10 August, 2007

Universal Readies DRM-Free Music, Snubs iTunes for Real Networks et al

Universal Music Group, the music giant owned by Vivendi (EPA: VIV), has announced a testing phase of an online music plan that will see the company sell digital tracks without Digital Rights Management (DRM).

The debate over DRM has raged since the inception of digital music and the growth of Apple (AAPL) and its iTunes Store. Even Apple's head Steve Jobs wrote a letter discussing DRM on Apple's website (Link). Apple's first partner into the DRM-free world was EMI (LON:EMI) and together they launched iTunes Plus. An additional service for music that gave customers better quality tracks that were free of restrictions. These tracks could be played, burned or used anywhere, virtually on any device.

Universal has shunned the online music juggernaut that is iTunes and its 70+% market share. It has chosen to partner with Real Networks (RNWK), which has its well known Rhapsody service starting to gain some momentum in the space. The stock jumped off its 52-week low today finishing up 7% on the news. Before we jump on the Rhapsody bandwagon, investors need to consider that this 6-month Universal test is available also to online stores run by Best Buy, Wal-Mart, Amazon and Google. While some of these big net names don't exactly offer complete online music services to consumers you can see that the biggest name is missing. Apple Inc.

Contract renewal negotiations fell apart between Universal and Apple some time ago and it was clear then that Apple's firm demands were not met with smiles. Reportedly during the talks, Universal wanted changes to pricing and Apple wanted to keep the same pricing simplicity and get rid of DRM completely. It seems Vivendi's Universal unit holds a big grudge. However, if DRM-free music is truly the wave of the future it wont be long before iTunes is back in Universal's good graces. With CD sales down sharply quarter after quarter and digital sales, although growing, failing to compensate, its only a matter of time before shareholders become unhappy with the fact that the biggest music distributer in the world excluded the most powerful online music store in the test.

The question investors have to ask now is whether the 6 month test period is enough for any competing service, such as Real's Rhapsody, to gain any traction against iTunes simply because of DRM-free music? The same songs will still be available through iTunes just packaged with digital rights management. Will this be enough to lure people away from the iTunes store and into competitor online music stores, where they can buy individual songs, put them back into the iTunes media management software and load them onto their iPods? Based on market trends it doesn't appear very likely.

iTunes music sales have always been a low margin business for Apple as its been said that of each $0.99 track almost $0.70 goes to the record label and the rest covers network and advertising costs. What Apple's profit machine feeds off of is sales of iPods and Mac Computers. So for Apple shareholders is this a big deal? Well, yes and no. It isn't a big deal being shut out of the DRM-free test by Universal, however if this strains the company relationships further and Universal decides to pull songs from iTunes that could provide a significant blow to Apple's music business. Universal does sell about 1/4th of the world's music.

Anything Apple loses in the online music business will most notably be picked up by Real's Rhapsody, which would have a positive effect on shares of Real Networks. However, the online music business is still very low margin and Real as a stock I would not recommend based on this DRM-free test alone.

The music trends are clearly forming to a purely digital age with freedom and sharing being at the forefront of consumer minds. With that will come more DRM-free offerings, which will spur further music player sales. The product everyone seems to still want is the iPod and the company making that particular gadget is none other than Apple. Those executives at Universal better start to mend fences soon because not working with Apple in online music is a severe mistake, with the iPod still on the consciousness of virtually every music consumer on the planet.

Disclosure: Author is long AAPL

1 comment:

Chris Krasowski said...

Commentary on whether Apple should licence its iPod DRM-technology. I don't think it'll ever happen. The simple solution of DRM free is best, so why would licensing DRM be better?

Studies have said that a lot of the music on iPods is pirated. Is this really valid? I don't think it's a fair guess that most of the music on iPods is pirated. First off, the biggest capacity iPods also store a lot of video for a lot of people and secondly, I think a majotiry of iPod users used iTunes to digitize their entire CD collections. Another point of contention in the entertainment business model is making consumers pay several times for the same entertainment. It happens in music, movies, tv, almost every form of entertainment. Vinyl, tapes, then cds, now mp3s. In films, theatres, pay per view, and you had VHS, then DVD and now blu-ray or HD-DVD.

When people throw around numbers like 100 million ipods sold and 3 billion songs so only about 30 songs per iPod so the rest of the space must be pirated, they always fail to mention how many people have vast CD libraries that they've burned to MP3 format to put on their iPods. So I feel like that point of piracy is not a strong one without any concrete study facts. Yes there is piracy in the digital world, you have to face that, but at the same time, making a consumer buy the same song or album from the same artists just cause its in a different format is an entirely different form of piracy.

I think this Universal DRM-free test will not fare well simply because those other stores do very little business, so to expect a massive uptick when most digital music consumers are already familiar with iTunes is very optimistic. I think if Universal were to embrace iTunes Plus they would see a much much higher increase in interest in their online music offerings.

I personally don't think companies should be forced to license anything. You've made a great successful product, and consumers have embraced it. That should be the end of that within legal non-monopolistic business practices.
Would industry also demand that Microsoft for example licensed the Halo games so they can play on PS2 or PS3. No! Because that would completely cannibalize sales of XBox so why would the company do that.

The simple fact of licensing is that it only makes sense to do it if it makes strategic sense for the company. The way iTunes and iPod work so seemlessly together is one of the main selling points for a lot of consumers so why would Apple want to knock the fence down and make iTunes remarkably more complex?

While Each side has had their faults in negotiations it seems like Apple fights for the consumer (and of course the bottom line) whereas Universal fights simply for the bottom line. The way the music industry treats not only consumers but also artists I can't help but feel that them being well behind the curve in digital music is for the better in the long run. The trend of indie labels and bigger bands moving to indie labels has slowly started with this digital revolution and I think you'll see more of it as digital music becomes a much more social experience over the internet. Bands won't need massive major label marketing budgets, because word of mouth is your biggest selling point. Now if only the Payola would stop so some of these truly great musical acts can get their songs played on the radio once in a while we'd be living in a beautiful world, musically.