Pandora cofounder Tim Westergren would love to slash the high performance royalties that cost his business dearly. "Last year, we paid over half of our gross revenues in royalties just from performance fees," says Westergren, referring to the fees his Internet radio company must dole out under the Digital Millennium Copyright Act's music license. "That compares to satellite radio, which pays 7.5% or 8% of gross revenue, and broadcast radio, which is completely exempt from it."
So even as Pandora enters this year's CES buoyed by tremendous growth--125 million registered users, 18 hours of average monthly user listener time, and a 68% market share of Internet radio--the company's revenues still take a sizeable hit from the DMCA's fees. True, last quarter Pandora did post an unexpected net income of $638,000, but it warned not to expect any more profits for the rest of the year. Pandora's share price has also dropped significantly since its IPO in June, partly out of investor concern for high licensing fees. Worse yet, the rates Pandora and other digital music services pay to artists and labels won't be open for renegotiation until 2015, and until that time, Pandora will just have to "grin and bear it," Westergren says. "We're fans of paying royalties. We think performers should be compensated, but this massive uneven structure doesn't make sense, and needs to be fixed."
Not all players in the industry agree with Westergren's viewpoint. For the artists and labels, possibly lowering fees received from streaming services is all but a nonstarter. "There's no way we'd want [the rates] to come down," says Michael Huppe, president of SoundExchange, the nonprofit that collects and distributes performance fees to rights holders. "I would be shocked if there was an economic rationale for having them lowered."
From Huppe's perspective, artists deserve more for their contribution to the space, not less. SoundExchange helped pay out somewhere in the neighborhood of $300 million to rights holders in 2011, thanks in part to increased usage of services such as Pandora. But as much as Pandora might want to take credit for its contribution--creating a new revenue stream for artists through personalized web radio--Huppe believes it's the content providers themselves who deserve most of the credit. "Pandora would not exist if it weren't for the recordings that are provided to them through this process," he says, in somewhat of a chicken-and-egg argument. "We like what they do; it's a very exciting company. But if you remove the sound recordings from the mix, I would say the value proposition of Pandora drops off substantially."
Asked about the disparity in fees paid out by services such as Pandora and SiriusXM radio, according to Westergren's figures, Huppe says it's an unfair comparison. "I like Tim--he's a nice guy--but it's a bit disingenuous to simply look at percentage of revenue as a marker that you judge everything by," he explains. "It's no secret that Pandora's focus over the last five years has not been on generating revenue. They've been trying to work on their product, their brand, and building a huge following. I salute that. But it's not unusual for companies in the early stages to focus on things other than cash flow."
What's more, Huppe adds, Pandora's fees are already incredibly low. SoundExchange's licensing team break down the numbers for me: "The 2012 rate for Pandora’s free service is $0.0011 per performance, or 1.65 cents per listener per hour (assuming 15 songs per hour)." So, assuming you have a $0.0165 rate per hour, at the maximum 40 hours of free listening per month, that amounts to just "$7.92 per listener, annually," according to SoundExchange, for 480 hours of consumer engagement over the course of the year. Huppe says that's next to nothing for the amount of targeted advertising Pandora can do during that time.
Though a flat fee might seem the fairest solution to charge the various services, it's not likely to ever to happen. The economics of each product are looked at to determine the rates. Just as you'd expect the fees for broadcast and Internet radio to be different, you might also expect different costs for a song used in a movie, a Super Bowl commercial, a Hallmark greeting card, or a musical toothbrush. Both Pandora and SoundExchange have found common ground in some areas, though. Westergren and Huppe hope broadcast radio will start to pay a performance fee, too. "We are 100% in agreement with Pandora," says Huppe. "It is an accident of history and politics that FM radio gets away with paying nothing for this primary input to their service."
Still, Westergren wants a fairer shake for his own platform of Internet radio, despite whatever rates they decide in the future for broadcast or satellite radio. "Legislation was created at a time when Internet radio was just too young to represent itself properly," he says. "The early negotiations around the statutory rates and the language in the bill was just not properly argued by Internet radio. We're a more mature industry now. Ultimately, there will be a rational answer to this--we've just got to hang tight."
Until then, however, hanging tight might just be the only solution. No matter what Pandora shows off at CES this year, whether that's new automotive partnerships, new mobile devices, or new usage statistics, it's not likely to affect its business as much as renegotiated performance fee rates. "In 2015, they'll cough up another number for the ensuing five years," Westergren says. "It's something that we'll be arguing for in Washington--it's an ongoing flag we carry."
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