Why the Major Labels Are the Streaming Wars’ True Villains

When Vox technology site The Verge got a hold of a 2011 contract between Sony Music and Spotify, signed right before the Swedish streaming company’s US launch, the terms were so favorable to the label that the site’s writer Micah Singleton wondered “…who really should shoulder the blame for the lackluster streaming payments that artists like [Taylor] Swift have been complaining about — the labels or the streaming service?”

It’s an excellent question. There’s money in streaming; one need only look at a recent Spotify valuation or Drake’s Apple Music deal to see that. But how does that money get from paying subscribers (or advertisers) into the hands of the artists and songwriters? If the overall recording industry is in decline, why do major labels and publishers seem to be the only ones making real money?

The answer is complicated, but can be distilled down to one universal truth: since the advent of recorded music, labels have exploited artists. And though they’ve certainly taken their licks, the big three (Universal, Sony, and Warner Bros.) have also begun to learn from some of their mistakes, and may have positioned themselves to regain their stranglehold on the industry. In the book The Song Machine, (October 5, W.W. Norton & Company, Inc.), John Seabrook uses years of reporting for The New Yorker to pull back the curtain on how the music industry produces its most valuable commodity: Hits. In the process, he reveals some of the more nefarious deeds of the men that run the machine — the same men that would have you believe the streaming services are the villains, trading pennies for artists’ hard work. But the numbers tell a different tale.

Annual-Payout-2bn-total
Source: Spotify

For simplicity’s sake, let’s take a look at Spotify, the streaming service with the most paid subscribers. Since its launch, Spotify says it has paid out $2 billion to rights holders. Yet the company and its audience is still relatively small, with just 75 million users and 20 million subscribers worldwide. If Spotify’s paid subscriber base continues to grow, the royalties it pays will increase exponentially. But it has several competitors: Rdio, Apple Music, Tidal, and Deezer, to name a few. The service with the largest total user base, YouTube, is said to have paid out $1 billion in advances — in the past two years alone.

So there’s definitely money to be (and being) made. But how does it get divvied up?

Following the precedent set by Apple’s iTunes Music Store, Spotify takes a 30 percent cut of all revenue generated by paid subscriptions and advertising from their freemium tier. The remaining 70 percent gets split by rights holders. There are three different kinds of royalties paid out for music licensed through streaming services: master recording rights, performance rights, and mechanical rights. Masters are the most lucrative, and are typically owned by the label that produced and/or distributed the record. Performance royalties are paid to the writer and publisher of a composition, usually in a 50/50 split. Mechanical royalties are set by the US Copyright Review board and are paid out on a per-unit basis for the use of a recording. Major labels with publishing arms — such as Universal — can potentially get a piece of each royalty that Spotify pays out.

41WYf+ZFqML._SX327_BO1,204,203,200_This is where it starts to get ugly. Spotify says that in the United States, statutes dictate that publishers receive approximately 21 percent of the amount that master-recording owners receive. So when Universal negotiated its contracts with the streaming services, their publishing arm accepted bargain rates on the publishing end in order to get more favorable terms on the more lucrative licenses for master recordings, according to “one music publisher” Seabrook interviewed (The Song Machine, pg 297).

Spotify’s payouts for master recordings are paid directly to the labels, who get hefty upfront payments to license their catalogs to the service. None of that money is specifically earmarked for the artists who performed on the records. Then, based on how many plays the label’s catalog as a whole racked up (and how many of those plays came from paid subscribers), the label is paid a lump sum, which it is then tasked with distributing amongst its artists, based on their individual recording contracts. (The same happens with publishers and publishing contracts).

This process is completely opaque. Spotify gives detailed data on streams to the labels and publishers, who decide how (or if) to share that with artists. The artists and writers have no choice but to trust that they will be done right by their labels and publishers. As a “music industry leader” told Seabrook (The Song Machine, pg 294): “It’s like you go to your bank, and the bank says, ‘Here’s your salary,’ and you say, ‘But what is my employer paying me? I work for them, not you!’ And the bank says, ‘We are not going to tell you, but this is what we think you should get paid.’”

Labels have also been accused of committing outright fraud. 19 Recordings, the record label owned by Simon Fuller, the creator of American Idol, accused Sony of inappropriately categorizing individual streams as “sales” or “distributions,” rather than “broadcasts” or “transmissions.” The result? Were they to properly label streams as “transmissions/broadcasts,” the artists would be due a 50 percent share of the royalty, versus just a fraction for the “sale.” 19 Recordings lawsuit alleges that fraud resulted in at least $3 million in damages.

But the labels’ tried-and-true tool for maximizing their margins has always been the recording contract. In one of the more egregious examples, when the CD was introduced in the early 1980s, labels used the format’s high-fidelity audio (that, unlike analog formats, never degraded) as justification for raising the cost of an album from $8.98 to $15.98. They also increased their share of each sale. But when it came to artists’ royalties, the labels were able to prevent artists from raising rates, saying that they needed the extra money to market the new format to consumers (The Song Machine, pg. 25). These days they issue contracts that somehow allow Aloe Blacc, the co-writer of one of the most-streamed songs of all time, to earn less than $4,000 domestically from Pandora for that song, or mean that Rosanne Cash can pull in only $104 from 600,000 streams over 18 months on Spotify (The Song Machine, pg 296).

Aloe Blacc. © Thesupermat
Aloe Blacc. © Thesupermat/Wikimedia Commons

The labels’ tactics are becoming more ruthless as they learn from their past mistakes, specifically in regards to new technology platforms with massive user bases. Instead of conceding control over the platform like they did with Apple’s iTunes, the majors have begun to forgo some of the massive upfront monthly payments from Spotify to license their catalog — choosing instead to demand equity in the company. The collective stake of the majors in Spotify is estimated to be about 15 percent; If the company goes public, those shares could be worth hundreds of millions, of which the artists get nothing (The Song Machine, pg 294).

But the streaming services are not yet the profit machines that Aloe Blacc imagines them to be; despite clearing more than a billion dollars in revenue in 2014, Spotify’s losses are growing faster than their revenues, and last year Pandora posted losses in the tens of millions. So why are artists like Cash and Aloe Blacc still pointing the finger at the streaming services? By Spotify’s most conservative estimates ($0.006/stream), Rosanne Cash’s 600,000 streams should have generated about $3,600 for her label. The clues as to where the money went likely lie in her recording contract.

This still doesn’t qualify Spotify (or Pandora, or Rdio, or Apple Music, for that matter) as a victim. Even if it’s not currently profitable, the company’s founders and investors (which include the major labels) will undoubtedly get rich from the inevitable IPO, and artists will see exactly zero percent of that windfall. Independent labels don’t get the massive lump sum payments the majors get, and their total stream numbers are considerably lower, so the returns for most indies are still quite low. And if an artist is so DIY that they haven’t registered their mechanical licenses with Harry Fox Agency — which administers those royalties for Spotify — that money will never get paid out.

By the end of 2014, the US recording industry was about 1/3 the size ($7B in revenue) of its peak in 1999 ($20.6B, adjusted for inflation). If that sounds ghastly, it’s only because the size of the music industry before the fall was inflated. Spotify isn’t responsible for the industry’s massive contraction over the last 15 years. That was inevitable, set in motion the moment released digital copies of music on CD. It was only hastened by the recording industry’s stubborn resistance to listen to what its consumers actually wanted.

The post-Napster market correction was only as severe as it was because the majors refused to let go of their exploitative model — they  had made too much money for too long to drop that model and embrace the future. The founders of Napster didn’t think that piracy was the future; they hoped that the labels would take it over and make it their digital distribution service. After all, its popularity had proven the popularity of on-demand digital music on the Internet.

Instead, by killing Napster and chopping of the Hydra’s head, the labels just ensured that more, similar services sprouted up in its place (KaZaA, LimeWire, etc). As Sean Parker told Seabrook (The Song Machine, pg 115): “There was this unique opportunity in history. We said, ‘If you shut down Napster, it’s going to splinter, and you’re going to have a Whack-A-Mole problem on your hands, where you’re fighting service after service and you’re never going to get all those users back in one place.’”

“I own my own masters/No, I ain’t missin’ no royalty statements” — Jay-Z, “We Made It”

So if streaming is the future and the record labels have found creative ways to boost revenues, what’s a struggling artist to do? Being aware of just how exactly their music generates revenue for their label is a good first step. The next is to negotiate a fair contract, though that endeavor is not without challenges. But for aspiring entrepreneurs, one need look no farther than Jay-Z for inspiration. As part of his negotiations to become president of Def Jam in 2004, Jigga was able to secure the return of all the master recordings of the records he made with the label. As of 2015, he was in control of both his master recordings and publishing rights, meaning that whenever his songs are streamed, he gets a bite out of every slice of the pie. The more often marquee artists like Jay-Z leverage their star power into greater control of their work, it stands to reason that it will become easier for the little guys to negotiate more favorable terms of their own.

For now, the best option for most independents is collective bargaining. The Worldwide Independent Network (which advocates for independent music companies), Merlin (an independent rights agency), and Beggars Group (a conglomerate of venerable indie labels) were able to pressure Apple to reverse its decision to forego royalty payments during a planned 90-day free trial. Without the strength of numbers, it’s hard for indies and DIY bands to go toe-to-toe with the streaming giants.

But the most realistic solution to the industry’s revenue problem is quite simple, if staggeringly difficult to carry out: More users, less fragmentation. Had the labels swallowed up Napster and used it as their new proprietary, copy-protected digital music delivery portal, the recording industry would look quite different to how it does today. Instead, so many potential customers are now accustomed to music being free that convincing them to pay for a subscription is an uphill struggle.

But if the industry as a whole can look past the short-term growing pains of streaming’s early years and imagine a bigger pool of (paid) users, it might just be able to close the gap a bit between revenues from physical sales and those from streaming. Robb McDaniels, the founder and former CEO of INgrooves, Universal Music Group’s digital distribution arm, summed up the streaming era’s ideal endgame in an interview with Forbes: “If everyone signed up, the pot would be many times as big. So that’s actually good for artists. The key is, we have to get the average music consumer to sign up, instead of just the early adopters.”