Zune: Music industry's new BFF

Company breaks from Apple with promise to pay music producers a royalty for each music player sold.

By Grace Wong, CNNMoney.com staff writer

NEW YORK (CNNMoney.com) -- Microsoft is opening up its arms to the music industry as it launches its new portable music player against rival Apple's iPod.

Microsoft (Charts) has agreed to pay Universal Music Group a cut from the sales of its new Zune portable music player, a Universal spokesman confirmed Thursday.

Microsoft will pay Universal Music a royalty on each Zune device it sells.

Under the terms of the deal, first reported by The New York Times, Microsoft will pay Universal a flat fee for each $250 Zune it sells.

Universal, a unit of Vivendi (Charts), wouldn't disclose the amount it will receive, but the Times reported it's likely to be more than a $1 per device.

Microsoft also will pay royalties on songs bought through Zune Marketplace, its new music download service.

Microsoft's concession could give song producers more leverage as they continue to negotiate music licensing deals with digital music services.

Apple (Charts), in particular, could encounter more resistance: CEO Steve Jobs has so far refused to share revenue from iPod sales with record companies. And Apple's licensing deal with the music industry is up for renewal soon.

"It shows that part of the Zune strategy isn't only to win the hearts and minds of consumers but the hearts and minds of record companies as well," said Michael Gartenberg, research director at Jupiter Research.

Until now, music companies have received royalties only on songs sold on music services like iTunes and not on the actual devices themselves.

But digital music sales haven't been growing fast enough to offset the declines in CD sales, according to Michael Goodman, senior analyst at The Yankee Group.

The revenue shortfall has made music executives anxious to find new ways to increase their slice of the digital music pie.

Microsoft too is eyeing the market with the launch of Zune and its online music service Zune Marketplace. Although this isn't Microsoft's first foray into digital song downloads, this is the first time that it's rolled out an MP3 player meant to compete directly with the iPod.

But Microsoft faces a tough battle. Apple has a lock on 75 percent of the market for portable music players, according to market research firm NPD Group.

"Zune has to differentiate itself from the iPod and one of the ways they're trying to do this is create a groundswell of support from industry and artists," Goodman said.

Universal promised to share its Zune royalties with its own artists, which include Black Eyed Peas and U2.

If other music labels like Sony BMG and Warner Music (Charts) follow suit, then other music player makers like Apple could find themselves in a tough position, industry experts said.

Just how much leverage, if any, the record labels will gain from Microsoft's move won't be known for awhile, these experts added.

"This is a way for Microsoft to drive a wedge between labels and Apple, but it doesn't give music companies leverage against Apple until Zune gets market share," Gartenberg said.

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