Microsoft, The Entertainer?

Since the dawn of the PC era, you would be hard pressed to find much that
Apple Computer CEO Steven P. Jobs and Microsoft Corp. Chairman William H. Gates
III agreed on. Now that Apple has reinvented itself as the king of the digital
music world, Microsoft is trying to wrestle that mantle away with a new breed of
iPod rivals, including ones that play color video as well as music. It's one
more instance of clashing world views. "We don't think people have a
burning desire to watch video on tiny little screens," Jobs said earlier
this year.

But Gates points to the growing phenomenon of kids watching videos during
long car trips as proof that there is a market for small screens. "I guess
Steve's kids just listen to Bach and Mozart," Gates quips. "But
mine, they want to watch Finding Nemo. I don't know who made that, but it's
a really neat movie." Of course, Gates knows: It was Jobs's own Pixar
Animation Studios.

When the boss gets sardonic, you can tell Microsoft is getting serious about
a market. On Sept. 2, the company is launching its most comprehensive foray yet
into the digital media world. Portable video players, which run on Microsoft
software and are made by Samsung Group and others, are just a piece of the tech
giant's plan to steal Apple's rock 'n' roll mojo. Microsoft also is
opening the doors to an online music store that includes a handful of popular
artists that Apple's iTunes site doesn't have, such as Radiohead. More
important, the company is rolling out an update of its Windows Media Player
audio and video software that's designed to make it just as easy to purchase
and manage music with Microsoft powered gear as it is with Apple's iPod and
iTunes combo. "There's nothing that the iPod does that I say: 'Oh, wow,
I don't think we can do that,"' Gates says.

The digital media push is aimed at helping Microsoft recapture a measure of
its youth. The company has been wrestling with questions about maturity as its
growth slows. Analysts expect that as the digital media market grows over the
next few years it could contribute $400 million to Microsoft's revenues. While
that's a fraction of its $36.8 billion annual take, the company is hoping over
time to generate far more meaningful revenue for its MSN unit by jump-starting
the sale of low-cost digital goodies. Once music shoppers give MSN credit card
numbers to buy songs, Gates believes they'll be more willing to buy other
products Microsoft is developing, from text-messaging services to digital
characters that can be used as personalized icons for instant messaging.
"There's a lot that has to be done to make it really comfortable and easy
to spend small amounts of money online," Gates says. "Music is
definitely one of the applications that's going to bootstrap that kind of
consumer, lots-of-transactions-online e-commerce."

The new technologies are also key to Microsoft's march into the living
room. If consumers get used to Windows Media Player and the portable video and
audio players, they're more likely to use the company's technology as they
shuttle digital content around their homes. Wide customer acceptance may help
Microsoft persuade record labels and movie studios to wrap their music and video
in its software. The idea is that the cycle could feed on itself, making
Microsoft's media technology as ubiquitous as its Windows monopoly. "You
don't have anybody investing more in bringing these consumer scenarios
together," says Gates.

Yet for all the effort, Microsoft isn't going to displace Apple anytime
soon. The stylish, simple elegance of Apple's iPod, together with its
pioneering iTunes download service, has come to define digital music. It has
sold nearly 4 million iPods and more than 100 million songs, and its momentum
shows no signs of abating. By comparison, Microsoft hasn't shown the flair
that's necessary in digital entertainment. It's relying on partners to gin
up iPod killers, and to date, they haven't come close to Apple's allure. And
even as Microsoft's partners are improving their designs, so is Apple, making
its lead that much more difficult to overcome. "The iPod has transcended
being a consumer device and become a cultural icon," says Jupiter Research
analyst Michael Gartenberg.

With the iPod so strong in the digital music biz, Microsoft thinks that
video-on-the-go may be its best chance to pull ahead long term. There, it sees a
market that looks an awful lot like the digital music business did just five
years ago. Back then, about 13% of Web-connected U.S. homes had music files on
their PCs, according to Jupiter. That's roughly the same percentage as those
who have digital video files today, according to tech research firm the NPD
Group Inc. Now, 63% of Web-connected U.S. homes have music stored on their PCs.
Microsoft's devices, which record video as well as songs, can untether
prerecorded TV shows and movies so people can watch them wherever they want. The
first devices, by Samsung, Creative Technology, and iRiver, will store 20
gigabytes of digital content-about 80 hours of video or 5,000 songs.
"Video is definitely the gee-whiz factor here," says Lisa O'Malley,
a senior brand manager at Creative Technology

The gadgets, though, aren't likely to kick-start a video revolution anytime
soon. Their biggest drawback is simply that they're inconvenient. Users can
copy video only from a PC, not directly from a television or DVD player. IDC
analyst Roger Kay estimates that fewer than 1% of the world's computers have
the TV tuner cards that are required to copy TV programming. Those can be bought
for $70, but even then the only way to watch the latest episode of, say, The
Daily Show with Jon Stewart on a Portable Media Center is to connect a cable
jack to a PC, copy the show onto a computer, and then download it to the
portable device. Although there are no restrictions on copying television shows
now, broadcasters could impose them in the future. To avoid all the bother,
customers will need to pay companies that have partnered with Microsoft to
provide content directly from the Net. That presents another problem: Microsoft
has lined up only two video content providers so far, Major League Baseball and
CinemaNow Inc. MLB.com and the movie site have less than 2 million monthly
customers combined.

Hefty And Pricey

Copying hassles aside, the products are hefty and pricey, at $500 each.
Adding video capabilities adds bulk and reduces battery life to at most seven
hours while watching videos, vs. as many as 20 hours for music-only devices.
Design is a big deal because, as Apple has proved, cool devices are the key to
winning the digital media battle. Consumers pick a device first. Everything else
is secondary. All of which likely will relegate the first generation of devices,
about the size of a paperback book, to niche status. Especially since there
already are viable alternatives for watching videos on the go. "There are a
lot of them out there already. They're called notebook computers," says
Mike McGuire, research director at GartnerG2 (IT ).

Microsoft's work in digital music holds more immediate promise. The new
Windows Media software has mimicked iTunes, letting users buy in one click songs
from MSN Music and a handful of other music retailers and have the tunes
automatically added to music libraries. But unlike iTunes, MSN Music has agreed
to carry music from artists who only want to sell entire albums online, instead
of individual songs.

Vanishing Music

Another big innovation is a feature that for the first time lets people who
use music subscription services transfer their rented tunes to portable devices.
That means customers of Napster, for example, will be able to add as many songs
from the service's one-million-song library as they can fit on their portable
players. The technical breakthrough, to reassure the record labels, is that
songs disappear from devices when the customer's subscription expires.

Still, the record labels are extracting a price for the newfound freedom.
They want more money to let consumers put subscription songs on a portable
device - they believe, rightly or not, that customers who subscribe will spend
less money buying music. Napster Chairman and CEO Chris Gorog says the company
will hike the monthly subscription fee from $10 to at least $15 for the portable
service. That's likely to limit the market, since $180 a year is a hefty tab
for music that will vanish once the subscription lapses.

Gates has grand plans for how Microsoft can change the world of digital
media. "Media today is so far short of what it can be," he says. But
he'll have to do more work to get the company's strategy in tune with its
ambition.

By Jay Greene in Redmond, Wash., with Peter Burrows and Cliff Edwards in San
Mateo, Calif. in BusinessWeek. Copyright 2004 by The McGraw-Hill
Companies, Inc

Sound and Fury: Microsoft's Digital Media Strategy

On Sept. 2, Microsoft is unveiling an offensive to strengthen its position in
the digital media market. But the push likely won't match Apple's runaway
success anytime soon

Video to Go Samsung, Creative Technology, and iRiver are launching Portable
Media Centers. These $500 handheld devices, about the size of a paperback book,
can play TV shows, movies, and music. They may catch on eventually. But the
first versions are bulky and expensive and can copy programs only from PCs, not
from TVs.

Competing Music Store Microsoft is introducing its online music store on its
MSN portal. While the service will eventually offer as many songs as Apple and
let users quickly buy songs as they hear them on Web radiocasts, it doesn't
differ much from other music retailers. Apple's pioneering iTunes is building
on its momentum and expanding overseas.

Revved-up Media Software Microsoft is bringing out an updated version of its
Windows Media Player software that plays digital video and music. The approach
is clever. The updated software makes it a snap to buy or rent digital music and
movies and download them to a new breed of mobile devices.

MOVIES: Gates Tries for A Hollywood Ending

It looked like a boffo debut for William H. Gates III and his attempt to go
Hollywood. Two years ago, flanked onstage by Oscar-winning Titanic director
James Cameron and rapper LL Cool J, the Microsoft chairman unveiled his company's
latest version of its audio and video software. But Microsoft Corp.'s upbeat
show hit a dark second act. Holding court later in a suite at the Four Seasons
Hotel, Gates delivered what one Hollywood mogul called "a second-grade
tutorial" on the economics of selling movies online. It was "a little
uppity," says the mogul, "even for the richest man on the
planet."

Someone must have sent in a script doctor. Since the debacle, Microsoft has
phased out the geeks in favor of Hollywood insiders, such as former Warner Bros.
DVD chief Warren Lieberfarb. In July, Microsoft hired Blair Westlake, former
chairman of Universal Television & Networks Group, to run a newly created
unit to lobby Hollywood. Their goal? Persuade the studios to wrap their movies
in Microsoft's software, which the company is offering for free. That way,
Microsoft can turn around and sell the software that plays these digital
versions of movies to computer makers, consumer-electronics companies, and
online video services.

Microsoft is smoothing over its legal disputes as well. During the past year,
the company settled lawsuits with Time Warner Inc.'s Netscape unit and tiny
InterTrust Technologies Corp., a copyprotection technology maker that's partly
owned by Sony Corp.

The new approach is helping Microsoft make headway. It won nonexclusive
software licensing deals with Time Warner and Walt Disney Co. Time Warner is
considering making its content available to PCs and portable devices that use
Microsoft's Media Center software. Disney is looking at using Microsoft's
software to deliver movies and TV shows over the Net. Microsoft has also won
approval to include its encoding software in the nextgeneration HD DVDs,
including the new Blu-ray format backed by Sony.

Still, the studios remain wary of Microsoft, given its bruising monopolistic
practices of the past. Hollywood execs, originally concerned that they would
have to pay for every movie or show digitized using Microsoft's software, were
relieved at the company's willingness to provide it for free under a 10-year
agreement. But the historical distrust lingers. "Sounds great, but studios
are waiting for what happens in the 11th year, when Microsoft says it has
Windows 15 and it's gonna cost you a bundle," says Richard Doherty,
research director at the Envisioneering Group, a consultancy that has advised
studios in the past. At the same time, these strategies have raised the hackles
of competitors. In December, rival RealNetworks filed suit, charging Microsoft's
practice of giving away software to content providers was part of a pattern of
anticompetitive behavior.

Hollywood is being careful to avoid becoming dependent on Microsoft. The five
studios that own the Movielink movie download service use software from both
Microsoft and RealNetworks. And despite its recent deal with Microsoft, Disney
shows no inclination to drop the copyprotection technology that it licenses from
Switzerland's Nagravision to protect movies on Disney's MovieBeam video-ondemand
service for TVs.

Tinseltown execs may still love a tale of redemption. But it may take more
than a new script for Microsoft to remake itself from villain to hero. ..

By Ronald Grover in Los Angeles