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Is Internet radio doomed?

Wharton experts say a recent royalty decision by the U.S. Copyright Office may price many small content providers out of the market, leaving some with no choice but to shut down forever.

If you have ever listened to your favorite radio station online or surfed one of the many Web-exclusive streaming audio sites around the world, you have probably experienced Internet radio. Web radio stations come in all shapes and sizes; some boast niche-specific playlists, others promote independent artists, and still others simply stream simulcasts of traditional radio programming.

Broadcasting on the Web, or Webcasting, allows audio to be streamed in real time to the listener, eliminating the wait times for downloads. The audience can be international, since there is no signal strength constraint as there often is for terrestrial radio. Most sites require listeners to use special software such as RealPlayer, Windows Media Player or custom players to access the streaming content.

Wharton public policy and management professor Gerald Faulhaber notes that many people listen to Internet radio at work, where broadband connections are more readily available. As reported in USA Today, research firm GartnerG2 estimates that 16 percent of the 156 million adults who use the Internet at work and at home listen to the thousands of radio stations available on the Web. While some Internet radio offerings are affiliated with large media companies, like Radio@AOL, much of it is provided by small sites that focus on particular formats or musical genres.

But the days of independent radio on the Net could be numbered, say some experts. A recently established royalty fee payable to record companies may price many small content providers out of the market, leaving some with no choice but to shut down.

At issue are the royalties Webcasters have to pay for the right to stream songs. Royalties can be broken down into two categories: those paid for the song as it is written by the composer, and those paid for the song as it is interpreted by the recording artist. Terrestrial radio stations are mostly exempt from paying the latter, since they are considered promoters of new music. The Recording Industry Association of America, an organization representing several major record labels, contends that Net radio services are different--since there are ways for listeners to digitally reproduce the music--and should therefore pay the sound recording fees.

In 1998, Congress passed the Digital Millennium Copyright Act, giving record companies the right to collect royalties from Webcasters for the music they play. On June 20 of this year, the U.S. Copyright Office set the rates payable for Webcasters at 70 cents per song heard by 1,000 people. If this decision stands, the first royalties are due in November, and payment of royalties from past years (to 1998) is due in October. Although it is half the rate recommended by a government arbitration panel in February, Webcasters still claim that they will be driven out of business. This is despite the fact that Cary Sherman, president of the RIAA, recently stated that the rate still "does not reflect the fair market value of the music."

On July 15, the National Association of Broadcasters and radio firms Bonneville International, Clear Channel, Cox Radio, Emmis Communications, Entercom Communications and Susquehanna Radio appealed the royalty rate decision in federal court, claiming that Congress intended the fees to apply only to services that allowed users to download songs and not to broadcasters.

Who's listening?
Tom Mondell, a sole proprietor, runs whereveRadio.com, a Net radio service specializing in electronic music. He sees the possibility of a fair exchange between Internet radio and record companies. "We're advertising people's music, exposing it to the Internet world. Most of the music I play no FM station would ever touch. But unfortunately the record companies don't see it that way," he says.

It's not like the music business really is in need of new channels of distribution. There are plenty of ways to distribute music--MP3s, AM/FM, satellite, CDs, etc.
--Gerald Faulhaber, professor of public policy, Wharton
Faulhaber isn't sure that the Internet radio business model will survive. "If it's not sustainable, there will be wholesale bankruptcies in the Net radio space. The content providers won't shoot themselves in the foot; if they're wrong and Net radio players are not able to pay them, they might change the rates or lose the medium. But then, it's not like the music business really is in need of new channels of distribution. There are plenty of ways to distribute music--MP3s, AM/FM, satellite, CDs, etc."

Internet and streaming media consultant Alan Wallace, a former senior vice president at Live365, notes that some large players necessarily straddle the fence in awkward ways. "It's a strange situation: On the one hand, for instance, AOL Time Warner is a record company, but it also does Webcasting."

David Landis, founder of the Ultimate-80s.com Internet radio site, says that recordkeeping constraints are a major--and often overlooked--problem. "They want to know how many listeners heard a song, at what times we played songs, etc., when we pay royalties. That's what the rates are based on. But there's no real way to calculate how many listeners heard the song with the kind of international audience that an Internet radio offering has. The recording industry says there are costs involved with playing music. Yes, there are--and we pay the composition fees to the American Society of Composers, Authors and Publishers (ASCAP), BMI, and SESAC, either a flat fee or a percentage of revenue. We all assumed that the fee for the sound recording would be similar. There was no way to budget for the kind of rates they want now when we launched our stations."

Why Internet radio?
Mike Hays, a country singer and co-owner of TwangCast.com, says he has firsthand experience of what Internet radio can do for an artist. "I have seen the value of Webcasters promoting my work. It gives independent artists exposure that they can't get anywhere else," he says. As a Webcaster himself, he notes that his site ? which he claims gets 60,000 unique sessions per month ? sends more than 300 people daily to retail partner CD Universe where listeners can purchase music.

"Perhaps a bluegrass station can?t attract a large enough audience to be sustainable in a major city. But put it on the Net, and you can get people from all over the world listening to it,? says Paul Maloney, editor of RAIN, the Radio and Internet Newsletter. ?Then you do have enough demand. Internet radio benefits the vast majority of artists who aren't getting on commercial radio stations or MTV or enjoying point-of-purchase displays at music stores."

"The public gets confused between Webcasting and peer-to-peer music swapping services like Napster and Gnutella," notes Wallace. "But this is quite a different issue. Many Webcasters are former DJs who got into the business because they felt traditional radio vastly underserves the music community."

Michael Mazis, a Wharton graduate and professor of marketing at American University's Kogod School of Business, conducted a survey a few years ago for Webcasters and radio broadcasters to determine whether Internet radio use encourages the eventual purchase of music. "The survey found that among heavier users--those who listened to Internet radio several hours a week--there was a pretty strong effect. It did promote the sale of CDs and worked much the way traditional radio works," he explains. The majority of those surveyed at the time, however, were not heavy users, so the overall results did not show any effect on purchasing habits.

Mazis notes that the argument for the other side is that since Internet radio can be narrowcasted, it can displace a consumer's purchasing of music in ways that traditional radio cannot. "Suppose you're a Jimi Hendrix fan, and you can listen to a Jimi Hendrix station on the Web. That's almost like being able to customize your listening," he notes, adding that such a service could be seen to lessen a consumer's need or desire to purchase CDs.

It's almost certain that unless some emergency legislation goes through, most of the Webcasting industry will go away.
--Paul Maloney, editor, RAIN, the Radio and Internet Newsletter
Revenue models
Many Webcasters rely on advertising and commissions from CD sales to make money. "The industry is in its infancy. Most of the independent Webcasters are looking to build revenue through ads, just like traditional radio stations,? says Maloney. ?But Web sites can offer more ad functionality. You can incorporate a visual with an ad, allow listeners to click on a 'buy' button which takes them directly to an online music retail site such as CDNow, etc."

"Audio ads take on whole new capabilities on the Internet," adds Wallace. "Such technology allows advertisers to target marketing geographically.? For example, a single Webcast could include particular ads for lunch specials tailored to the place from which each listener is accessing the stream.

But Mazis points out that niche advertising hasn't lived up to the hype. "Everyone keeps saying there's room for small players; but in reality, what's successful has a lot to do with how advertisers buy advertising. There was hope in the dot-com world that advertisers would want to focus on narrow target markets, but it hasn't worked too well. Why? Advertisers don't want to make a buy for a thousand narrow segments because they don't want to produce separate creatives for each segment. They want to pursue media where they will get a lot of reach. Narrow targeting hasn't really been worth the cost."

An uncertain future
What's going to happen depends on whether the royalty ruling is reversed or modified. "It's hard to tell in the long run where this will go,? says Mazis. ?Even if the economy picks up and there are more advertising dollars being spent, it will be difficult for Webcasters to survive. Because of the low start-up costs associated with these Internet radio stations, there are a lot of them. All can't be profitable; there are too many in the market."

With no action, adds Maloney, Internet radio might indeed be doomed. "It's almost certain that unless some emergency legislation goes through, most of the Webcasting industry will go away."

 
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All materials copyright © 2002 of the Wharton School of the University of Pennsylvania.