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Biting the hand that feeds you: why are record labels fighting Pandora?

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Labels want streaming and web radio to grow the pie, but want their share too

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A few years ago, leaders from the major record companies planted the seeds from which they hoped would spring the next generation of music distributors.

Apple's iTunes, the overwhelming leader in the sector, went largely unchallenged. Megastores like Tower Records and Sam Goody had vanished long before. Apple used its position as the top music store to dominate the labels, gradually pushing them to give up DRM while limiting their ability to price music. In response, the record companies licensed unproven streaming and subscription services in the hope that some of them would find audiences. The labels dubbed these services "access models" and the surviving companies — YouTube, Rdio, Spotify, Vevo, Pandora — are now starting to bear fruit.

"This underscores how vital it is to protect these increasingly important revenue streams."

The money generated from these nascent businesses totaled $1 billion last year, according to a report issued Tuesday by The Recording Industry Association of America (RIAA), the trade group representing the largest record companies. After a decade of plummeting revenue, it's a safe bet that label managers will cling tightly to these new sources of cash, since the access models are the fastest growing segment of the music business.

But the RIAA's numbers also raise the question about how far the labels are willing to go to nurture this new wave of distributors. Spotify and Pandora, neither of which has found profitability, are each seeking to lower music costs. For the record companies, it's like walking a tightrope. They must balance their desire to maximize profits while they avoid killing the new revenue stream in its infancy. If access models fail, the labels risk ending up back in a world where a single player like Apple holds all the power.

"iRadio is coming. There's no doubt about it anymore." In February, The Verge broke the news that Spotify is in negotiations to renew licenses with the record companies, with Spotify asking for significant price breaks. Music sources have said that the industry is confident that a deal will get done relatively quickly as the labels are eager to help Spotify. But Pandora faces a much tougher road. Sources say the labels have a love-hate relationship with the web's top radio service. Yes, Pandora paid an estimated $275 and $325 million to labels and artists, but the labels argue Pandora chokes off demand for other services that are more profitable for them.

In its biggest market, the United States, Pandora doesn't negotiate for music licenses directly with the record labels. The company takes advantage of a royalty rate set by Congress available for any web radio service. Pandora now says the statutory rate is too high for it to build a profitable business.

Last year, the web's top radio service tried getting the Internet Radio Fairness Act (IRFA) passed. The bill went nowhere, but Pandora, which is looking for a new CEO, is expected to take another run at Congress. Any reduction in the royalty rate cuts directly into the music labels profits. They helped derail IRFA and will continue to fight.

Battling Pandora will be tricky for the music sector Battling Pandora will be tricky for the music sector. Multiple music industry insiders have told The Verge that the labels consider Pandora a capable and communicative partner. Then there's the money. According to the RIAA report and statements made by SoundExchange, the group that collects royalties from web radio services, Pandora contributes about 25 percent of all the money the labels receive from the access models. (Incidentally, SoundExchange's revenue was up 58 percent last year.) But this is precisely why the RIAA won't budge on the rates. Sources say that the labels believe web radio is bigger than Pandora and the market will expand soon. Apple is coming.

Much has been written about Apple's plan to launch a Pandora-esque service this year. Now multiple music industry insiders have told The Verge that significant progress has been made in the talks with two of the top labels: Universal and Warner. One of the sources said "iRadio is coming. There's no doubt about it anymore." Apple is pushing hard for a summertime launch.

"Access models are our present and our future," Cary Sherman, the RIAA's CEO, told The Verge. "[This] underscores how vital it is to protect these increasingly important revenue streams."

The New York Post reported last month that Apple wants to pay 6 cents per 100 song streams. According to the Post story, Pandora currently pays under the statutory rate 12 cents per 100 spins. By comparison, Spotify pays as much as 35 cents.

Whatever the ultimate rates, if the labels give Apple a better deal, that would give Pandora plenty of ammunition to argue on Capitol Hill that web radio is getting screwed.