The Last Days of Internet Radio?

A decision by the Copyright Royalty Board to raise royalty fees could put some small online radio stations out of business

Kurt Hanson runs a Chicago-based online radio station that streams more than 300 channels of classical, jazz, oldies, and other music genres aimed at adults. The station, AccuRadio, lures more than 1 million visitors a month—not bad for a startup that's only been around since 2002. If a Mar. 5 decision by the Copyright Royalty Board (CRB) takes effect, AccuRadio may not be around much longer.

The decision, due to take effect sometime during the next two months, could raise royalty fees paid by some online radio stations more than tenfold—enough to put many smaller stations out of business, Hanson says. Currently, most small Webcasters have paid royalties calculated as a percentage of revenue. Under the new rule, those outfits will begin paying on a per-song, per-listener basis. "The more intensively an individual service is used and consequently the more the rights being licensed are used, the more the service pays, and in direct proportion to the usage," according to the 115-page ruling.

Here's what the change will mean for AccuRadio. The station employs six full-time staff members and records about $500,000 in annual sales, mostly from advertising. Of that, Hanson pays record labels about $50,000 in royalty fees. The rule change, which will impose fees retroactively, will jack up royalty fees to more than $600,000 for 2006. Other Webcasters will be in the same boat. "I don't think any of the operators would break even," Hanson says. "Internet radio is in danger of becoming extinct," shouts a headline posted on the company's Web site, urging listeners to sign a petition or send a message to Congress. "The rates are so high that they exceed 100% of most Webcasters' total revenues!"

Battle Royal

Hanson and his peers aren't getting much sympathy from music labels and SoundExchange, the company that collects royalties on behalf of the recording industry and urged the royalty fee change. The last time royalties were negotiated, in 2002, "we had the same exact response: that this is terrible, it's going to put everybody out of business," says SoundExchange Executive Director John Simson. "But the industry grew." Indeed, revenue from online streaming music radio has risen to $500 million from $49 million in 2003.

But that's thanks in part to Congress, which stepped in and decreed that smaller Webcasters would pay on a per-revenue basis. Larger Webcasters such as Time Warner's (TWX) AOL Radio, Yahoo!'s (YHOO) online station, and Clear Channel's (CCU) Online Music & Radio already pay on a per-listener, per-song basis—though their rates too would rise under the most recent set of changes.

Specifically, from 2006 to 2008, Web radio music royalty rates will double to 0.14¢ every time a song is streamed to a listener. For a Webcaster playing 14 songs an hour, that will come to 2¢ per listener per hour in 2008. For radio stations with thousands or millions of listeners, those pennies add up. "The rates are disastrous," says Joe Kennedy, chief executive of Pandora, which creates custom radio streams for users. "I'm not aware of any Internet radio service that believes they can sustain a business at the rates set by this decision." The board stipulates further double-digit royalty rate increases through 2010.

Bad for Business

Even large companies such as Yahoo Music may not be able to afford the new rates, says the Digital Media Assn. (DiMA), which counts Yahoo as a member. "DiMA companies are reevaluating the viability of the Internet radio business," said Jonathan Potter, executive director of DiMA, in a statement. As a result, some Webcasters may have difficulty raising money from venture capitalists and may have to shutter their business or seek to be acquired by large companies that can absorb the losses. "The rates have come on the high end of what's been expected, and valuations will be lower," says Rags Gupta, a former Live365 Internet Radio executive who now consults for venture capitalists and digital media companies.

Bummer for the growing slice of U.S. listeners flocking to Internet radio. As much as 19% of U.S. consumers 12 and older listen to Web-based radio stations, according to a survey of 3,000 Americans released by consultancy Bridge Ratings & Research on Feb. 21. That's up from 15% a year ago and indicates some 57 million weekly listeners of Internet radio programs. More people listen to online radio than to satellite radio, high-definition radio, podcasts, or cell-phone-based radio combined.

A "Sinking Ship"?

To cope, some broadcasters are already considering moving operations overseas, out of the CRB's reach. Others are looking into playing fewer songs and expanding talk shows. Some may run more ads. Trouble is, most listeners want mainly music. And increasing the frequency of ads or raising ad rates won't work for some smaller sites, where advertisers haven't exactly been knocking down the door. "We were just getting our foothold, now we have to start all over again," says Bryan Payne, CEO of Spacial Audio, a seller of software and services for Internet broadcasters. "We are all on the same sinking ship."

Unless the CRB decision can be reversed or renegotiated on appeal. Indeed, the decision itself states that it "does not mean that some revenue-based metric could not be successfully developed as a proxy for the usage-based metric at some time in the future by the parties." Many Webcasters are counting on DiMA and larger Webcasters to renegotiate the deal. On Mar. 7, when a subcommittee of the House committee on Energy & Commerce will hold a meeting on the future of radio, DiMA is expected to offer criticism of the decision. Some Webcasters hope Congress will get involved and establish different royalty rates for small broadcasters. The now-expired Small Webcaster Settlement Act of 2002 stipulated that certain noncommercial Web radio stations didn't need to pay royalties at all, while other small businesses only paid a percentage of their expenses or sales.

Jeff Bachmeier, president of Minneapolis-based Web radio station Club 977, says the recording industry benefits from the existence of small Webcasters and should be willing to be a party to renegotiated terms. "I don't think the labels want Internet radio to go away," he says. After all, people often discover songs on the radio and then buy the actual recordings. A DiMA survey of 1,008 online music radio listeners and music services subscribers published in January found that nearly half are spending more than $200 per year on music, and nearly 30% are spending more than $300. Before the Internet, an average consumer only bought about $100 worth of CDs a year.

Negotiations over fees could take months, however, while the impact on the Web radio industry is expected to kick in almost immediately. "It's just sad for Internet radio because it has such high potential," says Paul Palumbo, founder of consultancy AccuStream iMedia Research. "Wranglings over copyright will limit its growth," he says. "It's going to cause confusion, concern, and pulling back."

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