Universal Music Reconsidering iTunes Deal

The future of digital music may be at stake. What will the label's next move mean for Apple and for ad-supported online music?

Universal Music Group has seen the future of digital music, and it's one where Apple's domination is diminished.

The music label is balking at renewing a deal that gives Apple (AAPL) unfettered access to Universal's massive music catalog and limits Universal's ability to strike exclusive distribution deals with competing download services. Apple hopes the two companies can still hash out a new agreement. "It's just not true that they have refused to re-sign," says Apple spokeswoman Katie Cotton. "We're still in negotiations, and their music is still on iTunes."

Exploring Options

But sources close to Universal say the company has moved to what's known as an "at will" arrangement that enables it to strike exclusive distribution deals with other digital music providers for individual artists or tracks, though it will continue to sell music through iTunes. Under the new arrangement, for example, Universal could charge another music e-tailer (or Apple, for that matter) a premium to sell Jay-Z's latest single exclusively for a limited time.

Some analysts characterized Universal's refusal as a negotiating tactic—that the music label was holding out for a bigger cut of the 99¢ Apple charges per download.

But there's more than money influencing Universal's decision. As the world's largest record label, Universal has the future of the music industry to think about. It's a future that could very well be dominated by a business model other than the pay-per-download version that Apple popularized. "I can see them wanting to have flexibility so, a year from now, if the music industry has gone through a revolution they are not locked into next year's contract," says James McQuivey, an analyst for Forrester Research (FORR).

Ad-Supported Tunes

What revolution may be in store? Alongside Apple, there well may be ads. Already, Universal has agreed to a deal with SpiralFrog, an ad-supported download service owned by Mohen scheduled to launch in the U.S. by the end of the summer with a catalog of 2 million songs (see BusinessWeek.com, 9/5/06, "Meet the iTunes Wannabes").

Qtrax, an ad-supported music file-sharing service owned by Brilliant Technologies scheduled to launch this fall, has licensing deals with Universal, Warner Music Group (WMG), EMI Group (EMI), and Sony BMG Music Entertainment (SNE). Ruckus Network, a music service that offers both ad-supported and subscription models, has a catalog of more than 2.5 million songs.

Robin Kent, the former chief executive of SpiralFrog who now runs the ad sales company behind Qtrax, Rebel Digital, believes ad-supported music download services will take off. People are accustomed to receiving ad-supported music on the radio and, thanks to rogue peer-to-peer services, many younger people have grown used to downloading free, albeit illegal, digital music. According to ARTISTdirect, a company that tracks illegal downloads, between 300 million and 500 million files were pirated each day in 2006 (see BusinessWeek.com, 10/31/06, "Music Downloading's New Deal"). "The future is potentially huge if you look at all the indicators," says Kent. "You have got an advertising market that is moving fast online…and advertising has been paying for media content for years."

Room for More Players

The U.S. online advertising market is expected to grow from nearly $22 billion this year to nearly $30 billion by 2010. The market for music downloads pales in comparison. Analysts estimate that Apple's iTunes service dominates more than 70% of legal digital music downloads. Apple is expected to sell 2.5 billion songs this year. At about 99¢ per song, the total market for music downloads would be shy of $4 billion.

Even if consumers don't embrace ad-supported music downloads, there's no guarantee that Apple's iTunes will remain the most popular music service in the long run. A new popular player could sway people to use another company. San Diego-based Slacker has received buzz recently for its soon-to-be-launched portable radio player, which also enables song downloads and has a four-inch screen.

Don't expect Apple's influence on music distribution to erode swiftly—and certainly not in the aftermath of the release of the generally well-received iPhone. Still, where Universal throws its weight will certainly help determine which company, or business model, is successful in the future. After all, Universal's early support for iTunes helped make that service popular. "I would imagine the other record labels would follow suit," says Forrester's McQuivey.