Fri Jun 16, 2006 10:01am ET

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NEW YORK (Reuters) - Software giant Microsoft Corp. is laying the groundwork to compete against Apple Computer Inc.`s iPod digital entertainment device and iTunes service, sources familiar with the discussions and plans said on Friday.

Microsoft has held licensing discussions with the music industry to create its own music service, the sources told Reuters.

The Redmond, Washington-based developer of software that runs most of the world`s PCs is also demonstrating an entertainment device that plays videos and music, the sources said.

It is unclear when Microsoft plans to launch, they said.

Microsoft`s software technology has provided the copyright framework for a handful of subscription music services globally. But these services have failed to topple Apple`s dominance in music and device sales, despite well financed backers including Yahoo Inc..

Apple and Microsoft were not immediately reachable for comment