It’s no secret that streaming media is the way the music, TV and movie industries are headed.
Look around and see the success in Netflix streaming business for both studio produced as well as original programming, like House of Cards.
According to Nielsen (NSLN) Soundscan numbers, digital music track sales fell 12.5% in the 1Q 2014 to 312 million, down from 356.5 million while digital album sales dropped 14.2% to 27.8 million from 32.4 million. And just in case you are wondering, CD sales are declining even faster down 20.5% to 31.9 million from 40.1 million.
By comparison, on-demand song and video streams in the first quarter climbed 35% to 34.28 billion up from 25.44 billion streams in the first quarter of 2013. Is it any wonder why Apple is looking to beef up its iTunes and iRadio service with Beats?
Figures like that also help explain why many think that both Amazon.com and Google are poised to enter the music streaming business. One of the more recent rumors has Google acquiring Songza for $15 million.
However, what should be an exciting growth industry for investors and the music industry is being threatened on multiple fronts.
Hollywood and the recording industry, often called the content industry, have a long and ignoble history of opposition to new technology. That list now includes streaming services. The record industry is pushing every button to try to kill off this growing marketplace.
Look at Pandora (P), which had 77 million active listeners at the end of May. During the month those millions and millions of people listened to 1.73 billion hours of Pandora programming, a 28% increase year over year. Wall Street expects Pandora to grow its revenue 38% this year to 900 million – that’s the good news. The bad news is the company is only expected to deliver $0.17 per share in earnings – $34.9 million in next income or a net margin of only 3.8%. That’s a far cry from other technology and media companies.
Why the big disparity?
The greatest differentiator is the content acquisition cost that Pandora has to pay in the form of royalties for sound recordings. But here’s the real problem, content acquisition costs increase with each additional listener hour so the more you listen, the more they have to pay in royalties.
Despite the clear potential for profit, one of the heavyweights that Pandora pays royalties to is the American Society of Composers, Authors and Musicians (ASCAP), which has more than more than 500,000 songwriter, composer and publisher members. ASCAP is working behind the scenes to try to get allies in Congress and the executive branch to squeeze more blood from the stone.
Last year, Pandora, was forced to sue ASCAP when Sony Music, which controls nearly one-third of all the music publishing world, announced it was withdrawing digital streaming rights from ASCAP then promptly refused to identify what songs it owned, opening Pandora the potential fine of $150,000 per song if it were played. This created a Hobson’s choice for Pandora — pay a higher royalty rate on each song it streamed or shut down their service.
Such action was also a direct violation of a “consent decree” issued by the Justice Department in 1941 to ensure a competitive marketplace. The decree was put into place to limit the massive power ASCAP has on the industry. Emails uncovered during the discovery process of the lawsuit showed music industry insiders thumbing their nose at the law and colluding to keep the pressure on Pandora.
Judge Denise Cote detailed what she called “troubling coordination” between ASCAP and two of the world’s biggest publishing companies, Sony and Universal Media Publishing Group, against Pandora that “implicates a core antitrust concern.” The decision set a rate of 1.85% of Pandora’s revenues for each of the five years of the license term (2011-2015). This court set rate is in addition to the nearly 60% of revenue Pandora is required to pay to performing artists. Yes, the court set rates for publishers expire next year and already ASCAP is starting to make its case for an even higher royalty rate.
Interestingly, a number of Republicans, including those who represent Nashville, Tennessee, the home of country music, have taken up the industry’s effort to stack the deck in favor of the music publishers and songwriters. Sens. Bob Corker (R-TN), Lamar Alexander (R-TN) and long-term music industry supporter Orrin Hatch (R-UT) recently introduced the “Songwriter Equity Act” to rig the system so a court examining royalty rates would essentially be forced to raise them. Standing in support of this is ASCAP, which is actively encouraging the use of Twitter (TWTR) and the #SongWriterEquityAct hashtag.
At the same time, lobbyists for ASCAP and the recording industry are pressing their allies in the Obama Administration to unilaterally lift the consent decree. Removal of this consent decree would hand ASCAP and the other two performance rights organizations that together effectively control 100% of all music, unfettered power to collude and set prices. Given the industry’s long history of anti-trust behavior, the types of extortive negotiations ASCAP and Sony attempted on Pandora recently would become the norm.
The result could be catastrophic.
If royalty rates paid by Pandora and other steaming platforms move dramatically higher, it could result in the death of the streaming music. Just as the movie industry tried to outlaw the VCR and the recording industry the cassette recorder, such efforts might turn streaming music into another version of the Betamax — a superior product for the consumer would squashed by the very industry it challenges.