Bobbing for Apple

In a few months, Apple (Nasdaq: AAPL  ) may find that it needs to oblige to offer up Mary J. Blige, follow YouTube if it wants some U2, and give up something ludicrous for Ludacris.

With Universal Music Group's licensing deal with Apple's iTunes up for renewal come May, a recent USA Today article hints that the country's largest music label will raise the stakes. Speculation indicates that Universal may even demand a piece of iPod sales.

Shocked? You shouldn't be. Universal and its peers have been able to strike deals with companies such as Sirius (Nasdaq: SIRI  ) and Microsoft (Nasdaq: MSFT  ) , in which they get a royalty from every digital music player sold. The major labels claim that, without them, there wouldn't be a demand for portable MP3 players. They're right, for the most part, but Snoop Dogg's label would be barking up the wrong tree if it decides to play hardball with Apple.

Falling on Def Jam ears
Apple is the undisputed leader in selling digital downloads. It has sold more than 2 billion songs through its iTunes store. In a perfect world, Universal would love to skim a buck or so off each iPod sold, the way it does on each Zune. That would be $70 million in found money. Unfortunately, that isn't going to happen.

Apple would be stupid to yield to Universal's whims. Now that its larger iPods sell on the merits of their video playback functionality, can you imagine what would happen if every music label, television network, movie studio, and viral video star came panhandling in Cupertino?

It wouldn't be pretty. Turning the old razor-and-blades analogy upside down, Apple surrenders most of its iTunes track sales to the respective artists' labels. There will be healthier potential for margin expansion in video, but Apple's pretty much at the whims of its hardware sales to bring home the bacon (for now). In short, Apple makes money on the razor, but not necessarily the blades.

If it threatens Apple, Universal may soon find itself on the outside of the digital smorgasbord looking in. That would be like Ebeneezer Scrooge looking in on Bob Cratchit and his family whooping it up over Christmas dinner. Over the past year, rival Warner Music Group (NYSE: WMG  ) has seen digital revenues double from 6% of total revenue to a beefy 12% slice. Unlike the fading physical product business, this is a goldmine of passive royalties and fat margins. Now's the time to count your coins, Ebeneezer, without appearing too greedy.

Universal's best angle may be to persuade Apple to up the ante on the music licensing side. Labels aren't happy about being tied to Apple's thrifty $0.99-a-song pricing. It belittles the CD as a value proposition, even as consumers applaud the ability to skip the filler material and cherry-pick the songs they want.

Is there room for Apple to charge more for tracks? Probably, but does Universal want to be the one to open up that Pandora's Box? If Universal somehow stands out as the one label charging $1.49 on Apple, will consumers follow? We may find out soon, as Amazon.com's (Nasdaq: AMZN  ) digital music store is widely believed to be rolling out with variable pricing later this year.

Up in a Puff Daddy of smoke
Is it just me, or are music labels starting to get cocky again? Some moves make sense. Striking up revenue-sharing deals with video-sharing sites like Google's (Nasdaq: GOOG  ) YouTube makes sense, because those sites are profiting directly off proprietary content. No one will argue that the labels (and hopefully their respective artists) are wrong for getting the lion's share of those 99 coppers you're handing over to Apple.

That's fair. Let's just hope that the labels recognize when they're going too far. When the industry was drowning, digital music strapped on a bright red bathing suit and dove in to save it. The platform has been an enabler, yet unsigned artists have learned to cash in on the process, too. Artists like Aimee Mann and Clap Your Hands Say Yeah! claim to be better off financially without a label calling the shots.

Now might be a good time to tone down the chest-thumping bravado. Greedy labels won't look too pretty exiled from the more popular digital music outlets, especially if that move sends their established roster of artists pining for their garages and the open-ended potential of freedom. Does Universal really want to take that kind of chance?

Amazon.com is an active Motley Fool Stock Advisor pick. To see what other great companies have been recommended to subscribers of the market-crushing newsletter, take a free 30-day trial today.

Microsoft is an Inside Value recommendation.

Longtime Fool contributor Rick Munarriz hasn't bookmarked any of MSN's Live sites yet, though he's been entertained by its QnA section. He does not own shares in any of the companies mentioned in this story. He is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.


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