Royalty Rate Hike Prompts ITunes Shutdown Threat

A potential raise in the rate of royalties paid to music publishers has led Apple to threaten to close the iTunes Store if running the online music retailer becomes financially burdensome.

The National Music Publishers Association, a trade group representing music publishers, has presented a proposal to the Copyright Royalty Board, the three-judge panel that determines royalty rates and copyright terms in the U.S., that would see the royalty rate for digital music sales paid to music publishers increased to 15 cents per track. The move comes after the expiration of a ten year agreement that had set the royalty rate for all music sales at the current rate of 9 cents for each song. The board's forthcoming ruling, expected Thursday, will set the rate for the next five years.

As the leading online music store, iTunes could find itself particularly hard hit by such a price raise. In fact, according to a story in Fortune, Apple's vice president of Internet Services, Eddy Cue, said in a statement to the board last year that raising the royalty rates could lead to Apple being forced to operate the iTunes Store at a loss. That would likely cause the company to choose to close the store instead, Cue added.

Apple did not respond to a request to comment for this story.

Phil Leigh, president of digital-media analysis group Inside Digital Media, thinks there's at least a fifty-fifty chance that Apple will follow through on its threat. "I think that Apple is serious about what they're saying, because they feel strongly that the price of one dollar a track is where things ought to be," he said.

Leigh says that research shows increasing the price of a track above the one dollar mark would probably result in an overall loss, since a drop in unit sales would be higher than the corresponding gain in revenue. Most music stores charge under the one dollar mark for tracks, excepting rare occasions--such as when Apple sold iTunes Plus DRM-free tracks for US$1.30 a track, which it later lowered to the same 99 cent price point as the rest of its catalog.

The increase in price could also potentially drive consumers away from legitimate stores such as iTunes and Amazon MP3 and back into the arms of peer-to-peer file-sharing networks. Piracy is a big concern for the music industry, which has seen CD sales declining in recent years as consumers move more and more to online music sales and illicit downloads.

In its quarterly financial conference calls, Apple has repeatedly stated that they operate the iTunes Store at slightly above break-even, and that the company sees the store primarily as a way to drive hardware sales of higher-profit iPods and not as a money-maker itself. But the store has expanded to distribute not just music, but also video, podcasts, and now applications for the iPhone and iPod touch. It's now intricately connected with several different threads of Apple's business.

"If they decide not to close it down, it's because the iTunes of the future is going to be not just music, but movies, podcasts, etc.," says Phil Leigh. "They wouldn't want to close."

That's not all either: the iTunes Store has risen to become not just the largest online music store around, but the top music retailer period. Though the record labels have been squeamish about the level of control that Apple and Steve Jobs exerts on the music market, losing iTunes would likely mean a significant drop in revenue for the music industry.

That leads to the possibility that the record companies, who are widely believed to take around 70 percent of proceeds from the iTunes Stores, may absorb the increased royalty costs. "I think they could," says Leigh. "It's a question of probabilities, but raising the price above one dollar does drive the consumer away from the legitimate stores."

One way or another, it seems unlikely that the situation will come to iTunes having to shut down, since it would be bad not just for Apple and the labels, but also the music publishers pushing for the royalty increase in the first place.

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