Why Spotify Will Never Be Profitable: The Secret Demands Of Record Labels
By Michael Roberston, the founder MP3.com and founder and CEO CEO of MP3tunes and DAR.fm
(UPDATED) Imagine a new hot-dog selling venture. Let’s also say there’s only one supplier to purchase hot dogs from. Instead of simply charging a fixed price for hot dogs, that supplier demands the HIGHER of the following: $1 per hot dog sold OR $2 for every customer served OR 50 percent of all revenues for anything sold in the store.In addition, the supplier requires a two-year minimum order of 300 hot dogs per day, payable all in advance. If fewer hot dogs are sold, there is no refund. If more than 300 hot dogs are sold each day, payments to the supplier are generated by calculating $2 per customer or 50 percent of total revenues, so an additional payment is due to the supplier. After the first two years, the supplier can unilaterally adjust any of the pricing terms and the shop can never switch suppliers.
Would this imaginary hot dog establishment be able to generate a profit? Never, because the economics are one-sided. The supplier will always elect the formula that captures the largest amount of money for themselves, completely disregarding the financial viability of the store. If the store miraculously managed to generate a profit, the supplier would simply raise the rates after two years.
Such economic demands may be imaginary for the hot dog business, but they are the stark reality that every digital-music subscription service such as Spotify, Rhapsody, MOG, Rdio, and others must confront. These details aren’t well-known because digital music service deals are always wrapped tightly with strict non-disclosure agreements.
For the first time, people are talking, and these previously secret demands are being made public. The specifics are even more onerous than the hot dog example cited above. Together they doom online audio companies to a life of subjugation to the labels, as you will learn below.
Here are some specific demands that digital music companies are compelled to agree to:
- General deal structure: Pay the largest of A) Pro-rata share of minimum of $X per subscriber, B) Per-play costs at $Y per play, C) Z percent of total company revenue, regardless of other business areas. As stated previously, this means labels de facto set retail price (they also regularly negotiate floors on price, giving even less wiggle room), which limits the ability of the music service to develop ancillary revenue streams that aren’t siphoned off by the labels.
- Labels receive equity stake. Not only do labels get to set the price on the service, they also get partial ownership of the company.
- Up front (and/or minimum) payments. Means large amounts of cash are necessary to even get into the game. In my experience, this further stifles innovation in services and business models.
- Detailed reporting, including monthly play counts. This seems rational enough — you would assume this information is necessary to pay artists and make other business decisions. The problem is, the labels each make additional demands, including providing additional reports unrelated to payment, including overall market share of sales in various categories. I doubt that, for example, phone manufacturers demand Best Buy provide the percentage of sales of competitors’ phones. The labels effectively offload their business analysis (and the cost of such analysis) onto the music services. I can’t think of another industry where that is standard practice.
- Data normalization. Labels all provide their data and files in different formats. That data is constantly changing as labels make available new material and make unavailable old material. This might seem trivial. It’s not. Without standard naming conventions and canonical methods for referencing artist, tracks and albums (ISRC and UPC don’t cut it), the services are left to try and match artist, track, album names provided by one label with those of another. It’s incredibly inefficient, as each service must undergo this process separately (although there are now companies that provide a service for doing this for the retailers).
- Publishing deals. Once you’ve signed deals with the labels, you then need to cut deals with the publishers. Determining ownership is a complete nightmare and there are huge holes in the licensable catalog. The data issues here are worse than with the labels. The long and short of it: Although you may have the rights to stream from labels, you sometime can’t get the rights to stream from the publisher, or worse, even find the publisher.
- Most favored nation. This is a deal term demanded by every major label that ensures the best terms provided to another label are available to it as well. This greatly constricts the ability to work out unique contractual terms and further limits business models. It is a form of collusion since each label gets the best terms the other label negotiates. It’s also why it’s easy to get one label (typically EMI) because they’ll provide low-cost terms knowing that others will demand higher rates, which EMI will then garner the benefit from.
- Non-disclosure. Every contract has strict language prohibiting the digital music company from revealing what they pay to the labels. If they speak publicly about any of the licensing terms, they jeopardize invalidating their license which would torpedo their business. Since labels license on behalf of the artists any payment to the artist comes from the labels not the digital music company. This is the main reason music services, not the labels, have been getting heat from the artist community. Music services can’t defend against accusations about low artist payments because they pay the labels who don’t disclose what they’re paying to the artists.
With most other businesses, if a supplier makes unreasonable demands, a retailer can turn to other providers. Since copyright law gives record labels and publishers a government-granted monopoly, no such option is possible with music. Digital vendors have only two options: Accept the terms or not include those songs in their offering.
The sale of EMI to other music companies means there will shortly be only three major labels. If a music service rejects terms offered by a label, then that service’s offering will have an enormous hole in their catalog of 25 percent or more of popular songs. In the business world, a monopoly leads to lopsided economics, and the subscription digital music business is a poignant illustration of that.
Final note: Online radio services such as Pandora take advantage of a government-supervised license available only to radio broadcasters thus sidestepping dealing with record labels. While the per-song fees are daunting, they bypass virtually all of the terms listed above.
Michael Robertson is founder and former CEO of MP3.com and currently CEO of personal cloud music service MP3tunes and radio recording service DAR.fm. He can be reached at firstname.lastname@example.org. Michael would like to thank Paul Petrick for his contribution to this piece.
Image courtesy of Flickr user walknboston
Never mind bloody Spotify and the rest of the abusers.. Look after the music makers/creators!!! Writers and artists are the bedrock on which everything else relies!
Saving music means paying the creators FIRST
but what if the hot dogs themselves go to the store and ask to be sold directly?
You neglected to mention that Spotify is only paying $0.00029 per stream of a song. At that rate it will take upwards of 3,500 streams of a single song on Spotify to earn $1.00. If you’re going to point fingers…. everybody’s fingers seem dirty.
Hypebot, you are stooping low here.
Spotify and other digital services will continue to face these challenges because ultimately, their assets are made up of 1’s and 0’s, which is easily “imitatable” by the competition. Aggregators like Spotify find clever business models (that may potentially be profitable if given the right circumstances) while trying to fit all artists into a one size fits all service (or a one stop shop music store). This ignores the harsh reality that not all music is equally valuable.
As long as there are artists of great value, there will be a label/management team on their side to protect and exploit that value. Artists are entitled to a monopoly over their art, the freedom to share that monopoly by partnering with labels (yes, even majors), digital services (Spotify), and protections from others who just want to earn money by exploiting other people’s property without giving back (grooveshark).
Michael Robertson paints an artist’s “monopoly” over their work as a bad thing. Copyright empowers the individual to create works that capture others attention. No matter what medium, the artist should be entitled to this monopoly, is free to relinquish their rights all together, and everything in between. But it is wrong to assume that others should be entitled to exploit that art without an agreement with the artist.
Be weary of arguments that throw in loaded words like “monopoly” to make their point. There is tremendous value between the artist and the audience. Anyone in the middle of that is trying to get a piece, and Michael Robertson of mp3.com is no different.
While you fiddle, Rome burns.
Listeners will pay artists directly when they can find them, otherwise they will use torrent services. Labels are ensuring that their monopoly will be broken by the black market. Not everyone will lose, but many will, as the labels’ greed squeezes every fractional cent until they are all bankrupt.
Many of us look forward to that day, and celebrate every opportunity to cut out the middlemen who have for so long done so little and extracted so much at the expense of lovers of music — both creators and listeners.
wise words 🙂
Pretty sure the direct-to-consumer thing isn’t as simple as some people are saying. Every business has the benefit of direct-to-consumer, yet major brands still dominate every market out there. It comes down to scale. The music isn’t 100% of the value, the artist brand has a lot to do with it too. At a certain point, that brand cannot scale up without an investment from a larger entity (like a label or publisher), and in exchange for that investment they are going to take something in return … like the right to set up barriers and controls that make the music created more valuable and profitable.
Not saying any of this is right or wrong, it’s just the way that the free market and media cultures are set up.
I think what the industry needs to do now is really nurture our independent artists (as they will be those big stars who are now on major of the future), ensure that independents are not signing up to the majors so that when they do reach critical mass and people are wanting their music everywhere, the terms can be much more favourable on sites like Spotify for both the company and the artists.
Its a long term solution to really moving away from the majors, a needed change in our current environment!
By the article Spotify isn’t paying anything directly to the artist. They are paying the label the artist produces for, and are under a binding agreement to disclose nothing. You cannot tell how much Spotify pays therefore, and how much of this the label pockets.
You can say that there’s only one hot dog vendor all you like, but it’s simply not the case. Major labels and publishers are in the business of acquiring and exploiting copyrights, for which they pay creators, promoters, retailers and broadcasters. (pittance though it may be, for the creators)
If you want a better deal, you must either play the majors off against each other or go directly to the source of new music and establish your own artists; this means your new music service can feature only new music, but so what? Tyhere are plenty of music fans fed to the gills on Clear channel and ‘classic rock’. To bitch that you’re not being allowed to exploit catalog that you neither acquired nor developed (nor even licensed) smacks of cryass whining, at least to me. Too many so-called innovators want to piggyback on the work of others instead of doing their own heavy lifting, imo. The majors own their ball, they can take it and go home, as they please. If you want to go around them, the door’s wide open, innovate away.
rick, you are SO VERY correct. there are to many old greedy men sitting in there offices at the major labels doing absolutly nothing, because there is nothing for them to do. but until artist and musicians stop selling there souls for a seat at the grammys or the american music awards, just to get robbed by major labels. things won’t change soon enough. peace.
Supplier are the lifeline of every business. But if you are not satisfy with your supplier then you can also change the supplier.
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