SUBSCRIPTION MUSIC SERVICES: Turning the Music Industry on Its Head
In the tech world, a “disruptive technology” is one that changes a fundamental business or technical paradigm in the industry. Streaming subscription radio services, such as Pandora Internet Radio (also known as Pandora Radio or simply Pandora), is just such a disruptive technology. In a prior post, I discussed the interesting and innovative approach that is being taken by Pandora and its “Music Genome Project” from the standpoint of the listener’s musical experience. Today’s focus is on the business and legal impact of services such as Pandora on the record labels and recording artists, as well as on the music publishing companies and songwriters.
Pandora, like many of the streaming music services (such as Rhapsody and Spotify), has two levels of subscriptions: a free subscription supported by advertisements, and a fee-based subscription without ads. As might be expected, most users choose the free subscription.
Currently, because of copyright issues, Pandora is only available to subscribers in the United States, Australia and New Zealand. Even so, its growth (notice that I did NOT say profitability) has been impressive. So much so, in fact, that Pandora became a publicly traded company on February 11, 2011 and officially began trading on the New York Stock Exchange with ticker symbol “P” on June 15, 2011 at a price of $16/share. This gave them an initial public offering valuation of nearly $2.6 billion. During its 2011 fiscal year, Pandora reported $138 million in revenue with a $1.8 million net loss, excluding the cost of a special dividend associated with the IPO. Over time, Pandora hopes to become profitable, but that is no certainty. Pandora announced $80.8 million in total revenue for their first quarter of fiscal 2012, which was up 58% over their previous year’s first quarter results. Of the $80.8 million, $70.6 million came from advertising, while the other $10.2 million came from subscription. In addition, Pandora has seen a 62% advertising revenue increase, and a 38% subscription revenue increase year-over-year.
Pandora’s cost structure is highly variable, with “content acquisition costs” (mostly license fees) representing roughly 50% of Pandora’s total costs. There are three main costs associated with their content acquisition:
- fees payable for performing the recordings;
- fees payable for performing the musical compositions embodied in the recordings; and
- fees payable for song and artist information included as part of the service.
In the traditional radio world (e.g., playing a CD on a standard terrestrial station broadcast), public performance royalties are payable only to the owners of the copyrights to the musical composition (normally, a music publishing company and the songwriters) while the owners of the copyrights to the recording (i.e., the record company) do not receive a royalty. The theory was that playing recordings on the radio helped sell those records so there was no need to compensate a record label that just received that “free advertising.” Digital music services such as Pandora are treated differently: they are required to pay a digital public performance royalty to both the song publishers and the record companies.
A company called SoundExchange collects content fees on behalf of labels or artists on the recording themselves for these digital performances. These are by far the largest content acquisition costs. Pandora also pays licensing fees to the public performance societies, namely, Broadcast Music, Inc. (BMI), American Society of Composers, Authors and Publishers (ASCAP), and SESAC, Inc., in order to compensate composers, songwriters and publishers for the performance of their musical compositions embodied in the recordings.
So what is the impact of Pandora and other music streaming services on the music industry and musicians? For starters, it means that fewer consumers are purchasing CDs or even mp3s of their favorite music. Instead, they are getting it from these services. This means losses to the record companies and musicians.
Record companies and musicians are looking to offset those losses with licensing revenues from Pandora and other digital streaming services and with revenue from licensed ringtones and incorporation of music into video games.
These additional revenue streams for the record labels do not make up for the losses from CD and mp3 sales, however. Recording artists do not receive the normal artist royalty (which is based on a percentage of the retail sales price of CDs, etc.—normally around 15% before deductions), although they do get a percentage of licensing revenues. These revenues are not nearly as lucrative and a song needs to be played many, many times before the artist will receive meaningful compensation.
Even with the loss of revenues to record labels and artists, Pandora and other music services have lobbied hard to have the royalty rates reduced, claiming that they cannot make money while having to pay rates that are currently in effect. It seems the single biggest problem is that consumers have become accustomed to getting their music for free and that may be a trend that is very difficult to reverse.
So, is the emergence of this disruptive technology all bad news for the music industry? While this change in the business is just the latest in a series of body blows that have been suffered by the industry in the past ten years, there are those who feel that it actually presents the industry with a great new opportunity: despite the great decline in sales, the Internet has exposed consumers to more music than ever before. That accessibility has been difficult to monetize, however.
Artists see these new avenues as a way to better and more “democratically” promote their music, which leads to greater revenue opportunities for live performances. Record labels, seeing the same thing, now are attempting to negotiate so-called “360 deals” with artists that entitle the label to a percentage of the artist’s live performance and other music industry revenues (revenue streams that traditionally were off-limits in an artist recording agreement with a record label).
Stay tuned, as the one constant in the music business seems to be change.
A RARE TALENT: The Multi-Talented Jacob Collier
Born in 1994, Jacob Collier is a musician and multi-instrumentalist, based in London, England. He is a brilliant arranger, singer, jazz pianist and bassist. Check out this video of him singing all six parts (and playing a melodeon solo) in his terrific arrangement of Pure Imagination. In an age when we are quick to label singers or musicians as “stars,” he truly is deserving of that label.
PANDORA: Unlocking the Music Genome
People love music. As a musician, that’s important to me. The way people get their music has changed considerably over the past several years, and as a lawyer, that is equally important to me. Ten years ago, music fans got the majority of their music from two sources: CDs and commercial FM radio. Today, CD sales have dropped dramatically (to under 50% of all music sales for the first time in 2010). Total revenue from U.S. music sales and licensing plunged to $6.3 billion in 2009, according to Forrester Research, from a high of $14.6 billion in 1999. This does not mean that music is less popular than before. It means that listeners have turned to different sources, including YouTube and digital streaming services such as Spotify, Rhapsody and Pandora Internet Radio. These services offer a novel opportunity for listeners to create customized “stations” tailored to their particular tastes in music. (Kind of a modern “mix-tape” for those of us old enough to remember cassette tapes.)
As both an entertainment lawyer and a musician, Pandora Internet Radio (commonly known just as “Pandora”) is particularly interesting to me. Pandora’s popularity has expanded greatly over the past few years: there are now over 150 million Pandora users. Recognizing that people choose to listen to music through a variety of devices, Pandora is available both as an internet version and as a mobile version (both for Android and Apple devices) and car manufacturers are even programming Pandora as a common option on their entertainment systems.
Unlike the other streaming services, Pandora utilizes a patented technology that it refers to as “The Music Genome Project.” Just as molecular geneticists have broken down the human genome into its constituent parts in order to better understand the makeup of the human body, genetics and the cause of diseases, the “Music Genome” breaks down music into a huge number of constituent characteristic pieces to create a musical map of recordings. Over four hundred different musical attributes are considered when selecting a song. These attributes are combined into larger groups called focus traits. There are approximately two thousand focus traits. Examples of these are rhythm syncopation, key tonality, vocal harmonies, proficiency on a particular musical instrument and the actual mix of instruments played. A listener sets a Pandora “station” by specifying a particular artist or song, or a combination of multiple items of any kind. Once set, a listener can tune into their list of newly created stations or, instead, can select other pre-made genre stations or other users’ stations.
After a station is selected, Pandora will play a track (either by the artist chosen by the listener, if applicable, or another artist that Pandora’s “Music Genome” technology predicts the listener will like). Each track played can be responded to with favorable (thumbs up) or unfavorable (thumbs down) buttons. These responses determine if the track should be played and how much should similarly classified songs be played in the chosen station. A second negative response to the same artist will remove that artist from the selected station unless the user has marked the artist positively on another occasion or if that artist is listed under the station’s variety. After a while, the station becomes more tightly focused in terms of the type of music preferred by the listener in that station, but with a broader array of artists. This is one of the really cool features of Pandora—the listener is exposed to artists with whom they are not familiar but might enjoy. It is also interesting to set up a new station with one of the suggested artists to see what other artists will be suggested after that.
I have found that Pandora works best when an artist’s musical output has some consistent qualities. For example, if a jazz artist has recorded both traditional bebop and smooth jazz, Pandora’s suggestions may be based only on a part of the artist’s musical output which may not be truly reflective of most of the artist’s work. For example, Dave Grusin, a talented jazz pianist, long has been known as one of the pioneers of the so-called “Smooth Jazz” movement. However, he has also released straight ahead jazz recordings that do not fit that label. Depending on which Dave Grusin recording is played first (and, of course, how it is then analyzed with Pandora’s technology), Pandora may either feed straight ahead jazz music or smooth jazz music. How a listener reacts (with a thumbs up or a thumbs down) can impact how the “Dave Grusin” station will be created.
In the next blawg post of this series, I will discuss the business and legal aspects of this changing marketplace for recorded music and, in particular Pandora’s business model. In the meantime, check out Pandora and start exploring the Music Genome Project.
For those curious about the reasons why people love music, check out this site: http://news.discovery.com/human/psychology/music-dopamine-happiness-brain-110110.htm
FOREIGN MANUFACTURED COPYRIGHTED GOODS: No Longer a Grey Area
Anyone who recently has purchased college textbooks knows how expensive they are. A student from Thailand who moved to the United States to study mathematics recognized the huge price disparity between textbooks in the U.S. and his native Thailand. So, he asked friends and family to buy foreign edition English-language textbooks in Thai book shops, where they sold at low prices, and to mail them to him in the United States. Being an enterprising businessman, Kirtsaeng then sold the books, reimbursed his family and friends, and kept the profit. So what’s the problem? The book publisher, Wiley & Sons, did not want him importing and selling books in the U.S. that it had only authorized for sale outside of the U.S. because they set different price points for the same books, depending on the territory.
Wiley & Sons decided to sue Mr. Kirtsaeng under a provision of the U.S. Copyright Act that enables copyright owners to block imports of copies made overseas. Seems straightforward, right? Wrong. The Copyright Act also has a provision, commonly referred to as the “First Sale Doctrine,” that gives the owner of a copy “lawfully made under this title” (i.e., the Copyright Act) the right to resell or rent that particular copy. Wiley & Sons argued that even though the copies purchased by Mr. Kirtsaeng were lawfully made (they had licensed a foreign subsidiary to make and sell the books in Thailand), they could still prevent the import of them.
The case was heard on appeal by the United States Supreme Court and their decision was announced couple of weeks ago. The Supremes announced that copies lawfully made under the authority of the copyright owner may be imported and resold, regardless of where they were manufactured. The Court’s decision could have significant consequences for U.S. copyright holders and their attempts to control distribution channels for their works.
The Wiley decision is important because it removes copyright law as a weapon for U.S. companies to prevent the importation and sale of so-called “grey market goods.” Grey market goods are goods lawfully produced under the authority of a copyright or trademark owner. However, there are territorial restrictions place by the owner on where such goods may be sold. If you have ever tried to purchase a camera or consumer electronics item from an internet retailer, you will often find that there is a large price disparity between the exact goods if one carries a U.S. warranty and one that does not. That is because the latter likely is a grey market good not intended for resale in the U.S.
Now that the Supreme Court has stated that “grey market copyrighted” products (such as books, movies, software, artwork, etc.) are legal to import, what can the owner of such products do to prevent such sales in the U.S. that are not intended? In certain cases in the copyright world, the owner still can use technological means, if available, such as using country codes on DVDs. (A country code is a piece of embedded software on a DVD that only allows the DVD to be played on machines with the same country code.) Removing or disabling such copy protection devices is a violation of the Copyright Act.
Trademark law may be the best alternative to prevent the importation of such grey market goods. Under U.S. trademark law, importation may be prevented only if the grey market product is “materially different” from the corresponding U.S. product. The threshold for a “material difference” under U.S. trademark laws is fairly low and can include differences in the composition or ingredients of the product; differences in the language of the labels, stickers, or owner’s manuals; differences in the availability of warranty coverage; and any other differences that would be material to a U.S. customer. Even with that relatively low threshold, in the Wiley case, it appears that the quality of the books sold in Thailand was not materially different from those sold in the U.S. and, as a result, importation could not be prevented under trademark law either.
Another option available for intellectual property owners would be to remove some of the incentive to import the goods from a foreign territory into the U.S. Pricing the goods in other countries at a point closer to the U.S. price point would reduce that incentive. That could mean either raising prices in foreign markets or lowering them in the U.S.
As a result of this case, I expect to see intellectual property owners adding more “material differences” to their products designed for the U.S. market.
CHILD STARDOM: Too Often Not a Happy Ending
For every example of a young child actor or singer who grew up to be a happy, well-adjusted adult (see, e.g., Ron Howard, Claire Daines, Leonardo DiCaprio and Joseph Gordon-Levitt, to name just a few), unfortunately there are multiple examples of unhappy endings (e.g., Lindsey Lohan and Britney Spears). Here is another example. Amanda Bynes was a talented, funny, fresh-faced star of a kid’s sketch comedy program on Nickelodeon. Today, her life appears to be a mess. Another cautionary tale about the dangers of young kids in show business:
