Music Downloads: Is the Price Right?

from businessweek.com - by Olga Kharif

A contentious battle between Apple and part of the music industry is set be decided today (Oct. 2), when a panel of judges appointed by Congress is expected to rule whether Apple and other online music distributors should pay higher royalty fees to music publishers.

The ruling by the Copyright Royalty Board affects not only Apple but also Amazon.com, EMusic, RealNetworks' Rhapsody, and Best Buy's Napster. Music publishers, who represent creators of song lyrics and sheet music, want an increase in royalty payments while Apple and the other companies are pushing for a reduction.

Their dispute underscores the larger debate over the best methods for distribution and how to divide the proceeds from online music sales. As more consumers access music over the Web and eschew compact disc purchases, a cross section of companies led by Apple has emerged as a conduit between consumers and the music industry, keeping a share of sales.

Publicly, Apple has railed against the prospect of a fee increase. During a 10-month trial that concluded earlier this year, Apple executive Eddy Cue claimed that a rate increase could narrow already thin margins and that the company "would not continue to operate [the iTunes Music Store] if it were no longer possible to do so profitably." The testimony fueled worry that iTunes, whose downloads have helped drive sales of iPods and iPhones, would shut down or drastically change its business model if a royalty increase comes down the pike.

Strange Bedfellows

Many within the industry expect the board to leave the current royalty rate unchanged at 9.1¢ for every 99¢ music download. The panel is due to provide the parties with a written decision on Oct. 2 before making it public on Oct. 6.

Music publishers would like to see the rate raised to 15¢ for every 99¢ sale, arguing that online music distribution costs much less than those of CDs, which also carry a 9.1¢ royalty. "You don't have to ship them, there aren't any breakage problems," says David Israelite, president and CEO of the National Music Publishers' Assn..

In an unusual twist, Apple's opposition to a royalty increase puts it on the same side of the debate as the Recording Industry Association of America, which represents record labels including EMI, Sony BMG, Universal Music Group, and Warner Music Group —and is often at odds with Apple. Under existing agreements with online music sellers, the recording industry would be forced to absorb royalty increases, at least until it could strike new accords with Apple and others. Record labels currently receive 70¢ of every 99¢ song download. They, in turn, dole out the portion that accrues to publishers.

The RIAA and the Digital Media Assn. say the current rate is already too high and want it reduced to about 4¢ per download. Record labels are competing against music that's distributed freely, explains DiMA Executive Director Jon Potter. "It's a difficult thing to do," he says.

The 99¢ Price Is a Hit

If royalties are increased, Apple is unlikely to change its tune on what it charges per download. CEO Steve Jobs has adamantly clung to the 99¢-a-song price tag. And even if Apple eventually coughs up a few pennies a song, the company's bottom line won't take a big hit, says Trip Chowdhry, an analyst at Global Equities Research. The iTunes Music Store accounts for less than 5% of Apple's sales and just a sliver of earnings.

Analysts also don't expect much change in Apple's pricing or business model either. JupiterResearch surveys show that the 99¢ price strikes a chord with consumers. Higher prices and different approaches, such as subscriptions, apparently do not find favor with the mass market. "Going to subscriptions is not a simple solution," says Jupiter analyst David Card.

Ultimately, the music industry could suffer if Apple were somehow forced to raise its prices, some analysts say. "If the price is too high, everyone is going to go the other way, which is free," says Daniel Ernst, an analyst at Soleil-Hudson Square Research, which has a buy rating on Apple.

Whatever decision the board announces, it's highly unlikely to go uncontested. Parties to the dispute can petition the board to revise its decision within 15 days. If a rehearing is refused, combatants can appeal to the U.S. Court of Appeals for the District of Columbia Circuit. Congress is another means of recourse. Just this week, House and Senate lawmakers passed legislation asking the music industry and Webcasters to reconsider royalty rates that the board imposed on Internet radio stations in 2007.

Kharif is a senior writer for BusinessWeek.com in Portland, Ore.