To read Part 1 of this two-part editorial -- "RIAA may win the battle but lose the war (and billions of dollars)" -- click here.

If the RIAA and its member labels continue their current aggressively adversarial approach, they risk losing a royalty right that could be worth billions of dollars to them in the long run. But here's how they can save the day! (Part 2 of 2)

BY KURT HANSON
It’s not too late for the record industry to position itself as the friend of music lovers, not their enemy. By stepping forward and proposing an accommodation that could save Internet radio, the industry would be taking a huge step in that direction!

And this makes good financial sense for the RIAA and its member labels as well.

For the long-term benefit of their member labels, in my opinion, the RIAA should stand down from its current adversarial position (“500% of past revenues and 200% of current revenues is barely sufficient!”) and offer terms that would (A) provide a healthy new income stream for record labels and artists (B) without killing the nascent webcasting industry.

Here is the outline of a proposal that I think that the record industry could afford to make and that webcasters could live with. And that would thus be in labels' best interest because it would probably keep the entire "sound recordings performance royalty" concept for Internet radio from being second-guessed by Congress...and potentially lost forever.

Proposed terms on royalty rate:
3.75% of revenues, $500 minimum
For decades, composers of songs have received a royalty rate for U.S. radio airplay of their songs, on top of the compensation provided by the promotion value of the exposure of their songs, of about 3% of station revenues. In Europe, where there is a long history of paying a royalty to both composers and performers, the sound recordings performance royalty is generally set at a similar royalty rate to the composers’ royalty rate.

These two pieces of history suggest a reasonable solution for Internet radio:

The royalty rate should be set somewhere near the same rate that composers get…and certainly no more than, say, 150% of that. In other words, a reasonable royalty rate might fall somewhere in the range between 3% and 4.5% of revenues; the midpoint of that range would be 3.75% of revenues.

Note that the high end of that proposed rate range (i.e., 4.5%) happens, probably coincidentally, to be somewhat consistent with the CARP’s recommendation. According to the 146-page "CARP Report" written by the arbitrators, the RIAA initially set a “sweet spot” in their negotiations with webcasters of $.004/performance or 15% of revenues. Proposing a royalty of $.0014/performance, the arbitrators gave the RIAA about 1/3 of their "sweet spot" rate. Giving them the same fraction of their percentage-of-revenues “sweet spot” rate would suggest a royalty rate of 5.25% of revenues. (In other words, even though the Yahoo!/RIAA deal is from the heart of the crazy dotcom era, if we convert the arbitrators' decision into a percentage-of-royalties rate, we are still in the same ballpark.)

And a $500 minimum for genuine commercial operations does not seem that unreasonable.

Minimums, variations, and exceptions
Certain categories of webcasters warrant additional detail:

For conglomerates, offer an appropriate
flat-rate OPTION each year
Finally, for corporate conglomerates with multiple revenue streams that may not be specifically and clearly associated with their streamed audio (e.g., AOL, MSN, Yahoo!, and perhaps some larger broadcasters), giving those conglomerates the right to elect a flat-rate option would benefit everyone involved.

However, the proposed $.0014/ performance rate is too high. (The CARP felt legally obligated to use a rate from one deal back in the heart of the dotcom craziness era two years ago. It makes no sense in 2002. I've said it before and I'll say it again: A royalty rate that works out to 200% of revenues (in the current advertising environment) is not reasonable.) It will kill the industry.

My proposed solution for setting a flat rate option would be based on the following two precepts: (1) The flat rate should currently be set reasonably but should grow each year as the advertising market for Internet radio begins to develop. (2) Corporate conglomerates are probably capable of bringing in more revenues per hour than other webcasters (as they have existing sales staffs and can bundle Internet radio spots into larger advertising packages).

Using those precepts, the flat rate for each calendar year could be set in the following manner:

Voila! That four-step process generates a flat-rate option that makes things easier for everyone to determine an appropriate royalty payment from the big conglomerates who can't clearly separate out their Internet radio revenues.

(CONTINUED BELOW)

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(FROM ABOVE)
Proposed reporting requirements:
Three accurate data points, three days per year
Even if you're with me so far, reasonable royalty rates won’t keep the nascent webcasting industry alive if the associated reporting and recordkeeping requirements are so complex and expensive that they kill it. There are two key questions: How much data do webcasters need to provide, and how often?

Three simple data points – song title, artist name, and album title – should be sufficient to identify the vast, vast majority of the sound recordings played on Internet radio. The arguments presented thus far for multiple and often-redundant pieces of additional information are spurious, particularly when considered on a cost-benefit basis.

In the recent Copyright Office roundtable, for example, the RIAA and SoundExchange (John Simson, executive director, pictured above) asked for many more data points, explaining that they may need additional information when the first three data points are not provided accurately — e.g., when song was ripped from a compilation CD and the artist is mistakenly listed as “Various Artists.” But that type of problem can simply be addressed by requiring webcasters to provide accurate data in each of the three fields!

Another problem raised by a record exec who was present in Washington DC was the problem of identifying the background artists on different radio promo mixes of a song. This is simply a cost-benefit issue – it could cost the webcasting industry millions of dollars per year to provide all of the additional data points required, yet the net effect in the distribution of royalty checks to background artists might be as little as plus or minus $5 per musician. (Note that background musicians as a class would receive the full amount due; we're only talking about subtle differences in how it's distributed). Such a skew in costs vs. benefit is not rational public policy.

Similarly, the number of times that different recordings, with different beneficiaries of the royalty, will have the exact same song title, artist name, and album title will probably be a fraction of a fraction of a percent of songs played. "De minimus" is the relevant legal term. It's not good public policy to require one firm to spend millions of dollars so another industry can redistribute hundreds of dollars.

Sample vs. census
The other question is whether webcasters should be required to provide a sample of their programming (e.g., the three days per year they provide to ASCAP and BMI) or a census (i.e., listing each song they play to each listener all year).

The truth is, a carefully-produced three-day sample of data each year will deliver more accurate information than a not-as-carefully-produced census. (True, each artist’s royalty checks will be a few dollars too high or too low each payment cycle, reflecting the margin of error of the sample, but that effect will average out across three or four such cycles.) A three-day sample system has worked well for ASCAP and BMI for decades and will work well here.

On the other hand, reporting requirements may be an aspect of the issue that the RIAA and webcasters can leave in the hands of the Copyright Office. But a good deal of goodwill could be generated if a compromise was to be offered.

Webcasters can offer more
to labels and artists, too
In conclusion, I should point out that the webcasters are capable of offering additional value to labels and artists – and I believe most of them would be glad to do so.

For example, most webcasters have already added features to the webcasts that are designed to encourage the purchase of CDs – album cover images that display while songs are playing, links to CDNow or Amazon to buy the album that’s playing, lists of the past five or ten songs played (with purchase links), etc. Webcasters are doing this both for ulterior motives (they may get a small commission on each CD sold) and altruistic reasons (they are genuinely fans of the music they play and want to promote their selected genre of music).

They can be encouraged to do more – perhaps links to artists’ websites and tour schedules, promotional announcements every hour encouraging CD purchases, etc. They would probably be happy to do more. Remember, again, people who chose to enter the radio industry are almost always music fans!

The next move must be the record industry's
But the next move has to be made by the RIAA (or, failing that, its member labels).

The webcasters are fighting to keep their small businesses from being bankrupted right now, this spring. But the record labels are in a position where they can afford to – and need to – take a longer-term perspective. They are putting a potential multi-billion-dollar future revenue stream at risk if they shortsightedly allow that bankruptcy scenario to happen.

"Makes it possible for many new providers of content and services..."

This is not for attribution, unfortunately, because I am doing some current work with the recording industry.

No time, no talk. I think that your notes today are right on target, as usual. I actually think it even goes a bit further. Not only has the record industry done a remarkable job in pissing off over the years every important constituency that it needs and serves, the appallingly bad performance of the radio industry in the current oligopoly that Congress permitted (but didn't intend) magnifies the general anger of the communities being served. The result, as you note, is a huge potential backlash.

The recording industry, as you know, has a long and nasty history of nearly or completely illegal behavior (mob-controlled distribution channels, payola, etc.), intentionally screwing artists out of royalties due (as is true in the film business), and failing to even minimally serve niche or fringe audiences (which gives lots of nice opportunities to niche labels, but distribution remains a huge barrier).

At the same time, local format competition in our old friend radio has nearly entirely died due to consolidation, ad inventory is overloaded and playlists are narrowed.

As a result, the opportunity for broad content to be heard by potential buyers on major distribution is probably the most restricted in the last 30 years. This results, as you note, in not only the listeners being angry but also the artists. Imagine the difficulty for a new artist to "break." It's enormous.

I think that among the possible outcomes of this is the following sequence of events:

(1) Billington approves the CARP in substantially the manner offered. (I don't blame him, and don't think he has much choice. His process was long, expensive, and by the book. To overturn it would suggest the overturn of many other similar CARP proceedings. He may approve and suggest that Congress review the Act.)

(2) There is a swell of anger from both artists and listeners.

(3) Congress gets into the act. A very prolonged lobbying effort ensues (never diminish the power and motivation of big media to influence Washington). This lasts for at least two years.

(4) At the end a poor compromise is reached, but one that generally favors an open market, blanket %-of-revenue agreements, and a payment process that bypasses the record industry entirely (because they have shown time and time again that they cannot be trusted to make agreed-to payments).

This compromise makes it possible for many new providers of content and services to emerge, as we all hoped and tried over the past few years. All types of content released will be formulaic, including electronic distribution of owned content. This will permit small providers of services to grow and reasonably thrive and, within 10 years or so, a real new set of niche providers will have grown up. Big radio and big records will suffer somewhat, but not disastrously, and both listeners and artists will have greater opportunities.