Becoming Steve Jobs

by Brent Schlender

  In fact, Steve was so attuned to the piracy issue that he knew the issue might help him sell his next big music idea—the iTunes Music Store. Steve believed, with some justification, that iTunes was a more elegant form of digital music management than anything else on the market. And he knew that an iTunes music store, if properly designed, could give the consumers such a fluid and simple way to buy music that they would stop stealing tracks via Napster and the like, which were cumbersome applications that opened up a person’s computer to all manner of potential security issues.

  The creation of this particular online “store” is a crucial turning point in the evolution of Steve Jobs. It represents the moment when Steve’s ambitions for Apple first stretched beyond Cupertino. Up until this point, everything Steve had done had been within the confines of Apple’s own operations. He had stabilized the company, focused its mission, rebuilt the staff, shaped a core leadership group of first-rate executives, and produced the striking new iMac and a modern new operating system. Every step he’d taken had naturally proceeded from what came before, ensuring that the company was on a solid foundation in its core business even as it wandered into the uncertain future. Now he was about to make a bet that Apple’s bedrock was so strong that it could move beyond its own walls and start looking for opportunities that would reshape the businesses of others.

  To accomplish this, Steve would have to work on two fronts, both inside and outside the company. Inside, he would need to have his engineers customize Apple’s digital compression and distribution technology in a way that would solve problems the music industry couldn’t handle on its own. More expedient options, like buying an existing online retail music distribution website and “Apple-izing” it to get a running start, wouldn’t work because such sites didn’t yet exist. Nor did it make any sense to simply grant a license to the music labels to promote, sell, and deliver music directly to iTunes users, given how technologically inept the companies had shown themselves to be with their repeated, compromised efforts to sell their wares online. Sony Music, for example, made a hash of its early stab at selling digital music that would play only on players made by its parent, Sony Electronics. Not only did it offer very little music from the other big record companies, but Sony also made the tracks it sold unplayable on personal computers, which was where the lion’s share of consumers played digital tracks at that time.

  If Apple were to try to sell music itself, Steve would have to convince the heads of all five major record companies that an independent online store operated by Apple was their best, and perhaps their only, choice, given the sophistication of the digital onslaught they faced. Even then, given their temerity, he’d have to bend over backward to give them a comfortable way to try it out.

  Selling music online was a complicated challenge. Apple’s engineers needed to adapt iTunes so the music could be bought and organized easily, so charges could be recorded and billed appropriately, and so purchased tracks were encrypted to prevent buyers from copying and sharing purchased music indiscriminately. This last bit, a measure that would protect the labels from further piracy, was actually the most straightforward. Software companies had been working to address such security problems for more than a decade, and had developed all manner of digital locks and online verification tricks to protect their own software. Depending on what the label heads would eventually decide they wanted, Steve could easily customize the encryption, or watermarking, of MP3 tracks. It was much easier for Apple to tame that technology into a simple, foolproof lock than it was for the labels.

  The more significant challenge facing the store’s developers was billing. This seemingly simple problem was profound—existing billing systems might have cost music purveyors more for each transaction than the profit they could earn. This was in large part because of an issue that was becoming as vexing to the industry as piracy—namely, that online buyers were showing a preference for buying individual singles rather than higher-priced albums.

  Napster’s own traffic had demonstrated this new consumer behavior. When music fans could download whatever music they wanted, they liked to cherry-pick their favorite tunes, rather than get an entire album. This was a complete reversal of what happened to the music business in the late 1960s and early 1970s, when the recording industry all but did away with the single and focused instead on albums that commanded a much higher unit price. Many artists embraced the change and recorded “concept” albums, such as the Beatles’ Sgt. Pepper’s Lonely Hearts Club Band, The Who’s Tommy, or Pink Floyd’s The Wall. But labels abused the concept and regularly released albums with just one or two strong tracks, knowing that committed buyers would spend $10 to $15 on the whole album just to get those tracks.

  Steve knew that there was no turning back from the “Napster effect.” Now that listeners had the option, they would nearly always choose singles over the albums padded with forgettable tracks. Steve thought singles should sell for 99 cents, which more or less represented the imputed value of a track on an album, since the average conventional CD in the 1990s had a dozen or more tracks and sold for about $15. The price also appealed to Steve’s nostalgic streak, since it was the same price that he and others our age had paid for the 45 rpm singles we’d purchased in the 1960s.

  There was one problem with Steve’s idea, however. Historically, Visa and MasterCard charged 15 cents, plus around 1.5 percent of the transaction value for a single purchase; while American Express charged 20 cents plus 3.5 percent of the transaction value. That’s not such a big deal when the sale price is in the tens or hundreds of dollars, but when a single song costs just 99 cents, a transaction fee of 17 to 24 cents would be ruinous.

  If Apple was going to become a significant music e-tailer, it needed to figure out how to process charges for small purchases without forcing the credit card companies to radically alter their commission structures. (Apple wasn’t the first to face this conundrum of finding an affordable way to process and pay for non-cash “microtransactions” of less than a dollar. It had befuddled just about everyone except the phone companies, who solved it by aggregating their own internal accounting and billing for customers’ individual phone calls once a month.)

  Eddy Cue figured out a couple of ways to get around the problem. First, he suggested that the iTunes music store periodically bundle groups of purchases from an individual customer to send to the credit card clearing companies as a single transaction, rather than post them individually. That wouldn’t always be possible, but as the store’s traffic increased, the credit card charges could be consolidated into fewer separate transactions. Also, Cue had the store offer a simple way for parents to set up “music allowances” to prepay for their kids’ purchases, which would provide up-front payments in large enough increments to cover the cost of reconciling transactions as they trickled in later.

  These kinds of intricate answers delighted Steve. When Apple took on a major project, he wasn’t just concerned with the design and marketing. He wanted to know everything about the project, and he expected his employees to attack every conceivable problem—from design and engineering to seemingly mundane tasks such as packaging and billing—with creativity. Steve told me he was just as proud of the microtransaction solution as he was of the redesigned iPod models he would introduce in conjunction with the opening of the online store.

  Cue’s team made another crucial decision: Apple would build the iTunes digital “storefront” right into the iTunes application, rather than create a public website to serve as its music retail site. If you look for “www.itunes.com” online, you come to an Apple.com marketing page for iTunes, which describes its many wonders but doesn’t allow you to buy music. The only way to get to the store is via the iTunes application, which at that time was available only for Macintosh computers. This appealed to Steve for several reasons. It gave Apple control of all the technology behind the store, and it cemented a direct commercial relationship with customers. The simple transaction of buying a song, and of handing ove
r a credit card number to Apple in order to so, became part of what Steve had begun calling “the Apple experience.” As a great marketer, Steve understood that every interaction a customer had with Apple could increase or decrease his or her respect for the company. As he put it, a corporation “could accumulate or withdraw credits” from its reputation, which is why he worked so hard to ensure that every single interaction a customer might have with Apple—from using a Mac to calling customer support to buying a single from the iTunes store and then getting billed for it—was excellent. Steve had told me back in 1998 that the only reason for companies to exist was to build products; he was now using his company to build more than just products. Apple was now creating a holistic customer experience. Everything the company did, from technology development to the design of its stores, offline and on, was in service of that customer experience. Apple’s broad-based, intense focus on this was far ahead of its time, and would have wide cultural implications. After seeing and experiencing the uniform excellence of Apple’s products and service, customers would increasingly demand the same from other companies. Apple redefined the word “quality” and forced other companies to wrestle with the higher expectations of their customers.

  There was another key short-term benefit to building the iTunes store into the iTunes application: the limited reach of the iTunes store would be reassuring to the nervous music industry executives Steve had to woo. Half a million iPods had been sold, enough to create a meaningful niche but not nearly enough to affect the broader economics of the entire music industry. After all, Mac users accounted for a measly 4 percent of all personal computer users. For once, that minuscule market share was a competitive advantage. Since online sales of digital music represented a fearsome change to the label chiefs, Steve went to them with a simple, seemingly safe proposition: Why don’t you experiment with selling music downloads, to gauge demand and learn the customer and marketing dynamics, in my safe and tiny “walled garden”?

  Steve’s negotiating challenge was considerable. He needed every leader of the big five labels—Universal, EMI, Sony, BMG, and Warner—to sign on. He was probably right in presuming that any online store that couldn’t claim a huge selection across every major label was doomed to fail. And he was charging a stiff price in return for his end-to-end solution: 30 percent of every sale made on the iTunes Music Store.

  Fortunately for Steve, he quickly found an ally: Roger Ames, the head of Warner Music, whom he knew through an executive at AOL named Barry Schuler. Ames, an unpretentious realist in a business that was then still floating on the fumes of past profits and successes, saw clearly what Warner could accomplish on its own technologically: “Absolutely nothing,” he says. “We didn’t have any real technologists at Warner. It’s a record company, not a tech company!” Convinced that Steve had the only reasonable solution to where the industry was headed, Ames introduced Steve to the leaders of the four other major record studios, starting with those he thought would be most receptive. Their progress was steady, if bumpy. The reluctance of the record company executives was palpable and understandable. Some still denied that digital distribution of music was inevitable, while the more pragmatic feared that they would lose pricing power over their own products by ceding distribution to an outside industry that they didn’t quite understand or trust. Steve listened to them, and modified the store and the digital protections on singles to their liking. He knew he couldn’t just impose a solution on the industry.

  Steve also knew how to get what he wanted, and he negotiated with both carrot and stick. While he worked with the studio chiefs and led them to see that he truly did have a safe and complete solution designed for them by the very best technologists, he was also sure to remind them that the digital onslaught they were trying to ignore was inevitable and irrepressible. If they were worried about losing control, well, he invited them to just wait and see what might be wrought by the smarter, sneakier successors to Napster!

  Of all the record company heads, Andy Lack at Sony was the most suspicious. Sony had its own consumer electronics division, with its own approach to selling portable digital music players that used a completely different compression and encryption scheme. Furthermore, everything in Lack’s decades of experience as a media executive at NBC and other places told him that iPod sales would soar if Apple could offer a full-service music store, and that the company would probably even sell millions more Macs as a result. If that was the case, why weren’t the music companies the ones getting a slice of Steve’s business, rather than the other way around? Other studio heads sensed this as well, and they—or the CEOs of their parent companies—made equity offers that would have created partnerships that went deeper than mere revenue-sharing on music tracks. But these were halfhearted, and Steve believed that the longer he held out, the more the record companies would see that they needed his solution.

  Finally, Lack caved. On April 23, 2003, the iTunes Music Store opened for business with an inventory of 200,000 songs. During the very first week customers downloaded a million tracks, and by the end of the year Apple had sold more than 25 million songs.

  JUST AS LACK had predicted, iPod sales soared, to the point where several of Steve’s lieutenants believed that the market of existing Macintosh users was nearing saturation. They argued that the next logical step in the expansion of the iPod was to create iTunes application software for Windows—which of course meant opening the iTunes Music Store to every computer user in the world, which was exactly what Steve had promised not to do.

  Steve initially resisted the idea, for reasons that were both strategic and emotional. Steve had always wanted Macs to have distinctive features that consumers couldn’t get from a Windows PC. Also, he still wanted to see if the iPod itself might begin to drive up Mac sales—that part of Lack’s prediction had not yet come true. But Ruby, Schiller, and others argued that iTunes for Windows coupled with the iPod would give hundreds of millions of PC users a means to taste for themselves Apple’s more inviting approach to personal computing. The idea that the iPod could be a diminutive Trojan Horse to help Apple finally begin to win back some market share for Macintosh personal computers really intrigued Steve. After all, the team reminded him, wasn’t he the one who was always saying that if the company could pick up just a few points of PC market share, revenues would soar? Furthermore, even though the expansion would mean that PC users would use iTunes software on Windows, Apple would still control their entire digital music experience, from its iTunes software to its store to its iPod. As it had with iMovie, the team wore Steve down—quickly, this time—and convinced him to shift direction. Changing his mind now would pay off as much as it had then.

  Just a few months earlier Steve had cajoled the music label chiefs into signing off on that “little,” Mac-only test of the iTunes Music Store. Now here he came again, wanting to expand the experiment to, oh, every other personal computer user in the entire world. He had to get their permission, because the terms they’d agreed to applied only to the smaller universe of Mac users. But in the few months in between, they had seen that what Steve had forecast was true: consumers really would forgo piracy if given an easy way to acquire digital tracks at a cost that seemed fair. This time they put up minimal resistance; their business was headed in the direction Steve had predicted, whether they liked it or not. The iTunes Music Store gave them a way to like it a little better than the alternatives.

  Once again, Sony’s Andrew Lack felt he had no choice but to go along with others, even though he felt duped by the speed with which Steve expanded the iTunes Music Store’s market. Despite Sony’s ample content and history of great consumer electronics devices, its business units were stubbornly independent operating divisions that couldn’t possibly collaborate well enough to create any kind of “whole widget” alternative. Years later, Lack still bemoaned the weakness he thought the music studios had displayed in their negotiations with Steve. “The iPod was empty without the music,” Lack has said. “I felt strongly t
hat without a dual revenue stream [in which Apple had to give a cut of iPod sales back to the recording companies] the music business was going to struggle. If they’d stuck together, there was a chance they could have gotten somewhere. It’s my greatest regret.”

  On October 16, 2003, Steve announced that Apple was offering free downloads of the iTunes application for Windows PCs. For some of the Mac faithful, this was as shocking as Microsoft’s investment back in 1997. Most, however, saw it as a vindication of their faith that Apple software, and its entire approach to personal computing, was far superior to anything offered by the Windows juggernaut. Steve knew it, too; he gleefully made part of his announcement under a slide reading “Hell froze over.”

  Within three days, a million Windows PC users had downloaded iTunes and purchased a million songs via the iTunes Music Store. By the end of the year, more customers were downloading music from Apple through their Windows computers than through Macs. What the team was beginning to call “the Apple experience” had begun to infect the world of Windows.