Earlier this week, Facebook announced a new blockchain-powered currency called Libra, and a digital wallet for it called Calibra. Spotify was among the companies backing the plans by becoming a founder member of the independent Libra Association.
Now Spotify CEO Daniel Ek has been talking about his hopes for Libra, including the suggestion that it could one day facilitate direct payments to musicians from fans.
“I think like cryptocurrencies and blockchain are obviously two of the biggest buzzwords you can have today. And for me, I don’t think technology in itself is that interesting· What I do think is interesting is what we can do with that technology,” said Ek, in an interview for Spotify’s own Culture: Now Streaming podcast.
“What everyone who’s a part of Libra is trying to accomplish is: it’s interesting that we have all these different currencies, all of these different ways of doing things. But the reality is, there’s several billion people around the world that don’t even have access to a bank account,” he continued….(Whatever you think of Libra, the fact that Spotify is, right up to CEO level, even thinking about direct payments from fans to artists is a significant talking point for anyone mulling how the streaming service will evolve in the coming years.)
“How did you go bankrupt?” Bill asked.
“Two ways,” Mike said. “Gradually and then suddenly.”
Ernest Hemingway, The Sun Also Rises.
No matter how much people would like to deflect it, the unvarnished per stream rate is an ever diminishing income stream. Given the number of calculations involved for both sound recording and song, it is likely that the total end-to-end cost of rendering the accountings for the streams costs more than the royalty earned on that stream by any one royalty participant. Solving this problem is the difference between a short-term stock-fueled sugar high and a long-term return of shareholder value for all concerned. So now what?
If you’re someone who receives or calculates streaming royalties, you’re already familiar with the problem of the ever-decreasing per-stream rate. The Trichordist’s definitive “Streaming Price Bible” for 2018 confirms this trend yet again, but simple math explains the problem of the revenue share allocation.
Remember that the way streaming royalties are calculated in voluntary agreements (aka “direct deals”) revolves around a simple formula (Formula A):
(Payable Revenue ÷ Total Service Streams) x Your Streams = Per Stream Rate
Which may also be expressed as Formula B:
Payable Revenue x (Your Streams ÷ Total Service Streams) = Your share of revenue
(Formula A and B are also known as “the big pool” in the user-centric or Ethical Pool models.)
Here’s the trick–it’s in the correlation of the rate of increase over time of the numerator and the denominator. If you focus on any single calculation you won’t see the problem. You have to calculate the rate of change over time. Simply put, if the numerator in either Formula A or Formula B increases at a lower rate than the denominator, then the quotient, or the result of the division, will always decline as long as those conditions are met. That’s why the Streaming Price Bible shows a declining per-stream rate–a contrarian fact among the hoorah from streaming boosters that sticks in the craw.
Services make these accounting calculations monthly for the most part, and they are calculated a bit differently depending on the service. This is why the Streaming Price Bible has different rates for different services, rates that vary depending on the terms of the contract and also the amount of “Payable Revenue” that the service attributes to the particular sound recordings.
The quotient will also vary depending on the copyright owner’s deal. If you add downside protection elements such as contractual per stream or per subscriber minimums, then you can cushion the decline.
This is also true of non-recoupable payments (such as direct payments that are deemed to be recoupable but not returnable, or “breakage”). Nonrecoupable payments are just another form of nominal royalty payable to the copyright owner, and increase the overall payout. And of course, the biggest nonrecoupable payment is stock which sometimes pays off as we saw with Spotify. These payments may or may not be shared with the artist. (See the WIN Fair Digital Deals Pledge.)
So each of the elements of both Formula A and Formula B are a function of other calculations. We’re not going to dive into those other elements too deeply in this post–but we will note that there are some different elements to the formulas depending on the bargaining power of the rights owner, in this case the owner of sound recordings.
So how is it that the per-stream rate declines over time in the Streaming Price Bible?
Putting the Demon in the Denominator
Back to Formula B, you’ll note that the function “Your Streams ÷ Total Service Streams” looks a lot like a market share allocation. In fact, if the relevant market is limited to the service calculating the revenue share allocation, it is a market share allocation of service revenue by another name. When you consider that the customary method of calculating streaming royalties across all services is a similar version of Formula B, it may as well be an allocation of the total market on a market share basis.
Note that this is very different from setting a wholesale price for your goods that implies a retail price. A wholesale price is a function of what you think a consumer would or should pay. When a service agrees to a minimum per stream or per subscriber rate, they are essentially accepting a price term that behaves like a wholesale price.
For most artists and indie labels, the price is set by your market share of the subscription fees or ad rates that the service thinks the market will bear based on the service’s business goals—not based on your pricing decision.
Why is this important? A cynic might say it’s because Internet companies are in the free lunch crowd–they would give everything away for free since their inflated salaries and sky-high rents are paid by venture capitalists who don’t understand a thing about breaking artists and investing in talent. You know, the kind of people who would give Daniel Ek a million dollar bonus when he hadn’t met his performance targets, stiffed songwriters for years and gotten the company embroiled in multimillion dollar lawsuits. But had met the only performance target that mattered which was to put some cosmetics on that porker and push it out the door into a public stock offering. (SPOT F-1 at p. 133: “In February 2018, our board of directors determined to pay Mr. Ek the full $1,000,000 bonus based on the Company’s 2017 performance though certain performance goals were not achieved…”)
But long-term, it’s important because one way that royalties will rise is if the service can only acquire its only product at a higher price. Or not. The other way that royalties will rise is if services are required to pay a per-stream rate that is higher than the revenue share rate. How that increase is passed to the consumer is up to them. Maybe a move from World Trade Center to Poughkeepsie would help.
The Streaming Price Bible is based on revenue for an indie label that did not have the massive hits we see on Spotify. In this sense, it is the unvarnished reality of streaming without the negotiated downside protection goodies, unrecoupable or nonreturnable payments, and of course shares of stock. While some may say the Bible lacks hits, that’s kind of the point–hits mask a thousand sins. Ask any label accountant.
Will Consumption Eat Your Free Lunch?
Let’s say again: The simple explanation for the longitudinal decline of streaming royalties measured by the Streaming Price Bible is that the rate of change across accounting periods in the “Payable Revenue” must be greater than the rate of change in the total number of streams in order for the per-stream rate to increase–otherwise the per-stream rate will always decrease. Another way to think of it is that revenue has to increase faster than consumption, or consumption will eat your lunch.
What if you left the formula the same and just increased the revenue being allocated? Services will probably resist that move. After all, when artists complain about their per-stream rate, the services often answer that the problem is not with them, it is with the artist’s labels because the services pay hundreds of millions to the labels.
We don’t really have much meaningful control over what goes in the monthly payable revenue number (i.e., the mathematical “dividend” or numerator). What kinds of revenue should be included? Here are a few:
–all advertising revenue from all sources
–bounties or referral fees, including recoupable or non-refundable guarantees
–traffic or tariff charges paid by telcos
–revenue from the sale of data
Services will typically deduct “small off the tops” which would include
–VAT or sales tax
–ad commissions paid to unaffiliated third parties (usually subject to a cap)
Indie labels and independent artists may not have the leverage to negotiate some of these revenue elements such as revenue from the sale of data for starters. Other elements of the revenue calculation for indie labels and artists will also likely not include the downside protections, subscriber target top up fees and the like.
And of course the biggest difference is that indie labels (at least not in the Merlin group who may) typically do not get nonreturnable advances, nonrecoupable payments, or stock.
Is That All There Is?
Why should we care about all this? There is a story that is told of negotiations to settle a lawsuit against a well-known pirate site. One of the venture capitalists backing the pirates told one of the label negotiators that he could make them all richer through an IPO than any settlement they’d ever be able to negotiate.
The label executive asked, lets’ say we did that, but then what happens? You say we should adapt, but you’re still destroying the industry ecosystem so that there’s nothing left to adapt to. The most we could make from an IPO would cover our turnover for a year at best. And we would be dependent on your success, not our artists’ success.
Spotify is experiencing the joys of being a public company–or at least a quasi public company if you count public companies as ones whose shares are actually held by the public as in Mrs. & Mr. America. But both analysts and investors have to always remember that Spotify did not conduct an IPO in the traditional sense where an underwriting syndicate of bankers bought a block of shares from the company that the syndicate then resold to the public. This is why Spotify’s recently announced $1 billion stock buy-back program bears closer scrutiny.
Instead they conducted a DPO, a direct public offering which is unusual and radically different than an IPO. The DPO has an essential conflict–the sellers of shares are insiders in the issuer and have an incentive to keep the stock price high and to manipulate that stock price however they can. Like through a stock buy back after less than a year of trading, for example.
From a financial markets point of view, that DPO makes almost everything about Spotify’s stock a different analysis than a market traded IPO–including Spotify’s recently announced stock buy back. Stock buy backs happen all the time, particularly in declining markets. But what is unusual is for a company that’s still in its first year of operating as a public company whose shares are largely traded by insiders and is a money losing company to take the odd step of using $1 billion of the shareholders money to buy back stock.
Or maybe not so unusual if the shareholders whose money it is are both the sellers of those shares and the beneficiaries of the stock buy back–as they try to find a bigger fool to sell the shares to in the retail market. Another core problem with DPOs is that you don’t have an independent body setting the opening price as you would with an underwriting syndicate. DPOs have to get an opening price from somewhere–so Spotify’s pricing problem started with the SEC and NYSE allowing Spotify to price at its last privately traded price (as some shares of Spotify traded in what used to be called a “Rule 4(a)(1)1/2” exemption for resale of restricted stock, now codified in Section 4(a)(7) of the Securities Act by the FAST [Breakfast at Buck’s] Act–a bit of a gloss but OK for our purposes here).
So by letting Spotify use the private market for restricted stock as a proxy for a market price, at a minimum the SEC and the NYSE assume that the rights, preferences and privileges of an unregistered share of Spotify stock are the same as a share of registered SPOT. They’re not. They also assume there are no price distortions from the relatively low number of unlegended restricted shares available in the private market. They also assume that there’s nothing odd about a company like Spotify–staring down relatively slam dunk infringement lawsuits of significant value and in a money-losing business run from 10 floors of the World Trade Center like it was Apple or something–pricing way above the opening prices of Amazon, Facebook, Google and so on.
If that sounds cynical, it really isn’t once you understand the dynamics of a DPO compared to an IPO. The DPO produces a market effect that is similar to the business model of Larry Ellison’s famous 1999 “HeyIdiot.com” parody of an Internet company:
HEYIDIOT.COM is tightly focused on selling just one product. Elegantly enough, that product is the stock of HEYIDIOT.COM, which will be offered to you for sale on-line at our web site of the same name. Buying the stock is simple, you can buy as much stock as you want with the only rule being that each new purchase must be executed at a successively higher price. We call it a cash portal.
We’re seeing the result of the DPO come home to roost in Spotifyland which looks something like this:
After a run up in the stock price–on low volume and with no meaningful news–the stock retraces its steps and suggests its testing lower lows. It’s hard to say what “price support” there is for a stock that’s had less then a year of trading, but let’s just say that if it broke through $100 to the downside, there would be rending of garments and closer examination of executive compensation unless Spotify executives could continue to blame artists for “high” royalties.
Also note that three out of four of Spotify’s biggest volume days were to the downside, and that the stock has been trading down, essentially, since August.
We can also assume that at these low trading volumes, the shares have gradually been accumulating in the trading accounts of Mrs. & Mr. America which also means that there are potentially more and more shares available to short sellers–the buy high sell low crowd that I discussed back in March.
In fact, there are a few November 30 puts in the $115 range already. Daniel Ek has announced he’ll be selling Spotify shares with a value of about $20 million on a monthly basis for a while. You have to notice that those board-approved sales are overlapping with the board-approved Spotify stock buy back that will help to support the higher price point while insiders dump their shares. This is another inherent conflict problem with the whoe DPO concept–but when you have the 1:10 voting power over your board as does Mr. Ek, many things are possible.
It’s nice work for a “cash portal.”
Stocks go up, stocks go down, what does it all mean? In the very recent declines of the stock price of credible companies, you saw them punished for good quarters but guiding lower. Even “big tech” stocks like Google and Amazon were punished for revenue misses and cloudy guidance.
And then there’s China–is the US in a trade war or a new cold war? (Read Mike Pillsbury for the answer.) Spotify’s has double whammy exposure to China trade woes plus the Ten Cent investment (itself getting hammered by China’s President for Life’s concerns about videogame addiction).
What’s happening with the Spotify stock price? I would argue the main downward driver for SPOT is much more straightforward–the market is simply catching up to the Spotify DPO and its insider-heavy stock sales. We won’t really know the hard numbers on insider trades until the SEC starts making those insider Form 4 sales more easily available online. That should should happen any day now (and none of the mainstream music industry publications seem to be interested enough in the the truth setting them free to actually dig through the SEC Form 4 filings at the source).
But–there could be enough shares out there in the marketplace that SPOT may be starting to trade like an IPO as opposed to an insider cash-out (or DPO). And once the market really becomes part of the Spotify trading day and trading volume increases, a few things start happening. One is that as more shares are held by the public, there are an increasing number of shares available to allow the “buy high, sell low” short trading that can cause big swings in a stock’s price due to short covering if nothing else.
SPOT also starts to become more susceptible to the other stocks in its cohort as more retail investors have to answer the question, what will I sell to buy Spotify? The answer will be different for different people, but if there are more sellers than there are buyers, we know what happens. That’s why the majors, Sony in particular, were very smart to start selling their holdings almost immediately.
What would you sell to buy Spotify? Probably not its competitor Apple–whose shares trade almost opposite to Spotify on a relative basis.
If you’re looking at the performance of SPOT, you have to ask yourself what about this chart says “buy”?
You have a stock that’s broken through both its 100 and 50 day moving averages to the downside as of yesterday, and so far in today’s action is testing lower lows. And not surprisingly sank like a stone following a “head and shoulders” top technical chart pattern indicating a potential bearish trend that has now been confirmed (as I began watching in June on Music Tech Policy before the stock gave up almost $50 of its share price).
I guess the MMA safe harbor is priced in.
Keep asking yourself that question: What would I sell to buy SPOT? If you’re not an insider, that question will eventually guide you (and the market) to the right share price. That will have nothing to do with Spotify’s royalty payouts, how many floors of World Trade Center it rents, or competition with YouTube or Apple. Don’t let the analysts (or the company) fool you–although some analyists are starting to face the Spotify reality.
That will be–I would suggest–a problem with the insider-controlled Direct Public Offering structure and the SEC’s decision to allow Spotify to price at a meaninglessly high number. What goes up on fantasy comes down hard on reality.
Buckle your chin strap.
Copyright reform is on the front burner again after the passing of the Register of Copyrights Selection and Accountability Act by a vote of 378-48. But there’s another problem the Congress needs to fix that won’t require legislation in the short run: The mass filing of tens of millions of “address unknown” notices under the archaic compulsory license for songs.
I’m going to assume that readers know the general background on the millions of “address unknown” NOIs filed with the Copyright Office under a loophole in the Copyright Act (Sec. 115(c)(1)). If that is Geek to you, see my recent paper on mass NOIs for more complete analysis (or previous posts on MTS for the armchair version of the story. The first distinction to remember is that we are only concerned in this post with song copyrights and not the sound recording. This story implicates songwriters and publishers, not artists and record companies, and it only applies to the government’s compulsory license for songs, a uniquely American invention.
In a nutshell, Amazon, Google, Pandora, Spotify and other tech companies are serving on the Copyright Office tens of millions of “address unknown” notices of intention to obtain a compulsory license to make and distribute recordings of certain types of songs. Under what can only be called a “loophole” in this compulsory license, a service can serve these “address unknown” NOIs on the Copyright Office if the owner is not identifiable in the Copyright Office public records. The Copyright Office stands in the shoes of the “address unknown” copyright owner to receive and preserve these notices.
On the one hand companies like Amazon, Google, Pandora and Spotify say that they can’t find these millions of song owners, while at the same time at least some of the same companies brag about how comprehensive and expensive their song databases are (like Google’s Content ID) or their agents puff up the agent’s own massively complete song databases as “the worlds largest independent database of music copyright and related business information.” And yet, these same companies and their agents can’t seem to find songwriters whose names, repertoire and contact information are well known, or whom they already pay through their own systems or through their agent.
The Database Double Loophole Trick
Here’s the loophole. First, the loophole requires a very narrow reading of Section 115(c)(1) of the Copyright Act, a 40 year old statute being applied to NOIs served at a scale the Congress never intended. If the song owner isn’t found in the public records of the Copyright Office, even if the digital service or its agent has actual knowledge of the song copyright owner’s whereabouts, the digital service can say they are not required to look further.
Even if you buy into this willful blindness, these digital services may not be looking at the complete public records of the Copyright Office. The only digitized records of the Copyright Office are from January 1, 1978 forward, and my bet is those easily searchable records are the only records the services consult. That omits the songs of Duke Ellington, Otis Redding, The Beatles and five Eagles albums not to mention a very large chunk of American culture.
The Copyright Office records from before 1978 are available on paper, so the pre-78 songs are still in the public records (which is what the Congress contemplated in the Copyright Act).
The identifiers are just not “there” if you decide not to look for them. However, it is not metaphysical, it is metadata that exists in physical form. This is the “double loophole”.
The Double Triple: New Releases
Another category of song copyrights that will never be in the public records of the Copyright Office in their initial release window are new releases with recently filed but not yet finalized copyright registrations. The Copyright Office itself acknowledges that it can take upwards of a year to process new copyright registrations. This allows “address unknown” filers to bootstrap a free ride on the back of Congress during that one-year period.
No Liability or Royalties Either: Trebles All Round
Once a company serves the “address unknown” NOI on the Copyright Office, songwriters are arguably compelled by the government to permit the service to use their songs. Filing the “address unknown” NOI arguably allows the service to avoid liability for infringement and also–adding insult to injury–to avoid paying royalties. If the NOI is properly filed, of course.
In current practice, a mass “address unknown” NOI is usually a single notice of intention filed with a huge attachment of song titles with the required fields, such as this one Google filed for Sting’s “Fragile”, the anthem of the environmental movement (which was clearly filed incorrectly as the song was registered long ago):
The number of mass “address unknown” NOIs being posted by the Copyright Office on an almost daily basis suggests that tech companies now view mass “address unknown” NOIs as the primary way to put one over on songwriters and the Congress, too. Companies like Amazon, Spotify, Google, Pandora and others are using this heretofore largely unused loophole on a scale that flies in the face of Chairman Goodlatte’s many hearings in the last session of Congress on updating the Copyright Act.
This “address unknown” practice also undermines the efforts of Chairman Goodlatte and Ranking Member Conyers to modernize the Copyright Office. Indeed, based on the very lopsided vote on HR 1695 the Register of Copyrights Selection and Accountability Act, it is clearly the desire of the overwhelming majority of Members of Congress, too.
What Can Be Done?
Congress can play a role in in providing immediate relief to songwriters by stopping the mass “address unknown” NOIs or at least requiring the Library of Congress and the Copyright Office to take steps to verify the NOIs are filed correctly.
At the moment, the government takes away property rights from the songwriters by means of the compulsory license without taking even rudimentary steps to assure the public that the “address unknown” NOI process is being implemented correctly and transparently.
Here are five steps the Congress can take to rectify this awful situation.
- Stop Selling Incomplete Data: Congress should instruct the Library of Congress to stop selling the post 1978 database until due diligence can be performed on the database to determine if it is even internally correct. It appears that many if not all the mass “address unknown” NOI filers use the LOC database to create their NOIs. It is also highly unlikely that this database will include new releases. Congress can simply instruct the Librarian to stop selling the database.
- Stop Accepting “Address Unknown” NOIs With Compressed File Attachments: Congress should instruct the Library of Congress and the Copyright Office to immediately cease accepting “address unknown” NOIs with compressed files as attachments for what appears to be a single NOI. These compressed files are so large in most cases that songwriter can never uncompress them on a home computer to determine if their songs are subject to “address unknown” NOIs. Google in particular is a major offender of filing huge compressed files. Each compressed file contains tens of thousands of song titles.
- Require Accounting Compliance with Copyright Office Regulations: Long standing regulations require that anyone relying on an NOI must file mostly and annual statements of account reflecting usage of the songs subject to the NOIs. The tech companies serving mass NOIs are not rendering these statements and thus fail to comply with the transparency requirements of Copyright Act. All of the “address unknown” NOIs served during 2016 are out of compliance with the regulations, and all “address unknown” NOIs served in the first quarter of 2017 are likewise out of compliance. Congress should instruct the Copyright Office to require monthly and annual statements of account be filed with the Copyright Office for anyone who has relied on these NOIs as required by the regulations. All statements of account should be certified in the normal course as required by the regulations, and made available to the public by posting to the Copyright Office website.
- Require the Library of Congress to Create a Searchable Database of NOIs:Congress should instruct the Library of Congress to create a single database maintained online that is maintained by an independent third party and is searchable by songwriters in a manner similar to a state unclaimed property office. That database needs to be updated on a regular schedule. Given the size of the compressed files served to date, it is essentially impossible for songwriters to determine if NOIs have been filed on their songs. This is particularly true as the NOIs are served on an effectively random basis, so even if songwriters were able to search, they would essentially have to search all the time.
- Pay Royalties Into A Permanent Trust Account: Given that it is highly likely that the mass NOIs filed to date have a significant number of errors, it is also likely that songwriters will become entitled to payment of royalties retroactively if these errors are ever caught. Therefore, the Congress should require that royalties should be paid to a trust account maintained at the Copyright Office and held in perpetuity like a state unclaimed property office. Of course, it is equally likely that the song copyright owners will be entitled to terminate any purported license under 17 USC Sec. 115(c)(6). These payments should be based on actual usage and not black box. This is another reason why the statements for “address unknown” NOIs should be public.
What started in April 2016 as a trickle of NOIs from a handful of companies has now expanded exponentially. Based on Rightscorp’s analysis in January 2017, some 30 million “address unknown” NOIs had been filed–and that did not include the dozens of “address unknown” NOIs filed by Spotify in March 2017 alone which themselves likely total over a million songs.
|Top Three Services Filing NOIs
April, 2016-January 2017
|Number of NOIs Per Service|
|Amazon Digital Services LLC||19,421,902|
|Pandora Media, Inc.||1,193,346|
It is rapidly becoming standard practice for tech companies to try to pull the wool over the eyes of the Congress by leveraging an apparent loophole and they are doing it on a grand scale.
As we have seen with everything else they touch from the DMCA to royalty audits, the tech companies will continue this loophole-seeking behavior until they are forced to stop. Since no one at the Library of Congress seems to have the appetite to right this wrong, the Congress itself must step in.
Ultimately Congress should fix the loophole through legislation, but in the meantime most of the harms can be corrected overnight by policy changes alone.
All of you who subscribe to the New York Times, fly Quantas, use any of a number of mobile carriers or who are in the 6th month of your third Spotify 30 day (or 90) free trial may be interested in this post.
According to Billboard in a story titled “Spotify Officially Hits 50 Million Paid Subscribers“, the “official” announcement came from a tweet:
I found this intriguing–how did we go from “Spotify Officially Hits 50 Million Paid Subscribers” in the headline to a tweet that doesn’t really say the same thing? Maybe like this?
First, what makes a tweet “official”? Much less “official” totals of “paid subscribers”? Finding out may be like asking what makes ketchup “fancy”.
Newspaper subscriptions have long been verified by a company specializing in verifying circulation. Television has the Nielsen ratings, music has Soundscan, and so on. None of these systems are perfect, but they make it harder to outright misrepresent success in a business where frequently the only people who really know how well they are doing are the people who would like you to believe they are doing well. This is nothing new, it’s as old as moral hazard.
The quest for truth leads one to independent verification services.
Reuters reported the same story with a more subdued headline: “Spotify Says It Reached 50 Million Subscribers“. A little more factual, a little less Kool Aid.
This is important because I have yet to find anyplace that Spotify actually says the 50 million subscribers were “paid”. The press leaped to that conclusion, but Spotify did not say that.
And neither does Apple, a company which is already public and has to be careful what they say about the money they are making or not making. Yet somehow nobody transforms Eddie Cue’s statement that Apple has “well past 20 million subscribers” into an “official” statement implying a verified number of “paid” subs.
Actually–it may well be that there is a significant revenue difference between “paid subscribers” and “subscribers”. As the Music Industry Blog wrote last year:
[T]here is a more important story here: Spotify’s accelerated growth in Q2 2016 was driven by widespread use of its $0.99 for 3 months promotional offer. Which itself comes on the back of similar offers having supercharged Spotify’s subscriber growth for the last 18 months or so. In short, 9.99 needs to stop being 9.99 in order to appeal to consumers.
As Spotify has been “dominant” in the music subscription business for a while now (and yes, I mean that in an antitrust sense of “dominant”), it seems that it’s high time for someone to independently audit the veracity of the number of their subscribers.
Or would the Securities and Exchange Commission like to rely on a tweet?
By Chris Castle
As an important publisher panel observed at MIDEM this year, revenue share deals make it virtually impossible for publishers to tell songwriters what their royalty rate is. That’s especially true of streaming royalties payable under direct licenses for either sound recordings or songs or the compulsory licenses available for songs.
There are some good reasons why streaming rates developed without a penny rate–or at least some reasons that are the product of sequential thought–but there are also good reasons for creators to be distrustful of the revenue share calculation. This is particularly true of compulsory licenses for songs where songwriters and publishers don’t even have the right to examine the services books to check if the service complied with the terms of the compulsory license (known as an “audit” or “royalty compliance examination”).
If you thought record deals were complicated, you will probably have to find a new vocabulary to describe streaming royalties. (Calling Dr. Freud.) But even under direct licenses for songs or sound recording licenses where there usually is an audit right, the information that needs to be audited is so closely held, so over-consolidated and the calculations so complex that there may as well be no audit right.
The result is that smart people with resources at big publishing houses cannot determine the penny rate coming out of Spotify and others with the information that is on their accounting statements. That is hard to explain to songwriters (or artists for that matter, as they have similar problems).
Why is the calculation so complex? The artist revenue share calculation looks something like this in its generic configuration:
[Monthly Service Advertising Revenue or Monthly Subscription Revenue] x [Your Total Monthly Streams on the Service/All Monthly Streams on the Service] x [Revenue Share] = Royalty per stream
Both monthly revenue and monthly usage change each month–because they are monthly. In order to get a nominal royalty rate, you have many calculations on both sides of the equation. Because these calculations are made monthly, it is not possible to state in pennies the royalty rate for any one song or recording at any one time. There’s actually an additional eye-crossing wrinkle on subscription deals of setting a negotiated minimum per subscriber which can vary by country, but we will leave that complexity aside for this post–YouTube’s “Exhibit D” lists 3 pages of one line entries for per subscriber minima around the world.
In a simple example, if both advertising revenue and subscription revenue were $100, your one recording was played 10 times in a month, all recordings were played 100 times in a month and the revenue share was 50% for the sound recording then you would get:
$100 x [10/100] x .50 = $0.50 for that month. How you get to the multiplicand in the revenue pot is not so simple and has gotten more complex over the years. In fact, the contract language for these calculations make the Single Bullet Theory seem more plausible.
Revenue share formulas produce a different product when the factors change–which for the most part changes every month. The formula we’re using is for the sound recording side, but publishers have a version of this calculation for their songwriter’s royalties, too. The statutory rates are a version of this formula (see the nearly unintelligible 37 CFR §385.12).
Most of this information is under the exclusive control of the service, and largely stays that way, even if you are one of the lucky few who has an audit right. Bear in mind that the “Monthly Service Advertising Revenue” in our formula is a function of advertising rates charged by the service, and “Monthly Subscription Revenue” is a function of net subscription rates charged by the service. These calculations take into account day passes, free trial periods, and other exceptions to the royalty obligation. There is essentially no way to confirm the revenue pot when the royalty rates appear on the publisher or label statements.
The problem is that the entire concept of revenue share deals is out of step with how artists and songwriters are used to getting paid, even for other statutory mechanical rates such as that for downloads. If a publisher or label can’t come up with a nice crisp answer for what the songwriter or artist royalty is based on, the assumption often is that the creator is being lied to. And who’s to say that’s an unreasonable conclusion to jump to? The question is–who is lying? Here’s a tip–it’s probably not the publisher or label because they’re essentially in the same boat as the artist.
How Did We Ever Get Here?
Let me take you back to 1999. Fish were jumpin’, the cotton was high, and limited partners showed up for capital calls. Startups were starting up their engines–some to drive into a brick wall at scale, others to an IPO (and then into a brick wall at even greater scale).
On the Internet, you didn’t just do business with a company, they were your “partner.” You didn’t just negotiate a commercial relationship with a behemoth Fortune 50 company that could crush you like a bug–in the utopian value system your little company “partnered” with AOL for example. Or Intel. Or later, Google.
What that meant for music licensing was that startups wanted rights owners to take the ride with them so if they made money, the rights owner made money. Rights owners shared their revenue, you know, like a partner. Except you only shared some of their revenue. You weren’t really a partner and had no control over how they ran their business even if the only business they’d had previously run was a lemonade stand.
The revenue share deal was born. To some people, it seemed like a good idea at the time. And it might have been if there were relatively few participants in that revenue share. But revenue share deals don’t scale very well.
Enter Professor Coase and His Pesky Theorem
Here’s the basic flaw with revenue share deals: Calculating the share of revenue for the entire catalog of licensed music on a global basis requires a large number of calculations. For companies like Spotify, Apple or YouTube, calculating the share of revenue for millions of songs and recordings requires billions of calculations.
Free services like Spotify or YouTube involve billions of essentially unauditable calculations, all of which are based on a share of advertising revenue. Advertising revenue which is itself essentially unauditable due to the nearly pathological level of secrecy that prevents any royalty participant from ever knowing what’s in the pie they are sharing.
That secrecy runs both upstream, downstream and across streams. And as we all know, keeping secrets from your partner is the first step on the road to ruining a relationship.
But before you get too deep into nuances, let’s start with a basic problem with the entire revenue share approach. In order to get to a per unit royalty, you have to multiply one dynamic number (the revenue) by another dynamic number (the usage). Meaning that the thing being multiplied and the thing by which it is multiplied change from month to month. The only constant in the formula is the actual percentage of the pie payable to the rights owner (50% in our example).
Remember–this all started with the digital service proposing that artists, songwriters, labels and publishers should take a share of what the service makes. If you have a significant catalog, however, you do what you do with everyone who wants to license your catalog–you require the payment of a minimum guarantee as a prepayment of anticipated royalties (also called an “advance”).
So in our simple example, if the service is pitching that they will invest heavily in growth and make the catalog owner $50 over a two year contract, the catalog owner is justified in responding that however much confidence they have in the service, they’d like that $50 today and not a burger on Tuesday. The service can apply the $50 minimum guarantee against the catalog’s earnings during the term of the contract, but if the minimum guarantee doesn’t earn out, the catalog owner keeps the change. This shifts the credit or default risk from the catalog owner partner to the digital service partner (who actually controls the fate of the business).
But–given the complexity of the revenue share calculations, at least three questions arise:
Question: How will creators ever know if they are getting straight count from the service due to the complexity of the calculations?
Answer: The vast majority will never know.
Question: How will anyone know if the advance ever recoups with any degree of certainty if they cannot verify the revenue pot they are to share?
Answer: The royalty receiver has to rely on statements based on effectively unverifiable information.
Question: And most importantly, if streaming really is our future as industry leaders keep telling us, then which publisher wants to sign up for a lifetime of explaining the inexplicable to songwriters and artists who question their royalty statements?
Let’s Get Rid of Revenue Share Deals
There’s really no reason to keep this charade going any longer. If the revenue share deal was converted to a penny rate, life would get so much easier and calculations would get so much simpler. There would be arguments as always about what that penny rate ought to be. Hostility levels might not go away entirely, but would probably lessen.
Transaction costs should go down substantially as there would be far fewer moving parts. Realize that it’s entirely possible that the transaction costs of reporting royalties in revenue share deals (including productivity loss and the cost of servicing songwriters and artists) likely exceeds the royalties paid. My bet is that the costs vastly exceed the benefits.
And the people who really count the most in this business–the songwriters and artists–should have a lot more transparency. Transparency that is essentially impossible with compulsory licenses.
Because when you take into account the total transaction costs, including all the correcting and noticing and calculating and explaining on the publisher and label side, and all the correcting and processing and calculating and messaging that has to be done on the service side, surely–surely–there has to be a simpler way.