The curious case of the Microsoft Zune phone

While Microsoft has been busy dilly-dallying with its Zune digital music device, rival Apple has started dominating a vastly more powerful market: Mobile phones. The iPhone has changed things — it makes even the iPod feel like a relic, which makes the Zune feel like bad relic. So it should be no surprise that we’re now hearing a lot of rumors about Microsoft jumping into the mobile phone space.

But the rumors, which have intensified over the past few days, are starting to conflict, so where are we? Two days ago, a report said that Microsoft was working with graphics-chip maker Nvidia on a device that would be unveiled in February. This seemed highly unlikely for a few reasons, the most suspicious of which was the quick timeline.

But a different report today suggests that the Zune is about to evolve into a smart phone under the code-name “Pink,” a “good” source tells CNBC’s Jim Goldman. This device would combine the Zune with the technology acquired when Microsoft bought Danger, the company that made the Sidekick for T-Mobile. Goldman said a prototype of Pink could be unveiled as soon as January at the CES trade show, but that a wide release would probably be a year away. That does seem a lot more plausible.

But not so, says Jupiter Research’s Michael Gartenberg, who writes that “Microsoft will NOT do their own phone anytime soon,” in a blog post on MobileDevicesToday. His rationale is that since Microsoft already has a mobile software platform (Windows Mobile) on some 20 million devices, it would be foolish to compete with itself. After all, a Microsoft phone would likely have to ally with a wireless carrier, and that could alienate other carriers whose devices run Windows Mobile, basically killing the platform.

But Gartenberg doesn’t mention one key thing: Windows Mobile is awful.

Sure, there may be 20 million licenses out there, but if Microsoft doesn’t get its act together soon with its mobile software, it’s going to be run out of the market by not only smart phones like the iPhone and BlackBerry, but more directly by Google’s Android platform. Anyone who has used a Windows Mobile device compared to these three others knows exactly what I’m talking about.

Certainly, most developers do. I’ve talked to a ton of them over the past year, and I’ve yet to meet one who really takes Windows Mobile seriously as a platform for the future. Granted, most of them are already geared toward the iPhone, Android or BlackBerry, but at some point, there are going to have to be some developers that want to work on Windows Mobile, or it will die.

Definitely also worth noting is that Microsoft doesn’t make that much money off of Windows Mobile. Even at high-end estimates, those 20 million licenses probably only pull in some $300 million in revenue, Silicon Alley Insider estimates. That is pocket change for Microsoft. And Apple is already pulling nearly $5 billion in revenue from the iPhone — a quarter!

With the next version of Windows Mobile, version 7, delayed, possibly until 2010, Microsoft needs a new mobile strategy — fast. That new strategy could be and probably should be a piece of hardware with a new core mobile operating system.

Perhaps it’s reading too much into it, but Microsoft recently reassigned the head of its MacBU division (the team that builds software for Apple products), Craig Eisler, to a position in the Entertainment & Devices division — the one that makes the Zune. Eisler previously severed as the general manager of AOL Wireless, something that could help a new team of Microsoft engineers working on something like, you know, a phone.

It’s not rocket science, it’s business. Microsoft will build its own mobile device. It may not be next month, but it will happen. God forbid there be a market that Microsoft doesn’t try to compete in.