Sony Contract Leak: The Bright and Shiny Object

Regardless of who you believe actually leaked Spotify’s contract with Sony Music, Spotify’s CEO Daniel Ek certainly is trying to capitalize on the leak.  (“Spotify CEO says middlemen gobble cash“)  It sounds like this is just another indication of how badly a defiant Spotify has broken trust with its label “partners” and their artists.

The spin from Mr. Ek is that he wants you to believe that the reason that artists think Spotify’s royalties are low is not because of Spotify, it’s because of the greedy major labels.  More accurately–with the benefit of the contract leak–any label that has MFN treatment with Sony Music.  (Because if you’re leaking contracts, you can’t really leak all the contracts, but you don’t need to if you can leak a single MFN contract from which terms can be extrapolated due to the MFN treatment.)   Because I don’t know all the labels with “most favored nation” treatment, I’ll refer to those labels as “MFN labels” rather than major labels (partly because the MFN definition in the Sony Music contract is not limited to other major labels).

Of course any labels or distributors licensing to Spotify get a share of the royalty payments, like they do any other service.  (Even if a distributor covers its downside risk with a flat fee payment instead of sharing the risk with its artists, there’s still an imputed share of Spotify royalties which could be massive or tiny depending on how the artist does.)

How much labels take is not well known and varies from label to label and artist to artist.  This makes a label’s share of royalties ripe for conspiracy theories that Mr. Ek appears to be fomenting.  And is a great “bright and shiny object” to deflect attention away from a simple truth:  Spotify loses money hand over fist, pays terrible royalties, and is cannibalizing higher margin sales.  Its valuation is driven solely by venture capitalists with liquidation preferences that make a down round unthinkable and a compliant press that in some cases is in the streaming business themselves.

The Empirical Check

So how would you know whether Spotify’s artist royalties are low regardless of the label’s share?  Easy.  Look at the royalty Spotify pays to an independent artist who does not share their royalties with a record label.  This won’t tell you what the MFN labels get, but it will tell you that the MFN labels should get no less than the independent artist collecting 100% of the Spotify revenue.  You can also assume that Spotify’s independent royalties are a cram down of lower per-stream rates than what Spotify pays the MFN labels.  Why?  Because they can.

Of course, the argument could easily be made that if Spotify’s goal is fairness in all things and world peace, Spotify would actually pay independent artists more than the MFN labels because Spotify doesn’t have to pay all the extras–starting with an advance and equity–to the independent artists.  (Whether services ought to pay extras is a whole other conversation.) Even so, if Spotify’s royalties are as great at Mr. Ek would have you believe, you should see that uptick in the “source” Spotify royalty paid to an artist who collects 100% of the royalty and not just the artist share under an MFN label contract.  

Last week, Zoë Keating courageously published her most recent royalty statement from Spotify.  As usual, Zoë makes an outstanding contribution to the knowledge of all artists grappling with life in the Age of the Internet.  Zoë’s Spotify statement gives a great example of the true royalty rate that Spotify pays to record labels–without the big advances and other financial incentives paid under the MFN label deals as seen with the leaked Sony Music contract.  Not to mention the cost of the detailed reporting required under the Sony Music contract.  A couple things jump out.

First, it’s not really sound to speak of a global “per stream” rate for Spotify except in the most generic sense.  As you’ll see from Zoë’s statement, there are many, many different rates.  I would guess that these rates vary based on some high level variables and rule sets such as ad-supported or subscription and mobile or desktop.   The statement doesn’t break this out and just refers to “streams”.  Not all streams produce the same value as the statement reveals.

Then there are different rates for each country where Spotify operates, just like on a record company royalty statement.

As you will see in her statement, Zoë’s per-stream royalties ranged from $0.0000013284 to approximately $0.01 per stream, except for 3 streams in “CH” (presumably Switzerland) that broke $0.02.  I would guess that the lowest royalty rates are from ad supported streams and the higher rates are likely from subscriptions.

Remember–this is 100% of the Spotify royalty, not shared with a label.  So Mr. Ek would have you believe that if it just weren’t for the greedy middlemen, artists would find Spotify profitable, because, after all, Spotify pays millions to superstars–the superstars whose labels spend millions marketing their records and driving traffic to Spotify.  Low royalties are not Spotify’s fault, it’s the greedy middlemen.  (This rhetoric also resonates with the Google and Pandora-backed “McCoalition” that is running those tired 1999isms to try to divide our community.)

Mr. Ek points to the leaked Sony Music contract to justify his position, and I point to Zoë’s statement to ask who in their right mind would think that Spotify royalties (or streaming royalties in general) are worth the trouble.

And don’t forget that Mr. Ek is quick to point out that streaming revenue is a growing share of overall digital revenues and displacing downloads.  Yes, that’s right.  In a race to the bottom, micro-margin streams are replacing high margin downloads.  Correct, it’s called cannibalization.

That cannibalization is happening across the board, too, not just to major labels.  “CD release parties” that used to generate a significant contribution toward recording costs for local independent artists now are a rapidly vanishing share of artist revenues (right alongside cover charge).

So Mr. Ek’s misdirection doesn’t work when you look at the numbers.  Evidently, Spotify hopes you won’t.

More is Less: Why Do Artist Revenues Increase at a Lower Rate than Artist Streams?

But here’s another interesting metric.  Zoë’s spreadsheet shows that in 2015, Zoë had 1.4 million streams and $4,821.07 in royalties or an average of $0.003 per stream.  I’m using a per stream average as a way to compare per-stream value over time because the spreadsheet also shows Zoë’s royalties from 2013 and 2014.  I don’t recommend using a per stream average for any other purpose because it tends to overstate the ad-supported royalty and understate the subscription royalty.

Zoë’s per stream average from 2013 was $0.0042, in 2014 it was $0.0040 and was $0.0032 in 2015. So even though Zoë’s own total streams increased from 416,112 to 1,487,584 during the 2013-2015 period, her average per stream royalty declined from $0.0042 to $0.0032.

Given that a simple per stream average tends to understate the subscription revenue, wouldn’t you think that a 350% increase in streams would result in a higher per stream average?  Particularly because Spotify wants you to believe that it is growing its subscription business as well as its business in general, hence its massive investment valuation.  Even if you consider the difference in Zoë’s gross revenue, her total royalty payment increased by 271%, much less than the increase in her overall streams.

Maybe there are anomalies that explain this, maybe there are specific attributes of Zoë’s fans that explain that difference, but it seems very, very odd.

Who Are the Real Greedy Middlemen?

Face it, the streaming business is a horrible business.  Everyone in it loses money based on cash flow and the only people who make bank are the executive teams who get stock in the enterprise.  Remember, Spotify has a bigger valuation than the entire music business.  If that’s not a bubble, I don’t know what is.

It’s only a matter of time before Spotify does exactly what Pandora is doing–comes to the government and tries to force a lower royalty down our throats so Spotify can stay in business.  Spotify will likely do it through manipulating the antitrust law (notwithstanding Spotify’s own self-admitted monopoly on music subscription services.)  There’s only one thing such people fear more than an artist who publishes their royalty statement.

That’s a venture capitalist collecting a preference on a down round–so the valuation has to constantly increase even if it is not connected to reality.  And if reality ever catches up to Mr. Ek, all he’ll do is flip the keys to the first bum on the street after he cashes out–and destroys our business.

Remember–he’s not in the music business.  If Spotify fails, Mr. Ek will just go into some other “disruptive” tech company that preys on people like child data profiling.

Thanks to Zoë Keating, we once again can see that Spotify gives truth the back of the hand in its rush to IPO riches.  As long as the VCs keep rewarding fast buck artists like Mr. Ek and governments turn a blind eye toward Bit Torrent, the race to the bottom will continue and artist innovators will keep being punished.