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March 28, 2006

Apple and France

There continues to be a lot of chatter about Apple Computer (AAPL) and the potential French law that would force the company to open up its iTunes digital rights protection. One thing that I think is misunderstood is that the law will only really impact AAPL by forcing it to withdraw iTunes from the French market. The company can continue to sell iPods in France if it chose to do so.

The issue that is bugging the French lawmakers is that music which is downloaded from iTunes can not be transferred to a digital music device other than iPod. The lawmakers note that when a consumer buys a physical CD they can load the music onto any device. Therefore, the lawmakers wonder why shouldn’t music purchased online from iTunes store be transferable to any other device?

The problem with the French lawmakers is that they are totaling misunderstanding the music market and how iPods +iTunes fit in. Today, most of the music that is stored on iPods or within iTunes on Macs and PCs has come from one of two places: illegal free downloads and uploads of physical CDs. For example, the Birenberg family iTunes library has over 8,000 songs. Roughly 6,000 songs have come from uploading physical CDs which we already owned or have purchased since we started using iTunes. I added about 1,000 songs by attaching a hard drive full of MP3s owned by a friend and just dragging what I wanted into iTunes. Another 500 or so have come from purchases via iTunes. The balance have come from non-iTunes downloads (overwhelmingly legal), borrowing CDs from friends, or copies of CDs friends burned for us.

Most importantly, I can load anything I want into iTunes. It doesn’t have to be digitally encrypted to Apple's proprietary digital rights management software. So the iPod is already encryption free. Only the music that comes from iTunes is digitally encrypted and non-transferable....

What the lawmakers and many investors are missing is that all the French are really talking about opening up is the iTunes digital rights management system. This will only directly affect music downloaded from iTunes (and other similar sites that use proprietary encryption technology). So how does this impact the music industry and AAPL?

For the music industry, opening up iTunes, by far the most popular legal, for profit, music download site will merely mean that future sales will be sacrificed. If everything that I have ever downloaded from iTunes can just be copied over to any other device owned by any other person, the result will just be lost sales. Sales of digital music over platforms like iTunes are actually allowing revenues for the music industry to grow again even as physical sales continue to dwindle. Opening up iTunes, the dominant legal download site, will cut off or limit the new revenue growth vehicle. Why pay when you can get it for free from someone else? Is this really what the music labels want? Shouldn’t they be helping AAPL to build the market for legal, for profit downloads?

As for AAPL, I am assuming that all that would happen were France to enact this law is for the French version of iTunes to be shut down. I see no reason why they would stop selling iPods in France. After all, French folks who wanted to buy an iPod could still load it with all the CDs and free downloads and iTunes downloads they want. Additionally, they could just point their browser to an iTunes site in another country and download and purchase from iTunes. Would the French buy fewer iPods? I suppose that is possible but the question is why are they buying iPods in the first place. Is it because they want to gain access to iTunes downloads? Or is it because iPod + iTunes offers the best user experience for managing and listening to your music library? I'd suggest the later.

The question you should ask if you are an APPL investor is will iPod sales slow if the iTunes digital encryption system is forced open. I’d argue that iPod + iTunes has already won the battle, not because of access to iTunes downloads -- iPods drive iTunes demand, not vice versa -- but because the iPod is a better music gadget. iPods, not iTunes, drive profits for AAPL.

Posted by Steve Birenberg at March 28, 2006 04:02 PM in AAPL