Some time ago I was asked to provide a note that could be circulated to European ISPs about some of the practices employed by music copyright owners which, in my view, represented obstacles to the growth and health of the online music market. A recent discussion on the Pho mailing list prompted me to dig this out and give it a less restricted airing.
It is certainly the case that new entrants to music distribution find the licensing process onerous. One ISP reported a year long negotiation for what seems a simple enough proposition. However the possession of a full hand of licences is such a valuable asset, even in their usual short term and maladapted state, that few successful licensees cry foul, preferring to enjoy the compromised advantages of being in a still exclusive club.
And yet the information that they have, locked down under NDA and the threat of arbitrary withdrawals of catalogues, is crucial for our regulators and public policy makers if they are not simply going to change one set of dysfunction for another. I very much hope that people with inside knowledge of how music licensing actually works will come forward so that there can be a reasonable debate in advance of the macro reform rippling around the world.
Some Unreasonable and Discriminatory Licensing Practices
The fragmented nature of music rights, involving complex contractual obligations wrapped around IP rights in the reproduction, performance, and ‘making available’ of both musical works and sound recordings, makes taking a fully licensed music service to market extremely onerous even if all the rights owners offered simple and efficient ways to access their catalogues. Coupled with this, consumer expectations are very high for online music, and gaps in the available music are not well tolerated.
Set out here are some additional obstacles to efficient music licensing which combine with the already difficult nature of the market to add cost and risk to the emerging digital entertainment industry. All of these practices are potentially repeated by the owners of each of the separate rights that are required to offer music to the public.
Direct licensing or withholding
Most music rights owning parties insist on licensing the use of their catalogues directly, rather than using collective or wholesale clearing houses. Music rights are highly fragmented and require complex management systems, so direct licensing multiplies cost and difficulty for the licensee. Each licensor has the ability to set terms and rates that critically damage the viability of a service, or indeed to withhold the catalogue required to offer a compelling customer proposition.
The underlying rights are territorial, and this is exploited by rights owners in order to limit the operations of music services to specific countries, and also introduce price discrimination. Additionally, licensing of rights within the music industry means that different owners might need to be found and negotiated with for the same rights in different countries, adding cost and complexity to rights and royalty payment systems.
The larger rights owners usually demand advance payments and deal and delivery fees, which can be many times the expected royalty payments for the use of the music during the term of the agreement. This introduces a financing risk as well as adding a start-up cost to launching a new service. Often these will be staged as quarterly payments, with the threat of catalogue withdrawal or even insolvency proceedings should they not be met. Advances also reduce transparency to other music stakeholders, as they break the relationship between sales and royalty payments.
Short term deals
Many deals have a one year term with no obligation on the rights holder to renew. This introduces obvious risks, that a new music service might not be permitted to continue to offer key catalogues, or that the rights owner might introduce new and onerous obligations. A one year term will in almost all cases be considerably shorter than the planning horizon for a large operator, making it impossible to predict the terms on which a service will be operating as it is rolled out across a customer base, or as marketing activity attracts new customers.
Rights owners use contractual minimum payments in order to inflate their revenues over and above the value of the music that is actually sold by a service. In some cases this is relatively benign, such as setting a minimum wholesale price per track and taking the greater of that or a percentage of retail price. In per subscription pricing however it can be used to set a price per subscriber that is higher than the licensor’s pro-rata revenue share, or it can be set across an entire service so that the licensor receives a fixed percentage even when their pro-rata share drops. The effect of this is to compel the licensee to pay out over 100% of the royalty pool, eating into margins or operating costs.
Customer proposition approval
Rather than set wholesale pricing and allow operators to develop compelling services, music rights owners seek approval over most aspects of the consumer offering, and insert conditions in contracts that require any changes to be agreed in advance.
Rights holders sometimes tie warrants or grants of equity to licensing deals giving themselves a route to benefit from increase in the value of that equity alongside any revenue they receive from the sale of music. This has the effect of unbalancing incentives so that rather than the most compelling consumer offering being the market leader the rights holders instead have a reason to exclude competition from the services in which they hold the largest equity positions.
Rights holders can sometimes put pressure on music service to accept arbitrary conditions, such as using a preferred provider for some aspect of the service, or committing to guaranteed placement for priority releases. Some other arbitrary conditions might include anti-piracy action either as a pre-condition of licensing, or as a commitment included in a contract, or access to a large amount of consumer behaviour data, including data which does not relate to the music included in the contract.