Business Matters: If Big Radio Had Pandora's Royalty Rate, It Would Owe Billions
Business Matters: If Big Radio Had Pandora's Royalty Rate, It Would Owe Billions

Some artists don't like what they're paid by streaming services. But the problem may stem from artists comparing streaming rates to purchases rather than what they get from terrestrial radio.

Compared to terrestrial radio, by far the most popular music format, new streaming services pay out a much higher rate on a per-listener basis to record labels, according to calculations by David Touve, Assistant Professor of Business Administration at Washington and Lee University. Since record labels are not paid for plays on terrestrial radio in the US, a good place to look is the UK market.

According to Touve's calculations, the per-listener value of a spin in the UK is $0.00012. That small amount is just 1/36th a typical per-listen value ($0.0042) paid by Spotify, 1/10th the rate ($0.0011) paid by pure-play webcasters such as Pandora in the US and 1/18th the CRB-established webcaster rate ($0.0021) in the US.

Business Matters: If Big Radio Had Pandora's Royalty Rate, It Would Owe Billions

There are a couple ways to think about these disparities in value to labels and artists. One obvious conclusion is that digital services provide a greater return than radio. Even though terrestrial radio is generally considered to be a healthy revenue stream, these numbers show artists stand to benefit as listeners shift their listening from terrestrial radio to streaming services. And they are switching. NPD Group has seen a 10 percentage-point drop in Pandora users who also listen to AM/FM radio since 2009. All things being equal, artists and labels will be paid more when consumers opt for streaming services over traditional radio.

Of course, some people worry that all things are not equal. Terrestrial and Internet radio are seen as promotional tools while on-demand services such as Spotify are thought to be substitutive in nature. In other words, there is a fear that people will buy less music and be less valuable consumers when they use subscription services. However, there is no evidence this is happening yet. Digital sales continue to rise and the decline in CD sales is no different than before the arrival of Spotify and other services in the second wave of subscription services. More time is needed for substitutive effects to materialize.

Such a great disparity in payouts could be a signal of underlying problems. David Pakman of venture capital firm Venrock is among those who believes current rates are unsustainable. Testifying at the House Subcommittee on Intellectual Property, Competition and the Internet hearing on November 28, Pakman said Venrock is "skeptical" that "profitable, stand-alone digital music companies can be built" with current royalty structures. He blames the high failure rate of digital music companies -- which he calls "among the highest of any industry we have evaluated" -- solely on "the over-burdensome royalty requirements imposed upon digital music licensees by record companies under both voluntary and compulsory rate structures."

Ironically, Spotify CEO Daniel Ek told AllThingD last week he's "incredibly happy" with the terms it has with labels. No, Spotify has not turned a profit yet, but it could if the company stepped away from its goal of "[reaching] every single person on the face of the planet," said Ek.

As Venrock has probably discovered, success comes down to scale. The more you pay rights owners, the more subscribers and listeners you need. The problem over the years has been that digital music services haven't acquired the proper scale given their cost structures. Spotify pays 36 times as much as a UK terrestrial radio station to the owners of sound recordings for a single play to a single listener. That 36-to-1 ratio is why Spotify needs to operate globally while a radio station can operate locally.