2019 American Music Awards

The Evolution of iTunes

The creation of the world's biggest music retailer seemed to happen almost in spite of the record labels, but they knew a good thing when Steve Jobs showed it to them.

When executives from Warner Music and Sony Music reached out to Steve Jobs in January 2002 in hopes of recruiting Apple into a consortium to develop a standard for interoperable music devices, they approached the meeting in Cupertino, Calif., with much apprehension for the future of the music business. A few minutes into the pitch, Jobs interrupted and said:

"You guys have your heads up your asses."

"Everyone else in the room was silent," recalls Warner executive VP Paul Vidich, who attended the meeting after flying in from New York that morning. "I replied in a hoarse voice, 'You're right, Steve. That's why we're here. We need your help.' The intent of the meeting was to recruit Apple to join the consortium, which they did. But this consortium never produced a product or standard."

Still, the meeting sowed the seeds for something much bigger. It started Apple down its own path, and two months later Jobs called Vidich and requested a separate meeting with Warner executives alone. Jobs said he wanted to discuss his own vision for a digital music store. It had been tried by other companies before, but nothing really caught on. This pitch seemed different somehow, more elegant.

Vidich flew out to Cupertino again, this time with Warner Music CEO Roger Ames. During the two-hour coffee-fueled meeting in Apple's board room, Jobs talked through his plan excitedly.

By the end, Ames was onboard. He told Jobs: "Work with me alone until you're completely ready. Don't make the mistake of trying to work with all of us [majors] at the same time."

For the next six months, during several Cupertino visits by Ames and his team, Apple and Warner ironed out the business plan while Apple built the infrastructure for its store.

During those meetings it was Warner executives, not Jobs as is commonly thought, who suggested tracks be sold for 99 cents. At the time, many labels wanted to price tracks at $3.49 each. But not Warner.

"When we told Steve, he looked at us like we just gave him a gift," Vidich recalls. "We knew we needed to alter consumer behavior in a big way. Below $1 was an emotional threshold for people. It became an acceptable impulse purchase."

"It all moved very quickly after that," one executive involved in the discussions says.

By early fall, Jobs had a prototype he could show. He flew out to Warner's headquarters in New York. By all accounts, Jobs was gracious and charming, in full sales mode that day in his distinctive black mock turtleneck and jeans. He gleefully demonstrated a prototype of the iTunes store, enthusing over every minute detail of the software.

"He was like a kid in a candy store," Vidich says. Ames and team were just as excited.

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.

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."

Jobs, on the other hand, had perfect pitch when it came to winning over an audience.

"We had no idea of the level of the 'cult of Apple' and the power of his presentation until the day of the launch. It blew us all away," another executive says.

When he introduced the iTunes Music Store on April 28, 2003, to an auditorium packed with technology journalists and analysts at the Moscone Convention Center in San Francisco, he quoted Hunter S. Thompson: "The music industry is a cruel and shallow money trench, a long plastic hallway where thieves and pimps run free, and good men die like dogs. There's also a negative side."

The auditorium exploded with laughter. Even Morris, Jimmy Iovine and other music executives sitting in the front rows chuckled.

"It was smart positioning on Steve's part," Vidich says of why no one took offense. "The labels were loathed by musicians and consumers. So for him to position himself as taking on the industry to put out a product that was consumer-friendly was appropriate. We all recognized that."

All the majors were there, but Universal and Warner, whose CEOs had led the partnership with Apple, had a sizable contingent at the launch, including Tom Whalley, Sylvia Rhone and Val Azzoli. The executives gathered after the presentation and marveled over plates of sushi at how this could be the start of a rebirth for the struggling music biz.

When it opened its doors, the store was a modest affair, stocked with a couple of hundred thousand tracks that were only available to the 2% of computer users and 5% of laptop users who owned Macs. But a buoyant Jobs promised the store would grow.

The iTunes store debuted in April 2003, and within a week, it sold 1 million tracks.

Apple's market capitalization averaged just $6.7 billion in 2003, a fraction of the roughly $400 billion it commands today. But already the tables were beginning to turn.

"By the end of the year, Steve had sold so much music that the leverage began to shift in his favor," Vidich says.

Morris concedes that during the nine years he had known Jobs, Morris lost all of his arguments with him--save perhaps one, and only because Jobs let him win.

"We had a lot of arguments with Apple, and we lost most of them, to be honest," Morris recalls, citing one he waged with Apple on tiered pricing. "I told him he was selling his own goods at different prices, but that he was selling ours at one. He agreed to raise the price. A week later, he called me and said, 'I changed my mind.' I told him, 'I have a great deal of affection for you. But when it comes to business, you're a real dick.' And instead of getting mad, he started laughing."

On Christmas Eve in 2008, Jobs called Morris at home. "He said, 'I've changed my mind again. I'm giving you a Christmas present.' He decided that it was OK to go to variable pricing."

Samit, who negotiated three licensing contracts with Jobs while he was at three separate labels, said, "At the end of it all, I told Steve, 'I surrender. You are a brilliant military strategist. You didn't read "The Art of War." You freaking wrote it.'"

There was, however, one thing Jobs didn't get--his own label. In 2003, Jobs approached Morris to see if France-based Vivendi would sell Universal Music to him for more than $5 billion. "It was half cash and half stock," Morris recalls. "The French rejected the offer." Two years later, Jobs made a similar pitch during a breakfast meeting with Lack at the Four Seasons in New York to buy Sony Music, which had just merged with BMG. Jobs didn't mention a price, Lack remembers, and neither party pursued the matter any further.

"He felt that music companies were poorly run," Lack says. "He felt he could do a better job."

As iTunes gained momentum, it crushed most other competitors. By 2007, it had a solid 68% share of the U.S. market for music downloads by units, a percentage that stayed roughly the same for the next five years as the market for digital music itself grew, according to NPD Group. In fourth-quarter 2012, iTunes had slipped only slightly to 63% despite inroads by Google's Play store and Amazon's progress in converting its CD customers into digital downloaders.

Though a ruthless competitor and negotiator, Apple didn't flex its muscle in ways that significantly harmed the music industry or even fully exploited its power to dictate terms, according to most of the executives Billboard interviewed for this story.

"You hear stories about Apple being a bully," says a veteran music executive who has negotiated with Apple for many years. "But I would say, when you consider their market power, they were fairly constructive and generous. They kept their eye on the big picture. If music was healthy, that was good for iTunes. That's still true today."


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