With the leak of Spotify’s contract with Sony last week, there’s a lot of attention on the streaming service right now. I’ll be taking a closer look at that contract over the next week, but for now I’ll focus on the fallout over the last week. In particular there seems to be a lot of renewed interest on the music space, more so than I’ve seen in a while. I think, though, that this has to do with a lot more than simply one contract between two companies; for the first time perhaps, the general public (including music producers, artists, and general music listeners) is aware of the kind of deals being struck behind the scenes.
Even as Spotify soars in newer valuations that have the company somewhere in the $8B range, yesterday’s leak shows that such a valuation may in fact be misleading — Spotify has to cough up around $43M just for licensing from Sony alone. How much do you think they need to cough up for the other two majors, Warner and Universal? Even if we snip off the extra $3–4M, and assume an upfront licensing fee of $40M from Sony — and then simply assume similar prices for Warner and Universal — then Spotify has already spent $120M of investor money. And that’s just for the privilege of having access to the major labels’ stable of artists.
The upfront licensing fees are basically just for the privilege of having further access to the major labels’ stable of artists.
Also, don’t forget that’s before royalties and any other metrics that Spotify has to hit. Therefore it’s more like $43M upfront for the privilege to pay more later on; it’s not a one-and-done purchase. And most unfortunate for Spotify, this latter number is also predicated on how an artist performs in popularity, something they have essentially no control over.
I’m not going to rewrite Micah Singleton’s article, but I will draw on a number of points he highlighted and what they mean in reality. There are numerous points of importance, but these are the ones I think the general public really needs to be apprised of. Though the contract has since been removed, we got the basic gist:
1. Written by Sony
First let’s just take a moment to note that the contract was written by Sony. Of course this is their prerogative, but when considering the fact that Sony holds the rights to much of the content that Spotify wants to license, it clearly illustrates who is subject to whom. Frankly, since Sony holds the content rights, they (and the other major labels) essentially hold Spotify’s lifeblood in their hands — that’s not an opinion, it’s a fact. Realistically Spotify is not built around an independent and free model, so they need to play ball with Sony and the other labels, or they won’t play at all. Period.
Spotify paid Sony $42.5M just for the right to license the music. That’s an upfront fee just to get in the door. This means that anyone looking to compete head to head with Spotify or Rdio needs to magically have about $130M lying around or in funding before they even get their feet wet (projecting the combined upfront licensing fees of the Big Three major labels). One of the reasons that Spotify has to raise such massive funding rounds is because these advances are somewhat annual, and thus need to be renegotiated all the time. And as the major labels continue to get squeezed in their wallets, these numbers are only going to rise for services looking to use major label content.
3. Divided How and Among Whom?
As Singleton points out, Sony can essentially do whatever they want with that money; there’s no stipulation that it has to be divided in any particular way, or that any of it has to go to artists or songwriters. According to multiple sources, that money usually stays with the label and is generally not shared with artists. This particular point has raised such criticism that its prompted both a response from the EU, which is now looking into Spotify’s contracts, and virtually obliged Sony to come out with a public statement on the matter.
4. Most Favored Nation Clause
Essentially a clause that guarantees that Spotify’s balls remain in Sony’s vicegrip. The clause guarantees Sony the right to amend any portion of the contract if it perceives that any other label has a better deal than it does. This means that Sony is essentially never bound to Spotify in any way; it can decide — based on its own perception — that another label has a better deal (which it may or may not) and rework the entire deal for its own benefit. And Spotify has to swallow everything.
Where this really kills Spotify is when used in conjunction with the clause dictating payment based on market share. Thus, if another label has a better deal in that regard — perhaps double what Sony is getting monetarily — then Spotify has to cough up and pay Sony the difference.
5. Spotify’s 15%
Basically exactly what it sounds like. Spotify takes 15% of the revenues from third-party advertising right off the top. What they do with this money is unknown, though it’s quite plausible that they’re not redistributing it to the artists, and are probably giving third-party advertisers a raw-ish deal. Next time Spotify releases a statement saying that they don’t have the funds to pay the artists more money, let’s all remember this little financial tidbit.
6. Sony’s Ad Spots
This one’s pretty easy to understand: essentially Spotify is obligated to give Sony a certain amount of free ad space on its service. The ad space — which is clearly worth a fair amount of money — is given to Sony at a massive discount.
But that’s not all; Sony retains the right to sell the credited ad space to whomever they want, whenever they want. Again, Spotify gets squeezed.
7. User Metrics
Spotify essentially has goals it needs to hit in terms of its user metrics (on both payment tiers), and if it misses those, it could be penalized. Conversely, if it exceeds expectations in either of the tier metrics, it recalculates that number so that Sony gets paid more. In English, what this means is that the better Spotify does, the more money Sony is entitled to, but doesn’t necessarily mean that it all works out for the streaming service.
It’s important to remember that Sony isn’t in the business of making sure that it backs up Spotify. It — like the other major labels — is licensing its music to numerous services, so its only real loyalty is to its bottom line. How that affects Spotify is essentially irrelevant to the major label.
8. The Royalty Distribution (Forget About the Artists)
Without going too deeply into it (Singleton’s initial analysis and infographics are worth consulting), it basically boils down to this: the royalties per stream are so miniscule that you need to be getting millions of streams in order to make any real money (and by real, I mean anything more than $10.00). We all know that independent artists are never going to get to that level trying to compete on an unfair playing field, so let’s just put that point to bed right now. One thing that is worth noting now, though, is that not even every artist has a contract entitling them to royalties. So for all the bluster about royalty payments, many of the artists signed to major labels aren’t even entitled to fair cuts from the streaming.
But even more so, the way in which streaming royalties are calculated is so incredibly convoluted you almost need a degree in economics just to understand it. That’s not how it should be. For independent artists — and even mainstream artists who simply want to understand the financial dynamics — this is yet another way of keeping them in the dark. No one in any other industry would accept some sort of voodoo economics principle when it came to calculating their earnings, so why should music artists — mainstream or independent — have to settle for that? That’s the point, they shouldn’t.
There are numerous other points worth discussing, but these are some of the major ones that discussions of the music industry revolve around. Though arguably a major embarrassment for Sony and Spotify, the leaking of the contract between the two really shines a bright light on what goes on behind the scenes. It clarifies that what happens behind the curtain affects every type of artist, and underscores why more transparency and reform is needed in the music industry.
And it highlights something else: the music industry is not dead and foregone. We’re now right on the precipice of a whole new type of music industry that’s taking shape every day. Those who accept and embrace the new dynamics will be the ones who benefit most from them when they inevitably come.
Thanks to Shelley Marx for reading early drafts of this.
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