Anti-scale in music licensing: The Spotify example

More often than not, startups are in pursuit of venture dynamics that exhibit benevolent economies of scale: cost per unit, or per user fall as the number of users increases.

When licensing key inputs, rational startups pursue ceilings and not floors: license terms that place limits on the obligations rather than really high minimums for the obligation.

Music service startups face their own very special sort of “anti-scale.” Really high minimum obligations alongside ceilings that scale 1:1 with user growth or music use.

Eric Eldon of Techcrunch claims to have otherwise “secret” information on the license terms accepted by Spotify:

Its deal structure with the labels requires either a $200 million annual payment, like what it had to do last year, or around 75% of total revenue (whichever is higher)

That “whichever is higher” aspect of the licensing context says it all: Anti-scale.

First, by agreeing to such a significantly large upfront and guarantee, Spotify hopes to develop a barrier to entry– to offer a similar model any new service may have to match the scale of this payment.

Second, rather than license costs quieting with user growth, these costs get louder. In other word, once the risk of whether Spotify can acquire users dissipates a bit such that the guarantee can be paid, the total cost pool proceeds to expand linearly with that user base–a floor for the obligations rather than a ceiling.

In contrast, major radio stations will offer a large fixed pool of money for their royalty pool, enabling costs per user (listener) to decline once revenues exceed the size of this pool (which they do by many multiples).

Perhaps, someday, music service startups will not have to be completely irrational to operate. I guess it’s all for the fame, and they will just make money selling t-shirts and autobiographies.

How the first subscription-based music service was built online, and why it’s time to move on.

Nearly fifteen years ago I began hashing the plans for what would become, as far as I can tell, the first subscription-based music service online. What we built was pretty straightforward and, as a result, the initial business model was nearly identical to that model later adopted by services such as Spotify. (Aside: True old-timers will remember that Patronet would also launch, but it offered music from only one artist, Todd Rundgren—who built Patronet).

Importantly, neither technology nor copyright law were ever really the roadblock to opportunity, even back in the Web 1.0 days. What and How people—meaning artists, lawyers, owners, consumers, developers, and even policy makers—thought about these music services were the speedbumps that would prove to be large enough to block the road, even still today.

In the end, I am pretty certain the following hold true:

  • The business model of subscription music services is and should be brain dead simple.
  • No amount of “That’s not how it’s been done,” or “Are you sure this won’t cannibalize iTunes?” or “But I make more from a CD sale” is going to change the fact that adapting to this model is both required and will require change.
  • The longer any adaptation to change stalls and the higher the price for that change, the fewer the number of ecstatic fans, the fewer the number of happy customers, and smaller the pile of money that will be on the table for the music artists and owners involved.

It is time, quite frankly, to move on… regardless of the road conditions.

In the beginning…

In 1998 we launched a simple subscription-based music service online, thanks to a number of artists who were willing to experiment—way back then—with something new. That paid site would later shift to a free site, Noisebox, through which we shared ad revenue with artists and copyright owners. The business model was designed to fit within BDS (Brain Dead Simple) constraints.

The pitch to consumers, artists, and copyright owners for this way-too-early-to-be-plausible music service was pretty simple:

(1) Consumers were charged a monthly fee to stream/download music from the site. The initial price was $2.99/$3.99.

(2) Artists, and any other party with a financial interest in the recording and/or the composition/lyrics, would split the subscriber revenue based upon each song’s proportion of all songs streamed each month. The initial pool for royalties was 70-80% of revenues. The initial catalog of music came from self-released artists, which limited the complexity in who/what was in the pool.

For context: Napster had yet to be released. MP3.com was still for the most part a news site, with only a few music downloads. DimensionMusic, or dMusic, was more actively engaged than MP3.com in hosting MP3 files for artists. IUMA was still hosting MPEG2 audio files. eMusic was still for CDs, and the digital download store of the day was called NordicDMS. Neither iTunes nor the iTunes download store would exist for nearly half a decade. Spotify would not exist for a decade.

Ironically, points (1) and (2) above basically describe the subscription music service model by which services such as Spotify operate today, nearly 15 years later. Why? Because that model was and is brain dead simple.

This model also happens to be the same one that is debated almost daily on music news and artist sites, as people try to grapple with the implications of not being paid $X for every album sold, or ¢Y for every iTunes download sold, or a guaranteed ¢Z for each stream on these sorts of services. Even though part (2) is essentially the same method through which radio royalties have been distributed (weighted by actual rather than imagined listener numbers) for decades–either as a portion of ad revenue or license monies.

Frankly, its time to move on.

And so I figured I would describe how simple that basic design truly was, and why neither technology nor copyright law were ever really the roadblock. Any roadblocks were in the minds of copyright owners, artists, developers, policy makers, and even consumers.

How does a music service work?

Technically, in the simplest of terms, you really only need three things to build a subscription-based music service:

(A) A number of music files, encoded in a streamable format (with mime type set, back then), and stored on a working storage device that is connected to the internet;

(B) A method for preventing access to those music files unless the user can present appropriate credentials (e.g., show they are a paying customer); and

(C) A means to accept some form of payment (e.g., credit cards) on a regular schedule (e.g., monthly) the result of which is the user acquiring the credentials mentioned in point 2 so they can access and stream the files mentioned in point 1.

Some copyright owners would add an additional lettered point that would require truly bullet-proof security on the files. But that point, in the end, is pointless.

Aside: Negotiating licenses is not a technical problem, its a time/effort problem. However, yes, I realize that acquiring these license can be a real challenge. But, in my opinion, the law was not the ultimate roadblock. It took us less than 30 days to license the music we were looking for in the initial experiment and the law never stopped us. Artists/owners who participated were willing to license and learn—and these were the two dimensions that mattered. The law simply gave these artists/owners the right to say, “No,” if they wanted to.

That was it, and that’s what we built through the absolutely simplest means possible via a traditional LAMP (Linux, Apache, MySQL, and Perl/PHP) setup.

All the music files were placed in a folder that was “protected” through .htaccess (those in the know will know why I used quotes). When a user paid for a subscription they were given a password. That password was added to the .htaccess list. If the user did not pay the next month, the password was removed from the list. Voila, Subscription music service in a box!

Modern services use a wider and more sophisticated range of technical means to accomplish their objectives, but the A, B, C’s listed above are ultimately “the basics” that inform any subscription service—whether in music, film, text, or otherwise.

Why it’s time to move on.

Since those early days, very little technical or legal change has intervened. Technology still provides the means to accomplish the A, B, C’s listed above—the formats and acronyms have simply changed. Copyright law still spells out the necessity of negotiating licenses with the appropriate parties. Most importantly, after years of music service licensing deals that are highly-punctuated with sophisticated protections (e.g., per stream minima) the underlying business model is returning to its origin:

(1) Consumers are charged a monthly fee to stream/store music from the site.

(2) Artists and/or those parties with a direct financial interest in the recording and the composition/lyrics, split the pool of subscriber revenue based upon each song’s proportion of all songs streamed/accessed each month.

Any substantive change that has occurred over the last decade and a half—meaning the sort of change that made this BDS business model more acceptable—has occurred in the minds of people, not the granite or silicon pillars of institutions or technology within which these minds make decisions or with which they take (virtual) action.

Change has been slow. Glacier, slow.

What I have found is that over the last 10-15 years I keep hearing the same questions, having the same conversations, and meeting with many of the same people (who simply work at different companies, have new haircuts, or wear different hats). From conferences panels to research chats to board meetings, the discussions usually leave me in a nearly perpetual state of deja vu. Bookmarked by entrenched positions at extremes. Punctuated by far too many egos (one of which is my own).

What was once thought of as “renting music,” is now thought of as “renting music.” Except, fewer consumers are freaked out about that idea. What was thought of as “the end of CD sales” is still in part “the end of CD sales,” and so what. Executives who used to think $19.99/month for music was a bargain now think $9.99 is a bargain (that’s a change), regardless of what consumer behavior suggests (that’s not a change). What was thought of as a challenging licensing market is still a challenging licensing market—except the incumbent firms now see that challenge as a barrier to competition.

In the end, and as I said at the beginning of this post, I am pretty certain the following hold true:

  • The business model of subscription music services is and should be brain dead simple.
  • No amount of “That’s not how it’s been done,” or “Are you sure this won’t cannibalize iTunes?” or “But I make more from a CD sale” is going to change the fact that adapting to this model is both required and will require change.
  • The longer any adaptation to change stalls and the higher the price of that change, the fewer the number of ecstatic fans, the fewer the number of happy customers, and smaller the pile of money that will be on the table for the music artists and owners involved.

Frankly, it is time to move on.

The dangers of SO + IF + EEE = BPB (Best Practice Bingo). Example, CWF+RTB=$$$

Just about everyone wants to succeed at what they do.  As a result of this basic desire, a basic human instinct often kicks in to help out—mimicry.  In business speak, this mimicry operates under the term Best Practice.  In marketing this instinct is triggered through classic marketing campaigns such as “Be Like Mike.”  How might we succeed?  The answer: Do what winners do, or Be what winners are.

Unfortunately, the methods for and outcomes of mimicry often get conflated.  The result of this conflation is something we might call Best Practice Bingo.  A few people are starting to be concerned about the nature of this bingo game (Billboard, more), and these concerns are warranted.  We are in danger of confusing consequences for causes, attributing success to what really are outcomes while overlooking the far more complicated How and Why that led to these outcomes.

The basic equation for this bingo game are as follows:

SO + IF + E3 = BPB

(Study Outliers) + (Ignore Failures) + (Exceptions Exceptions Exceptions)
= (Best Practice Bingo)

Study Outliers

The first stage of best practices bingo involves studying outliers—i.e., successful firms (or individuals)—and describing either  the basic process of what these winners do or the basic attributes of these winners.  The appeal of this first stage is so compelling, quite frankly, we cannot help ourselves.  Winners often seem to success despite the odds, and condition that should immediately suggest outlier status.

When presented within the best practice argument for success the SO stage usually takes the form of case studies—rich stories that present the behaviors/attributes of winners as truly novel and or unique.  Importantly, these stories are told backwards.  They describe what the winner did from the beginning with the end result of these actions being success.  In truth, the winner succeeded and this success led the researcher to notice the firm and then attribute a set of behaviors/attributes to this success.

Ignore Failures

The second yet obviously related stage of this bingo game involves ignoring failures through the outlier selection process.  Ignoring failures is built into the study outliers stage, yet the presence of failures should be key to any test in search of what separates the wheat from the chaff, the winners from the losers.  By way of ignoring failures we turn off the capacity to tell whether what we see winners doing happens to be something truly unique to winners.  And by explaining the behaviors and attributes of only the winning outliers in arrears, we lose the ability to distinguish prediction from description. Losers in Bingo games never stand up and scream “we lost!”

Exceptions Exceptions Excpetions

The final condition for the best practice bingo game is the ongoing introduction of exceptions, exceptions, exceptions.  In the event of any failing firm (or individual) that seems to otherwise display the attributes of winning firms we propose exceptions, usually based on some prototypical case or argument.  By prototypical I simply mean the process or attributes of winners are argued to stand as ideal examples of the process or attribute in question.  Failed firms may have something that looks like these processes/attributes, but they just didn’t do/have these things just right.  These firms are, therefore, excluded from the condition in arrears.  When you start hearing the word “but” all the time, be very worried that someone may be making as ass of you.

Best Practice Bingo

The result of this all-too-common three stage process is a situation we might call best practice bingo.  Upon learning about these behaviors and attributes of winning firms, other firms begin to mimic these features and the bingo game begins.  Some of these firms succeed, others fail.  The pundit excludes failures from the model for simply not doing/having it “just right .”  Successful outcomes are almost always accepted as de facto and are used to support the model.

Example #1: CWF + RTB = $$$

Circulating the network of pundits (examples here, here and here) these days is Techdirt’s recent proposition that the model for future business success can be phrased: (Connect with Fans) + (Reason to Buy) = $$$.  When presented in public (here and here), this proposition is pretty much always a function of case studies—Trent Reznor, Jill Sobule, etc.

Just about every presentation on the CWF+RTB premise involves studying outliers—winners who seemed to embody the ethos of this model.  These artists appear to be succeeding by way of this model, so what’s the problem?  IF + EEE.

First and foremost, failures are ignored.  Any number of artists, both now and in the past, have employed a method through which they aspire to connect with fans and give these fans a reason to buy.  In fact, just about every business on the planet is in the business of trying to connect with potential customers and give these customers are reason to open their wallets.  Some of these artists have succeeded while others have failed.

Finally, the exceptions are starting to roll in.  In order to workaround the bingo game, we are starting to hear about folks just not really connecting with fans, or just not given those fans are reason to buy.  And so, the big buts will begin.

Example #2: CWE + RTV = Election

Let’s be honest, a translation of the CWF model for politics would be: Connect with the electorate + Give them a reason to vote for you = Election to office.  CWE + RTV = Election

When translated to other markets, the model seems to offer less insight than description.  The winner of any election connected with the electorate and gave that electorate a reasons to vote.  However, these features were consequences not causes.

Here’s to a bingo-free lifestyle.

Music rights societies and licensing alternatives

A brief paper written by WIll Page (of MCPS-PRS Alliance, in the UK) and myself has been made publicly available.  The piece was meant to stir a larger discussion around alternative licensing structures rights societies might put to use, particularly in the context of new, music-related startups.  These startups usually (1) cannot afford the rates societies have set based upon the financials of more mature businesses, and (2) are trying to use music in novel ways, for which a collective license may not already exist.

The paper can be downloaded from the MCPS-PRS Alliance site for independent research

Must read book on whatever the heck entrepreneurship is

One of the most frustrating challenges when working, researching or teaching around the subject of entrepreneurship is the “what” of entrepreneurship.  What the hell is it?  More important, how do those assumptions people hold about this thing that is entrepreneurship stack up to reality?

Scott Shane, at Case Western Reserve’s Weatherhead School of Management, has written a book, The Illusions of Entrepreneurship, that is (imho) an absolute must read.

Social entrepreneurship and Monk eBusiness

Wired has an interesting peek of a story on a group of monks in Wisconsin who have just happened to create a flourishing business re-filling toner cartridges.  The business, LaserMonks (Real Savings, Real Monks), passed the mark of over $2 million per year in business.  No one takes a real salary, though it would seem food, lodging and vespers come with the gig for those so spiritually inclined.  The monks donate portions of each sale directly to charity.  They also are rumored in the story, to have some perquisites including a private plane (no mention however as to whether its a Cesna or some more luxurious ride).

Makes you wonder… non-profits, if stuctured properly, could really be a problem for for-profits businesses in low-investment markets.  If your goal isn’t to sell the business, pursuing a social goal while making a living just might be a great option.