Paul Pacifico: Is Compulsory Licensing The New Next Big Thing (Again?)

18 Sep 2015

Credits: geralt@pixabay

There seems to be a fundamental misunderstanding at the heart of the music industry that is behind much of its perceived dysfunction in the face of what should be the most tremendous opportunity; the internet.

This long-running misunderstanding goes a long way to explain why artists and labels have often publicly expressed such different positions on the streaming model.  It may also give an insight into why, when some parts of the music industry talk about the ‘transfer of value’ from music to tech, it is in some respects seen by artists as artificial.

Essentially, it comes down to the deals artists sign with labels and their different perceptions of what those deals actually mean.

Artists sign deals with labels that comprise two core revenue streams; an advance and a royalty rate which are normally given to the artist in exchange for the ownership of the copyrights in their recordings.

The artist usually believes that the record company’s job is to do its best to commercialise their recordings and that the artist’s royalty will reflect their shared benefit from that endeavour.

Assignment of copyright gave a long-term interest to the label that was deemed appropriate consideration for the sometimes considerable risk a label would take in supporting an artist who, once signed, could devote themselves to recording and have their lifestyle supported whilst doing so.  However, any deal for the life of copyright is a long-term transaction that can be very difficult to unpick if the parties fall out for any number of reasons at any stage in an artist’s career.

It is important to note that the label normally retains the right to recoup advances before starting to pay out royalties to the artist and that any advances are recouped only against the artist’s royalty cashflow rather than the total cashflow from a recording, so a recording could in theory be very profitable to a label whilst remaining unrecouped from an artists’ point of view.

However, as Sony Music recently explained in how artist royalties are treated in deals with streaming services filed in Court in New York City, “The implied covenant [in an Artist-Label recording contract] does not require SME [The Label] to structure its affairs in whatever way yields the greatest royalties for 19 [i.e. The Artist].”

In other words, the label has no obligation to protect the artist’s income stream in the deal.  There is no duty of care from the label to its artists beyond the precise wording in the individual recording contract and, as Sony indicates in their defence, their responsibility is to their own profits.  This could clearly be problematic in situations where the label and the artists have divergent interests.

To further compound the issue, the majority of contracts in the music industry were signed before the advent of streaming and the labels feel under no obligation to renegotiate terms as a result of these new business models and modes of exploitation as the deals they did were for life of copyright, which in Europe is currently 70 years.

Labels take the position that they are not obliged to renegotiate with artists even in the face of the staggering changes to the rights environment and business models now applied to the music industry, although a recent Court ruling in Finland goes some way to starting to challenge this assumption.  Certainly many artists do try to instigate discussions around the application of legacy contracts to services like streaming, but any changes would usually be felt to be to the detriment of the label and therefore only the most powerful artists succeed.

It is interesting to note that Major labels tend to invest later in the development of an artist these days.  An artist would be expected to have recorded and self-released some music, built a social media following and toured before even being considered for a deal.  In which case the old world approach of justifying copyright assignment over advances should be challenged if the label is investing later and at an arguably less risky stage.

Pre-streaming contracts still represent a significant proportion of contracts in the music industry and the experience of most artists with pre-digital, so called ‘Legacy’ contracts is that their analogue deal is applied directly to the digital market.  Royalty rates due on physical sales are paid on downloads and streams and subject to the same deductions for items such as ‘packaging’ which clearly have no place in the digital economy.  These deductions can have severe consequences to artist income.

Take for example the following illustration based on a real-world contract from the 1990s with a headline royalty rate for CD Singles of 16% on “Dealer” (i.e. ‘wholesale’) price.  Deductions occur as follows:

 

Analogue Discounts

Discount Rate

Royalty Rate After Discount (%)

Headline Royalty Rate

16

Packaging Deduction (whether or not it exists)

25%

12%

Import Discount (platform servers are overseas)

25%

9%

Breakage Allowance / Returns

10%

8.1%

Net Royalty Rate

8.1%

Divided by 4 band members

2.025%

Average payment of £0.005 per stream in £

0.00010125

 

Average payment per stream is a hotly debated number with Spotify claiming around £0.007 on their artist information website, but this information may be out of date.  Self-releasing artist Zoe Keating claims an average rate from Spotify of USD $0.0032 (around £0.002) on her Spotify revenue.  The example calculation here is based on an indicative rate of £0.005 to more or less split the difference.

At £0.005 and based on the contract referenced above, a member of the band would need around 25,000 streams from a streaming service such as Spotify or Deezer to buy a £2.50 cup of coffee (assuming they had already recouped all of the advances, recording costs etc and ignoring all the costs on the artist side such as management commissions and overhead).  The equivalent number of physical CD singles would have been more like 125.  On this rough calculation, the metric the Official Chart Company use whereby a 100 streams is equivalent to one single sale is off by a considerable factor.

Obviously these numbers are an illustration but they are fairly indicative of the situation many artists face.  It is little wonder why confusion ensues when platforms claim to pay vast sums to the industry and yet artists complain about not getting paid.

It is becoming increasingly clear that in the early days of streaming, large, unrecouped advances were paid to the major labels along with other inducements, the most contentious of which remains equity stakes as all three Major labels have now agreed to share advances (although it is not clear on what basis and how far back they will go).

If the major labels were able to leverage their control over the vast majority of the most popular music recordings in history to extract equity for free (or at a discount) from the streaming platforms, then there has not so much been a transfer of value from music to tech, but rather, a delayed monetisation of value from music.  If a streaming platform had a capital event such as a sale or IPO, the value derived from the liquidation of an equity position would flow back to the record label – with no certainty at this stage as to what share, if any, would be shared with artists whose work generated that value.

Questions still hang in the air as to whether ‘per stream’ rates which form the basis of royalty calculations (subject to recoupment and deductions) were cannibalised for these equity stakes and other inducements.  It is interesting to note that the Independent label community has committed to share with their artists the value derived from any such equity stakes through the World Independent Network Charter (‘WIN Charter’).  To its credit, Warner music has been the most forthcoming of the three Majors, stating that it will share the upside of future capital events related to equity holdings in platforms, however it has not committed to a predetermined mechanism to calculate the appropriate apportionment of value.

The opaque and complex transactions between Major labels and streaming platforms have resulted in the trust between artists and labels hitting an all-time low.

So where do we go from here?

Certainly in an ideal world an industry code of practice would help.  This is something artists have been arguing for some time, but there is at best muted support and no agreement yet for even the most basic principles of transparency and a fair reflection of the value derived from an artists’ work.

If the internal music industry market is not sufficiently serviced by individual contracts negotiated between counterparties (often with significant disparity of negotiating power) and it cannot agree a voluntary code of practice, we must ask ourselves where we go from here.

There is a process currently underway in France that illustrates the deep divisions that still separate contracting parties within music.

The French government, through the Ministry of Culture has initiated a project to try to reach a voluntary code of practice to govern relationships between digital platforms, record labels and artists.

The project is led by Marc Schwartz, who has form having successfully negotiated the landmark deal between French publishers and Google back in 2013.

Mr Schwartz has an unenviable task on his hands in needing all sides to agree on a joint, voluntary code to be policed by a government appointed ‘Mediator of Music’.  He needs the buy-in not just of artists, labels and platforms, but also of the French trade unions and collective management organisations, each with different priorities, interests and levels of transparency.

Whilst there are specific points of detail that are peculiar to the French market, this process in general indicates the broad debate within the industry, affecting every territory in which music is monetised and has access to the internet.

The International Artist Organisation (IAO) has been active in the French process in support of its French member, the ‘Guilde des Artistes de la Musique’ (GAM) who are cognisant of the potentially precendential nature of setting the first such code in the industry.

So far, common ground has been hard to find with the Major labels represented by their French trade body, SNEP, stating that things are pretty good for them right now – and no doubt they are.  Recent reports by market commentators such as Music Business Worldwide have written in detail on the recently increased profitability of the three so called ‘Major Labels’ (Universal, Sony and Warner).  Such results come at the same time as the Sony statements in court confirming the legal right of these labels to maximise profit even at the expense of their own artists.

A recently leaked Sony-Spotify deal from 2011 points to numerous inducements that have allegedly gone straight to these Majors’ bottom lines and not been shared with the artists on whose catalogues the deals have been built.  The extent to which this sort of buccaneer capitalism has dominated the labels’ deals with platforms, however is still unclear as all of the deals sit behind the murky world of the non-disclosure agreement (‘NDA’) which, the labels say, prevents them discussing any details of the deals with the artists who rely on them.

These apparently impenetrable NDAs have given fertile ground to knowledgeable critics and scaremongers alike.  The resulting crisis of trust between artists and labels is hugely damaging as music, like most industries, relies on an internal market, which like all markets needs confidence to function – a lesson highlighted with some alacrity during the 2008 banking crisis.

Put simply, trust is at an all-time low because the revenues derived from the commercial exploitation of music are going through fundamental shifts as a result of the twofold disruption the industry has experienced in the impact of digital technology: First how it impacts on the delivery of music to consumers but also how technology has rapidly altered consumer expectations in society across the board.

Mr Schwartz thus has a tricky task to accomplish in a very short timeframe – he must report back to the Ministry before the end of this month having got all sides to agree.  This presents the participants in the music industry an historic opportunity to come together and work out how all the various pieces should fit together in the digital world.

The cost of not seizing this opportunity with both hands is to send a message that the music industry cannot work together and find a position that is to the best mutual interests of its constituent parts.  Regrettably at this point in the process and with only a couple of weeks to go, it is possible to feel that there is very little chance of an agreement being reached and so the question arises – what next?

The French government has made its position clear.  If no code of practice is agreed, they will propose legislation for compulsory licensing which would effectively make the licensing environment for streaming much more like radio.  This would mean standard rates across the board and no right for the labels (or artists) to prevent platforms using their music.  The upside could be a proliferation of new services but the downside is the fear of sub-market rates for commercial music and the cannibalisation of profitable sales revenue in exchange for lower prices and statutory remuneration rights for artists.

To be clear, the artist demands in a code of practice are pretty straightforward – a fair share of revenues generated by the work we create and transparency through the value chain so that we can understand how much our work is worth and see the various deductions being made.  As our contracts generally centre around royalty rates, we retain a financial interest in the exploitation of our work throughout the value chain and therefore this transparency is critical.

Without transparency and the confidence of an enhanced duty of care from the labels not to manipulate deals to the prejudice of their artists, we must consider carefully the last remaining option for the music market.

Compulsory Licensing (‘CL’) is an option that has historically been seen as anti-competitive and as closing down a free market in favour of some sort of socialist protectionism for artists, however in the context of digital, CL is not necessarily the music industry’s equivalent of socialist utopia to be feared by the Centre and Right.  In actual fact, it may just be the platform the digital market needs to open up competition and foster the innovation in services and business models so desperately needed.

At the moment, Major labels control the vast majority of the music industry’s crown jewels and they have used the power this gives them not only to extract advances and equity stakes, but also to wield significant influence over the business models of streaming platforms and how they interact with their customers.  For example we are led to believe that Major labels impose front page promotion of artists according to market share, which prioritises the Majors almost exclusively and inhibits editorial curation and the promotion of niche or independent artists that platforms might want to recommend to their customers.

It would seem to be a missed opportunity if the potential for cultural diversity and niche specificity that digital offers was missed in favour of ever increasing homogeneity based on the market share of a few dominant global players.

It might be argued that labels have been slow to respond to the transformation to a digital market and that their response tends to react to, rather than drive innovation.  It might also be argued that they have a vested interest in slowing the pace of change, even if this is to the detriment of their artists and indeed to consumers.

If music is to blossom in the digital age, we must ask where innovation will occur and give support where it is needed.  CL could give platforms security on pricing and the confidence that they have the right to access the world’s music catalogue on both the master rights and publishing sides, so long as they pay their dues.  They would also know that they would not be beholden to a handful of global corporations to know whether or not they have a business from one day to the next.

A world freed to experiment and explore, a digital music market open to niche players, be it genre based or by geography gives perhaps real potential for music to blossom in the digital world.

Pricing mechanisms would be needed without doubt and there is much work to be done, but it worked back in the ‘60s for radio – why not now for streaming, which at least in terms of consumer behaviour is converging so rapidly with radio usage?

CL however does not need to be stuck in the expensive and laborious administration constructs of the 1960s.  This could equally be an opportunity to improve the architecture of Collective Management Organisations and finally solve the industry’s other major problem; that rather incredibly in this digital age, it has no definitive database of who actually owns what copyrights.

The implementation of CL could be inspired by ideas from newer technologies such as blockchain, on which cryptocurrencies like Bitcoin are built to keep track of all the ensuing micro payments and give everyone instant access to the information they need and should be entitled to.

Crazy?  Perhaps.  But high street bank Barclays announced just last week that it was set launch Bitcoin services for consumers later this year and London law firm Sheridans are already the first in the world to accept payment in Bitcoin.  Artist Imogen Heap has been leading some very interesting work in this area for the music industry and these ideas have received support from respected academic institutions like the Berklee School in Boston.  The UK Government’s own Digital Catapault team and the Copyright Hub are also starting to explore some of the potential solutions blockchain suggests.

Perhaps to resist the tide of change is to stand like chalk cliffs in a storm – strong for a while but destined to crumble.  Maybe instead it is time to dive in to the sea of opportunity ahead of us and allow innovators to innovate.  If we can’t find our own way of working together, perhaps CL will force the changes the music industry so desperately needs before it is too late.


Editorial by Paul Pacifico, President, IAO & CEO, FAC 

iaomusic.org | thefac.org

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