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How Taylor Swift Overpowered Apple Music

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When I was in business school, I had to miss a final exam due to an interview. Fortunately, my economics professor let me make up the final by meeting in his office and answering questions.

It's been a while but I still remember one of the questions he asked -- What is a bilateral monopoly?

The answer is an industry in which a big buyer and a big seller are trying to figure out how to set the price for the seller's good. Who wins in the negotiation? The one with the most market power.

This comes to mind in considering the announcement that Apple caved into Taylor Swift's complaint about not paying artists during a three-month free-trial period by way of explanation for her decision to keep her music off of Apple's new streaming music service.

Apple plans to launch Apple Music -- "the iTunes download store plus a $10 streaming subscription plan, a free Internet radio station and a media platform that will let artists upload songs and videos" -- on June 30, according to the New York Times.

Apple caved because it has less bargaining power than Swift. How so? In a nutshell, Apple's iTunes store is losing out to Spotify and other streaming services -- and since Swift has already shunned Spotify, it is perfectly logical that she should do the same to Apple.

In case you missed it, on June 21, Swift explained that she was withholding her latest album, “1989,” from Apple’s new service because the service would not pay artists during a customer's first three months of use -- which would be free to the consumer.

However, after reading Swift's Tumblr post to that effect, Apple's Eddie Cue, who runs the service, announced that Apple "will pay its full royalty rates for music during the free trial," according to the Times.

Unlike Spotify, which lets customers listen free or pay monthly fees to eliminate ads, Apple’s subscription feature will have no permanent free level.

Swift -- whose father is a Senior Vice President at Merrill Lynch and whose mom worked in mutual-fund marketing, according to Vulture -- has accumulated a significant amount of economic bargaining power since her birth in 1989.

Her net worth came in last fall at about $196 million. Vulture estimated that she took in $239 million in income between 2008 and 2014 and that she owned $86 million worth of real estate and airplanes. Vulture subtracted off $94.6 million in taxes and another 15% for management and staff fees -- leaving her with about $196 million.

But net worth is not the real source of her leverage -- for that you have to look at her sources of income and market position.

Her albums are consistent chart-toppers which gave Swift an impressive $206 million take from concerts, albums, and downloads.

The concerts account for 52% of her take. In 2013, for example, she took in about $108 million from tours for her albums Red, Speak Now, and Fearless -- generating gross revenue of $133 million, $123 million, and $63 million, respectively -- and taking 34% of that gross after paying manager and promoter fees, according to Billboard.

The other 48% -- about $98 million -- comes from selling albums and digital downloads. Billboard notes that she has "sold more than 30 million albums and 75 million singles downloads." Billboard assumes she gets 20% of the revenue those sales generate after subtracting producers' fees.

Vulture estimates that the albums generated about $78 million for Swift (assuming $12.99 per album) and over $19 million -- a mere 9% of her income -- for the digital downloads (at $1.29 per single).

Indeed the winners like Swift take more of the spoils from recorded music than from streaming revenue. According to the Atlantic, the top 1%  of bands and solo artists earn about 80% of recorded music revenue but the "top-ten playlist accounts for a miniscule .00003%" of streaming revenue.

Vulture also guessed that Swift pulls in about $34 million from endorsements from the likes of "Diet Coke, CoverGirl, Keds, Sony , Elizabeth Arden, L.e.i. Jeans, and American Greetings."

Even though digital downloads are a small portion of her income, Swift has a solid track record of keeping the digital versions of her music off of streaming services that give away much of it for free through so-called freemium business models.

For example, in fall 2014, she pulled her music off Spotify -- whose freemium service is an "ad supported, free-to-users tier that aims to convert listeners to subscribers" -- calling the company a “grand experiment” -- in the year ending November 2014, her record label told Time she got a mere $500,000 from Spotify -- that doesn’t fairly compensate creators of music, according to Billboard.

Artists generally perceive Spotify -- which is valued at $8.5 billion after a more than $500 million financing -- as paying them less than does iTunes. For example, Billboard calculates that Spotify's freemium service "pays one-fifth to one-seventh what its subscription service does."

Former U2 manager Paul McGuinness told Billboard, “Artists worldwide are aware that Apple’s iTunes store is honest and pays them real money, unlike Spotify, where the sums are trivial.”

But those trivial sums to artists are music to the ears of Spotify freemium users "who might otherwise use iTunes or YouTube," according to Billboard. Spotify claims "more than 60 million active users." Spotify said that 25% pay $10 a month for subscriptions and that they account for 50% of the revenues of the streaming market.

Since people find it cheaper to get those digital tracks through the likes of Spotify, iTunes revenues have been shrinking -- down 13% to 14% in 2014, according to the Wall Street Journal.

It remains to be seen how Apple will pay artists during the first three months when Apple Music's streaming service is free to consumers.

But Swift's superior bargaining leverage has made it a bit more expensive for Apple to try to regain the market share it's lost to Spotify.