Apple's New iTunes Business Model

There have been rumors making the rounds that Apple has been looking at offering a music subscription service as an alternative to its so-called “a la carte” model where iTunes customers pay a flat fee for every song they buy. Naturally the a comparison with RealNetwork’s Rhapsody service comes to mind.

But now there’s a report from the Financial Times that suggests that Apple is instead looking at another model: Charge an extra premium for the iPod or iPhone device, and then offer consumers full access to the entire iTunes music library. It’s similar to a deal from phone maker Nokia. But the FT says the big difference is in scale. Nokia is said to offer a pot of money that amounts to $80 per device, and then divide the pot among the record labels according to market share percentages. Apple’s proposed rate is said to be closer to $20, which makes a lot of sense. Of course they’re pretty far apart on what constitutes a reasonable rate.

Assuming this story is true, then Apple has set a reasonable rate. Twenty bucks is pretty close to what the average iPod owner spends on iTunes in the first place. Take the 4 billion songs sold on iTunes in its lifetime, and divide it by the number of iPods and iPhones sold since the beginning and you get an average of about 28 or 29 songs per unit. Where’s the rest of the music coming from? Either existing CD collections, new CD purchases, in which case the recording industry is already paid, or from other means including file-sharing networks.

At $20 a unit, Apple keeps the up-front price impact lower, making consumers happy, minimizing the push back on unit sales. The math also works out nicely. Apple is thought to keep about 30 cents of a 99-cent song purchase. Assume the average tracks sold per device remains the same at 28: That works out to $8.40 for every device sold to Apple, and $19.32, or 69 cents a song to divide among the labels. That makes a lot of sense to me.

Nokia sells a lot of phones worldwide. Its handset volume in 2007 was 437 million in total. Of that 146 million, or more than a third were music-ready. During the same period (calendar year 2007) Apple sold 52.7 million iPods plus another 1.4 million iPhones.

If it’s true that Nokia is giving the labels $80 a handset — and that amount seems a little high to me — then its making a big, costly bet on music. From what I understand of its forthcoming “Comes With Music” plan, its going to be very confusing for a consumer to navigate. You purchase a music-ready phone and get unlimited access to Nokia’s music store for a year. The tracks you get can be downloaded from to a PC or directly to the phone, and yes, they’re hobbled by DRM, compatible with neither an iPod nor a Zune. If you want to burn them to a CD, you have to pay to “upgrade” them. (After which you’d probably just rip them to your computer as an MP3, and ignore the rules from that point on, but I digress.)

Then what of the music when you’re ready to get a new phone? You can keep the music you’ve already downloaded, but when you get that new phone, you pay another subscription fee as this is already bundled in to the purchase price. If you upgrade your phone once a year (as is fairly common outside the U.S.) then the labels can’t help but be happy with this revenue stream, because they end up being paid for music they don’t even sell. It’s a bit of a leap to me to assume that consumers will download three times as much music to their phones when its “free” than when they’re paying a per-song fee as they do with iTunes. Even if they download twice as many songs as the average iTunes owner, say 60 songs per unit, that extra $20 is gravy, and it would seem to me that Nokia is over-paying, and as such losing money. Apple? It makes a profit on iTunes, if only a slight one.

Meanwhile, I can’t help but remember that Steve Jobs years ago derided the idea of “renting” music. He often hates something before he loves it. Remember when he said music was a background activity and that as such video wouldn’t make sense on the iPod? It wasn’t long before Apple launched TV shows on iTunes. Yeah. It’s like that. This story is probably true. Posted by: Arik Hesseldahl ,@BusinessWeek