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Apple's music: Microsoft's sour note?

Apple's new music service could reinvigorate the drive for online digital media standards, complicating Microsoft's plans to make Windows Media the recording industry's format of choice.

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Apple Computer's new music service could help shift the battle to control digital media away from Microsoft's proprietary file formats, according to analysts.

Cupertino, Calif.-based Apple on Monday launched the new service, which makes a catalog of about 200,000 songs from all major record labels available for download to a computer. Liberal licensing terms mean the songs also can be burned to CDs or moved to portable music players, such as Apple's iPod. Apple charges an average of 99 cents per song.

While some record labels have called the music service an "experiment," analysts see huge potential for Apple to stall or potentially derail Microsoft's own digital media strategy if, as expected, it brings the service to Windows as well as the Mac.

"There's a possibility that Apple could do an end run around Microsoft...(particularly) if Apple makes the service available to Windows users," said IDC analyst Roger Kay.

Apple's iTunes Music Store launch comes at a significant moment for the proprietary formats that first pushed digital media onto the Net. Those formats face increasing pressure from media companies eager to guarantee interoperability and reasonable licensing terms as well as greater control over their content.

The new service uses technology known as Advanced Audio Coding (AAC), endorsed by the International Organization for Standardization (ISO) and developed by AT&T, Dolby Laboratories, the Fraunhofer Institute and Sony Electronics. AAC has won positive quality comparisons with its main competitor, MP3, but it has been kept on the sidelines in part due to licensing delays and a lack of built-in anticopying controls.

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After a slow start, AAC is gaining popularity with content companies such as America Online, which recently decided to use the format in its Radio@AOL service in place of technology from RealNetworks. If the iTunes store proves to be a success, AAC could win wider industry support as a download format and further complicate efforts of proprietary vendors to establish their technology as the de facto industry standard.

Signs of the shift toward online media standards came first in the video world, when Apple based the latest version of its QuickTime multimedia software on MPEG-4, a specification being developed by the ISO's Moving Pictures Experts Group (MPEG). RealNetworks followed suit with a surprise shift toward open and standards-based technology, agreeing in principle to support MPEG-4 as well as Microsoft's Windows Media formats, and later releasing its code to the open source community. Even Microsoft has flirted with interoperability, agreeing to license Windows Media for non-Windows operating systems, including Linux.

Avoiding a hostage situation
Behind all of these moves lies a powerful motivation, analysts say: The entertainment industry is loath to lock itself to proprietary formats that might one day hold companies hostage to a single technology provider--particularly one like Microsoft.

"There is clearly an incentive to look at these standard models rather than locking themselves into a relationship with a company that has reputation for being opportunistic," said Technology Business Research analyst Lindy Lesperance.

If entertainment companies are eager for digital media standards, they have not propagated as quickly as many would have liked.

Although MP3 (MPEG Layer 3) audio is the closest thing so far to an online digital music standard, the record industry wants security, something that both MP3 and MPEG-4 lack. MP3 also comes burdened with patents and licensing terms that have made it unattractive for some developers. Also, it is being challenged by newer technology such as MP3Pro, Windows Media Audio and Ogg Vorbis that promise substantial improvements.

MPEG-4's proposed MP3 upgrade is AAC, which proponents claim provides 30 percent better compression with no loss of audio quality. A supercharged version of the technology called aacPlus, working its way through the standards process, would improve compression rates by a further 50 percent.

MPEG-4 has had its problems, with notorious licensing hang-ups that some believe may ultimately hurt the standard's competitiveness--especially considering Microsoft's history of giving away key products and recouping its costs through sales of its Windows operating system.

There's little doubt that Microsoft has used MPEG-4's problems to its advantage. Notably, Microsoft is banking heavily on anticopying technology as an incentive to sell Windows Media to piracy-fearing record labels and studios. The software giant's sales pitch includes offering content creators free use on CDs and DVDs of digital rights management (DRM) technology that could help curb rampant file trading. The DRM technology works only with Microsoft's proprietary Windows Media file formats.

The strategy has paid dividends, with all of the major record labels now distributing music online using Microsoft's Windows Media Audio format. Windows Media video technology is also used in the handful of video-on-demand services that have launched on the Net to date. None of those services yet supports Apple's QuickTime, which lacks similar controls.

"At this point we see all the momentum is behind us in this world," said David Caulton, group product manager in Microsoft's Windows Digital Media division.

"The whole ecosystem is humming," he continued. "Just because Apple comes out with a service with AAC isn't going to change things overnight." Caulton said Microsoft would disagree with the idea that the service would drive AAC adoption.

Apple has long taken the stance that DRM is a mistake, arguing that digital locks make it difficult for law-abiding customers to access products they've paid for but set up only minor barriers to skilled hackers. That philosophy, as well as Apple's miniscule market share, has meant that Mac users have had no access to licensed online music services prior to Monday's launch of the iTunes store.

In a significant concession to the record labels, Apple agreed to embed copying controls in songs sold through the iTunes store, using an in-house DRM technology it calls Fairplay. Customers are limited to burning play lists to 10 CDs, although any changes to the play list allows an additional 10 burns. Previously, Apple had prevented iPod users from copying songs from the devices, although circumventing the restriction has proved relatively simple.

It's unclear whether Fairplay is just a stopgap to satisfy the record labels in the short run or the start of a major new investment in DRM development from Apple. In the past, Apple executives have said they are in favor of standards-based DRM, something that won't likely arrive anytime soon.

Apple did not immediately return phone calls seeking comment.

Despite obstacles, some analysts said, the pull of standards is strong enough that Microsoft will face an uphill battle in the long run in its efforts to win entertainment companies over to its proprietary technology.

"It's common sense that entertainment industries are cautious about working with Microsoft," Lesperance said. "Now more than ever they look at the long-term implications of making deals with Microsoft."

The $100,000 question
Even if Apple's music service fails to find broad acceptance in the market, analysts say they believe the door is opening to standards-based media formats that Microsoft will likely find hard to close.

Apple's open-standard alternative needs market momentum to gain traction that would ensure content creators would stay on board. From one perspective, the prospects are dismal. Apple's worldwide market share is a paltry 2 percent, according to IDC. Limiting the music service to Apple customers might be good for selling some new Macs, but might also do little to expand MPEG-4 video or audio as alternatives to the MP3 or Windows Media formats.

Still, Apple's iPod, which is available for the Mac and Windows operating systems, is rapidly emerging as the preferred music player among digital media aficionados. During the fourth quarter, Apple's dollar market share reached 27 percent compared with about 10 percent for second-ranked Rio, according to NPDTechworld. In terms of unit sales, Apple captured 11.2 percent market share, following closely behind Rio at 11.3 percent and top-ranked RCA at 13 percent.

During the first quarter, Apple sold 78,000 iPod music players, according to the company, with about half going to Windows users.

The hard decision Apple will need to make is when to offer the music service to Windows users. The transition to Windows could be trickier than working inside the all-Apple system--and that could play into the decision of whether to use AAC again.

Apple will either need to rewrite its iTunes jukebox for the Windows platform, or adopt another company's software. It will need to decide whether to allow its songs to be played on non-iPod MP3 players, and many players don't yet support AAC.

Kay said such broad penetration is essential to help "establish the standards" that Apple is championing. Success in this area also could ensure that Microsoft could not at a later time use proprietary formats to choke the Mac of digital media content, which is seen as an important catalyst driving computer sales.

But success is measured in more than just market share. The demographics of Apple users are appealing enough that the company could exert tremendous sway over standards even from its small Mac base, said NPDTechworld analyst Stephen Baker.

At retail, one-third of the people buying portable music players have annual incomes of $100,000 or more, according to NPDTechworld. By contrast, 55 percent of people buying Apple's iPod have incomes in that bracket. The group also is more likely to embrace a music service and buy additional ancillary products or services than many other income brackets.

Apple's attractive demographic is more than just people with spending power. About 20 percent of people buying portable music players at retail are between the ages of 25 and 34, according to NPDTechworld. One-third of iPod buyers are in the same age bracket.

With those demographics as a starting point, Apple could use its small installed base to help direct record labels and Hollywood toward standards--a place they already seem inclined to go.

"If anyone can do it, Apple can," Baker said. "Their installed base is highly loyal and is willing to spend money."