Putting Washington and the Music Industry Under the Microscope

Over the last few years, the impact of the Internet and the transition from what I call an analog lifestyle characterized by physical magazines, newspapers, records, CDs and the call to a digital one has had numerous implications. Key among that is the how as in how consumers access and consume content. While some will still buy CDs that house the latest tunes and games, devices and services such as Apple’s iTunes, Spotify, Pandora Media as well as streaming services from Netflix and others have had the same impact on music that Amazon.com, Kobo and others have had on book publishing.

There have been changes in business models that have been beneficial to those companies that saw the future and embraced it. There have also been companies that have struggled along the way.  Some companies like The New York Times, The Washington Post and others still trying to find their way in the digital content age even as Netflix has released its third season of House of Cards.

According to Nielsen SoundScan, sales associated with downloaded albums and songs plummeted in 2014 with paid downloads of albums and songs falling 9% and 12% respectively. In total, American consumers bought 257 million albums in 2014, of which 106.5 million were through downloads. Looking past albums sales, individual digital song sales fell to 1.1 billion from 1.26 billion in 2013.

The use of streaming grew sharply to 164 billion songs -- a 54% increase from 106 billion in 2013 -- thanks to services such as Spotify, Amazon.com, Pandora and Google’s YouTube. However, what should be an exciting growth industry for investors, the music industry is being threatened on multiple fronts.

Hollywood and the recording industry, often called the content industry, have a long history of opposing new technology. As you can imagine, streaming services have been added to that list. Pandora is a great example. Exiting 2014, Pandora had 81.5 million active listeners that listened to more than 20 billion hours of content in 2014, up 20% year over year. While one might quickly jump to the conclusion that Pandora was dropping big earnings to the bottom line given those metrics, remember the company is saddled with content acquisition costs that increase with each additional hour. In other words, the more you listen, the more Pandora pays in royalties.

One would think that would be sweet music to the recording industry, one that is increasingly viewed as a monopolistic one. Recently the Eastern District of Pennsylvania determined the music collective SESAC (originally called the Society of European Stage Authors and Composes, and is the smallest of the performing rights organizations with roughly just 2% of licenses) has operated in an anti-competitive manner. When Pandora was forced to sue ASCAP (the American Society of Composers, Authors and Musicians, which has more than more than 500,000 songwriter, composer and publisher members) and Sony Music, which controls nearly one-third of all the music publishing world, Judge Denise Cote detailed what she called “troubling coordination” between ASCAP and two of the world’s biggest publishing companies, Sony and Universal Media Publishing Group, against Pandora that “implicates a core antitrust concern.”  Even a layperson would be quick to see the music licensing market is not competitive and it certainly is not a free market.

Sony's and ASCAP’s action were a direct violation of a “consent decree” issued by the Justice Department in 1941 to ensure a competitive marketplace. The decree was put into place to limit the massive power ASCAP has on the industry. Rather than adapt to the changing landscape and provide alternative business models, ASCAP and others are putting for the argument that digital services are not paying the enough even though they are getting paid more as Pandora and others see their streaming hours rise.

To force its play, music industry is telling the Department of Justice that if they don't lift the consent decree they will pull out of ASCAP and vacate the agreements, which only apply to the Performing Rights Organizations and not to individual music companies themselves.  But as we saw with the Sony/Pandora incident, that action would not benefit consumers and, in the end, should be seen as another attempt by a school yard bully looking to intimidate his or her classmates.

While some would be quick to think the music industry is battling technology companies, they are merely the delivery mechanism for the content that consumers are opting for in a format they are increasingly choosing.

Just like the argument to raise the minimum wage without realizing the full consequences of higher costs on business, what’s being proposed might yield more revenue, but the higher fees would be passed on to businesses and consumers across the country. A pretty steep request for an industry that has already been identified as having monopolistic powers.

Next week, Sen. Mike Lee (R-Utah) will hold a hearing in the Senate Judiciary Committee to get to the bottom of the issue.  He wants to know if the recording industry, in part due to their strong political support of the president, will get a special deal from DOJ.

Consumers should be watching closely.  While a special deal would be good for Hollywood and the recording industry, it could kill the burgeoning streaming music industry.  And for the anti-tech crowd in the record industry, that would suit them just fine but for millions of Americans who love streaming music and the businesses who have relied on the near 75-year consent decree for their industry, it would be a disaster.