Universal Music to Get Cut of Zune Sales

UPDATED November 9, 2006 2:00 pm ET In a formal statement issued this morning, Microsoft and Universal Music Group –- one of the "Big Four" music publishers worldwide -– announced they have reached a licensing deal, which would allow for royalty payments to be attributed to the new Zune MP3 player, to be launched next week.

A UMG spokesperson, in a discussion this afternoon with BetaNews, flatly denied elements of a story published this morning by The New York Times, which sought to clarify elements of this deal. While UMG is not willing at this time to discuss the royalty schedule itself in detail, what it did provide to BetaNews does contradict most of what has been published since a Microsoft spokesperson first confirmed the existence of the deal during a Merrill Lynch investment analysts’ conference call yesterday.

Here are the facts as we now understand them: Microsoft has agreed not only to share revenue from songs downloaded from its Zune music service, which is a common deal in the industry, but to also share a portion of proceeds from the device itself. The formula for these proceeds will be calculated based on the number of Zune units that eventually sell through to consumers. This fact is critically important, especially since it distinguishes the type of royalty payments Microsoft will be making, and how they may be regulated under current US law.

The royalty payments, UMG told BetaNews, will not be a percentage of the revenue from retail sales, but instead a flat fee based on the number of Zunes that end up in consumers’ hands. This is also critically important for several reasons. Typically, royalties collected on sales of units –- especially of books –- are calculated based on how much resellers and retailers paid for them, as opposed to 1) the number of units sold, and 2) their sale to consumers at the end of the chain. This means that resellers will not, in effect, be responsible for royalty payments, or that UMG would be responsible for units left unsold by retailers.

Though the spokesperson would not reveal the formula used to determine the amount of Microsoft payments, we were told it would be a flat fee, not a percentage. The fee will not be $1 per Zune sold, contrary to what The New York Times reported this morning, leaving us with subtle indications that the fee is actually higher.

As the UMG spokesperson told us, this per-unit payment would come in addition to the share of revenue that the music group already plans to receive from per-download sales of songs through Microsoft’s music service.

This deal, if it stands, has the possibility of obliterating the entire business model that other manufacturers had planned for the MP3 industry. For decades, manufacturers of all kinds of recording and reproduction equipment have maintained they are not responsible or liable for the content they record or play back – a point of view that the US Supreme Court eventually upheld.

If Microsoft upsets the apple cart, as it were, setting a precedent that says that manufacturers can be held responsible for royalties, and the publishers themselves start seeking fees directly –- instead of relying upon the traditional collective rights holders -– then not only could publishers start demanding per-unit fees from Apple and other MP3 player manufacturers, but it could seek equal terms from producers of other digital music equipment suppliers, including from Sirius and XM satellite radio.

In other words, so long as Microsoft is not only willing but eager to pay publishers for the right to let digital content flow through their devices, the manufacturers’ case that most use is “fair use” under the law, is undermined.

Content providers of all types might be compelled to seek compensation from all types of console manufacturers – for instance, movie studios from the makers of high-def DVD players – reversing the outcome of court rulings in the early 1980s which established that the makers of such devices as VCRs were not responsible for royalties for the movies played on those devices.

In response to our question about whether UMG would be willing to discuss the possibility of similar licensing and royalty deals with other MP3 player manufacturers, the UMG spokesperson told us, "Absolutely." The music group will invite other manufacturers to make similar proposals, and it will be open to all suggestions for a period of time.

How long is that period of time, and would the group be willing to take a more legal approach to the topic if it doesn’t hear a response? Our impression was that the period would be measured in months rather than years. Getting lawyers involved in the situation to put pressure on manufacturers, we were told, is the course of action a company would take if –- hypothetically speaking, of course -– government regulation were required to sort out the differences between publishers and manufacturers. Comment was declined as to whether UMG would pursue government involvement, though the spokesperson conceded it might not be the desirable alternative.

During this limited time, though, UMG’s weapons will remain withdrawn. "We always negotiate first," the spokesperson said.

Would UMG support other publishers seeking similar deals with Microsoft and other manufacturers? Yes, BetaNews was told, since such deals may be good for the industry. But would UMG be willing to provide other publishers a glimpse into the formula it worked out with Microsoft, in order that they may collectively benefit the industry more rapidly? Absolutely not, the spokesperson responded.

A big question left open Thursday is why Microsoft would make such a deal and potentially open a Pandora's box. The answer may lie in a review by the Wall Street Journal, which noted that early versions of the Zune Marketplace contained far less music that Apple's iTunes. The reason is because UMG had not yet signed on to Microsoft's service, despite being so close to launch.

Microsoft launching Zune with fanfare to rival Apple while missing one of the major record labels would be disastrous to its marketing efforts. In turn, the Redmond company may have been willing to make major concessions to get UMG on board - including handing over a cut of sales from the Zune player itself.

Next: How the UMG deal threatens Apple’s best-laid plans