business

Apple May Need to Play Better with Others

To continue to thrive in both music and video downloads, Apple must improve how it deals with content makersor risk being left behind

If this year's Macworld Conference & Expo follows form, Apple (AAPL) Chief Executive Steve Jobs will pull the curtain back on a new device or two that will capture the consuming public's fancy. Early word, for example, is that he'll announce a slick new sub-notebook that, if successful, could help make mainstream a product that until now has occupied only a niche. That's what Apple did for digital music players with the iPod and for smartphones with the iPhone.

But for Apple to make the most of its peerless products, experts say it will need to improve relations with the folks who create the content to run on them, especially after the series of spats that marked 2007. Recall the refusal by Universal Music Group, the world's largest record label, to re-up its long-term contract to supply music to Apple's iTunes Store, or the move by General Electric's (GE) NBC Universal to pull its TV shows from iTunes.

Despite the setbacks, Apple still maintains more than 70% of the online music business and, by BusinessWeek estimates, controls nearly the same share in online video download sales. Still, an inability to play well with the entertainment industry could hurt Apple in the long term. The recording industry, for example, could move further into the arms of competing online distributors, such as Amazon.com (AMZN). And as Apple hopes to push deeper into video distribution and playback, it will need to at least match the access of a slew of rivals to the world's films, shows, and other forms of video. "Everyone is flexing their muscles to prove they don't need each other," says eMarketer analyst Paul Verna. "But the truth is, they do."

Compromising in Video

There are some signs of détente. At Macworld, studios including Disney (DIS) and News Corp.'s (NWS) 20th Century Fox are expected to announce support for a new iTunes movie rental service. Fox and others are also expected to make their newest releases available at iTunes, something only Disney currently does. But Apple is clinching such deals in part because of its newfound willingness to compromise, say sources. Apple has agreed to increase the wholesale price it pays to studios, from $14 to closer to the $16 they get when they sell a DVD to Wal-Mart (WMT), say people familiar with the negotiations.

The more conciliatory stance in video contrasts with the company's historical approach to the recording industry. With 70% of the digital music market, Apple is the third-largest distributor behind Wal-Mart and Best Buy (BBY). Little wonder Jobs won't budge on key points, such as paying labels variable rates for various artists or charging customers anything other than 99¢ a song.

Jobs has far less leverage in video. Sure, Apple has an early jump on sales of movies and TV shows online. But the online download market accounts for a miniscule portion of the total, just $268 million, or 0.7%, of $35 billion in 2007, according to Adams Media Research. Studios have little incentive to give Jobs advantages over well-entrenched, bigger partners, from Wal-Mart in DVD sales to TV networks via broadcast licensing deals.

Even video-on-demand services from cable companies such as Comcast (CMCSA) and satellite operators such as DirecTV (DTV) now make up a $1 billion market that's growing rapidly. Says one network executive of sales through iTunes: "There's nothing wrong with it, but it's a niche business."

Competition Grows

Even if Internet distribution ultimately wins the day, Apple faces far more competition than it ever did in music (BusinessWeek.com, 1/10/08). Many rivals already offer much of what Apple hopes to accomplish in the living room. Scrappy DVD rental specialist Netflix (NFLX) is cutting deals with set-top makers so its 7 million loyal customers can order downloads directly from the couch—no more waiting on mail delivery. TiVo (TIVO) users can already download movies and other fare from Amazon.com's Unbox video service. Executives over at Microsoft (MSFT) think they've moved a Trojan horse into millions of living rooms with the Xbox game console. Besides boasting a DVD player, the device also lets users order movies through the online Xbox Live service, says Ross Honey, senior director of Microsoft's content unit.

It doesn't help that Apple's newly introduced Apple TV, designed to send movies wirelessly from the home computer to a TV, has met with criticism for having poor resolution and offering access to movies only through iTunes. "In the music business, [Jobs] made a confusing situation simple," says Abe Peled, CEO of set-top box software maker NDS Group, which is 72%-owned by Rupert Murdoch. "With video, he is trying to make a simple solution difficult. People don't need one more box on top of their TV sets."

Jobs can and will improve Apple TV, but there's less he can do about the threat posed by free (or low-cost) distribution of video on the Internet, which limits Apple's ability to tether video to its slick devices. A year ago, buying a TV show like ABC's Lost on iTunes for $2.99 was novel. Now, many shows are offered for free soon after they air. "Eighteen months ago, you could sell an episode of The Office for $2 apiece," says eMarketer's Verna. "Now, you can get all that stuff for free. TV content is no longer seen as a transactionable download."

Digital Music in Flux

If Apple's not careful, its grip on digital music may also loosen. Already, the top four music labels have agreed to sell songs on Amazon.com without the copyright protection software many users find onerous (BusinessWeek.com, 1/4/08). Only EMI does the same on Apple's iTunes. All four—Sony BMG, Warner Music Group (WMG), Vivendi's Universal, and EMI—will participate in a billion-song giveaway by Pepsi (PEP), sources say. The promotion, to be launched at this year's Super Bowl, dwarfs an earlier $100 million marketing agreement between Apple and Pepsi in 2004. "This is like Apple's promotion with Pepsi a few years ago, times 10," says an executive with one independent label.

Of course, Apple could always adapt to a new paradigm in music or video distribution, but it may well require a greater degree of cooperation than Jobs will abide. Says a media titan who recently approached Jobs about exploring ways to work together but didn't get far: "Steve doesn't want partners." That luxury, afforded in recent years by iPod and Mac-fueled successes, is one Apple may not always have.

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