In cutting a deal with the Warner Music Group, sources say Apple caved on publishing and has agreed to pay at least 10 percent of advertising revenue to license the songs, sources say.

While the WMG deal is for both master rights and publishing, the latter component has been considered one of the main obstacles holding up Apple’s iRadio effort.  By going to at least 10 percent of advertising revenues, Apple has signaled its willingness to double the publishing rate that Pandora pays publishers, which has been about 4.1 percent of its revenue. Sony/ATV Music Publishing has since negotiated about a 5 percent rate, after it withheld its digital rights from ASCAP and BMI, in a move to cut its own licensing deals with digital services, according to sources.

With the other major publishers like Universal and BMG also pulling digital rights from the major U.S. collections societies, iTunes, which started out by offering publishers the same rate that Pandora pays publishers, was suddenly confronted with a scenario of appeasing the major publishers, who are all looking to cut their own direct deals at better rates than the U.S. performing-rights societies.

At press time, reps from Warner, Sony and Universal had not responded to Billboard.biz’s requests for comment.

The proposed iTunes  digital offering has been described as a hybrid, Pandora-like service that will allow users to build their own listening stations informed by whatever song or artist is chosen, plus each listener’s own buying history at iTunes, and–if they have cloud accounts–the music uploaded to it. But in another important distinction, it will also allow the labels to pitch music that can fit in with listener’s choices in building stations. Finally, the iRadio service will come with a buy button, which labels hope will spur sales at iTunes.

The service will compete with Pandora, but in order to gain what it hopes will be a profitable business model and a competitive advantage, Apple has been cutting direct deals with the major music partners, instead of applying for a “pureplay” license, which is the route that Pandora went in order to license music.

The distinction between direct licenses and a pureplay license is important to Apple. In going the pureplay route, the master recordings licensing rate is determined by the Copyright Royalty Board, which for this year has assigned 0.0012 cents (other sources have said 0.0016 cents) per listener per play. In addition to that rate, that license also comes with another formula, which consists of 25 percent of total company revenue. Then, whichever formula generates the most revenue for record labels and artist — the 25 percent of total company revenue or the per-play, per listener rate of 0.0012 cents — is chosen to make payments. With Pandora, the latter formula of 0.0012 per play per listener, when added up, came to about 56 percent of revenue in its most recent fiscal year, so royalties were paid out of that bucket on a pro-rated basis.

Up to now, the pureplay license carried an advantage on the publishing side. Since it is a compulsory license, once a service applies, they are licensed to use any music they want as long as they pay royalties. So even though a service may not have yet negotiated a deal with the publishers, they could start playing their music as soon as they applied for the license by agreeing to pay the statutory rate to recorded music rights holders.

In the case of Pandora, negotiations with ASCAP wound up in rate court, while BMI says it is still negotiating. So far the process has resulted in Pandora paying the two performaning-rights organizations and SESAC a combined total of 4.1% of advertising revenue, according to the company’s filings with the Securities and Exchange Commission.

The reason why some of the major publishers have been opting out of the U.S. collection societies when it comes to digital rights is because they feel publishers have been shortchanged by the Pandora model, where master rights owner enjoy a 14-1 ratio, if you consider that the service paid out 60% of its revenue to rights owner’s last year and only 4.1% of that went to publishers.

Since  both BMI and ASCAP operate under consent decrees with the U.S. government, it makes it harder for them to negotiate a competitive rate under compulsory licenses with digital services, according to music publishing executives with companies that have pulled their digital rights from the PROs.

While Apple probably would have liked the pureplay license for publishing reasons, that license lost some of its appeal when the major publishers began pulling digital rights from the PROs. But the pureplay license came with another ingredient that would make going that route cost prohibitive for Apple: the 25% of advertising revenue bucket.

Unlike Pandora, Apple has many businesses beyond its music-streaming service, and all the revenues from its computers, tablet, iPhones and iPods, would also be in that bucket, if it chose the pureplay license. That means that with revenues of $156 billion last year, Apple would be on the hook for $39 billion to music rights owners, if it had a compulsory license for its service.

Consequently, it had to go the  direct deal route with music rights owners if it wanted to launch a profitable internet web service. That’s why it initially sought a rate below Pandora from the recorded music operations but eventually agreed to pay a rate similar to the 0.0012 cents per play, per listener. It also has agreed to an advertising bucket, which would be split evenly between the rights owners and Apple, after a 20% cost of servicing ads were deducted, and whichever bucket is higher is how the recorded music rates would be determined.

So while it appears to have gotten both Universal’s and Warner’s recorded-music rights by agreeing to pay a rate similar to the Pandora rate of 0.0012 cents per play, Apple also held out for an advantage of not paying when a customer skips a song in the suggest play list, which would have effectively given Apple a lower recorded music rate than Pandora, one executive says.

But now with all the advance money that Apple is offering–the amount of which Billboard was unable to determine–that mitigates the non-payment for the song skips and potentially makes the rate Apple pays higher than the Pandora rate,  that executive added.

In going the direct route, sources say that Apple initially sought to pay publishers the 4%-5% of advertising rate that publishers are getting from Pandora.  Since Apple has chosen to seek a direct license rather than use a compulsory license, it is subject to what the rights owners will agree too and can’t use rate court as its fall back position. So it apparently caved and agreed to at least a 10% rate to Warner/Chappell Music, but the question remains if that will that be enough to appease Sony/ATV, BMG and Universal Music Publishing Group, all of which hadn’t signed as of last week and all of which were looking for a rate of up to 15% of advertising revenue, according to sources.

While at least one source indicated that 10% would be the lower range it was willing to accept, now that Apple has agreed to at least that rate with the Warner Music Group for its publishing rights, will the other publishers hold out for the higher rate knowing that Apple is reportedly trying to cut a deal by next week so it can announce the deal at its Worldwide Developers’ Conference in San Francisco on Monday.

Last week, one major label executive familiar with the negotiations told Billboard, “the Apple guys are going nuts to get this deal done, but there are not there yet. They have never been this eager to do a deal before.”

That executive senses desperation on the part of Apple executives, which he says will spur the company to cut deals with all the major parties. But one music-publishing executive says that Apple will eventually strike a deal with all rights-holders. “The Apple folks are pretty smart; they recognize an opportunity to create a better service and have a meaningful market share is here now and won’t be here three years from now.

“They will be remiss if they don’t do a deal now,” the executive added. “Sometimes when you are introducing  a new product, your costs might be higher than anticipated, but in the long-term this service could become a great way for them to sell more great iPhones and maybe sell more downloads for everyone. They have a history of building services that are friendly and intuitive and while this ad-supported service is a new area for them, it could be a toe in the water that will lead to other big things for them.” [Billboard.biz]