Can Apple save the music industry from the destructive greed of record labels?
But the cabal of companies currently involved in a dispute with the Cupertino firm is so shamelessly greedy, I'm an iWatch and a ponytail away from becoming a full-on Apple fanboy.
According to Bloomberg, Apple is embroiled in heated eleventh hour negotiations with record labels over the firm's upcoming streaming music platform, Apple Music. Despite being hours away from unveiling the Spotify-esque service at next week's Worldwide Developers Conference, sources tell the outlet that Apple has yet to agree on revenue-sharing terms with the three major record labels. (Newer reports suggest the launch is still a go but that a few details of the deal are still unresolved). Universal, Sony, and Warner Bros have reportedly demanded 60 percent of Apple's subscription revenue, which is 5 percent higher than what Apple was willing to pay. It's also 5 percent higher than the cut Spotify offers and doesn't include the 15 percent streaming services pay to music publishers, which thanks to industry consolidation are often part of the same conglomerates as the labels.
On first glance, this dispute seems like an ordinary squabble between two corporate giants, neither of which deserve much sympathy from anybody. But the quarrel is also part of a larger, decades-long trend that has seen record labels perpetrate some of the ugliest and most destructive displays of American greed. Maximizing profits is an expected and understandable ambition for any for-profit entity. But the labels' hunger for cash -- a hunger that's eternal, insatiable, and irresponsible, like that of a Tolkien villain -- has once again put the future sustainability of the entire industry in jeopardy. And the people who stand to lose the most in this conflict are not tech companies like Apple and Spotify, but artists and consumers.
Silicon Valley isn't killing music -- labels are
Universal, Sony, and Warner Bros declined to comment on this report, but I imagine if asked to defend their aggressive negotiating the trio would make the same righteous argument they have for decades when accused of abject greed: that they're protecting the financial welfare of artists from filthy rich tech CEOs who apparently believe musicians should be compensated one fraction of a fraction of a penny at a time. Under the narrative told again and again by labels -- which many artists, fans, and most troublingly journalists have come to believe without question -- tech platforms shoulder every ounce of blame for the often insignificant payments musicians receive as part of the new economics of digital music. And if it weren't for the heroic labels acting as noble stewards and protectors of artistic excellence and consumer delight, music and the creative lifeblood of humanity that conjures it would be swallowed up by the uncaring techies of Silicon Valley as they play Minecraft and laugh maniacally from the comfort of their schooners.
As empirical and anecdotal evidence has shown, however, record labels are the ones largely at fault for cheating artists out of their fair share of the industry's revenues. Anyone who knows the story of Barrett Strong and Motown Records can tell you these corporate gatekeepers have for decades used every tool and technique at their disposal to keep money out of the hands of the creatives who produce their product. Earlier this year, analysts at Ernst & Young estimated how streaming revenue is shared among digital platforms, labels, songwriters, and performing artists. They found that after the IRS takes 16.7 percent of the revenue, streaming music platforms collect 20.8 percent. That's not a bad haul, but out of the remaining 62.4 percent, the record label keeps three-fourths of that, leaving only 10 percent of the total to be split between publishers and songwriters and only 6.8 percent for artists.
That means labels could very easily leave more on the table for artists if they wanted to -- and if record companies operated with any sense of fairness that's precisely what they would do. With no longer any need for physical products and taking into consideration the more decentralized nature of digital distribution, labels offer less to artists than ever before. But that hasn't staved off their appetite for profits, and so the chances are slim that the extra revenue labels have demanded of Apple will be passed on to artists.
What's worse, in demanding more money from Apple the record labels likely aim to set a new benchmark for every other deal with streaming services, thus threatening the space's already tenuous business model and for no other reason than the record companies' own greed -- remember, it's not as if artists are likely to see any of this additional cash. And just as artists struggle to make ends meet on one end of the industry, on the other end streaming music platforms like Pandora and Spotify have failed to achieve sustained profitability despite producing what so many well-funded tech companies like Snapchat and Pinterest have not: Meaningful revenue.
Could these services cut their operating costs to become profitable? Maybe. But consider that in 2014 Pandora paid "content acquisition costs" to labels and publishers in the amount of $446,377,000 -- which is greater than the rest of its operating expenses combined.
Granted, it's not the responsibility of record labels or anybody else to figure out Spotify's and Pandora's business models for them. Nobody owes tech companies anything, especially not ones valued at billions of dollars. But consumers have spoken, and as they continue to replace digital downloads -- and piracy for that matter -- with streaming, it behooves record labels to help establish a revenue sharing agreement that satisfies all parties, allowing streaming music to become a sane and sustainable industry.
Freemium isn't free
There are only a couple ways sustainability can be achieved -- and none of them involve record labels taking as much as possible from the industry and giving so little in return to artists, platforms, and consumers.
The first possibility is that record labels could refuse to license their content to platforms that offer a free ad-supported tier for users. At heart, the biggest reason why streaming music doesn't make these stakeholders enough money -- not even labels, which as one executive told me are "still living off that Nat King Cole money" -- is that the vast majority of users don't pay a dime for music anymore. Only 15 million of Spotify's 60 million users pay $9.99 a month for its service, which allows listeners to avoid ads and access every feature of the app on mobile.
What's more, the revenue generated by ads on the free tiers of these platforms is dismal in comparison to the revenue generated by subscription fees. According to the most recent IFPI Digital Music Report, the revenue created by ads served up to the estimated 400 million people who use free on-demand streaming music services each month -- that includes YouTube which we often forget is the most-used streaming music platform on the planet -- was only $610 million, Meanwhile, the revenue generated by the 41 million users who pay subscription fees to use Spotify, Rdio, or Deezer is 1.6 billion. That means one-tenth of the world's digital listenership generated over two-and-a-half times more revenue than everybody else. Extrapolate that as a per-user figure, and you'll find that each paying customer created 26 times more revenue a year than each freeloader who generates revenue solely by suffering through -- and likely tuning out -- audio ads. To be fair, ad revenue growth has accelerated over the past two years, either as a consequence of the industry scaling or because services have developed more innovative ad products like sponsored playlists. That said, an industry is much more stable when it's supported by direct consumer payments rather than ads.
So even if a few million users leave Spotify and revert back to piracy, total music industry revenue would likely explode if the record labels made every user become a paid subscriber. Apple alone already has 800 million credit cards on file. And if it convinces just 4 percent of these cardholders to pay $9.99 a month, the company would singlehandedly double the total amount of streaming revenue made in the US last year.
But labels have made sure that free streaming is here to stay for the time being. That's because Apple -- which sources say will not offer a free version of its music service -- reportedly suggested this move to record labels already, asking them to withhold their catalogs from Spotify until the company eliminates its free tier. The labels refused and like a bunch of undercover NARCs leaked Apple's scheme to the press. They were shocked, they proclaimed, just shocked I tell you, that Apple would pull such a dirty trick, sleazily telling the Verge in a tone of faux-righteous indignation, "All the way up to Tim Cook, these guys are cutthroat." That's like the pot calling the kettle black, only the kettle is hot pink.
Was the attempt to kill Spotify's free tier a little underhanded? Maybe. But it doesn't change the fact that killing free streaming tiers, if done right, could very well make streaming music a sustainable business overnight.
Furthermore, labels gave Apple little choice but to launch an attack on free streaming -- which leads to the second way streaming could achieve sustainability if it weren't for the labels exerting so much control over the price of music:
One of the biggest reasons Apple wants Spotify to eliminate its free tier is that Apple's rightly concerned about its ability to convince a massive number of users to pay $120 a month for music, especially when free options like Spotify exist. Even in the 1990s at the height of the music industry, when Americans spent more on music than ever before, the average US consumer only dropped $28 a year on the medium. That's why Apple originally proposed charging users $5 a month which at $60 a year is just a bit more than the $48 that the average iTunes customer spends annually on music. But labels rejected Apple's $5 proposal. And when Apple suggested a compromise of $7 a month, the labels rejected that too. Sensing that labels would never budge on pricing, Apple finally agreed to the record companies' original offer of $9.99. Sure, that means Apple will make more revenue per subscriber. But if decades of music purchasing habits are to be trusted, the number of total subscribers will be greatly diminished thanks to the labels' stubbornness.
The post-label era?
But if all these moves that the labels oppose would increase the revenue potential for everybody in the industry -- including themselves -- why won't they agree to them? And why would labels insist on Apple charging no less than $9.99 and then turn around and fight efforts to eliminate free streaming on Spotify?
That's because despite a lack of profitability, Spotify still has a huge war chest of funding that it continues to pull from to give labels big advances for the right to play their catalogs. And considering only 25 percent of Spotify's users pay for a subscription, killing its free tier could kill the company altogether -- and cut off those hefty advances. Though remember: paid subscribers are absurdly more valuable than freeloaders. In fact if Spotify convinced just 500,000 of its 45 million free users to stay and pay $9.99 a month, the rest of its users could bolt, and the company would still earn the same amount in revenue as it had the year before. Of course, like any good Silicon Valley firm revenue isn't Spotify's game: Scale is. And I imagine VCs wouldn't take too kindly to Spotify losing 75 percent of its users in one fell swoop, even if meant higher revenues.
Labels also benefit from having two major players in the field. This lets record companies play Apple and Spotify against one another in their attempts to wring as much cash and positive public sentiment as possible out of these deals.
As for the labels' dogged refusal to budge on Apple's pricing, $9.99 has become an unofficial benchmark for paid streaming services. And even if that's more money than most consumers are willing to pay, labels are foolishly hoping they'll somehow change their minds. Unlike Apple, labels know little about the psychology of consumers. What they do know is that the last thing they want to do is open the door for other streaming companies to cut prices.And finally, there's a vindicate element to these negotiations. Although it's been 12 years, the labels' wounds still haven't healed from the time Steve Jobs seized control of their industry, like a sober person taking the wheel from a drunk friend about to drive head-on into a tree. Apple may have saved the labels' lives, but like any self-destructive addict they don't see it that way. And now it's payback time.Whatever the reason, labels seem content to lord their ownership of copyrighted material over streaming companies while lording the fading allure of a "record deal" over artists. Maybe they think they can bleed Spotify and Apple just a little bit longer until the former runs out of money and the latter gets sick of operating streaming music as a loss leader on its balance sheet.
But labels need to be careful. Suppose the Spotifys and Apple Musics of the world -- like Netflix and Hulu in video -- take control of not just distribution but production, signing bands to deals and finding a way to purchase the rights to back catalogs of classic artists.
Is that a plausible outcome? I don't know. But if it is, that would pose one more way for the music industry to become sustainable:
Cut the record labels out completely.
[illustration by Brad Jonas]