Apple's iRadio Royalties Problem

Apple seems to be having a little problem in negotiating the royalties for their upcoming iRadio. The problem is the value that the record companies think they control over the value that Apple thinks it controls. The whole story is a useful reminder of one of my pet themes: the profits flow to whoever controls the scarce resource.

Here's the Financial Times giving us the details:

These people said that Apple had first offered a royalty of about 6 cents for every 100 tracks it streams, but had raised this to about 12.5 cents, in line with the rate paid by internet-radio service Pandora. But it was unclear whether Universal had accepted the 12.5 cent rate, and other labels are thought to be pushing for better terms.

Apple declined to comment.

Some music industry executives argue that cash-rich Apple should pay a higher rate than Pandora, which had 70m “active listeners” in April, because of its broader ambitions for iRadio.

Think this through from the point of view of the record labels. You control all of the access to this music that an increasing number of people want to license. Obviously, the prices that you're going to try and charge them are going to go up. When the (formerly, at least) world's largest company walks through the door your prices certainly aren't going to decline, are they? Yes, yes, there's the volume that they might pump out but that's more usually something to do with production costs declining on large orders. Here, we're talking a royalty stream which is a very different matter indeed.

The people familiar with the terms said that Apple was offering labels three tranches of revenue: a royalty per track streamed, a share of iRadio’s advertising revenue and a guaranteed minimum sum over the course of the contract that would provide a safety net in case the number of plays or amount of advertising sold disappoints.

That's extremely sensible from Apple's point of view. If the basic streaming rate is too high then it will be impossible to make a profit whatever they do. Every extra listener will just be a further expense, an expense greater than any marginal revenue. However, if they can break this out, into a fee per stream plus a segment of the marginal revenue then they can avoid this problem.

But that's where the disagreement with the record companies comes in. The rights holders want to extract the maximum amount possible from the negotiation. Apple wants to pay the minimum: that's not unusual, that's how most negotiations run. But there's an added layer here: Apple must have the right numbers before they even think of launching. And they must have the record companies signed up, of course. Whereas the record companies? Sure, Apple would be nice to have. But they might well decide that they'd rather enter the market through Spotify, Pandora, the new Google adventure planned, instead of signing away too much of the revenue to Apple.

Another way to put this is that the record companies are interested in Apple's proposals. But there's no requirement for them to deal with Apple at all. On the other hand, there's no requirement for Apple to launch a service: but if they do they must, must, have the record companies on board. We'd all thus, as profits flow to those who control the scarce resource, assume that the record companies will get the better end of this deal.