Technology

Apple's iTunes Movie Muddle


Water coolers from Cupertino to Hollywood are abuzz over the prospect that Apple Computer is plotting a frontal assault on the movie business. Indeed, Apple has held serious negotiations with movie studios about adding a movies section to its famous iTunes Music Store, sources confirm.

Apple has hoped to get the store up and running within weeks, Hollywood sources say. But the deal isn't yet done—and there's a chance it won't be any time soon. That's because Apple (AAP

L) and studios remain at loggerheads on a range of issues, from how much movie downloads should cost, to the degree of piracy protections they should carry. ""This will take months and months to figure it out,"" says one source involved in the talks. "It may even be a 2007 kind of thing."

WAITING GAME. And even if a deal is inked, it may well lead to more headlines than actual sales in the near term. For starters, movie studios might withhold some of their hottest titles. Moreover, Apple has hardly turned the video-watching world upside down since it first began selling TV reruns and other video fare last October. Many analysts believe Apple's big play for Tinseltown will arrive only should it come out with a new kind of consumer device designed specifically with movies in mind, rather than the iPod and its tiny screen.

Little wonder both sides may be content to play a waiting game. Apple Chief Executive Steve Jobs seems determined to approach the movie business with a similar formula to the one that enabled Apple to create a $1 billion-a-year market for legal music sales. The recipe includes a low, uniform 99-cent per-song price.

To the studios, Apple's version of "consumer-friendly" looks more than a bit self-serving—and unnecessarily tough on them. Jobs is said to want to sell movies at a flat $9.99 apiece. That's far below the $19.99 that studios want for downloads of their newer films and major hits, and that they now get for selling DVDs through Wal-Mart (WMT) and other retailers.

DIFFERENT MODEL. Studio executives want to avoid the fate of their counterparts in the music industry. Consumers pay Apple anywhere from $69 to $329 for an iPod but end up paying the music label just 65 cents or so for its cut of the song's 99-cent download. "Steve has a lot of leverage, but [the Hollywood executives] aren't going to tolerate what he did to the music labels," says a digital media consultant who has spoken with studio executives about the negotiations, and who requested anonymity.

Instead, studio executives also want Apple to try methods other than the basic download store, particularly movie subscriptions that would let consumers buy a specified number of movies for a given price.

Rather than give in to Jobs' demands, studios are rapidly placing other bets. In the last few months most have agreed to allow their films to be downloaded to hard drives through Movielink (MOVI) and CinemaNow, and Warner Brothers is even allowing it with BitTorrent, the one-time peer-to-peer pirate site. Others are in talks with Wal-Mart to let the retailer set up kiosks where consumers can pay less than $10 for a DVD-on-demand of slow-selling older films that aren't on the shelves, says the industry consultant.

NO PRESSURE. At this point, there doesn't seem to be much middle ground. Sources familiar with the talks say Hollywood executives are frustrated with Jobs, who is personally doing most of the negotiating for Apple. "It's all his thing, and he is the one making it happen at this point," says one source. Some Hollywood insiders are uncomfortable haggling with Jobs, who is a director and the largest shareholder of a huge rival, Walt Disney & Co (DIS).

Another reason a deal may not be imminent is that neither side needs it to happen right away. Music studio sales were collapsing at the time they negotiated deals with Apple. Not so with Hollywood studios, which can continue to work on other deals with the security of knowing that Apple might not be able to sell a lot of movies on their behalf anyway.

It's been nine months since Apple announced an iPod capable of playing video and opened a video section of the iTunes site with a deal with Disney to sell reruns of shows such as Lost. Since then, it's sold just 30 million videos. Sure, that's nearly 30 million more than any rival. And the company has landed a string of landmark deals with other studios that have helped sales of shows such as NBC's The Office and Showtime's Weeds.

NO COMPETITION. But some percentage of that 30 million is for music videos and video podcasts (the company won't break out details of the mix). Piper Jaffrey analyst Gene Munster figures the company has sold 20 million of its video-enabled iPods since they were introduced last year. Translation: statistically speaking, the average video iPod owner has purchased just 1.5 videos. "The reality is that people don't want to watch video on their iPods," says Piper Jaffrey's Munster. "Video is a feature on their iPod—a distant second to music."

The flip side is that Apple doesn't need a big video payday right off. Merrill Lynch expects Apple to grow 35% in fiscal 2006, which ends in September, and 21% the following year. That's thanks to continuing demand for iPods and improving Mac sales. Indeed, while online video companies such as YouTube are growing at Internet speed, so far nobody is cashing in with video-specific hardware—and hardware is where Apple gets nearly all of its revenue and profits. (iTunes was a $476 million business last year and brought in negligible profits.)

And it's not like any competitor is threatening to steal this video opportunity from Apple any time soon. While PC makers have been selling computers running Microsoft Corp.'s (MSFT) Media Center PCs for years, analysts say few consumers use these computers in place of TVs.

A number of companies will be bringing out new-fangled DVD players with disks capable of holding movies shot in high-definition clarity, but a standards war is breaking out between a Toshiba-led camp that supports the HD DVD technology and another that supports Sony's Blu-Ray technology. That should keep most consumers on the sidelines. What's more, the introduction of Sony's Blu-ray compatible PlayStation 3 has been delayed until November, and supplies will likely be limited at first.

THE LIVING ROOM WAITS. This is why, according to one highly placed source, Jobs feels like there are few threats for consumers' electronics-related dollars for the remainder of the year. That gives him time to come up with hardware that a movie buff could really get excited about. Some geekier Mac fans connect Apple's diminutive Mac mini, a full-featured Mac about the size of an office phone, to TVs. That lets users watch from the couch shows downloaded via iTunes. But it's hardly taken off in a big way.

No doubt Jobs does hold a wild card if he wants to get iTunes movie sales started: He could convince fellow Disney directors to take the first step by making some of its movies—say, the new Pixar (PIXR) film Cars—available for his $9.99 price. If sales take off, other studios may follow suit—just as they did soon after Disney became the first to make some of its TV shows available on iTunes.

Still, many experts believe Apple's game-changing opportunity is to come up with a new gizmo, tailor made to get film buffs to buy films online. Rumor sites have long predicted the company will release a portable device with a wider screen, possibly in the fourth quarter. Others see the opportunity for the company to create a hassle-free, Mac-branded product that even a couch potato could love. "I believe they're going at a measured pace," says Piper Jaffrey's Munster. "But you can bet that within the next two years we're going to see some dramatic moves into the living room."


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