Zune's not a failure. Yet

The conventional wisdom: Microsoft's effort to compete against the iPod juggernaut has failed. Early reviews of the Zune were scathing. Sales have been slow, coming in at less than 10% of hard-drive-based players, and less than 3% of the overall portable music player market. The executive who oversaw the launch of the product has left the company. What's to argue about?

The conventional wisdom is wrong.

To understand why, look at the Xbox business. From any normal company's perspective, the Xbox has been a resounding failure, costing Microsoft somewhere in the neighborhood of $5 billion.

But consider this: after the introduction of the first PlayStation in 1995, Sony completely dominated the gaming market, becoming the undisputed leader in unit sales, available titles (developer mindshare), and revenue for the next decade. But as of early 2007, a little more than five years after Microsoft got into the game, the situation has been reversed--the Xbox 360 is selling faster, has more available games, and is more financially successful (although this means only "losing less money" at this point) than Sony's PlayStation 3.

(OK, it's absolutely not fair to ignore the current success of Nintendo's Wii. I'm merely pointing out that Microsoft achieved its main goal: knock Sony out of the driver's seat in console gaming.)

With Zune, Microsoft's goal is to knock Apple out of the driver's seat in digital media. And it's following the Xbox strategy to the letter:
1. Focus on the hard core first. With Xbox, initial marketing and features focused on hardcore gamers; with Zune, they focused on hardcore music fans first.
2. Build in networking technology, even if it's not fully functional at first. Xbox had an Ethernet a year before Xbox Live launched; Zune has Wi-Fi but it's grossly underutilized at this point.
3. Start with a fairly rudimentary online service, then expand it over time. Xbox Live started as a fairly simple way to play games head-to-head against other users. It's morphed into a voice chat service, game download service, and source of entertainment content, such as high-definition video. The Zune Marketplace started as a simple music download store with only 2 million songs available, compared with iTunes' more than 5 million (not to mention video programming).

Taking some lessons from the Xbox business, here's why I think Zune can succeed.

Brand. At launch, with a fairly weak first-generation set of products (the hardware's good, the online service is OK, the software is fair to poor), Microsoft has already garnered nearly 10% of the market for hard-drive based players, putting it in immediate 2nd place. Such is the strength of Microsoft as a brand and marketing power. Their overall market share will increase two or three times whenever they introduce a line of flash-based players (which I expect by this fall).

Persistence. Microsoft has enough profit from its core businesses to keep after this market for a much longer time than, say, Dell. They outwaited Sony until Sony stumbled by introducing a high-priced console with a much weaker online story and, amazingly, even worse margins than the Xbox 360. They can afford to outwait Apple until Apple stumbles.

Networking. The iPod is a fundamentally antisocial device, but I agree with Microsoft that technology can make music a social experience, and this will eventually make the iPod appear outdated. They made this big bet with Xbox Live, people scoffed, and Microsoft has turned out to be correct--the biggest advantage of the Xbox platform over Sony is the better online service.

With Zune, I expect them to do things like:
1. Enable Wi-Fi-based access to the subscription version of the Zune Marketplace (as competitor SanDisk is already doing with itsSansa Connect player, which connects wirelessly to Yahoo Music's subscription service).
2. Tie the Zune Marketplace into users' Windows Live contacts lists, enabling a community to grow up around music. For example, allowing me to stream my playlist to my friends (as was possible with Microsoft's short-lived threedegrees IM client), make recommendations with links to the Zune Marketplace, and so on.

Other assets in the company. In the Xbox business, Microsoft could leverage expertise and assets in other parts of the company. The Microsoft TV folks helped design the Xbox 360's video processor, Passport and Messenger back-ends were used on Xbox Live, the game development platform is based on DirectX. Sony could certainly match or surpass some of them (hardware expertise), but not all.

With Zune, Microsoft will try and leverage assets that Apple lacks and cannot quickly build. Apple knows about networking and digital media technology. Apple doesn't have:
1. Hundreds of millions of online users with address books and buddy lists (Hotmail and Messenger), providing a framework for users to build social networks quickly.
2. A decade of experience with a mobile phone platform and relationships with carriers and handset makers. Imagine ties between Zune and Windows Mobile, perhaps a mobile version of the Zune client and/or service?
3. A game console, popular online gaming service, in-house game development studio, and relationships with third-party game developers. Imagine downloading portable games from the Xbox Live Marketplace to the Zune player.

There are countless other integration or cross-marketing opportunities...the Media Center interface built into every high-end consumer version of Windows Vista...the Microsoft IPTV platform being rolled out by AT&T and several European telephone companies...MSN Video...lots of possibilities that Apple can't currently match.

Partnerships. Microsoft knows how to be a good partner when in its interest to do so. With Xbox, Microsoft offered much better terms to game developers than Sony. With Zune, they already appear willing to offer better terms to content owners (such as per-unit payments to Universal) than Apple. Content owners would be happy to see the Zune succeed, as they could then use Microsoft to drive Apple into a tough negotiating spot.

All that said, Microsoft is certainly capable of messing it up. The first Zune has some real flaws. They've got to fix the Zune PC software so it has all the functions--and ideally more functions--of iTunes (the superior Mac version), and works as smoothly. (It's completely beyond me why Microsoft's digital media experts cannot figure out how to handle metadata--the tags that describe songs, artists, and so on--without mangling it or trying to auto-update it incorrectly.) They've got to do something interesting with the Wi-Fi connection. They've got to release an inexpensive Flash-based player. They've got to keep improving the hardware, perhaps adding a built-in digital recorder?

Most important, they've got to stay focused, and not allow the Zune team to get caught up in the next companywide strategy shift or reorganization.