A close look at the iTunes licensing agreement for indie labels shows iTunes Radio royalties have limited downside and strong upside. The minimum royalty calculation ensures labels will be paid a decent royalty until iTunes Radio becomes effective at generating revenue. iTunes Radio could be very valuable to labels if Apple can convince listeners to buy downloads at a healthy clip.
 
Even if Apple generates no revenue, labels will be paid 0.142 cents per stream under the minimum royalty. The contract defines the minimum royalty as 45% of net advertising revenues or $21.25 per 1,000 listener hours in the first year and $22.25 in subsequent years. In this case, $0.2125 per listener hour works out to 0.142 cents per stream, assuming iTunes Radio will stream 15 songs per hour with an average of four-minute songs.

Apple iTunes Radio's Licensing Agreements With Indie Labels Emerge

The standard royalty kicks in once Apple becomes better at generating revenue. In the first year, the standard royalty is 0.13 cents plus 15% of net revenue. In subsequent years, the standard royalty is 0.14 cents plus 19% of net revenue.
 
Once iTunes's revenue-generating ability is 39% as effective as Pandora, the standard royalty of 0.142 cents (barely) exceeds the minimum royalty. For these calculations, I use Pandora's revenue per listener hour of 0.3 cents. The company had 4.18 billion listener hours and revenue of $125.51 million in its quarter ended April 30.
 
If iTunes Radio becomes extremely effective at generating revenue against its listener hours, it will share its success with labels. The minimum royalty will exceed the standard royalty when iTunes becomes 171% more effective at revenue generation than Pandora is right now. In other words, the event iTunes Radio revenues go through the roof, labels will not be stuck with a small share of the revenue. (Here I use terms applicable after the initial year because I assume iTunes Radio will not generate that much revenue in its first year.)
 
None of these calculations take into account skipped songs or songs that are in the user's collection. iTunes Radio can play up to two songs per listener hour royalty-free if the song comes from the user's iCloud collection, is a Complete My Album track (a promoted track that has not yet been purchased) or a "heat-seeker play" (a track that received promotional consideration from Apple). I also ignore the fact that iTunes Radio will not pay any royalties during the initial 120-day beta period.
 
Adjusting for royalty-free streams reduces the effective per-stream royalty. Taking away two royalty-bearing tracks every hour would turn a minimum royalty of 0.142 cents into an effective royalty rate of 0.124 cents, or slightly above the 0.12 cents Pandora is paying this year for ad-supported streams. (Streams from its Pandora One subscription service have a royalty of 0.22 cents.)
 
iTunes Radio's impact really soars when download purchases are taken into account. The radio service will have a "buy now" button to allow the listener to purchase a song at iTunes while it's playing on iTunes Radio. Since a single download is worth far more than a single stream, purchases can have a huge impact. And because Apple will stream promotional tracks to encourage purchases, it makes sense to adjust the iTunes Royalty to account for these incremental revenues.
 
Purchases' impact on the effective royalty rate depend on how often people buy a track they hear. If listeners buy one track for every 100 songs heard on iTunes Radio (one track every six hours and 40 minutes) a 0.142-cent royalty turns into an effective royalty of 1 cent -- a 661% increase from the standard royalty rate. If listeners purchase only one out of every 1,000 tracks heard (one track every 66 hours and 40 minutes) the effective royalty would be 0.232 cents.
 
Labels will find iTunes Radio royalties falling within a comfortable range. The per-stream royalty won't be lower than the 0.12 statutory rate received from pureplay webcasters (as part of the Webcaster Settlement Act). If Apple can get just one download out of 1,000 streams, labels will get at least nearly twice that statutory rate.