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California and the West

Online Music Deals Probed

Eliot Spitzer's inquiry is said to be focusing on 'most-favored nation' terms that guarantee competing labels get the same prices for songs.

January 12, 2006|Dawn C. Chmielewski and Charles Duhigg | Times Staff Writers

Eliot Spitzer's probe of the recording industry's dealings with online retailers is focusing on contract terms that guarantee competing labels get the same prices for their music, sources said Wednesday.

Critics of the labels' practices said they threatened the legitimate market for online music just as it was taking off, potentially raising the familiar 99-cent price customers pay for their tunes.

The New York attorney general last year issued subpoenas to major record labels as part of an investigation into whether they colluded to set prices for the music they sell online. Several people familiar with the probe said Spitzer was examining "most-favored nation" clauses in the labels' contracts with online music services.

Spitzer's office declined to comment.

But the head of the trade group for Internet music retailers said that the labels' insistence on pricing guarantees threatened the legitimate online music market just as consumers were beginning to buy, rather than steal, music online.

"Some of the major labels have proposed and re-proposed and insisted on the inclusion in their licenses of most-favored nations clauses which would grant that label the benefits and pricing negotiated by a competing label," said Jonathan Potter, executive director of the Digital Media Assn., whose members include Yahoo Inc., RealNetworks Inc. and Apple Computer Inc. "Collusion has never been known to lower prices."

Music industry executives, all of whom requested anonymity because Spitzer's investigation is ongoing, said the "most-favored" clauses are appropriate.

"The music industry wanted to establish the online marketplace as quickly as possible, but we didn't want to get bogged down in debates over prices," one executive said. "These clauses let us create a viable marketplace quickly, and then make sure all musical artists are equally compensated."

Sales of digital tracks more than doubled in 2005, climbing to 352 million, according to Nielsen SoundScan. But increases in the online marketplace have not offset declines in the overall sales of U.S. music albums, which fell 7% last year to 618.9 million.

Executives at some music companies said the most-favored clauses have not been activated. But executives at online music retailers said the clauses have been executed multiple times, giving some companies more favorable rates than those originally negotiated.

Spitzer's investigation comes as some online music services are trying to flex their muscles. Last week, for instance, Yahoo Music pulled from its website some of Warner Music Group's videos, in a bid to force the company to renegotiate the prices Yahoo pays when users stream the clips. Executives from both companies have begun discussions to resolve the issue.

Executives at various music companies said that most-favored-nation clauses were common in contracts governing music subscription services, and that some of the largest record companies had clauses ensuring them the highest prices on music downloads. Some companies also have clauses forcing online music stores to spend equal amounts on marketing songs from the various record labels.

In 2000, the Federal Trade Commission found that the major labels had used cooperative advertising money as a tool to compel retailers to charge higher prices for music CDs. To be eligible to receive money to buy newspaper, television or radio ads, retailers had to agree not to advertise CDs below a set "minimum advertised price." The FTC said the practice cost consumers $480 million in inflated prices.

But antitrust experts said the case law governing clauses like those Spitzer was examining was ambiguous. In the 1970s, for instance, the Federal Trade Commission sued companies selling a gasoline additive, claiming that firms' insistence on most-favored clauses violated antitrust laws, said Robert H. Lande, a University of Baltimore law professor. The government lost that case, Lande said, because firms proved that the clauses helped promote long-term economic stability within the fuel industry.

"But in this case," Lande said, "if the clauses only benefit the music companies, they may violate the law."

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