How Pandora and Spotify Pay Artists

As many of you know, music websites Pandora and Spotify are two of the more popular options to listen to music on the internet.  Pandora is essentially internet radio, wherein the consumer creates a “channel” from an artist, song or genre.  The software then identifies the songs in its database that fit the channel model based on a range of musical characteristics.  Pandora is based on the clever “Music Genome Project“, which, borrowing from the Human Genome Project, creates identifies music “genes” for different genres.  Genes for house music might include, for example, “four on the floor beats”, “synth loops” or “disco influences”, while jazz genes might include “syncopation” and the like.  Spotify has a channel feature like Pandora, but gives the user more flexibility.  Unlike Pandora, users can select individual songs and stop, start or store these songs as the user likes, in much the same way as if he had the song on his computer.  Spotify users can interact with each other in a Facebook-like manner, share songs across social media

But how do these companies make money, and why would a DJ or artist allow their creations to be played seemingly for free?  The key is that they pay licensing fees for the music (part of which goes to the artists) and then get money from people who come to their sites.

Pandora pays a number of different parties a three layer cake of royalties.  Pandora’s approach is to pay for the right to broadcast music under a so-called “compulsory music license” for the composition itself.  This is a program created by federal copyright law.  It allows internet radio stations to pay set royalty rates for the right to play copyrighted music without asking for permission from the owner.  Second, Pandora pays a performance royalty.  This gives them a license to broadcast a particular version of a sound recording (song) by a performing artist.  A third party, SoundExchange, collects performance royalties, and after taking its cut, sends the rest to the record labels (who typically own the copyright to the sound recording) and the performing artist.  Performing artists on average tend to collect about 45% of the royalties collected by SoundExchange.  Pandora then pays songwriters and composers and their music publishers a publishing royalty.  This royalty typically goes to the music publishers, who are often also the record companies that own the sound recording and performance rights. Out of all of them, performance rights represent the highest percentage of the royalties paid to the different parties.

Pandora attempts to recoup money in royalties by selling advertising space to other companies on its website.  Only a small portion of its revenue comes from listeners who pay for its premium features.  This model has yet to mean a profit for Pandora.  It has lost money every year of its existence.

Spotify, on the other hand, avoids the compulsory music license process and negotiates directly with record labels on performance royalty rates.  This can lead to lower music royalty rates, but these bargains are difficult and time-consuming.  Making these agreements is an extra cost that can reduce savings from lower royalty rates.  It also still has to pay publishing royalties.  These publishing royalties are also small relative to the performance royalties.

Spotify earns most of its money from paid subscriptions, rather than advertising like Pandora.  Four million users across 15 different countries pay $5 to $10 a month for access to its premium services.  All of this still added up to losses of $57 million for Spotify last year, despite a large jump in revenue.

Music Royalties

Music Royalties

Declining sales and music piracy have hit artists and the music business hard over the past decade, but internet streaming provides one interesting solution.  Pandora has a stated goal of creating a “middle-class” for smaller acts.  It has claimed to pay 2,000 artists over $10,000 per year in licensing fees despite being a small player in the radio listening business.  Music websites also potentially reduce the need for stealing music when listeners can have it for “free.”  This also doesn’t account for another way to promote music for new listeners.  With both companies currently losing money and lobbying for changes in the royalty system, however, it’s going to take some serious compromise for all involved to find a way to keep a good thing going.