An occasionally dusted-off blog by M. Scott Smith

RealNetworks wants to partner with Apple, but what's in it for Apple? 🔗

According to press reports today, RealNetworks CEO Rob Glaser sent Apple CEO Steve Jobs an e-mail recently suggesting that Real and Apple join forces. Glaser would like to license Apple's FairPlay technology so that songs purchased on Real's on-line music store can be played on Apple's market-leading iPod player. Glaser has been publicly vocal against Apple in recent weeks, arguing that Apple should open the file format up.

Songs on the iTunes Music Store are encoded using Apple's FairPlay technology, which wraps limited Digital Rights Management around industry-standard AAC-encoded music files. Currently, songs purchased on the iTunes Music Store may only be played on the iPod -- unless they are first burned to CD, and then ripped into an alternative format such as MP3, a process which slightly degrades the quality.

It is clear what Real stands to gain from this partnership: they have their own on-line music store, but songs purchased on their music store cannot be played on the iPod. The iPod is without question the dominant music player on the market, and with over 800,000 sold in the last quarter alone, that dominant market position seems to be solidifying further.

Apple's iTunes Music Store is also currently the market-leading on-line music store, with sales far exceeding its dozens of competitors, including Real. Most other on-line music stores use Microsoft's own proprietary format, meaning that songs purchased on competing services cannot be played on the iPod, and songs purchased on the iTunes Music Store cannot be played on music players other than the iPod.

That could be a bad thing, if the iTunes Music Store and iPod weren't both leading the market by a wide margin.

So Real stands to benefit; it wants access to the 2.5 million (and growing) iPods on the market.

But what does Apple have to benefit by openings its file format up to Real?

Here, Glaser hasn't presented a compelling argument.

The on-line music business is already a commodity business -- in the long run, there is little to differentiate one on-line music store from another. (The iTunes Music Store generally receives the most favorable reviews for its ease of use, but there's nothing to suggest other music stores won't eventually catch up.)

And the dirty secret of the on-line music business is that there's really no money in it. The "going rate" for individual songs has been set at 99 cents. Of that, the music label gets the biggest chunk. Credit card companies get a big chunk as well -- each credit transaction has a minimum fee, even if the total charge is only 99 cents. Most analysts feel that companies like Apple are, at best, making a couple pennies profit on each song they sell after all expenses are accounted for.

Apple acknowledges this, and says they view the iTunes Music Store as a vehicle for selling more iPods; Apple makes a healthy profit margin on each iPod it sells. This strategy seems to be working quite well.

But for companies like Real, it's not clear where there's money to be made in selling on-line music. The market is quickly becoming saturated with nearly-identical music stores, all selling the same songs for the same price. If a heavyweight lowers the price (as could happen if Apple negotiates a better deal with the music labels), then it would be a losing proposition for other companies to try and match the lower price -- most are already losing a lot of money selling songs at 99 cents. (Walmart is experimenting with selling some songs at 88 cents, although they've indicated this is more of a come-on to get people to their web site, which will hopefully result in sales of higher-margin products.)

So it doesn't look like a good business proposition to open up an on-line music store.

Which brings us back to Real. Real believes they would sell more songs on their on-line music store if the songs could be played on the iPod player. I'm not sure that this is necessarily true, because I don't view their on-line music store as being significantly different than the iTunes Music Store. And the iTunes Music Store integrates perfectly with the iPod, using Apple's patented syncing technology.

But let's assume it helps Real sell more songs. Does this help Apple in any way?

It's hard to imagine that it would. It can't be in Apple's best interest for someone to buy a new Britney Spears song from Real's on-line music store instead of the iTunes Music Store. And one thing that makes the iPod and the iTunes Music Store so popular is the strong synergy between the two products -- they work perfectly together, and are supported by the same company. The iPod probably would not work as seamlessly with other products -- such as Real's music store -- because Apple couldn't work on the fit and finish from both sides.

It just doesn't seem like a deal with Real would provide benefit to Apple. If Real's on-line music store had sales higher than the iTunes Music Store, it would be totally different -- then Apple would be foolish if they didn't make the iPod work with the Real store.

Contrast this with Apple's deal with HP. Starting this summer, HP will begin selling HP-branded iPods. This is a tremendous deal for both Apple and HP -- Apple will gain a broader distribution channel and a strong marketing partner, and will sell even more iPods. HP will get a cut of the profit, and won't have to exert much effort to generate this profit -- they get to benefit from the strength of the iPod and the huge amount of research and engineering Apple has already contributed to it. Both sides win.

Apple should be nimble and constantly assess the digital music business environment, being prepared to change their position if they need to. I think this is what they're doing. They're in a sweet spot right now -- almost owning the growing digital music market -- but they're also exploiting opportunities to expand their position with strategic partnerships, such as the HP deal. So far, Real's proposition doesn't seem to have strategic benefit for Apple.

Real could change this by trying to differentiate their music store from Apple's (and everyone else's). Make it unique and better! As an iPod owner, I see no reason to purchase songs from Real's store vs. the iTunes Music Store, even if I could play Real's songs on the iPod. Unless they can change that, I just don't see how Apple would gain from a partnership with Real. Not as long as the iTunes Music Store remains as popular as it is. And more sales of iPods only makes the iTunes Music Store that much stronger -- a fact that is undoubtedly really annoying Apple's competitors.

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