Microsoft's cautious approach spurs shortage of new Zunes

If you want to buy Microsoft Corp.'s new Zune 80 Portable Media Player (PMP) for the holidays, chances are you may have to wait awhile. The well-reviewed model has been in short supply or backordered at many popular retailers like Amazon.com.

Creating some confusion, media reports have suggested that the Zune is outselling Apple Inc.'s iPods on Amazon.com. In reality, those reports referred to a sales spike for the older, deeply discounted Zune 30 model.

"The question is whether the Zune 80 shortage is the result of high demand, short supply or some combination of both," Chris Crotty is the senior analyst for consumer electronics at iSuppli Corp.

"Given the widespread criticism of the first Zune model, it is likely Microsoft erred on the side of caution when placing initial orders for the new Zunes, which include the Hard-Disk-Drive (HDD) based Zune 80 as well as the flash- memory-based Zune 4 and 8," Crotty added.

Overall, Microsoft has been surprisingly non-aggressive in its approach to the PMP/MP3 player market, which will amount to global unit shipments of 211.5 million and revenue of $19.5 billion in 2007. With its video capability and larger display, the Zune belongs to this fast-growing PMP segment. As a percent of total PMP/MP3 player unit shipments, PMPs will rise from 38 percent in 2007 to 66 percent in 2011.



Passive strategy
Exemplifying its surprisingly passive approach to the market, Microsoft waited nearly a year to follow-up its initial Zune launch with the Zune 80, and the first flash-memory-based models. Certainly, Microsoft had sufficient resources to develop the products more quickly. Furthermore, there was no shortage of flash memory or of the controller Integrated Circuits (ICs) that are the main semiconductors used in its players. While the Zune 80 does boast some advanced wireless features, competitors launched similar products earlier this year.

Another example is Microsoft's long delay in adding more content, particularly video, to its Zune Marketplace Internet site.

Terra incognito
Perhaps Microsoft is moving tentatively because the company is treading some unfamiliar territory with the Zune.

The first unfamiliar aspect for Microsoft is that the Zune uses a proprietary, closed operating system that differs from the open approach of the company's flagship Windows software. On the other hand, Microsoft could have leveraged its experience with the Xbox 360 video game console, another closed system.

Second, Microsoft is not the market leader in PMPs, an unusual situation for a company accustomed to dominating the areas in which it competes. Microsoft lags far behind rival Apple in the PMP business, another reversal from the PC operating system market, where Windows vastly outsells Mac OS.

Microsoft may feel a lot of self-imposed and media pressure to position the Zune as an "iPod killer."

To that point, the new Zune 80 competes directly with Apple's iPod Classic and its new iPod touch. The former uses an HDD like the Zune 80, but has a much smaller display. The latter features the same cutting-edge, large-sized touch display used on the iPhone. However, it employs flash memory with a density of only 16Gbytes

Although channel checks indicate strong demand for the iPod touch, the model is somewhat of a contradiction, i.e., adding a video-centric display to a product that only has limited storage capacity for video content. That disconnect raises the question of why Apple did not launch an HDD-based iPod touch.

Apple may have expected flash memory prices to drop more quickly. When that did not happen, Apple may not have had time to develop an HDD-based iPod touch. The question now is whether Apple will continue to wait for flash prices to fall, or if the company will add a HDD-equipped iPod touch during the coming months.

Locking in customers
One of Apple's long-term competitive advantages is the ever-increasing cost for switching among its customer base. The longer a consumer owns an iPod, the more content that consumer purchases from the iTunes site.

To move to a non-iPod player, the customer would need to repurchase the content or reformat through a cumbersome process that degrades quality - and breaks the law. With its closed Zune system, Microsoft is trying to replicate these switching costs within its customer base, but the company may be starting too late.

And working against both companies is the possibility of the greater availability of content free of Digital Rights Management (DRM) restrictions, an effort spearheaded by EMI Music Publishing.

Media hype aside, the new Zunes are in reality less likely to be "iPod killers" and more likely to steal share from the many non-Apple competitors.

SanDisk keeps its eye on Microsoft
One of the key competitors likely keeping a close eye on Microsoft is SanDisk Corp., one of the few PMP sellers to gain share steadily in both the U.S. and worldwide markets. SanDisk has combined a broad, compelling product line with key strategic advantages including a strong supply of flash memory, proven retail distribution, and savvy partnerships with content providers.

iSuppli estimates that through the first three quarters of 2007, SanDisk's share has grown to 2.2 percent of worldwide player shipments, up from 1.5 percent in 2007. Apple has remained nearly steady with about 25 percent of worldwide player shipments.

Find out more about the PMP market with Crotty's latest report entitled: Does Apple Have the Right Touch? To learn further details about this report, please visit: http://www.isuppli.com/catalog/detail.asp?id=8548