The Evolution of iTunes: The Birth of a Colossus

The tale of how iTunes was created remains one of the few unqualified success stories of a Silicon Valley technology company teaming with the entertainment industry to fully exploit an emerging business model.

Looking at iTunes’ well-oiled operation today, it’s tempting to conclude that the decisions that led to its creation were obvious, its path to market was clear and the outcome of its dominance inevitable.

Nothing could be further from the truth.

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The music industry was in chaos. Ravaged by piracy, executives were desperate as they watched a $40 billion-per-year business crumble beneath their feet and, ultimately, reduced to half its size. The only certainty was that music sales would drop even more -- unless the industry could give consumers a reason to pay.

Apple’s solution, it seemed to many at Warner who saw it for the first time that day when Jobs demonstrated the service on Warner’s own Windows-based computer, could very well give consumers that reason.

By early fall 2002, with a Warner deal in hand, Apple began herding the other labels, including EMI, Universal, BMG and Sony. Things didn’t go well at first.

“Apple certainly had very good people, but they couldn’t get the deals done,” says Jay Samit, then-president of digital distribution at EMI. “To the labels, Apple was this small company with 2% market share in PCs. iTunes would have been stillborn if Steve hadn’t gotten personally involved.”

Jobs brought the spark that lit up the deals -- one after another. First with EMI, then Universal and BMG.

“He was a great salesman,” says Doug Morris, who was head of Universal Music at the time. “He had a clear, complete thought that went from the iPod to iTunes. It made absolute sense to me.”

There were snags, of course. BMG balked at having to break apart the album and make every song available as a single. Universal thought the price should’ve been higher. EMI wanted Apple to devote more marketing dollars to the store. By early 2003, all had agreed to a deal -- except Sony.

Jobs turned to Sony last, inviting Andy Lack and Howard Stringer to Apple’s headquarters in February 2003, just a couple of months before launching the iTunes store. Lack was CEO of Sony Music, and Stringer head of Sony’s U.S. operations.

“He came to us last because he saw Sony as a competitor, and he rightfully didn’t want to tip us off too early to what he was doing,” Lack recalls.

The prevailing sentiment was that Sony’s Walkman would bury the iPod. Sony had a potent combination of hardware expertise and content from Sony Music. All it needed was the software. And the Japanese consumer electronics giant was already working on its own digital music service called Pressplay.

“What he showed us was game-changing. Howard and I left the meeting thrilled,” Lack says. “But I also saw that Sony had a big challenge.”

Lack walked away thinking that if his company didn’t move quickly, Apple was poised to snatch the crown away from Sony. “Andy Lack saw what no one else did, which was how valuable iTunes would be to Apple’s entire business,” says Wayne Rosso, then-CEO of Grokster. “He was the only one who seriously tried to leverage that by insisting for a device royalty on the iPod.”

Lack had little control over Sony’s consumer electronics business, but he saw an opportunity for Sony as the head of its music label, a way to tap into a second revenue source by getting a fee for every iPod sold. To do that, however, all the labels had to be united in insisting on a device royalty.

“My point was that the iPod was empty without the music,” Lack says. “I felt strongly that without a dual revenue stream, music was going to struggle. If they’d stuck together, there was a chance they could have gotten somewhere. It’s my greatest regret.”

Sony eventually agreed to license its music without a device royalty -- on the assumption that the deal was short term and wouldn’t interfere with Sony’s attempts to build its own music store. He had played them all, Lack recalls with a chuckle.

“The music industry was ‘Balkanized,’” Lack says. “Steve knew how to deal with them. He divided and conquered the labels. He was more ruthless than they ever were. They had no idea.”

This is an excerpt from an article that first appeared in the May 4, 2013 issue of Billboard magazine. To read the rest of this story, purchase a copy of Billboard Magazine here, or subscribe by clicking here.