. At some point, if it continues to succeed and refuses to license its DRM, Apple will have to split into two companies: a computer/CE company and a multi-billion dollar retailer. It will be just too unwieldy, and the business demands of a manufacturer and retailer are too diverse to remain as one in this scenario.

That said, Apple has years to go before this happens. It is successfully reinventing itself as a seller of Macintosh computers running on standard (Windows-compatiable) PC hardware, and we expect its iPod ecosystem to continue its digital content domination even in a more open world.

Waiting for Zune 2.0

As for Microsoft, Zune 1.0 will be seen as a flop. Like the Xbox, Zune will cost Microsoft hundreds of millions of dollars, with no near-term profits. As Lee said:

"You should think of this certainly not as a 12-month or 18-month investment horizon ... I'm not sure I'll be able to replicate all [Apple's] margins coming out of the gate, and I will disproportionately spend to build brand .... but the investment magnitude probably shouldn't be anywhere near what the Xbox business was."

Basically, Zune will be a financial loser for Microsoft for some time, despite how Apple has shown that the digital content market is extremely profitable (at least for devices).

And unlike the Xbox, Microsoft shouldn't rely on Apple to damage its own future market position as Sony appears to be doing with its next-generation PS3 console. Zune 2.0, evolving and emerging sometime next year, will attempt to fix the launch flaws, but Zune won't really take off until PlaysForSure offerings disappear and the digital content ecosystem becomes a clear two-horse race.