Testing iTunes supplier power

The iTunes [Music] Store has been so successful that the record companies are envious. Many but not all rival stores have failed (most recently Sony’s), and so the record company oligopolists find themselves at the mercy of Steve Jobs and his control of the most successful legal download site to date. Not quite two years ago, Apple got some of these same companies (through the overlap of the music and movie media megapublishers) to provide video for its site — mostly TV episodes — which met with immediate success. But that success has brought bitter complaints from Hollywood (and Nashville and New York).

One of the key issues has been that Jobs believes that $0.99 (or €0.99) per track is a magic number, and wants to keep a single simple price to promote adoption. Prior estimates have shown that (due to high royalties) Apple makes very little off the content but instead makes all its money off of hardware, and thus wants an ongoing supply of attractive content to sell more iPods.

Instead of a fixed price, the record companies have long argued for a range of prices, with higher prices for hot titles and less for run-of-the-mill titles. (Despite occasional claims to the contrary, it would appear that the 99¢ would be the floor and not the average price). Such a “versioning” strategy is very consistent with the work of economist Hal Varian in his book with Carl Shapiro entitled Information Rules. (Labels today are able to charge a premium for some tracks, in that they require download of an entire album to get one or two popular songs.)

Although the record companies have made threats to withdraw — and in July Universal decided to go month-to-month in supplying music to Apple — so far none of the music companies have been willing to cut off their nose to spite their face. Universal also decided to license its DRM-free music to everyone but Apple. But apparently this week NBC (i.e. the same Universal) decided to make a stand on licensing its television content.

NBC decided that it wanted a price increase on what it got for its TV episodes, and thus leaked it would not renew its contract at the current prices beyond the end of 2007. Apple claims that the net result would be to increases episodes pricing from $1.99 to $4.99 each. Whatever the number, it’s clear that NBC think the market will sustain a higher price — and it’s also clear that some outsiders believe NBC is overestimating the value of its content.

IP lawyer Chris Castle articulates what everyone knows: that the suppliers want to reduce Apple’s control over online distribution channels:

“I think there is a general perception in the industry that we need to get tough with Apple and break the lock they have on the consumer market,” Castle said. “I think what’s happening is that there is a general gestalt of ‘Apple is a pain in the (butt) so let’s help some other companies out. Let's do something to build up a retailer other than Apple.’”

Conversely, NBC may be playing a weak hand to challenge Apple on its own. Disney and its ABC subsidiary were first aboard the S.S. iTunes and will likely to be the last to leave — at least as long as Steve Jobs is a director, the largest shareholder, and a key player in its Pixar animation unit. Meanwhile, our local paper implies that NBC will blink now that Apple has decided not to carry any new NBC shows:

That said, NBC is in a tough position, too. The NBC network came in fourth place in the Nielsen ratings last year and has struggled to come up with new hit shows. Not only does iTunes provide an extra source of revenue, but it can serve as an important buzz generator and audience builder for new programs, something NBC arguably could use.

Apparently the biggest loss for Apple will not be NBC, but from its SciFi Channel subsidiary. (With the end of Stargate and the increasing absurdity of Galactica, it’s not clear who’s still watching SciFi anyway).

I happen to think that Apple is dead right on music prices —reasonable prices are necessary since the alternative is an illegal download. Video isn’t there yet, but that’s really a temporary question of bandwidth rather than some difference in practical enforceability or moral compunctions.

If Apple is right, NBC will do a deal to avoid giving ABC and Fox a huge advantage in generating word of mouth. If Apple is wrong, it will lose suppliers until it’s forced to capitulate to their demands to yield more revenue from every subscriber.

Where will it all end up? Gartner VP Allen Weiner predicts that eventually all the downloadable video business models will shift to advertising infested supported ones. As a consumer, I find the prospect appalling, but as an economist I think the logic is unassailable. Variable advertiser pricing is a lot easier to implement than variable consumer pricing, and of course this is the way that the entire industry is set up to monetize mindless TV sitcoms.

Apple is unveiling new iPods on Wednesday, so any doubts about the future of the iTunes store will take some of the wind out of its intro event.

Technorati Tags: Apple, iTunes, movie industry