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Yesterday, Pandora CEO Joseph Kennedy asked congressional leaders to pass new legislation — the Internet Radio Fairness Act — that lowers music licensing fees for Internet radio services.

Currently, services that stream music over the Internet pay higher licensing fees than traditional broadcast radio, satellite radio, and cable TV radio stations. That means the old  business models are inherently more profitable by default — something that Kennedy believes is an unfair advantage.

“The current rate-setting structure is a clear case of discrimination against the Internet and innovative services,” Kennedy said during House Judiciary subcommittee hearing, adding that its “fundamentally unfair and indefensible.” (It’s worth noting that this isn’t his first time to speak out about unfair digital music licensing.)

Right now, more than half of Pandora’s annual revenue goes toward music licensing fees.  The company generated a record $$101.3 million in revenue during FY13 second quarter by aggressively growing its advertising operations. And much like traditional radio stations, Pandora is now targeting regional ads and marketing sales. It’s also boosted the number of devices (including automobile dashboards), and experienced a drastic increase in the number of hours its users listen (3.3 billion listener hours last quarter).

Yet, Pandora is still firmly in the red — and has been for the last several quarters.

Others who testified at the hearing said Pandora’s inability to turn a profit is due to missteps in its business strategy.

President of SoundExchange, a non-profit organization that collects digital music royalties for copyright holders, Michael Huppe said Pandora chose to focus on increasing its audience with fewer advertisements and low subscription fees. (Essentially, he’s saying Pandora could have made sure its ad sales kept pace with audience growth.) During the hearing, he argued that artists shouldn’t have to sacrifice what they’re getting paid because Pandora isn’t a profitable company.

Others during the hearing argued that all radio businesses should pay the same music royalty rate as Pandora and other Internet radio companies. This opinion is supported by major music companies, SoundExchange, popular musicians, and other music performance organizations.

SoundExchange and trade group musicFirst even rallied 125 high-earning music performers to sign a letter speaking out against Pandora and the legislation that would lower digital music royalties.

As for lawmakers, the members of the judiciary committee didn’t seem overly swayed by either side’s argument.

What the future holds for Internet radio

If Pandora’s plea to congress fails, then one thing will become abundantly clear about the publicly traded company: it needs a new business model. That said, the company’s options are pretty limited.

It could start gobbling up traditional radio stations that spend less on music royalties, thus diversifying its revenue model. But that means Pandora would become an old school media company, with DJs, syndicated talk-radio programs, local promotional events (e.g.  Concert ticket giveaway at a local gas station that just opened), and maintain physical FM radio station facilities. This option is a giant step backwards, and clearly the opposite of innovative.

Another option Pandora has is to begin making its Internet radio service more palatable to independent artist that own the rights to their songs, as well as unsigned music groups looking for another clear path to profit off of their work. This will be more difficult, because any musician deemed successful on Pandora will be easily swayed to sign with one of the large music companies that can offer more exposure and higher profits.

Pandora can’t launch its own music publishing division, either — or at least not without consequence. If Pandora becomes a competing music company, its library of popular song licenses could quickly disappear, causing Pandora users to seek alternative listening options.

What does seem inevitable, is that lawmakers and regulators will eventually need to come up with a standard royalty rate across all platforms.


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