Long ago, in the dawn of the Internet age, pirates ruled the digital waves and music-lovers found, to their delight, that anything could be downloaded for free. Sales of recorded music crashed. Every musician was playing the blues.

Those days are over, but the road to a business model that works for Internet companies, music producers, and recording artists remains rocky.

Two Digital Players

Spotify and Pandora are two of the big names in Internet music delivery.

Key Takeaways

  • Judging by usage numbers, music listeners are willing to pay for a wide selection and ad-free listening.
  • Subscriber services appear to be preferred over ad-supported radio-style programming.
  • Each service sets its own royalty payment rates and changes them frequently.

They used to be quite different. Pandora focused on free, advertiser-supported music with limited customization. That made it, basically, a radio service delivered over the Internet. Spotify was primarily premium radio. It has a free service, too, but its purpose is to drive the listener towards a subscription.

As it turns out, Internet users expect a high degree of choice and personalization and are willing to pay for them. The Pandora audience began to shrink while Spotify's continued to grow. 

Pandora started playing catchup in 2018 when it introduced a premium $9.99 per month service and a $14.99 family service.  That pricing matches Spotify's services. The change coincided with the company's purchase by SiriusXM, the satellite radio company.

80%

The percentage of music industry revenue that comes from streaming music royalties.

As of early 2020, Pandora had 6.2 million paid subscribers and Spotify had about 130 million. 

Pandora also is playing catchup in its music catalog. Until recently, it had somewhere between one and two million songs, and now boasts a 40 million song catalog compared to Spotify's 50 million. 

Radio Royalties

Through the rapid growth and expansion of the Internet music industry, controversies have flared between artists and the industry over the perceived lack of proper compensation. In 2014, platinum recording artist Taylor Swift pulled her music from Spotify’s platform to raise awareness of what she deemed inadequate artist compensation. She was back on by 2017.

The music industry generates a portion of its income from royalties that are due every time a song is played in public. Public performance includes music played over the radio or through Internet services. 

Royalties are payments made to the legal owner of a copyrighted work, which may or may not be the artist who created it. Performance rights organizations collect songwriting royalties from music users and distribute them to the legal owners.

The organizations that collect royalties from radio performances include BMI, ASCAP, and SESAC.

BMI classifies a radio performance as a broadcast that lasts 60 seconds or more. Each performance is categorized as commercial, classical, or college radio.

  • Commercial radio performances encompass music typically played on FM broadcasts, with a potential for bonuses based on popularity.
  • Classical radio is associated with traditional instrumental and vocal performances and grosses 32 cents per minute.
  • Performances played on stations associated with colleges or universities are classified as college radio and pay smaller royalties than commercial stations.

Granted, streaming companies have tried to push the envelope a bit. Back in 2015, Apple Music offered a three-month free trial of its service and quietly told the labels they were not going to pay any rights on their trial use, though it later backed down after a public complaint from (you guessed it) Taylor Swift. 

Digital Royalties

Music streaming services continue to proliferate, as exemplified by industry leaders Pandora, iHeartRadio, Apple Music, and Spotify.

By 2019, streaming music accounted for 80% of music industry revenue, according to the Recording Industry Association of America. Total revenues grew 11% to $11.1 billion in 2019 compared to a year earlier.

The increased revenue share from streaming can be attributed to greater numbers of people signing on to subscription services as well as sales from downloads.

The company SoundExchange operates as a fee collector for the industry, charging performance royalties for recording artists and labels whenever music is played through a digital platform. As a representative of the music industry in the digital space, SoundExchange also has negotiating power over royalty agreements. 

Pandora

Pandora makes its money the same way radio stations do, from advertising that is inserted into the playlist. Estimates are that about half of its revenues are paid out in licensing fees.

As an industry leader in digital music services, Pandora boasts 250 million users with one million songs in the Pandora collection. Users have the option to use Pandora for free with limited advertisements or pay a premium for no advertisements.

In 2019, Pandora had the industry's highest per-play royalty rate, at 0.01682 cents per play, according to Digital Music News. At that rate, the industry site notes, an independent artist would need to be heard 87,515 times to earn the U.S. monthly minimum wage of $1,472 according to their calculation. 

As expected, royalties are Pandora's largest operating expense. As of 2018, 52% of Pandora’s revenue was paid in royalties, slightly down from years prior.

Spotify

Spotify offers a free service with advertising and premium services. Since its inception in 2008, royalties have been Spotify's largest expense, accounting for about $9 billion since its launch.

The company once ranked as one of the industry's worst royalty payers, but it is steadily increasing its payments. Its per-play rate was 0.00437 cents in 2019, according to Digital Music News.

(The worst-paying platform historically is YouTube. Its rate in 2019 reportedly was 0.00074 cents.)

As of mid 2020, per stream royalty payments are estimated to be between $0.00331 and $0.00437. However despite large overhead costs, the Swedish company grossed $4.7 billion from its almost 100 million paying subscribers alone. Spotify had a market cap of $33.48 billion as of June 13, 2020.

Not surprisingly, artists have also witnessed stark decreases in album sales numbers due to the growth of streaming services such as Pandora and Spotify.

As technology has evolved, the landscape of the music industry has changed from radio broadcasts, to mp3s, and now to music streaming services. Companies operating in the digital music space have witnessed large year-over-year growth due to paid subscriptions and on-screen advertisements.

Even though artists such as Drake and Lil Wayne each gross an annual rate of $3 million from Pandora alone, some artists say the system isn't fair. 

As Pandora and Spotify continue their rapid expansion and revenue growth, we may see more artists follow Taylor Swift’s lead in bucking the current royalty model.