Can Nokia beat iPhone at its own tunes?

(Fortune Magazine) -- By the time Apple's iPhone hits Europe later this year, CEO Steve Jobs can expect a serious counterattack from the world's biggest handset vendor, Nokia. Just as Apple is marching onto Nokia turf with its first-ever phone, Nokia will reciprocate with its own long-anticipated online music service.

Fortune has learned from sources involved in the project that Nokia CEO Olli-Pekka Kallasvuo will launch the new worldwide service Aug. 29 at a London event that will include live music at the Ministry of Sound nightclub. The new Nokia Web site will let consumers download songs to their PCs and transfer them to mobile phones and other portable music players, similar to Apple's iTunes. Nokia is expected to let users transfer songs to non-Nokia phones using digital-rights-management software.

Nokia CEO Olli-Pekka Kallasvuo

More from Fortune

Floating city nears maiden voyage Stop the 'jobless recovery' madness! Playing through with one of golf's top execs

FORTUNE 500 Current Issue Subscribe to Fortune

It's not clear what record labels or artists have signed on to the service, which will also include digital games. One source says Nokia (Charts) will offer more than a million songs, fewer than Apple's five million - plus but more than the 200,000 at iTunes' 2003 start. Nokia would make the service available by fall, possibly early enough to beat Apple's iPhone to Europe.

Anssi Vanjoki, executive vice president of multimedia, who is expected to run the operation, will neither confirm nor deny the launch. Spokesman Kari Tuutti says he "cannot comment" on what the company will announce. Nokia is also expected to unveil new music phones to complement the 70 million it shipped last year, out of 348 million total, trouncing all other vendors.

Kallasvuo hinted at the music service in June. While explaining a corporate restructuring that will establish a new "software and services" division, he said, "The convergence of the mobile communications and Internet industries is opening up new growth opportunities for us, both in the devices business as well as in consumer Internet services and enterprise solutions."

A music-downloading site fits right into that plan. It would be key to Nokia's future, as services provide more growth potential and wider margins than what Nokia can garner in saturated and commoditized handset markets. "There isn't that much they can do in the phone market that will really push up the value of the company," says analyst Martin Garner of telecom research firm Ovum in London. "These other moves are aimed at extending their reach into other parts of consumer wallets."

Nokia has dabbled in online music since last fall, when it launched an Internet site called Music Recommenders, featuring David Bowie. Bowie and dozens of record shops around the world review and suggest tunes, often from obscure bands on independent labels. Consumers can purchase some of the songs, although Nokia does not promote the site as a downloading destination. It soft-pedals Recommenders as a referral site, in deference to mobile operators like Vodafone that resell Nokia phones and try to get consumers to download from "operator portals" like Vodafonelive.

But Nokia can't keep bowing to operators, because mobile music customers are gravitating away from portals in favor of other conduits. Research firm M:Metrics says that 85 percent of the 32.2 million people who listened to music through their phones from February to April in the U.S. and the EU's five biggest countries bypassed operator portals.

Handset rival Sony Ericsson is also likely to push into the music-downloading sphere. "Watch this space," says president Miles Flint, pointing out that the company has sold 35.6 million Walkman music phones since introducing the line two years ago and 130 million music phones in total.

The iPhone will challenge Nokia and Sony Ericsson to make phones more user-friendly. Even though Apple won't bring the iPhone to Europe until late 2007, European reviewers have built up expectations, heaping praise on iPhone's touchscreen. Ovum's Garner calls the iPhone "a kick up the backside to most handset vendors," which, he says, will have to roll out their own touchscreen models.

Apple spokesman Alan Hely won't say which European operators will distribute the iPhone. However, it is expected that Apple will sell the iPhone through its slick retail shops. That, in turn, is further shaking up the mobile industry. Nokia and Sony Ericsson have copied Apple's retail strategy, opening high-profile stores in major cities, increasing the volume of sales outside operator shops. "We need to make much more of a direct-branding proposition as we appeal to the consumers to drive them into the stores," says Flint.

Nokia has opened flagship stores in Helsinki, Moscow, Chicago, New York, Hong Kong and Mexico City, and will soon open in London and Shanghai. This from a Finnish company that not too long ago sold rubber boots to the Soviet army. On Aug. 29, it will write another chapter in its transformation.