How Spotify could pinch back over $320m from songwriters with its new legal appeal

You’ve got to hand it to Apple. The Cupertino company has unleashed some clever music-based marketing campaigns over the years – but this one might end up being its most powerful yet.

Admittedly, Apple’s not actually behind it – that credit goes to Spotify and Amazon. But an industry-wide wave of pro-Apple Music rhetoric is currently sweeping the music business, and it’s getting louder.

As Irving Azoff puts it: “Apple understands they’re in the artist business. Clearly, Google, Pandora, Spotify and Amazon don’t.”

This is happening, of course, because Apple decided not to challenge a recent ruling from the US Copyright Royalty Board to rise songwriter pay from streaming services by at least 44%.

In contrast, Spotify and Amazon (alongside Pandora and Google) have filed legal challenges in an attempt to reverse the CRB decision.

Within Spotify’s own defense of the move, one thing is pretty clear: the company, which posted a 26% gross profit margin across its free and premium tiers in 2018 (alongside a €43m operating loss), feels it will economically struggle to pay songwriters and publishers more while still paying record labels and artists the majority of its revenues.

(It also continues to refuse to countenance the idea of raising prices – which would solve the problem, but potentially put Spotify at a severe competitive disadvantage versus the likes of Apple Music.)

So, crucial question: as the fury of songwriters over their potential pay-cut continues to build, exactly how much money are we talking about?

It’s impossible to give a definitive answer to this query (for reasons we’ll come on to), but we can make a solid conservative estimate.

The Copyright Royalty Board’s ruling specifically concerns mechanical royalties derived from on-demand streaming music platforms in the US.

The CRB’s decision – now being objected to by Spotify and Amazon – will likely see streaming royalty rates rise each year from 2018 to 2022 on the following basis. (We’ll also delve into that ‘likely’ qualifier shortly.)

In 2017, the CRB-approved royalty rate saw 10.5% of a streaming company’s total US revenues passed to songwriters (and their publishers).

In Spotify’s case, the firm turned over €1.58bn in 2017 in the US (see below from the firm’s recent F-20 SEC filing) – the equivalent of $1.78bn.

The correct mechanical rate, then, would have seen 10.5% of this figure (ie. $187m) distributed to songwriters and publishers at the close of 2017.

The new official CRB-approved rates will see this 10.5% rise to 11.4% in 2018 (retrospectively), then 12.3% in 2019, 13.3% in 2020, 14.2% in 2021 and, finally, 15.1% in 2022.

(Technically, not all of this money would be paid out as mechanicals by Spotify: around 50% of the final royalty tally is re-allocated as performance royalties in the US, and is therefore deducted from the mechanical total. But, either way, performance or mechanical, this money all goes to songwriters and publishers.)

Obviously, we don’t yet know what Spotify will turn over in the United States in 2019 or the years to come, but we do know what the company’s US-only revenues were last year: €1.97bn, the equivalent of $2.33bn.

Let’s assume that Spotify won’t turn over any less than this amount in the years ahead – which it definitely won’t – to build a very conservative estimate of songwriters’ CRB-approved streaming pay rise across this five-year period.

It goes something like this:

  • In 2018, the US streaming royalty payout on Spotify’s total US revenues (ie. 11.4% of $2.33bn) would have been $265.6m;
  • In 2019 (ie. 12.3% of $2.33bn) it would be $286.6m
  • In 2020 (13.3%) it would be $309.9m
  • In 2021 (14.2%), it would be $330.9m
  • And in 2022 (15.1%), it would be $351.8m.

Factoring in the CRB-approved pay rise for songwriters, this would mean that, between 2018-2022, Spotify – based on its 2018 turnover – would have to pay out $1.54bn across these five years.

Now, remember that Spotify is currently attempting to scrap these rate rises – and also remember that the previous CRB-approved mechanical payout rate was 10.5% of a company’s total annual revenue, as implemented in 2017.

Using that percentage ruling, once again based on Spotify’s 2018 turnover, the streaming songwriter/publisher royalty paid by Spotify would come out at $244.7m each year in 2018-2022 (ie. 10.5% of $2.33bn annually).

Should Spotify and Amazon et al. succeed in doing away with the CRB’s new rates, then, taking things back to 10.5% in this hypothetical example, Spotify’s total five-year US streaming royalty payout would reduce to $1.22bn.

In other words, based only on Spotify’s 2018 turnover – not factoring in its future growth – the company would be paying circa $320m more to songwriters between 2018-2022 in US royalties on the basis of the new CRB rates, versus to the prior agreed rate of 10.5%.

The real number, of course, would be much higher than this: Spotify’s annual turnover in the States grew by over $400m in 2018 alone, while MBW’s calculations above are based on the (ridiculous) idea that SPOT’s US-based revenues will remain flat in the years ahead.

What’s more, the CRB rates might not actually be calculated on the percentage of revenue model above at all (thus ‘likely’).

Following successful lobbying by the NMPA and others, the CRB agreed that the annual streaming royalty rate in the States between 2018 and 2022 will be determined by one of three different models.

The first, and most likely of these tests is the percentage of revenue example given above.

The second option is a percentage of what Spotify pays to record labels each year. And the third is a flat fee per subscriber in the US.

The CRB ruled that Spotify (and other streaming services) must pay out on the basis of whichever of these three tests comes out with the highest sum – meaning our hypothetical model (percentage of revenue) may under-play the real pay rise going to songwriters and publishers under the new CRB rules, but, importantly, it certainly doesn’t over-estimate it.

It’s little wonder, then, that songwriters and publishers are becoming increasingly furious about Spotify’s legal challenge to the CRB ruling.

In a blog post yesterday (March 11), Spotify said: “We are supportive of US effective rates rising to 15% between now and 2022 provided they cover the right scope of publishing rights. But the CRB’s 15% rate doesn’t account for all these rights. For example, it doesn’t consider the cost of rights for videos and lyrics.”

In the United States, video and lyrical rights are negotiated separately from blanket mechanical rates (it’s a different story in Europe). However, US publishers might understandably point out that, should video and lyrics be ‘baked in’ to the CRB rate, it would mean less money going to songwriters each year in real terms.

Spotify added: “The CRB judges set the new publishing rates by assuming that record labels would react by reducing their licensing rates, but their assumption is incorrect.”

“The CRB ordered a rate increase for songwriters. Spotify is against it. It really is that simple.”

David Israelite, NMPA

David Israelite, President and CEO of the NMPA, has rubbished that accusation, responding: “Wow. I didn’t think Spotify could sink much lower – but they have. This statement is one giant lie. I’m sure a PR team spent a great deal of time and energy crafting a statement to try to deceive artists and songwriters.  They must think artists and songwriters are stupid. They are not.”

He added: “The CRB ordered a rate increase for songwriters. Spotify is against it. It really is that simple.”

Others have been even blunter. Dina LaPolt, founder of LaPolt Law, wrote: “Spotify you cheap pieces of shit — Fuck you and your secret bullshit genius awards. You should be ashamed of yourselves.

“You too Amazon Music. Grow a set.”

Interestingly, Spotify highlights the CRB rate rise under ‘risks related to our business’ in its annual financial report to shareholders.

The company’s 2018 20-F filing reads: “With respect to mechanical rights, in the United States, the rates we pay are, to a significant degree, a function of a ratemaking proceeding conducted by an administrative agency called the Copyright Royalty Board.”

It adds: “The most recent proceeding before the Copyright Royalty Board… set the rates for the Section 115 compulsory license for calendar years 2018 to 2022. The Copyright Royalty Board issued its final written determination in November 2018. Based on management’s estimates and forecasts for the next two fiscal years, we currently believe that the rates will not materially impact our business, operating results, and financial condition.”

“If any such rate change increases our content acquisition costs and impacts our ability to obtain content on pricing terms favorable to us, it could negatively harm our business, operating results, and financial condition and hinder our ability to provide interactive features in our services.”

Spotify 20-f filing

However, it adds: “The rates set by the Copyright Royalty Board are also subject to further change as part of future Copyright Royalty Board proceedings.

“If any such rate change increases our content acquisition costs and impacts our ability to obtain content on pricing terms favorable to us, it could negatively harm our business, operating results, and financial condition and hinder our ability to provide interactive features in our services, or cause one or more of our services not to be economically viable.”Music Business Worldwide

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