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September 26, 2006

Zune Not A Near-Term Threat To iPods

Apple Computer (AAPL) shares have continued to rise following the introduction of Microsoft's Zune music player. Apple has benefitted from growing recognition of the company's outstanind momentum in Mac sales, excitement over the previewed iTV device, and the introduction of updated iPods for the holiday selling season. Additionally, the Zune has been met with a yawn from previously worried observers. I think the momentum will hold and AAPL shares can make a new all-time high in the nex several months.

Given the recent focus, here are are some thoughts on the Zune player written from the perspective of the impact on Apple shares over the next three to six months. Obviously, Zunes and iPods will both develop their capabilities and ecosystems, so I am keeping my mind open on a long-term basis.

I see three differentiating factors for Zune vs. iPod. First, the wireless capability. Second, the subscription model. Third, the larger screen. For this holiday season, I see minimal value in wireless, potential value in the subscription model and real value in the larger screen....

As far as I can tell, the key wireless feature is that Zune lets you do is receive songs from someone else's Zune (with limited playback). Microsoft (MSFT) appears to be placing a lot of emphasis on this "connected entertainment," relating it to the success of MySpace. It doesn't seem to be a big deal to me. Until there are tens of millions out there, your friends have to have Zune unless you want to approach somebody on the street you happen to notice has a Zune.

I suppose Microsoft thinks the MySpace concept will drive groups of friends to buy Zunes so they can share. Anecdotally, I asked my son, who is freshman at NYU, how many people on his floor had an iPod. He said virtually 100%. That would seem to be the target market for the "connected entertainment" concept. Are these kids going to dump their hundreds to thousands of dollars in investment in an iPod and iTunes downloads just so they can share?

Also, does anybody know if Microsoft has any kind of patent on this sharing technology? If not, I've got to think that Apple would respond quickly if it took off.

I guess wireless also means syncing Zune with your library without wires. Again, I say big deal. It's really not very hard to attach your iPod to the USB port. Finally, I'd expect wireless to hurt battery life. Cody Willard seems to see other potential uses for the wireless capability but Microsoft doesn't seem to be mentioning anything else.

Some folks will like subscription if it is accompanied with a solid player, so some value exists there. The larger screen is good for video, assuming the picture quality is not compromised. That seems like something Apple could have done unless maybe the part of the click wheel we can't see gets in the way. I wonder if flipping the Zune portrait and landscape for music and movies might cause some issues with the controls? Also, when I read Apple blogs, folks are really hung up on picture quality. Is there a risk of degradation when you flip it? I wouldn't expect so but something to think about. We also need to see whether Microsoft will offer a better library of video downloads. I thought the interview on CNBC with the head of Zune left open the possibility that it would launch with minimal video downloads available.

As to disadvantages, I personally think it looks clunky and early blogger comments indicate it is bigger and heavier than an iPod. Zune doesn't have a click wheel. Apple has that ergonomically friendly feature patented. We don't yet know about pricing but I think Apple upped the ante there with the new iPods. Also, the ecosystem of accessory suppliers for iPods is huge and provides a competitive advantage. Will Zune be able to ramp accessories quickly?

Finally, and probably most important, will the Zune store, apparently named Argo, match iTunes? iTunes is the part of the Apple ecosystem that is underappreciated by investors. And the latest version improves on an already great program.

The bottom line is that if Microsoft wants to sell units, they can probably get it done. They could steal a little market share from Apple but most likely its market share gains will come from the 25% Apple doesn't have. And Zune better get a cool factor quickly or at least for this Christmas, it won't be under the tree. Someone on RealMoney or Street Insight said that you don't want to open a Zune and have to fake your excitement because you really wish it were an iPod.

I am staying long Apple and watching booming Mac sales while CNBC and too many others are focused on music players.

Posted by Steve Birenberg at September 26, 2006 11:22 AM in AAPL