ad-sponsored music and the major labels

What are the economics of ad-sponsored streaming music services like iMeem? Labels want some amount, most commonly quoted as a penny a play, and the question is whether this price makes sense, or if not what the price will have to be.

A song lasts 3.5 minutes. The majors have been asking $.01 for it. The site pays for the play by selling advertising. Let’s say the site shows a new ad every time the song changes. To break even the site needs to sell one ad per song at the rate of 1 penny a song, which gives you an effective CPM (“eCPM”) of $10.

A $10 eCPM isn’t feasible. Sites don’t earn that kind of rate with 100% sell-through. Even if were feasible it leaves no room for the rest of the business. They have other costs. They need to earn a profit, and it has to yield a return on investment comparable to web businesses that don’t pay music royalties; otherwise investors will move their money out of music-related products into royalty-free products like search engines.

A $1 effective CPM is closer to the mark, meaning that Myspace, Google, Facebook, etc need a 10X price reduction from the labels to make this business work. The labels see this as unreasonable. They’re already lowering prices from what they earn at the iTunes store — why should they keep going to accomodate third party businesses at their own expense?

The alternative business for the labels to be in is selling music by the piece. The majors gross about $.70 on a download at the iTunes store, 70X what they are proposing for an ad-sponsored play; $.01 is only 1/700th of that! So naturally the price change is freaking people out.

Volume

But of course price is irrelevant by itself. Profit is a function of price, marginal costs, and volume. In the recording industry marginal cost is close to zero, and fixed costs like studio time don’t go up with volume, so the basic equation is price*volume.

Music plays which feel free because they are sponsored by advertising should get a lot of plays. If you could search for a song and play it right there, without all the friction of paying for a download or even downloading at all, you’d be more likely to go through with the transaction. Price would be lower, but there would be more transactions. And the only question that matters is whether the number of ad-sponsored transactions would be high enough to make up for the lower revenues per piece.

If the price is 1/700th, there needs to be 700X more transactions. A gold single with 500K sales would need 500K*700 = 350 million plays to get into the black if all those sales were converted to ad-sponsored plays paying a tenth of a cent per play.

What’s the likelihood of this working for the labels? Will ad-sponsored plays be at least 700X more popular than sales at the iTunes music store?

Almost nobody buys CDs; only 15% of the population; and the number of people who buy singles from iTunes is miniscule. But almost everybody listens to the radio. Ad-sponsored plays would extend the reach of monetizeable events to people who don’t buy CDs and to people who aren’t committed enough to a particular release to buy it. For the fan club members who listen to a CD over and over again, every play would be monetized. Plays in an incidental context like background music in a sports site would be a worthwhile business. Ad-sponsored plays in the browser would replace much filesharing, because they would be so much more convenient, and this is a gargantuan pool of monetizable events.

So the volume is indeed likely to be very high. Because these numbers are very fuzzy there’s no way to say whether the volume growth will be 350X, 700X, or 1400X. Still, they’ll easily get into the right range. The necessary volume isn’t guaranteed but it is realistic, and there is plenty of upside because of the possibility that volume growth will blow way past 700X.

Internet strategy

But there’s one other issue in addition to volume: compatibility with the web. The web is almost everywhere, and it needs music to be able to flow with no more friction than any other content. It can do this with or without the majors on board, and unless they choose to get on board it will leave them behind.

Sites that try to comply with label requests repel users and soon go out of business. There is no way users are going to stop for a paid download whenever there’s a need for a song. First of all, acceptable page load times are in the range of a few seconds, and when you add on the time to acquire a download the load time goes up to minutes. Monetizing via ads is the only way for the labels to support acceptable load times. Second, interrupting the user to incorporate a paid download into page rendering creates fatal usability problems. Users will get confused and leave the site. Third, there’s no way to enforce the use of paid downloads without restricting available music to what the iTunes store will carry, and this is not a web-scale design. Because these are fatal problems, successful sites route around the labels by having users of music-related features fall back to filesharing for provisioning.

Can labels counter filesharing networks without moving to an ad-oriented revenue base? It depends on how advertising compares to other revenue sources. Labels can sell complementary products like concerts and merch, but other businesses already occupy those niches. They can earn a cut of a music tax to cover filesharing, but that’s a wildly speculative idea which the labels don’t support because it would undercut their per-unit sales. They can take part in other experimental blanket licensing schemes, but they don’t support those because they undercut per-unit sales. Labels can get paid for subscription services like Rhapsody, but these are and will always be a small niche. They can earn a living on CD sales, but these won’t support a very big recording industry. They can earn a living on download sales, but these aren’t growing fast enough to replace CD sales.

The only bright spot in this picture is that online advertising is thriving. It can generate the revenues the labels need. In addition it makes technical sense, since ad-sponsored music can flow as easily as ad-sponsored text, and ad-sponsored text is the majority of the web. This model works.

I don’t mean to say that per-piece sales will go away: fans will keep buying them here and there. Providers like eMusic will continue to exist. But this business will be an adjunct to the ad business, just like all premium services on the internet. The only thing that will save the major labels is to embrace ad-sponsored plays as their primary revenue source, and that requires them to drastically lower the royalties they’re seeking.

16 thoughts on “ad-sponsored music and the major labels

  1. If current rates charged by labels cannot be supported by ad sales, maybe the music service has the wrong business model. It’s worth thinking about. The prevailing thought is that a site like last.fm has the right business model. That should be questioned. Always.

    For many consumers, Internet radio will be a substitution — not just a complement — for music purchases. When I look at the numbers, I think it is unlikely that there will be enough volume to compensate for lost purchases. That’s exactly why labels aren’t rushing to lower their rates. Right now, it’s better for them to let the struggling music service figure out a way to generate more revenue.

  2. Glenn, I agree that ad-sponsored streams are often substitutional, especially for low-touch listeners who would listen to radio otherwise. But notice that the radio business is much bigger than the recording industry. Ditto Google, Yahoo, and other major web vendors. Low-friction ad-sponsored attention is a better business than high-friction unit sales.

    What the labels are doing with rates and deals is to let successive generations of digital businesses go down, one after the other, while they wait for a mutation that can survive both the market and the licensors. This is a crazy bet.

  3. You know what should be questioned? Always? Why does it takes 500k in sales for a single to break even? And who is the company serving when they deny access to the fans and sales to the artist?

    If the major labels want to believe that there is some magic they have when it comes to picking talent and producing music and that it will always cost $50,000 to produce an album of 12 songs, then yea, “… she’s all yours” ;)

    They seem bound and determined to leave the barn door as wide open as possible for a whole generation of great mySpace singers to be produced by a distribution of musicians where the first “single” is produced for $2,000 (ProTools and some decent mics) and every single after that is $0 – and where their fans assume they can stream the artists’ music without friction.

    God forbid they should try to partner with the struggling music service to perhaps come up with a solution somewhere above Mutually Assured Destruction.

    Meanwhile in the non-label scenario the artist is pocketing tens of thousands instead of entering into the a Faustian deal with a loan shark that expects her to go into debt for a crazy, un-repayable vig to a company that owns 100% of her music just so they can refuse to allow her fans to hear the music or music sites to sell the music.

    One of these scenarios *does* sound crazy.

    Look, I don’t want to fix major labels, I don’t want bring them down – I just don’t care about them any more. They really are, in the end, irrelevant. I read Coolfer every day so I think I get what the arguments are. But I’m also pretty clear that there is an irreversible, undeniable trend in which better and better musicians are finally catching on to the devil’s lottery scam known as the major label recording contract.

  4. For musicians who self-publish with a copyleft license, they only need a fraction of their audience (those who say “Heck that’s good! In fact it’s so fricking good I’m gonna patronise them to the tune of a quid for their next work.”) to click-thru, there is no label and no sponsoring advertiser.

    Because your music is unconstrained by license, web radio stations will play it knowing they don’t have to pay for it (unless they too want more of the same in order to build up their audiences). Moreover, the listeners know that they can download MP3s (or FLAC versions if they want it in high quality) without hassle and for nothing if they want a permanent record, and can give it to their friends without being locked up by the IP cops.

    Unencumbered music is the future. Especially as the labels are intent on making encumbered music more expensive and more dangerous.

    You’ve demonstrated that the numbers for label music simply don’t add up. Any residual viability is the inertia of tradition, and ultimately as good as pissing in your fuel tank to travel another couple of miles. Eventually it will come to a grinding halt.

  5. It’s hard to imagine the major record companies adopting an approach that ends up being something that works–they have so much baggage. I mean, if they were a new industry in the 1990s, they probably would have tried this ad sponsored approach to online music 10 years ago and maybe had a big success.

    I say that not to just knock the major labels, but because I wonder: in general what kind of advertising works better being associated with (name brand) music? And, then, how does the web make that even better?

    And, then the big question relative to record economics: what role(s) do individual music tracks, or artists, play in the advertising scenario? In other words, like radio, maybe there is little justification to equate ad value to any individual tracks or artist over a big aggregate (even, a whole genre) of tracks.

    To be more specific: big radio advertisers don’t necessarily look to have their ad appear after a specific track, as much as to have their ad appear a bunch of times for a particular audience.

    The more specific music-brand advertising models that seem to have some traction are all about connecting a product with a music-brand, e.g., Budweiser sponsoring The Who tour, or VW using a Wilco song as the soundtrack in a TV commercial.

    The successful ad systems, on the web and otherwise, are successful because they enable advertisers to compete to reach particular audiences in particular context. So, there is a sense of premium for particular advertisers.

    So, if there isn’t a sense of premium for being associated with any particular track or particular artist, where / what is the thing that’s the premium attraction for advertisers?

  6. [Here is a comment which Paul Sanders emailed to me. I’m posting it with his permission and under his name. -Lucas]

    ==========

    I think you are missing a few angles on this.

    1. Higher prices force more discrimination, which pushes revenue up the popularity curve. With lower discrimination the same money might well be spread more thinly. The owners of the ‘must have’ tracks will be able to exploit this and thus indirectly drive down compensation for the rest of the market. This is already a feature of negotiations with the ad-funded businesses that want to use music. I am reliably informed that iTunes actually concentrates revenue more than physical shelving used to in the days of big stores. I don’t know how small racks in supermarkets compare.

    2. The web does not require frictionless transactions – as anyone who tries to look at people on MySpace or Facebook without logging in can tell you. Minimal necessary friction does seem to be a reasonable strategy – but the necessity is not defined by the consumer but by businesses that are actually seeking to make money. Another way to look at this is to think how Google requires content to be created and organised in order to get maximum penetration and effectiveness for the AdSense/AdWords platform – massively distributed, highly targeted, unpaid, and ultimately unsatisfactory short articles, and no effective organisations among the creators of them to provide a negotiating counterweight. Bingo. Blogs.

    3. All consumer uses of music are licensable – and I am hopeful that this year I’ll be among the crowd who prove it to the skeptics! In one of my ventures we have managed to put a value proposition together that beats the paid for download model in total returns to the music industry across a given market, and is interesting to ISPs getting out of the more for less competitive spiral. The reason we have been able to do this is the high value that a reasonable proportion of people place on music – provided that it is delivered in a way that suits them. With iTunes flatlining in some territories the residual optimism that the right mix of models can exclude licensing filesharing seems to be seriously on the wane in the UK and elsewhere. YMMV.

    My conclusion – don’t let new entrants force consumers to pay less than they want to for services that don’t meet their full expectations, at the expense of a more comprehensive approach that rewards the value added. If iMeem can more effectively than anyone else monetise the organisational tools they offer around music then that is great and they should be rewarded for it. But we do need to remain aware that iMeem is pricing the attention for the advertiser, not the music for the consumer, and people seem to be making the assumption that you can’t do both, which to my mind is complete nonsense!

  7. I’ve now read Paul’s response several times and I’m having a hard time parsing. Hopefully someone can clarify:

    This:

    “With lower discrimination the same money might well be spread more thinly.”

    seem to imply to me that at least music that is less in-demand will at least see *some* revenue

    But then this:

    “The owners of the ‘must have’ tracks will be able to exploit this and thus indirectly drive down compensation for the rest of the market.”

    Drive down from zero? Isn’t some revenue better than none?

    “2. The web does not require frictionless transactions – as anyone who tries to look at people on MySpace or Facebook without logging in can tell you. Minimal necessary friction does seem to be a reasonable strategy”

    I thought Lucas addressed this by saying that accessing music is already high friction activity – certainly more than a one time registration and login to browse pages in social network… no?

    “The reason we have been able to do this is the high value that a reasonable proportion of people place on music”

    Is this suggesting that some portion of the population would, say, pay a subscription fee for zero-friction access to some otherwise restricted pool of music?

    I guess I still don’t get why the questions are even framed in terms of how to save the major labels’ businesses. It just seems like the core of the business model that’s left after you strip away the CD-distribution-hegemony is hardly worth the effort.

  8. I tend to use the short-hand expression about how the major labels are merely dinosaurs. Yet perhaps this post lets me pause and be more precise than my stegosaurus speech to the mammalian choir.

    I do not begrudge artists and labels the opportunity to try to profit from creative work.
    I favor open source/CC/GNU/PD, but do not insist upon the abolition of copyright. I prefer voluntary sharing to arcane arguments about whether intellectual property rights are “good” or “bad”.

    My issue with labels is that their business model in recent years depended on three things:
    1. a stranglehold on the means of distribution of music; 2. adhesive contracts which required artists to take on the risks of production without a commensurate royalty rate for success; and 3. a CD pricing model which inevitably tends to support structural inefficiency. These things are history now, long live the past–in memory only.

    My issue with artists is much more muted. The financial ability for indie distribution has been in place for a decade now, and yet too many kids still want to be “discovered” and placed on adhesive, unfavorable contracts. I think that any small business owner either gets business chops or hires them. The romantic notion that musicians do not have to do this is part of the problem. I consider the argument that musicians can forego business as unfortunate–like arguing that surgeons can forego the operating theater and a medical license.

    My notion is that ad-based music distribution is likely to be a sustainable way to sell music, and that one way or another someone is going to meet this need at a more affordable price. The only thing an artist needs is demand for her or his music. What myspace has taught us is that the artist can create her or his demand, without the need for a record company expense budget (that the artist in effect finances at unfavorable interest rates).

    I also believe that a digital download business can be sustainable, and that a B2B licensing business, with heavy consumer CC releases, is sustainable. I imagine a few artists could create subscription services of 1,500 fans.
    I think that specialty labels which use the artisan approach, as in the case of Pittsburgh’s Sort Of Records “crafted” releases, will fill a neat micro-niche not that far removed from having an etsy.com shop.

    Yet I find myself in line with Victor’s statement that in many ways the traditional record industry is not so much as a problem to be reformed as irrelevant to my interest in music. I don’t mean this in a haughty, superior way–I buy a big label release from time to time, as I would buy a gingerbread man from a bakery even if I don’t need daily bread.

    I don’t worry whether a professional record industry will survive, for the simple reason that I can now find hundreds, if not thousands of releases on netlabels which appeal to me.

    I believe that the only piece missing in this “velvet revolution” is the spread of the word. I once thought we needed gifted-writer tastemakers. In recent weeks, I am evolving my thinking, to think we must all simply become the tastemakers.

    Am I opposed to people making money from music? Of course not. It’d be a silly thing to insist that artists must surrender a right, just because big record companies tried to take it away.

    Yet my friends all over the world and I, and thousands upon thousands of unmet friends, are making music in a new way. We start our own netlabels. We share music under CC licenses. We visit one another’s weblogs, and download at will.

    I compare the 214 or so songs in my definitely-not-Apple mp3 player right this minute with my old LP collection. My current collection is perhaps an older fellow’s collection–but it is also indisputably more fun. It’s also much more niche, much more varied, and much less filler-afflicted on the album-length releases. It’s made in the main by home musicians, pursuing interesting ideas for friends to share.

    What I propose is not anarchy or piracy or some radical notion. What I propose is merely what happens when music enters every home, not as product, but as a process of creation, and a shared experience.

  9. Lucas, thanks for running the #s!

    Anyone have an opinion on pre and post roll audio ads?

    I don’t see why listeners should have to listen to more ad minutes per hour online, than they do via the radio.

  10. Chris–good topic. I think that ads do have to be restrained. I am not sure if an ad minutes/hour comparison like “cannot be more than radio” is the right one, but I agree that consumers will have a “tipping point”, and the “tipping point” of “people will not consume if there are this many ads” will be the market force that determines how much advertisers pay for spots, and, indirectly, how much revenue musicians can make from an ad-based distribution model.

    I don’t have the knee-jerk negative reaction to ads that some have, but I know that too many ads hits my personal “tipping point” pretty quickly.

  11. Chris, I can think of a couple reasons why users would have to listen to more ads online than they do with terrestrial radio.

    Online music has much higher royalties. Online has lower CPMs for in-stream ads.

    Higher bills + lower revenues = more ads online than off.

  12. The biggest problem I see with the pay-per play rates is that it creates misaligned incentives. Theoretically, if you had infinite ad inventory that monetized at consistent rate your costs would scale linearly with your revenue. The reality is that pay-per-play causes you to disincentivize the exact behavior you want – more listening. This is particularly killer for the subscription services that are stuck with penny per play with no cap. Not to mention startups…

    This leads me to the conclusion that revenue sharing is going to have to be a key component of any model, advertising supported or not.

  13. @Lucas: Couldn’t some of that deficit be offset by in-page ads? One of the big differences between old-fashioned radio and web-based music distribution is that, in addition to listening to a flow of music that can be interrupted by ads, users also visit web pages on which visual ads can be placed. This is another area where streaming seems a big disadvantage to me over real mp3s with solid URLs aggregated in sensible ways. If each page or playlist (i.e. album/artist/mixtape) has a corresponding page where listening begins and additional metadata and fan activity resides, then there’s a second monetization opportunity to which all the standard tools of web advertising can be brought to bear. Streaming has always seemed like a weak technology mostly used to try to artificially keep the use case/business model as close to terrestrial radio as possible. While the progressive download of mp3s theoretically lets users take the songs offline where they can listen without exposure to ads, they also are the key to improving user experience online to an extent that could make it possible to reach web scale audiences. And the real secret is that most users don’t want to download most mp3s anyway. Actual files fill up your hard drive, they partition your library across individual machines, etc. The only unique virtue of actual mp3s is that they can make it onto iPods and streams can’t compete with that anyway. Plus, as portable devices become increasingly connected (cough, iPhone, cough) that issue will become less and less important. If all the music had solid mp3 urls, downloading would fade away, not because it would enable successful enforcement, but because it would simply be less convenient than progressive download in the browser.

  14. Also, maybe this is just blunter way of putting everyone else’s sentiment, but those numbers look a lot better if you take the label out of the picture. At $0.01 per listen, I only need 200,000 plays to make $2000/mo. which is plenty of money for a 20-something musician living in Portland (or other affordable artist enclaves). If the question is not: “Can the music industry support three multi-billion dollar corporations?” but instead “Can the music industry support a half million middle class artists?” then these ad-driven economics start to look really revolutionary.

    And maybe there’s an opportunity for a few companies to become big by offering services to all of these artists that increase their efficiency or execute the irritating parts of the business on their behalf.

  15. Hey guys!! You all sound like you have a lot of experience in this matter. I’m a songwriter from Mexico and just recently, I’ve been trying to learn more about the business. Perhaps you could help me with some advice.
    I found a website (www.newmelodies.com) that pays a fixed usd 0.025 each time my song is downloaded. The download are free to the user and just before you can download it, a tv-ad-spot is presented to you. The website explains this is the way I can make money while “giving it for free”.
    From which I’ve red in your opinions, maybe this is not so bad, is it? speaking about cpm’s and the huge potential of free downloads, right?
    Thanks and have a great day!

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