Apple threatens to close iTunes Store over increased royalty claims

Posted by Christian Zibreg

Chicago (IL) - A new chapter in the standoff between Apple and the music industry has begun: Content owners and publishers are pushing for higher royalties that are paid to composers and songwriters and ask Apple to eat the cost itself or pass them on to music buyers. Apple, however, says it would rather close iTunes than raise songs above the current rate.

The music industry could score a small but important victory against Apple and its  iTunes Store (iTS), if the Copyright Royalty Board (CRB) confirms a request by the National Music Publishers' Association (NMPA) to increase the royalties paid to composers and songwriters from 9 to 15 cents per song. Whether approved or not, the forthcoming ruling will, for the first time, set royalty rates for digital sales over the next five years, following a 1997 ruling that had defined royalties for physical music sales until 2007.

Apple's reaction

Not surprisingly, Apple does not agree with the request. "Apple has repeatedly made it clear that it is in this business to make money, and most likely would not continue to operate the iTunes music store if it were no longer possible to do so profitably," wrote iTunes Store (iTS) vice president Eddy Cue in his statement to the CBR.

It is somewhat apparent that music labels are pushing for the increase in royalty rates since they know Apple really has only two choices - eat the increase itself or pass it on to consumers. Both scenarios are unlikely, especially the latter as it would raise the per-song pricing above psychologically important sub-$1 barrier. "If the iTunes Store was forced to absorb any increase in the royalty rate, the result would be to significantly increase the likelihood of the store operating at a financial loss - which is no alternative at all," wrote Cue.

According an article published by Forbes, music labels demand that the CBR drops the fixed royalty model in favor of the 8% commission of wholesale revenues, or 5.6 cents, to artists. Apple and other online music stores propose a 6% commission, or 4.2 cents, much to the dismay of artists.

For each track sold, Apple pays about 70 cents to a record label which then hands 9 cents to artists. Apple and keeps the remaining 20 cents to itself. Apple said that its share covers infrastructure costs (servers, bandwidth, payment processing fees) and marketing. In the early days of the iTS, the company used to claim that the store barely breaks even and was simply a marketing tool to promote iPod sales. This isn't necessarily true today. The five-year old store currently has 65 million active accounts with credit cards and currently owns 85% of the digital music market in the U.S. Song sales zoomed past the five billion mark as of this July and Piper Jaffray estimates that the iTS will shift 2.4 billion songs this year alone.

In the June quarter, Apple's music-related activities raked in $819 million and huge chunk of this revenue comes from iTS sales. We should not forget the fact that the digital-only iTunes Store has become the largest music retailer in any format and pushed Wal-Mart down to the second rank. It is now the largest online content store in the world and no-one has succeeded in breaking its dominance so far.

Artists? It's about the infrastructure.

Common sense suggests that this new argument is another disagreement between two divas that are in a love-hate relationship. While the music industry relies on iTunes as a major revenue source, it does not necessarily like iTunes’ growing dominance. History shows that music labels play the “poor artist card”, as in this case, when they see their traditional role as the middleman between artists and stores being threatened. It happened when Napster (and then illegal downloads) grew too large and it happens now (with legal downloads) again. If you put yourself in the shoes of a music label executive, it isn’t particularly difficult to imagine that Apple might expand its role to become a music publisher one day, signing exclusive contracts with artists that will remove publishers from the entire infrastructure.

We should not be too surprised if music labels come up with more creative ways to reduce the market share of Apple’s iTunes Store - and drive them to other music service for a more balanced market, in which music labels would have much greater control overall. The problem with iTunes, however, is that it is well-funded and that it can’t be sued that easily.