In April 2024, Spotify announced a price increase for its ad-free premium subscription plan. This is the second price increase in 10 months and will go into effect in the United States later this year. According to Spotify, the latest price increase is tied to the addition of audiobook offerings to the premium subscription plan. Although Spotify initially added select audiobooks to the premium service in October 2023 without any additional cost, the impending price increase coupled with the introduction of audiobook-only and music-only plans coincides with the strategic reclassification of the premium subscription plan as a “bundle.”1 This reclassification is significant because it directly impacts the mechanical royalty fees that Spotify is required to pay to rightsholders. Despite raising prices for subscribers — a perennial desire of songwriters and publishers — royalty payments are projected to plummet.
As expected, the response from the music publishing and songwriting community was negative and swift. Within days, the National Music Publishers’ Association (“NMPA”) accused Spotify of “attacking the very songwriters that make its business possible.”2 This public volley was followed by the initiation of a lawsuit by the Mechanical Licensing Collective (“MLC”)3 and a formal complaint from NMPA to the Federal Trade Commission (“FTC”). NMPA also sent letters to multiple states attorneys general citing the violation of various consumer protection laws.4 The common thread of complaint from the aggrieved parties is Spotify’s alleged manipulation of existing law and the resulting underpayment of royalties.
Under applicable law, bundled service offerings allow a service provider to silo revenues derived from each service source. As such, only the revenues attributable to that source are used to calculate any royalties due to participating rightsholders. The end result is a significantly smaller pie to share with eligible stakeholders.5 Although both Amazon6 and Apple7 have historically taken advantage of “bundle” accounting and discounts, Spotify’s reclassification move appears to be a bridge too far for rightsholders. In real numbers, some suggest that the “bundle” discount means Spotify, as the market leader, will pay $150 million less in mechanical royalties in 2024.8
Brief History of Mechanical Royalties
The origin of the mechanical license and royalty is traced back to the early 20th century. At the time, copyright holders complained that their sheet music was being mechanically copied and used by the player piano industry without authorization. In response, Congress, through the Copyright Act of 1909, codified the exclusive right of the owner of a musical work to mechanically reproduce and distribute that work. As a result, any third parties (i.e., the player piano dealers) that desired to copy and/or distribute copyrighted music were required to first secure a license for such use. Hence, the birth of the mechanical license. Significantly however, addressing concerns about enabling monopoly power, the 1909 Act also introduced the concepts of the “compulsory license” and the “statutory rate”9 to the mechanical licensing scheme. The “compulsory” nature of the license means the copyright owner generally can’t deny a mechanical license to any interested third party so long as they pay the established royalty.10
Over the next century, the Copyright Act underwent multiple revisions and updates, but the compulsory mechanical license framework remained mostly intact. In 2018, in response to the rapid growth of digital streaming, Congress passed the Music Modernization Act (“MMA”) to close various gaps in existing law as applied to new technologies. Specifically, the “notice of intention” process had become overly burdensome as digital streaming service providers (“DSPs”) flooded the copyright office with compulsory license requests. For the first time, the MMA allowed DSPs such as Spotify to secure a blanket mechanical license to stream their entire music catalog to end users. In exchange for this blanket license, the DSP pays a mechanical royalty to a newly formed clearinghouse created by the MMA called the Mechanical Licensing Collective (“MLC”). The applicable mechanical royalty rate is determined by a panel of three copyright review judges known as the Copyright Royalty Board (the “CRB”) and is subject to comment and modification every five years.11
Phonograph IV
The current five-year period, which began on January 1, 2023, is known as Phonograph IV. Unlike the fixed “penny rate” fee that is used for physical reproductions, the royalty rate for streaming is a percentage calculation applied to eligible DSP revenues. This percentage is based on various factors, including the nature of the licensee’s service (add-free versus add supported), the service subscription cost, and the fee amounts paid to other rightsholders such as record labels and distributors.12 The royalty rate established by CRB for Phonograph IV resulted in a 44% increase in the headline percentage rate that Spotify and other DSPs must pay for interactive streaming services (an increase from 10.5% to 15.1%). However, while the royalty rate increase was almost uniformly cheered by the industry, some voiced lingering concerns over bundle accounting rules and related discounted rates available to providers of “mixed service bundles.”13
The net portion of mechanical revenue derived from bundled services is determined by calculating the value of a service offering (e.g., the audiobook service) as a standalone offering relative to the combined value of the premium bundle subscription plus the specific service offering (e.g., the audiobook-only service). For purposes of the Spotify premium service, the value of the music offering is approximately 52% of the overall subscription.14 Assuming that Spotify’s premium service qualifies for bundle treatment under the law, the company may reduce their mechanical royalties payable to rightsholders by a comparable percentage subject to a floor known as the “TCC Prong” (“Total Content Cost Prong”). The resulting reduction is now applied to the revenues collected from almost 50 million Spotify premium subscribers receiving bundled services.
Now we ask: bundle or bungle?
Proposed Changes to Copyright Act
In response to Spotify’s recent moves, NMPA sent a letter to the U.S. House and U.S. Senate urging modifications to the century-old “compulsory licensing” and government rate-setting framework. Framing the argument, David Israelite, CEO of NMPA, characterized the compulsory license process as a “100-year-old mistake.” Specifically, Israelite requested that songwriters and publishers be granted the right to (1) individually opt out from the MLC blanket licensing regime created by the MMA; and (2) negotiate mechanical licenses and fees directly with licensees. This proposal effectively guts the compulsory license right, which was initially developed to forestall monopoly and encourage creative expression.
We must evaluate the practical impact of eliminating the compulsory license. The recording industry, as we know it, is wholly dependent on the ability of artists to efficiently secure compulsory licenses for previously published works. Consider, for example, the obstacles NMPA’s proposal would create for recording artists who wish to release cover songs from publishers who have opted out, or the impact on the distribution of works administered by joint-owners with conflicting interests. As an alternative, perhaps calculating mechanical revenues based on a user’s actual consumption of bundled services would be a fairer and more palatable direction. Regardless, the likelihood that Congress will entertain, let alone pass, radical modifications to the compulsory mechanical scheme is highly unlikely. However, the existence of such a proposal speaks to the current volatility in the industry and previews where we may be going.
[1] For purposes of the law, “bundle” is defined as “a combination of a Subscription Offering providing Eligible Interactive Streams and/or Eligible Limited Downloads and one or more other products or services having more than a token value, purchased by End Users in a single transaction (e.g., where End Users make a single payment without separate pricing for the Subscription Offering component.” See 37 CFR § 385.2.
[2] See https://www.billboard.com/business/publishing/nmpa-david-israelite-spotify-bundling-music-plan-legislative-proposal-1235687751/.
[3] See https://www.reuters.com/legal/litigation/spotify-sued-over-millions-allegedly-unpaid-music-royalties-2024-05-17/.
[4] See https://www.billboard.com/pro/nmpa-spotify-bundling-war-continues-ftc-complaint/.
[5] See 37 CFR § 385.11.
[6] The Amazon Prime bundle includes Amazon Music, Prime Video, and Prime Gaming services.
[7] The Apple One bundle includes Apple Music, fitness, gaming, news, and cloud storage services.
[8] See https://www.billboard.com/business/streaming/spotify-songwriters-less-mechanical-royalties-audiobooks-bundle-1235673829/.
[9] The statutory rate established by Congress was $0.02 from 1909–1976 and was raised to $0.0275 in 1976. The rate is currently $0.124 for recordings under five minutes or $0.0238 per minute for recordings over five minutes.
[10] A compulsory mechanical license (1) cannot be used for a so-called “first use” publication; (2) cannot be used to duplicate an existing sound recording; and (3) the arrangement “shall not change the basic melody or fundamental character of the work.” See 17 U.S.C. Sec. 115.
[11] See 37 CFA 385.21 et. seq.
[12] See 37 CFA 385.21(b).
[13] See 37 CFA 385.2.
[14] Spotify’s audiobook-only subscription price is $9.99 per month and the value of the premium bundle is $10.99. The bundle discount calculation is $9.99 / $20.98 = ~48%.
