By Jon Fortt
October 3, 2007

Say what you will about Microsoft (MSFT) and its product flops – when it enters a new market, the company has an uncanny way of making gradual improvements until it begins stealing market share.

That’s why Apple (AAPL) and SanDisk (SNDK) shouldn’t laugh too hard at the latest version of the Zune media player, which Microsoft announced today. Yes, the original Zune has been an embarrassment for Microsoft, selling a paltry 1.2 million units in its first year – Apple sold 40 million iPods during the same period. Yes, the first Zune’s software was glitch-ridden from the start, prompting howls from reviewers who compared it to Apple’s iTunes.

But you can’t count Microsoft out. As veterans of Apple, Sony (SNE) and Palm (PALM) will tell you, the folks in Redmond are relentless.

From all appearances, the latest Zune is indeed an improvement over the original. It’s slimmer and smaller, positioning itself to compete with Apple’s most popular iPod model, the nano. Like the nano, the flash-based Zune comes in two configurations: A 4-gigabyte model for $149, and an 8GB model for $199. (There’s also a new 80GB Zune for $249, but that’s less interesting.) From what I’ve seen, the Zune’s industrial design stands up well next to SanDisk’s Sansa media player and Sony’s Walkman, which are realistically Microsoft’s main competition this time around. Apple is so far ahead that Microsoft needs to focus on winning second place.

We’ll have to wait a while to see whether consumers are any fonder of this Zune lineup than the last one. The latest Zunes won’t go on sale until mid-November, just around the time the holiday shopping rush begins. That’s also when Microsoft plans to roll out new software for music downloads, including 1 million unprotected MP3s for purchase. (Amazon.com (AMZN) and Apple also offer unprotected downloads.) Microsoft says the latest Zune will also be able to auto-sync TV shows that people record using Windows Media Center for Vista. If Microsoft can keep the sync process from being too painful, that could help the Zune compete with the iTunes video store.

But the key here is that Microsoft clearly isn’t expecting this version of the Zune to be an overnight success. The company is taking a longer view. When Reuters asked whether there were any plans for a Zune phone, for example, J. Allard, a Microsoft executive in the Entertainment and Devices division, gave this telling answer:

“The thing we are focusing on is that Zune is music first. We think there is a lot of runway first in redefining the music experience with partners. That said, we built it on the same operating system as that phone right there,” he said, pointing to a Motorola (MOT) Q phone that uses Microsoft’s Windows Mobile operating system. “So we have the flexibility to take these in a different direction where our customers, our partners and we are ready.”

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