OK, so why would Apple agree?

Universal Music would like a slice of every iPod pie (click here).

Universal, the world’s largest music company, owned by French media giant Vivendi, was the first major record label to strike an agreement with Microsoft to receive a fee for every Zune digital media player sold.

“It would be a nice idea. We have a negotiation coming up not too far. I don’t see why we wouldn’t do that… but maybe not in the same way,” he told the Reuters Media Summit, when asked if Universal would negotiate a royalty fee for the iPod that would be similar to Microsoft’s Zune.

I would like that slice too. (Actually, come to think of that, I get it in the form of consumer surplus.) But why would Apple give Universal that?

If Apple were flexible in its song pricing (which it isn’t), whether Universal got a dip into the iPod pool wouldn’t matter. iPods and iTunes songs are complements and so Universal can make as much on one as on the other. For example, if Universal wanted to earn 80 cents per song and the average iPod customer bought 20 songs from Universal, it would be indifferent between charging Apple 80 cents per download or $16 per iPod sold (or any revenue neutral mix of these). Notice that the mix here will impact on iTunes and iPod pricing but for consumers it is the overall expenditure — the sum of iPod and iTunes pricing — that matters and so once again, the precise balance between them does not matter.

There is a potential reason why the mix might matter. If Universal spends marketing dollars selling songs and Apple spends money selling iPods then there is a more direct link between their efforts and their rewards if Apple earns as much as possible per iPod and Universal as much as possible per song. In this case, it would be preferable to keep the status quo.

Because Apple fixes its iTunes song prices, however, an issue arises. If Universal wants to get more money (which it would) and has the bargaining strength to do so (which is unclear), then the only way to achieve this would be to give Universal a share of the iPod revenues. So some more elaborate royalty agreement becomes necessary when Apple wants lots of discretion over its retail pricing policy for iTunes. Then again, if it is making enough up on iPods, then why should it care even if iTunes songs make losses?

This is one negotiation I wouldn’t mind being a fly on the wall for.

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