Apr 9, 2015 · 6 minutes

Pandora is dead. Or so a Digital Music News report from yesterday would have you believe. Its headline reads -- rather apocalyptically -- that "The US Government Is About to Destroy Pandora’s Business Model."

For those in the digital music industry, that's a pretty terrifying headline. Or at least it would be if it were accurate.

The truth of the matter is, the US government is not about to destroy Pandora's business model. A more accurate headline might read, "Sources Say The Department of Justice Is Considering Changes To How Publishers Collect Royalties Which Could Result In Pandora Making Higher Payouts But First The Rules Must Undergo A Lengthy Approval Process During Which Major Revisions May Be Made." That's not exactly the most clickable concept, but complex legal distinctions rarely are.

So where did Digital Music News get the idea that Pandora, with a $3.6 billion market cap and over 80 million monthly active users, would be set out to pasture in short order at the hands of the innovation-hating bureaucracy?

It all began earlier this week when Billboard reported that the DOJ would soon propose a major overhaul to the rules surrounding how online radio platforms like Pandora pay royalties to songwriters and publishers. This is a big deal because it involves changes to rules set in place as far back as 1940. At the time, these songwriter royalties were collected by Performance Rights Organizations (PROs) like ASCAP and BMI -- the reason being that it was too onerous for individual songwriters and publishers to track down every radio station or bar in the country that played their song and demand payment.

To ensure that ASCAP and BMI didn't engage in duopolistic practices at the expense of publishers, the DOJ entered into what's known as a "consent decree" with the PROs. Going forward, radio royalty rates to songwriters would be determined by federal rate courts. In turn, if publishers wanted to negotiate directly with licensees who distributed their music, they would be forced to withdrawal their entire catalogs from BMI and ASCAP.

This system -- like so many systems -- worked fine for decades until the Internet happened.

In the digital age, distribution channels are far more consolidated, with the vast majority of Internet radio usage coming through a handful of services like Pandora as opposed to thousands of terrestrial stations. And because publishers don't need BMI and ASCAP to collect these digital royalties from a comparatively small group of players, they want to negotiate royalty rates directly with online radio platforms like Pandora -- just like they do with on-demand services like Spotify and Rdio which aren't subject to as much government control -- in the hopes of striking a higher rate than the one mandated by the courts. That rate is currently 1.85 percent of Pandora's revenue, a figure that is tied to what the rates might be in a hypothetical free market. Meanwhile, publishers wish to retain ASCAP and BMI's services in collecting royalties from terrestrial radio -- which despite what your disruption-damaged brain might tell you, is still wildly popular. As of 2013, 91 percent of Americans over the age of 12 still listen to traditional radio weekly.

That would require what's known as a "partial withdrawal" from BMI and ASCAP -- publishers would still use BMI and ASCAP for non-digital distribution but negotiate directly with online radio stations like Pandora. But last year Judge Denise Cote ruled that these "partial withdrawals" violated the original consent decree. Furthermore, it allowed publishers to collude with PROs by removing their catalogs and negotiating new higher rates with Pandora under unfair market conditions. For example, one publisher refused to disclose to Pandora which songs belonged to the catalogs they wanted higher rates on, before threatening Pandora with a copyright infringement lawsuit if the company didn't agree to the new rates. The plan was to have Pandora agree under duress to pay higher royalties so the PROs could then lobby with the courts to create higher statutory rates -- citing rates negotiated under this supposed "free market." At which point, with the rates they always wanted, the publishers would rejoin the PROs.

So to prevent shenanigans like these, Judge Cote ruled that for publishers that relied on BMI and ASCAP for decades, it was all or nothing -- no partial withdrawals.

Which just about brings us up to date. Again, Billboard reported that the DOJ, contrary to Cote's ruling, was planning to amend the consent decree to allow these partial withdrawals. And if the proposed changes are approved, publishers would almost certainly begin withdrawing their digital catalogs from the PROs and demanding higher royalty rates from Pandora.

Without a doubt, that's bad news for the streaming music service. Pandora is only sporadically profitable at best, and despite its success at building a brand and offering a service users love, its business model is far from proven. Any increase in royalty rates is a loss for Pandora.

But the threat to Pandora isn't as existential as it sounds. First off, there's an important distinction to make here between the two types of royalties Pandora collects: Royalties to songwriters and royalties to performance artists. This debate concerns the amount Pandora pays to songwriters as mandated by the rate courts -- which is only 1.85 percent of the company's total revenue. Frankly, that isn't enormously onerous and, with no other information to consider, should maybe be higher.

But most of the royalties Pandora pays -- the ones that eat into the company's revenues most ravenously and prevent it from achieving longterm profitability -- go to performing artists, not songwriters, at rates set by a separate organization called SoundExchange. For example, you may have heard the widely-repeated claim that pop artist Aloe Blacc earned less than $4,000 from Pandora on a song that was streamed 168 million times. That's true, but it's also disingenuous. That was only the amount Blacc received as a songwriter. He doesn't mention how much Pandora paid in royalties to him as a performing artist -- which many estimates put at around $250,000. Meanwhile, terrestrial radio pays artists nothing, because traditional airplay is considered free promotion.

Is it fair that Pandora pays songwriters far less than performance artists? Or that performance artists receive royalties from Pandora but not terrestrial radio? No. But this inequity was set into motion by bureaucrats and regulators in the 1990s before Pandora even existed, with the passage of two pieces of legislation. Furthermore, in the new music economy, performers like Lady Gaga and Katy Perry are far more valuable than the people who write their songs. This may be an overstatement, but in my mind there's little shortage of amateur producers with ProTools setups in their basement that could make a Katy Perry-ready track.

In any case, the larger point here is that the prime factor in Pandora's fraught royalty situation are these massive performance royalties. And even if songwriter royalties were doubled -- or for that matter dropped to zero -- the company would likely still be hovering around profitability.

And finally, these changes will likely have to undergo a months-long process, where it will be subject to approval by a number of government stakeholders -- including the very rate court judges like Judge Cote who already struck down the concept of "partial withdrawals."

Of course that doesn't mean "partial withdrawals" won't be approved and that Pandora won't be forced to pay higher songwriter royalties. But if they are approved, they will likely include stipulations that require far more transparency from publishers in these dealings which is good news for Pandora. That way, the collusive behavior between PROs and publishers that marred earlier negotiations and threatened to cost Pandora millions in copyright infringement fees do not again rear their head.

The music industry -- particularly in the realm of online radio where the government wields a great deal of control -- is absurdly complex, as are the legal decisions surrounding it. And plenty of threats exist to Pandora's business model. But if Pandora fails, "partial withdrawals" and "consent decree amendments" won't likely be the causes of its demise.

[Illustration by Brad Jonas for Pando]