The music industry has been in the doldrums for a while now with the Internet (and Napster) dealing them a heavy blow. Things improved with Apple’s (AAPL Quick QuoteAAPL - Free Report) iPod but online music piracy and unauthorized consumption escalated with technology serving as facilitator.

With artists and record labels fighting for their rights ever since, things are now poised to get much better. But traditional business models could be in for a shakeup because of technological progress facilitating content creation and distribution.

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Historically, the music creation and production food chain looked something like this. 

While plastic records, CDs and physical music storage materials are produced and distributed this way, artists and labels are also required to register with a performing rights organization (either BMI, ASCAP or SESA). These organizations help them collect royalties from business get-togethers, clothing stores, restaurants and such other places where copyrighted music is played. Royalties thus collected are split (usually 50-50) between artists and labels. However, artists have disputes with labels over their share of the proceeds.

As is obvious from the above, the Labels, record companies, publishers and producers (often combined into a single business) constitute the most important piece of the music business. They not only do most of the work, but also have the copyrights to the works. So in case of reproductions by recording companies, royalties are paid to the copyright holders (congress determines the rate, but recording companies usually negotiate). Copyright holders/publishers also earn royalties from digital copies sold.

The proliferation of the Internet has led to new complexities however. Alphabet’s (GOOGL Quick QuoteGOOGL - Free Report) YouTube in particular has been targeted by artists, some of the most prominent of which are Taylor Swift, Paul McCartney, U2 and so forth. Their direct battles against YouTube have led the platform to cancel a number of fan uploads upon notice served for copyright infringement by the rights holders. Since this is a tedious process requiring music creators to scour the Internet, they are now moving to change the law that they say unfairly helps technology providers like YouTube. In a fresh letter to the Congress referencing the Digital Millennium Copyright Law (DMCL), 180 musicians are now saying that the law “no longer works for creators”.

YouTube has of course denied any such favor (or any wrongdoing on its part), for exploiting the safe harbor clause in the DMCL. In a statement released to the Rolling Stone the company said, "The overwhelming majority of labels and publishers have licensing agreements in place with YouTube to leave fan videos up on the platform and earn revenue from them…Today the revenue from fan uploaded content accounts for roughly 50 percent of the music industry's YouTube revenue. Any assertion that this content is largely unlicensed is false."

So artists are now fighting two battles. One is against the labels etc for recovering more from them and the other is against technology platforms like YouTube. The labels etc are also fighting the BMI, ASCAP or SESA because many believe they have become redundant in the digital age.

For users, technology has tremendously helped consumption, while also making it hard to share stuff with people. In the past, you could have a gathering and play music without the fear that someone was going to have a problem with it. No one wanted to penalize you for recording and sharing these experiences. But now, technology platforms are far more powerful, with much broader reach, so personal sharing assumes the character of public sharing, which can (and probably are) affecting artist revenues.

Show Me the Money

So there are many conflicting interests at play, especially with respect to who deserves what for the support provided. Labels still want 50% and artists don’t want them to have more than 25%. Artists would like to keep 75%, but digital distribution companies aren’t profitable without a 30% share. This means that any kind of profitable digital distribution will generate some kind of dissatisfaction from some quarter.

And today, we aren’t talking about plastic sales either, so the sales unit is down to a “listen” or “watch” or “stream,” leading to huge volumes of data that must be processed based on confidential agreements between artists and the various parties they employ for commercialization.

Another problem is the different distribution models in the digital realm. While Apple Music or iTunes will pay per stream, Google’s YouTube will also split advertising revenue generated (55-45 split) for their freemium models.

Internet radio has more or less replaced regular radio with the advent of companies like Spotify and Pandora . A March 2016 Edison Research report finds that 50% of U.S. respondents aged 12 and older listened to some sort of online radio in the preceding week, up from 44% last year. With 57% of Americans using online radio monthly, the conversion of monthly to weekly users is now 88%. Podcast listening also grew nicely while in-home ownership of over-the-air radio dropped sharply. Of online radio providers, Pandora awareness topped at 82%, followed by Apple Music (67%), iHeart Radio (65%) and Spotify (52%). Pandora remains the most-used brand (48% of the time) with Spotify up to 14% of the time. Broadcast radio remains the go-to place for new music (68% of the time, same as recommendations by friends/family) with YouTube close behind at 66%. Of 12-24 year-olds, YouTube tops for new music (86%), friends/family (74%) and broadcast radio (58%). But this scenario is changing rapidly as penetration of mobile devices continues to increase even amongst people aged 55 and older.

Internet radio providers usually offer unlimited music for a fixed subscription based on the 70-30 model, but naturally, the higher the consumption, the lower the per-stream revenue. For rights holders, this means a relatively steady and growing (as subscribers increase) revenue stream. These platforms also offer ad-supported free services where revenue is split per industry standards.

Pandora has signed an agreement with music rights administrator Music Reports for mechanical licensing and royalty management for the paid on-demand music streaming service it is about to launch. Music Reports allows any music publisher to create an account to handle licensing and royalty reports. A beta version of the service is expected to launch in the fourth quarter and the incremental transparency could be welcomed by rights holders.

Rights holders generally don’t like freemium models because they bring in another variable in the form of advertising revenue, which might be harder to track.

Technology Remains a Huge Disruptor

As outlined above, technology has already utterly disrupted music retail and distribution models. Spotify’s 30 million, Apple Music’s 13 million, Tidal’s 3 million, Rhapsody’s 3.5 million, Deezer’s 6 million and Pandora One’s 3.9 million subscribers are proof of this phenomenon. But observing the way some technology companies are operating, it appears that there is further disruption afoot.

When companies like Amazon (AMZN Quick QuoteAMZN - Free Report) and Google start devoting resources to original content, Apple starts attracting artists to its platform by facilitating interaction with fans, Twitter starts facilitating music discovery and Facebook launches Facebook Live (it’s already very good at helping videos go viral), something is bound to happen soon.

All the pieces in the puzzle are already out there in the digital world and it’s only a matter of time before they start working cohesively. The only thing standing in the way is the rights holder but its position can weaken with new music that starts out online (using the cloud maybe @ Amazon, Google, Apple?!).    

Conclusion

At the heart of this movement (if I may call it that) are several secular trends, i.e. improving telecom infrastructure, declining streaming cost, technology for easy and effective transmission, mainstream acceptance of anytime-anywhere media consumption and of course the proliferation of mobile devices.

With Facebook and Twitter entering the picture it has also become easier to share musical experiences and likes/dislikes virtually, something that naturally helps consumption and thereby further feeds the production cycle. 

That said, the online channel is still far from replacing regular TV, which makes TV advertising a very big way to reach wide audiences. Labels and indies are still the best way to get in front those audiences. Also, many international markets haven’t adopted large-scale streaming because technology and streaming costs still don’t make it viable. For every stream you don’t just have to pay for the music but also the data downloaded, so it just doesn’t make sense if you can’t listen offline.  

While changes are ongoing, it’s equally possible that online disruptors will start doing more stuff in the real world to add a personal touch (like Amazon is doing with its physical book stores). I think both models will co-exist at least over the next few years.

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