There are rumors that Microsoft will try again to compete with Apple’s iconic iPod, this time with Zune 2.0 (not an official name).

According to media reports the Redmond giant is ready to launch a new version of its Zune player, which will be 3 inches tall and 1.25 inches wide, which is very close to iPod Nano dimensions.

Also Microsoft will use a Flash-based solution for storage instead of a hard drive. As its predecessor, the new Zune will have Wi-Fi connectivity and video playback capabilities. The tech site Gizmodo has even published the leaked specifications of the new Zune.

In fact there were rumors about a new Zune since July when ZuneInsider.com reported that a new Flash-based Zune is being crafted at Microsoft’s Entertainment and Devices Division under the code-name Draco ZuneInsider said that there will be a 4GB model and an 8 GB model.

They also said that Microsoft is considering a hard drive version, with a 80 GB HDD.

The current Zune, which went on sale last year in November, has a a 30GB hard drive, 3-inch QVGA LCD screen (320 x 240), Wi-Fi ‘Zune-to-Zune’ connectivity, FM radio, and access to Zune Marketplace.

Despite its limited success, in June this year Microsoft announced it has sold over 1 million Zunes.

Also last month, Microsoft has slashed the price of its MP3 player from $249 to $199.

Although the rumors about Zune are just rumors until now, the timing is perfect as last month the largest online retailer Amazon unveiled it "MP3 Store" the biggest collection of DRM-free music on the Web, with over 2 million songs from more than 180,000 artists.

With a new, better Zune maybe Microsoft and Amazon will team up to compete with Apple and its iTunes.