I’d Buy That for a Dollar

Friday, 10 November 2006

So the big Zune news this week is that Microsoft’s deal with Universal Music Group includes a per-unit royalty on each Zune player they sell. From Jeff Leeds’s report in The New York Times:

Universal Music, a unit of Vivendi, will receive a royalty on the Zune player in exchange for licensing its recordings for Microsoft’s new digital music service, the companies said.

Universal, which releases recordings from acts like U2 and Jay-Z, said it would pay half of what it receives on the device to its artists. The company is expected to receive more than $1 for each $250 device, according to executives who were briefed on the pact.

The deal represents a big departure from the standard set by Apple Computer, which pays record companies for songs sold through its iTunes service but does not give them a cut of the sales of its hugely successful iPod.

My initial reaction was this simple question:

I don’t get it. Why would Microsoft do this?

The Macalope offered a simple answer:

To try to screw up Apple’s business model.

Which sentiment echoed and neatly summarized, I think, what many people were thinking: that it’s part of some sort of dastardly Microsoft plot to undermine Apple by establishing this sort of per-unit royalty payment to entertainment companies as “normal”.

On his Blackfriars Marketing weblog, Carl Howe expounded upon this premise:

While this sounds like a simple “we wanted to get a major music label on board deal”, it’s really an attempt to poison next year’s licensing contract renewal between Universal and Apple. After all, Microsoft is unlikely to sell more than two million Zunes in the next six months to a year, so this costs them little. But I estimate that Apple will sell nearly 20 million iPods just this quarter (more about that tomorrow), and hundreds of millions of songs as well. And if Apple has to forfeit a dollar of every $79 iPod shuffle sale to Universal (and presumably to Sony, Warner, and EMI as well), well, that’s a nice way to make Apple pay for Microsoft entering this market.

This is classic Microsoft: crafting deals to attack competitors instead of spending the time and energy to positively market the product uniquely and powerfully.

Rowe is right that undermining competitors is classic Microsoft, but I think he, and The Macalope, are wrong that this is the case here.

What we’ve got here is a nice, warm, shit sandwich from Universal Music, and Microsoft concluded that they had no choice but to eat it. Oddly enough, this puts me in the same boat as Paul Thurrott,¹ whose analysis of the deal — “Microsoft Caves to Universal in Music Deal” — almost completely jibes with mine. Thurrott writes:

Sensing that [Microsoft] was in no position to bargain, given the failure of its previous digital music initiative, PlaysForSure, and the uncertain nature of its new Zune go-it-alone approach, Universal demanded the per-player royalty payment. The deal comes “after weeks of tense talks,” according to a report by “The New York Times”.

If Microsoft had vetoed the payments, it would have been forced to go to market with only a portion of the music available on the Apple iTunes Store. (Universal sells one-third of all music worldwide.) That limitation would likely have killed Zune before it even had a chance to fail in the market on its own. Meanwhile, Apple hasn’t been forced to make a similar deal because it enjoys the dominant position in the market. If Universal pulled out of the iTunes Store now, that action would harm Universal more than Apple.

Don’t get me wrong — if this deal somehow does wind up polluting Apple’s deals with the music labels, Microsoft won’t be shedding any tears. Misery loves company. But this is Universal’s idea, not Microsoft’s.

Remember that a year ago, Warner Music chief Edgar Bronfman Jr. said, “We are selling our songs through iPod, but we don’t have a share of iPod’s revenue. We want to share in those revenue streams. We have to get out of the mindset that our content has promotional value only. We have to keep thinking how we are going to monetize our product for our shareholders.”

Apple, along with everyone else, laughed this off. But Bronfman’s statement represented the thinking of the music industry. Logically, it makes no more sense for Universal to be entitled to a share of music player sales than it does for music player manufacturers to be entitled to a share of Universal’s compact disc revenues.

Music industry executives aren’t exactly known for their sense of fairness.

With regard to this Microsoft-Universal deal, billionaire music mogul David Geffen told The Times, “Each of these devices is used to store unpaid-for material. This way, on top of the material people do pay for, the record companies are getting paid on the devices storing the copied music.”

Universal Music CEO Doug Morris echoed Geffen’s we-deserve-it-because-everyone-using-these-devices-is-ripping-us-off sentiment, saying, “We feel that there’s a great deal of music that’s [stored] on these devices that was never legitimately obtained. We wanted to get some sort of compensation for what we thought we’re losing.”

The obvious question this raises was posed by John Paczkowski in the headline for his post on Good Morning Silicon Valley: “So does this Zune royalty cover all my pirated music, or just the tracks you presume I’ve stolen from Universal?”

Cheeky? Sure. But if the justification for this deal is that it’s compensation for bootleg music, does it not imply that Zune users should now feel entitled to bootleg Universal music?

Microsoft does have a history of making ruthless deals and engaging in conniving business practices that have helped their products overtake existing market leaders. Part of this can certainly be ascribed to executive cunning — but a big part of all such deals in Microsoft’s history is their willingness to use a dominant position in an existing market to put the squeeze on the new market they’re trying to enter.

Their problem with music, and the consumer space in general, is that they don’t have a dominant position with which to cudgel their opposition. They’ve got Windows, yes, but Apple has embraced Windows as a first-class citizen of the iPod-iTunes empire.² It’s Microsoft who, historically, approaches partners with “We know you need this, and if you want it, you’re going to do whatever we tell you to do” deals.

Far from seeing this Universal dollar-per-Zune deal as some sort of nefarious Redmond plot, I think it’s actually giving Microsoft a nice taste of its own medicine. Thurrott is right: Microsoft needed Universal’s support, Universal knew it, and they’re making them pay.

Even in the worst case, I don’t see this precedent as posing much of a problem for Apple (or, really, for Microsoft, for that matter — one dollar per unit amounts to a rather small turd in this particular shit sandwich). A few dollars on a $249 iPod amounts to very little. I mean, they lose one dollar on each unit just by pricing them at $249/$299 instead of $250/$300 — another couple of dollars for the record labels wouldn’t amount to much.

Apple, though, surely will continue to resist, if not outright laugh off, such deals. Partly out of general principle, but mainly because unlike Microsoft, Apple has leverage over the music labels because they have something the labels need: popularity.