Why Apple Won't Up-Charge Downloads


By Arik Hesseldahl The war of words that erupted last week between Apple Computer (AAPL) CEO Steve Jobs and Edgar Bronfman Jr., chief executive of Warner Music (a unit of Time-Warner, TWX), served to drive home how much the music industry has changed, and how much its executives still have to learn about what those changes mean.

Bronfman, speaking at an investor conference in New York, publicly aired the frustrations of music executives with the pricing structure of Apple's iTunes, the world's most successful digital-music store. iTunes charges 99 cents a song and $9.99 for an album. Locking the prices at those levels isn't fair, Bronfman said, suggesting that variable pricing would be more equitable.

"There's no content in the world that has doesn't have some price flexibility," Bronfman pointed out. "Not all songs are created equal. Not all albums are created equal." For his part, Jobs is adamant that prices should stay where they are, if only to keep the buying experience simple for customers.

A CLOSER LOOK. In principle, Bronfman may be right. Some books cost $25, others $15. There are magazines that sell for $4.95 a copy, while others go for $2.95. And who hasn't secretly perused the bargain racks of CDs, looking for a $5 disc from that hair-metal band you loved so much in the '80s? All Bronfman suggested was creating an environment where some songs would command a premium and others would do the equivalent of filling the bargain CD bin.

As it turns out, iTunes is already pricing some items higher than others. Look carefully, and you'll find occasional examples of albums priced at $11.99, $13.99, or $6.93. Clearly not all albums are created equal on iTunes. Some have fewer songs, some are incomplete, some are double albums and sell for $19.99

But the heart of the battle lies where the volume is: single-song downloads, which likely account for the vast majority of sales on iTunes, though Apple has never confirmed this. On this level, 99 cents appears to be the sweet spot, where consumers feel comfortable clicking the "buy" button without worrying too much about their credit-card bills. Bronfman says that's a pretty good price for most songs, but some songs should cost more, others less.

PIRATES AHOY. Again, he's not entirely off-base. It turns out that the sweet spot is really more of a sweet range, but it's a narrow one, according to Matt Kleinschmit, vice-president of Ipsos/Insight, a research firm that regularly surveys consumer attitudes toward digital music. There's little difference in the mind of most consumers between paying 99 cents and $1.29 per song, he says: "You could indeed take the price above a dollar with little impact."

Jobs is convinced that boosting prices will encourage a return to music piracy (as if it ever stopped). Certainly consumers are still willing to download from the file-sharing services, despite the recording industry's multipronged legal offensives intended to discourage the practice.

Ipsos-Insight surveyed consumers who are experienced at downloading music from both online stores and from free file-sharing services. When confronted with a simulated market environment, 62% favored the free file-sharing services. Take file-sharing off the table, and 44% say they wouldn't bother downloading music at all, while 39% say they prefer iTunes-like pay-per-download services over subscription services.

ROKR INOCULATION. Here's where the iPod and its newest sibling, the iPod Nano, turn out to be Apple's ace in the hole. Record labels such as Bronfman's hope to gain some leverage in their negotiations with Apple when their current licensing deals expire in early 2006. Bronfman has previously pressed the case of turning the mobile phone into a potential iPod rival in hope of eroding some of Apple's grip on the music business.

Apple inoculated itself against that possibility by collaborating with Motorola (MOT) on the ROKR phone, which lets users put some songs from their iTunes playlists on a phone. As the labels press the idea of transforming the wireless phone into an iPod rival, Apple will be in a position to say, "Been there, done that," and dismiss further phone-related products.

But the iPod Nano has turned out to be Apple's knockout punch. Having secured a large chunk of the supply of flash memory from Samsung and Toshiba and a price break from Samsung, Apple is going to constrain the supply for flash chips. That's going to make it difficult for competitors making flash-memory-based players that work with other music services to get their products on the shelves this holiday season.

CHIP HOARD. How bad will it be for Apple's rivals in the music-player business? A research report by WR Hambrecht says manufacturers of flash memory will be experiencing an uncomfortably tight supply environment this quarter and into the first quarter of 2006. Samsung and Toshiba both have their second- and third-tier customers on allocation -- which means lots of smaller companies will be told to get in line and wait for their flash chips.

And it may only get worse for those companies. Analysts at UBS Investment Research suggest that Apple could get an even bigger price break on flash chips from Samsung, and Toshiba may give it favorable pricing as well, making it even tougher for others to compete on price and amid constrained supplies. Rumors are also buzzing that Apple may soon tie up even more flash supplies by cutting a deal with Hynix Semiconductor.

That same research report suggests it's going to be a Nano Christmas. UBS says Nanos could account for almost half the nearly 32 million iPods it thinks Apple will sell in its fiscal year 2006, which begins next month.

WHATEVER STEVE WANTS. The more iPods sold, the more people will be patronizing the iTunes Music store. "The iPod drives people to iTunes, not the other way around," observes analyst Michael Gartenberg of Jupiter Research. A strong quarter of iPod sales will only solidify iTunes' position as the Microsoft (MSFT) of the digital-music industry, leaving RealNetworks (RNWK), Napster (NAPS), and others to bring up the very distant rear.

That makes the path for record companies clear: Jobs will get what Jobs wants. In the end, that means download prices will stay right where they are.

When asked earlier in the week at a press conference in Paris about the possibility of the music company raising prices, Jobs said: "If they want to raise the prices, it means that they are getting greedy." Greedy? Maybe. But right now, Steve Jobs is holding all the cards and can afford to talk tough. He knows this war of words is all but won.

Hesseldahl is a writer for BusinessWeek Online in New York


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