AfterTek

When Microsoft launches its Zune to compete with Apple’s iPod, it won’t just be reversing its own strategies but going against two decades of received wisdom. This could indicate a sea-change that will help more people get what they want. But it could also lead to users being increasingly locked into whichever systems they happen to buy and ultimately paying higher prices.

In this case, the key word is “experience”. When Microsoft announced Zune, it didn’t say it was going to ship a portable music player. Its press release was headed: “Microsoft to put Zune experience in consumers’ hands on Nov 14.” It was signalling that this isn’t just about shipping a product. It is, rather, about delivering a consumer experience that includes an online community and wireless music sharing between Zune owners. It is, says Microsoft, “an end-to-end solution for connected entertainment”.

Last December, Forrester published a research note: “Sell digital experiences, not products.” It points out that consumers buy products but often don’t buy the content and accessories to go with it. For example, half the US consumers with high-definition TV sets don’t subscribe to HDTV programming. The conclusion: “Digital industries must stop selling standalone devices and start delivering digital experiences products and services integrated end-to-end under the control of a single application.”

The idea’s poster boy is Apple’s iPod system, which includes the online iTunes Music Store and iTunes software on personal computers. Analysts believe that this vertical integration of online store, PC and portable player enabled Apple to deliver the ease of use that helped it overwhelm the businesses that pioneered the digital music business, such as Elger Labs, Creative Labs and OD2 (On Demand Distribution), the online music service launched by musician Peter Gabriel.

The alternative is so-called horizontal integration. For example, in Microsoft’s rival Plays For Sure music system, users have a wide choice of MP3 players from different manufacturers, and a wide choice of online music stores, with Microsoft’s PC-based Windows Media Player in between. Devices and music services are supposed to be interchangeable, but all must support Microsoft’s digital rights management (DRM) if they want to copy-protect songs. But it is openly licensed: anyone can play.

Microsoft has said this gives consumers more choices than Apple, which does not openly license FairPlay, its DRM. Its online music store is the only one allowed to supply songs protected with FairPlay, and Apple iPods the only portable MP3 players (not counting phones) that can play them. Some European governments, such as France, have objected to this approach, but it has been a huge success with consumers.

Apple’s vertical approach to the music market matches its vertical approach to personal computers, where it maintains control of both hardware and software, its own online service and even its own shops. Microsoft’s horizontal approach matches the one it took with its DOS and Windows operating systems: it licensed them as widely as possible. For Microsoft to try the vertical approach is out of character, and means it will be competing against itself and its own partners in Play For Sure.

But it’s not quite as shocking as it sounds. Zune has been produced by Microsoft’s Xbox games division, which already has a vertical integration strategy. It integrates the Xbox 360 console, Microsoft and third-party games, the Xbox Live online service and a built-in Media Centre Extender that relays movies and music from a PC to a TV set. Zune is just another extension to the Xbox game plan.

The trend towards vertical integration is also visible in the printing and digital photography markets, where companies are linking personal computers, printers, printer cartridges, photo paper and online services. Buy a Dell PC with a Dell printer and you will be prompted online when it’s time to order another Dell cartridge.  For instance, in a horizontal market, people would buy their phones and call services separately. Everyone would know the real cost of each phone and would shop around for the best value contracts. Open competition would drive down both phone prices and call charges.

The markets for printers and games consoles are manipulated in the same sort of way. Printers are sold at close to cost, or perhaps less, with the difference being made up from sales of expensive ink cartridges and photo papers.  Games consoles are almost always launched at a loss, with long-term profits coming from subsequent sales of high-priced games. Microsoft has been losing about $US1 billion ($A1.3 billion) a year on the Xbox, and Sony’s PlayStation 3 will lose well over $1 billion in its first year.

Many of us have seen it all before. Data processing was like this from the start and the ultimate master of vertical integration was IBM. It did the research, designed and built the hardware, software and networking, told you what you needed, trained your staff and did the maintenance. If you were short of cash to pay for it, it owned a bank: IBM Credit Corp. Other large computer companies Digital Equipment Corp (DEC), Data General, Sperry, Burroughs, Control Data, Wang - also adopted the vertical approach. And, of course, they were all incompatible with one another.

These integrated systems suited customers who did not know much about computing. However, they soon discovered the catch: once you had bought a system, it was hard or perhaps impossible to switch to a different supplier. Relief eventually arrived in the form of portable or cross-platform software and horizontal applications such as Unix and the Oracle database. In a vertically integrated market, most customers used the database that integrated with their system, such as IBM’s DB2 or DEC’s RDb. In the new horizontal market, they could buy Oracle to run on IBM hardware, or on DEC hardware, or on Unix, and so on.

Soon, most of the big vertically integrated computer suppliers disappeared, to be replaced by big parts suppliers such as Intel and AMD (processors), Microsoft (operating systems), Western Digital (hard drives), Cisco (routers), Epson and Hewlett-Packard (printers). Competition removed much of the vendor lock-in and brought prices crashing down.

Vertical integration may now be making a comeback because consumers are facing the problems businesses faced before: integrating a wide array of products that they barely understand. These include PCs, printers and webcams, smartphones, portable media players, digital cameras, set-top boxes and digital video recorders, games consoles, internet phones and home networking.