The Real Problem With Streaming

Much of the debate around the sustainability of streaming has understandably focused on artist and songwriter income and transparency.  It is a debate that I have contributed to frequently.  But the more fundamental structural issues are whether the business models are commercially sustainable and if they are, what the implications are.  Music consumption is inarguably moving towards access based models so the question is not whether streaming should happen or not, but how to make it work as well as it possibly can for all parties.  As unfair as it might seem, the baseline issues regarding creator income could go unchanged without streaming business models falling apart.  But, as I will explain, if broader commercial sustainability issues are not fixed then many streaming businesses will collapse leaving just a couple of companies standing.  And that scenario would almost certainly be worse for creators than the current one.

The Steve Jobs Revenue Share Legacy

As I revealed in my book ‘Awakening’, when Steve Jobs struck the original iTunes Music Store deal he walked away a happy man despite having given the major labels the big revenue percentages they wanted.  Why?  Because it meant that it was really hard for anyone without ulterior business aims like Apple had, to make money from selling tracks as a standalone business.  The revenue shares negotiated back then set the reference point for all digital deals since.  The fact that streaming services pay out more than 70% of revenues to rights holders can be traced back to that deal.

The Great Role Reversal And The De Facto Label Monopoly

In the digital era the record labels undisputedly hold the whip hand, and some.  In the analogue era the roles were reversed.  Retailers were the dominant partners and they knew it.  Record labels actually paid retailers for placement to promote new releases.  Compare and contrast that with labels contractually compelling services to provide placement.  Both models are wrong and both engender corrosive behaviour.  Because the major labels account for the majority of music sales it is nigh on impossible for a non-niche music service to operate without all three on board.  This gives each label the effective power of veto.  So even though no major label is a monopoly in its own right each has an effective monopoly power in licensing.  These factors give labels them the strength and confidence to demand terms that would not take place in an openly competitive market.  This, for example, is very different to how digital deals are done in the much more fragmented TV rights landscape.

Loading The Risk Onto Music Services

Why all this matters for the sustainability of streaming services is because of how it manifests in commercial terms.  Recent contract leaks have revealed to everyone the details of what insiders long knew, that labels and publishers front-load deals.  Services both have to pay large amounts up front and agree to guaranteed payments to rights owners regardless of how well the service performs.  (Some labels proudly state they don’t charge advances but instead charge a ‘set up fee’ for every track in their catalogue. Call it what you like, making a music service pay money up front is an advance payment.)  Even without considering the entirely intentional complexity of details such as minimas, floors and ceilings, the underlying principle is simple: a record label secures a fixed level of revenue regardless, while a music service assumes a fixed level of cost regardless.

Labels call this covering their risk and argue that it ensures that the services that get licensed are committed to being a success.  Which is a sound and reasonable position in principle, except that in practice it often results in the exact opposite by transferring all of the risk to the music service.  Saddling the service with so much up front debt increases the chance it will fail by ensuring large portions (sometimes the majority) of available working capital is spent on rights, not on building great product or marketing to consumers.

Skewing The Market To Big Tech Companies

None of this matters too much if you are a successful service or a big tech company (both of which have lots of working capital).  Both Google and Apple are rumoured to have paid advances in the region of $1 billion.  While the payments are much smaller for most music services, Apple, with its $183 billion in revenues and $194 billion in cash reserves can afford $1 billion a lot more easily than a pre-revenue start up with $1 million in investment can afford $250,000.  Similarly a pre-revenue, pre-product start up is more likely to launch late and miss its targets but will still be on the hook for the minimum revenue guarantees (MRG).

It is abundantly clear that this model skews the market towards big players and to tech companies that simply want to use music as a tool for helping sell their core products.   Record labels complain that they don’t get enough value out of big companies like Google and Samsung, but unless they make the market more accessible to companies that are only in the business of selling music they can have no room for complaint.  The situation is a direct consequence of major label and major publisher licensing strategy.

Short Termism And From Evil To Exceptional

Matters are compounded by an increasingly short term outlook from label licensing divisions, with the focus on internal quarterly revenue targets, or if you are lucky, annual targets.  The fact that much of label and publisher digital revenue comprises guarantees and advance payments means that their view of the digital market is different from how the market is performing.  If our small start up that pays $250,000 in rights payments doesn’t even get its product to market, the rights holders still see that digital revenue even though the marketplace does not.  (One failed music service that didn’t even launch went into bankruptcy owing two major labels $30 million).

This revenue comfort blanket insulates labels and publishers from much of the marketplace pain.  So if/when things go wrong, they feel it later, delaying their response.  There is also a cynicism in much deal making, with rigid templates applied to deals and a willingness to compromise principles if the price is right. The latter point was illustrated by the leaked negotiations between UMG and industry bête noir Kim Dotcom in which former digital head Rob Wells referred to being able to ‘downgrade’ Dotcom from ‘evil to bad’ and then from ‘bad to good and from good to exceptional partner’.  The message is clear, if there is enough money on the table, anyone can be a business partner whatever the implications might be for the rest of the market.

Wafer Thin Margins, Deep Pockets And The Innovation Drain

Current licensing strategy biases the market towards those with deep pockets and fatally compromises profitability.  Once all costs are factored in, a music subscription can theoretically have an operating margin of between 3% and 5%. Though only if it doesn’t invest sufficiently on marketing, customer retention and product innovation. But of course the streaming market is in early growth stage so every service has to spend heavily which means that profitability becomes a hostage to fortune. No wonder Daniel Ek is clear that Spotify is a growth business rather than on a profit crusade.

The market dynamics also create an innovation talent drain.  If you were a would-be start up founder the huge up front costs, non-existent margins, and complex time consuming licensing do not exactly make building a music app a welcome experience.  Building a games app however is an entirely different proposition: you own 100% of the rights, you don’t pay a penny to 3rd party rights holders and consumers actually pay for your product.  Music is already a problematic enough sector as it is without burdening it with a punitive licensing framework.

These are the structural challenges that could yet bring down the entire edifice of the streaming music economy.  The irony is that if Spotify has a successful IPO (sans profit of course) it will trigger a wave of copycat services and investment that will perpetuate the status quo a little further.  But it will only be a temporary delay.  Sometime or another the hard questions must be answered.

User Centric Licensing: Making Streaming Work For Everyone

Artist income is one of the most pronounced growing pains of the streaming era.  While there are many contributory factors, such as transparency and non-distributable label payments, the most significant element by far is how much artists get paid.  There are many moving parts to the equation, not least of which is how much labels themselves choose to pay artists, but even if labels doubled their payments to artists (which would be a good starting point for artists on 15% deals) the underlying dynamic would remain unchanged.  Namely that consumers are switching from buying music (which generates large upfront payments) to accessing it (which generates smaller payments spread over a longer period that as things stand look like they could still add up to smaller amounts even in the longer run).  If you’re a big super star artist or a major label this doesn’t affect you much as you get such a large chunk of the headline revenue.  But a new approach is needed for the rest.  Enter stage left the case for user centric licensing.

Under the current licensing model artists get paid on an ‘airplay’ basis i.e. what share of the total plays across the entire service the artist accounts for.  This model can skew the revenue balance to the superstars who will get played by a very large share of the user base of a service.  Under a user centric model an artist would get paid based on the share of an individual’s listening.  So if a user spends half their time listening to an underground techno producer, half of the royalties go to that producer.  In the existing model that producer would only get a tiny fraction of the royalties generated by that user.

user centric licensing

Let’s take a look at how this could work (see figure).  If a subscriber listens to Artist B 55% of the time but that artist only accounts for 0.5% of total listening, only 0.5% of the available royalties for that subscriber make it back to the artist.  Whereas Artist A who the user didn’t listen to at all gets 10% of the royalty income.  But in a user centric licensing model the artist would get 55%.  The revenue changes from a paltry $0.004 to a more meaningful $0.49 (assuming a 15% royalty share from the label).  And Artist A gets a fairer zero income for zero listening from that user.

Make no mistake, this model will be very difficult to license and the vested interests would likely resist it.  But until we get to scale with subscriptions, we need to explore all ways of ensuring revenues are distributed on as equitable a basis as possible.  This approach won’t fix all the artist-income ills of streaming but it will help smooth the transition.

I’m not going to pretend to take credit for this concept, it’s been quietly gaining momentum for some time now and the Trichordist has been building the case too.  But now is the time to really start giving this approach some serious consideration.  And if the incumbent streaming services are unable to implement user centric licensing because they are too close to the superpowers, then this is an opportunity for a new streaming service to seize the initiative and start to make some meaningful change.

I’m attaching the excel of this model so please go and stress test it yourself. Let me know your thoughts below.

MIDiA Research – User Centric Licensing Model

Music Start-Up Strategy 2.0

The music industry needs innovation more than most industries and yet the last two years has seen a slowdown in the number of new licensed music services coming to market and greater consolidation around the Triple A of Apple, Android and Amazon.  In this brave new world music start-ups need an entirely new modus operandi.

There are many reasons for the slowdown in new licensed music services, but a key one is the establishment of the license-advance business model in which record labels issue licenses only upon payment of sizeable, non-repayable advances in anticipation of forecasted income.  Depending on the scale of the risk to the labels presented by the licensed service these payments can range from relatively modest to downright gargantuan (Beyond Oblivion went to the wall owing $100m to Sony and Warner Music even though not a single consumer ever saw the service).  With so few services managing to make a dent on Apple’s market share investors have grown wary of investing in music start-ups that require licenses, some have effectively stopped investing in them all together.  The labels’ focus on partners with scale (and effectively using advances as means of sorting the financially robust wheat from the chaff) may deliver near-term security for the labels but it increases their long term risk by slowing music service innovation.  Hungry young start-ups are often more likely to create transformational innovation than heavily resourced R&D divisions of billion dollar companies.  Thinking ‘out of the box’ is always a lot easier when you’re not actually in the box in the first place.

Music Start-Up Strategy 2.0 Requires A New Set of Relationships

The status quo is a lose-lose for all parties, each of whom find themselves stuck in a Catch 22: labels need new services but also the safety net of advances, services need licenses but can’t pay for the advances and investors want to invest in music services but won’t do so when advances are required.  It is time to change the model, for this cycle of insufficient innovation and market contraction to be broken.

So just how can this circle be squared? The starting point is accepting the position of each of the three constituencies and then building from there:

  • Labels want market innovation but with their market contracting they need to mitigate risk
  • Services want to innovate but can’t afford to have advances as their core early stage expense
  • Investors want to invest in music innovation but want to put as much as possible of that investment in technology and people

Music start-up strategy 2.0 requires each party to think and behave differently, to accept the fundamentals of the new digital music economy.  And this requires a willingness to both embrace some new ideas and to help forge a few others:

Record labels – become investment partners: Record labels – majors and independents alike – deserve great credit for transforming their business in the last few years, but they cannot change the market alone.  Labels need to harness open innovation, leveraging the developer ecosystem.  OpenEMI is an early model of best practice but to fulfil its massive potential the approach needs underpinning with a more equitable alignment of label-developer relationships.  Start-ups are going to help solve record labels’ problem and labels need to not just tap that expertise but accelerate it.  To do that record labels need to apply A&R rules to technology start-ups. On the artist front labels already behave like Venture Capital firms, now they need to translate this appetite for risk to their commercial strategy.  To take the same sort of risks on start-ups as they do on artists. This of course means that labels will routinely require equity stakes – and sizeable ones, but instead of just being a licensing requirement, these will be in return for a new relationship in which labels establish nurturing partnerships with young start-ups, just like those they have with artists.

When a start-up is at pre-launch stage it is probably going to be more appropriate to take a good chunk of equity for licenses than it is an advance that the start-up can ill afford.  Of course it will still be appropriate for advances to be part of the mix in some circumstances – sometimes even the majority of the mix – but the balance of the relationship should be investing to become a business partner.  This means becoming active stakeholders, sitting on boards, working with the entrepreneurs to help make them successes.  In short, the relationship should change from licensee-licensor to investment partners with shared vision and motives for success.

Start-ups – understand what labels need: Though record labels are becoming increasingly confident of their own innovation capabilities, no media company is an innovation agency while technology start-ups have innovation imperatives at their core.  Unfortunately they often get the conversations with labels wrong.  Instead of going to labels with the “we’re going to save your industry” pitch, start-ups should better understand what label priorities are and then propose working with them to help them achieve those objectives, as partners. (This is something that Spotify did incredibly well right from the start).  Just as it is best practice to engage with an investor long before they actually need money, start-ups should apply the same approach to record labels.

However this change of relationship is probably going to take some time to realize, so in the more immediate term start-ups should look at ways to deliver their experiences without licenses.  No I’m not advocating the Groove Shark approach, but instead leveraging the content licenses of digital music services that are pursuing ambitious API strategies.  Music start-ups should think hard about whether they really need to own music licenses themselves to deliver a great user experience, or at least whether they need to right away.  Building, for example, a product within the Spotify ecosystem is a great way to deliver a real-world proof-of-concept, test consumer receptivity and have immediate access to millions of potential customers.  License conversations are a lot easier with proven consumer demand on the table.  (Though start-ups need to be careful with music API strategy, indeed they should treat music service APIs like mobile OS.  Don’t put all of your eggs in one API basket.)

Investors – work with labels as partners and embrace the API economy. Investors might have some reservations about working with record labels at start-up board level but they shouldn’t fear losing influence.  The odds are investors will still make the same scale of Seed and Series A investments, it is just that their money will be working smarter, helping build great technology and hiring better people at those crucial early stages of a company’s life.  Investors and labels often find themselves on opposite sides of the argument.  There is no inherent reason the relationship should be adversarial.

Investors should also think about how well their investment strategy harnesses the capabilities of the API Economy. Of course it is always preferable to invest in a business that owns all of the fuel that powers its engine.  But in the era of integrated music API’s it is no longer crucial for a music service to have its own licenses.  An investor wouldn’t expect a mobile app developer to own Android, iOS or Windows Mobile so they need not expect a music service to own music licenses.

Laying the Groundwork for Transformational Innovation

Some of these changes are already beginning to happen, others are a long way off from being realized.  But this change is needed to enable to next wave of transformational innovation that the music industry so desperately needs.  Freeing up precious and scarce early stage resources leaves start-ups able to focus on developing great, innovative technology.  Which in turn will mean better products, better user experiences and more revenue for everyone.

I first discussed some of the themes covered in this blog post in the Giga Om Pro report ‘Monetizing Music in the Post-Scarcity Age’ which can be found here

 

OpenEMI, an Innovation Files Case Study

Following on from Part 1 of the ‘Innovation Files’ series, this post looks at EMI’s OpenEMI initiative and how it could drive transformational innovation within the major record label and publisher.

EMI today announced an interesting developer initiative that aims to revolutionize the way in which developers work with EMI.  Securing licenses from record labels is a notoriously resource intensive and time consuming process that can leave some apps still born: many smaller developers – especially the one man outfits – often simply can’t spare the resources, time (and money) that can be required.

EMI have inserted themselves into the developer value chain

To streamline the process EMI have inserted themselves directly into the developer value chain. They have partnered with the Echo Nest to build a ‘sandbox’ where developers can access a repository of continually updated EMI content including music, videos and artwork. Developers need only sign up to EMI’s API to start working with the assets.

Developers can either proactively develop their own ideas or respond to briefs and requests sent from EMI, who will funnel combined requests from artists, managers and labels.  Developers however do not get to simply build Apps using EMI’s content and then go take them to market.  Instead every app requires EMI approval, and EMI hopes to encourage best practice of developers submitting requests as early in the process as possible.

Clearly not all apps will get approved and there is certainly potential for log jams.  However the process will most likely streamline organically – assuming all partners have the right attitude and willingness to be sufficiently agile.   It will also be a great platform for all the extra content that 360 artist deals now deliver and that major labels too often just aren’t utilizing well enough.

Open EMI can, and should, go way beyond artist apps

Although initially this set up will principally act as an innovative alternative vehicle for sourcing artist apps – with developers playing around with EMI’s APIs replacing the traditional tender and quote process – it has much bigger longer term potential.  The name EMI has given this initiative speaks volumes: OpenEM.  It is a statement of intent.  Even though what we will see in this initial phase is relatively modest, it takes huge amount for an organization like EMI to take what is for them such a radical approach to their content.  More importantly I expect this to be an opening salvo in a broader strategic move.

An API for EMI’s own innovation

EMI have not just built an API framework for developers, they have built an API for their own future innovation.  The challenge for EMI is the degree to which they can fully harness this new innovation toolset and respond to the new approaches and mindsets it will require.

These are the three things I would like to see EMI use OpenEMI to deliver:

  • Learn from the OpenEMI developer community to help start building the next generation of music product, not just Artist Apps
  • Seed the culture and mindset of the OpenEMI community throughout EMI
  • Learn and implement innovation best practices throughout the entire EMI organization

OpenEMI is a brave step that has the necessary senior executive support to be a success. To help ensure success, OpenEMI’s champions will need to win support across all levels of the organization, and to do that they will need to demonstrate clear benefits to the most sceptical of opponents.

Driving Transformational Innovation

Transformational innovation is never easy to implement because its path is littered with the corpses of the products, processes and jobs associated with the old ways of doing things.  But it is exactly this difficult path that all media companies must take if they are to emerge intact out of this unprecedented period of disruption.  The Terra Firma debacle was an unfortunate distraction for EMI at exactly the time they didn’t need it, leaving them at distinct market disadvantage. They need an unfair advantage to start re-levelling the playing field.  Driving transformational innovation through the entire organization, commercial partner relationships, artist relationships and product strategy  is the fuel for that advantage. If harnessed to its full potential OpenEMI can be the first step on that tricky path.