Why Pandora Radio Has Not Invested In The German Market - Yet
Why Pandora Radio Has Not Invested In The German Market – Yet Colin Schrinner Northeastern University
Author Note Colin Schrinner, College of Arts, Media and Design, MS Music Industry Leadership, Northeastern University.
This research paper is part of the course Intellectual Property For Music Management (MUSI 6300), Taught by David Herlihy, JD.
Correspondence concerning this research paper should be addressed to Colin Schrinner, 24 Farrington Ave., 02134 Allston, MA. Contact: schrinner.c@husky.neu.edu
November 15, 2014
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Abstract This paper explores the complexity of intellectual property rights in terms of music licensing by digital media. It will analyze why the California-based music streaming service Pandora Radio has not invested in the European market, and more precisely why it has not entered the German market – yet. Therefore, the paper describes the licensing negotiations between the German performance rights organization (PRO) GEMA and the streaming services YouTube, Spotify and Google Play and relates these to the possible future entry of Pandora Radio into the European, respectively the German streaming service market. Keywords: music streaming licensing, performance rights organizations, streaming service
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Introduction The removal of Taylor Swift’s catalog from Spotify and other music streaming services has caused an uproar within the music industry and reiterated the question of fair compensation for artists whose music is offered by online streaming platforms. Advocates and opponents of Big Machine Label Group’s decision to remove Swift’s music from most streaming services that do provide a free subscription model have been arguing in favor and against this measure. The recent example shows the significance of the licensing negotiations between streaming platforms and intellectual property right holders, that are in turn crucial for the research question that this paper will address: Why has Pandora Internet Radio not entered the German music market – yet? With an impressive market share of 31% Pandora Radio is the leader within the US-American market of streaming services, leaving its fiercest competitors iHeart Radio (9%), iTunes Radio (8%), Spotify (6%) and Google Play All Access (3%) far behind (cf. Statista 2014a). As of Pandora’s Third Quarter 2014 Financial Results, Pandora has 76.5 million active monthly listeners, amounts 9.06% share of total radio listening in the United States, which was “an increase from 7.77% at the same time last year” (Pandora Media Inc. 2014a), and generated a revenue of $600.23 million in the fiscal year of 2013 (Statista 2014b). However, there are two crucial obstacles that challenge the success of the fruitful streaming service and both of them can be connected to the complexity of content licensing. First, Pandora has – just as some of its competitors such as Spotify (cf. Richter 2014a) – not been able to generate profit because of the tremendous costs that stem from royalty fees. Second, Pandora has – in contrast to some of its competitors such as Spotify and Google Play All Access – not entered the worldwide market. In June 2012, Pandora spread its market to New Zealand and Australia. Ever since, Pandora’s Internet radio service has not entered any other country and access remains restricted to three countries. The most obvious reason for this matter of fact can be found in a statement from Pandora’s resigned former CEO Joe Kennedy who explained in an interview from December 2011 that the difference in copy and licensing rights in different countries would hinder Pandora to enter more countries (see Gottfried 2011). Similarly, former Head of Product
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Tom Conrad explained in regards to Pandora’s geographical restriction: “The reason we're not here [Europe] today is because of music licensing” (Shanklard 2012). The paper will elaborate on these statements and answer the question why Pandora Radio did not invest in the European market while its competitors did. First of all, the paper will give an overview of the licensing struggles that Pandora has been facing in its recent past. In order to show the complexity of the licensing negotiations between streaming services and royalty collecting societies the paper will then focus on Germany. In this respect the essay will analyze the differences in copyright law between the USA and Germany, taking the example of the everlasting negotiations between GEMA and each YouTube, Spotify and Google, as its basis to investigate the legal and financial obstacles that Pandora Radio would face when trying to enter the German market. Finally, the paper will talk about the latest licensing developments within the music industry in order to analyze Pandora’s future hurdles in terms of expanding abroad.
Pandora’s Licensing Struggles Licensing History After five years of planning and developing Pandora took off in 2005 and from its start came close to financial bankruptcy a couple of times. While its popularity grew rapidly in its first months of operation the first business plan consisting of a subscription-only model did not turn out well. Most costumers circumvented the obligatory subscription and were not willing to pay for the service. Hence, Pandora soon decided to make the service free and advertisement-based, while still offering a subscription model for the minority that was willing to spend money for Pandora Radio. This new model worked and brought along many new investors and venture capitalists. However, when in 2007 a federal panel of the Copyright Office decided to double the amount of the performance licensing fees Pandora was once again about to fail because it would not have been able to compensate the immense expenses. With the help of the Internet Radio Equality Act in the same year and the Webcaster Settlement Act of 2009, which put an end to the “royalty crisis” (Westergren, 2009), an agreement between the webcasters, record labels and
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SoundExchange was reached and Pandora Radio was able to overcome these renewed financial obstacles. In any case, every five years the panel of the Copyright Office comes together and reconsiders the performance licensing fees. Hence, the current statutory rates are only fixed until the end of 2015 (cf. Peoples 2014b) and might increase again, thereby once more putting the company into financial trouble. Current Rates Licensing fees are by far the largest expenses of the market leading music streaming services. Consequently, in 2013 Pandora paid $314,87 million in royalty fees, making up 88.2% of Pandora’s total operating expenses, which amounted to $356,71 million (cf. Pandora Media Inc. 2014b, 39). There are two sorts of licensing fees that the streaming service needs to pay: •
Publishing Licensing Fees Need to be paid to the royalty collecting societies ASCAP, BMI and SESAC
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Performance Licensing Fees Are collected by performance rights association Sound Exchange
The publishing licensing fees that Pandora paid in the fiscal year of 2013 accounted for “4% of [Pandora’s] total revenue for that period” (Pandora Media Inc. 2014b, 24). These rates are fixed in an agreement with the royalty collecting societies and established through negotiation. Having said this, the collecting societies do not charge Pandora any “mechanical royalties” because the company is labeled as a non-interactive streaming service which means that the users cannot chose the exact song that will be played. The performance licensing fees that Pandora needs to pay amount to $0.00130 per stream for non-subscription users and $0.00230 per stream for users that have subscribed to the service. Hence, Pandora pays these fees every time that a song is being played. This in turn explains the conflict that Pandora finds itself in. As the company tries to increase listening hours in order to “increase their market penetration” (Pandora Media Inc. 2014b, 14) the licensing fees increase as well and lead to “significant operating losses” (13) that Pandora has been facing since their inception (cf. ibid.) and amounted to a “$2 million
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net loss” (Peoples, G. 2014) in the third quarter of 2014. The statutory fees are changed every five years and will be determined by the Copyright Royalty Board in the end of 2015. This brings along long-lasting negotiations between SoundExchange and Pandora. While the PRO wants commercial webcasters “to pay 0.25 cents per stream” (Peoples 2014c), Pandora proposes 0.11 cents (ibid.). These different claims highlight the discrepancy and the complexity within the licensing situation that Pandora is dealing with.
Pandora’s Geographical Restriction Since its launch in 2005 Pandora has been operating under the Digital Millennium Copyright Act (DMCA) that “gives them a clear process to pay rights holders in the U.S.” (Arrington, 2007). Thus, the licensing rights are restricted to the United States and the webpage is legally not allowed to be accessed from anywhere outside the U.S. without a copyright agreement between Pandora and another country. While the first two years Pandora only required a zip code registration, in May 3rd 2007 Pandora Radio blocked the access to their service from any server outside the US via “IP-based filtering” (Pandora Blog 2007). On December 12, 2012 Pandora expanded its service to Australia and New Zealand (cf. Pandora Blog 2012) after having worked on licensing deals with the “Australasian Performing Right Association (APRA) and the Australasian Mechanical Copyright Owners Society (AMCOS) in Australia and well as PPNZ Music Licensing in New Zealand” (“Pandora Expands,” 2012). In an interview in December 2012 former CTO Tom Conrad explained that the biggest obstacle of expanding Pandora to Europe was that the service would need to work with direct licensing deals instead of a “statutory licensing provision” (Shanklard, S. 2012) as it is the case in the USA. How hard and long-lasting these negotiations can be show the examples of YouTube’s and Spotify’s struggles with the GEMA, the “state-authorized (de-facto monopolist) collecting society and performance rights organization in Germany” (Peukert and Kretschmer 2014, 3) – thus, the German equivalent to CISAC, ASCAP, BMI and also SoundExchange.
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German Royalty Rates The German music industry is the fourth largest market in the world. The performance royalty organization GEMA is the middleman between music distributors and each the labels and the artists. GEMA has come up with the following royalty rates for webcasters that offer music streaming services: •
For subscription model: o On Single-Platforms: EUR 0.75 per month and consumer o On Multiple-Platforms: EUR 1.25 per month and consumer Multiple platforms include products that are connected with mobility and can be carried around, such as mobile phones, mp3 players, etc. (cf. GEMA 2013 a).
•
For ad-funded model: o For high interactivity of the service EUR 0.00375 per stream o For intermediate interactivity of the service EUR 0.002 per stream o For low interactivity of the service EUR 0.00025 per stream Interactivity is measured in terms of how active the user can chose from the music catalog that the service provides. Hence, an internet radio such as Pandora is one, or Spotify and other services offer it, has a relatively low interactivity as the user can only chose the artist, song or genre that he would like to base the songs on that the service will automatically play for the consumer. Streaming services like YouTube or Spotify on the other hand give their users the free choice which song they would like to listen to (cf. GEMA 2013b) and are therefore highly interactive.
YouTube VS. GEMA On November 17, 2014 YouTube will launch its very own fee-based streaming service called YouTube Music Key. The service will offer ad-free videos, off-line listening and the downloading of playlists, competing with industry giant Spotify for the Euro-
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pean streaming service market lead. Music Key will be accessible in seven different countries, including the UK, Italy, Spain, Portugal, Finland and Ireland (cf. Dredge 2014). Germany is not one of them. The reason for this is enduring, gridlocked negotiations between YouTube and GEMA. In 2007 a German YouTube version launched after successful negotiations between the platform and GEMA had been settled. YouTube made a starter’s contract with GEMA for a comparatively low flat fee that is made available by the German collecting society in order to give new businesses an easier start into the German market (cf. Weigert 2013). In 2009 this contract ran out and the two organizations have been fighting over the licensing fees ever since because the two parties have very different ideas about theses rates. GEMA asks YouTube for a minimum reimbursement per stream, meaning that YouTube would have to pay every time a video is watched. YouTube argues that not every video is advertised and is only willing to pay a certain percentage of their ad revenue to the German PRO, which is what YouTube has been doing in several other European countries like Italy, Spain and the UK so far. GEMA argues that artists in these countries receive “alarmingly low revenues” (Wragge 2012) from their YouTube videos and does not want to give in to a similar agreement. Thus, until the launch of VEVO Germany in September 2013 a large number of official music videos were banned on YouTube when entered from a German server because YouTube was afraid of copyright infringement claims by GEMA (cf. Brühl 2013). Since October 2013 the video portal VEVO can be accesses in Germany via YouTube, which is why at the moment most of the music videos can be accessed from German servers. While market newcomer VEVO Germany pays the same lowered licensing fees as YouTube did during its first contract it is questionable if the videos will remain accessible on YouTube once this contract runs out and the video hosting service would have to deal with increasing fees (cf. Weigert 2013b). Spotify VS. GEMA? The streaming service giant Spotify launched in Germany in March 2012. However, this does not mean that in contrast to the case mentioned above the company reached an agreement with GEMA. In contrary, Spotify and GEMA have also not been
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able to come to an official agreement ever since the launch of the service. So, why then is Spotify available in Germany? One answer is to be found in an agreement from 2011 between GEMA and the German industry association of infonomics, telecommunication and new media BITKOM, which offers streaming services that are – unlike YouTube – not solely based on advertisement and offer a pay-to stream subscription, to get a blanket license of EUR1.25 per user instead of a per-stream rate (cf. BITKOM 2011 & Weigert 2011). This means that it is much easier for streaming services to calculate their licensing expenses, as they are able to estimate the numbers of users and how these numbers might increase, whereas it is much harder to say how often each individual user will click on a song. In any case, Spotify has a two-tiered free-and-premium model which means that they will be charged in two different ways. For every premium user Spotify must pay EUR1.25 per month (cf. GEMA 2013a), while the rates for free users somewhat close to EUR0.00375 per stream (GEMA 2013b). Be that as it may, Spotify has not paid any money to GEMA yet as they are still negotiating about the per-stream rate and are most importantly acting under a new regulation of the German copyright act, the “Urheberrechtswahrnehmungsgesetz”, which implies that the rates of PROs are considered to be acknowledged without a signed contract (Weigert 2013a). This means that Spotify is able to pay the licensing fees retroactively until the two parties have come to an agreement. This is possible until up to three years after the launch of the service, which means that Spotify will need to come to an agreement until 2015 if they do not want to pay the statutory fees. Google Play & GEMA! As a last example stands Google’s music streaming service Google Play. The service launched in Germany in December 2013 and has a fixed contract with the RPO GEMA (cf. Handelsblatt 2013). Google Play is a subscription-only streaming service that can only be accessed from users who pay a monthly subscription fee of EUR 9.99 per month. GEMA asks services that offer a subscription model to pay EUR 1.25 per month and consumer if it is a multiple platform. As mentioned before, this blanket license, which is not based upon the number of songs that the users listen to, but solely on the number of users that prescribed enable the service to limit, estimate and oversee the li-
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censing costs way better than in the per stream conditions of ad-funded models. Hence, Google Play is one of the few examples where there exists a negotiated contract between the GEMA and a streaming service that has been approved by both sides.
Pandora’s Way To Germany Profitability 88% of Pandora’s revenue is generated from advertisements as Pandora states in its 2014 annual report (cf. Pandora Media, Inc., 2014a, 5). Furthermore, the financial report of Pandora’s second Quarter of 2014 reveals that mobile advertisement reached a record of 76% of Pandora’s total ad revenue (cf. Pandora Media, Inc., 2014c, 1). This means that the most lucrative market for Pandora is the smartphone market. Pew Research reported in January 2014 that “58% of American adults have a smartphone” (PewResearch, 2014)1. According to mobilforge.com (2013) the Pandora app reaches about 42% of these users, making it a total of 77.7 million consumers that use the Pandora app, which comes close to the 76.2 million monthly active users that Pandora stated and thereby proves these numbers. As the smartphone market is booming, Pandora’s revenue continually increases. These numbers point to a positive financial outlook and might be one reason for Pandora to finally invest into the European market.
Conversion Rates As mentioned before, at the moment Pandora pays $0.00130 per stream for nonsubscription users and $0.00230 per stream for users that have subscribed to the service to SoundExchange. As of November 2014, in Germany Pandora would have to pay most likely something in between EUR 0.002 and EUR 0.0025 per stream for every song that is being streamed via their ad-funded model. Even including the different currency rates, this means that Pandora would not have to pay significantly more royalties in Germany 1 As of the United States Census Bureau on October 9, 2014 there live 319 million people in the US: http://www.census.gov/popclock/
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than they are right now in the US. According to BillboardBiz as of September 2014 Pandora “had 76.5 million active users and 3.53 million subscribers” (Peoples 2014d), equaling a conversion rate of 4.6 percent. The conversion rate in this case shows how many people who use the service are willing to pay for it and thus become part of the fee-based subscription model. This could mean that in Germany also only a low percentage of the new users might be willing to pay for the service, thus enabling Pandora to pay the less expensive licensing rates also only for a small percentage of their users. At the same time, Spotify has “2.5 million subscribers and 50 million active users” (ibid.) which equals a conversion rate of 25 percent. According to a data set by Statista, in 2012 Spotify had 3 million active users and 600,000 subscribers, which would still equal a conversion rate of 20 percent (cf. Statista 2012). Thus, at the point that Spotify entered the German market, they could have assumed that they would be able to pay the cheaper rates for approximately 20 percent of their listeners. These numbers let draw the conclusion that interactive streaming services are more likely to attract users that are willing to pay for the service, as they are more interested in being able to chose from a wide variety of music content. On the other hand, streaming services that are not as interactive like Internet radios such as Pandora are not able to gain as many fee-based subscriptions. In terms of licensing fees this is a hurdle that might have hindered in the past and might in the near future prevent Pandora from investing in other markets such as the German one. The Revolution of Licensing Deals Something that may however change the way in which Pandora is struggling with licensing fees in the United States right now and possibly in other markets in the future are possible direct deals with labels. In a lecture that Pandora co-founder Tim Westergren held at Loyola University New Orleans in July 2014 he stated that Pandora’s alternative to the statutory license fixed by the digital millennium act would be to ”go directly to labels an artists and actually negotiate on direct licenses” (cf. Loyola CFMAE 2009) and added: “Obviously, that's incredibly inefficient, we couldn't afford to do that” (ibid.). At that point in time, Pandora thought to regulate royalty rates via statutory licensing and put a lot of effort in the Internet Radio Fairness Act legislations. This is a standpoint that
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seems to have drastically changed over the years. Not only mentioned Tim Westergren in September 2013 that “direct deals are not something that we’re allergic to” (Peoples 2013), Pandora also announced to stop their efforts for new legislation in terms of the Internet Radio Fairness Act. Not even one year later Pandora signed their first direct deal with a label, the independent rights group Merlin. In this deal Merlin receives the “standard statutory rate” (Peoples 2014b) for short-term period. In the long-run however, Pandora only pays a “discounted rate” (ibid.) for streams that “result from Pandora ‘steering’ listeners” towards songs from artists that are signed by Merlin. One of the reasons for this change is the increasing value of user data that media like Pandora have been able to mine throughout the past years. These data become more and more important to artists and labels as they provide them with important information about consumer behavior and needs. Another big change may come from the labels’ side. An article from October 12, 2014 published in the New York Post and written by Richard Morgan reveals that Sony/ATV is “set to ditch licensing firms over streaming dollars” and go into direct negotiations with the streaming services in order to circumvent statutory rates. In the light of these significant changes within the licensing system it may as well be possible that Pandora might be able to sign deals with labels that may give the service discounts on rates in European countries, for example in exchange for user data that Pandora has been mining throughout the past years. Europe’s New Deal The investment into the European market will become even more appealing from 2016 on. In February 2014 the European Union decided to facilitate the European digital music market. A report from the German newspaper Die Zeit explains that from 2016 onwards streaming services will be able to get statutory licenses within all of Europe without having to negotiate with each country on its own (cf. ZeitOnline 2014). This would make it especially more easy to break into the German market as GEMA has been one of the most resistant PROs so far, demanding higher rates than its affiliates in the UK, Italy or France.
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Conclusion There have been various reasons that may explain why Pandora has not entered the European market. The streaming service has gone through a lot of difficulties concerning the statutory rates within the USA itself, bringing Pandora close to financial bankruptcy. Even in 2013 Pandora has not been able to generate a profit, which is mainly due to the immense licensing fees that go along with the ‘zero-sum’ game of per-stream licensing. Thus, Pandora might have wanted to become profitable before entering the European market. However, Pandora is gaining more and more revenue, especially via mobile advertisement, which may enable them to reach “domestic profitability” (Roettgers 2014). While the European market, and especially the German one, is connected with gridlocked and long-lasting negotiations as the examples between GEMA and each YouTube and Spotify have shown, the statutory rates in Germany seem to be quite affordable for streaming services that provide a paid subscription model as these are blanked licenses. The example of Spotify and Google Play show that the German market can be entered and that licensing is more profitable for services with paid subscription. Thus, Pandora could focus on gaining more subscribers when expanding internationally. Be it as it may, there are also other directions that Pandora has gone and could go in the future, thus, signing direct deals with labels, in order to circumvent high licensing rates, as it has already happened in terms of the deal between Pandora and Merlin. Pandora has a good basis to negotiate with labels directly through the development and increasing importance of data mining. The company has an immense market share within the number one music market in the world, the United States, and counts as many as over 200 million registered users. This should enable Pandora to get decent deals also in respect of the European market. Especially with the upcoming European statutory licensing regulations, which will change the industry landscape within the European streaming service market. In this respect one has to bear in mind that in the USA Pandora was the first mover, which is one of the reasons why it was able to gain the market leadership. As they have missed the opportunity to establish their market share within Europe it might be hard for Pandora to enter this competitive field – especially now that the multibillion-
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 dollar corporation Google is taking another shot at the streaming market with its service YouTube Music Key.
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