(FORTUNE Magazine) – Steve Jobs (yes, him again) was working his way methodically through one crowd-pleasing new feature after another at Apple Computer's early January new-product launch in San Francisco when he welcomed onstage an unexpected guest: Kunitake Ando, the president of Sony. Given how thoroughly Apple's iPod music player and iTunes music service have humbled the Japanese giant in a world where Sony and Walkman once were the only two words that mattered, Ando's appearance was a bit jarring. The No. 2 Sony executive ostensibly alighted for his five-minute cameo at Macworld to promote a new high-end Sony camcorder that's compatible with Apple's latest high-definition video-editing software. "Strategically, it is very important for Sony to work with Apple to create great applications that work seamlessly with all Sony products," Ando said, smiling broadly at Jobs, who seemed to be enjoying the irony of mighty Sony deferring to little Apple. Jobs graciously returned the compliment, noting the two companies' cooperation on camcorders and digital still cameras. And hinting at a deeper relationship, he added, "Who knows? Maybe one day on computers and music."

That Sony should need anybody's help when it comes to music, let alone that of a computer company that wasn't even in the home electronics business five years ago, speaks volumes on just how far Sony has fallen. Yes, it is still the world's biggest and broadest consumer-electronics company, with a name ranked as the world's 20th-most-valuable brand and operating earnings in its most recent quarter of $1.3 billion. But don't mistake heft for health. Revenue fell in the quarter by 7.5% as profits dropped 13%, and Sony has faced one humiliation after another, from its failure to anticipate the demand for the technology that goes into flat-screen televisions to its flat-footed response to the rapid commoditization of conventional TVs and DVD players.

Yet it's in digital music that it has suffered its greatest embarrassment. Even though music only accounts for 16% of revenues, it's music that put Sony on the map. When it came to navigating the digital future, Sony should have been the bold leader, not a bumbling follower. Instead, Sony developed various nondescript portable music players--one is the Network Walkman, which until recently didn't play the most popular kind of digital music--and a digital-music download service, Sony Connect, that barely anyone uses. The missteps that brought Sony to this point and the way it's coping with them reveal a lot about the bigger struggles this consumer- electronics powerhouse is battling. They provide salutary lessons in the perils of adhering too rigidly to proprietary technology and in how owning content--the music and the movies--doesn't always help you understand what your customers want from their gizmos. Ironically, one potential solution to Sony's music woes may not even lie in its music business--for it is Sony's latest gaming device, the PlayStation Portable, that's emerging as its most potent weapon.

For help out of this mess, Sony has reached out in an extraordinary fashion. It has tapped a young American who not only is a gaijin, but one with scant big-company experience, to steer Sony's efforts at saving face. His name is Phil Wiser, a founder of the 1990s digital-music software pioneer Liquid Audio and currently chief technology officer of Sony's U.S. organization. As of November 2004, Wiser had added an additional title: co-president of Sony Connect, a subsidiary that reports to Howard Stringer, head of Sony Corp. of America, as well as to Keiji Kimura, the Tokyo-based executive who runs Sony's Vaio computer division. Wiser's tasks are to rethink how Sony sells music online (its download-music site is also called Connect), craft a strategy to make sure that Sony devices work with all forms of digital music, and oh, by the way, find a way to persuade the far-flung fiefdoms within Sony to pull together and accomplish all this. At 38, Wiser is full of optimism and energy. The latter will come in handy as he shuttles among Sony's offices in New York, Los Angeles, and Tokyo. "We've done it before, and we'll do it again," he says, when asked to rate Sony's chances of regaining its rightful place in portable music. But before we hear more about Wiser's formidable To Do list, it's necessary to recount how Sony got itself into this pickle in the first place.

As illegal downloads exploded in popularity in the late 1990s, Sony, like the rest of the music industry, froze. Its music and movies divisions wanted to protect their intellectual property from being stolen. The electronics unit, whose products always were built on proprietary technology, wasn't about to build devices that would play MP3s, the popular compression technology that enables music to be downloaded. Neither was it interested, importantly, in making products that would work with the other gadgets being developed to play the purloined goods. Sony, you see, is happiest when its customers are using Sony technology--and only Sony technology. Even as music fans illegally downloaded songs by the bucketload onto their PCs, Sony was slow to create a service that enabled them to buy music legally. In 2001 it launched a joint venture with Universal Music Group called Pressplay that initially failed to license music from competing labels and as a result never attracted many users. (They eventually jettisoned Pressplay.) Leaving the MP3 market open to lesser-known players such as Rio, Creative Labs, iRiver, and of course Apple, Sony instead chose to build devices around its own MiniDisc technology.

Apple's introduction of its iTunes music store and downloading software in April 2003 was a watershed in digital music. (See "How Big Can Apple Get?" in this issue.) Although Apple insisted on its own copy-protection software, FairPlay, which meant that songs purchased from iTunes would play only on iPods, it licensed a widely available compression technology called Advanced Audio Coding (AAC) and, crucially, enabled the iPod to play MP3s. What's more, Apple quickly followed up by making iTunes work almost as well with PCs as it does with Macintosh computers, opening its potential market to the broadest possible audience of computer users. (Most other download services and devices use software from Microsoft called Windows Media Audio, WMA, which has quickly become the digital-compression and piracy-protection choice of the non-iTunes and non-iPod world.) When Sony belatedly opened its Sony Connect online music store in 2004, it used its own proprietary compression technology, ATRAC3, as well as its own protection software, OMG. (It stands for Open Magic Gate, and is neither open nor magic, its critics like to say.) Mimicking Apple's strategy, Sony ensured that songs purchased at Sony Connect played only on Sony devices. But those devices wouldn't play MP3 files, which still account for as many as half the songs in the libraries of most downloaders. "If you create a device that doesn't even allow the playing of MP3s, you clearly don't understand the market," says Phil Leigh, who runs the research boutique Inside Digital Media.

Sony might have gotten away with its tardiness and closed system if it had built a superior music service. It didn't. Connect's clunky software and jumbled interface turned users off, especially compared with iTunes, which loads in a snap. The critics were brutal. The Wall Street Journal's Walt Mossberg called Connect "bad all over." The New York Times was even tougher, suggesting that "for the time being, maybe they ought to call it Sony Disconnect." Not surprisingly, Sony hasn't sold many songs on Connect, despite promotions with United Airlines, McDonald's, and others. The company doesn't release sales figures, but in a Nielsen/NetRatings survey of music sites visited in December by Internet users, Sony Connect ranks No. 23, with Yahoo's Launch, AOL Music, and iTunes the top three sites. Even Sony Music, the record company's site and more a promotional venue than a music store, ranked much higher at No. 6. Sony also hasn't managed to sell many of its music players. Apple claims a 65% share of the U.S. digital-music player market, which includes low-end, flash music players like the iPod Shuffle it has just released. "Sony's market share is so small in this marketplace that they just get lumped into the 'other' bucket," says Michael Goodman, an analyst with Yankee Group.

The failures are reverberating all the way to Tokyo. When Sony released its disappointing quarterly financial results on Jan. 27, it singled out weak portable audio sales as one of the culprits. In a speech to foreign journalists the week before, PlayStation chief Ken Kutaragi, widely considered to be a candidate to succeed 67-year-old Sony CEO Nobuyuki Idei, acknowledged that piracy fears had kept Sony from building the right devices and services. "Even three years ago, because we had music, Sony was reluctant about introducing an iPod-type of new product," he said. "The situation is a bit frustrating for everyone."

Phil Wiser's job is to end that frustration. At first blush, he is an unusual choice for such an important job at Sony. In the early 1990s, Wiser bounced around a handful of Silicon Valley startups before co-founding Liquid Audio in 1996, which came up with software that music labels could use to protect their songs from piracy. He repeatedly called on Sony Music, he says, unsuccessfully pitching it his products. Those sales calls, however, led him to join Sony Music in 2001 as chief technology officer, responsible for dealing with the new music-download services, including negotiating Sony's first two deals with Apple's iTunes. Such practical experience aside, it turns out that Wiser just might have the perfect background for Sony's engineering-oriented culture. Like the legendary Sony CEO Norio Ohga, Wiser was a musician in his youth, playing bass guitar for the Baltimore- area band Child's Play. He has impressive technical credentials as well, having published research on auditory neural processing (that's a fancy way of describing how our ears work) while at Stanford's Center for Computer Research in Music and Acoustics.

Now barely into his new job and unwilling to tip his hand just yet on his group's evolving plans, Wiser clearly is wearing the hair shirt. "We need to move faster and deliver real results," says Wiser, in one of his first interviews in his new role. "And we need to continue to keep the consumer as the top priority. As at any big company, sometimes the strategy can get in the way of the product." Sony has great software, he says, but "it hasn't focused specifically on consumer-application software." Of course, that's a polite way of saying that Sony has produced some clunkers and just might not be up to snuff when it comes to software.

As for Wiser's mission, to figure out how to make Sony devices work with more services and other companies' devices, the buzzword here is "interoperability." Consider that before the Internet, most of your toys were islands in your home. Today you want them all to connect regardless of who made them--and that's not so easy for Sony. Wiser's task, then, is to calibrate how much revenue Sony can stomach giving away and what it will try to keep to itself. "We're making interoperability a priority, and we want the solution we deliver to the consumer to be as open as possible," he says. "There are technical issues around what we can do, and there are business issues around what we can do. You know, Steve Jobs has made it very clear he's not interested in opening up his system. So what we can do, we will do." If Apple carries its closed strategy too far, as it arguably did for the Macintosh computer, it could, ironically, create an opportunity for Sony, provided it can find a way of loosening its own equally strong attachment to in-house standards. It seems certain that Sony will embrace other technologies--it's just a matter of which ones and how quickly. Already, it has released its first music device that accommodates MP3s, the Network Walkman HD3. At $350 it's about $50 more expensive than the comparable 20-megabyte iPod.

Wiser also must figure out how Sony Connect can work seamlessly with other Sony products, especially the PlayStation Portable (PSP). PlayStation arguably was the company's last megahit when it was released in 1994. In mid-December, Sony released the first handheld version of the PSP in Japan and quickly sold half-a-million units. It reaches U.S. shelves in March. The size of a large taco, the PSP is a multimedia wonder complete with Wi-Fi wireless capability and high-quality video and audio. There are some problems, though. Try playing your own music on it--it's not so easy. Currently the only way to capture a song from Sony Connect on a PSP is first to save it to a Sony Memory Stick, which then can be inserted into the handheld gaming device. Purchasing music from the PSP directly over the Internet using the wireless connection would be a heck of a lot cooler, but there are no current plans to allow users to do so.

Improving the interoperability of its own gadgets and services is one thing, but Sony's bigger challenge is reaching out to competitors. The easiest but perhaps most humbling move would be to license Microsoft's WMA software. Bill Gates hinted at Sony-Microsoft cooperation in early January. Sony is loath to allow Microsoft to earn revenue on Sony devices, but working with WMA would be a quick way to boost its customer base. It's also possible that Sony and Apple could work together. A linkup of the two companies, whose relations with each other always have been friendlier than either's with Microsoft, could give Sony access to Apple's iTunes customers and Apple access to Sony's worldwide distribution network. Remember president Ando's plea for Apple to "create great applications that work seamlessly with all Sony products"? Even though Wiser can't yet say how Sony will achieve interoperability, he does rule out one major option--that Sony simply kill its download service and focus instead on selling devices that work with other companies' offerings. Says Wiser about the Sony Connect service: "It's core to our strategy going forward." Sony has no intention, he says, of sending its own customers elsewhere to buy Sony's music.

So is it too late for Sony to catch up to Apple? Sony executives like to say the game is still early. "I remind you we are only in the first inning of a nine-inning game," Dick Komiyama, president of Sony's U.S. electronics operation, said in an early January speech. In a sense he's right. Digital music represented less than 2% of U.S. music sales last year, and even in iPod-crazed coastal cities, there are still plenty of people who don't yet own a portable digital-music player. But that doesn't let Sony off the hook. It's critical that it make the right format decisions soon or risk being permanently crippled. "This business only has a three- to four-year history," says Alan McGlade, CEO of MusicNet, an industry consortium (partly owned by Sony BMG Music) that runs music services for sites like AOL Music, Virgin Digital, and TransWorld Entertainment. "What you see today in terms of proliferation of formats simply won't exist in the future." As any market begins to mature, one format generally becomes the standard (think CDs and VHS). Put differently, if Sony persists in going it alone, it runs the risk of becoming sidelined, especially when it could be focusing instead on the next area ripe for a download revolution: video.

Focusing strictly on the future, come to think of it, might be Sony's best option. True, Wiser insists that salvaging a digital-music strategy is mandatory. But the PSP, in all its multimedia glory, presents a tantalizing opportunity for Sony to simply move beyond its digital-music travails and leapfrog the competition with a totally different gadget that stands a chance of becoming the ultimate arbiter of cool. Now that would be a feat that would put Sony's stamp on the current century as much as the last one.

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