Microsoft is famous for losing the initial battle but winning the long, drawn-out war. And while Apple’s combo of the iPod and now iPhone may seem an insurmountable competitor, Microsoft today released a major upgrade of its Zune device and software to more directly compete with Apple, amid rumors it may also have a “Zune-phone” in the offing soon as well.

Microsoft is already on the second generation of hardware for its Zune player, which, like the iPod, delivers music, podcast and video playback. Microsoft has lagged behind Apple on the software front; its Zune software up to now has not offered movies or TV shows for sale, although it does offer a subscription-based music service, something Apple has shied away from.

Today Microsoft released the Zune 2.5 software, which among other new features will offer downloads of TV shows from a variety of sources, including Comedy Central, NBC, Nickelodeon, Ultimate Fighting Championship and elsewhere. Overall, Microsoft will offer more than 800 TV episodes for download, priced at 160 Zune points (or about $1.99). Movies were not part of the announced offering.

The pricing based on “Zune points” is sure to confuse some customers. It is an off-shoot of Microsoft’s Xbox Live Marketplace, where customers use points to conduct e-commerce – including purchasing movies and TV shows – for download to the Xbox platform. Xbox has proven a major winner for Microsoft, and leveraging that community onto the Zune player is something the company has been pursuing, up to now with very mixed efforts and results.

Overall, Microsoft said it has 3.5 million music tracks (two-thirds in non-DRM MP3 format), 800 TV shows, 4800 music videos and 3500 audio and video podcasts. By comparison, Apple touts 6 million songs, 11,000 videos, 30,000 audio books, 100,000 podcasts and 600 TV shows – not to mention movies – in its iTunes store.

In the first quarter, Apple had 71% of the US portable-music-player market in the first quarter, compared with 4% for Microsoft, according to market-research firm NPD Group.

“The Zune has little chance of overtaking the iPod any time soon,” said Avi Greengart, research director-mobile devices at Current Analysis. “But Microsoft has clear strategic reasons for creating a viable alternative platform to Apple, and I would think that there is a fairly healthy business opportunity in music players for a second- or third-place challenger. Microsoft is not alone thinking so; SanDisk, Sony, Samsung, iRiver, and Archos (among others) are all creating new generations of hardware.”

The biggest differentiator for the Zune right now is its subscription pass offering, which, for $14.95 per month, allows customers to listen to all its available music as well as download to their Zune player. Microsoft has shied away from marketing the subscription service heavily, focusing initially on the “social aspects” of the Zune – ie, song-sharing over its built-in wireless capabilities.

Another differentiator is the “built-in” Zune social network, which lets Zune users share their music interests with other Zune customers. The service is slick but pales in comparison and user base to Web-based alternatives such as Last.Fm and iMeem.com, which not only count millions of users but have also begun to offer free streaming of music content off of their Web services. Elsewhere, Nokia has begun offering “Comes with Music” subscriptions on some of its devices, which let customers download unlimited tunes to their phones from participating record labels, initially Universal and EMI.

“Consumers want more than the traditional transactional model of an online music store plus portable device,” said Chris Stephenson, general manager of Global Marketing for Zune at Microsoft, in a statement, taking a swipe at Apple’s music model while also touting not only the Zune’s new video offerings but its subscription service and integrated music-based social network.

Among other Zune software updates included the addition of auto-playlists; drag-and-drop editing of album and track info; organizing music by collections; gapless playback; and the ability for the Zune software to synch multiple Zune players simultaneously.

The additions get the Zune closer to feature parity with Apple iPod/iTunes – and beyond it in some key areas. But it does not yet address rumors around a possible “Zune-phone” competitor to Apple’s iPhone. Microsoft already delivers phones under the Windows Mobile brand – with promises that the just-announced Windows Mobile 6.1 and upcoming Windows Mobile 7.0 platforms will help it catch up with the iPhone in terms of user experience and features.

But Microsoft’s phone plans – particular on the consumer side – could extend beyond Windows Mobile. In February, Microsoft acquired Danger Inc., makers of the popular Sidekick cell phone, for $500 million. Microsoft’s Stephenson, (as he has done in the past, once calling an integrated phone “definitely part of the future of this brand”), reportedly touched on the potential of a Zune phone this week, including the prospects of bringing together the Zune and Danger teams.

But for now, the Zune-phone remains pure speculation, said analyst Greengart.

“Microsoft has not announced what its plans are for the Danger acquisition, so any projections or potential combinations would be extremely speculative,” Greengart said. “Still, the market for consumer smartphones is still wide open – the vast majority of phones sold today are still basic featurephones, even in developed markets like the US. Microsoft has long had all the pieces to succeed in this market but has not managed to put them all together.”