It doesn't play files in the avi container because Microsoft's format is WMV. As far as they are concerned it makes no sens e to support other containers and codecs that are direct competition to their own proprietary format. Another reason is the DRM capabilities of WMV. Movie studios will not allow you to buy a digital movie without controlling the way it can be copied and played back. Hopefully MS will eventually build more compatibility between Zune and Xbox360 so that you can buy videos on either and use them on both, but with the resolution differences it doesn't look like things will go that well.
mod the zune to play .avi file formats
