Grizzly Bear was blowing up my Twitter feed this weekend after asking the question: what’s up with Spotify’s payment model?  It’s not an uncommon question lately, likely due to the fact that no one can seem to pinpoint how exactly the service pays artists.  Grizzly Bear themselves claim to get about $.001 per stream, David Harrell from Digital Audio Insider averages closer to $.004 per stream over the past three years, and this infographic, which circulated widely a while back, indicates that artists on a label are paid $.00029 per stream.  So, what’s the deal?

The confusion is warranted – the interactive streaming payment model that Spotify, Rdio, MOG and Rhapsody use is less transparent than the permanent digital download model that iTunes employs, for example. The payments are variable, and payments are made to labels who distribute to their artists directly, which further obfuscates the process.  That being said, the subscription based interactive streaming model will likely continue to play a growing part in the future of music consumption.  As the most recent 2011 RIAA Year-End Shipment Statistics outline, subscription services were up 18.9% in volume from 2010, and up 13.5% in revenue. Small numbers compared with CD and permanent digital download (MP3) revenue and units shipped, but impressive when you consider that one of the major interactive streaming companies, Spotify, has only been active in the US since July of 2011. As we move towards a world where interactively streaming music will be one of the many growing options that consumers will choose to listen to music, it makes sense to understand how the financial process behind subscription interactive streaming works.

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I’ve known D.A. Wallach for several years, after first interviewing him for my Online Music Marketing with Topspin course.  In addition to being the lead vocalist and songwriter in Chester French, D.A. works with Spotify as their “Artist in Residence.”   Below is a transcript of a conversation I had with D.A. about Spotify’s payment process.

Mike King: I feel like there’s a disconnect between artists and Spotify in regards to the mechanics behind Spotify’s payments.  There’s a lot of discussion about the deals that Spotify has with the major labels, and how the payments to indie artists vs. the payments to major labels is lopsided. Is there any difference between the payments Spotify makes to the majors, and the payments Spotify makes to indie labels or indie artist services like TuneCore or Cd Baby?

D.A. Wallach: We treat payments to indies and major labels the same way.  Let’s take a step back first and talk about some of the basics with the service.  We make money in two ways.  We make money through advertising to free users, who have access to Spotify only on computer.  The service is interrupted by ads, and the functionality is a lot like YouTube.  There is no mobile option for free ad-supported users, either.  Second, we generate revenue from selling subscriptions.  In the U.S., a subscription is $120 a year.  In the U.K. it is ₤120 a year, and in the E.U, it is €120 a year.

We aggregate all of this revenue from these two streams, and distribute back 70% in royalties based on a pro rata share in accordance with the popularity of a piece of music.  For example, if one of your songs has been streamed 1% of the total number of streams in a month, you will get 1% of the 70% of royalties we pay out to rights holders.  We pay this out to whomever owns the music.  If you are going through TuneCore, we’ll pay them directly, and because TuneCore takes no percentage on the revenue, whatever we pay TuneCore on behalf of the artist goes directly to the artist.  If you are signed to a label, we’ll pay the label, who is then responsible for paying the artist based on the contract the label has with the artist.

MK: Can you talk a little bit more about the revenue split between publishers and master rights holders?  How is the 70% of revenue you pay out split between publishing and the master side?

D.A.: With the publishing side, it’s a bit of a complicated formula. The rates are statutory, and have been negotiated with the PROs.  [NOTE: A good starting point to understanding how the interactive streaming services pay publishing royalties is this article from The Future of Music Coalition. Boiled down to basics, interactive streaming services pay a mechanical royalty rate of 10.5% on the revenue they generate, MINUS any amounts for performance royalties. In other words, services like Rhapsody and Spotify are subject to both a mechanical and performance royalty, but the entire compensation for songwriters and publishers from any limited download or interactive streaming site is "capped" at 10.5% of the site's revenue.]  In the U.S., we use Harry Fox as our service provider, and they do the distribution to the publishers.

MK: So there are no differences between what you pay a major label and what you pay an indie label?

D.A.: We have thousands of deals with all sorts of entities including distributors like the Orchard and TuneCore, the majors like UMG, and thousands of other independents.  The basic principle of the deals and the rough numbers are within a small margin in all of these deals. At the end of the day, the indie artist is not at a disadvantage compared to a major label artist, and we feel that all artists are being compensated fairly.

MK: Why do you think that there is so much confusion about how Spotify pays artists, and a general concern from artists about the payments they are seeing?

D.A.: I think there are three answers to this question.  First, we’re not a big company.  We have four million subscribers, and 15 million active users at the moment.  These are satisfying numbers but they are not staggering numbers.  We’ve paid out a good amount in royalties so far, close to $200 million dollars.  I think that people are comparing what we are doing to iTunes, which is not a legitimate comparison.  iTunes is orders of magnitude larger than we are.  People are expecting to see iTunes numbers, but we’re not there yet.  The second answer is that people need to transition from unit-based thinking to consumption-based thinking in terms of royalties.  We feel the metric of success should be based on how many people are listening to your music over a period of years, as opposed to looking at how many units are shipping in one week.  People are used to seeing big numbers from a unit-based model, but that’s really front loading what is happening. Comparing iTunes sales with Spotify payments over a two month period of time is not a great way to look at things.  What we are trying to create is a system in which you earn royalties forever for good music, and the time horizon is simply different than what folks are familiar with now. One can actually think about a download sale as a down payment on all future listening that a fan will do. If you took the effective per play rate that I’ve paid for every time I’ve listened to my Dark Side of The Moon CD, it would be trivial compared to what I’d have generated if I’d done all that listening on Spotify. The third answer is that it’s a confusing model since it is unfamiliar.  There is no fixed play rate, and as we grow, our royalty base constantly expands, driving higher and higher royalty payments. There is also confusion that arises from the fact that we pay royalties (just like iTunes, by the way) to whomever owns the music. In the case of a band on a label, the label generally mediates the accounting of those royalties. My band was on UMG, and when I look at my statement, as one example, it’s confusing. I personally hope that the conversations about Spotify royalties actually lead to efforts at increasing transparency in the entire digital music system. We’re very proud of the hundreds of millions in royalties that we’ve been able to pay out to the creative community, and we want the flows of revenue to be clear to artists.

MK: So to reiterate, as Spotify grows, the pool of revenue will increase, and the royalty rate will increase for rights holders.

D.A.: Yes, the larger Spotify gets, the larger the royalty rates should be. The royalty rates we’ve paid out have been growing at an exponential rate, and we expect this to continue.  If we can get to the scale of Netflix – which has 20 million subscribers – we estimate we’d be paying out to artists what iTunes is paying out on a year to year basis. This is a simple calculation based on the average download consumer spending $60 a year with iTunes, and the average premium subscriber paying $120 a year with Spotify.

MK: Do you think that Spotify is cannibalizing other revenue streams, such a downloads or physical sales?

D.A.: In no market where we exist has there been any data illustrating a downturn in physical or digital sales.  Many labels view us as an extra check, as a purely additive income stream, and I think this is an accurate way to think about what we are doing.  Our main demographic is 18-29 year olds, and in many ways, this is a generation who has never paid anything for music.  They grew up with P2P services, and most of these folks are paying for music for the first time in their lives.  It’s found money for artists and rights holders. On an individual artist level, we’re paying out royalties of $200-300 thousand dollars a month for some of the biggest acts.  The bottom line for us is that we have paid out nearly $200 million in royalties and we feel we are making a real contribution back to the music business. Not all artists are earning big checks, but this reflects a small user base and their relative level of popularity. It is also true that if not a lot of people buy your album on Amazon or iTunes, you won’t be seeing massive payments, either. That being said, we are a newcomer to the market, we’re making huge strides, and it will only get better.

 

I think there’s no debate that a part of the future of music is going to include an access (as opposed to ownership) approach to listening to music. On a large scale, music consumers have always chosen convenience over almost everything else, and the opportunity to listen to as much music as possible, anytime and anywhere, whether connected to the Internet or not, is a compelling proposition. And while I think it’s only a matter of time before Apple gets the licensing together to re-activate some version of LaLa, there are some great services out there in the US and abroad right now that offer a really compelling approach to music in the cloud.

I’ve been checking out Rdio for the past few months, and been really impressed with what they are up to. They have a pretty extensive catalog (made all the more extensive in recent weeks with the addition of the Beggars Group catalog), and interesting social media tools to help with music discovery.

I spoke with Rdio’s CEO, Drew Larner, a couple weeks back about the service. Here’s our conversation:

Mike: Can you tell me a little bit about the background of Rdio, and how you became involved with the company?

Drew: Janus Friis and Niklas Zennstrom, who were the founders of Skype, are the founders of Rdio, and they are the ones who have been funding it for the last two plus years. I met them first in 2000 and started working for them in about 2003, when they were just kind of getting out of the Kazaa phase of their careers. So it was interesting to meet them at that point because I had come from the film business, I had worked in the film industry for twelve years. To meet them with all that was going on – it was an interesting change for me. Shortly thereafter they started Skype, and then Joost, and now Rdio. So they’ve done a lot of things, and I’ve worked with them in fits and starts over all of that period.

Mike: I talk about Rdio in some of my courses, and one question that always comes up is “Okay, Rdio sounds great, but how do I get my music on the service as an independent artist?” Is there an opportunity for folks that are unsigned to get their music on Rdio?

Drew: We don’t have a self-serve option yet. There are aggregators out there that we’re speaking with that effectively provide that service for artists. You know, content aggregation for a service like this, is a long, and I don’t want to say tedious process, because it’s not, it’s an interesting process, but it’s a long process. So to provide a catalog that you are going to charge people for, you are going to need the building blocks, which are obviously the major labels and the major Indies. You get the publishing deals in place and you start adding to the catalog over time. So right now, we’re at seven million plus tracks. Very, very deep catalog. But like you’ve said, there are lots of great indie artists out there who aren’t yet at a label or may never want to go to a label. The paradigm may be changing where they don’t need to sign with a label and you understand that stuff better than I do. As far as marketing directly, we don’t have a self-service option yet and I don’t think it’s in our future over the short-term but I think once we sign with an aggregator that is a more geared towards indie artists, then that would be the way that they can get on Rdio.

Mike: So, from an overview, you are starting with the big guys, which makes sense in trying to get all of the content that the larger population is going to be interested in, and then your going to be moving down the line into working with an aggregator that is more focused on independent artists. Is that accurate?

Drew: No. I mean we’ve already done deals with IODA and some of the bigger Indie aggregators – what I was referring to simply is almost self-serve. So I guess I’d term it non-label indie artists. Those who aren’t signed to any label but are producing music that they want to be distributed. Yeah, we’ll get there.

Mike: Maybe through a partnership with CDBaby or TuneCore.

Drew: Exactly.

Mike: How difficult is it for you to get the licensing deals done right now, as opposed to three years ago? Is there a shift that you are seeing with the majors where they are saying, “Streaming is definitely going to be part of the future and we have to get our content on there?”

Drew: Well, our deals are done. We needed the deals in place before we could launch the service but it is a very good question because it was an iterative process in that, when we started this over two years ago, we were trying to figure out what the right model was. We were looking at companies that were doing ad-based premium type models and personally, because I am the one who was on the hook for defending the model that we choose to my board and my investors, I didn’t really believe in that ad supported model because the ad revenue doesn’t come in at a level that is significant enough to pay for the royalty costs. You know, I come from the content world and I believe content is valuable and needs to be treated as such, so it’s not that the royalty costs are out of line, they are what they are because this stuff is valuable.

So we kind of thought about what kind of model we wanted, and we decided to move towards the subscription model. The majors, as we were negotiating our deals, were moving in that direction as well. There were subscription services out there already, of course, but the functionality in those services are not as robust as they are now. I think the most important change is the offline caching, which if you are using mobile, you are hopefully using a lot because we think that is kind of the light bulb moment. You know, “Wait a second! I can turn my Android phone into a iPod!” You know, “I have a Blackberry and I can play a thousand songs on my Blackberry!” So it creates a single device strategy, and that kind of functionality is something that over the course of the negotiations came into the deal.

Mike: Are there any limitations to how much music you can cache?

Drew: The only real limitations are on the functionality side – what your device storage limit is. If you have a lot of storage on your device, you can store as many songs are you want. On the deal side, once you stop subscribing, your music is no longer available. But that’s the concept of moving, in terms of the model, from an ownership model to an access model. Meaning that you don’t need to physically purchase every song because they are all there. Why would you need to purchase anymore when you have access to everything?

Mike: Are there any other major partnerships that are on the horizon for Rdio that people can look towards in 2011 that you can talk about?

Drew: On the content side?

Mike: Yes.

Drew: We’re doing deals all the time. While we do have some announcements coming, my PR people would get pissed at me if I blew the lid off. So there is nothing specific I can speak to, but I can promise that stuff is coming. Again, it’s a process where you get those cornerstone building blocks that everybody needs for service, and from there you start adding more and more interesting elements. Whether its world music or classical music or additional deeper jazz – it’s a process! We have someone in-house who is very good and very savvy, and she is just continually doing deals. It’s just that it’s time consuming.

Mike: I was really pleased to see the Beggars Group up there.

Drew: I would agree. I’m very, very excited that Beggars is on there and by extension now, the Arcade Fire. It’s very important to have that extensive catalog.

Mike: Can you speak a little bit to the social component of Rdio and music discovery using the service?

Drew: We keep pushing new updates to the clients constantly and just keep making it a better experience in terms of finding new people to follow and giving you more information as far as new music and music that we think you would like, that we believe is unique and based on people rather than algorithms. Now we do have an algorithmic approach, I don’t know if you checked out the radio that we have? So for me, I like that because I am more of a passive listening guy. If I want to listen to Wilco, I can create a fantastic play list with Wilco, the Jayhawks, and Son Volt; that does it for me. Other people want a more core discovery experience, so we’re constantly updating and making it better, but social is really the core to our DNA. The fact is music brings people together. Music is a social conversation and that sense of community is what we really built this service around, and we believe that this differentiates us from the other services in the marketplace. We believe we’ve created a way to accurately & interestingly filter all that music to give users an experience where, instead of just a static search and play where you need to know what you want to listen to, you can come back to Rdio not just everyday but every hour and you will see new stuff! That we really believe is unique and creates a great experience.

Mike: Are you working with a third party like The Echo Nest here in Somerville for your radio algorithm, or is that homegrown?

Drew: It’s homegrown. We’re all in-house, everything is built in house. We don’t outsource, we really have a fantastic engineering and design team, and you’ve seen the result of it. It’s in-house.