An analysis of why labels need to reduce their royalty demands

By August 22, 2008Music

Yesterday I wrote about the threat to Pandora’s business model from high royalty demands, so I was interested this morning to come across this analysis on Silicon Alley Insider (thanks to Jason Ball for the pointer):

There’s a lot of interest in ad-sponsored streaming music services like iMeem, and  MySpace’s upcoming music venture. One big question: How can they possibly surive?  Answer: They can’t, unless the labels change their pricing demands.

The basic economics: A song lasts 3.5 minutes. The majors have been asking for a penny each time one gets played. Let’s say the site shows a new ad every time the song changes. To break even the site needs to sell one ad per song at the rate of 1 penny a song, which gives you an effective CPM (”eCPM”) of $10.

A $10 eCPM isn’t feasible. Sites don’t earn that kind of rate with 100% sell-through.  And even if it were feasible, it leaves no room for the rest of the business. They have other costs. They need to earn a profit, and it has to yield a return on investment comparable to web businesses that don’t pay music royalties; otherwise investors will move their money out of music-related products into royalty-free products like search engines.

A $1 effective CPM is closer to the mark. Which means that Myspace, Google, Facebook, etc need a 10X price reduction — down to a tenth of a penny per play — to make this business work.

The labels see this as unreasonable: They’re already lowering prices from what they earn at the iTunes store — why should they keep going to accommodate third-party businesses at their own expense?

This maths only covers part of the story, but it shows clearly the dilemma facing the industry. The other type of deal on the table for startups is to pay sizeable up front royalties, maybe including an equity stake, and then operate on a rev share. These deals face the same issues as straight royalty deals because the heart of the problem is the difference between labels’ expectations for revenues and what startups can realistically hope to get from ads.

For me it is obvious that if labels don’t adjust their expectations then these services won’t fly and people will continue to use filesharing networks – leaving the labels worse off. Moreover this will undermine the role of labels in general and individual artists and bands will continue to innovate around them.