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Can Apple Win Over a Music Industry Burned by Pandora?


When Apple rolled out iTunes Radio last fall, it marked a radical departure from business as usual and a possible lifeline for recording artists.


If he joins Apple, [Beats CEO] Mr. Iovine is expected to use his industry clout to help strengthen iTunes Radio, with a particular eye toward generating more advertising revenue, one of the people familiar with the matter said.

Mr. Iovine said in a recent interview with the Journal that he was one of the first people to see iTunes, and began talking to Mr. Jobs about a subscription-music service in 2004, flying up to Cupertino for lunches and other social functions.

"The idea of be very frank, I got from Apple," he said, noting the "uniqueness of their blending of technology with popular culture."

--Wall Street Journal, May 8, 2014

Bette Midler is angry, and you won't like Bette Midler when she's angry. The singer lashed out at Pandora (NYSE:P) last month, after the streaming music provider paid her $114 in royalties for more than 4 million song plays. She's not the first to complain; last year, members of Pink Floyd accused Pandora of "tricking artists," while the Talking Heads' David Byrne called Internet radio "unsustainable as a means of supporting creative work".
The powers that be aren't pleased either. After striking deals with the major record labels, Pandora spent 2013 undermining them by lobbying in favor of the Internet Radio Fairness Act, a bill that would have reduced streaming royalties by some 85%. When the legislation failed, the company promised to take its case to the Copyright Royalty Board, a federal panel charged with setting royalty rates. And when ASCAP tried to negotiate a larger cut for songwriters, Pandora filed a lawsuit, kicking off off a legal spat that ended last March in a loss for ASCAP.
Pandora now has 250 million registered users, but few friends within the music industry. The streaming provider is aggressive and litigious even by L.A. standards, and remains something of an outsider -- a threatening presence, born out of the algorithms of the Music Genome Project, and headed by representatives of Silicon Valley and the venture capital community. More importantly, Pandora is hitting labels and recording artists where they're most likely to feel it: the wallet.
Last year, album sales fell 8%. Digital downloads declined 6%. A poll by Edison Research found that, while 44% of respondents saw Internet radio as a replacement for AM/FM, 30% saw it as a surrogate for CDs and MP3s. And while streaming audio has become an important source of revenue for the music industry, the tiny minority of paid subscribers accounts for nearly half of that income.

Not only is Internet radio threatening to become the sole venue for recorded music, it's also pushing the industry towards a freemium model that has yet to provide artists -- or streaming providers like Pandora -- with any meaningful income.
So when Apple (NASDAQ:AAPL) rolled out iTunes Radio last fall, it was a sea change. Tim Cook and Co. not only offered to pay more in performance royalties, they threw the labels a slice of advertising revenues to boot. Songwriters were offered a 10% cut from Apple -- more than double what they receive from Pandora. This was in addition to less tangible benefits, like integration with the iTunes Store, independent licensing deals (not possible with Pandora), and the ability for artists to get paid directly and avoid large Performance Rights Organizations like SoundExchange.
In return, Apple got exclusivity. Earlier this month, Coldplay, which pulled its catalogue from Spotify last year, pre-released a new album on iTunes Radio. The Black Keys did likewise. December's Beyoncé album was an iTunes exclusive, and the Los Angeles Times reported in March that Apple is pressuring the major labels for more such deals. They have no reason to refuse. Pandora's royalty rates may be protected by the courts, but there's more than one way to skin a cat.
A Beats acquisition may figure into Apple's coalition-building efforts. The headphones maker is, in a sense, the anti-Pandora. Headed by a who's who of industry superstars, Beats has pointedly avoided Pandora's algorithmic approach to programming instead relying on human "curators" like the Academy of Country Music. The subscription service offers on-demand tracks and downloads, making an apples-to-apples comparison too difficult, but it's probably fair to say that, while Pandora has been burning bridges, Beats has been building them. As TechCrunch reported last week, a buyout could smooth the waters for further expansion of iTunes Radio.
Apple is defying conventional wisdom by working with an incumbent industry rather than disrupting it, but this may prove to be the more sustainable approach. Like Netflix (NASDAQ:NFLX), Pandora has become a threat to the very people it depends on, and to much the same effect. The television networks are allying themselves with the cable companies; the major labels are hitching their carts to Apple. Content is expensive and, unlike Web companies, content creators don't have the luxury of nursing perennial losses.
Internet radio -- subscription or otherwise -- is unlikely to be a moneymaker for Apple. It may feed into iPhone sales, particularly if Cupertino leverages free trial subscriptions like Beats has done with AT&T (NYSE:T), but the best reason for playing nice is probably the least satisfying one in this age of moving fast and breaking things. iTunes and the iPod arose out of collaboration with the music industry. Consumer loyalty has seen Apple through good times and bad. This is, after all, a company that survived the late '90s by mending fences with archrival Microsoft (NASDAQ:MSFT). Sometimes, it pays to have friends.

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