Europe vs. Apple: Facing the Music

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Deconstructing DRM

The stakes are far greater than the tiny Norwegian market. If Apple agrees to modify its DRM policy under order, or avoids the situation by pulling out of Norway altogether, it may have to take the same steps to accommodate other European countries with strong consumer protection laws. With a combined population of nearly 200 million, the seven countries already examining the iPod problem represent a big, wealthy market. Indeed, in a report released last year, Credit Suisse Group (CS) analyst Robert Semple projected Apple could sell more than 309 million iPods in Europe by 2009.

That makes this a tough call for Apple, which has built its digital music empire on the seamless integration of the best-selling iPod and iTunes. Apple's FairPlay DRM system enforces the restriction that iTunes downloads can be played only on iPods and that iPods can't play songs downloaded from other paid services.

The close link has been a key to Apple's success, and the company is loath to weaken it in any way. "[Apple's] overwhelming market share is based in large part on its ability to lock people into that device," says Josh Bernoff, principal analyst with Forrester Research (FORR) in Boston. "Hell will freeze over before Apple gives up the secrets to its DRM system."

Apple's Options

Though it won't discuss the issue publicly, Apple quietly acknowledged the risk in its 2006 10-K. Noting that "certain countries have passed legislation or may propose legislation that would force the Company to license its DRM solutions so that content would be interoperable with competitor devices," Apple cautioned that such moves might lessen antipiracy protection for digital content and affect its licenses with suppliers. What's more, if the company were unable to devise alternative solutions in a timely manner, it "could have a materially adverse affect on the Company's operating results and financial position."

So far that risk hasn't spooked investors, who have driven up Apple shares 43%, to $85, since the Norwegians made their move last June. Some say there are obvious holes in the case—including the fact that tech-savvy consumers can disable its DRM simply by burning the songs onto a CD and ripping them back onto a computer. Analysts say Apple would marshal that and other arguments in its defense. Norway might have to settle for a compromise solution, such as a requirement that Apple more clearly disclose to potential customers that its products are not interoperable with rival offerings.

Changing Market

Norway and the EU aside, Apple may not be able to resist responding to market forces. Some major music companies have already discussed the possibility of selling non-DRM-protected MP3s directly on their own Web sites, which would put pressure on Apple to modify or eliminate FairPlay. And the growing strength of music phones and other alternatives to the iPod eventually may force Apple to modify its business model.

Until that happens, the erstwhile computer company will continue to make hay with its music bonanza—and Europeans will likely continue snapping up iPods and iTunes by the millions. The long-term outlook of Apple's digital music business in Europe may be darkened a bit by the prospect of heavier regulation, but the company's rapid growth isn't likely to be halted anytime soon.

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Carlin is a reporter in BusinessWeek's Paris bureau.