STICKING IT TO STARTUPS AND ARTISTS ALIKE
The iTunes talks demonstrated that a multibillion-dollar corporation running its own sophisticated legal and lobbying operations could take on the major labels and win. Silicon Valley entrepreneurs armed with a few million dollars in venture capital generally don’t fare so well. Neither do artists, especially independent ones with even fewer resources at their disposal.
In January of 1999, Rob Reid started Listen.com, with the goal of becoming the dominant online music source. But none of the major labels would license to him. For three years he held out, developing music databases to sell to search engines and licensing symphonies from Europe to give the business something to show investors.
Finally, in the summer of 2002, the labels cut a deal. At the time, the Department of Justice was investigating the labels for potential antitrust violations, and labels felt enormous pressure to sign deals with independent providers. DOJ eventually dropped its inquiry, but Reid said that two separate major record labels sent his team contracts with identical typographical errors.
Rather than attempt to take on Apple and Amazon in the market for music sales, most digital music startups tend to tackle online streaming. Listen.com became the streaming service Rhapsody and was sold to RealNetworks and Viacom in 2003.
Digital licensing agreements for streaming services today still follow the same general terms of the deals that Reid signed, he said. First, labels demand a large upfront cash advance, which is recouped through a complex royalty scheme. If the royalties never equal the advance, the labels still keep their original payment.
Labels then get to calculate their royalties in one of two ways, whichever is more lucrative. They can take a small amount every time one of their songs is streamed — frequently about a penny per play — or just take a set percentage of the service’s total revenues.
Typically, Reid said, the upfront advance is so high that the royalty regime is mostly academic: Digital platforms rarely generate enough money to send labels a check beyond the original advance. But if they do, he said, services routinely send half or more of their total income to the major labels.
That’s an enormous amount of revenue for a startup to cede, and far more than FM radio, which pays the record labels absolutely nothing.
Major labels control so much of the world’s music catalog, however, that new providers have to ink deals with them before turning to independent labels or unsigned artists. The bigger the label, the bigger the cut of the service’s revenue they can demand — and the worse the eventual deal for independent artists.
“For a subscription service, there is a collective pot of money that can be divided up among record companies based on their market share,” said Beggars Group’s Mills. “If Universal’s market share is 40 percent, they automatically come in and ask for 55 or 60 percent of that pie. By the time these services get around to talking to small labels, the pie’s gone. And that, I think, is harmful to artists and to the market.”
Indeed, while streaming services pay out millions to major labels, independent and unsigned artists are left with just fractions of a penny per play.
“I hate Grooveshark and Spotify,” said Rebecca Gates, former lead singer of the band The Spinanes, which had been signed to the independent record label Sub Pop. Gates now releases her own music. “I own two of my records, and if they are on Grooveshark or Spotify, it is without my approval.”
Gates received strong reviews for her latest record and has been experimenting with selling digital versions directly to her fans. So far, operating outside the digital licensing world remains an uncertain experiment, but she’s been able to finance a European tour with the proceeds, which is more than most independent artists can claim for streaming proceeds.
Labels now often demand equity in the new digital services as part of a licensing deal — a situation analogous to the labels owning stock in brick-and-mortar record stores. All four major labels are currently shareholders in Spotify, for example.
When some of your biggest shareholders are major labels, your company may be in a good position to fend off competitors. But it also becomes very difficult to criticize the labels or negotiate a better deal down the line.
Spotify and Grooveshark did not respond to requests for comment. But Napster co-founder Sean Parker, who now sits on Spotify’s board, has publicly praised the merger between Universal and EMI.
“They’re all two-year deals, and the labels have full visibility into the financials, as shareholders and from royalty statements,” noted Reid. “So if a service is getting any kind of profit margin, the labels are going to come right back and negotiate a new contract that eats that margin. It seems impossible for these services to generate any kind of sustainable profitability.”
Record labels would likely be unable to make such extreme licensing demands if the music market were more diverse, however. If the world’s music catalog were more evenly distributed among more record companies, for example, new services could launch more easily, without the approval of a few big labels.