How the Upcoming Change in Digital Royalty Rates Will Alter How We All Listen

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Big surprise: A huge gap exists between labels' and webcasters' proposed rates.

It's not hyperbole to say the future of digital music in the U.S. -- or at least a great part of it -- rides on the outcome of the webcasting royalty rate proceedings now underway. What services like Pandora and iHeartRadio pay to stream music is directly related to the financial health of webcasters as well as the digital revenues earned by record labels whose music they stream.

First, some background. Rate proceedings that will determine statutory webcasting rates for 2016 through 2020 recently entered the discovery phase, and companies' filings have been made public. Webcasters pay statutory rates if they stream music under a compulsory license -- and adhere to certain restrictions to ensure services are non-interactive (like Pandora) -- rather than negotiate directly with labels. The Copyright Royalty Board, a group of three judges appointed by the Library of Congress, sets rates that a willing buyer and willing seller would agree to in a regular market transaction. The CRB will announce the rates in late 2015.

The CRB filings show diversity in the rates proposed by the stakeholders. To no surprise, SoundExchange (the government body responsible for digital collections on behalf of rightsholders) wants a sizeable increase, while webcasters want to pay substantially less. The parties are far apart. SoundExchange wants commercial webcasters to pay 0.25 cents per stream in 2016. Pandora proposes a rate of 0.11 cents per stream -- 27 percent less than it currently pays for advertising-supported streams. iHeartMedia wants a rate of 0.05 cents for its simulcasts. AccuRadio proposes 0.01125 cents.

Related

This rate proceeding is different. In addition to the usual arguments behind their proposals, webcasters now point to royalties that were actually the result of direct negotiation with record labels. Previous rate proceedings looked at direct licenses for interactive services to guide the CRB for setting rates for non-interactive webcasters.

Take Pandora's direct deals with independent rights group Merlin. In this two-tier system, Merlin receives the standard statutory rate for plays that would normally occur in an absence of the licensing deal. The second tier represents a discounted rate for incremental streams that result from Pandora "steering" listeners toward Merlin music. In other words, Merlin traded a discount for increased plays while keeping the statutory rate for baseline plays. That trade-off demonstrates Merlin is embracing the competitive market, says the written testimony of economist Carl Shaprio on behalf of Pandora.

Another example of direct deals comes from iHeartMedia (formerly Clear Channel). According to iHeartMedia filings, its two-tiered deals also pay a statutory rate and an incremental rate. The details of the deals have been redacted from the publicly available filings, but its expert witnesses estimate the "projected compensation" reflects an incremental royalty rate of 0.5 cents for Warner Music group and 0.2 cents for independent labels.

Both Pandora and iHeartMedia argue the second tier, the one involving incremental plays, is relevant when considering what a willing buyer and willing seller would negotiate in the absence of government involvement (in this case, the CRB setting statutory rates). If not for the statutory rate, they say, a negotiated royalty would be equal to or similar to the incremental rates.

There's more to this story, of course. The seller (the record labels) agreed to the discounted rates knowing it will also receive the statutory rate, not the lower rate, for many -- perhaps most -- streams. In addition, the licenses include a share of terrestrial radio that sellers undoubtedly figured into their calculations. And the non-monetary points to the deals -- all redacted from the filings -- are evidence that sellers are willing to trade a lower royalty for preferential treatment. But because all sellers cannot be given preferential treatment, the lower rate applied to incremental plays isn't evidence of a rate negotiated by a buyer and all other sellers.

Statutory royalties are an explosive issue partly because they're a zero-sum game. If record labels get a rate increase, webcasters will have less money left over after royalties to SoundExchange, the digital performance rights organization representing them in these proceedings, and more money would flow to labels and artists. On the other hands, a rate decrease would mean labels and artists receive less and webcasters would gain financial health.

But a CRB determination isn't a final say on either rates or revenues. A lower rate could possibly encourage more investment in webcasting from AM/FM broadcasters and more entrepreneurism in standalone digital services. This is exactly the argument made in filings by iHeartMedia and Pandora. In this scenario, a lower rates leads to more webcasting and greater webcasting royalties for labels and artists.

On the other hand, a higher rate could encourage webcasters to, out of necessity, negotiate direct licenses that provide greater value to some labels -- i.e. non-monetary, promotional benefits -- while lowering their royalty bills. These are the tradeoffs seen in the direct licensing deals labels have with iHeartMedia and Pandora.

The digital environment is barely recognizable when compared to when the CRB set rates for 2011 to 2015. Pandora was a smaller, privately held company, Clear Channel's iHeartRadio a year old and neither Apple nor Google had entered the webcasting business. Today, Pandora has a more established business, iHeartRadio is an established brand, Apple operates iTunes Radio -- under direct licenses -- and Google is integrating its Songza acquisition into its music offerings. There are more, and bigger, companies with a vested interest in the outcome of these proceedings.

This article originally appeared in the Nov. 8 issue of Billboard.

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