By Peter Burrows For proof of Apple Computer's (AAPL) makeover, consider this: After being ridiculed for playing the patsy to Microsoft (MSFT) in the PC wars of the '80s and '90s, rivals in digital music now accuse it of hogging the winnings in that arena at the industry's expense. Why? Apple's red-hot iPod music player enjoys roughly a 50% market share. And since the iPod works only with Apple's iTunes Music Store, device owners have made Apple king of the legal download market as well, with more than a 70% share. So far, even giants such as Sony (SNE), Wal-Mart Stores (WMT), and Microsoft have failed to counter this one-two punch.
Yet a smaller rival, RealNetworks (RNWK), thinks it has found a way to break Apple's lock. As of July 27, consumers can go to Real's Web site and download software, dubbed Harmony, that lets them play songs purchased at Real's download store on any portable player they choose -- including the iPod. What's more, Real is in talks to license Harmony to other online stores that might also want to sell to iPod users -- without Apple's approval.
"Apple clearly has a great device with the iPod, and that's great for them," says Richard Wolpert, Real's chief strategic officer. "But we just want consumers to be able to choose whatever device they want to choose. We think that will make the entire market grow."
LEGAL BATTLE? You might think Apple would welcome a product that encourages consumers to legally download music onto their player. But it's said to be more than a little unhappy, and with good reason. Apple CEO Steven P. Jobs should clearly and firmly squelch Real's attempt to infiltrate Apple's music empire. GartnerG2 analyst Mike McGuire sums it up: "At some point, Apple may decide to license [its iPod technology] to others. But they should do it for good business reasons, not because a rival issues a press release or some beta software."
Apple isn't commenting on Real's move yet. But it's almost certainly exploring the possibility of a copyright lawsuit. And that's not the only option. Experts say it could require iPod owners to download a firmware upgrade the next time they try to buy a song from iTunes that would render Harmony useless -- much as a security patch resolves a computer virus.
If Jobs's lawyers tell him it's legally justified, the CEO might even consider an even more radical way of making his point: loudly inform iPod owners that Apple will no longer honor their warranty if they buy songs from Real or other rival online music stores.
BIG-TIME PARTNERS. Such a move might temporarily cast Jobs as the Darth Vader of interoperability to industry watchers. But in the long run, it's in Apple's best interest. Jobs & Co. don't need anyone's help to achieve their iPod sales growth or profit goals. Despite an already dominant position, iPod continues to outgrow the market. In the second quarter, Apple sold more than 800,000 iPods and just sold its 100 millionth song.
The momentum should continue in the months ahead, due in part to savvy marketing deals. Later this summer, computer giant Hewlett-Packard (HPQ) will begin selling an HP-branded iPod and start loading iTunes software on millions of its home PCs. And on July 26, Motorola (MOT) announced that by early 2005, some of its phones will be capable of storing and playing a handful of songs downloaded from iTunes.
Such deals have far more potential to drive iPod sales than what Real is proposing so far. At this point, Harmony will apply only to Real customers who purchase songs from Real's seven-month-old RealPlayer Music Store. It's similar to Apple's iTunes Music Store in that it sells 500,000-plus songs for 99 cents apiece -- but unlike iTunes, it has a piddling single-digit market share.
In the future, Real plans to adapt its Rhapsody all-you-can-eat subscription service -- in which music fans pay a monthly fee to rent all the tunes they want -- for the iPod and other portable devices. Until then, Apple's investors have little to gain from letting Real's music customers play their songs on iPods.
MUSIC IS DIFFERENT. What about the consumers and the music industry in general? Conventional wisdom suggests that open standards are better than closed. Just as free markets work more efficiently than planned economies, the argument goes, thousands of competing companies can do a better job than Apple can do on its own with a proprietary approach. It's one reason executives from many big record labels publicly support Real's efforts with Harmony.
But the market for legal digital music may be an exception. For years, the open approach failed to turn it into a viable business. Apple made that happen. For starters, Jobs figured out a simple 99-cents-per-song formula that the record labels could live with. Also, Apple used brand and advertising panache to make legal music downloading a hip alternative to illegal file-sharing to a degree far beyond what nerdier tech companies were capable of.
Also, Apple's control over its hardware and software created the most elegant, glitch-free music-buying experience for consumers. Of course, that experience is far from perfect. Apple customers have complained about the iPod's low battery life and its high price. But Apple is improving the product. On July 19, it unveiled new models that feature 12 hours of battery life and a starting price of $299, $100 lower than before.
COPYRIGHT CLAIM? Will a time come for Apple to give up the keys to its proprietary digital music kingdom? Almost definitely -- but not until a real contender emerges, or until falling iPod prices make it more profitable for Apple to sit back and collect royalty checks while cloners battle it out in the market.
In the meantime, odds are good that a legal fight will break out between Apple and Real, say some analysts. Just a few months ago, Jobs rebuffed overtures by Real CEO Rob Glaser to license the Fairplay digital-rights-management software (DRM) inside the iPod. Since Real's Harmony software essentially circumvents the need for a device maker to license the DRM software, Apple might have a strong copyright claim, legal experts say.
That might be especially true if Real begins to license Harmony to others. The way some experts see it, Apple could claim Real is denying Apple's right to license its own technology.
"SERIOUSLY INTERESTED." But it's no legal slam dunk. Elements of the Digital Millennium Copyright Act give some leeway to companies that reverse-engineer a rival's technology for the purpose of compatibility. "Reverse engineering for the limited purpose of interoperability is generally considered to be permissible," says Ian Ballon, an intellectual-property lawyer with Los Angeles-based Manatt, Phelps & Phillips. Says GartnerG2's McGuire: "It's all a very big, fun, interesting gray area." Real's Wolpert denies that his company reverse-engineered anything or that the DMCA is relevant to the case.
The stakes in this battle are big -- and not just for Apple. Chris Gorog, the CEO of Roxio (ROXI), which runs the Napster music site, says he would consider licensing Harmony once its legality is established. "We're going to look at it very carefully," he says. "If Apple doesn't fight it, and the technology works, we'd be seriously interested. But Apple will most likely fight it."
And Apple should fight it --- whether in the courts or by competitive means. In the long run, that would be a good thing for the industry and consumers. Burrows is Computer editor in BusinessWeek's Silicon Valley bureau