Universal’s Big Mistake, Thumbing Their Nose to Apple

Universal have made the decision not to renew their contract with Apple to supply the iTunes music store. Or, at least, are considering it. The decision is being reported as a major blow to Apple, but I’m not so sure.

Universal must be making this decision because Apple will not allow them to dictate the pricing on the iTunes store. This has been the chagrin of the recording industry since the introduction of the store. Apple wish to have a single price for all songs, which is 79p a track here in the UK. The record industry wish to have variable pricing, which they control. Popular artists would be more expensive, less popular artists less so.

The single-price structure is good for Apple. It means they have a very simple sales model. It also means that they don’t have to produce a complicated back-end system to allow the record industry to arbitrarily change song prices whenever they feel like it.

More important, however, the structure means the record industry doesn’t have control of Apple’s profits from the store. Presuming Apple gets a cut of each sale, a fixed price means that Apple get a fixed amount for each sale. Modulating selling prices would make profit per track less predicable for Apple, especially as the record companies want direct control over the pricing. The record companies would greatly increase their power over Apple: they could put pressure on Apple by lowering their prices temporarily, for example.

Of course, the record industry also wants to have variable pricing structures so they can manipulate prices to give them best profits. Popular acts are guaranteed sellers, and so high prices mean more profits for the companies. Lower prices on less popular artists hopefully mean a reasonable revenue stream from them, the lower price means they are likely to sell more copies.

Now, on to why Universal’s decision may not be such a major blow to Apple and why Universal is shooting themselves in the foot.

Universal is the biggest record company, so the loss of their tracks in the iTunes store is obviously a blow to Apple. No longer can they claim to have all the major labels on board. However, unless the other major labels follow suit, they still have a large selection of music, and they still have their single price structure. Retaining this is important for Apple.

Stating that the loss of Universal is a major blow to Apple is predicated on the fact that the iTunes store is a major part of Apple’s strategy. To counter this, consider Steve Jobs himself mentioned in his note on DRM and music that the vast majority of tracks on iPods are not purchased from the iTunes store. The tracks are ripped from CDs or downloaded from P2P systems.

If you take Jobs’ numbers, around twenty tracks on an average iPod are bought from the iTunes store. It’s obvious from this that each iPod brings in far, far more revenue than the tracks from the iTunes store that may be put on it. In addition, if the majority of the tracks on each iPod are not from the iTunes store, it means that the majority of users are not going to be inconvenienced by not having Universal’s artists on the store; they are not getting their music from there anyway.

Whilst the iTunes store may appear writ large over Apple’s site, it’s hard to believe it’s terribly important as far as Apple’s revenue stream goes. It’s a flagship item, but more there for publicity. Perhaps some people are encouraged to get an iPod as they know it’s easy to buy music for it. When they get the iPod home, however, it appears few of them actually use the store. Even without Universal, the store still exists, and it’s still got a lot of music. The publicity angle still works (it’s still easy to buy music for your iPod).

No one is going to notice their favourite artist is missing, however, because most of them won’t be looking in the iTunes store in the first place. Apple makes money from the iPods, not the associated store, and the associated store isn’t the reason people buy iPods. Therefore Apple don’t have much to fear from this defection as their main revenue stream in this area is unaffected.

So Apple don’t stand to lose much. How about Universal?

Ask any record executive what they are worried about, and it’s a sure bet most will say piracy, mp3s and p2p. One of the blunt instruments currently being flailed around in a vain attempt to tackle this is law suits against music downloaders. Taking your music down from the largest online music store doesn’t really play well with this. Removing the people’s option to buy your music legitimately online — remember, iPod owners cannot use Microsoft-technology based stores — makes it rather harder to justify suing people for downloading said music.

Secondly, Universal is removing their content from one of the few areas where music sales are actually growing. Physical media music purchases are in decline, whether as online music sales are still on the increase. Whilst no-one knows who will win the battle for online music sales, removing your catalogue from the biggest current player seems like a no-win strategy.

Both of these factors point to a self-defeating move from Universal. It sounds like Universal tried to bluff too hard and Apple just turned around and said no.