Thoughts on Apple, Satellite Radio and the Record Industry

By Richard Menta 10/17/05

Why does the record industry shell out payola?

For those who don't know what payola means it is when label execs bribe radio stations to play their artists over the artists of other labels. Payola has been going on from the earliest days of radio when the record industry realized it was their biggest promotional tool. It's not legal, of course. Just a few months ago Sony BMG paid the State of NY $10 million to settle payola charges there. Still, it is a good bet that such activities will continue in ever creatively masked ways, because the industry obvious sees value in promoting their top artists through this tactic.

It also lays bare the limitations of the recent saber rattling that the major labels are conducting against the commercial Internet and satellite music services.


The 4GB iPod Nano is available on Amazon

The latest label hardball negotiation rhetoric targeted towards Apple, satellite radio companies XM and Sirius, Yahoo, and Microsoft has made quite a bit of press lately. All of these services are offering stiff resistance to recent record industry demands that they raise prices (Apple), stop the sale of portable units that can record satellite broadcasts (XM and Sirius), pay them more money for music videos (Yahoo) and just pay them more money period (Microsoft).

Now let's just preface all of this with the fact that everything is up to negotiation. If the record companies can get Apple to charge $3.50 for every single sold on iTunes god bless them ($3.50 is what Sony priced each track when they opened in 2000 the very first pay download service that sold major label music. The service failed miserably).

The problem with this scenario is two-fold for the major labels. First, if the labels succeed in getting all of their demands, prices will skyrocket and that can only turn away new customers and anger existing customers. For example, at $3.50 a song (or $42 for a twelve-song CD's worth of mix music) I suspect a lot of steady iTunes users might question the value of continuing to buy songs online.

The second problem for the labels is that most likely all of these services offer the promotional power of terrestrial radio. What if they all decide to work more favorable deals with the independent record artists, deals where these artists are given greater visibility on iTunes and get heavy rotation on satellite radio to promote their music? Visibility at the expense of the major label acts?

If FM and AM radio can make stars I say so can these services, especially if they promote a superior artist for $0.99 a track like Roger Clyne and the Peacemakers (who are building a name for themselves on the road as the Bruce Springsteen/E-Street band of the Southwest) versus any number of mediocre, but heavily pushed, major label singles for three bucks each.

Could these negotiations be the catalyst for the rise of the Independent artist?

If so that would change the activities of the most influential force on the record industry…Wall Street.

When Steve Jobs called the record labels greedy in the press, that statement wasn't intended just to rile the average reader. He was slyly broadcasting to the investment community too, investors who hold Apple stock as well as the stock of the major record labels.

For any company who has stock transacted on the trading floor Wall Street wants to see growth. With CD sales down the record industry has been touting the rise of iTunes and other online ventures as their next source of growth. Taking greater control of how revenues flow from these ventures shows how the labels will cultivate growth. Raising prices will supposedly increase revenues faster and help propel the label stock valuation.

But, if Apple and the satellite radio stations start to promote independent artists to hedge against upcoming negotiations the major labels can lose big as it will demonstrate to Wall Street that they far less control of the future with regards to either the Internet or satellite radio. Worse for the labels, if successful independent labels decide to go IPO to raise cash, investors may take money marked for a major and invest it in their smaller competitors who offer higher growth potential.

Maybe.

Hard-core tactics are just a day in the office for the record industry, but Microsoft and Apple are hardly strangers to them. Microsoft has already walked away from the table and threats to deny iTunes their renewal plays worse for the Big Music than Apple. Remember, iTunes is sold as a break-even vehicle to promote the sales of more iPods. People love the iPod (and so does Wall Street), but the image of the major record labels has tanked the last several years. As Paul Resnikoff stated on his Digital Music News site:

The record industry is ultimately about dollars and cents, so why should the perception of the average consumer matter? The reason is that consumers often buy with their hearts, and want to feel good about the purchases they are making. An iPod feels good, and iTunes makes the whole thing work. And if tomorrow, every single major label track disappeared from the iTunes deck, the consumer would still feel good about buying a nano

So if you ask me who will blink first, I say it will be the record industry. In the end the ridiculous demands to share in iPod and satellite player revenues will not come through.

But then these silly demands are only negotiation tactics. The rule in negotiations is to start high and come down. Unreasonable requests only set the stage for winning more reasonable ones. In the end, modest wins show growth to Wall Street and overall that is what the industry will get.

Predictions

Apple - will win its negotiations, because it has a very strong upper hand. If a label pulls all of its music from iTunes there is no guarantee everyone will just buy these songs from Napster or Real, especially if Apple sells 10 million iPods this holiday season. That's because music purchased on these services do not play on iPods. A drop, instead of rise, in big label online sales will very look bad to investors searching for growth.

XM and Sirius - Satellite radio is in a different situation. They deliver their music via targeted channels such as the big band music channel or greatest hits of the 80's. While independent record labels and artists can certainly supply new music, the popular music of older generations has all been bought up by the majors. You can't have a Sinatra channel without Sinatra. This gives the labels more leverage against XM and Sirius as they can hold back this content if the sat networks balk at playing (and paying top dollar for) their latest greatest.

Of course terrestrial radio - a group with a powerful congressional lobby themselves - does not pay any such fees and that gives XM and Sirius leverage should negotiations go to arbitration. They can simply state that they are radio, period, and therefore demand that they be given relative parity with the FM/AM folk. Satellite radio has people who can negotiate too. There will be pushback and after extended negotiations the major labels will get a reasonable percentage more than what they get under the existing conract. The labels have incentive to prevent the Satellite radio negotiations from going too far, because if Satellite radio decides to thate this to court the uncertainty will injure major label valuations until it is settled.

Microsoft - Microsoft is more open to such demands as their primary goal is to have the Windows Media codec replace iTunes' FairPlay as the default encrypted format for paid downloads. The fact that Microsoft walked away from the bargaining table last week was a negative for the record industry, though again, it is also a negotiation ploy.

And Yahoo? Like Microsoft music is just a tool to garner other goals. They will prove more malleable than the rest.

A better plan

I have always said that growth will come not from raising prices, but from lowering them to generate volume sales. These sales will come by offering a compelling reason for more file sharers to purchase rather than trade. The $0.99 price point is a premium price point in my view, commonly released during the early stages of a new business model to cover start up costs. Such prices drop as efficiencies of market are realized. For example, plasma screen TVs are down (way down) not up from a few years ago.

The record industry is claiming just the opposite. They are claiming that prices were offered at a special low rate to spur the growth of these new businesses. Now that these services are established it is time to pay more. The claim that these prices are low is just rhetoric, because the major record labels provide no physical product only permission. For the most part revenues that come from iTunes are pure profit (though more marketing expenditures are being spent on promoting top acts on iTunes).

Jobs does not want to see prices go up for obvious reasons. Lower prices stimulate volume sales and volume sales support Apple's iPod sales. Lower prices will also help iTunes. As a consumer with an iTunes and MSN account I want to see lower prices also. I think they are too high myself with a $0.10 - $0.25 per track price point compelling me to download in volume.

Since the cost of delivery on the Internet is marginal and there is no physical product produced with paid download sales, paid downloads are a fixed-cost. Sell one thousand songs or one hundred thousand and the cost is basically the same, bandwidth is cheap enough these days. In such a scenario volume pricing is they way to greater iTunes profits.

Consumers want their music in volume. Cheap downloads = volume = value (the average person only buys 6 CDs a year, a number that has been relatively steady for the last three decades). You don't compel consumers to buy with high pricing. If the price is too high they will just trade with their friends. Close to 10 million people trade in any given second on the P2P services. That alone says a lot.

Wall Street is watching. So is the consumer.

Other MP3 stories:
Will the iPod Video concept sell? Notes
iPod Killers for Christmas 2005 Part I
iPod Killers for Christmas 2005 Part II


The 4GB iPod Nano is available on Amazon