OPENING PANDORA’S BOX:Music Royalties in the Internet Age

By: Exam Number 25166

Entertainment Law

Professor K.J. Greene

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TABLE OF CONTENTS

I. INTRODUCTION 3

II. ISSUE 4

III. BACKGROUND 5

A. History of Radio 5

B. Streaming Radio Industry 7

IV. THE PARTIES 9

A. Pandora 9

B. Performing Rights Organizations 11

V. MUSIC ROYALTIES 14

A. History 14

B. Industry Royalty Structure 15

C. Copyright Royalty Board 16

D. Pandora’s Royalty Structure 16

VI. DISCUSSION 18

A. Classification 18

B. Pandora’s Appropriate Royalty Rates 19

VII. SOLUTIONS 20

A. Pandora’s Business Model 20

B. Royalty Rates 21

VIII. CONCLUSION 23

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I. INTRODUCTION

In 1993, alternative rock band Cracker released their gold-selling album Kerosene Hat.

One of the hit singles on that album was “Low,” reaching #64 on the Billboard Hot 100. During

the last three months of 2012, the song was played 1.1 million times on the internet radio service

Pandora.1 Band member and co-founder David Lowery revealed that he was only paid $16.89 for

the one-million plus plays, with another $25.36 going to his fellow band members.2 Just to

compare, the song was played about 116,000 times on Spotify. Those plays netted Lowery

$12.05, a substantially higher rate than on Pandora.3

As internet radio services like Pandora grow in popularity, the frequency in which a song

is played increases. There is a much larger market for music than is served by AM/FM

(“terrestrial”) radio. This is especially true for older music. While a song like “Low” only has a

short life expectancy on terrestrial radio, it can live on in perpetuity online. Online radio is also

unique in that the customer has more control over the content. They can seek out a particular

song or band whenever they choose. With terrestrial radio, music is selected by the station’s

program director or DJ.

This underscores a growing problem in the music industry. There is a growing disconnect

between the expectations of the artists and those of Pandora. Artists feel cheated by the royalty

rates that Pandora is paying them. Pandora maintains that they are paying the highest rates in the

radio industry. Furthermore, they point out that they are paying the rates agreed to by performing

rights organizations such as ASCAP and BMI. In fact, Pandora believes that they should be

paying less. Pandora claims that between the rates paid to performing rights organizations and

1 Timothy Stenovec, Pandora Payout for Songwriters Totals $42 After Song Played Over 1 Million Times, Huffington Post (Jun 25, 2013), http://www.huffingtonpost.com/2013/06/25/pandora-payout_n_3498615.html.2 Id.3 Id.

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those paid to SoundExchange (more on this later), they are losing a substantial portion of their

revenue to royalty payments.

II. ISSUE

The debate over music royalties is exceptionally complex as there are multiple issues and

parties. First, it must be determined what category of radio Pandora falls under. Once this is

determined, the parties must look to the current legal standard for royalty payments. The final

step is to determine if any viable solutions exist that will improve on the status quo for both

Pandora and the artists.

Perhaps the most important issue from Pandora’s perspective is whether internet radio

should be treated the same as terrestrial radio. Pandora has lobbied hard to be classified as

terrestrial radio. The distinction is important because while internet radio services must pay

royalties to the performers and copyright holders of sound recordings, terrestrial radio stations do

not. If Pandora were to receive this treatment, it would dramatically reduce their royalty

obligations. However, courts have previously disagreed with such a notion, most recently in the

United States District Court in New York.4

If it is determined that Pandora does not qualify for terrestrial radio treatment, the second

issue looks to what the appropriate royalty rates should be. There are established legal standards

in place to answer this question. These include the agreements between Pandora and performing

rights organizations, prior court decisions, and government regulations.

Because of the growing tensions between music artists and Pandora, the legal standards

in place are not enough. Eventually the agreements between Pandora and performing rights

4 Ben Sisario, Pandora Wins a Battle, but the War Over Royalties Continues, New York Times (March 20, 2014), http://www.nytimes.com/2014/03/21/business/media/pandora-wins-a-battle-but-the-war-over-royalties-continues.html?&_r=0 [hereinafter “Pandora Wins Battle”].

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organizations like ASCAP will lapse, leading to hostile and unproductive renegotiations. It is in

the parties’ best interest to resolve the dispute now before it leads to a breakdown. Although it

will be difficult, creative problem solving can improve the relationship between the parties and

create an outcome that leaves everyone satisfied. This paper will propose solutions which will

help bridge the gap and aid the parties in reaching a fair and equitable agreement for the long-

term future.

III. BACKGROUND

A. HISTORY OF RADIO

In 1886, German physicist Heinrich Rudolph Hertz demonstrated that rapid variations of

electric current could be projected into space in the form of radio waves.5 A short time later,

Italian inventor Guglielmo Marconi proved the feasibility of radio communication in 1895 by

sending and receiving a radio communication.6 He would later send the first successful

transatlantic telegraph in 1902.7

During the early 1900s, Lee Deforest invented space telegraphy, the triode amplifier, and

the audion.8 He provided an efficient detector of electromagnetic radiation, making it possible to

amplify radio waves.9 This amplitude-modulated (“AM”) radio allowed for the creation of radio

stations.10

5 Mary Bellis, The Invention of Radio, About.com Inventors, http://inventors.about.com/od/rstartinventions/a/radio.htm.6 Id.7 Id.8 Id.9 Id.10 Id.

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During WWI, the United States government took control of all patents related to radio

technology.11 They were released in 1919, and the Radio Corporation of America (“RCA”) was

created to distribute control over the patents.12

In 1933, Edwin Howard Armstrong invented frequency-modulated (“FM”) radio.13 This

improved signal quality by controlling noise static. In 1965, the first master FM antenna system

was created, which allowed individual FM stations to broadcast simultaneously from one

source.14

The AM/FM radio industry would continue to develop over the next several decades. In

1992, the Digital Audio Radio Service was created by the Federal Communications Commission

(“FCC”) to establish segments of radio frequency for satellite radio.15 Through an auction, two

companies would be awarded a license to operate on these satellite radio frequencies.16 The

companies selected were American Mobile Radio (later renamed XM Radio) and CD Radio

(later renamed Sirius Satellite Radio). After starting out in select test markets, both would be

launched nationwide between late 2001 and the summer of 2002 respectively.17

Satellite radio is convenient for customers because its signal is capable of reaching where

traditional AM/FM radio will fail. Although popular in the city, its true benefit can be utilized in

rural areas. This makes satellite radio especially valuable for farmers and travelers. Satellite

radio is also able to provide exclusive and unique content to its users. Most stations on Sirius and

XM are unique to the satellite radio platform, and not available without a subscription. Popular

musicians and radio personalities such as Eminem, Bruce Springsteen, and Howard Stern have

11 Id.12 Id.13 Id.14 Id.15 The History of Satellite Radio, Satellite Radio USA, http://satelliteradiousa.com/satellite_radio_history.html.16 Id.17 Id.

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their own satellite radio stations. For more traditional radio listeners, they can still hear their

favorite talk radio stations, such as ESPN radio or NPR.

The two satellite radio services would monetize through subscription and advertising

revenue. While most music stations on the platform are commercial free, stations that offer news

and talk programming still utilize commercial breaks. Both Sirius and XM offer a variety of

subscription packages. Their goal is to sell more long-term subscriptions, so the price per month

decreases as the term of the agreement increases.

On July 25, 2008, the FCC approved a merger between the two companies. Sirius XM

Radio is now the only competitor in the satellite radio market. This has drawn backlash from the

National Association of Broadcasters and many politicians.18 They believed that approving this

merger would create a monopoly in the satellite radio market. Nevertheless, the merger went

through. Today, Sirius XM boasts 25.6 million users and revenue of $3.8 billion.1920

B. STREAMING RADIO INDUSTRY

There are three battlefronts in which radio services compete for listeners in today’s

market: home, mobile, and online. The home market has traditionally been served by terrestrial

radio. Before television, listeners would gather around the radio for entertainment. However, the

home radio market is changing as technology continues to improve. Online radio services like

Pandora are on their way toward to becoming the primary source of radio in the home.

The mobile market includes the automobiles and a wide variety of portable electronic

devices (such as terrestrial pocket radios, 3G/4G/Wi-Fi enabled phones and tablets, etc.). Society

18 Richard Siklos, Merger Would End Satellite Radio’s Rivalry, New York Times (Feb 20, 2007), http://www.nytimes.com/2007/02/20/business/media/20radio.html?pagewanted=all&_r=0.19 Georg Szalai, Sirius XM Reports Record Quarterly Revenue, The Hollywood Reporter (Feb 4, 2014), http://www.hollywoodreporter.com/news/sirius-xm-reports-record-quarterly-676898.20 SiriusXM Reports Fourth Quarter and Full-Year 2013 Results, SiriusXM Investor Relations (Feb 4, 2014), http://investor.siriusxm.com/releasedetail.cfm?ReleaseID=823023.

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has become very mobile, yet as technology continues to improve, this market will continue to

grow. For example, automobile manufacturers are beginning to produce vehicles equipped with

Pandora and capable of streaming radio online.

Advances in technology as well as the growth in the home and mobile markets are aiding

in the growth of the final battlefront, online. In recent history, there has been a significant

increase in the popularity of online radio. If there’s one thing we know about our society, it’s that

we don’t go backwards when it comes to technology. The music industry will not go back to

vinyl (except for a small niche market). The motion picture industry will not go back to using

film. As technology continues to improve, the customer experience will improve and online will

become the customer’s primary source of radio.

The first online radio stations began broadcasting in the early 1990s.21 Due to the early

stage of the internet, it did not take off right away. Some of these internet stations belonged to

actual radio stations that were looking to expand online. As technology improved, many internet

radio stations and music downloading sites (including Napster) began to pop up. In 1998, the

Digital Millennium Copyright Act set forth specific rules for internet broadcasters regarding

copyrighted material. Broadcasters cannot make a copyrighted work available for free without

the permission of the copyright holder.22

Unlike terrestrial radio, streaming internet radio can be accessed anywhere in the world

where there is an internet connection. This makes it very popular in today’s mobile connected

society, as well as in rural areas.

Recognizing its importance, most terrestrial radio stations carry an online option. They

have to in order to compete with the likes of Pandora and Sirius XM. This makes it possible for

21 A History Lesson about Internet Radio, 977 Music, http://www.977music.com/blog/2010/03/a-history-lesson-about-internet-radio/.22 Alex Cosper, The History of Internet Radio, Tangent Sunset, http://www.tangentsunset.com/internetradio.htm.

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listeners to hear their favorite radio stations when out of market. Along with their mobile radio

service, Sirius XM also has an online option available, making them available to customers on

all three of the battlefronts discussed above. However, Sirius XM’s internet radio is not a stand-

alone package. It must be purchased through one of their higher tier subscriptions.

The main competitors in the internet radio market include Pandora, Spotify, Beats Music,

Sirius XM, and potentially Apple. At the moment, Pandora is the market leader. There are two

kinds of internet radio; selective and non-selective.23 Selective internet radio allows the user to

specifically choose which song they want to listen to. Examples of selective internet radio

include YouTube or Spotify. Non-selective internet radio stations choose the music for the

customer. However, some use algorithms to personalize the experience for the user. An example

of non-selective internet radio is Pandora. These distinctions will become more important later

on in this paper.

IV. THE PARTIES

A. PANDORA

Founded in 2000, Pandora Media, Inc. (“Pandora”) is a publically traded company,

incorporated in Delaware24 and with its principal place of business in Oakland, CA. From

humble beginnings, Pandora has quickly become the largest player in the internet radio market.

They went public in 2011, generating $235 million in capital.25 In 2012, they had 175 million

23 How Radio Royalties Work, Indie and Unsigned (July 12, 2012), http://www.indieandunsigned.com/how-radio-royalties-work/ [hereinafter “How Radio Royalties Work”].24 State of Delaware Corporations, https://delecorp.delaware.gov/tin/controller.25 Alex Pham, Pandora Media prices IPO at $16 a share, above expectations, Los Angeles Times (June 15, 2011), http://articles.latimes.com/2011/jun/15/business/la-fi-ct-pandora-ipo-20110615.

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registered users26 and 72.1 million monthly users.27 Today Pandora has 250 million registered

users and over 1,000,000 songs in their library.28

Pandora offers customers a personalized listening experience. Customers can choose a

song title, artist, or genre of music and Pandora will create a personalized station for them based

on the style and similarity of their search criteria. Customers can give the song a thumbs-up or

thumbs-down. This action gives Pandora additional data, which they use to further personalize

the station. Although the station is highly personalized, the customer does not actually choose the

songs that are played, making it a non-selective form of internet radio.

Pandora offers two kinds of subscriptions: basic and premium. With a basic subscription,

the user is not required to pay for the service. Instead, Pandora creates its revenue through

advertising targeted at the particular user (a benefit of Pandora’s personalization algorithm).

Basic subscribers are limited to 320 hours of listening per month.29 With a premium subscription,

there is no advertising. Here, Pandora’s revenue comes from a monthly fee paid by the user. The

premium subscription also offers fewer disruptions, better audio quality, and a variety of

cosmetic appearances.

At this point, advertising accounts for almost 80% of Pandora’s revenue30, totaling $643

million in 2013.31 This means that the majority of Pandora’s customers are signing up the basic

subscription package. Nevertheless, they have managed to capture 8.4% (and rising) of the

26 Claire Suddath, Should Pandora Pay Less in Music Royalties?, BusinessWeek (July 1, 2013), http://www.businessweek.com/articles/2013-07-01/should-pandora-pay-less-in-music-royalties#p1 [hereinafter “Should Pandora Pay Less”]27 Associated Press, New Pandora CEO Faces Royalty Fight with Artists, Billboard (Sept 12, 2013), http://www.billboard.com/biz/articles/news/5694958/new-pandora-ceo-faces-royalty-fight-with-artists.28 2014 Pandora Annual Report, available at http://investor.pandora.com/phoenix.zhtml?c=227956&p=proxy [hereinafter “Annual Report”].29 Id.30 Connie Guglielmo, Pandora Plays Nice As Apple’s iTunes Radio Spins Up, Forbes (Nov 13, 2013), http://www.forbes.com/sites/connieguglielmo/2013/11/13/pandora-media-needs-a-new-music-royalty-deal-will-it-be-the-same-one-apple-got/.31 Id.

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market share for radio listening in the US market.32 Despite their success, Pandora has not been a

profitable venture since going public in 2011. Their net loss has increased each of the past three

years. In 2013, their net loss was $38,148,000. To be successful in the long-term, Pandora will

need to cut costs and increase revenue.

B. PERFORMING RIGHTS ORGANIZATIONS

Performing rights organizations (“PROs”) have been called an artist’s best friend. They

protect the rights of composers, songwriters, and other artists. Their main function is to collect

royalties from those seeking to use the works publically, and distribute these royalties to their

member copyright holders. Membership in one of these organizations is beneficial to the artist

because of the organization’s expertise, resources, and diligence in protecting its members.

In the United States, there are four main PROs. These include the American Society of

Composers, Authors and Publishers (“ASCAP”), Broadcast Music Inc. (“BMI”), the Society of

European Stage Authors and Composers (“SESAC”), and SoundExchange.

ASCAP

Representing songwriters and publishers, ASCAP is the oldest of America’s PROs.

ASCAP was founded by Victor Herbert in February 1914. Its mission was to protect the

copyrighted music of its members, who were associated with New York City’s famous “Tin Pan

Alley.”

In 1917, the United States Supreme Court issued a unanimous landmark decision in

Herbert v. Shanley.33 In that case, the defendants arranged for unauthorized public performances

of the plaintiff’s music with the intent of drawing customers to their hotel or restaurant.34 The

32 Annual Report, supra note 28.33 Herbert v. Shanley, 242 U.S. 591 (1917).34 Id. at 593.

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court said that it didn’t matter whether the defendants charged admission or not.35 They

concluded that the defendant’s use of the plaintiff’s music was done for commercial gain and

violated the plaintiff’s copyright.36 This ruling was significant because it gave ASCAP the legal

backing to license their members’ music to users.

The introduction of radio technology was an important step for ASCAP. It created a new

source of revenue for artists. The District Court’s holding in Witmark & Sons v. Bamburger &

Co. (see infra) further legitimized the organization by allowing them to begin collecting radio

royalties on behalf of their members. As a result, ASCAP membership and royalty payments

grew significantly.

Today, ASCAP is still a membership organization of songwriters and music publishers.

With nearly 500,000 members, it is one of the largest PROs in the world with membership made

up of some of the biggest names in the industry. ASCAP has non-exclusive rights37 to license

works created by their membership and collect royalties on their behalf. They license music to

over 11,500 local commercial radio stations, more than 2500 non-commercial radio broadcasters

and hundreds of thousands of general licensees. Users have the option of buying a blanket

license to the copyrighted works. In 2010, ASCAP collected $935 million in royalties.38 Finally,

ASCAP is a far-reaching global organization that maintains reciprocal relationships with 100+

other performing rights organizations around the world.39

Other PROs

Although this paper puts a special focus on ASCAP, there are three other major

performing rights organizations in the United States. These PROs include SoundExchange, 35 Id. at 594.36 Id.37 This means that an ASCAP member can be a member of another performing rights organization.38 Frederic Choquette, The Returned Value of PROs, Berklee College of Music, Music Business Journal (May 2011), http://www.thembj.org/2011/05/the-returned-value-of-ascap-and-bmi/.39 International: Collecting Foreign Royalties, ASCAP, http://www.ascap.com/about/collecting.aspx.

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Broadcast Music Incorporated (“BMI”), and SESAC (formerly the Society of European Stage

Authors and Composers).

SoundExchange is different from the other performing rights organizations in that most

of the time they represent different parties. Rather than representing the songwriter,

SoundExchange represents the recording artist. However, there are times in which the songwriter

and recording artist is the same person.

SoundExchange is controlled by a board of directors. The board is made up of recording

artists and copyright holders (record labels).40 They are designated by the Librarian of Congress

to collect and distribute royalties from companies using digital transmissions of sound

recordings.41 Authority was created by the Digital Performance Right in Sound Recordings Act

of 1995, as well as the Digital Millennium Copyright Act of 1998. The rates owed to

SoundExchange are set by the Copyright Royalty Board, but more on that later.

BMI was founded in 1939 by the National Association of Broadcasters.42 Its purpose was

to compete with ASCAP, which had dominated the music industry up to that point.43 Their early

success was dependent on finding artists which ASCAP ignored, as well as purchasing libraries

of music to license.

Today, the organization is made up of more than 600,000 songwriters, composers, and

music publishers.44 Their membership has created more than 8.5 million musical works in over

40 Board of Directors, SoundExchange, http://www.soundexchange.com/about/our-team/board-of-directors/.41 Notice Of Designation As Collective Under Statutory License, United States Copyright Office, http://www.copyright.gov/carp/notice-designation-collective.pdf.42 Broadcast Music Incorporated, Princeton, https://www.princeton.edu/~achaney/tmve/wiki100k/docs/Broadcast_Music_Incorporated.html.43 Id.44 Id.

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85 countries.45 In 2013, BMI had its best year yet, bringing in revenues in excess of $944 million

and distributing $814 million in royalties.46

SESAC was founded in 1930 by German immigrant Paul Heinecke.47 Its purpose was to

serve European composers, who at the time were not adequately represented in the United

States.48 Based in Nashville, SESAC is different from ASCAP or BMI in that they operate for

profit. SESAC is the smallest of the American performing rights organizations.

V. MUSIC ROYALTIES

A. HISTORY

At first, the introduction of radio was damaging to the music industry. The industry that

relied mostly on record sales saw a steep decline during the Great Depression. Among other

reasons, radio was cited as a significant factor in that decline. Consumers could either pay for

records or listen to them on the radio for free. It was such a threat that some record labels even

had their stars sign agreements to not appear on radio.

In 1923, the first major radio music copyright case created a right to royalties.49 The

defendant, L Bamburger & Co., was a large department store that sold a wide array of items,

including radios. The controversy arose when the defendant used the plaintiff’s copyrighted

song to demonstrate the use of their radios.50 The District Court in New Jersey found that the use

was unauthorized and for commercial gain.51 That made it a public performance for profit and

entitled the copyright owners to payment.

45 Fast Facts, Broadcast Music Incorporated, http://www.bmi.com/press/presskit/BMI-Fast-Facts.pdf.46 Broadcast Music Inc. Reports Record-Breaking Revenues of $944 Million, Broadcast Music Incorporated (Sept 23, 2013), http://www.bmi.com/press/entry/563077.47 Our History, SESAC, http://www.sesac.com/About/History.aspx.48 About Us, SESAC, http://www.sesac.com/About/About.aspx.49 M. Witmark & Sons v. L. Bamberger & Co., 291 F. 776 (D.C.N.J. 1923).50 Id.51 Id.

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With the holding in Bamburger, ASCAP began collecting licensing fees from radio

stations. This turned radio into a profitable venture for both radio stations (because of

advertising) and songwriters (because of royalties).

B. INDUSTRY ROYALTY STRUCTURE

There are two types of rights associated with a recorded song. There is a copyright which is

held by the writer of a song. There is also a copyright held by performer (usually held by the

record label).52

The royalty structure in the music industry depends on which forum the music is being

played in. There are five forums, which include terrestrial radio, selective internet radio, non-

selective internet radio, satellite radio, and physical locations (restaurants and bars).

Terrestrial radio stations have been treated very leniently with respect to royalties. They

are not required to pay royalties to performers or copyright holders (which are most often record

labels) for sound recordings. Instead, they are only required to pay royalties to the songwriter

and publisher.5354 While this isn’t always the case, the recording artist often is the songwriter, and

the sound recording copyright owner is often the publisher.

Internet radio and satellite radio currently receive the same treatment. They must pay

royalties to the songwriter and publisher, as well as the recording artist and sound recording

copyright owner. This is the structure that platforms like Pandora and Sirius XM must work

within. This means that in order to acquire a license to play music in a public performance for

commercial gain, the user could potentially owe royalties to four different parties. Not

surprisingly, this could get quite expensive.

52 Should Pandora Pay Less, supra note 26.53 Ann Sanner, Musicians want radio stations to pay to play tunes, ABC News, http://abcnews.go.com/Business/story?id=6952903.54 How Radio Royalties Work, supra note 23.

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C. COPYRIGHT ROYALTY BOARD

Formed in 2005 pursuant to the Copyright Royalty and District Reform Act, the

Copyright Royalty Board (“CRB”) determines the rates which licensees must pay in order to

license sound recordings. The CRB is a subdivision of the Library of Congress55 that is made up

of three judges who are appointed to a six year term.56 These judges are empowered to adjust the

rates and terms of the statutory licenses (pursuant to current and developing copyright law) and

determine how the royalty pool is allocated.57

Every five years, the CRB sets royalty rates that radio stations must pay to artists and

copyright holders (represented by SoundExchange) for sound recordings. The rates set forth by

the CRB are binding in that they set rates that must be paid absent some special agreement

between parties. Companies like Pandora are free to negotiate (and have done so) with

SoundExchange to change the agreement as they see fit.

D. PANDORA’S ROYALTY STRUCTURE

Without question, Pandora’s largest costs are for content acquisition. In 2012, Pandora

paid $258.7 million in royalties, or $1.48 per user.58 This is actually quite low when compared to

Sirius XM, who paid $11.33 in royalties per subscriber.59 However, Sirius XM brings in much

more revenue than Pandora. These include royalties for works of music and sound recordings.

Pandora pays royalties to SoundExchange for sound recordings on a per performance rate. The

standard rates are set by the Copyright Royalty Board, discussed above. The current agreement

sets rates through the end of 2015. However, rather than paying the rates set forth by the CRB, 55 Andy Fixmer, Pandora Is Boxed In by High Royalty Fees, BusinessWeek (Dec 20, 2012), http://www.businessweek.com/articles/2012-12-20/pandora-is-boxed-in-by-high-royalty-fees.56 Copyright Royalty Judges, The Library of Congress, http://www.loc.gov/crb/background/.57 Licensing, United States Copyright Office, http://www.copyright.gov/licensing/faqs.html.58 Should Pandora Pay Less, supra note 26.59 Id.

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Pandora reached a settlement with SoundExchange in which the rate is determined by which

kind of subscription the listener has.60 For the year 2014, Pandora must pay

SoundExchange .00130 cents per performance rate when a song is listened to by a basic

subscriber. They must pay .00230 cents per performance rate when a song is listened to by a

premium subscriber.61

Pandora pays royalties for musical works to ASCAP, BMI, and SESAC.62 Pandora’s

agreement with SESAC automatically renews every year, but may be terminated by either party

at the end of each year.63

Pandora operates under interim licenses with ASCAP and BMI.64 These are governed by

a consent decree from the United States Department of Justice.65 The rates can be established

through negotiation or with a rate proceeding through the United States District Court, in the

Southern District of New York.66

In an effort to reduce their royalty costs, Pandora briefly lobbied the Congress to pass the

Internet Radio Fairness Act.67 The legislation, which was ultimately unsuccessful, was aimed at

lowering the royalty rates paid by webcasters. In lieu of the legislation, Pandora is focusing their

efforts on persuading the Copyright Royalty Board to reduce the rates.

VI. DISCUSSION

A. CLASSIFICATION

60 Annual Report, supra note 28.61 Id.62 Id.63 Id.64 Id.65 Id.66 Id.67 Glenn Peoples, Pandora Stops Internet Radio Fairness Act Legislation Efforts, To Focus on CRB, Billboard (Nov 25, 2013), http://www.billboard.com/biz/articles/news/digital-and-mobile/5800772/pandora-stops-internet-radio-fairness-act-legislation.

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The first issue looks to how Pandora should be classified. Pandora strongly believes that

it should be classified as terrestrial radio. Accordingly, they assert that they should be given the

same lenient royalty treatment. This means that Pandora would not be forced to pay royalties to

recording artists and sound recording copyright owners (SoundExchange). There is no doubt that

this would be good for Pandora. Their content acquisition costs would drop dramatically (music

would become almost free for them), and they would likely become profitable.

This decision would be devastating for both songwriters and recording artists. Many PRO

member songwriters are also recording artists. This means that their royalty revenue would

plummet. From an economic standpoint, many artists would have no choice but to leave the

industry. For every one Jay-Z, there are thousands of starving artists. With a royalty rate

reduction further inhibiting the artist’s ability to earn an income, they are left with a difficult

choice to make. While it is true that a majority of artists work in the industry because they are

passionate about what they do, they also have to feed their family. Maslow’s Hierarchy of Needs

suggests that there is a point where a person has to put his physiological needs (food, water,

shelter) above all others.68 This means leaving the music industry to take a job that will meet

such needs. If this were to happen, the music industry would significantly suffer due to a loss of

the creative forces that drive the industry.

As I mentioned earlier, the court has disagreed with Pandora’s assertion. Judge Denise

Cote of the United States District Court for the Southern District of New York stated that “unlike

traditional broadcast AM/FM radio, in which one program is played for many listeners,

Pandora’s digital radio service provides the opportunity to have a unique program created for the

enjoyment of each listener. This distinction between programmed and customized radio has been

68 Saul McCleod, Maslow’s Hierarchy of Needs, Simple Psychology (2007), http://www.simplypsychology.org/maslow.html.

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referred to as the one to many, versus the one to one distinction. But, despite that differentiation,

made possible by digital technology, Pandora is radio.”69 Judge Cote found that while Pandora

does qualify as a form of radio, she did not agree that it was equal to terrestrial radio.70

B. PANDORA’S APPROPRIATE ROYALTY RATES

Armed with the knowledge that Pandora will not receive treatment equivalent to that of

terrestrial radio, the next step is to determine what their appropriate rate payments are. To answer

this question, we need to look at current case law and government regulation.

Pandora must negotiate with the artist’s PRO and pay the fees agreed to for the right to

license music. This means that each PRO will have a different arrangement. In the most recent

case between Pandora and ASCAP, Judge Denise Cote set the rate owed at 1.85% of revenue.71

This was largely a victory for Pandora (who sought a lower rate of 1.7%) as ASCAP was seeking

a gradual rate increase to 3%.72

As was briefly discussed earlier in this paper, Pandora must pay SoundExchange for the

license to use sound recordings. In the absence of a particular agreement, the parties must go

with the rates set forth by the CRB. However, because they reached their own agreement,

Pandora must pay the agreed upon .00130 cents per performance when a song is listened to by a

basic subscriber and .00230 cents per performance for a premium subscriber.

VII. SOLUTIONS

A. PANDORA’S BUSINESS MODEL

69 Pandora Wins Battle, supra note 4.70 Id.71 Id.72 Id.

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Right now, Pandora is in trouble because their business model is not suitable for the long-

term. As I mentioned earlier, they have incurred a loss every year since going public. What’s

more, these losses have only increased over the past three years. While losses for a new business

are common in the short-term, there comes a time when the business has to turn the losses into

profits. That time has come for Pandora. To operate a sustainable business, Pandora must lower

their costs or increase revenue (the most successful strategy would find a way to do both). My

first recommendation is that Pandora work with the PROs and SoundExchange to figure out a

way to find long-term sustainability.

While Pandora might be resistant to do so, it is logical for the parties to work together to

solve this problem. They have nothing to lose. If Pandora continues to operate at a loss, their

debts will grow to an unmanageable level and they will not have the money to cover their

operating costs and interest payments. This will force Pandora into bankruptcy and most likely

out of business. If this were to happen, nobody wins. In the short-term, the radio industry

(specifically internet radio) will take a significant hit. Many jobs at will be lost. With almost nine

percent of the market share disappearing overnight, the amount of royalties paid will decrease

significantly. In the long-term, a new competitor will fill Pandora’s shoes. However, a

substantial amount of royalty money will be lost while waiting for that new market leader. Even

when the new competitor reveals itself, they will face the same problems as Pandora. A few

years down the road, we will be back to the exact same situation.

Pandora needs to show good faith in letting the PROs and SoundExchange help them claw

their way to profitability. Whether it’s increasing the amount of advertising or finding additional

ways to draw more people to the premium subscription package, the parties should be able to

brainstorm a way for Pandora to move toward a healthier income statement.

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Additionally, opening the channels of communication between the parties will create trust.

This will create a better negotiating environment that is conducive to problem solving rather an

overly competitive environment in which both parties are trying to “win” the negotiation. For

example, if SoundExchange knows of Pandora’s financial struggles, they will be more likely to

work with them in order to find a solution that benefits both parties. There is no reason to fight

over a piece of the pie when it is possible to grow the whole pie.

B. ROYALTY RATES

It’s clear that the current royalty rates are not going to work for either party. Pandora wants

them lowered while the PROs want them raised. Although there might be some fundamental

differences between them, the parties can reach a solution which will make both sides happy. I

recommend that they turn their focus toward terrestrial radio.

If there’s one thing that the parties agree on, it’s that terrestrial radio does not pay nearly

enough in royalties. This is an opportunity for internet and satellite radio companies to work with

the PROs (including and especially SoundExchange) to lobby for legislation that will remove the

lenient treatment afforded to terrestrial radio. Terrestrial radio is still the largest player in the

radio market, yet they pay the least in royalties. They essentially get a free blanket license to play

copyrighted for commercial gain. President Obama has even spoken in support of artists

receiving royalties from terrestrial radio.73 And really, logic would dictate that they should be

paid. Terrestrial radio stations are using their sound recordings as a public performance for

commercial gain.

Terrestrial radio stations today are not the same as they once were. Most have taken

advantage of technological advances in order to move online. Moreover, many have figured out a 73 Frank James, Obama Supports AM-FM Radio Royalties For Musicians, NPR (April 1, 2010), http://www.npr.org/blogs/thetwo-way/2010/04/obama_supports_amfm_radio_roya.html.

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way to monetize their content online in some form or another (through exclusive memberships or

advertising). They are now directly competing with Pandora and Sirius XM. So why should

terrestrial radio receive such a competitive advantage? What difference is there between them

and Pandora? It’s a restraint on competition, one which is fundamentally opposed to American

ideals.

Up to this point, the terrestrial radio market was an untapped source for SoundExchange. If

the parties were able to convince the legislature to remove (or even reduce) terrestrial radio’s

lenient treatment in regard to sound recordings, SoundExchange should expect to see an

avalanche of royalty payments heading its way. After all, terrestrial radio is still has the largest

market share in the radio industry.

This will allow SoundExchange to amend their current agreements with Pandora, Sirius XM,

and other internet radio services. In exchange for their help, SoundExchange should agree to

lower rates, but with the caveat that the internet and satellite radio companies must increase their

rate agreements with the PROs. While this may seem to go against SoundExchange’s interest, it

really doesn’t. First, many SoundExchange members will receive those royalty dollars back

through their PRO. Second, as I mentioned above, Pandora staying in business is the best thing

for SoundExchange. SoundExchange stands to lose a lot of money if Pandora goes under.

In this situation, we have a scenario where all boats will rise (except terrestrial radio, but

they’ve been unjustly enriched by their royalty structure for far too long). Pandora will save

money on royalty obligations because the reduction in royalties paid to SoundExchange will be

greater than the increase in royalty payments made to PROs. This should help them reduce costs

and fight their way to profitability. The PROs will benefit because they will see an increase in

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royalty payments owed to them. SoundExchange will be the biggest winner of all, with a huge

new market to draw royalty payments from.

VIII. CONCLUSION

There is significant friction between music artists and Pandora. Artists believe that they

are being cheated because of the low royalty rates in place. Pandora believes that they pay far too

much in royalties and are seeking to pay less.

Pandora’s financial situation dictates that they work with PROs to solve these difficult

problems. They need to open the channels of communications and work toward growing the pie,

rather than fighting over it. They should focus on terrestrial radio. By lobbying Congress to

remove the lenient treatment afforded to terrestrial radio, Pandora, the PROs, and the internet

and satellite radio industry will significantly benefit.

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