Internet music companies like Pandora, Spotify and Turntable.fm create some but not all of the value they offer to users. The rest is created by the musicians and labels. Some of the revenues coming into the internet company flow back to the musicians and labels. Some stays with the internet company.
The internet company is buying the music as a raw material, processing it, and adding a markup. It’s like a candy bar company. It buys sugar and other ingredients, turns them into candy bars, and sells the bars at a higher price than the ingredients.
The internet music company must be able to add a markup. If it is paying the musicians and labels the same or more than it is earning, it goes bankrupt.
The internet music company must be able to keep the markup rather than pass the additional revenues back to the musicians and labels. If it does not have the negotiating leverage to do this, it might as well not be adding a markup at all.
Pandora pays about ½ its revenues for royalties. The rest goes to expenses, I believe mainly ad sales. The amount it owes for music is a percentage of revenues. The more it earns the more it owes. When Pandora makes a great new app for the iPhone or for auto dashboards it gets additional users, but it doesn’t make more money.
“We’re definitely on a steep growth curve right now,” said Tim Westergren, who founded Pandora in 2000 and now serves as chief strategy officer of the Oakland, California-based company.
“We just passed 60 million users and I’ve never advertised,” Westergren told technology and media executives at the Fortune Brainstorm Tech conference here. “I’ve been a beneficiary of this incredible viral phenomenon online.”
Westergren said Pandora, which creates personalized radio stations for users based upon their favorite artists or songs, was seeing booming growth on mobile devices.
Note what he’s not saying: that Pandora is seeing booming profits. It’s nice but irrelevant that Pandora’s traffic was growing. Pandora has never had a problem getting users.
You only get to keep the revenues from the value you generate yourself. Part of your value to customers comes from the music. Revenues for this part of your product flow back to the labels and musicians.
When Pandora grows as a result of shipping software for iPhone, the value is in the software. Users could already get music on iPhone. What they couldn’t get is the usability and convenience of the Pandora user experience.
There is no exception to this rule for businesses based on infringement. If your internet music company doesn’t pay royalties it will pay out at least as much in legal expenses.
if your internet company don’t add value to the music, it has no reason for living. You are not a music company. You are in business to sell whatever it is that you add to the music.