Note: I have promised to republish this when things die down, so it’s not thought of to be special media pressure. Though it’s ought to be. This is my opinion, and from here if the media wants to run with it so be it, I am not sending this story out to anyone nor is there a call to action for people. An economic or market analysis is just that, there’s only insight to gain and nothing wrong with it. 

Internet Radio is a very important and growing market with plenty of players whether anyone likes it or not. This post is on the subject of what happened with the royalty decision from the judges some months back. The Copyright Royalty Board judges ruled and specified such high fees for Internet radio performances that they will make my company go out of business unless a percentage of revenue is offered by SoundExchange instead.

SoundExchange is the chosen body in the United States that is supposed to be collecting royalties for the recording music industry through a few ways. One of those ways is a blanket license, the idea of which greatly removes the beaurocracy required to otherwise try and find all the artists to ask their permission to play music. It is this blanket license that most Internet radio operators in the US are using.

SoundExchange has a range of folks on the board, which I guess range from the RIAA to independent labels and coalitions.  In this post I will refer to SoundExchange since that’s who we pay the checks too. But really this is meant to be, I hope, a helpful guide for the whole music industry about where Internet radio is going and why they cannot afford to misunderstand it…

I could talk about my business, Digitally Imported, but the whole thing is really besides the point and is so much bigger than my company. I wanted to be more of a market analyst to you to show what’s coming anyway, and what’s coming in our place once we go out of business as a result of unreasonable CRB rates.

There are always concerns on the other side that Internet Radio may make music very cheap since people just listen for hours. That it may cut into CD sales and other consumptions. The fallacy is to think one is directly proportional to another. Internet Radio is a separate and growing vertical, and is growing like crazy in many forms, by many players - both legal and especially illegal (peer to peer, etc). It’s not my job to explain why Internet radio helps to sell digital music through iTunes or CDs. I could explain it, but whether it is true or not makes absolutely no difference. Why? Because it’s here, it’s coming, and it’s growing. Selling music or not, too cheap or not - there is absolutely NOTHING anyone can do about it. The ONLY thing that they may do about it is foster the growth in such a way so that they come along for the ride.

There’s no shortage of disruptive technologies attacking the market from all sides. Internet radio operators who wish to get properly licensed under a rate that works make up the only group competing in our vertical with disruptive unlicensed services. We are the only kind who can pay something to recording companies and artists, a little now and more as we grow while our market matures. And if we don’t get major funding soon by removing the roadblocks, we won’t scale in time to hold competition in check. Miss a few years now and it’s all over - peer to peer and other technologies focusing on webcasting and streaming will dominate permanently.

Some people think there is no urgency to think about where the market is headed while milking the huge portals using the new CRB per performance rate. The CRB judges who determined the rates weren’t even comparing our vertical, and they specifically were told by the CRB rules that they didn’t have to take affects of the decision on the market into consideration.  So the just used some examples from the on-demand or subscription services, and somehow based their rates on that. In other words from a completely different business with only the Internet in common between that and Internet radio. That’s like trying to set the rate for melons based on the kiwi market. But once SoundExchange milks the big Internet radio guys for previous years of music use using these new CRB rates, the big players’ future efforts into music will be stopped. They are already spiraling down their music offers because they are not profitable for them under the new terms.  

Once these big guys (AOL, Yahoo!, MSN, etc) stop competing for Internet radio market share, who will you tax then? There will be nobody left standing. I don’t think SoundExchange understands that even the big portal players would be exiting and not competing for the market share. Who knows, maybe record companies are totally okay with that fact, thinking people buy CDs or downloads instead of going elsewhere for their streaming fix. In the real world online, that’s like saying if one store stops selling apples, this will make you eat more kiwis rather than go to a store nearby for apples. 

Big Webcasters vs Small Commercial Webcasters - who is who

It is important to understand this part here. I always thought that the way SoundExchange probably thinks of Big Webcasters is that this means anyone who streams a lot of hours, and has deep pockets. I don’t know which causes which or if anyone cares of the causal order. Occasionally they call someone with a lot of hours a Big Webcaster, even if they don’t have deep pockets. But mostly it’s not about who streams how but who may have enough cash to pay the CRB rates, in my opinion anyway.

It just so happens the Big Webcasters are AOL’s music services, Yahoo!’s Launchcast, MSN music, probably Real to some extent and the like. Big in the sense that they do other things too besides just streaming, and are profitable companies through other services, so they have money to pay regardless of the economics. Then there are companies such as Live365 and Pandora, who seem to be on the line. They have investors, they got some cash, and they stream a large enough audience. The hard part is that they only stream with no other businesses to subsidize the royalty rates, and so ultimately their funds may be limited. It’s like thinking the big guys will pay from their deep pockets from other services for royalties at a loss, but these guys, well, they are more problematic.

So then there are what we came to call Small Commercial Webcasters, such as my company Digitally Imported along with peers such as SomaFM, AccuRadio, etc.. This is a huge misnomer in reality. What makes us small, is that we’re not big, yet. We are small compared to AOL and Yahoo!. The key difference is that we do only internet radio, and nothing else - we are a PUREPLAY webcasting company. In theory this shouldn’t matter, royalties shouldn’t be absurd for anyone, but life’s not fair.

Take a look at this chart I quickly made. It’s not drawn to scale but it shows how we differ from the “big webcasters” in the amount of streaming we do compared to our total business operations and revenues.

 
Now instantly one of the problems is that Live365 and Pandora are also pureplay webcasters, I’ll touch more on that in a bit too. They should be in our category, but they are often lumped in the left side. The reason is that they have more money from investors and stream more hours, so one thinks they should be paying the new CRB royalties  - which is a payment per performance on the radio stream per listener. 

People have argued that the performance rate is not rooted in the reality of the business, but that’s beyond the scope of this long post. Suffice to say the stink you have heard in the media about all of us going out of business is about exactly this rate, and still absolutely applies. The argument was made that Small Commercial Webcasters only do Internet radio, so they should get “different rates”. A reasonable person who would think the CRB rates were quite fair and sustainable would think no different rates should apply. But they are truly unreasonable, and if playing the small card will help in the meantime that’s what small webcasters are trying to do - at the expense of the big guys which are a sinking ship. The sad part is that in an ideal world that cared about the growth of this industry the rates would be super low for everyone.

The way I see the CRB royalty footprint affecting services is exactly like this:

 

My claim is that the green royalty representation makes it uneconomical for big companies to sustain and continue their music services - something which I think SoundExchange people do not yet believe. As you can see on the image above, the big players can pay for it by taking some money out of their other operations, but it doesn’t mean they have to grow it under these terms. Why would you grow what’s costing you more. As for Pureplay webcasters - our royalties are anywhere from 200% to 400% of revenue, and with that gap getting wider each year in fact (because the royalty rate increases every year too).

So why are Pandora and Live365 lumped with the big players? I have no idea, nobody should think of them this way. They are pureplay companies. Well I do have an idea, it’s because they stream a lot of hours probably making SoundExchange members feel uncomfortable. They actually don’t like so many hours streamed without being able to tax the service so much that it causes it to spiral down. And this is what brings me to the misnomer. We all argued to congress and everyone that this is about giving a sustainable rate to small commercial webcasters. It’s easy to understand marketing, and it just so happens to be true at the moment that most of the pureplay webcasters happen to be small at the moment. But really, it should mean Pureplay webcasters. And we pureplay webcasters want to get very big! So we need a sustainable rate to get very big, not a rate in which we can call ourselves forever small.

Now before anyone screams any gotchas as if we are guilty of wanting to be big all along, you have to read the rest of this post. In it I claim why it shouldn’t matter who is big or small, and that we should all be racing to stream as much as possible head over heels. Are you big or are you small - that is the wrong question.

This all creates a problem of political correctness. As I said, there really shouldn’t be a distinction between big or small. So why is there one? It’s because you can get away with sucking the left side dry, while possibly letting the right side live under a different deal if you make up two classes of operators. So poof, out of thin air two classes were thought off - big and small which almost exactly coincided and fitted with meaning portals or pureplays. It sounds like it’s the same thing, but it is not, and it will be very evident over the next 5 years as I’ll try to show. 

But what’s also interesting is that Live365 and Pandora are cought in the middle - an inconvenient evidence popping its head up that big vs small webcaster is not the same thing as portals vs pureplay webcasters. Here we have two big pureplay webcasters, and SoundExchange can’t make up its mind on which side of the fence to count them without breaking the fence. The irony of it is that the two sides are made up and the fence doesn’t exist, it’s imaginary. But don’t forget - if you can’t make up two classes of operators, it’s very hard to argue why anyone should be given a break at all, instead of none, or everyone.

So that’s the dilemma as SoundExchanges probably tries to think of a way to keep the CRB rates to cash in on the big portals (with no regard for said portals spiraling services down), and also keeping another percentage of revenue option for “just the small guys” so that the big ones don’t qualify. But I can’t tell them how to make Live365 or Pandora fit in these scenarios personally, because simply the business doesn’t work that way and they are looking for an artificial way to split the market (assuming they care about at least one side surviving). No wonder nobody can find this solution, because the real solution makes market sense, but the way they want to get paid does not work with the market forces.

What’s sad is that my own company is on the verge of being in the middle too, right beside Live365 and Pandora as we do stream to a lot of people. We’re almost a big pureplay webcaster now in their eyes, and the reason we got so big was not because we were able to cash in with revenue so much. Quite the opposite, it was because we were super aggressive in our business practices, trying to survive and grow on what little we did have coming in so far as this industry matures and advertising scales. In other words, we were very efficient in gaining market share given our resources and now stand to suffer for it instead of being rewarded as any business would be in any other space.

This way I bet SoundExchange finds itself wondering how everyone can have their cake and eat it too. How can we get as much cash from the big portals now, without killing the little guys. I say there’s no such thing as little guys, only pureplay operators. 

So at best, if one needs to think of two classes of webcasters in order to artificially make a line in the middle, it would have to be the portals vs pureplay only webcasters. The pureplays would have to include Pandora and Live365 to let them continue and grow, and the artificial way of ensuring this is through a percentage of revenue option. In other words, if the percentage of revenue is 12% instead of the CRB rate - no big portal like AOL or Yahoo! will touch this with a ten foot pole because it would mean 12% of the company’s entire revenues from everything it does.

Aside from lowering the rate for everyone, this is my best recommendation to SoundExchange to try to have its cake and eat it too. But really, letting Live365 and Pandora off the hook wouldn’t mean that much of a big deal, unless there are other reasons behind wanting to lock them out. Who knows, maybe there’s bad blood and someone pissed another off, we’ll never know. The interesting part is that what bugs the recording industry then is that these services just stream too many darn hours, like it’s a bad thing. Again I am making the case in this post that it’s instead a wonderful thing, and the best friend that SoundExchange can have given what is coming.

There is an economic side effect which will happen if the above recommendation is adopted, that is if pureplay webcasters are left to play and flourish under a reasonable royalty rate with no limits on growth. That would be that investment will flow to pureplay companies, and they will continue to evolve, expand. Some would grow into very big outfits, others would consolidate to improve econimies of scale needed to stay in business with all the competition that’s coming. So while big portals such as AOL and Yahoo! will not be growing music services by nature of not being pureplay webcasters, some small outfits will grow into very big pureplay only companies, bigger than we see any today. No big company will want to ever buy them, because as soon as someone like Microsoft would buy them they would not be able to pay percentage of revenue, and in turn they still won’t afford the CRB rates. So in the face of not being able to be bought, a few companies will start swalling up other pureplay only companies - since that’s the only way that they could grow. And while not totally ideal, that will be the healthiest thing for SoundExchange in the long term. Healthy because companies will survive and compete and dominate in their Internet radio vertical - as opposed to letting the competing unlicensed services take over the exact same market share without paying a dime back to SoundExchange.

Very Little Time Left

In this post I attempt to make my case of why arguing about who is small and big is the wrong fight to have. Everyone should just do their part in deregulating and growing services as fast as possible - not milking and killing services off in the short term. Because in reality there’s very little time.

Some at SoundExchange may think that when the big portals spin down their music services, that they could change the rates back to something more reasonable, say 5-10 years from now. In other words, make the rates high now so they could kill the golden goose, but later lower the rates to get more geese. DEAD WRONG. You can’t have golden geese multiply if you killed yours off. They will be so valuable in 5 years that by then nobody will be crazy enough to lend you theirs (is anyone reminded of the domain names asset market?) . By then the market will be gobbled up by foreign services with legal shelters and peer-to-peer services. By foreign I don’t mean companies in foreign countries like Germany where reciprocal SoundExchanges may exist. No, this is a global problem and a global market. What I mean is entities in places like the Cayman Islands or other legal and tax heavens. This isn’t a switch you can flip on and off, it’s a race and if the recording industry doesn’t “invest” into making sure it grows for them now, they will loose all.

Do you think SoundExchange properly represents the artists and recording industry if it adopts a strategy of sucking outfits dry in the short term, kill in the long term? Who will be responsible when they loose market share in Internet Radio 5-10 years from now as a result of decisions which they will be making today? If the government makes bad decisions really screwing up the financial future of its citizens, either heads should roll or those people decades later are considered to be the worst presidents and administrations ever. And the people who elected them are considered either morons, or they were truly mislead into thinking they were going to be represented by people who really knew better.

So when legal webcasting in the US dies in the short term, in 10 years, I predict the market will force Soundexchange to offer lower, non-absurd rates. Just as the market forced them to go with services such as iTunes instead of selling only CDs (and tapes) in stores. This is why I don’t care that much about the exact rate of the % of revenue SoundExchanges offers, as long as a reasonable one is offered. Because I really do think the market forces in 5-10 years will bring this down, and I don’t have to argue over a few percent of a difference now. We don’t have to agree philosophically on this, we can just wait and see.

But the problem as I said before -  it’s just that important to repeat it -  it will be too late by then. All the foreign and disruptive players would have taken over by then, so the revenue from any new net radio operators will be a trickle compared to what it could have been if they had the foresight. It’s a fallacy to think that it’s okay for the market to be screwed up right now, as if it will naturally rebound in 5-10 years. Look at the search engine industry: thanks to less regulation in the U.S., companies such as Google and Yahoo sprung up faster and better than in over-regulated Europe.  Google dominates the market now, and there’s absolutely nothing Europe can do. Google even outdid previous competition in the US by giving it’s service away entirely for free - for years you saw the blank Google page with zero ads and zero distractions. Europe can try deregulating today, making it easier for businesses to be profitable and competetive - but it will all be too late.Google and others are there and will fight every inch of the way, with billions in pockets to fight competition, before relinquishing even a percentage of their marketshare to new startups. And the ultimate irony? Who wouldn’t kill to have 12% of Google’s revenue now, never mind profits - when 10 years ago Google.com page earned nothing and gae away search for free unsponsored. If someone would have been offered 12% of revenue from Google back then and that person passed on it in favor on a “per search” tax - that person’s head would roll today.

We had the same advantage with Webcasting and deregulation of bandwidth services, allowing better conditions to create more Internet Radio outfits in the U.S. compared to over-regulated parts of the world. That is one huge advantage that the recording industry currently has - enough legal outfits are out there trying to make this into enough of a snowball effect to stem the tide of illegal competition. It’s like the effort of making digital music easy enough to buy, and cheap enough to buy - in order to be able to compete with illegal downloads and competition from peers. Hey, Amazon and Wallmart entered that game, and we see digital music going from 99 cents to 89 cents. Apple’s DRM free music is now down to 99 cents as well. Do you see a trend here? That was the sound of market economics working. Same will happen with Internet radio years from now, and nobody will argue as to why the royalty rates on streaming have become so low 5 years from now, but for now some people refuse to see this.

Investment is Required to stay Relevant

Internet Radio companies such as my own needs to start investing heavilyinto our services. We need to spend like crazy to make the services easier to use, make them more entertaining and interactive to compete with what the illegal competition is working on around the clock, even as we speak. We need big investments to buy traffic, buy market share, and expand fast just like Google expanded market share first - and left monetization of the market share later when it matured and made new ways of doing so. We don’t just need investment to grow audience, we need to build new interactive methods for advertising that will be relevant in the near future. If we don’t build and integrate those, we too will be overrun by the unlicensed competition who has no such limits.

At a time like this when the clock is running, to hear proposals from SoundExchange which would limit the number of hours we could stream - or limit the revenue we could generate only to qualify for a rate that would let us exist - is lunacy in my opininon. It means no sane investor will touch us. It is as if SoundExchange would be proposing to iTunes that they could only sell digital music if they stay small enough - otherwise they’d much rather prefer people buy CDs in stores. Are you kidding me? Slow down digital sales with any regulation, and illegal downloads explode more than ever.

The key difference is, digital sales are kind of like a commodity market - you either buy it here, here, or there, or download illegally - at the end of the day what you get is exactly the same thing. So market can somewhat rebound later, compared to illegal services, once regulation is removed. Not so with Internet Radio. The latter is about selling experiences and their own brands - so at the end of the day you get something different at every place. That means the regulated guys will not develop brands, will not get a name out there that matters, and will not get enough followers for their experience. But the illegal competition, illegal in so much as they find work-arounds to not pay anything to SoundExchange or anyone, will have plenty of time to win the hears of minds of users and develop huge brands which will be hard to push aside.

With illegal downloads, there’s no brand, all is alike no matter where you get it. Actually, AllofMp3.com is not the same, it was so good it actually developed a brand. But with the streaming entertainment vertical, brands and ideas can’t easily be stopped, especially if operating from safe heavens. Just look at FIQL, which looks great and allows ‘radio’ playlists to be piped through YouTube to avoid royalties, becoming ‘video playlists’. Just look at SoundFlavor, which has a widget that can be put on any site, but ties in distributed files stored illegally on servers and storage lockers all over the world. They look awesome, they look interactive, and the legit market needs investment to compete with things like this - not to have limits on growth and revenues which prevent investment in the first place.

 

Who can we Blame in the future?

So coming back to the representation, and SoundExchange’s duty to supposedly provide for the better future of those it represents. Can someone tell me whose heads will have to roll 5-10 years from now? Metaphorically of course. Who will we hold responsible for being the biggest short-sighted executives,  and failed economists, out of all time if my analysis plays out? Just for Wikipedia’s sake, you know, decades from now. So for the record, I’ve stated my prediction here it here so I expect to be in that Wikipedia article some day. But I speak for others too when I say we need to know who those people are for history’s sake, in the case that SoundExchange does not do the right thing soon.

Online Casinos anyone?

Online casinos are illegal to operate and even use in the US now, yet everyone still gambles. The US government doesn’t see a penny in taxes from what has grown into multi-billion dollar business. If suddenly the US now makes gambling legal, the existing foreign operators will still dominate for a huge amount of time, if not ever. Trump Casino, Bellagio, or others in Vegas won’t be able to open their versions and suddenly expect to get the big piece of the market share. So effectively the US, if it ever thinks of allowing online gambling, already shot itself in the foot for good. Although I wonder how many of the foreign operations are really fronts in safe heavens for some of the big players here? If any, that just shows you what will happen with online radio too and Sound Exchange won’t see a dime on this growing vertical.

We are now in the late stages of coming to a fork in the road. SoundExchange has to decide on the future of licensed Internet radio operators.  Notice I didn’t say on the future of Internet radio - that will continue to flourish with unlicensed players anyway. If the recording industry does not allow FULL SPEED AHEAD for us now, it can kiss goodbye to ever milking this vertical in the future. So it’s not about my company, it’s not about AOL, Launchcast, Live365, Pandora - all those are just keeping the marketshare safe for SoundExchange, away from unlicensed folks. Don’t milk them now and kill the golden goose. If these companies can’t continue to scale now, it’s not that they will stay small - they’ll be overrun by competition attacking from all sides. The only way is to grow. Staying put means death in this business.

More Points to Make

Governments usually tax companies only on profits, and not the revenues, for a very good reason. That’s to encourage spending to make these companies grow. As soon as there’s a lot of profit left over, that means there’s extra money to be had, or growth has reached a cap for that time period. It’s basic economics 101. Goverments thus encourage a system of spending for growth, even though they could tax revenue too and get away with more tax revenue. But keeping hands off helps companies grow, and compete globally. Compete to stay relevant in the long term. What good is the extra tax revenue to a government now, if this extra was enough to slow the local company’s growth rate down to a level which caused them to slip from dominance in a global market.

SoundExchange already had 12% of revenue from us under the old SWSA deal which expired, and that’s before any profit. The irony is the folks there think this is dirt cheap, and that it should be more. It’d be relatively okay to ask for more on the profit portion, but not on operating revenue. Still, in the face of closure we can survive with a few percent more to ride out another 5 years or so. By 2015 it should be blindingly obvious to everyone how the economics of streaming works, and the rate will be lower.

Comparing Expenses

Some may argue that bandwidth expenses are a far bigger pie of the revenue than the music royalties. And music is just as essential to Internet radio as bandwidth. That is certainly true, and I didn’t come there to make a presentation where I would lie and make it look like this isn’t a fact. I do have points on this though:

Everything is a main ingredient of something. 

This fact doesn’t make an item or service cost more. Philosophically it sure does make you think of something as more precious - but market conditions and economics prevent philosophy from ruling the world. If that didn’t happen, we could see a few interesting things, for example:

• The building I am in is made out of steel and concrete. Without those two there would be no building, and I couldn’t conduct my business unless I build a wooden shack on the beach. So should steel and concrete producers argue philosophically that my business is built on their backs? Maybe they should have a big pie of the revenue as my business grows.
• Starbucks could not continue to operate without coffee. Not just coffee though, milk, caramel. Philosophically coffee growers and milk companies can argue that it is not fair, Starbucks makes a killing building the business “on coffee and milk’s back”. We all know Starbucks sells far more than coffee, it sells the experience. Maybe coffee markets should get a share of Starbucks - preferably of the revenue, pre profits
• My Internet Radio business cannot survive without running servers which use AMD and Intel CPUs. Should they have a share in my revenue too?

Keeping Costs to a Minimum

Our company already gets bandwidth almost at cost by virtue of us having to operate a separate hosting business. The stuff that one can buy on a real market is at the very best “at cost.” You can get a free bandwidth donation but you can’t count on it in your business plan. That’s temporary help which is great, but a real business needs to scale, and the best you can ever hope to get is at cost. Bandwidth is not free because there’s a cost with almost each incremental service - there’s throughput capacity requiring switches, requiring fiber connects, support service requiring man hours, etc. You can’t possibly expect people to loose money on it, but the best that you can hope for is that you’ll talk them into doing it at cost to them.

With music there’s no incremental cost to the music industry as we stream to more people (there’s cost to our bandwidth though). The best that the recording industry can do for us without being directly hurt, is free. In other words, between the time it takes us to serve 100 listeners or a 1000 listeners - the recording industry didn’t have physical resources or man hours dedicated to make that scale happen. But we are not asking for getting it at cost, we have been paying 12% of revenue for it. That’s 12% of revenue that is ABOVE “at cost”. To compare with bandwidth, most operators are already almost at cost, so you can honestly make the claim you did as much as you could to save money to reinvest back into the business.

So saying that 30% of revenue goes into bandwidth, but only 12% of it goes to royalties is not at all comparing apples to apples. I know I might have pissed off a lot of artists or industry folks with my above mention of “free”. Please don’t misunderstand me. I am not saying it’s free to create that music for you, I am sure you worked and sweated for producing the recordings and promoting them…

I merely said that the cost of scaling that resource in streaming music, is X. It just so happens that X is free in this case  - when we make a digital copy on a server, no artists had to run back to a studio and record their album over, or no other work had to be done. But I am not even saying it should be free, we were paying 12% of revenue so X is definitely something very real to us. But with bandwidth the scaling cost is Y, and Y happens to be greater than zero and actually have a cost for each increment.

So one can make a valid an argument that if you’re only paying X for music, but you are paying 2*Y (two times Y) for bandwidth, that it’s unfair. You could argue that in that case wouldn’t it be fair if you also paid 2*X for royalties. But we are at scale, so we can’t do better. Saying that Y is greater than X in comparison to each other on scale is like saying apples are larger than kiwis - true but so what.

Eating Into Competing Verticals

The only remaining fair argument that one could make (I didn’t say a true one, just a fair one) is the claim that I am wrong about X. That is, the at cost value of scaling streaming is not free, because it is cutting into other verticalslike selling CDs or selling digital music. That is, if we stream a lot and it causes people to buy less music in the process eating into sales - then X is very very real. But we already were paying 12% of revenue, effectively setting the X value to that…

But we actually HELP sell more music, that is our claim with some data to back it up. We certainly let the masses find more music - less hits sold in the old way of making CDs, but certainly more on the long tail. We definitely help sell music, the question is do we help sell enough music? And also, it’s not just music, it’s promotion for the artist - let’s not forget the artist can have concerts, merchandise, etc - and the new models are evolving to have the record labels have a piece of this. Either way one of the following stands to reason:

• The amount that we help sell, is that enough to add to 12% of revenue to cover that revenue which is lost by streaming music online?
• If we help sell a lot of stuff, perhaps it’s so much that we don’t even need to add 12% of revenue. Then X is truly zero - what we eat into we offset by promotion. That is certainly how terrestrial radio operates - the judges found broadcasting to be sufficiently promotional to not anything to SoundExchange, for decades. For some similar was true for satellite (4.5% or around that), MusicChoice on cable systems (around 6.5%). So, why 12% for net radio or more, I don’t get it.
• And if we help promote and lead to massive sales on top of what we potentially might be cutting into, X becomes negative. Does that mean the recording industry should be paying us to play their music instead of asking for royalties? Payola anyone?!

But all this doesn’t matter really, it’s a trip in philosophy. Nice, but why did I just waste time on it when the market forces around us are making this debate irrelevant. Internet Radio is growing legally or not -  and once the unlicensed brands and services take over they will not ask these questions. They will make X -  the cost to stream more copies - completely FREE to them by not paying royalties. And in the next section I talk about this more…

Philosophy Is Irrelevant

The subject is touchy when you are on the receiving end. Think about it - you are making music recordings, trying to sell them, and here comes a business which wants to give it very cheaply away for next to nothing. It sounds absurd to you as an artist when you are asked to just receive 12% or something of this sort. In times like this you forget about the promotional value that this new business offers to sell your music to new audiences world wide. Hey, you think your hard efforts are under attack, and they are. 

Unfair as one may think this is, it is completely irrelevant - the market for Internet radio is there and is being overrun by services who won’t pay a single cent.

Lots of things are unfair in life. Maybe I think us Americans are nice people, and it’s unfair that the dollar is taking a plunge compared to other currencies when we continue to work so hard. Well boo hoo too bad, the way the economy and the market works has no space for feelings or fairness. Someone made stupid decisions and the dollar is worse off than it could have been, and it wasn’t any of us directly.

Your only alternative as an artist, or as SoundExchange, is to do something about holding on to as big a market share of Internet radio as possible. By holding on market share I mean to enable us, the licensed licensed players to compete exceptionally. Don’t give in to short term temptations, make an acceptable rate that scales with no limits on caps - and some day you will be rewarded by revenue share from a mature market in the hands of licensed operators. The alternative is you’ll have nothing in this space at all while the space will flourish through unlicensed players anyway.

It’s as simple as that, please check your feelings at the door. Us feeling bad about it doesn’t change anything - the market dictateshow this plays out. And the way it is dictating now is that there are too many unlicensed players starting to get the upper hand. In comparison, the market also dictated how music was to be available through illegal download services, feeling bad, saying it’s unfair, or suing people did little to prevent Naspter, Newsgroups, Bittorrent variants, AllofMp3.com and numerous others to emerge.

Radiohead, who is known and heard worldwide, recently released their latest album on their site - available to anyone for whatever price they want. They understood that the model was under assault. They didn’t want to be bulldozed waiting for it to happen at the back at the curve - so they jumped ahead at the curve. For that they are praised now. If you are an artist at the back of the curve - you will be bulldozed if you don’t realize that Internet radio is coming huge and unlicensed to a browser near you. And if you are an artist in the middle, waiting to see and react which way the wind will turn - you might survive if SoundExchange’s greatest economic minds don’t do you in. You’re still a bit mediocre though, I am sorry. Your music might be awesome, but the way you are doing business is not ahead of the curve, it’s at the mercy of people who are too willing to kill the golden goose in your name.

As concerned as the Recording industry is about their existing businesses being attacked by new disruptive Internet radio technologies, this is the only objective truth -  it’s coming whether we all like it or not. Change happens. I didn’t come into the meeting to stroke people’s egos, apologize, or make excuses on how we can minimize this impending change for them. That’s backward thinking. If we try to minimize it, the change will happen JUST AS FAST, but from even more disruptive technologies taking over the market share. And realize this please, just because you may not know of enough examples of such technologies - that does not mean that they do not exist, and that millions of people aren’t using them already. The web grows virally, and it’s huge. You may not have always known about AllofMp3.com, but millions use it and its clones. Let’s not play the game of out of sight, out of mind. We can’t afford to make such assumptions. The stuff is already here, and more is brewing - we aren’t brewing the competition enough to help us all (us being net radio and who SoundExchange represents). Among all these uncertainties of the royalty rates, investors won’t touch us and we can’t fight back.

At least if SoundExchange adopts a way for us licensed companies to flourish, we will take a lot of this market share away from the unlicensed. Help us grow, help us flourish, and we will pass on the revenues to you when we scale. It might take 5-10 years for this to grow huge, but the decision is now. You can’t undo in 5-10 years what you decide now - it will be too late.

More Examples

Let me give you another example. Microsoft just made an investment into Facebook, for less than 2% so far but the relationship was worth over $200 million (number doesn’t matter really). Now some may say Facebook is growing like a platform on the web, and in a way it is competing with the old Operating System paradign that Microsoft has a stranglehold on - just like with Recording industry, for a blanket license we only have SoundExchange to go to. Microsoft realizes that no matter what they do, this is another vertical - space that is growing and will grow whether Microsoft likes it or not, whether it tries to slow it down or not. They were smart enough to try and get their foot in the door quick, because competition (Google) was already bidding against them to do the same and accelerate the process.

Decision is now in the hands of SoundExchange - what they choose now determines the outcome for good.

The problems with Golden Geese…

Let’s talk about available options the way I see them, using metaphoric terms if you can bear with me: 

On one hand, SoundExchange can sell ALL its golden geese now. Someone will roast them and have a tasty meal, while SoundExchange gets a nice bag of cash.  This is an analogy for standing firm on the per performance CRB rates and not offering any other deals to anyone. Internet radio companies will go bust, and big portals (AOL, Yahoo! LAUNCHcast, etc) will exit gradually over a few years due to inability to properly monetize services under the new CRB rates. They’ll go into video instead or will try direct licensing which has its own problems and is not good for the artists as a whole.  

On the other hand, SoundExchange can sell SOME golden geese now, but still keep a few “small” geese around for later.  This is the analogy of throwing just the big portals under the bus - make portals pay CRB rates, while offering “small commercial broadcasters” some kind of a % of revenue deal. Such a deal would have to be crafted in such a way so that most big guys don’t qualify - so that they will be good to be sold and roasted. But the small commercial guys like my company, under such a deal, would survive enough to grow a little and live to see a few more days of grazing.

Which Brings Us to a Moral Dilemma - at least for some people perhaps:

How can SoundExchange on one hand get away with killing some geese, while allowing others to survive? How shall it decide which geese are worthy of living another day?

I don’t have an answer to how to choose - but I didn’t create this problem. The guilt of having to possibly decide which goose lives and which goose survives is being shifted onto the goose inline for the slaughter. As if we, the geese, are supposed to defend ourselves on such metaphoric cases as follows:

“So, you are one of the geese in line for the slaughter - we think you’ve grown too fat so you’ll do well for a roast. 

Tell us why you think you’re not fat enough yet so that we may spare your life now.

What was that? You say all the geese who are still growing and multiplying should stay alive? But how can you say so! Look at those two fat geese over there - if we allow you to still grow and have offspring, we’ll have to let those two other fat geese to do the same. We can’t make any money if we don’t sell them, plus on top of that we’ll just have way too many geese here if we keep this up!”

Sorry, I am never going to be begging for my company’s life. Why should the problem of the keepers’ be shifted on me. To apologize for growing too fast, becoming too fat of a goose, is absurd. If the music industry wants to draw a line and say which geese should live and which should not, they should choose themselves. What’s with the guilt trip - if you are a butcher and your model revolves around selling geese for meat, just do it, don’t ask the geese to dance around to live another day - because all those geese know at the end of the day the knife is coming for them soon.

All that I can do is make an argument for a better, richer business model. Instead of killing or selling so many geese now, let them multiply as much as possible. If they were cows you’d make milk from them, darn I should have used a cow analogy. But the key is in optimizing the business in a way that ensures maximum growth of the geese population, and faster too - the more there are the more and quicker you can make a buck from the ones that retire old and fat. The turnover will be on volume.

Then There’s Competition… 

The pitfall with the approach above is how healthy are they willing to keep the golden geese? Because the only geese who survive in the first place are kind of starved. Starved how? The proper care is withheld - to the tune of withholding 12% of it. That’s the symbolism of the % of revenue option that was in our past deal, and what we are hoping to get. What’s the point you ask? Well the point is, how well do you think a population of geese with 12% of care withheld compared to a competing population with none withheld? Terrestrial radio pays no SoundExchange royalty. Satellite radio pays around 4.5% I believe. Competing Internet radio disruptive services which are taking over don’t withhold any care for their geese. So can a population survive on just 12% withheld - maybe, how about 20%, 30%, where do we stop? It depends on the competition as follows…

The more they feed the golden geese, the healthier they will be. The healthier they are, the more offspring they can have. BUT, if they withhold resources and the geese aren’t as healthy - then the neighboring business who does feed his own geese properly will see his flocks multiply much faster. Soon the nieghbor’s golden geese will multiply so fast that they will take over all the available pastures and will strong arm distributors to buy geese only from them. So much so, SoundExchange will find that by limiting the supplies in the form of a high % of revenue, it didn’t allow its flocks to grow fast enough to outdo competition in time. This is why it’s not enough to only make a percentage or revenue, but it has to be reasonable enough to matter in the long run.

Either way, if there’s strong regulation the game is over.