When you drill down on exactly what goes into tracking and accounting for songs and recordings on streaming services one thing becomes apparent:  No matter how much you automate, those systems are expensive and the royalties are minuscule.  This is in large part because of the revenue share method of royalty payments that creates a vastly more complex accounting world than a simple per-use penny rate would require.  It’s time to make that change to simplify the reporting.

A recent post by a founder of a digital distributor gives you a sense of the complexity involved:

It’s easy to figure out how much an artist made. But if you want to figure out how much each collaborator is owed from each stream… now you’re looking at millions of rows in hundreds of royalty reports from dozens of sources — every month.

Payments are paid in fractions of cents.

Did I say fractions? I meant 20 decimal places.

Did I say cents? I meant 30 different currencies.

Did I say 30 different currencies? I meant a 350-row exchange rate lookup table. “Customer currency: Swedish Krona, royalty currency: Ukrainian Hryvnia” is a thing (and so on, and so on).

Did I say a 350-row exchange rate lookup table? I meant a different table every month — from every streaming provider.

This gives you a look under the hood of the number of transactions that are inherent in a royalty system that pays every time an end user listens to a track.  It also informs why artists and especially songwriters are royally cheesed about the sharp decrease in the size of their royalty payments.

The hidden transaction costs of the configuration shift from album bundles to singles with  the coming of iTunes was challenging but was at least manageable.  The shift from singles to individual streams is cost multiplier of significant proportion above the shift from albums to digital singles.  I would submit that not only is the cost not manageable, but when distributors promote themselves based on their ability to handle twenty decimal places to the right, it probably never will be.

When a firm’s costs exceed revenue, the firm must either take on debt, sell equity or shut down the insolvent business or business unit–or delay paying royalties, more about that later.  Royalty accounting is, of course, a core business function of distributors, but it is also a core function of the parties receiving those royalties out to twenty decimal places to the right–record companies and music publishers.  There are even more accounting costs incurred by the labels and publishers in calculating the artist or writer shares and their own share of revenue, which will cause the decimal places to increase–to the right.

What this means is that in order to stay in business, be able to meet contractual obligations and pay their artists or writers, royalty systems must be able to handle a new level of complexity they were never before required to process.  Sound expensive?

Add to this complexity that many digital music services use the compulsory mechanical license that requires monthly statements and a true-up annual accounting signed by a CPA and no audit right–instead of quarterly or semi-annual accounting with an audit right.  Even if a publisher is accounted to monthly and pays writers quarterly or semi-annually, the publisher still bears the cost of processing the monthly accounting.  The frequency of ingesting these monthly payments may compound the transaction costs at the publisher and songwriter level.

One technique employed in the Pandora on-demand song license (paragraph 6(a)) is to defer both payment of mechanicals and royalty statements until the revenue payable is $50.  While this may seem reasonable on its face, it’s not–for largely the same reasons that the Copyright Office rejected this approach (37 CFR Sec. 210.16(g)(6)).  Pandora’s license is clearly a variation on the law, which limits the deferral to $5 (not Pandora’s $50) and requires that Pandora pay any deferred royalties on the Annual Statement of Account.

That means that the service cannot write itself an indefinite interest free loan with the songwriters money and not tell the songwriter it is doing so.  And, of course, you can’t audit statements you don’t receive.

Holding these sums is one way to finance the cost of running these accounting systems that deliver ever-smaller fractions of a penny paid to songwriters and artists.  That should sound familiar–new money used to pay old obligations.  Does the name Madoff come to mind?

It’s also important to note that in a revenue share world where money is allocated based on a core calculation of uses of your catalog divided by all songs used on the service in a month, that fraction will produce an ever smaller share of revenue if the rate of change in your catalog titles is less than the rate of change in the number of all songs on the service. (This will likely be true even if the service revenue increases, because your share of it will decline on a relative basis.)

So what is twenty decimal places today, could be even more decimal places in a year or two.

Where the industry went wrong was in the beginning when services got us to buy into the idea that getting something was better than piracy and that we owed the services a chance to find an audience.  When the revenue shared was low and higher margin goods were the focus, that was one thing.

The current state of plays is another thing altogether and revenue share deals for per listen payments require a level of complexity we can’t continue to support.

And yes, that means you, Facebook negotiators.