To establish the Windows PC as the hub of home entertainment, Microsoft is building technologies into Windows that improve the PC's ability to work with digital audio and video (digital media). The company and its partners are also creating a wide variety of entertainment products and services, from portable audio players to online music stores, that support the PC in this role.

The main goal of this strategy is to increase sales of Windows. Just as demand for Web access and e-mail created a huge spike in consumer PC demand in the mid-1990s, Microsoft hopes that new entertainment scenarios will spur consumer PC sales, particularly because working with audio and video requires significant processing power, memory, storage, and other hardware (graphics cards, soundcards, speakers, microphones, and so on) that will require most users to buy a new PC. Microsoft also expects to earn royalties by licensing and selling its digital media technologies to partners, particularly device manufacturers and content distributors.

Microsoft has other home entertainment businesses, such as the Xbox gaming console and a platform for TV providers. In the 1990s, Microsoft also took steps toward becoming a major content producer or distributor by launching the MSNBC cable news network with NBC and investing more than US$8 billion in cable TV companies. However, none of these ventures has proven profitable, and many of them are long-term bets or predominantly defensive moves meant to protect the company's Windows franchise, which remains Microsoft's largest and most profitable business.

Partners Can Benefit

If Microsoft's home entertainment strategy succeeds, hardware vendors will benefit as consumers upgrade or replace their PCs and buy new classes of devices that work with those PCs.

Content owners will also benefit by repackaging and reselling their content in new ways—particularly directly over the Internet—but only if they and the computer industry can find an effective balance between protecting content against piracy and giving consumers the ease of use they want.

For the consumer electronics industry, Microsoft's home entertainment strategy presents a mixed opportunity: it could help sell new consumer electronics products that work better with a PC. However, Microsoft’s strategy could also reduce the importance of consumer electronics hardware and lengthen its upgrade cycle, while giving a large and powerful software company a critical role in setting standards. Because of these threats, many consumer electronics companies are taking a cautious approach toward Microsoft's home entertainment strategy and platform.

Challenges

Microsoft's reliance on partners to support its home entertainment strategy puts it at a disadvantage compared with companies that own more pieces of the digital media puzzle, such as Apple (hardware and software) and Sony (hardware, software, content, and distribution). These competitors can use a popular product to steer users toward related products and services. In addition, Microsoft’s devotion to its platform leaves an opening for platform-agnostic distributors, such as RealNetworks.

However, the biggest challenge for Microsoft and its partners will be convincing consumers to abandon the status quo—a household full of discrete consumer electronics devices, each of which performs one or a few functions well—in favor of a PC "hub" connected to "spokes" throughout the home. To succeed, Microsoft and its partners must make the PC and associated devices as easy to use and reliable as today's consumer electronics products. A wave of new products released in fall 2004 brings Microsoft closer to this goal than ever before, but nagging PC problems such as security vulnerabilities and instability continue to pose a problem.

What's Ahead

This report will help hardware manufacturers, content owners, and consumer electronics companies understand the threats and opportunities posed by Microsoft's home entertainment strategy, with a particular focus on digital media. It will explain the underlying technologies and strategic reasoning behind Microsoft's digital media products and services, including the wave of products released in late 2004, and will identify likely directions for the future.

The report includes both new material and updates of material previously published in Update, and consists of the following chapters:

Understanding the Pieces explains the "hub and spoke" components of Microsoft's Windows Media strategy and how they fit together, and describes the Windows Media platform and its role in the overall strategy.

Improving the Hub: Windows Media Player 10 explains how the Windows Media Player 10 client software, released in Sept. 2004, improves the PC's capabilities as a digital media hub.

Improving the Hub: Windows Media Center explains how Windows XP Media Center Edition 2005, released in Oct. 2004, is also meant to help establish the PC as a digital media hub, while letting Microsoft sell a higher-priced OS.

Building Spokes: Devices Link to Home Hub describes networked and portable digital media devices that link to the PC.

Content: MSN Enters Music Store Race explains why Microsoft got into the business of selling digital media content over the Internet with MSN Music, launched in Sept. 2004.

Beyond the PC describes Microsoft's other forays into home entertainment, including Xbox and TV platforms.

Conclusion: Betting on Convergence explains the challenges Microsoft faces in realizing its digital media strategy, and outlines some likely future directions.

Resources contains links and pointers to additional material about Microsoft's digital media products and technologies.

Appendix: The Windows Media Platform describes the parts of the platform in more detail.