What would happen if Pandora did direct deals with major labels? Less than you might think. As long as Pandora continues to operate as a statutory service, artists would receive 50% of performance royalties -- the same share they currently get from SoundExchange -- that would be paid to labels.
 
Whether or not Pandora will someday do direct deals with labels is an ongoing question. Pandora founder Tim Westergren has told Billboard that labels have "been trying to undermine [compulsory licenses] by making the rates so high that Internet radio companies would rather do direct deals with them." There are some precedents here. In efforts to reduce its performance royalties, SiriusXM Radio has done dozens of direct deals with independent labels. Clear Channel has signed deals with such indie labels as Big Machine Label Group, Glassnote Entertainment Group and Wind-Up Records.

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The focal point here is the compulsory license used by services such as Pandora. A compulsory license allows a digital service to pay a pre-determined royalty rather than directly negotiate with record labels. Requirements for the statutory rate, outlined in Section 114 of the Copyright Act, limit what a digital service can do (e.g. no on-demand access, limited song skipping). The compulsory license provides certainty to services, labels and artists and the royalty process is more transparent than that of direct licenses. The compulsory license also makes Internet radio an artist-friendly platform: SoundExchange evenly splits royalties between labels and artists.
 
A direct deal with majors might give Pandora greater functionality, a la Apple's upcoming Internet radio service, but the labels would not get more money. A source tells Billboard major labels have made a commitment with SoundExchange to pay half of royalties from a statutory service in the event they have negotiated a direct deal. In other words, a major label with a direct deal with Pandora would still pay to SoundExchange the 50% of royalties afforded to artists under the statutory license. The label would not keep 100% of royalties and pay artists a royalty -- after recoupment -- as it does with royalties from purchases and non-statutory services. This person does not know if independent labels have made a similar commitment with SoundExchange.

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Depending on the service, direct deals could carry some benefits. Apple is negotiating direct deals for its upcoming Internet service rather than operate a statutory service. Universal Music Group has reportedly been offered a royalty equal to the current statutory royalty of 0.12 cents per stream in addition to a share of advertising revenue. Because Apple's service won't be a statutory service, labels would not be required to pay artists 50% of the per-stream royalties. But Apple's service is said to encourage listeners to purchase track downloads. Incremental sales would benefit artists. And the service could be a hit, taking some market share from Pandora and/or growing the overall Internet radio market. When consider all these factors, artists could possibly benefit more from Apple's decision not to use the compulsory license.
 
Don't expect a rush of Internet radio services to follow Apple's example. The compulsory requires less effort and resources that are required to secure direct licenses from three majors label, thousands of independent labels and an unknown number of independent artists. Apple's model requires a large in-house advertising division -- iAd, in this case -- and a music download store (both of which help drive sales of consumer technology hardware). Services will continue using the compulsory license. Artists will continue to get half of the resulting performance royalties.