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The news agency reports record companies will receive prototypes to test in the coming weeks. Microsoft is said to be attempting to emulate Apple's successful strategy of tightly integrating the iPod portable music player with its iTunes downloads service.

'They're proposing an iTunes model approach,' one source told Reuters. 'They're now interested in controlling the whole vertical stack of technology from the device to the service to the software.'

The project is being led in part by with J. Allard, vice president of Microsoft's Xbox team. His involvement is seen as significant, Reuters says, because of his experience of successfully launching a consumer electronics device. Then again, Sony too has plenty of that, but has markedly failed to break Apple's grip on both the portable player and digital music markets.