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Robbie Bach is the president of the multibillion-dollar Entertainment & Devices Group at Microsoft. The group is closing in on a big fiscal year end on June 30. The company has projected that the group will be profitable this year for the first time since its inception in 2005. One of the products that isn’t profitable yet is the Zune media player. A challenger to Apple’s iPod, the Zune is so far a quixotic attempt to unseat Apple in making cool music devices that capture the buzz among consumers.The Zune is just one of many products within Bach’s domain, where the common theme is “connected entertainment.” VentureBeat was part of a small group of reporters that recently got to quiz Bach about all of his businesses, from Zune to the Xbox 360. This edited transcript is the first of several parts and focuses just on the Zune business.

Q: GameStop decided to drop the Zune player from its retail stores. That can’t be good for sales.
It’s not like they sell iPods either. GameStop saw it as a place to expand. We tried. It hasn’t gone as well as they’d like so they decided to stop selling them. It doesn’t say a lot. It was a channel expansion opportunity and it didn’t work out. It was a good thing to try. But it’s not called GameStop for nothing. It’s not called MusicStop. We have good traction with Best Buy, Circuit City and elsewhere.

Q: Where can we see signs of momentum on Zune?
The biggest place is Zune Social, our music social network site. You will see us continue to invest in the category and the product. We are selling Zunes and we are selling software on the device. We can update it. The web site marketplace software on the PC is important. People download Zune Social just for the social networking client, even without buying the device.

Q: Is Zune Social’s purpose to drive sales of Zune players, or is there a free-standing business model for Zune Social?
A little bit of both. Certainly, the Zune Social community creates an ecosystem of fans, and that helps drive Zune player sales. We make most of the money here on hardware sales, not on the music sales per se. Most of the dollars we make on music go to the guys who create the music, the labels and the artists. The music helps drive hardware volume. But the entire Zune effort is also part of a broader effort in connected entertainment. We want to create places where people can have social entertainment experiences. Over time, it is our objective to monetize that, the same way we have with the Xbox Live online gaming service. When we started Xbox Live, there were a lot of skeptics [questioning] that people would pay for a subscription for an online service. For that, people have been willing to pay subscriptions. But we have also been able to monetize Xbox Live through advertising, through downloads, and promotional sponsorships. It turns out it has a nice balance in its business model. It is still subscription focused from a P&L perspective, but advertising and downloads are an increasing part of the pie.

Q: Can you trace any increase in hardware sales from Zune Social?
No. It’s still too early. We’ve only been in the market with Zune Social for four months. It was beta until just six weeks ago. That’s still a little early. Even in the case of Xbox Live, where we are very confident that it helps sell Xbox hardware, if you asked me for an empirical formula for that, I couldn’t produce one for you. But you just have to talk to someone.

Q: Are you worried the MP3 stand-alone player market will give way to music on cell phones such as the iPhone?
The MP3 market has slowed its growth. Just look at the NPD data in the U.S. In markets in Europe, the phone has always been more popular than MP3 players. Ultimately, music will play a bigger role in the phone and visa versa. But we think of it as software and services, not just the Zune device. As the device market evolves, we can evolve with it.

Q: Will this year be the peak year in MP3 player sales?
I don’t know. It certainly has slowed its growth.

Q: You’re trying to break into a market that has peaked?
That’s why I say it’s not about just the device. The investment is in software and services to go with it. People say music is a bad business. The irony is the music business has never been better. If you’re a music label, it’s not a great time. But that’s just one part of the ecosystem. The touring business has never been better. Music promotions have never been better. Consumer engagement with music is at a peak. We look at it as a long-term investment in the music category.

Q: The Xbox guys showed a demo of games running on the Zune. It seems like a very timid way to launch games on the Zune. It is like dipping your toe in the water, seeing if hobbyists will create games on the Zune. Compare that to the major effort Apple has under way to put games on the iPod.
The way you have to think about it is to ask whether Zune is just a portable music player or a portable entertainment player. We think of it more as a portable entertainment player. The point of demoing games is to show that games can run on that entertainment platform. We didn’t demo games running on some big service because there isn’t some big service to announce. But the idea is that Zune does music, video, photos, and it has the hardware to do very compelling games on it. It is more compelling than an iPod because it actually has a D-pad. From a gaming perspective, it is reasonably well suited. You can read a little or read a lot into it. The point is that we think of it as a portable entertainment device.

Q: Do you look at it like the PlayStation Portable? It is a beautiful player of video. Isn’t that a portable entertainment device?
The PSP is a reasonably successful product at the profit-and-loss level. But as a product concept, there are cautionary tales to learn from it. While it is good at producing audio, it’s not a good music player because it doesn’t have local storage (except for flash memory slots). You can’t keep your music there. It has a beautiful screen, but you can only get the video under the Universal Media Disc format. That format hasn’t been successful. On a game level, it has done well. But even there, it is mostly PlayStation 2 ports. There isn’t much original content. When you do these devices, they can’t be pretty good at a lot of things. They need to be great at what they do. Zune is a great music player. We have local storage, a marketplace, the social network. We didn’t do video right out of the gate because you want to do those things in a high-quality way. Same thing in the gaming space. It is technically possible to do games on there. But you aren’t going to see a broad gaming effort from us until we sort that through and have it figured out. I don’t think of Zune like the PSP. The PSP is a game player that also does video and music. We think of Zune as a broad-based entertainment device.

Q: Can you talk about content on Zune? Apple has video available on the same date it is available elsewhere, like on TV. How difficult is it going to be to get similar video deals?
All of the content things over time will work out. What I mean by that is that, if you have any kind of scale, content providers will want their content on [your] platform. Apple has scale on iPods. We have scale on Xbox 360. That’s why we’re both getting content on those devices. There isn’t a lot of motivation for content providers to play favorites with platforms in the long term. They start in places with bigger volume. In the end, it’s about reaching as many customers as possible. You will note that NBC Universal wasn’t happy with the deal they had on Apple and so they pulled back. We now have a deal with NBC Universal. You will see that go back and forth between the two different sides. That’s OK with us.

Q: Is that a pricing issue, where they wanted to sell their content for higher prices?
That is the rumor that you hear. It’s about how NBC Universal wanted more control over the content and the pricing for that content. I don’t actually know for a fact.

Q: You are showing flexibility on pricing?
Our perspective is to say we have to work in a cooperative way with the content providers. Do we come with an agenda? Sure. But we look at what is the right thing to do for the customer and the right thing to do for the content provider. Philosophically, not specifically here, is there a rational reason why everything should cost the same? I think consumers are smart enough to deal with multiple price points. Pricing is uniform today because that is what content providers wanted. But on Xbox Live, there are different prices for different game- or video-elated things. So we are not deeply religious about that.

Q: Is that part of your competitive strategy?
The pricing point? No. But the partnership and ecosystem approach is a deep part of our strategy. We protect intellectual property in a serious way. If you think about the mobile space, we think operators are really important and they want to have a great business. Apple sometimes takes that approach and sometimes they are very Apple-centric.

Q: A common problem across a lot of your businesses is that you are up against competitors that have a lot more buzz than you do. The iPod and the iPhone get a lot more coverage, or buzz, than Microsoft does. Sony and Nintendo too. What is the common strategy to overcome these obstacles? You’re not going to get a tattoo or color your hair?
No. I am not going to brand myself with my clothing. Your general point is a real one. We have to be strong at creating consumer brands. I think we have done a pretty good job with Xbox. We have the potential to do that with Zune. We want to create a brand with a personal connection to people. In phones, it’s a little less true. Our Windows Mobile brand isn’t the main one for the device. The phone makers have the brand. The same is true for the Media Room IPTV technology. AT&T gets to brand that with their Uverse service brand. That’s the way it works. We do a good job with branding in some places and we need to dial up our efforts in other places. Branding is not a science. It’s also an art. We’re making a lot of progress. I don’t think it is our biggest challenge.

Q: Is it a bigger corporate issue?
On one level, we have some of the best brands in the world. Microsoft itself is an incredibly strong brand. So is Windows, Office, Xbox. Even down in the goo, with Visual Studio, we have strong brands where we operate. But when it comes to getting emotional responses from people, we could be stronger.

Q: You get the wrong kind of emotion.
How do I respond to that? (laughs).

Q: Vista went through my mind. That’s not your fault.
There are a lot of things that are going well with Vista. Branding is not one of the problems. To the extent we have them, it’s been about driver support. That gets reflected back at the brand but it’s not the marketing guy’s responsibility to see we have drivers in place.

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