The Music Industry Buries Startups: “No Standalone digital music company has achieved profitability,” says David Pakman
The startup world is tough one, particularly when it comes to the music tech industry. This piece looks at how high royalty rates and the threat of lawsuits has prevented music tech startups from seeing the kind of success which other sectors have.
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The Music Industry Buried More Than 150 Startups.
Now They Are Left To Dance With The Giants.
Guest post by David Pakman, a partner at Venrock investing in early-stage tech companies.
“Since 1997, according to PitchBook, approximately 175 digital music companies were created and funded by venture investors. Of those, approximately 33 were acquired by larger companies, often for less money than their investors put in. Of those who have exited, I believe only seven achieved meaningful venture returns for their investors by returning more than $25 million in profit to their investors (Last.FM, Spinner, MP3.com, Gracenote, Thumbplay, Pandora and possibly The Echo Nest), representing an investor success rate of only approximately 4%, far below that of other internet and technology market segments. Only two have achieved an IPO, and at least 15 companies have resulted in a distressed exit and/or filed for bankruptcy so far, for an 8.6% failure rate to date. Given that I know of no profitable standalone webcasting or digital music companies, I believe this failure rate will only worsen over the coming years as the remaining companies in this space continue to struggle.”
The section above comes from my U.S. Copyright Royalty Board testimony in front of the Library of Congress in May of 2015 as part of the Web IV rate setting proceedings.
I am unaware of any standalone digital music company or webcaster who has achieved profitability. This is a direct result of the high royalty rates required by startups who wish to license digital music for use in their apps. Whether you negotiate voluntary agreements or avail yourself of the existing compulsory licenses, you will not turn a profit. At least, no one ever has. The few that refused to pay these rates were often sued out of existence.
Given these facts, digital music startups are unlikely to survive and thus unlikely to attract meaningful investment. The failure rate in this market segment dramatically exceeds that of SaaS, eCommerce, and Mobile, to name just a few. More importantly, the success rate of digital music companies (4%) is far less than these other segments (Mobile at 26.5%, SaaS at 28% and eCommerce at 23%).
It is no surprise, then, that far fewer digital music companies get funded. Only about 175 have been venture funded since 1997 by my count compared to 5,175 (mobile), 7,987 (SaaS) and 1,800 (eCommerce).
The end result of these perilous market conditions is that the only companies who can afford to be involved with digital music are the internet giants prepared to subsidize their digital music services with profits from their other businesses. The high royalty rates and up-front cash advances required by the record companies prevent profitable, sustainable businesses from emerging. As a result, the recorded music businesses is left only with these giants — Amazon, Apple, and YouTube and, to a lesser extent, Spotify and Pandora. They now complain loudly about the “leverage” these giants have over them. First they criticized Apple iTunes for not agreeing to raise prices above $0.99, then they went after Pandora and other webcasters by insisting webcasting rates were too low, then they attacked Spotify for not paying them enough, then they insisted Apple Music pay them more than Spotify did, and now, just as the YouTube licensing agreements are coming up for renewal, they complain YouTube doesn’t pay them as much as Spotify.
But this is a “crisis” of their own making. Many of us argued for years that it was in the industry’s best interest to create a healthy ecosystem of hundreds or thousands of successful companies, all enjoying successful businesses around music. But those arguments fell on deaf ears, and instead the industry fought repeatedly to raise royalty rates over and over again, despite evidence that not a single company ever achieved profitability.
In my mind, it would have been in the long-term best interests of the recorded music business to enable the widespread success of thousands of companies, each paying fair but not bone-crushing royalties back to labels, artists and publishers. But the high royalty rates imposed upon startups, even after clear signs over the past 19 years that the strategy killed companies, prevented a healthy ecosystem from emerging. It’s a bed the music industry made for itself, and now it is left to lie in it.
[Unfortunately, the jury is still out on the few startups who have survived. I love Spotify, too. It’s an amazing service. But to my knowledge, even at 30 million paying subscribers, it remains unprofitable. It exists, at least at this point, thanks to the largess of its investors. It’s hard to build profitable businesses when your gross margins are in the 20’s (%). More than 70% of all of Spotify’s revenue is paid out to rights-holders. And still, many complain Spotify isn’t paying enough.
Pandora is the largest internet radio company, with more than 81 million monthly active listeners. Even with this extraordinary scale — more than one-quarter of all Americans listen each month — the company is unable to generate a profit and never has. And while many of its investors have made large returns on their invested capital through stock sales at higher prices than their cost basis, the company continues to remain unprofitable, even at the very large scale it currently enjoys.]
(Note: The data cited above comes from PitchBook. The search criteria and functions in the database allowed me to compare the performance results for the mobile, Software-as-a-Service (“SaaS”) , eCommerce , and digital music sectors. To determine the number of VC-backed companies in each sector, I used the “VC-backed” company universe search criteria. I next determined outcomes for each sector — i.e., whether profitable for the investors or simply a distressed/bankruptcy exit. In that regard, I used an “exit type” search where “Public Investments, Acquisitions” indicated a profitable outcome and “Distress” indicated either a distressed exit or bankruptcy. The searches were performed as of October 2014. I have not re-run them recently, but I don’t have reason to believe the results would vary all that much.)
David Pakman
I’m a VC at Venrock, investing in early stage internet companies. I used to be the CEO of eMusic and before that, co-founded MyPlay and Apple’s Music Group.
I’ve know David Pakman for over 20 years, we met when he worked as a Music Evangelist for Apple Music. Here’s my reply to his piece:
David you’re one of the smartest guys on the block, and I have massive respect for your opinions, but in this case you’ve left out one very important question: why? Why did the labels “bury” so many digital music startups?
Perhaps it is because most of these startups did either not know or not care about how the music business worked, and were more interested in a big IPO and payday for themselves and their investors than building sustainable businesses.
I’m not trying to defend the music business here (and I expect to get flamed because nobody wants to hear anything other than “the labels are clueless slimebags). Like any industry dealing with massive disruption, lots of mistakes were made, some of them stupid. But remember that the music business was “Omaha Beach” for the kind of disruption that hit many industries years later. Look at the controversy AirBnB and Uber are facing in a world where disruption is far more pedestrian than it was in 1999. Here are some of the things I noticed in sits with literally hundreds of startups over a decade spent in new media at major labels:
1) Music tech startups have always wanted music at reduced costs/higher margins vs what labels were getting with retail. They said this was because the costs for technical needs and customer acquisition were so high. I can’t count how many times some startup told me how expensive bandwidth was, or rent in Silicon Alley, a Superbowl ad was, as a rationale for why labels should lower costs of music. Why don’t you ask the server companies or your landlord for a big discount, we said? “Because what they charge is what they charge”, they replied. “You should lower the cost of your product to us, so we can lower the cost to the consumer, so we can have a business”, they said. Nobody came in the door and said, give us the same deal as you give retailers, the same costs and margins, and we’ll make it work (Liquid Audio were an exception, they got it and I think we fucked up not working with them earlier and helping them). Let’s not forget the music business was transacting billions of dollars with retailers, who worked with similar margins and thrived. The retailers had productive and profitable relationships with labels for decades. I guess we’ll have to see if Pandora lives longer than Tower Records did.
2) Tech startups wanted labels to be sensitive to their costs and timetables, but totally dismissed how much money and time it would take the labels to completely transform their industry. Labels needed to clarify rights with artists whose contracts in many cases had no digital language. They needed to completely rethink their releases processes, prepare massive catalogs for digital sale with the required attention to quality, educate not only employees within the companies but also all the artists and managers, many of whom were NOT on board with their catalogs being cherry picked, no matter how much consumers wanted it. There was a perception by the startups and the media that digital distribution would cost the labels nothing, require no investment, and hugely increase margins for the labels, which was simply not the case. The costs didn’t go away because of the shift from physical to digital, they just changed. But all the media and the tech industry believed was that a CD cost something to make, a download cost nothing. This perception fueled the “you should charge us and consumers less for your music” argument.
3) Most music tech startups didn’t know shit about how labels worked, or what their concerns were, and neither did their investors. I saw dozens of startup powerpoint presentations where the first 8 slides were doom and gloom overviews of the music business, followed by another 15 slides of why said startup was going to save us. And more often than not, the assumptions made by these companies were incorrect, with huge foundational flaws, and the meetings turned into an educational process. I don’t know how so many of these companies got funding from angels with such obvious fundamental problems in their business models, but always, always there was desperation to get an agreement in place so the startup could go get more money. And as a label, when you understand the leverage you have, when you see that the thing cannot exist without your assets, you squeeze the best deal you can. Isn’t that what VC’s do, too? People need your money desperately, you fund them, and you negotiate the biggest chunk you can get while still leaving them viable. If you have a music startup, you need music it make it work. To get the music, you have to make it work for the labels and artists. If you’re unable or uwilling to do this, then you’re not going to make it. Just like you won’t make it if your investors don’t see consistent growth.
4) More and more artists have chosen to go independent, direct to consumer, self-release their art. Stuff like Blockchain is exciting. If the labels are so impossible to deal with, then shouldn’t the investment be in platforms that will succeed in a post-label world? Shouldn’t the new startups, or the established players, be investing in content and talent development directly with artists, in a more substantial way? Shouldn’t they just take their great ideas and bypass the stubborn major labels? Can’t they bring great art to life, starting from almost nothing like Leonard Chess or Ahmet Ertegun or Berry Gordy — record people who didn’t have big catalogs behind them to get scale, who didn’t have angels raining down millions on them, who didn’t custom build opulent offices spaces in Gramercy or the Meat Packing District stocked with Hermann Miller chairs, who lived and died on how their records actually sold week to week? Today we venerate people like Daniel Ek, who succeeded in large part by giving music to people for free and who then tells the industry he’s their savior while needing a billion dollar credit line to keep the fucking lights on.
I might be misreading the intent of your piece, but it comes across at least in part as regret that the labels ruined the chances for the huge payoffs VCs would have received if these startups were successful. There’s not a line in it that ponders the impact on artists, who’ve watched billions of dollars go into music business disruption over the past 20 years, very little of which went to them and instead eroded their livelihood. And the real truth is that the investor’s insatiable hunger for growth and a big ROI is just as responsible for the death of these companies as the labels are. Perhaps more so.
If the labels aren’t happy, then boo-fucking hoo. But I’d say the same thing about investors and amoral tech companies who point fingers at record companies while doing exactly jack dot shit for artists. In 2016, they have no excuse.
Me, I’m here for the music, and I’m with anyone else that is.
(see also: https://medium.com/@musicFIRST/t-bone-burnetts-remarks-on-music-and-the-american-story-4b877fb66540#.xofjj7n2l )
Profits aren’t likely until we see the next step.
A decentralized blockchain/micropayment service, with margins of 2-3%. The right model at 2% is far more profitable that the wrong one at 20%.
Think transaction based, not the current clearing house model. Paypal, not “ten for a penny”. ie. starting to sound like an actual revolution.
The need for licensing deal negotiations, amassing subscriptions and pricing would be out of the hands of “platforms”. Labels and artists would flock to it (2% is a lot less than 20%). Platforms could give away, and run ads against the music as much as they wanted. For a per play cost.
Agreed and well worded, aster! Unfortunately norms are very powerful and we have a small window of time to change the norms to our way of thinking. If interested, please check out my proposal for a solution that is very close to what you are stating here: http://www.thepolr.org
Haven’t you heard no one wants ads, more and more people are filtering them out with various adblockers, and mobile carriers are starting to do the same on their networks. Even if the ads aren’t blocked 50% are never seen by a human, and some $8 billion is syphoned off by click fraud. The tech company reliance on ad revenue is dead in the water.
More power to you. We need change!
Exactly! That last sentence wasn’t delivered without sarcasm.