After weeks of mounting speculation, Microsoft revealed last week what had been dubbed the industry’s worst kept secret - the existence of Zune. The project involves a new combination of hardware and software products to be released later this year, aimed at breaking iPod’s stranglehold on the digital music and portable music player markets.

In what is shaping up to be a clash between computer titans, many are keeping close watch to see whether Microsoft will break through or break down in the face of iPod dominance.

So far, Microsoft has released scant details about the new project. The initial device will have a Wi-Fi wireless connection and will use a hard drive to store music. Chris Stephenson, general manager of marketing for Microsoft, in a prepared statement stated the purpose for Zune. “We see a great opportunity to bring together technology and community to allow consumers to explore and discover music together.

Rob Enderle, principal analyst at Enderle Group, said that the Redmond, Wash.-based firm would prove to be a powerful challenger to the iPod due to its enormous cash flow. He added that for Microsoft to win would require 20 percent planning and an 80 percent focus on executing the plan well. As Microsoft enters the market, his firm casts its eye on the huge market potential where conditions are ripe for entry. He said it would not be an easy challenge, given the dominance of Apple.

Market Status. Portable music devices such as MP3 players are popular around the world. In 2005, 140 million portable music players were sold, according to In-Stat. It expects more than 286 million units to be sold by 2010.

Digital music, which can be legally downloaded for a fee, is also proving to be a success. In 2005, paid-for single tracks doubled from the year before from 156 million to 420 million, according to Nielsen Soundscan. In the U.S., the number jumped from 143 million to 353 million. More companies have been moving in to take a slice of the lucrative market.

A positive correlation exists between the two markets, according to Enderle who used Apple as a model. The iPod achieved 75 percent of the market share in the U.S. MP3 player market, while its counterpart, iTunes recorded 85 percent of market share in the online music market, according to NPD group, a marketing research firm. The strategy of entering both markets by the software giant could enable it to gain a quicker market share.

Market Potential. Both the digital music and the portable music markets have the potential for tremendous growth. IDC had forecasted that the MP3 players would increase to 50 million units in 2008; while In-Stat predicted that global digital music sales to grow by 600 percent from $1.5 billion in 2005, to $10.7 billion in 2010.

The enormous appeal of iPod to adolescents is also proving to be a key selling point in getting Microsoft to enter the market. A survey of 600 high school students, conducted by Piper Jaffray & Co. analyst Gene Munster in 2004, found that the iPod placed 4th on their wish list even though it was not an option. This demographic segment is one of the most sought after market due to their potential to be lifelong customers.

The iPod is more than just a music player. Some versions double as video players, something Microsoft is trying to emulate. The informal survey, conducted by Unicast, an online video ad vendor in 2005, found 70 percent of advertisers and agencies plan to increase their use of online video. The potential to open up a new market based on the same product is proving that this market is worth fighting for.

Challenges facing Microsoft. Despite the attraction of entering into both markets, the primary obstacle blocking the firm has been the sheer market share Apple commands. In the same survey conducted by the NPD group, Apple's many rivals combined gained a total market share of 25 percent in the portable music player market and 15 percent in the online music market.

The entrenched position of Apple has given the company leverage against the competition. It has been able to sign licensing deals with major record labels and media companies. Shaw Wu, an analyst with American Technology Research, wrote in a client's note that (Apple) has sold over 1 billion songs and 30 million videos. Entering the market would be formidable challenge to Microsoft.

While the firm is concerned about the dominance of Apple in the digital music market, it's just one component of Microsoft's bigger plans for becoming a player in the digital home entertainment market where it is currently competing with the Internet-connected Xbox360 video game/DVD player.

It's more a concern that Apple controls a key endpoint in the digital home and that Apple bits flow only to other Apple controlled bits or devices, wrote Michael Gartenberg, vice principal analyst and research director at Jupiter Research. That scenario doesn't bode well for Microsoft's larger ambitions.