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.
