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Summary:

The just-filed IPO documents by Pandora Media show a company on the rise. The popular web radio service

Music Dog
photo: Flickr/BL1961

The just-filed IPO documents by Pandora Media show a company on the rise. The popular web radio service served up more than one billion (yes, with a ‘B’) listener-hours in the final quarter of 2010–a five-fold usage increase in two years. But read the S-1 with the term “copyright” highlighted–as I just did–and you’ll also see some big challenges for Pandora and any other web radio services that hope to make it big.

Pandora has to pay a lot of money to copyright owners–so much that it still isn’t making ends meet. Fully half of Pandora’s revenue goes to copyright collection agencies, and the fees are so high the company expects to stay unprofitable through at least the end of 2012. For the first nine months of fiscal 2010, Pandora shelled out more than $45 million in copyright royalties, or just over half its total revenue. However, that is an improvement over the same time period in the previous year, in which Pandora paid $22.5 million, representing 60 percent of its total revenue.

In order to stream music online, Pandora has to make royalty payments to four different groups. The largest payment goes to SoundExchange, a non-profit established by the government to divide up the royalties paid by internet broadcasters to owners of sound recording copyrights, generally record labels. That’s the biggest expense for Pandora–the company’s IPO documents reveal that it pays out 45 percent of its revenue to SoundExchange. Pandora also must make smaller royalty payments to songwriters and composers, who are represented by three collection agencies: BMI, ASCAP, and SESAC. Those royalties amount to 4 percent of Pandora’s revenue.

Paying up half your revenue to copyright owners might sound fair enough, but bear in mind that Pandora has to compete with terrestrial radio, which doesn’t have to pay one cent to these collection agencies record labels.

Pandora has had a falling out with ASCAP. As of Dec. 31, 2010, Pandora hasn’t have a working agreement with ASCAP. “We believe that royalty rates sought by ASCAP are excessive,” the company states simply in its IPO documents. While the dispute moves ahead, Pandora will still have a license to broadcast works covered by ASCAP. It might ultimately get resolved in court, in a battle that could be drawn out and costly. Since ASCAP is purely a licensing agency, it doesn’t have much hope for growth other than higher payments from growing music services like Pandora. That’s an incentive to play legal hardball.

Pandora wants to go global, but its business model relies on copyright rules that are unique to the U.S. If the bad news for a service like Pandora is that it has to pay big fees to copyright owners, the good news is that paying those fees is relatively straightforward. That’s because the fees are paid under a “statutory licensing” scheme. Pandora can make copies of any legally released sound recording on its servers and stream them online, as long as it pays those fees. It doesn’t have to negotiate with every individual record label. But in other countries, the negotiations are more complicated. For now, Pandora acknowledges that without U.S.-style statutory licensing laws, moving into other countries is prohibitively expensive.

Statutory licensing doesn’t obviate all the risks, in any case. A 2007 ruling by a U.S. copyright judge threatened a rate hike that could have killed off internet radio. (Avid net-radio listeners may remember the Internet Radio “Day of Silence” from that year.)

There’s still plenty of growth Pandora can do in the U.S. But in the long term, they’ve got to solve this international copyright problem. With 80 million registered users, more than one-third of U.S. internet users are already signed up at Pandora. Not all those registered users are active, but Pandora is probably going to reach a tipping point at which basically any potential U.S. users have heard about the service and made their choice to either use it or not. The advertising market is competitive and they can only raise rates so much; to really keep their stock price moving, international expansion will become vital at some point.

  1. You wrote, “Pandora has to compete with terrestrial radio, which doesn’t have to pay one cent to these collection agencies.”

    Were you serious when you suggested that terrestrial radio doesn’t make any copyright payments? Aren’t you aware that radio stations all pay ASCAP, BMI and SESAC for the exercise of the performing rights in the musical works they broadcast. They don’t pay record labels or performers, a subject being hotly debated in Washington. The odds are the American radio broadcasters will, sooner or later, have to pay performers and labels, just as their counterparts do in virtually every other country. But they’ve been paying the PROs for a very long time. Were you not aware of this?

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  2. David, thanks for the comment. I was going fast and didn’t think it through. It’s fixed.

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  3. Very interesting article. And the first comment makes a partially useful clarification. Yes, radio broadcasters have to pay copyright royalties to music publishers and not to record companies. At least with respect to their terrestrial signals. But that scenario all changes when you are talking about digital transmissions over electronic networks (as defined by the Digital Performance Rights Act of 1995). For simulcast transmissions and webcasts, the radio station – or other transmitter – has to pay royalties to both music publishers and to record companies/performers. So there is no ‘hotly debated’ issue about any licensing issue related to Pandora right now in Washington. (Though record companies annually seek to have a performance right in terrestial radio transmissions, that is not likely to happen).

    Also, the claim that there is some ‘international copyright problem’ in this area that needs ‘solving’ isn’t accurate either. Over 60 countries have signed up to the WIPO Internet treaties of 1996 that regularize license fee collections for all internet transmissions, and the collecting societies internationally are far more advanced in their database and collection facilities than is SoundExchange in the US. In any case, the US record companies are signatories to the worldwide reciprocal agreement among collecting societies administered by the IFPI that allows a company like Pandora to acquire an essentially worldwide license as easily as it acquires its US license. If there is something additional that complicates there potential for international growth, it is not likely to be a copyright issue (currency and tax problems are much more severe as they have not been harmonized by international agreements the way that the copyright issues have been).

    DAJ Hilton
    London .

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  4. DAJ Hilton, thanks for your comment, although my understanding is that international music copyrights are pretty complex despite these treaties. My suggestion that it will be both difficult and complex for Pandora to expand abroad comes in part from the company’s own admission, in its S-1, of how tough it will be.

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  5. UK and other international music licensing rates for Internet radio, particularly interactive, are even higher than US. I’m sure someone can give some exception… And, subject to negotiation… Pandora withdrew from the UK after unsuccessful negotiations.

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