Music streaming way up, as are Pandora's royalties

Music streaming is leading digital music sales past physical sales, but can streamers afford the royalties?

Strategy Analytics

Physical albums are one step closer to joining wooly mammoths, phone booths and Britney Spears’ career on the list of extinct things. According to a study released last week by Strategy Analytics, digital music sales are expected to surpass physical music sales for the first time in the US in 2012, and globally in 2015.

While digital downloads have been leading the way on killing off physical music sales, it’s music streaming that will apparently soon deliver the coup de grace. Strategy Analytics finds that the growth in streaming music revenue is outpacing that of download revenue in 2012, 40% to 8.5% meaning it is now leading the growth in revenue for the music industry. Apparently, people value the ability to play their music when and where they want via streaming from the cloud on multiple devices more than they do actually owning their music.

So, should Pandora be popping the champagne corks right about now?

Well, not quite yet. The problem is, the more listeners they get, the more likely they are to not be in business much longer, at least in the U.S.

Come again?

It all has to do with music royalties. Right now, as currently constructed, U.S. copyright laws require that those who stream music, such as Pandora, pay performance royalties on a pay-for-play basis. That is, they pay the artists who perform on recordings they streamed and the labels that owns them, at a rate of anywhere between $.0002 and $.0014 per digital performance. One “performance” is defined as the transmission of one song to one listener. So, more listeners = more performances = higher royalty payments.

See the problem for Pandora and other Internet radio providers?

Terrestrial radio stations don’t pay these performance royalties for the music they broadcast; instead they pay much smaller royalties to songwriters and music publishers (as do Internet radio stations), though there is a movement to impose the performance royalties on broadcasters.

Services that offer music on-demand (or via download) such as Spotify and Rhapsody negotiate with and pay record companies directly for the rights to offer their music, and so aren’t subjected to these royalties in the same way.

Performance royalties do, however, also apply to satellite radio, which partly explains why SiriusXM is currently suing SoundExchange, the non-profit performing rights organization that collects and distributes these performance royalties to artists and labels.

The digital royalty issue is already a serious one for Pandora and others, and one which some feel may threaten their survival if something doesn’t change. Under the current laws and rates they could very well be doomed to collapse from the weight of their own success.

However, there may be a light at the end of the tunnel. Clear Channel recently struck a deal with the record label Big Machine (home to Taylor Swift and Rascal Flatts, among others). Reportedly, Clear Channel has agreed to pay Big Machine performance royalties for their broadcasts, which they wouldn’t otherwise have to pay, in exchange for tying digital performance royalty payments to a percentage of their advertising revenue. This in spite of the fact that 98% of their current audience comes from broadcast, only 2% from digital. Clearly, they are gambling on the growth of their digital audience.

Is this the way that Pandora and other music streamers will be able to keep their business model profitable in the face of a rapidly growing audience? My fingers and toes are crossed that it is; I’d hate to not be able to listen to the Flock of Seagulls channel on my smartphone.

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