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Charting the Digital Music Changes

In case you haven’t noticed, there have been a number of groundbreaking moves in digital music of late. The traditionally close business relationships between the music and radio industries have prompted some to ask how these changes might affect the emerging digital radio market.

In case you haven’t noticed, there have been a number of groundbreaking moves in digital music of late. The traditionally close business relationships between the music and radio industries have prompted some to ask how these changes might affect the emerging digital radio market.

Good question — let’s discuss. First, we’ll review the issues.

DRM-free digital music

After some prompting (and perhaps cash) from Apple, EMI was the first of the four major record labels to agree to distribute digital music downloads without digital rights management (DRM) content protection applied.

For an additional 30 cents per song — which likely represents about a 50 percent increase in the record-label royalties — Apple iTunes is selling unprotected versions of EMI songs (still no Beatles, however).

These unprotected songs are provided at 256 kbps AAC, in contrast to the 128 kbps AAC of the DRM’d versions. Albums are offered at the higher bit rate without DRM at no price premium. (Note that both versions of all music will continue to be available.)

Besides being freely playable and copy-able, this means that such songs purchased from iTunes will now be playable on other AAC-supporting devices besides iPods.

While this may seem a downside for Apple — since it makes most of its revenue in this space from sales of iPod hardware, not iTunes music purchases — it helps the company in its current battle with European regulators, who are most concerned with the non-interoperability or “lock-in” that the exclusive arrangement between the iTunes service and iPod player represents. (In this respect, it also doesn’t hurt that EMI is a Euro-based record label.)

The deal EMI has arranged with Apple will likely be struck with other on-line music stores, and it could soon be matched by other labels, as well. The latter point is particularly important, and it remains to be seen whether EMI becomes the vanguard or the sucker in this movement.

The other labels have stayed fairly silent at this writing, but the few comments that have emerged do not indicate that the other (mostly larger) labels are ready to follow EMI’s lead. Nevertheless, you can bet they’ll be watching what happens closely.

Royalty flush

Meanwhile, as you’ve also no doubt heard, the Copyright Royalty Board has raised the hackles of both Internet and over-the-air radio broadcasters in the United States with significant increases in royalty rates for music played by online radio services. Industry reaction to this has been vocal and has caused a review process to be undertaken by the CRB.

Regardless of the outcome of that review, this process is a clear example of the darker side of the statutory license approach, wherein an uninvolved (governmental) third party unilaterally can change the business model of an industry overnight.

If the new rates stand, U.S. terrestrial broadcasters may curtail or abandon their Internet radio offerings. This implies that they will lose share in the online radio space to offshore services.

U.S. on-air broadcasters are hit especially hard, since at least some U.S.-based Internet-only radio services could relocate outside the country, but terrestrial broadcasters could only do so by establishing separate offshore facilities, which is unlikely to be a viable or cost-effective strategy for them.

The sad irony here is that American musical artists, particularly non-established ones, will likely suffer from this, because Internet radio presents such a variety of music.

But the CRB places more weight on what it hears from the RIAA and major labels/artists, and at this moment in history, the dramatic loss in revenue the major labels are experiencing is foremost on their minds, so any opportunity to recover cash from other venues is pushed to the limit. In this case, they may have gone too far.

Unlike the digital music download environment, there is little worry from the music industry about content protection in Internet radio. The changes they are pursuing here are strictly business, in that they feel that Internet radio is established and a viable industry segment. In the labels’ view, since their music is the chief draw of listeners to these revenue-producing online streams, service providers should pay up.

Further, since there is no scarcity in online radio, the labels are not concerned that some service providers may shut down as a result, calculating that if this were to happen, net royalty returns would still increase overall under the new rules.

Terrestrial radio walks a fine line here.

On one hand, the predicted contraction of Internet radio music services resulting from higher fees will reduce competition to over-the-air radio. Yet the terrestrial operators would also be themselves subject to the increased fees for their own online services, which are becoming increasingly important to them.

Add to this the strategic opportunity cost of fighting the record industry on this point, when potentially more important negotiations loom (more on this below). Thus while some broadcasters have spoken out against the new rules, the cumulative outcry from the sector has not been as strong as some feel it could be.

Impact on radio

What does this all mean for digital radio? Unfortunately, nothing good.

First, while the move to drop DRM might indicate a liberalizing of policy from the labels, don’t make the mistake of equating “no DRM” with “free.”

EMI is counting on the premise that it will increase sales revenue with the higher priced, DRM-free music, and this will offset any additional losses from the easier redistribution of unprotected content (it’s no worse than CD ripping in this respect).

The latter assumption likely also rests on the realization that every free copy made does not necessarily represent a lost sale, but it does potentially provide at least indirect promotional value for the artist and label.

EMI is also well aware that most songs in its library are already available free via P2P sites, but those are typically not captured at the high quality level offered by 256 kbps AAC (not to mention the security risks inherent in P2P music downloads).

So the label is banking on the fact that the twin carrots of higher quality and increased interoperability/security will trump the stick of DRM — at least for those who would even consider paying for the music in the first place. It will be interesting (to the entire industry) to see if these assumptions are borne out by results.

Back to radio, though, an important part of this equation to the labels is that at least the first access to content at this quality level is paid for — and at a premium. This could actually lead to even greater emphasis on digital radio’s not becoming a venue for free copying at relatively high quality (HD Radio’s HDC codec is considered to provide somewhat better quality than AAC at a given bit rate).

Thus any hopes that the move away from DRM downloads equates to reduced likelihood of a future “audio flag” or other content protection mandate for digital radio are unwarranted. In fact, by this analysis, there could be increased pressure for such regulation soon.

Finally, it should be noted that once the dust settles from the current CRB battle over Internet radio, the board will be right back at it, considering whether to change the rates for satellite radio; this process will probably begin in late summer or fall 2007).

What happens after that is anyone’s guess, but it is possible that the CRB could then take on the idea of revising terrestrial radio royalties, given that digital radio is now becoming established.

(Remember that today terrestrial radio pays only composer royalties to songwriters, but pays no recording royalties to labels or artists under its unique statutory license. This status has remained intact for decades, given that the terrestrial radio marketplace is considered mature and stable.

The change represented by the emergence of digital radio provides an opportunity to challenge this status, and thereby creates an opening for proposal of new royalties — at least for the new digital terrestrial signals. The intrinsically higher quality of these signals could also provide a basis for raising royalties to counter the assumed increase in lost sales from off-air recording of digital terrestrial broadcasts.)

It’s becoming obvious that nearly every move from this day forward in the digital music space could have some future impact on digital radio, either directly or indirectly. Broadcasters therefore are advised to take careful note of these proceedings as they play on.