Apple's tunes could threaten Microsoft

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 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 makes the music service available to Windows users as well as those running Macs.

"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 as proprietary formats that first pushed digital media onto the Net come under increasing pressure from media companies eager to guarantee interoperability and reasonable licensing terms as well as greater control over their content.

Apple's service uses technology known as Advanced Audio Coding (AAC), endorsed by the International Standardization Organization (ISO) and developed by AT&T, Dolby Laboratories, Frauenhofer and Sony. AAC has won positive quality comparisons in relation to its main competitor, MP3, but it has been kept on the sidelines in part due to licensing delays and a lack of built-in anti-copying controls.

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 Apple's iTunes store proves to be a success, AAC could win wider industry support as a download format and further complicate efforts of proprietary vendors from establishing 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.

Behind all of these moves lies a powerful motivation, analysts say: The entertainment industry is loathe to lock itself to proprietary formats that might one day hold companies hostage to a single technology provider--particularly a 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 to an online digital music standard to emerge so far, the record industry wants security, something that both MP3 and MPEG-4 currently lack. MP3 also comes burdened with patents and licensing terms that have made it an unattractive alternative for some developers. Lastly, it is being challenged by newer technology such as MP3Pro, Windows Media Audio, Ogg Vorbis and others 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. Meanwhile, a new supercharged version of the technology called "aacPlus" is working its way through the standards process that 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 for free and recouping those costs through sales of its Windows operating system.

There is little doubt that Microsoft has so far managed to use MPEG-4's problems to its advantage.

Notably, Microsoft is banking heavily on anti-copying technology as an incentive to sell Windows Media to piracy-fearing record labels and studios--something that MPEG is only beginning to address. 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 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 support 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 over 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. The idea the service would drive AAC adoption, "that's certainly something we would disagree" with.

Apple has long taken the stance that DRM is a mistake, arguing that digital locks are an unnecessary hindrance that makes it difficult for law-abiding customers to access products that they've paid for while posing 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 iTunes store launch.

In a significant concession to the record labels, Apple agreed to embed copying controls in songs sold through its 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 is relatively straightforward.

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 any time soon.

Apple did not immediately return phone calls seeking comment.

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

"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."

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 about a paltry 2 percent, according to IDC. Limiting the music service to Apple customers might be good for selling some new Macs, but do little to expand MPEG-4 video or audio as alternatives to MP3 or Microsoft's proprietary Windows Media formats.

Still, Apple's iPod, which is available for Mac and Windows, 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.

Apple's transition to Windows could be trickier than working inside its current all-Apple system, however--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 non-iPod MP3 players, and that will affect codec choice. Many players don't yet support AAC.

Kay said such broad penetration is essential to help "establish the standards" 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 so appealing, 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 install base is highly loyal and is willing to spend money."

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 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 makes the music service available to Windows users as well as those running Macs.

"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 as proprietary formats that first pushed digital media onto the Net come under increasing pressure from media companies eager to guarantee interoperability and reasonable licensing terms as well as greater control over their content.

Apple's service uses technology known as Advanced Audio Coding (AAC), endorsed by the International Standardization Organization (ISO) and developed by AT&T, Dolby Laboratories, Frauenhofer and Sony. AAC has won positive quality comparisons in relation to its main competitor, MP3, but it has been kept on the sidelines in part due to licensing delays and a lack of built-in anti-copying controls.

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 Apple's iTunes store proves to be a success, AAC could win wider industry support as a download format and further complicate efforts of proprietary vendors from establishing 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.

Behind all of these moves lies a powerful motivation, analysts say: The entertainment industry is loathe to lock itself to proprietary formats that might one day hold companies hostage to a single technology provider--particularly a 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 to an online digital music standard to emerge so far, the record industry wants security, something that both MP3 and MPEG-4 currently lack. MP3 also comes burdened with patents and licensing terms that have made it an unattractive alternative for some developers. Lastly, it is being challenged by newer technology such as MP3Pro, Windows Media Audio, Ogg Vorbis and others 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. Meanwhile, a new supercharged version of the technology called "aacPlus" is working its way through the standards process that 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 for free and recouping those costs through sales of its Windows operating system.

There is little doubt that Microsoft has so far managed to use MPEG-4's problems to its advantage.

Notably, Microsoft is banking heavily on anti-copying technology as an incentive to sell Windows Media to piracy-fearing record labels and studios--something that MPEG is only beginning to address. 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 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 support 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 over 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. The idea the service would drive AAC adoption, "that's certainly something we would disagree" with.

Apple has long taken the stance that DRM is a mistake, arguing that digital locks are an unnecessary hindrance that makes it difficult for law-abiding customers to access products that they've paid for while posing 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 iTunes store launch.

In a significant concession to the record labels, Apple agreed to embed copying controls in songs sold through its 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 is relatively straightforward.

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 any time soon.

Apple did not immediately return phone calls seeking comment.

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

"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."

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 about a paltry 2 percent, according to IDC. Limiting the music service to Apple customers might be good for selling some new Macs, but do little to expand MPEG-4 video or audio as alternatives to MP3 or Microsoft's proprietary Windows Media formats.

Still, Apple's iPod, which is available for Mac and Windows, 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.

Apple's transition to Windows could be trickier than working inside its current all-Apple system, however--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 non-iPod MP3 players, and that will affect codec choice. Many players don't yet support AAC.

Kay said such broad penetration is essential to help "establish the standards" 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 so appealing, 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 install base is highly loyal and is willing to spend money."