(UPDATE 3) With Congressional hearings set for Wed. 11/28, David Macias, president of Nashville based label services company Thirty Tigers, shares his views on The Internet Radio Fairness Act.
Somewhere up in heaven, Rube Goldberg is looking down, thrilled with the method by which owners of recording and publishing copyrights are paid for their use in the US (for those of you in the UK that want to follow along, substitute Heath Robinson for Rube Goldberg). If a song is played on terrestrial radio for a recording that I own, that radio station pays nothing for its use, so the percentage of revenues terrestrial radio pays for the use of that recording is, let’s say it together, ZERO. Now let us look at what Pandora pays for the use of recordings. It’s estimated that they paid $136M  to Sound Exchange for the use of recordings on gross revenues of $274m. As a percentage of revenues, Pandora is paying 50 PERCENT.
On the other hand, let’s look at what owners of publishing copyrights and songwriters get paid from terrestrial radio and Pandora. According to a recent article in Digital Music News , an unnamed executive claims Pandora pays to publishers less than 10% of what they pay out to owners of recordings. Let’s assume for the sake of easy math that it is 10%. That means that Pandora pays out approximately $15m in royalties to PROs (performing rights organizations) on behalf of owners or publishing copyrights and songwriters.
click on chart to enlarge
ASCAP and BMI collected revenues of $1.75b in 2011, and adding in revenues from SESAC (a private concern that does not divulge information about revenues), let us call it an even $2b. According to a 2005 paper by Harvey Reid , 35% of PRO revenues come from terrestrial radio; therefore we can estimate that $700m is collected by the PROs on behalf of owners or publishing copyrights and songwriters.
According to a Business Insider article from 2011 , Pandora accounted for 4% of total US radio hours (and that number is climbing). If you extrapolate what Pandora would pay if they paid the same rate as terrestrial radio, assuming that they were the same size, they would have paid $375m for what terrestrial radio paid $700m for.
The result of this confusing mish mash of royalty rates is that artists and songwriters often cannot keep tabs on how much money they should be earning from various mediums. Another outcome is that organizations that act as advocates for these constituencies use data selectively to lobby for the narrow interests of their clients, rather than try to look holistically at what will allow each link on the value chain to earn fair value for the contributions.
TO RECAP: Pandora pays far less to owners of publishing copyrights than terrestrial radio, and pays far more to owners of recording copyrights. And satellite radio pays rates on a different scale altogether.
The heads of the National Music Publishers' Association, Nashville Songwriters Association International and the Church Music Publishers Association recently released a joint statement to Congress that said in part, "Put another way, for every dollar paid in music royalties by Internet radio, only 8 cents of it is going to songwriters and publishers, while 92 cents is paid to record labels and artists through SoundExchange," they wrote. "This disparity is not defensible." 
Were the gentlemen that run those organizations as outraged by the fact that their membership receives 100% of the benefits for terrestrial radio play, while record labels receive none? I haven’t seen the entire statement, but my guess is that they probably neglected to mention that particular indefensible disparity.
On the other hand, Pandora founder Tim Westergren has been arguing for a royalty rate that equals 8% of revenues, essentially asking for the same percentage of revenues that SiriusXM pays for music. That rate would set a dangerous precedent for the recording industry and artist community, setting off what Rep. Jerrold Nadler has correctly termed “a race to the bottom” in terms of compensating the creative community for the use of their works. That 8% rate was set at a time when Sirius and XM were two separate companies, struggling for financial viability. That is no longer the case. It is time to revisit that rate, while we’re on the subject. One suspects that Mr.Westergren has done the math and understands the devastating effect that an 8% rate would have on the recording community.
I also find a couple of the bill’s points a little disingenuous. For those that have not read them, here are the five points the Copyright Royalty Judges will need to consider in addition to what is already listed as the criteria for setting royalty rates in the 801(b) section of the Copyright Act:
- not disfavor rates that are set based on a percentage of the online service’s revenue,
- establish a fee structure that encourages competition among copyright owners and between online radio and other services,
- consider the promotional value of online radio,
- consider the value online radio gives to the value of the works it streams, and
- not consider interactive license fees or prior CRJ rates.
Points 1, 2 and 5 seem reasonable enough. There are plenty of businesses that pay a specific percentage of their revenues for the right to use or license intellectual property. The US economy is best served by not giving competitive advantages to one segment of an industry over another, something that is clearly happening under the current royalty regime. And comparing rates that non-interactive streaming sites pay to those paid by on demand interactive sites seems obvious enough.
However, points 3 and 4 seem incredibly self-serving and could reinforce a dangerous precedent. Terrestrial radio has justified using, royalty free, the recordings owned by artists and labels for years with the same argument. It’s especially specious when it comes to Pandora. Artists and labels have no control over why and when their music is selected to be played. Unlike terrestrial radio or satellite radio, the industry cannot “promote” through Pandora, which frankly, is one of the reasons consumers probably like it so much. But to disallow any path to promote while simultaneously touting the promotional value is, well, disingenuous.
Critics of the recently proposed Internet Radio Fairness Act (IRFA) that Pandora has been lobbying so hard for have started fighting back. An ad ran in Billboard that was signed by a slew of artists asking why Congress is considering cutting the royalties that artists depend on. Ben Sisario of The New York Times wrote in a recent article that there is a widespread belief (a belief I have heard espoused personally) that Pandora could climb out of unprofitability, and lower that 50% number simply by selling more ads or increasing the number of subscribers. Undoubtedly that is true. But as someone who recently switched over from the ad supported side of Pandora to their ad-free paid Pandora One service because I was tired of hearing so many ads, I have sympathy for Pandora’s unwillingness to alter their ad mix to the possible detriment of their business. Advertisers seem to be coming around to the value of Pandora, however. 88% of Pandora revenues were from ads, and those revenues have skyrocketed in the past two years ($55m in YE 1/31/2010 and $274m in YE 1/31/2012). Their listenership grew by 50% last year, while their revenues grew by 100%. That would seem to indicate that, as listenership grows, revenues will grow even faster, which makes sense. Even if the rates per stream don’t change, other marginal costs per new listener should not be very much at all, as it the case with almost all technology-based mediums. I’m also confident that more people will opt, as I did, for the Pandora One service. People are gladly paying over $150 for SiriusXM service, so it’s not a stretch to think that, with some salesmanship, Pandora could grow from around 1m paid $36 subscriptions to 10m in the near future (SiriusXM has 25m), which would generate $360m annually, with a decent amount of revenue still to be garnered from advertising. Pandora will probably grow their way into profits in the near future regardless of whether the rate structure changes.
It has been speculated that the reason this has become such a cause for them of late has to do with the company going public in June of 2011, and that their case will be viewed more sympathetically now, when they are losing money, as opposed to the near future, when it is possible that they won’t be. There is undoubtedly intense pressure from shareholders to right the ship financially, but critics who mention this are wrong to use this as a justification to dismiss their argument. What difference does their timing matter, and why shouldn’t Pandora be able to pay a more reasonable rate to boost profits? Although I think Westergren probably overstates his case, the current rate structure is hard to justify, and Pandora has every right to compete without one arm tied behind its back. I would imagine that Pandora’s attorneys have looked at and rejected an argument that this violates the Clayton Act’s strictures on price discrimination, but how one runs a business paying for something that your competitor does not have to pay for would strike me as grounds for an argument of this sort.
I think it’s also possible that the music business could be doing itself a favor by agreeing to a lower fixed percentage of revenues, say 25%, if Pandora would agree to that. Pandora’s revenues for the first two quarters of 2011 were $118K; the first two quarters of this year were $182K. Revenues grew by 100% the previous year, and it is on pace to grow another 54% this year. Assuming that revenue growth tapers off over time, but they continue adding 10m subscribers annually, revenues from 25% of gross revenues will outpace revenues from the current royalty system by 2016 and pay more total revenues through 2020 (see table).
One would also hope that it would give moral authority to Congress to finally allow passage of a law allowing the collection of performance royalties from terrestrial radio stations (currently a much bigger piece of the radio pie). If terrestrial radio were able to pay just 1% of revenues in royalties to the owners of recordings, it would mean an additional $100m in revenues paid, at least according to proposal offered by the NAB to start paying performance royalties to owners of recording copyrights. That would more than make up for the loss in revenues that would come from moving Pandora from paying 50% of their gross revenues to 25%. That 1% rate seems too low to me, but I also recognize that terrestrial radio has built its business without having to pay these royalties (thank goodness that they seem to have dropped that nonsense about calling it a tax). A 1% royalty is a good place to start, as long as it can go up slightly over time, thus letting terrestrial radio financially adjust to the brave new world of performance royalties.
Of course, a similar reimagining of the pie would have to occur on the publishing side as well.
If Pandora gets its way in paying 8% of gross revenues, the owners of recording copyrights will be underpaid for their work. If some version of the IRFA does not pass, then we will be asking internet based radio entities to conduct business in an unfair environment that impairs their ability to compete and possibly even survive. If the IRFA passes without ALSO passing legislation mandating the payment of performance royalties by terrestrial radio stations, then it will have a devastating impact on the recording industry and its artists. If Mr. Westergren wants the music community’s support, perhaps he should call on Congress to finally rectify the wrong of the US being one of the only countries on earth that does not mandate the payment of performance royalties by terrestrial radio stations to owners of recordings. These two issues should absolutely be linked.
It is time to end the jury-rigged method of royalty payments that leaves the entire music creator community utterly confused about revenue streams due them, but it is also high time that all the players involved stop foisting one-sided viewpoints into the arena. A sensible approach that allows artists, songwriters, labels and broadcasters to earn their fair share can be crafted if we put our minds to it. I encourage the members of the House Judiciary Subcommittee on Intellectual Property, Competition, and the Internet to discuss the NAB’s previous offer to finally start paying a small performance royalty as a part of an equitable solution.
Also from Dave Macias - Making Dollars: Clearing Up Spotify Payment Confusion
 From Sound Exchange presentation attended by author in Nashville, TN, November 15, 2012.
 “Pandora Is Now Suing ASCAP to Lower Songwriter Royalties...”, Digital Music News, November 6, 2012. (http://www.digitalmusicnews.com/permalink/2012/121105ascap)
 “ASCAP & BMI – Protectors Of Artists Or Shadowy Thieves?”, (http://www.ram.org/ramblings/philosophy/fmp/royalty-politics.html)
 “Songwriters Oppose Pandora-backed Internet Royalty Bill”, The Hill, November 16, 2012
 “Pandora Radio Growing Like Gangbusters” Business Insider, November 23, 2011 (http://articles.businessinsider.com/2011-11-23/research/30432348_1_pandora-higher-revenue-spotify)