Why Spotify can never be profitable: The secret demands of record labels
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 landlord 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.
A 15-year veteran of the digital music business, Michael Robertson is the founder and former CEO of MP3.com and is currently CEO of personal cloud music service MP3tunes as well as the radio recording service DAR.fm. He can be reached at michael@michaelrobertson.com. He would like to thank Paul Petrick for his contribution to this piece.
Image courtesy of Flickr user walknboston
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The thing is, since people are slowly coming around to subscription music services, if they disappear, people are more likely than ever to pirate instead of buy more music.
According to lots of ‘studies’ and ‘research’ people who pirate music also BUY more music.
Given that someone buying music rather than streaming it would net the artist more money, then piracy is better for the artist than streaming it would seem.
Source?
http://www.guardian.co.uk/music/2009/apr/21/study-finds-pirates-buy-more-music
One source…my credit card. Since I signed up for Spotify two months ago I have bought about 5 CD’s from the local Newbury Comics and downloaded another 5 albums from Amazon. I have not bought that much music so quickly since around 1986
As Stav indicates below, I think streaming music encourages purchasing music in the same way piracy does.
Regardless of how much people who pirate music also purchase music legally, it does not change the fact that piracy is theft. If the theft is of a tangible object, it is condemned, and yet for some reason consumers feel no guilt about stealing intellectual property such as music or film. Excusing pirates of their crime because they also made some purchases legally is like excusing a consumer from stealing 500 hotdogs because he happened to pay for 30 recently.
It is true that digital streaming services such Spotify are one of the most likely ways to rescue the music industry from extinction by piracy, so the record companies really ought to learn to play nice. Unfortunately piracy has created such a financial burden on these companies that they must make desperate, one sided deals to keep from going bankrupt. In an ideal world, digital music services would pay artists directly, and artist would then pay a retainer to their record companies for the promotion and support provided to the artist. Such an arrangement would require record companies to make money for the artists in order to be profitable (which isn’t so true of today’s model), but would require a complete overhaul of the structure of the recording industry.
The intellectual dishonesty or probably just plain cluelessness of the “music professionals” never ceases to amaze a poor engineer soul like me.
“Excusing pirates is like excusing someone who steals hotdogs”: no it isn’t, see http://mybroadband.co.za/photos/data/500/piracy1.png
“because they also make some purchases” which is the same as they’re your CUSTOMERS. I’m not. The little music I’ve ever pirated hasn’t prevented me from buying a single CD. Actually, I’ve never in my life even considered buying a CD, I don’t need them. They’re not food, people CAN live without them. The people you want your government to mob and imprison are your customers.
Your analogy was also completely off; downloading music and then buying it afterwards it like “stealing” hotdogs and returning to pay for them. Guilty! say MPAA and “music professionals”. Down with the internets, down with information society, down with progress of technology! Shame on you.
I’m guessing a lot of hot dogs would get stolen, and then the hot dog supplier would lobby the government to hire guards for hot dogs. If a guard saw a person eating anything that looked like it might be a hot dog, the guard could confiscate all of that person’s food, without any kind of evidence.
Also, since backpacks were often used to hide stolen hot dogs, the government would be asked to charge an annual fee to everyone who used a backpack, so that the money could be given to the hot dog supplier to cover the cost of stolen hot dogs. Even vegetarians, who never eat hot dogs, would have to pay the annual fee.
@ KenG
You deserve some kinda medal for that comment. Perfect analogy.
Why is that a perfect analogy?
Thanks, Daniel, I appreciate the comment.
Mark, the music industry originally created the situation where the only way to get digital music easily was to steal it. Fortunately for them, Apple created itunes and demonstrated how music could be sold over the internet. however, this isn’t good enough for the entertainment industry, as they constantly ask for laws that would cripple computers, because computers are used to share music. They also have suggested taxes on internet service, that would be distributed among the music industry, to compensate them for their “losses”.
But possibly the most egregious demand is the SOPA legislation currently being considered by Congress. It would allow media companies to force ISPs to shut down websites they believe are infringing their copyrights, without proving their case in court. They just have to say a specific site is violating their copyright protection, and boom, the alleged infringer gets locked out.
I liked your comment.thanks for making laugh
Not entirely accurate. A better analogy would be suppliers also require consumers to only consume the hotdogs in places they specify. Consumers annoyed at these restrictions find a way to duplicate the hotdogs (not steal them) for next to nothing.
First the suppliers try to sue anyone they see eating a hotdog for 5000% of the cost of the hotdog. When this strategy fails as it costs them more to engage the lawyers than the money they receive from suing consumers, the supplier then lobbies the government to step in and introduce laws that allow them to shut down any form of hot dog consumption anywhere in the world due to the threat of ‘counterfeit’ foreign hotdogs.
Compulsory licensing, which makes broadcast music and services such as Pandora possible, isn’t an ideal solution, but it may be the only one. The current label-by-label licensing is hideously inefficient for rights holders and the services alike.
However, competition between record labels over high-profile artists for their contracts is probably one of the major components in creating “star power” in the music industry. Whatever the precise outcome, leveling the playing field with a fixed compulsory licensing rate would surely have significant destabilizing impact on what it means to be a talented/famous/amateur musician.
That sounds awesome, can we do that now please?
Spotify can easily solve the problem by simply publishing and producing music themselves. According to this article that is dead easy and risk free as you get given a ‘monopoly’.
This is exactly why the record labels (and by extension RIAA) are fighting a losing battle. Their greed will do them in. Why should any artist sign with a record label anymore in light of the fact that they can sell direct to the public via iTunes, Amazon, etc.?
It takes money to record and promote a record. Thats why artists sign with record labels. Plus they have experience selling music..Records labels arent ad greedy as people think everyone wants to play music but no one wants to pay for it
Which the record producers are only too willing to charge back to the artist against any sort of advance and production, marketing, stocking and promotion fees.
Ever why so may bands are “one hit wonders”?
It’s because they are starting with the odds stacked against them. They have to carry all the freight right off the bat and they’re paying or all of the promo, the distribution deals, (all at the record company;s rates of course,) and then they have to pay every hanger-on that comes asking for settlement of their ridiculously inflated bill (some of which the record company is getting a kick-back on as ‘fees’.)
The record companies are so corrupt that they make the drug cartels look tame.
It is a myth people pirate music because they don’t want to pay for it. It has been proven over and over that given a convenient way to get music online people will pay for it.
1) Can’t advertise/promote your music if you don’t have money
2) Can’t tour (promote your music) if you don’t have money
3) Can’t get on the radio (promote your music) without the support of a label
4) Can’t produce decent quality recordings of your music if you don’t have money
5) Can’t pay rent and buy food to live if you don’t have money
6) etc. etc.
The unfortunate reality is that the record labels have as much power as they do for many more reasons than just the ability to mint and distribute CDs.
Just because streaming and digital distribution services exist now, doesn’t mean there is a sudden utopia for musicians where they can be successful all on their own.
1. Give some or all of your music for free, and your music will market you.
2. Save some money until you can tour.
3. Not true.
4. Not true.
5. Keep your day job.
@gubatron: “Keep your day job” is a really, really moronic stance about all this.
Breaking news: making good, let alone great music is an extremely demanding and taxing job. No matter how talented and dedicated, an artist who’s forced to have a day job is doomed as far as said day-job will exhaust the intellectual, mental and physical energy it takes not to sound amateur-ish.
I’m not defending the labels, here, I really wish some thing different emerges than the current ways of doing music-business. But if you think “Keep your day-job” is the answer, you are terribly deluded.
Actually gubatron’s “keep your day job” is absolutely awesome. You know who makes good music? People who aren’t doing it for the money. Music isn’t a product, it’s art. There’s way too much mediocre music clogging up the world. If you’re not passionate enough to do it in addition to making a living do us all a favor and don’t bother.
OK – I come at this as a musician who has spent most of the last 2 years and most of my income in a serious band – we self-published, we had everything for sale on iTunes and Amazon, we paid for our own recording and production, we paid for PR (which worked, we got played on national radio in the UK and in the Republic of Ireland), we toured across the UK and Ireland and Spain.
We have a fanbase and do everything to a very, very tight budget, everything accounted for properly, we did everything we possibly could for ourselves, only hiring people in to do things we actually couldn’t do (recording, mixing and mastering because they had equipment we didn’t have, PR because they had contacts and relationships we didn’t have). We toured and gigged constantly, despite having to hold down jobs to earn money – we averaged 10 – 12 gigs / month including 7 tours of Ireland.
It cost us a small fortune.
I am no longer in the band (I wish them well, my departure was not acrymonious, they’re here: http://www.myspace.com/yngve)
Despite doing EVERYTHING we could to keep costs to a minimum we couldn’t cover costs. Arguably if we had some investment from a smaller independent label to help cover more PR and some radio plugging we could have covered our costs and got them paid back but apparently the industry is on its arse and no-one wants to invest in new music unless the money is already there.
There’s absolutely no bitterness on my part, it was a wonderful experience BUT it does highlight the reasons why artists sign to labels – the investment to break through is vital and that is missing from those artists who self-publish without the lifeblood of a publicity budget.
The problem here is that you are competing against other artists, both “old” and “new” music, who have the backing of labels. If it was a more level playing field, assuming that your music has quality, you would have succeeded much more likely. So this is a vicious cycle that can only be broken after some particular threshold of the market escapes from control of labels.
I understand your situation, but if a record label had given you an advance and distributed your album, there is no guarantee your band would have done better. Hip-hop is about the only musical genre paying the bills right now. And after taking the record company money, your band may have had to break up after a year. If the record company dumped you after your first CD (which happens in most cases), and you had a three-album deal (usually the standard), the record company would assess so many expenses to your “account” that no other record label would be able to afford to buy out your contract and you would have been in record company limbo. The end result would be that the band would be forced to break up and its members join or create other bands. And if two or more of the lead musicians decided to stay together, it could risk being sued by the record company under the claim that the band didn’t really break up. So the outcome might have been the same or worse.
At what point does a playlist become a radio station?
I’m guessing it’s at the point where the end user has no control over his or her experience what-so-ever.
Because otherwise they might not listen to the ‘right’ songs, you see?
Not exactly sure what your questions is but I’ll try to answer anyway. Technically, if audio is streamed over the internet it will never qualify as a traditional radio station. Who, by the way, are required to pay the arts anything. If you questions is about qualifying for a compulsory license, a playlist must be at least 30min long.
There a number of regulations around this, and a lot of them have to do with how often certain songs are played. For example, from the DMCA:
* no more than 2 songs in a row from the same album
* no more than 3 songs from an album in a 3 hour period
* no more than 3 different songs in a row by the same artist
* no more than 4 songs by the same artist in a 3 hour period
Somebody would be so kind to explain why or how iTunes made it? I have always heard they are profitable, is it something I am missing? Thanx for your answer.
Apple doesn’t make money on iTunes. iTunes is a loss leader for Apple’s hardware (which they sell a ton of). Which is why it doesn’t make a difference if iTunes makes money.
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I’ve heard this before and believe you, but do you have any data/links to back this up?
http://allthingsd.com/20100225/apple-billions-of-songs-billions-of-apps-not-much-profit/
Thanks Jeremy and Jesse for the link. I was misinformed.
How can you isolate iTunes music revenues from apps, movies, tv shows, etc revenues ? If we can’t than we can’t really compare spotify and iTunes profitability-wise right ?
Apple has said that it keeps about 10 cents a song. That means the record companies receive 90% of the money. If you think about the cost of bandwidth, servers, employees, credit card processing fees and so forth, the the $1 billion it’s made would probably be at about the break-even mark.
If Robertson’s first point is accurate, it absolutely makes sense why Apple hasn’t adopted a streaming model to date. Steve didn’t even want Sony to get a per-device royalty in exchange for access to their catalogue (Sony was the one label pressing the issue when iTMS was being negotiated). The terms that Robertson is describing here are way more onerous: a renevue share across all of Apple’s divisions (PowerBooks and iPads) and an equity stake on top of it? Out-bloody-rageous.
The music industry is allows a tough place to crack a profit. To many hands are out for every penny.
If musicians are paid so little I suggest they do a different job. Face it, recorded music as an income is fading away. I give it 10 yrs before all music will be free. Live music and licensed music for secondary media like movies/ads etc is the only way forward.
look at you, all gleeful over giving people who actually create something a hard time.
I look forward to your world when everything’s covered in ads and the only people who can afford to tour (that’s almost no one, by the way) are the very very top tier of earners.
“the worth of everything and the value of nothing”
I will enjoy it while I can…