Air of Despair Permeates MusicNets

Tim Westergren, co-founder of Oakland, Calif.-based Pandora Networks is normally a cheerful fellow. His happy-go-lucky demeanor fits right in with his musical roots. Lately, his brow is wrinkled in worry, as he ponders over the decision by the U.S. Copyright Royalty Board (CRB) to raise the royalty rates for webcasting music on the Internet.

According to some estimates, the performance royalties paid out by Internet streaming services could top $2.3 billion a year, four times the $550 million 14,000 terrestrial radio will pay in royalties. No surprise, the decision (pdf) has since then become a source of worry for start-ups that are combining Music and Social Networking features. While they are not ready to throw in the towel just yet, they are contemplating radical actions.

“It’s a burgeoning business but there are already unfair prejudices against us compared to terrestrial radio–we pay more than them,” says Martin Stiksel, co-founder of London-based that has raised millions in venture capital from Index Ventures and well known angels such as Reid Hoffman and Marc Andreessen.

Some record labels are displeased with the decision as well and feel that it basically keeps them in the grip of large terrestrial radio networks which have too much control on the music business, not to mention questionable taste and history of payola. Unfortunately it doesn’t help the innovators.

“The most radical option would be to stop streaming into the U.S.,” says Stiksel, who adds that nearly 30% of the traffic comes from the U.S. fans shouldn’t be worried just yet, but Stiksel admits things are going to be a lot tougher.

Many of these services might have tweak their business model, since many of them are depending on advertising dollars as a revenue source. The more traffic they can bring to their networks, the more advertising dollars they can generate, pay off the royalties and earn a little profit. The margins are clearly razor thin, and any changes in the royalty rates pushes profitability out of reach.

Westergren, in a chat pointed out that Pandora is pretty good at generating ad dollars, but the new royalty rates aren’t going to be enough for him to stay in business. “Left unchanged, it’s over for us and every other Internet radio service, period, makes it unviable,” he says.

We employ 11 full time people in our ad sales team, and despite very high licensing and streaming costs, believed that we could make it work over the next several years if Internet advertising continues to grow. This ruling drives the licensing fees (fees that are NOT paid by terrestrial broadcasters) completely out of reach, and makes our goal impossible. [Pandora Blog]

“This seems extremely counter-intuitive to me – the labels should be doing everything in their power to make music discovery as in-expensive as possible,” says Srivats Sampath, founder of Mercora, a P2P radio start-up based in Sunnyvale, Calif.

Doc Searls in his excellent summary of this crisis writes: ” Internet radio is a canary in the coal mine of an insane Net-hostile Regulatorium that stretches from the cableco/telco duopoly to the copyright oligarchs.”

Additional reporting by Liz Gannes.