I had the opportunity to give a presentation called  “Music Service Agreements 101” during yesterday’s ABA Section of Intellectual Property Law’s Young Lawyer Action Group conference call.  “Music Service Agreements 101” provides a basic understanding of music service agreements, such as iTunes/Apple Music, Pandora, and Spotify. During the presentation, I discuss the common industry terms/definitions to know about, license v. distribution, standard deal terms, advances and delivery fees, minimums, mechanical royalties, and the differences between reporting and accounting.
You can watch the full recording on YouTube below. Make sure you like the video and subscribe to my channel for more content!

 

Transcript

Introduction

Okay, awesome! Well, let’s get started. So, I’m excited to be presenting today on “Music Service Contracts 101.” This is an introductory overview to some of the major aspects of music service agreements.
Who am I and why am I talking about this topic? Well, my name is Franklin Graves and I’m an attorney based out of Nashville, TN. I’m currently General Counsel for Naxos Music Group, the world’s leading classical music company. I’ve included some ways to get in touch or connect with me across the web. So, feel free to reach out!
Before we get started, I do need to give a small disclaimer. First, this is a personal presentation for educational purposes only. Everything I’ll be sharing or saying represents my own views and opinions, not those of Naxos, the ABA or any other organization. Second, this should not be considered legal advice and I am not your attorney. Please consult your own legal counsel for any specific issues you may have.
I’ve provided a roadmap to give some guidance as to the topics I’ll be covering today. I have time for questions built-in at the end, but that doesn’t mean you can’t interrupt me or ask questions along the way.

What is this presentation covering?

I think it’s important for you, as an attendee, to understand what this presentation is about and why it’s important to you. So, the “What.” This presentation is about key terms of a music service agreement or contract. I’ll use “contract” and “agreement” interchangeably as they both mean the same thing. The goal is for you to leave with an entry-level introduction to these kinds of agreements should they ever run across your path.
What are music services? They’ve evolved quite a bit over the past couple of decades, but I’m sure everyone listening has interacted with one in some fashion. Has anyone on the call every purchased music from the iTunes Music Store, or streamed music through a service like Spotify or Tidal?
Great. It may be safe to assume we’ve all utilized a digital music service at least some point in our lifetimes. These logos on the slide are examples of various digital music services that will be the focus of the presentation today. Some of them you have likely heard about, others are only available in Europe, Asia, or other ex-US countries.
Continuing with the “What” of the presentation, I’ve put together this flowchart to show the basic breakdown of music services and the ways they operate. Music services can be broken down into two basic functions: streaming and download. Sometimes both are available on the same platform (like Apple Music and the iTunes Store). Streaming platforms come in two varieties, as well: interactive and non-interactive, and then both of those offer options to listen by way of a subscription fee or ad-supported method. Download stores are fairly straightforward, with most now also having a locker service or cloud component included. I’ll get to what all of these definitions mean in a couple of slides.
The way music services operate is becoming more complex. Examples include genre-specific services (such as classical-only or country-only), device-specific services (such as Amazon’s $5 per month music streaming only on an Alexa device), and multimedia services (such as YouTube Red offering both ad-free YouTube access and music streaming through Google Play).
We, as an industry, are seeing a huge increase in the number of services offering subscription streaming options. Just during the last half of 2016 alone, I was dealing with the launch of SoundCloud Go, Pandora’s subscription service, and iHeartRadio’s service, plus 3-4 additional genre-specific services launching outside the U.S. It seems like everyone wants to offer a music subscription!

‘Music Industry Blog’ Resource

A great blog I recommend you check out is Mark Mulligan’s  “Music Industry Blog.” There is a link on the slide. Here you can see a pie chart showing the number of global music subscribers surpassed the 100 million mark at the end of 2016. As you can see, Spotify is clearly ahead of the rest, but it should be noted Apple Music, which launched only a year and a half ago (not counting its time as Beats Music), is already at just under half of the subscriber count as Spotify. I recommend checking out the additional in-depth analysis Mark provides on the blog.

Terms & Definitions

Now, let’s dive in!  We’ll first take a look at terms, or definitions, you should know. As Maria von Trapp from the Sound of Music says, “Let’s start at the very beginning.”

Aggregator & Distributor

Two terms you may encounter are “aggregator” or “distributor” and the differences between the two can be confusing. An aggregator is a company that offers business to business (B2B) services, specifically the delivery of music content to a music service on behalf of the content owner. A distributor is a company that takes the music content for a record label, or owner of the sound recordings, and coordinates the distribution to music services. Both an aggregator and distributor manage direct relationships with major music services for delivery of content. The main difference is that a distributor typically offers additional, more hands-on services such as marketing and promotion of content. For example, Sony Music owns a dist. company called Red Distribution and Warner Music owns a distribution company called ADA. Two of the biggest artists when it comes to album sales are on independent labels, but rely on major label distribution. Taylor Swift and her label Big Machine Records signed a deal to have Universal handle distribution for albums. Adele’s previous albums were distributed by Sony Music in the U.S.

DRM

DRM, or digital rights management, is software that prevents consumers from access music files in an unauthorized manner, such as burning to a CD or playing back on a different computer or device. DRM software can take many forms, such as a proprietary music format or an application for playback.

DSP

DSP, or digital service provider, is another term commonly used to refer to the music service.

File Locker

File locker (or cloud storage) allows for a consumer that purchases content to download, stream, or further access purchased content from a service provider.

Metadata

Metadata is data that provides information about other data. The easiest way to visualize metadata for music files is in iTunes. As you can see in this wonderful example of our wonderful friend, Ms. Ariana Grande, metadata for music includes information such as song title, artist(s), album title, composers, genre, release date, track information, and more.
Companies specialize in providing music metadata, such as Gracenote (which was just purchased by Nielson in December) and Rovi. For example, if you open Spotify and check out an artist profile biography or album information, you’ll see the data that is supplied comes from Rovi. Or, if you put a CD or DVD into a Sony player, you’ll likely see it accessing the Gracenote database to get the metadata to display.

Streaming

When it comes to streaming, there is a statutory difference to understand.
Interactive service allows a consumer to choose the music that is played back on the service. Examples include Apple Music, Spotify Premium, Tidal, and Deezer. Music services must negotiate and enter into direct deals with content owners to offer sound recording catalogs on their interactive service. That’s why you see Taylor Swift’s 1989 album only on Apple Music and not on Spotify.
A non-interactive service does not permit the consumer to choose specific songs for playback. Examples include Pandora, Spotify Free, and iHeartRadio. Music services rely on what’s called a compulsory license in the U.S. with royalty rates not negotiated with the content owners directly, but rather pay based on rates set by the Copyright Royalty Board (CRB).
As I mentioned before, many services now offer multiple types of playback to consumers, so you may encounter both types of services within the same agreement.

XML & DDEX

XML refers to the code, containing the metadata, that accompanies delivery of sound recording files to a music service. I’ve put together a simple example of XML code in this slide. If you know basic programming, you may recognize this as lines and lines of just opening and closing tags, specific to the music industry. For instance, this XML, again using our friend Ariana Grande, on lines 14 and 15 will communicate to the music service the publishing and sound recording copyright information. Those two lines will then be what you see if you scroll to the bottom of an album or single in Spotify, iTunes or another service. The full XML data for a single album can easily be upwards of 1500 lines of code, and can even include pricing information and lyrics, too.
As with most industries, there is a standardized process that’s been developed and adopted by the major players. DDEX refers to an organization that has established a series standards when it comes to delivery of XML data, meaning the code used to deliver music metadata to Amazon can theoretically also be used to deliver to Spotify.

License v. Distribution. What kind of rights deal are we making with a music service?

As you may be aware, Section 106 of U.S. Copyright law creates what is commonly referred to as the “bundle of rights” that are exclusive to the content owner. Therefore, a music service must be granted a right in some form to be able to exploit the content. An entire presentation could be put together on this topic alone. If you are interested in learning more about the differences between the 106 rights when it comes to the music industry, I’d encourage you to Google about the rapper Eminem and his fight with Universal on the application of these rights to music service agreements. Overall, I just want to make sure you know that these three rights I’ve listed are the main ones that are being negotiated when it comes to music service agreements.

Standard Terms

Next let’s take a look at some of the standard terms you might see or negotiate within a music service contract.

Take Contract Drafting!

An important note because I know we have some law students on this call.  Make sure you take a contract drafting course to learn the basics of contract formats, boilerplate provisions, MFNs, and more.

Kohn on Music Licensing

Easily one of the most important books I have carried with me from law school is “Kohn on Music Licensing” written by Al and Bob Kohn. It’s currently on the 4th edition, and I don’t think it’s been updated since 2009. However, the information in this nearly 2,000 page book and the accompanying CD of standard forms is invaluable!

Term / Length of Contract

As a content owner, you obviously only want to have one-year terms, but a music service wants multi-year terms ranging from 2-5 years. With multi-year terms, you typically see advances or guarantees being given in exchange, which I’ll get to in a couple of slide. From the consumer perspective, they don’t want to see their music disappearing from their playlists or favorites.

Territory

Territory should be negotiated based on where the service currently operates. As a content owner, you don’t want to grant rights beyond what is necessary, so you’ll try to limit the territory. However, as a music service, you may have grand plans to become the next big global company, so you’d want worldwide rights. It’s also standard for the content owner to withdraw or limit rights if they don’t have the authorization or legal right (maybe due to different copyright laws in a particular country) or lose the rights to offer something in their catalog. Music services will always allow for this type of language.

Windowing & Exclusives

Windowing is when a time limit is put on when an album is made available on a particular platform following its initial “street date,” or release date. Windowing can be anywhere from a week or two to a couple of months. Examples include Adele and Taylor Swift not allowing their albums to be streamed during the first few weeks or months of its release. However, in the EDM genre, artists like Avicii, Calvin Harris and David Guetta thrive off streaming revenues, so windowing wouldn’t be a smart business decision for their releases. Another thing we’re seeing, but perhaps less of going forward, is exclusives – a kind of hybrid or offshoot of windowing. Exclusives can also be service specific, such as the streaming service Tidal being the only place to stream Rihanna, Jay-Z, Beyonce or Kanye West releases. However, exclusives are typically for only a short period of time, despite what Kanye West may tweet. Either way, the contracts typically address the content owner’s right to set windowing periods or offer exclusives to both that particular music service and others.

Format

Format is another important point to negotiate. Standard definition, typically a max bitrate of 320kbps in mp3 format, is standard and the point at which most services operate. Lossless, or CD quality, is considered the next level up and typically offered on a music service for a higher fee to the consumer, such as Tidal. High-resolution, or HD audio or master copies, are rarely included in a standard deal, unless the music service specializes in offering that quality, such as with the HDtracks store.
The contract should also clearly explain the methods for exploitation, such as download and streaming, or free and ad-supported offerings.

Fees and Royalties

For a while, Apple tended to set the standard when it came to royalty splits for download music services. Spotify broke the mold with streaming and offering a free, ad-supported tier. However, they’ve been in heavy negotiations with the major labels, which don’t want to have the free tier available any longer. It’s suggested that one of the strategies Apple is using is setting higher royalty splits for streaming, including payments made to songwriters, since they have cash to back up their service, while Spotify has gone through several rounds of funding and is reportedly looking at an IPO in the future.
By now, it’s common knowledge in the industry that download store splits are typically 70% to the content owner and 30% kept by the music service. This revenue percentage changes when you add in factors such as whether the store is offering lossless or HD audio to the consumer, which often entails higher technical costs and maintenance for the music service, so may result in a different revenue spit.
Streaming services, however, are all over the map. Luckily, with Apple Music’s streaming service, our friends over at Digital Music News published an article that purports to be a full agreement with Apple for their music services, including the iTunes download store and the Apple Music streaming service and more. Of course, no one knows whether this is a real thing, or if it’s the final version since the article leaked the contract before Taylor Swift wrote her open letter to Tim Cook.  However, if you look in the agreement, the revenue share split for the streaming service is 58%. Therefore, perhaps we can assume the royalty rates for streaming services are somewhere in that ballpark.
Let’s take a closer look at this purported Apple Music agreement!
In the definitions section for the streaming service, you can see the term used is “pro rata share” and includes a written out method of calculating the content owner’s share of the music service royalties that it pays out.
If after reading that you feel like this. Don’t be afraid. It’s complicated and take a lot of practice and experience to read through and actually make sense of it all. I’ll take us on an illustrative journey to get a basic understanding of what pro rata share means.
With every subscription music service, the revenues collected from the consumers is put into a gigantic pool. There are typically many pools that are separated based on the type of subscription they collect, such as full premium, student discount, cell phone service bundled discount, 99-cent promo, etc. For the sake of this illustration, we’re only going to look at one pool generated from the standard 9.99 per month subscriber.
Let’s assume there are 20 million subscribers paying 9.99 a month. That would mean the “gross subscription revenue pool” for that service, the big green circle if I haven’t lost you, is roughly $200 million. Now, going back to that purportedly leaked Apple Music deal, that would mean of the $200 million, a music service would keep almost $84 million, and the music services would split almost $116 million.
Okay, now what do we do with that $116 million and how is it paid to content owners?
Here’s an example of what an artist with 5,000 streams would receive according to that leaked alleged agreement.  The artist’s streams are divided by the total number of streams generated on the music service for that month, to give us a pro rata share, or that content owner’s portion of the streams. We then multiply that $116 million that’s paid to the content owners by this artist’s pro rata share, and end up with roughly $960 in royalties.
This calculation is based on an assumption that every user is only streaming around 30 tracks each month, or roughly 3 albums, which falls closely in line with the estimated 20 billion hours of music listened to on the service in all of 2015. Some of you musicians or industry people might be looking at this and wondering, what the heck… I don’t make that much money! Again, this is just an overly simplified visual for the language of how some of these contract calculations are written. An actual music service pays based on factors such as the country where the content is streamed (which is a much different royalty rate than in the U.S, Europe, or more economically developed countries), currency conversions, the premium streams vs. ad-supported streams, streams based on a family account or student discount account, the label’s or distributor’s cut that is being taken, songwriter royalties, and more. When it comes down to it, a per-stream rate is not the way to view royalties from music services that operate a streaming package. Spotify, for instance, has admitted they have “an average ‘per stream’ payout to rights holders of between $0.006 and $0.0084.”
Now that we’re all enjoying a massive headache or have completely zoned out by this point, let’s move on!

Advances and Delivery Fees

Advances and delivery fees can be alternative ways to get money up front.
Advances are given to the content owner from the music service. Recoupable, but not refundable is best explained by an example. If a record label receives $10,000 in advance from a music service, that means that when people listen to the music on the service and generate royalties for the record label, before paying the royalties the music service gets to keep the first $10,000 in revenue generated before it starts paying money. However, it’s typically non-refundable, meaning that if the music service doesn’t end up being successful or that record label’s content isn’t streamed enough to generate $10,000 in royalties, the record label keeps it.
Advances can range from a couple thousand to $100,000+ depending upon factors such as: how large of a music catalog is being negotiated; what formats are being delivered; what quality is being provided; how extensive of metadata is requested; and how established is the music service? For instance, a tech company that makes devices and offers a music service as a secondary business to their main business, may be in a position offer advances, compared to a music streaming startup.
Advances can also be in the form of marketing credits or commitments, so that a record label can get their album included on the front page, or a newsletter sent to subscribers, or advertise to users that listen to ads.
Delivery fees are charged by the content owner to the music service. They are typically non-recoupable and non-refundable. The theory behind delivery fees is that they cover the technology investment involved in content delivery (bandwidth, encoding, storage, future deliveries, metadata updates, takedowns, etc.).

Minimums

You may have heard (or can easily go Google) about the eBooks price fixing issues from the early 2010s, or the CD “minimum advertised price” lawsuits in the early 2000s. Basically, it’s illegal for companies to conspire and price fix. That’s where minimum guarantees, sometimes referred to as a “wholesale price” or “minimum resale price,” come into play.
Let’s start with download stores. Music service contracts will have a minimum whole price chart or table that lists out wholesale tiers of pricing for content. The tiers provide the content owner a minimum amount of revenue they will receive when music is purchased, allowing them to set different tiers for different products. For instance, you may see a term called “back catalog” and “new release / priority titles.” Back catalog is typically anything released over a year or two years ago and can be offered for a less expensive price tier.
Here is an example of what that table or chart might look like in the Annex or Schedule to the music service contract. A tier 1 album might be priced by the music service to the consumer for $12.99, and a Midline, Tier 2 album, may be priced at $9.99.  For single tracks, it’s similar price structure. The tables will be more complex depending on the size of the record label’s catalog, multi-disc sets, bonus or extended editions, and more. You’ll also see additional tables included for lossless/CD-quality pricing and hi-res audio pricing.
To make things more complicated, the contracts will include a “greater of” calculation. The “greater of” language protects the content owner from the music service selling at a high retail price and keeping the revenues for themselves. Let’s take a closer look at what this means with an example.
He’s sample language I made up to illustrate what you might see in a contract. “Music Service will pay to Label the greater of 70% of the retail price, excluding taxes, and the minimum wholesale price as set out in the table below.” The greater of language means the music service will pay one of the two options: either 70% of the retail price paid by the consumer, or the minimum amount specific in the tables we just looked at.
Here are three different scenarios in which a music service would sell an album. Let’s say Service A sells an album for $10, and pays the label $7 per the contract. Service B sells the album at a heavy discount of $1.00, still has the pay the label the $7.00 minimum, and operates at a loss of $6.00 per sale. This is actually based on what Amazon did when they launched Amazon Music. They offered Lady Gaga’s “Born This Way” album for $0.99 as a way to capture a consumer base away from the then-dominating iTunes Music Store and promote their online cloud library service.  Moving on to Service C. Service C appears to market toward a consumer base that is willing to pay more for music, and they are able to get someone else to pay $20 for the same album. In this case, the music service won’t get to keep the profit all to themselves, and the “greater of” calculation comes into play.
Let’s move on to streaming.
With streaming services, contracts will typically what is called a “per-subscriber minimum.” Per-subscriber minimums ensure that the music service will pay at least a set amount into the subscription royalty pool each month for every subscriber. Think back to that big green circle visual I had in an earlier slide. That is what content owners want to make sure doesn’t fall below a particular amount, thereby giving a minimum value to the content that consumers are paying to access.

Mechanical Royalties

Mechanical royalties are the payments due, by statute, to songwriters. For music services that operate in the U.S., agreements typically pass responsibility off to the content owners for paying mechanical royalties on the sales that occur. For music services that operate outside the U.S., the responsibility for mechanical payments is handled by the music services because they can often pay directly to local collection societies within the territory.
Harry Fox has some helpful charts for those trying to understand the royalties due to songwriters. It’s easy when it comes to downloads and sales of digital music. It’s just like with physical CDs where for every song sold, the songwriters are due 9.1 cents. If a songwriter writes all 10 songs on a 10-track album, then they would get paid $0.91 cents when it sells. Same concept with singles, if a song is sold for $0.99, then the songwriter would get 9.1 cents.
However, streaming makes things more complicated. For the sake of time, we’re not going to discuss this. Just know that information is available if you need it over at Harry Fox.

Reporting & Accounting

To wrap up this presentation, let’s take a look at the differences between reporting and accounting.
A simple phrase to remember is: first comes reporting, second comes accounting. Reports are typically raw text files that can be opened as Excel spreadsheets (or equivalent formats). A report contains detail information about the exploitation of the content that has occurred by the music service. Accounting is when the music service pays any money, revenue, or other income generated from the exploitation of the content, and should match what is sent in the reports.
Reports typically include information about the artist, album, and track, date of the activity, country the activity took place, ISRC code, and more. For streaming services, report information includes number of seconds streamed, country in which the stream took place, currency, the stream rate for that accounting period, etc. For download or retail stores, report information can include whether it was an individual track or whole album sale, wholesale price, and price paid by consumer (retail price).  European services, due to their laws and regulations, will require an invoice be sent back once a report is sent before they account for any amounts owed.  When it comes to streaming services, the reports typically have 100s of thousands of lines detailing each stream that occurred.

Conclusion

That wraps up the “Music Services 101” presentation! Are there any questions or comments?  Again, I can be reached at any of the methods listed on the slide, so feel free to reach out!