Chapter Fourteen Streaming Recording star Taylor Swift shook the industry by demanding better royalty treatment from streaming service Apple Music.

Photo by Kevin Mazur/Getty Images.

“I love YouTube, but I think it is underpaying and getting away with it.”

—Singer-songwriter Nelly Furtado Reshaping the Landscape

Few developments in recent decades rival the rise of audio streaming for impact on the music industry. Although surprising for its speed of adoption, streaming’s displacement of analog and digital antecedents can be explained as addressing user desires. The reason is simple: convenience has always been a key driver for the mass market. Even in the heyday of the record business of the 20th century, most hours of music consumption were spent listening to a broadcast signal— not by juggling a relatively small number of tapes or discs in a treasured collection of purchased objects. One way of looking at the somewhat passive medium of streaming, then, is that it is the natural successor to radio in an interactive, digital age.

Early in the 21st century booming revenue from Pandora, , Tidal, and other streamers emerged as the best hope for returning prosperity to the financially battered music business. According to the trade group Recording Industry Association of America (RIAA), streaming swelled from just 7% of U.S. label recorded music revenue in 2010 to 65% by 2017. (See Figure 14.1.)

The monthly subscription revenue model is the big revenue-driver, offering an all-you-can-eat proposition to consumers for one price. Music streaming also comes in a “free” mode, supported by advertising that is less profitable for both streamers and the content creators.

Streaming is a medium that doesn’t get a lot of love from key players in music’s ecosystem. That’s because on a revenue-per-play basis, streaming is far less lucrative than downloads and sales of physical recordings (discussed in the economics section later in this chapter). The music industry executives and talent particularly dislike advertising-supported streaming—the free option—believing it generates inadequate compensation and devalues music in the eyes of the consumers when they pay nothing. Of course, in the 20th century industry executives also grumbled about radio’s economics, but at least in those days rights holders enjoyed the symbiosis of radio acting as a big promotional boost for the profitable sales of physical product.

In short, streaming rearranged the recorded music landscape. Record companies and terrestrial broadcast radio arguably were the platform players of earlier generations, while today digital streaming services are key pillars. Based on their economic heft and brand strength, arguably the streaming companies are more important to the business now than any other category of corporate players.

Figure 14.1 Digital Streaming Percentage of U.S. Recorded Music Revenue

Source: Recording Industry Association of America (RIAA)

Note: Recorded music industry revenue from online on-demand streaming, online noninteractive streams, and satellite radio. Streaming Technology

Streaming parses and compresses content that is then transmitted independently in digital pieces—called packets—to receiver devices. On the receiving end, the packets are rearranged to deliver an uninterrupted flow of content. When packets don’t arrive in time or aren’t processed quickly, streams freeze until the data flow catches up, at which time playback resumes.

Quality is not the highest, either, given that streaming files are typically compressed for better transmission flow and not permanently stored on the consumer’s device (with a few exceptions explained in a moment). Digital compression degrades audio fidelity, but that’s a trade-off for smoother delivery (so download-to-own alternatives deliver fatter files that generally offer higher audio quality). Another characteristic of digital streams is that they are difficult for consumers to share or duplicate. Satellite digital radio uses an audio streaming methodology as well but is not the focus here.

In rare cases a limited amount of streamed music is actually stored on consumer devices for playback with premium subscriptions when subscribers don’t have Internet connections available. These are sometimes referred to as conditional or tethered downloads offered with pay streaming (not the free ad-supported types), but they disappear once a subscription ceases.

To achieve smooth and high-quality streams, media players and apps are used, particularly on mobile phones and other devices with limited computing power. Besides boosting audio playback characteristics, the media players and apps improve navigation so users can more easily access and optimize playback of content. Streamers engineer their services to work on hundreds of different devices such as computers, cell phones, tablets, automobile media systems, smart TV sets, and wireless speaker systems. Most playback is on mobile devices. For example, Pandora reports that 88% of listening by its users in 2017 was on mobile devices. A Crowded Marketplace: Audio and Video

Streaming emerged as the Third Age of the nonphysical digital music revolution. The first was a vast outbreak of piracy misappropriating copyrighted music, particularly the launch of notorious file-sharing service in 1999 (a respectable streamer today uses that same name because of its cachet with consumers). The second act was legitimate commerce for digital music downloads with Apple’s successful iTunes store in 2003 as the landmark. We’re now well into the age of streaming, which kicked off in earnest a few years after iTunes emerged. Streaming today is dynamic in that it has quickly evolved in new directions and comes in several flavors that offer real choice to consumers, as illustrated in Table 14.1.

Let’s look at those various flavors. One level of choice is on-demand music streaming, which is interactive and permits listeners to individually select titles. The on-demand streams are offered on a pay subscription basis, or free but with advertising. The free-with-advertising alternatives usually have a reduced pool of available music, caps on the ability to skip songs, and other limits on users’ functionality. The music streamers try to entice their free customers to upgrade to pay. Subscription on-demand streamers like Spotify offer a larger selection of music, superior navigation, and better functionality with their premium offers compared to their free on-demand product.

Another type of streaming is noninteractive, where music is served up blindly (users can’t select specific tunes), but the flow of music fits a user-directed genre. It’s somewhat like conventional radio in that users create their own individual radio-like stations to deliver formats such as rock, rap, or country music. Such noninteractive services can be free or pay to consumers (if pay, then at a lower price than on-demand interactive services).

Such noninteractive streaming emphasizes music discovery, a polite way of saying reduced consumer choice. In some instances, listeners actively set up personalized audio channels, and in other instances the streaming service uses proprietary algorithms to present music that it calculates will fit each individual subscriber’s tastes. Algorithms are mathematical shortcuts that either predict or influence behavior. Consumers seem to favor interactive on-demand, prompting the leading radio-like streamer Pandora to introduce an interactive on-demand Pandora Plus in 2017, despite higher rights costs and higher costs for consumer subscriptions.

Streamers push the notion that they are expert at tailoring music delivery to individual tastes. Some services highlight that human music curators fashion playlists, and the services promote these tastemakers to cultivate personal followings among users. “From the moment users open the Spotify application, we serve them a personalized homepage with content that reflects our understanding of their music tastes, listening habits, musical moods, and daily activities,” says a 2018 Spotify disclosure filing.

Table 14.1 Selected Music Streaming Services Table 14.1 Selected Music Streaming Services

Users Audio Year Name Description Globally Tracks* Background Launched (millions) (millions)

Integrates with Apple ecosystem including On-demand iTunes, Siri, interactive etc. Apple only, after Offers both 50 45 2014 Music free on-demand introductory and radio-like streaming. period Dates to 2014 purchase of Beats for $3 billion.

Prime Music free with sales club membership. Amazon Paid upgrade Music Unlimited Unlimited On-demand provides more 20 n/a 2008 and Prime interactive music. Music Integrates with Amazon’s consumer electronics ecosystem such as Echo.

Partners with audio speaker makers to launch U.S. service in 2014. On-demand Warner interactive Deezer and also 16 53 2007 Music’s limited free controlling option shareholder owns big stake. Focuses heavily on international.

Terrestrial broadcaster launches with On-demand radio-like interactive iHeart streaming. and also n/a n/a 2011 Adds its All Radio radio-like Access on- streaming demand interactive in 2016.

Renames in 2016 after On-demand predecessor interactive Rhapsody Napster and pay 4 30 2001 acquires radio-like Napster. streaming RealNetworks owns 42% stake.

Acquires streamer Rdio in 2015. Adds on- demand Pioneering Pandora Plus pay radio- service in like 2017. Pandora streamer 72 30 2005 Satellite adds on- radio’s demand SiriusXM interactive buys Pandora in two transactions beginning in 2017.

Blue-chip investors finance India- Low-cost based Saavn on-demand n/a 36 2007 streamer. interactive Big offer of Southeast Asian music.

Multiple Sold for $50 on-demand million to Slacker and radio- 1.5 13 2007 LiveXLive Radio like stream Media in plans 2017.

Becomes publicly traded in 2018 with $26 billion Interactive stock market valuation. on-demand Claims a Spotify pay and 71 35 2008 domineering also free- 41% market with-ads share in 2017 for U.S., far ahead of nearest rival Apple.

Original business fosters music sharing for amateurs and emerging artists, Two pay swelling its song count. on-demand SoundCloud n/a 125 2008 interactive Two private equity tiers investors commit $170 million in late 2017. invests previously.

Emphasizes high-quality audio and video. Rapper Shawn Carter (Jay-Z) key investor. Other music artists get small stakes Two pay- as part of on-demand Tidal 4 42 2014 interactive music tiers licensing deals. Streamer gets infusion selling reported one- third stake to mobile phone company Sprint in early 2017.

Bundles music with video offerings from YouTube On-demand corporate Music interactive 10 40 2011 siblings in and also Google limited free ecosystem. option Replaces Google’s Play Music in early 2018.

Source: Companies, InformationIsBeautiful.com, and Consumer Reports covering 2017 or 2018.

* Be aware that Audio Tracks count swells when adding little-known amateur and semipro artists, and also obscure foreign artists. n/a indicates reliable information not available. Note: The term “radio-like” refers to noninteractive where the user does not select specific songs and typically has limited song-skipping capabilities, often is advertising supported, and may have a low subscription fee.

Thus, if a listener interacts with or selects music in the traditional blues genre, then songs in that genre and adjacent categories are presented. Says Pandora:

“The Music Genome Project is a database of over 1.5 million uniquely analyzed songs from over 250 thousand artists, spanning over 660 genres and sub-genres, which our team of trained musicologists has developed one song at a time by evaluating and cataloging each song’s particular attributes. … Once we select music to become part of the Music Genome Project, our music analysts genotype the music by examining up to 450 attributes including objectively observable metrics such as tone and tempo, as well as subjective characteristics, such as lyrics, vocal texture and emotional intensity. … With billions of data points collected from our listeners, we are able to use listeners’ feedback to fuel our ability to choose exactly the right song for our users.”

Cranking out music streams for millions of users is a vast, automated undertaking as, for example, Pandora says that it streamed a mind-boggling 20.6 billion hours of Internet radio in 2017. For on-demand interactive, a behemoth in the free-with-advertising category is YouTube, which can be considered a sprawling video jukebox but without the need to insert a coin to play a specific song. Rather, consumers actively select songs and artists. Performers and labels serve up their music because they believe YouTube exposure is good promotion. In addition, YouTube, which is a sister company of Google, offers revenue sharing of advertising accompanying official music video placements.

Nimble Start-ups Claim the Edge

Notably, today’s music streaming leaders were mostly formed by entrepreneurs and media technology outfits. Among tech media-owned platforms in today’s music streaming landscape are Prime Music from Amazon and YouTube Music. Furthermore, today’s new incarnation of Napster (formerly the Rhapsody service) was owned in its formative stages by a media tech outfit. Apple Music is attached to a computer/media colossus but was purchased in 2014 as Beats Music (founders include rapper Andre Young [Dr. Dre] and music executive Jimmy Iovine, who should be classified as music entrepreneurs).

The primacy of upstarts is something of a surprise because long-established record labels certainly realized that their business was migrating to online digital. But the music industry’s lack of enthusiasm for making risky, smartly executed bets in starting services at the critical early stage can be explained by little desire to upset the status quo, eroding economics due to digital piracy, and having to explain to their incumbent stakeholders such as artists why they were investing in disruptive media like streaming music. Many observers regard this initial hesitation as a historic mistake.1

As consumer momentum swelled, a number of labels tried to get involved, but hardly with consistent success. Labels dabbled in creating their own digital services and streamers, such as Sony’s Music Unlimited streamer that closed in 2015. Label-run streamers didn’t succeed in part because of the unavailability of content from rival labels. But even when they did partner, as with ad-supported video streamer Vevo, they eventually had to retrench. In 2018 Vevo bailed out of its consumer-facing apps and website, retreating to its content syndication business as a supplier to YouTube, the 800- pound gorilla in the category. Of course, even tech companies had their missteps. A watershed event was the sale of streamer Rdio to Pandora for a paltry $75 million in 2015. Rdio operated at a loss said to be $2 million per month. In 2017 computer software behemoth Microsoft closed its Groove Music Pass streaming service, directing subscribers to Spotify. Cell phone entities launched various music download and streaming ventures years ago, but they lacked portability. Consumers realized music from one mobile service isn’t transferable when changing their mobile phone handset maker or network provider.

The lesson from all these case studies: even those with overwhelming content assets or brand strength or financial heft can find it very difficult to compete against start-ups that have the right strategy and a nimble team. Licensing Sound Recording Rights

Most leading streaming platforms offer tens of millions of tracks, so big music libraries in themselves are not an obvious point of differentiation. Nevertheless, thanks to occasional exclusive deals for licensed content, streamers attempt to gain an edge over competitors with some releases that are at least temporarily unique. Whether with exclusives or the acquisition of vast back-catalogs, the key for negotiators is to cut the best deals they can within the constraints of industry norms and government guardrails set for certain categories of rights.

Streaming platforms license master recordings—essentially meaning rent—from record labels and other rights holders. Contracts specify countries covered, expiration dates, specified reasons the contract may be terminated early, penalties for slow pay or underpayments, separate financial treatment for streams by subscribers in free trials, limited use of label music in marketing materials, periodic reporting of user plays per song and the streaming platform’s subscriber headcount, and payment. Sometimes there’s an option to extend the contract for a specified time period at a preset price, which is a renewal.

Music from the three major labels (Sony Music Entertainment, Universal Music Group, and Warner Music Group) is most valuable. Spotify, for example, revealed that those big three plus indie licensing consortium Merlin accounted for an outsized 87% of its user streams in 2017. Several years earlier, Deezer said the three U.S. majors supplied just 13% of its music tracks but generated 67% of its streams. With the majors all aboard, increases in title count now mainly come from amateur, little-known, or foreign artists.

In general, the payments to major labels are calculated by formulas that can be the greater of a per-stream fee, a fee per subscriber irrespective of that subscriber’s consumption, or a percentage of a streaming platform’s revenue. In addition, major labels negotiate minimums, which are de facto floor payments, in the event the calculations of “the greater of” turn out to be low. Deals with the major record giants typically run 2 years and on a global basis.

The biggest battleground is new releases, where artists and their labels may arrange limited-time exclusive placements. After the exclusive period ceases— usually amounting to weeks—the same music is generally made available widely. This narrow-then-wide distribution follows the same path physical CDs traveled when offered initially as exclusive to one retailer, such as Walmart, Target, or Best Buy. In general, the streamer with the exclusive first window pays a premium price. Besides more money, streamers usually promise additional promotions. The risk for artists and labels that control distribution is that, after exclusivity ends and the music goes into wide distribution, other outlets delivering music to consumers may de-emphasize those recordings because a competitor had the exclusive. Over the years such pop artists as Beyoncé, Drake, and Rihanna have done exclusives with Apple Music or its predecessor.

Exclusives are not without controversy. In 2016 Kanye West claimed his new album would be a permanent exclusive with Tidal, in which he had a small equity stake. When that album later landed at other streamers, there was a backlash from fans and a consumer lawsuit claiming deceptive marketing, alleging fans were induced to sign up to Tidal under false pretenses.

Usher, Rihanna, Nicki Minaj, Madonna, Dead Mouse, Kanye West, Jay Z, Jason Aldean, Jack White, Daft Punk, Beyonce and Win Butler attend the Tidal launch event #TIDALforALL at Skylight at Moynihan Station on March 30, 2015 in New York City. Photo by Kevin Mazur/Getty Images For Roc Nation.

As part of the tug of war with licensing deals, there are suggestions that streamers give promotional boosts to certain music in exchange for secretly getting compensation from labels. Overt pay-for-play is called payola in terrestrial broadcast radio, where it is illegal under U.S. federal regulations, but those broadcasting regulations don’t apply to online. Stealth compensation to streamers to promote music can be a gray area too, particularly when the benefit isn’t a straightforward cash payment.

In the course of negotiating licensing deals for big catalogs, streamers have sometimes sweetened the deal by offering fractional ownership in themselves in addition to the usual cash royalty payments. For example, Sony Music held a 5.7% stake in Spotify worth $1.3 billion after the streamer mounted its direct stock listing in 2018. Some of that stock came in deals licensing music and the rest from a 2008 investment made in Spotify’s early days.2

In what can be viewed as good news for rights holders, the Deezer disclosure filing from 2015 blames the red ink losses on payments to labels. Its music suppliers held the negotiating upper hand because of Deezer’s desire to get music for new countries it enters. Deezer said that record labels negotiate minimum guaranteed payments that often “exceeded the anticipated amount of royalties that Deezer expected to be payable based on expected usage.” Hence, Deezer generally overpaid for music—since the usage of that music fell under the minimum guarantees that serve as floor prices set by licensors. Elsewhere, Pandora said in its financial disclosure statement, “Since our inception in 2000, we have incurred significant net operating losses and, as of December 31, 2017, we had an accumulated deficit of $1.3 billion.” Meanwhile, Spotify had revenues of $5 billion but a bottom-line net loss of $1.5 billion in 2017.

Although most of the world’s desirable music is now on streaming platforms, that has not always been the case. Music from artists such as The Beatles, Prince, and Neil Young was withheld from streaming over the years, usually due to dissatisfaction with payments offered. But as streaming boomed, holdouts relented to license their music because of rising aggregate fees and streaming’s growing hold on music listeners. Streaming Royalties

Unlike with terrestrial radio, streaming royalties are collected at two levels—for performers and sound recording copyright owners, typically labels, on the one hand, and lyricists/composers and publishers, on the other hand. The bulk of royalty revenue goes to featured recording artists and labels—and this license for use of masters is handled in one of two ways. One is direct licensing deals with recorded music rights owners for on-demand interactive streaming services. If the streamer is a noninteractive platform, collections for masters are typically handled by digital collection agency SoundExchange, which passes on monies to recipients. Pandora’s founding service with its radio-like flow of music is the leading noninteractive Internet streaming platform in the United States.

When SoundExchange collects for a nonnegotiated sound recording license, there’s no haggling over price, since the rate is set by the Copyright Royalty Board (CRB). Because these rights cover radio-like streaming, sound recordings under these terms cannot be used for interactive streaming. Parties are free to bypass the statutory rates to attempt to negotiate a deal for noninteractive usage. If noninteractive streamers don’t reach a negotiated agreement, they either pay the higher statutory rate or they don’t add the tracks.

For compositions, the second level of royalty is paid to songwriters—who create the words and notes—and their music publishers. U.S. performing rights organizations (PROs) such as ASCAP and BMI collect at this level for both noninteractive and interactive streaming. For mechanical rights for interactive, the Music Modernization Act established a Mechanical Licensing Collective, supervised by publishers and songwriters, to administer a blanket license to help capture some royalties that had been misdirected or never paid.

In terms of paying talent streaming royalties, here’s what might happen for a song cowritten by a recording artist and a non-recording artist collaborator. The two songwriters share money from per-stream fees collected by their composition PROs. They also share a portion of mechanical royalties. In a separate royalty avenue, the artist gets another set of royalties as a performer related to the sound recording from SoundExchange for noninteractive uses. For interactive uses like on-demand streaming, the copyright holder such as a label often would make a direct deal, passing on what is contractually due to performers.

Finally, if another band covers the same song, the two songwriters still get compensated as before, but the royalties for the sound recording go only to the cover-version artists. So, for example, after The Beatles made “Got to Get You into My Life,” the band Earth, Wind & Fire did a cover version later that also became a hit for which the John Lennon estate and Paul McCartney again collect royalties as the songwriters. But all the sound recording royalties generated by this cover version go to Earth, Wind & Fire, not to Lennon and McCartney (or The Beatles).

Because streamers were mere struggling start-ups a few years ago, royalty formulas in some cases set out more than one possible way to calculate, and the “greater of” gets selected. Of the multiple choices, one can be a percentage of a streamer’s music revenue, which is small for new services and also can be difficult to calculate with precision if a streamer has other businesses. Another method may be related to number of plays and is not connected to the streamer’s overall revenue.

Recording artists and labels gobble up the lion’s share of royalties in streaming for rights to their digital sound recordings, estimated at $8 for each $1 collected by lyricists and composers for noninteractive music streaming. A few years ago, the ratio was said to be even more lopsided at 14-to-1, so this ratio gap has been narrowing over the years. With the Music Modernization Act establishing the concept of a free-market rate, it’s likely that over time the ratio paid for digital transmission will somewhat swing away from performers and toward songwriters.

John Simson, executive-in-residence at American University who cofounded SoundExchange, attributes the smaller revenue slice going to composers and lyricists to historical rates paid by terrestrial radio. Because terrestrial radio doesn’t pay royalties to recording artists and music labels, the separate sound recording royalties in streaming were originally set at relatively higher rates because there was no radio rate to use as a guide. “The sound recording royalties were not benchmarked against traditional royalty rates that were being paid to songwriters and music publishers, despite streaming services’ best efforts to make that happen,” Simson says. Labels argue that sound recordings merit the lion’s share of royalty income because of costly studio recording, promotion/publicity, and distribution costs that record labels incur, while in comparison songwriters and music publishers operate in a lower-cost environment.

Let’s look at the situation for noninteractive streaming, applicable to royalties paid by a service like Pandora. The CRB set a sound recording statutory rate through 2020 of $0.0023 per stream play for noninteractive sound recording royalties covering paid subscriptions, and even a lower fee of $0.0018 per stream for free-with-advertising services. As we’ve explained, Pandora can negotiate directly with labels, either paying a percentage of Pandora revenue or a fee based on Pandora’s subscriber base. Naturally, Pandora will do a custom deal only if it can set a rate lower than the statutory minimum, or if it needs rights that can’t be obtained through a statutory license.

Compare that to the situation with on-demand interactive. In 2018 media researcher InformationIsBeautiful.net estimated streamers paid $0.0190 per on- demand, interactive stream from the highest-paying music-only streamer. The low was $0.0044 per stream—meaning less than a half cent per stream. Unsigned artists—without a label to negotiate get a better deal—end up with less money for the same number of streams.

Indeed, artists occasionally disclose they received paltry royalty checks in the hundreds of dollars or less for tens of thousands of streams or more. But the issue is murky. For one reason, artists with unrecouped label advances may receive nothing in additional payments—the same phenomenon with unrecouped CD sales. Economics of Streaming

Despite significant pockets of dissatisfaction from recipients, the existing royalty structure is delivering ever-increasing pots of money to rights holders in the aggregate. “Through December 31, 2017, we have paid more than €8 billion [$9.2 billion] in royalties to artists, music labels, and publishers since our launch,” Spotify announced. And the International Federation of the Phonographic Industry (IFPI), the trade group representing labels, estimates that pay and free music streaming services generated a hefty $6.6 billion in music industry revenue globally in 2017. For that year, streaming contributed 38.4% of recorded music revenue worldwide, making it the single biggest revenue stream, surpassing physical media such as CDs (30%) and digital downloads (16%). IFPI estimates that Spotify paid the record companies $20 per Spotify subscriber (of all types) in 2017, while the comparable figure was $1 from YouTube. It’s those modest revenue-per-subscriber numbers that make rights holders angry.

Streaming platforms groan that they pay disproportionally high costs for music content, especially in comparison to rival media. As a rule of thumb, streaming platforms pay about 70% of their revenues for all rights to music, which is a high proportion for content compared to other media. A comparable content figure for terrestrial broadcast radio is just 25%, and that figure includes such nonmusic items as disc jockey salaries. Movie distributors receive about 52% of box office receipts for rights to films in theaters, and all the rights holders combined keep only a portion of the 52%.

The reality is that there are really only two options for music rights holders to put more money in their pockets: (1) grab a bigger slice of the revenue pie generated by advertisers or user fees, or (2) see the overall pie grow.

Option number 1 is a tough pie to bake. As explained, the biggest expense for streamers is licensing sound recording rights from record labels, which is subject to individual negotiation. It has been typical industry practice for labels to demand at least 50% of streamer revenue for rights to recordings, which make up the lion’s share of the roughly 70% share that covers all rights. Deezer reported that all music rights amounted to 79% of revenue in 2014. As the medium matures, the trend across audio streaming is for this percentage to come down as the companies improve operating efficiencies and develop collateral businesses. In percentage terms, then, it would seem there is little hope in squeezing a bigger slice of total revenue for content owners.

That leaves option number 2, increasing the size of the pie. The big two ingredients that could make this possible are more advertising and more in subscriber fees.

Advertising

This part of the pie is growing, but it’s been tough to make money for either the music streamers or the rights holders. Spotify acknowledged that its ad- supported subscribers generated only a 10% gross profit in 2017 after a negative gross profit the prior year. (The gross profit metric reveals whether the company makes money after deducting only the direct costs of operating the service, including payments to rights holders plus other non-overhead expenses.) The way to raise financial performance is either to get advertisers to pay more per impression or to increase the number of ads. Advertisers resist paying more because they have other places to spend their ad dollars efficiently, and users resist ad clutter by reducing the number of minutes on the service, which reduces the number of plays, which reduces royalties.

Streamed music is capturing a share of advertising on third-party platforms. Although parties involved typically don’t divulge specifics, it’s believed rights holders get 50% to 70% of advertising revenue from multiple plays of their music videos on YouTube, depending on individual deals. But even a generous 70% of a low number is a low number.

Paid Subscriptions

The pay subscribers are the most valuable to streamers and rights holders. Again according to Spotify, subscribers who pay for streaming generate a gross profit of about 20%. The economic heft of pay subscribers is evident in generating 90% of Spotify revenue, with free subs just 10% (through advertising). In what irks rights holders, the free ad-supported subscribers tend to far outnumber paying subscribers for streaming companies that offer both.

Valuing a Streaming Company So, what are companies worth that are relatively young, often lose buckets of money, and don’t own most of what they serve up to customers? Well, Wall Street says the answer can be billions of dollars. The financial community attaches the high valuation on the theory that music streaming is a scalable business with potential for outsized profits if revenue continues to climb. Once music rights are acquired, staff hired, and streaming hardware and software installed, the built-out infrastructure for music streaming can handle any number of revenue-generating customers with relative ease. This is also the case in other sky-high technology-industry valuations that seem ridiculous based on a trickle of revenue and minuscule or nonexistent operating profit.

Despite financial losses, valuations of streaming platforms dwarf comparable values for traditional recorded music companies. For example, the valuation of Spotify in its 2018 public listing was a lofty $26 billion. Mere start-up Beats Electronics/Beats Music sold for a head-turning $3 billion in 2014 (streamer Beats Music was later renamed Apple Music). In contrast, major label EMI Group’s recorded music business commanded just $1.9 billion in its 2012 sale. (EMI’s music publishing was sold separately.) There’s an irony here. A growing array of upstart tech-centered music companies less than 20 years old and with not-impressive sales are more valuable than a handful of established recorded music majors, which each have huge catalogs of hit music, earn better net income, and in some cases trace their founding back more than a century.

The Complaint Department

Since the medium’s earliest days, rights owners have been beating the drum to get a bigger financial payoff. When the RIAA released the music industry’s annual economic report for 2015, the trade group’s boss lamented that the count of individual streams for advertising-supported, on-demand services soared 101% but associated revenue climbed just 31%. “This is why we, and so many of our music community brethren, feel that some technology giants have been enriching themselves at the expense of the people who actually create the music,” then–RIAA chairman and CEO Cary Sherman said in a blog commentary. “We call this the ‘value grab’ — because some companies take advantage of outdated, market-distorting government rules and regulations to either pay below fair-market rates or avoid paying for that music altogether.”

The gripe about digital platforms not paying their fair share can be traced at least in part to the regulatory cover for digital platforms from the Digital Millennium Copyright Act of 1998 (DMCA) and its safe harbor provisions. This extends legal protections to digital platforms when third parties use their facilities to violate copyrights. An example is online postings of homemade visuals accompanied by copyrighted music used without permission. Digital platforms are shielded from liability for monetary damages—the safe harbor that is a nautical metaphor signifying a protected position—if they follow specified procedures regarding infringing posts when responding to take-down requests by copyright holders. The music industry complains that infringers are hard to find, the take-down process is too cumbersome, and digital platforms actually tolerate copyright violators because increased time on the site (yielding more ad impressions) makes the platforms more money. Obviously, if no one catches the infringement, the rights holders never get paid.

Everybody claims to be a victim of streaming economics, even megastars. In 2015 Taylor Swift wrote an open letter that said in part,

“I’m sure you are aware that Apple Music will be offering a free three- month trial to anyone who signs up for the service. I’m not sure you know that Apple Music will not be paying writers, producers, or artists for those three months. I find it to be shocking, disappointing, and completely unlike this historically progressive and generous company.”

Shamed publicly by this essay entitled “To Apple, Love Taylor,” the computer/media parent of the streamer soon reversed its policy and was even able to license Swift’s music, which had been held back. Swift later made her music exclusive to Apple for streaming until mid-2017, when other streamers licensed her songs, too. Audience Targeting

In order to generate as much revenue as possible, streamers exploit impressively granular user information They argue that without that edge they can’t achieve the sustained profitability necessary to keep those royalty checks coming.

As we discuss in more detail in Chapter 15, a striking characteristic of some digital media is an ability to precisely monitor and analyze the actions of individual users. For digital music, that means identifying times of day when listening is or is not popular, how often music gets selected, titles that are called up but not played, and what point a song’s play is cut short (if not played to its end). Consumer activity today can be monitored at a level of detail unimaginable in the analog era. Besides monitoring actions, streaming services also have a demographic profile of users—such as age, gender, and location—that provides another layer of insights on audience appeal of music genres and even specific songs. Music Streaming Grievance List

Everybody Claims Victimization by Streaming Economics

Content owners say the music streamers don’t pay enough for using music, pointing to the huge valuations of streaming business. Streamers respond that their profitability is marginal and that their medium can’t be compared with royalties for purchased product such as downloads and CDs. Labels and artists say some streaming platforms profit from lax copyright enforcement or are essentially encouraging piracy. Streamers tell artists that they pay plenty to labels, but the problem is that artist contracts allow labels to pocket much of the money. Artists rip their labels for sometimes excluding them from equity stakes in streaming platforms that labels sometimes negotiate as sweeteners as part of large licensing deals. Streamers ask incredulously, “Why blame us?” when they pay millions to play masters, while terrestrial radio pays nothing for those rights.

Streamers with advertising use staff salespeople (or other sales resources) to sell ads in audio, website display, and video commercial units that are priced on the basis of cost-per-thousand (CPM) users in different demographic categories. Of course, to sell such access, streamers must know (or at least infer) which user has which characteristics—everything from taste in music to household income. That leads to an inevitable tension over privacy. Streamers and other big tech platforms such as social media sites deal with the privacy issue primarily by disclosing what they do with user data.

Privacy policies—the wads of fine-print legalese to which users click “agree” in order to use the service—typically permit using personal information of subscribers to learn about habits, sell platform services, and provide to third parties. For example, Apple declares:

“We may … use personal information for internal purposes such as auditing, data analysis, and research to improve Apple’s products, services, and customer communications. … We also collect data in a form that does not, on its own, permit direct association with any specific individual. We may collect, use, transfer, and disclose non-personal information for any purpose. … [Information transferred to third parties may include] occupation, language, zip code, area code, unique device identifier, referrer URL, location, and the time zone where an Apple product is used so that we can better understand customer behavior and improve our products, services, and advertising. … We may collect and store details of how you use our services, including search queries.”

Apple also monitors movements of subscribers tracking cookies, pixel tags, and web beacons, which Apple says enable understanding of how its services are consumed. Apple and other streamers allow subscribers to raise their privacy levels. In general, privacy advocates complain the processes to cloak privacy are cumbersome.

Consumer Marketing

With thin profit margins at best, streamers are constrained in how much they can spend to attract new users, the lifeblood of any growing business. In general, marketing efforts by streamers are focused online, where costs are lower than traditional media and tech-savvy consumers are found.

Streamers with both ad-supported and paid platforms prefer the profitability of pay subscribers, so they constantly nudge their free-service users to upgrade. Pop-up messages tell users that selected songs require a paid subscription. Elsewhere, Internet radio services remind users with pop-up messages and other direct communications that more skips allowed to pass through unwanted music are in the pay level than free.

Pricing for mainstream services typically runs at $5 to $10 per month for the pay option, with some offering family plans that add other users in a household for a few more dollars. Another mechanism to wring more revenue out of subscribers is charging a higher price for better-than-normal audio quality.

Streamers find it hard to raise prices because of intense competition in the fragmented marketplace, so most pricing action is discounting as a marketing tool to spur sampling by consumers. Inducements may include free introductory service to new subscribers, usually 1 week to 1 or a few months. For subscribers to qualify, they are required to immediately input billing information, such as customer credit card information, which will be billed unless cancelled once the free trial ends.

For streamers to prosper, they not only have to attract new subscribers but they also have to retain existing customers, especially those paying monthly fees. The marketing metric for subscriber loss is called churn, which is the percentage of cancelled accounts in a period—usually monthly. In music streaming monthly churn for paid users tends to be a relatively high 5–8%, which at the low end means 5 out of every 100 users cancel each month. That’s about double the rate of the mature cable TV and mobile phone industries, where monthly churn runs at 2% to 3%. However, former music streaming subscribers come back in very high numbers. Spotify said in 2018 that 40% of former premium-level subscribers return in three months. That probably reflects that cancelling and returning are simple, unlike a cable subscription where connecting home TV sets is a chore. In any case, growth in any subscription business requires having sign- ups of new subscribers exceed those who churn out.

In their quest to grow, streamers will partner with third parties such as cellular networks, music marketers, and retailers to sign up new users. Such third-party partners typically get a cut of subscriber payments, which can amount to up to 30% of initial payments and a smaller slice for the life of the subscription. Streaming platforms sometimes negotiate to be the exclusive music streamer of a third party in exchange for subscriber revenue sharing. Sometimes partners simply agree to incorporate music streamer apps on devices without significant revenue sharing. Whatever the form, such partnerships allow streamers to piggyback on the consumer reach and marketing spending of partners. On the other hand, streaming platforms keep 100% of subscription fees for users they enlist directly, although in that situation they shoulder greater marketing expenses. Looking Downstream

With competition intense among music streamers, efforts are being made to differentiate with original programming. Some streamers offer live concerts with video as exclusives as well as scripted video series. Some concerts include red carpet arrival of celebrities to create an event atmosphere. This trend toward original programming is hardly surprising, since it follows the playbook invented long ago by the pay TV networks such as HBO and Showtime when they were jostling to distinguish their mostly lookalike lineup of feature films in a crowded media environment.

Spotify stated in 2018 that it wanted to “expand our non-music content and user experience. We are an audio-first platform and have begun expanding into non- music content” citing podcasts, spoken-word programming, and short-form video. Investment professionals say that streamers might even acquire traditional music companies, using their outsized stock market capitalizations to buy what are less valuable enterprises and get ownership of music that streamers right now must essentially rent.

The music streaming business is still a long way from maturity, so more twists, turns, and innovations are expected. When pairing video with audio, music streamers could deliver holograms, virtual reality, and augmented reality presentations once there’s a large base of playback equipment in use by consumers. Furthermore, advertisers may sponsor music, channels, and portals; streamers are expected to create music lifestyle and reality programing; and more listener interaction is expected.

With earlier historical shifts in distribution technology, the music industry resisted change and fought to preserve old business models that enforced music scarcity. With consumers in control of media through digital technology, that old thinking won’t work today. The challenge to the music industry is to guide industry development and music consumption to a more prosperous configuration for the music business overall. The track record is, to say the least, mixed. Notes

1. Historians of business strategy will hardly find surprising this usurpation from unexpected sources. For two classic viewpoints on the impact of disruptive change on an existing business order, examine Clayton M. Christensen’s The Innovator’s Dilemma (Harper Business, 2003) and Carl Shapiro’s and Hal Varian’s Information Rules: A Strategic Guide to the Network Economy (Harvard Business School Press, 1999).

2. In 2018 both Sony and Warner voluntarily distributed to their artists portions of the labels’ respective windfalls from their capital gains on selling Spotify shares. Chapter Takeaways

Streaming is a fast-growing sector of the music industry as consumers embrace the concept of experiencing rather than owning music played on mobile devices. Streamed music generally is not stored or owned by users like digital downloads and physical CDs. Streamers operate in a pay subscription model, free to users with advertising, or in some cases both. The pay model generates more money for the music industry on a per-capita and per-stream basis. Music labels and artists have mixed feelings about streaming because of paltry revenues per play. Streaming platforms seek short-term exclusives for new music releases and also create original content, in bids to differentiate from competitors. As a rule of thumb, streaming platforms pay out roughly 70% of their revenue for music costs, which is a high percentage for content expenses compared to other industries. Music streaming companies historically have had low or negative profit margins but attract capital because investors predict robust profitability once the industry reaches greater scale. To stretch marketing reach, streamers often partner with third parties such as cell phone operators, Internet service providers, and other companies to sign up subscribers. These efforts augment direct advertising and promotions. Key Terms

cachet (p. 265) churn (p. 277) conditional or tethered downloads (p. 264) Digital Millennium Copyright Act (DMCA) (p. 275) impressions (p. 275) media player (p. 264) playlists (p. 265) PROs (p. 271) safe harbor provisions (p. 275) Discussion Questions

1. Discuss why streaming often provides lower-quality audio than downloads. 2. What are the reasons that music labels didn’t embrace streaming in its early days and were not leaders in launching streaming services that survive today? 3. Explain why financiers are attracted to the budding music streaming business, despite its lack of profitability. 4. When artists complain they get too small a piece of the revenue pie from streaming, are they right or wrong? What percentage royalty is fair? Why?