Barely a week before its Zune digital music player hits retail shelves, Microsoft has agreed to share the revenues gained from the device's sales with record labels and artists. This is the first time

Barely a week before its Zune digital music player hits retail shelves, Microsoft has agreed to share the revenues gained from the device's sales with record labels and artists. This is the first time that record labels and artists will receive payment directly from the sale of digital music players.

Forcing the issue was Universal Music Group, which at this time is the only label named in the revenue-sharing program. UMG refused to license its music to the Zune service unless it could receive a percentage of each device sold, in addition to the standard music licensing fees for downloads and subscriptions.

The label cites a Jupiter Research study that estimates less than 5% of songs stored on MP3 players are acquired through legal digital channels. The rest are tracks ripped from CDs or downloaded from pirate peer-to-peer services.
“These devices are just repositories for stolen music, and they all know it,” says UMG chairman and CEO Doug Morris. “So it’s time to get paid for it. That’s really what this is about.”

UMG was the last record label to hold out on licensing its music to the Zune service. Although Microsoft is not obligated to now offer the same deal to other labels who already have signed licensing contracts for the Zune service, Zune marketing GM Chris Stephenson says it is now doing exactly that.

“We felt it was the right thing to do because the industry is supporting us so much by evolving digital music that we felt it was the right model, really,” Stephenson says.

Microsoft is working with all major labels directly, and with independent labels via the American Association of Independent Music, to establish a similar revenue-sharing agreement.

Currently, artists are compensated only when their music is either downloaded from an a la carte store or streamed via a subscription service, at the royalty rate outlined in their individual contracts. In this case, artists will receive a share of the device revenues whether their music is ever played or stored on it at all.

Whether labels will make more money from sharing in device sales than licensing their music very much depends on the popularity of the service and the number of subscribers it can attract. Exactly what percentage of Zune revenues will make its way back to record labels and artists has not been disclosed, but it will be a flat fee per device. Sources at UMG have confirmed that half of all the proceeds it receives from device sales will be shared equally with all its artists.

Morris says UMG will demand a similar revenue-sharing element to any future music licensing agreement in which the device and the service are integrated, including any future negotiations with Apple Computer.

“We have a very good relationship with Apple,” he says. “We have a current contract with them, but I’m sure that we will talk with them about it when the time comes. There’s a lot of stolen music on the iPod I would suspect. In the end, I’m sure they will want to make sure that the record companies are healthy.”

Morris says he’d like to collect a percentage of all MP3 player sales. However that is unlikely unless the government passes regulation dictating manufacturers share their revenues with the music industry, popularly knows as an “iPod tax.” But devices like the Zune and the iPod are vulnerable because the companies selling them also operate digital music services that require licensing deals.

According to Stephenson, the revenue sharing may actually benefit overall Zune sales by giving artists and labels a vested interest in promoting the Zune device, which faces a stiff uphill challenge to compete with the market-leading iPod from Apple Computer.

“We know that we need the industry to rally behind us,” he says.