There is a lot of negative discussion regarding revenue streams for artists from emerging services such as Spotify and MOG. (Pandora and other internet radio sites have thus far avoided the lynching mob because these services pay the statutory rate set by Congress and so any cries for higher rates would be almost certainly futile.) Many have called for higher rates or the elimination entirely of these new music subscription services. Artists, including the Black Eyed Peas and Coldplay, have even begun to withhold new albums from release on these platforms after specifically citing the low royalty rates. But are music subscription services really the problem?
There have been many great articles written about the future of music subscription services (read about why Spotify will never be profitable here and why Spotify will most likely be profitable at some point here) but there are two key points that I believe have been missing from the discussion thus far: the power of record labels and the basics of supply and demand.
Let’s begin with the major record labels, which control nearly all of the music subscription services’ catalog when combined together. These labels have agreements with each of these music subscription services which provide them with a staggering amount of power. For the purposes of this discussion, the most important aspects of these agreements are the non-disclosure agreements which provide the labels the right to terminate the agreement (pull their catalog) should any details be disclosed by the music subscription services. This means we cannot know for sure how much Spotify, MOG, and others are paying the major labels and can only rely on rates reported by artists. But the labels are paid the royalties and then distribute them to the artists, so we are ultimately kept from seeing the big picture. How much are the majors passing on to artists? Is it fifty percent or five percent of royalties? This is critical information necessary for evaluating the revenue potential of these newly emerging services and yet it is not available to us (leaving me very suspicious).
The next missing piece of the discussion is supply and demand. So many of us discuss the ways in which the Internet has changed the music business, for both better and worse. Yet in our discussion we often forget to consider a fundamental part of any business: supply and demand. The majors (and many others) are desperately hoping to return to the high margins of the late 1990s (when CDs cost $12.99+), but this will never happen because consumer willingness to pay has drastically changed. So long as the majors hold prices higher than the equilibrium point, consumers will seek substitutes (i.e. alternative ways of downloading music). While this is painful to realize (because it means revenue cannot be as high as it once was, at least with the same business models), it is important to understand before we can truly turn around the business.
I truly believe the Internet provides an incredible opportunity. It was recently reported that Warner Music Group posted a $205 million loss for 2011. It is a disturbing piece of news. Yet, WMG could turn its business around if it accepted and competed at the market set price using, among other strategies, economies of scale to lower costs. Honestly, it seems to be a simple solution: use music subscription services and pay-per-download services to distribute music more cheaply (the marginal cost per unit is virtually zero) and leverage the Internet for interactive and more narrowly targeted marketing campaigns (cutting big marketing budgets in the process). This would result in lower costs and increased sale volume, helping WMG to turn itself around.
So while everyone screams at the music subscription services and cries foul, the point is being missed. Fans are now king, willingness to pay has decreased, and labels must now compete at market set prices. Music subscription services are a part of the solution, don’t let the labels silently lead you to believe otherwise. They are only acting out of self interest.