To be clear, Pandora phrased this carefully in its blog post on the topic, saying that it paid out all this money for" artists, rather than to" them. Just the same, we figured we'd check in with SoundExchange, which gathers these royalties and then disburses them to the proper copyright owners, for a reminder about how they disburse that money — and how much really goes to the artists in question.
The owner of the sound recording [usually a label] receives 50 percent, and 5 percent is shared with the session musicians and backup singers also on the recording," SoundExchange senior communications manager Sophia Majlessi told Evolver.fm. That leaves 45 percent for the featured artists."
So when Pandora says it is paying over $10,000 for the music of the late, great Oscar Peterson, it's really paying over $4,500 to his estate, assuming all of Peterson's music went through a record label, as is almost certainly the case. We just thought we'd make that clear, given that we may have contributed to the impression that Pandora and other online radio services were paying all that money directly to artists.
Say what you will about Pandora's compensation to artists and labels — some point to the fact that it doesn't have many high-profile competitors as a sign that the royalty rates for online radio are too high, while others blast the company for not paying out enough, even as it forks over the majority of its revenue to copyright holders. One thing is beyond dispute: Online radio, under these government-set rates, is different from nearly any other kind of digital business.
Usually, when you build something out of ones and zeros, your costs rise at a much lower rate than the revenues from people using it. If I put a song on iTunes, for example, and one person buys it, I lose money. If I sell a few more copies, I break even at some point. If 10,000 people buy it, I make a lot more, without incurring any more cost. And if I sell 100,000 copies, all of that extra revenue is pure profit. This is the way of most digital businesses, from magazines to movie rentals.
For online radio services like Pandora, however, royalty costs rise directly alongside usage because they have to pay an additional flat rate for each song streamed to each listener — a rate that increases each year. This is why Pandora currently pays half of its revenue to SoundExchange, even at its industry-leading scale
One response to this would be, Fine, so the payouts increase alongside usage — who cares? Pandora can just sell more ads to increase its revenue alongside those other factors, and make money, even if its profits won't scale the way those from a traditional digital business do."
Good point — except for one thing: There are finite ad dollars companies are willing to (or able to) commit to online radio, especially when so many other businesses are ad-supported. So even if Pandora expands past its already impressive ratio of about 1 in every 10 Americans using the service, its royalty costs will continue to rise proportionally as ad dollars are harder to come by.