The End of iTunes?

With a major decision looming about the royalty rates that music publishers receive from online sales, the digital-music arena could be headed for a meltdown.

Tomorrow, the Copyright Royalty Board (CRB) is expected to issue a ruling on whether to raise, lower or hold steady the fees that songwriters receive from digital music stores such as Apple’s iTunes. If the board hikes the rates, Apple has threatened to close down its store, which sells more music than any other retailer in the country — online or off.

Though the company declined to comment on what it might do after this week’s proceedings, Apple in the past has made no secret of its opposition to a rate hike.

In written testimony (PDF) before the board last year, iTunes Vice President Eddy Cue said that maintaining the price point of 99 cents per song was critical to Apple’s competitive position. Raising the royalty rates from 9 cents to 15 cents per song, as copyright holders are calling for, would force Apple to either raise prices or absorb the costs. Neither is an acceptable solution, Cue said.

In his testimony, Cue argued that keeping the price of iTunes songs low is critical to maintaining a compelling alternative to free, illegal downloading. An increase in royalty rates that was passed along to consumers would fuel piracy, he said, leading to a drop in revenue not just for Apple, but to the broader music-industry as well.

“Alternatively, if [the iTunes store] were forced simply to absorb any increase in mechanical royalty rate, the result would be to significantly increase the likelihood of the store operating at a financial loss — which is no alternative at all,” Cue said.

“Apple has repeatedly made clear that it is in this business to make money, and most likely would not continue to operate [the iTunes store] if it were no longer possible to do so profitably,” he told the board.

The Players

The CRB is a three-person council with statutory authority over the thorny digital-music issues of royalty rates and copyright licensing. Its members are appointed to six-year terms by the Librarian of Congress. Tomorrow’s ruling will fix royalty rates for digital downloads through 2012.

After the board issues its order, the parties will have a chance to petition the judges for a rehearing. If that motion is denied, the order becomes eligible for an appeal to the U.S. Court of Appeals for the D.C. Circuit.

The group leading the charge to increase the “mechanical” royalty rates copyright holders earn from online sales is the National Music Publishers’ Association (NMPA), which represents the interests of songwriters. Those copyright holders receive their digital royalties from the recording industry, which collects directly from Apple and other online sellers.

The NMPA, which is joined by the National Songwriters’ Guild and the Nashville Songwriters Association International, is calling for a rate increase based on its contention that songwriters are the engine of the music industry, but have seen their net royalties decline in recent years.

“As a result of their significant contributions, substantial risk and dwindling mechanical income, among other factors, the songwriters were unanimous in their belief that they are not fairly compensated by the current mechanical royalty rate,” the groups wrote in their final submission to the board (PDF).

The NMPA did not immediately respond to a request for comment.

Shifting Fee Models

As it slowly warms to a future that will be increasingly digital but continues its crusade against piracy, the record industry isn’t eager for a rate hike, either. In its testimony to the CRB (PDF), the Recording Industry Association of America recommended converting from a fixed royalty fee to a rate of 9 percent. Based on the industry-standard price of about a dollar per song, that would keep the royalty rates paid to copyright holders roughly where they are.

The Digital Media Alliance (DiMA), a group that represents online music distributors such as Napster and Real Networks, is calling for a reduction of the royalty rate to no more than 6 percent, reflecting the opinion that digital music needs to remain cheaper than the physical product.

Given its meteoric five-year rise to the apex of first the digital-music market, then the wider retail space, perhaps no company has a greater interest in seeing the royalty rates drop than Apple, which is also a member of the DiMA.

“An excessive royalty rate would stifle any effective competition with piracy or the physical retailers, as we would either be forced to raise prices, limit further investment in present and future services or even simply drop out of the market,” Cue said in his testimony, pointing out that iTunes already operates as a low-margin business.

“This industry needs reduced, not increased, costs in order to continue to attract the investments necessary to its growth and stability.”

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