The Washington Post has an article on Pandora yesterday in which they say the company is close to going out of business...

Pandora is one of the nation's most popular Web radio services, with about 1 million listeners daily. Its Music Genome Project allows customers to create stations tailored to their own tastes. It is one of the 10 most popular applications for Apple's iPhone and attracts 40,000 new customers a day.

Yet the burgeoning company may be on the verge of collapse, according to its founder, and so may be others like it.

They go on to lay the blame on higher fees imposed on Internet Radio by the record labels...

Traditional radio pays nothing in performance royalties, though SoundExchange is pressing to change that. Satellite radio pays 6 or 7 percent of revenue. And then there are webcasters, which pay per song, per listener.

Using listener figures from Arbitron for XM Satellite Radio, it is possible to estimate that the company will pay about 1.6 cents per hour per listener when the new rates are fully adapted in 2010. By contrast, Web radio outlets will pay 2.91 cents per hour per listener.

I've talked about Pandora before (just this week in fact) and admitted I'm a huge fan of the service.  Beyond that, as a purchaser of digital music I have to say Pandora drives more of my music purchases than anything else. 

Bottom line: I think this is short sighted on the Record Label's part. 

That said, the Internet reaction to this news gives some important insight to why the labels have become so stubborn in regards to the net and I wanted to give a few examples to make that point.  First from Warner Crocker of Life on the Wicked Stage...

Well, call off the negotiating. I think Pandora should just pull the plug. Take $17 million off the table. Others should follow suit. Let the Sound Exchange explain that to its clients.

OK, let's look at this realistically.  The music business makes about $12 billion per year meaning the $17 million Pandora is paying is the equivalent of pocket change.  I can almost guarantee you they spend more on private jets in a year. 

I'm not endorsing the behavior but truthfully Internet Radio doesn't mean anything to the labels.  It's a situation where they have virtually nothing to lose and are empowered by that to squeeze as much profit out of the Internet as possible.  The question is, why are they squeezing so hard?

Which brings me to Michael Arrington of Techcrunch...

For now the labels want to squeeze more revenue out of Pandora and others. But when these companies start to go under and the bird in the hand disappears, they may regret their overly aggressive negotiating stance. It’s time for the labels to die, and anything that cuts off another revenue stream is at least partially good. I’m reluctantly willing to sacrifice Pandora if it quickens the inevitable march of recorded music towards free. Let’s just hope it doesn’t come to that.

Beyond the point above regarding how little Pandora means to the labels the truth of the matter is that record labels are seeing improved profits.  In particular, EMI is seeing great success since becoming privately held and making some much needed management cuts.

I've said this several times before but I'll happily repeat it: Record Labels make good money.  When they report losses it's almost always because of bad business decisions and poor expense management. 

So there's no way Pandora's death is going to bring about a revolution.  Which brings me to Steve Hodson of WinExtra...

The problem is that unless there are some late ditch efforts on behalf of webcasters like Pandora and even smaller providers they will find themselves being driven out of business. In the end though we are going to be the losers because as more and more legitimate ways to discover new music and easy ways to purchase that music in ways that doesn’t include the record label. What will happen is that there will be more and more piracy of music regardless of the efforts of crooked organizations like the RIAA – and that you can take to the bank.

The position Mr Hodson is taking basically says "Take Pandora away because I don't believe in any compromise".  The reason that's true is because the record labels can't divorce themselves from the process.  So when you say "easy ways to purchase that music in ways that doesn’t include the record label" you're saying there's no point in trying to reach a reasonable compromise on their end.

So this has been a long post but I wanted to lay these out for an important reason.   I think the record labels are being unreasonable here largely because of the public sentiment shown above.  If I'm a record label exec looking at those posts I'd certainly be tempted to write off the Internet market all together. 

Unreasonable behavior begets Unreasonable behavior.  Take the position of "all we want from you is to die" when talking about the record labels and you take away any incentive for them to compromise.  That in turn leads to a no mercy attitude towards the Internet which is exactly what we're seeing right now.

Bottom line, your contempt for them breeds their contempt for you and they have all the power which makes that situation bad for you.

Addendum: Based on a few e-mails I've gotten I wanted to post this link to a post I wrote about 6 months ago entitled "Why Record Labels aren't going anywhere".  If you think I'm wrong because the Record Labels are close to death I'd ask you to give me one more minute of your time to read it.

Yesterday I went over how I think the music industry got itself into the trouble that it is in now.  Today I'll give you my attempt at fixing those problems.  Below is my advice on how the industry can make a few necessary changes that will allow them to not only survive the digital revolution but prosper in it.

I should say there are two basic principles that run through all of these suggestions.  First, the record industry needs better management from the top down.  Second, file sharing can't be stopped completely but by giving people most of what they want (e.g. the ability to share music) while cracking down on those who really are thieves you can dissuade the great majority of people from trading (which should be good enough for your bottom line)

That said, here is my advice to anyone who runs or would like to run a Record Label in the future.

Streamline the Business: As I laid out yesterday I think the record industry has been badly mismanaged in the last decade or two.  Very much so. 

I'm told there are departments with hundreds of people who deal with booking concert venues alone.  That's ridiculous.  A computer program could do that for gods sakes, it requires at best one person.  There are only so many venues and the people running those venues will decide what acts they want.  All the label needs to do is work out the scheduling.

The record labels are rife with these examples.  As I've said before I don't think most acts are going to go without the record labels.  But the fact that a few artists could go without them shows just how little they are doing right now and just how much they could be streamlined. 

Share Expenses Where Possible: There are few things that the record industry does well but one of those things is collaboration with their competitors.  This is something that should be pursued further.  There are things like manufacturing which every record label does EXACTLY the same and which get cheaper as you scale up. 

Labels should identify those things and collaborate on them just as they do when funding things like the RIAA. 

Cut Costs on Your Product: Look, the last couple decades were good times.  I know.  But now everyone knows a CD only costs a $1 to physically manufacture and if you streamline your business it shouldn't cost that much on the back end either.  Time to face the reality, prices need to come down.  If you haven't managed to streamline down enough to get the cost of a song to at least $.69 than you need to try harder. 

Redesign Your Product: I hate to be the one to say this but the reality is that the days of CDs with full color booklets and fancy packaging is over.  Record Labels need to lower the cost of their physical product by as much as possible.  Still make it look good, but maybe just an insert rather than a booklet. 

That said, they need to listen to the words of Radio Head's lead singer and realize that people want a physical product! But here's the trick...they also want instant gratification.  So give them both, use the physical product to sell your digital downloads.  Make songs available for $.69 per track or allow people to buy (and download) the whole digital album and then have the CD shipped to them for a little more.  Customers get everything they want and the record labels get people to start buying whole albums again rather than individual songs.  Everyone wins.

Make Music Available for Free (but NOT downloadable): People like to share music  and people sharing music MAKES MONEY for the record labels.  As long as those songs aren't being stolen while they are being shared.  The record labels' task is to make their music available far and wide just as long as it can't be downloaded.  They need to stream in a way that makes it easy to send, embed, share, and in any and every way distribute (again, as long as it isn't downloaded)

In fact, they need to go further. 

There are plenty of companies out there doing innovative things with music.  Buy or emulate companies like Last.fm and make some money while you are at it.  This is one of the only items on this list that will cost the labels money but its the most important and there are plenty of ways to make money off it if they try.

Bottom line: all a person should need is a computer and an Internet connection to access and share every song available for purchase.  But if they want to walk away from the PC, they have to buy it.

Use Watermarks & ISP Filtering: Labels need to watermark their music.  No if, and, or but about it there is no reason that a law abiding legal purchaser of music should have a problem with a watermark as long as its just that.  Not something that tries to transmit data back or anything like that, just a mark.  Labels need to earn the purchaser's trust and that means a watermark that is benign.

Then they need to spend some money and hire people to create a filtering mechanism for ISPs.  Software that they will then GIVE to the ISPs for FREE.  Don't expect the ISP to protect the label's product, they need to create a division of their business that works with ISPs to filter music.  In fact they should pay the ISP to do it!  Then, if they fight it, the label can sue them for aiding pirates! 

Carrot and a Stick. 

That said, they can't go overboard.  Filter p2p networks and that's it.  If someone e-mails a song to a friend they need to let it be (unless the person is making a mailing list or something).  Be reasonable with your customers (by giving them a wide berth) and they will be reasonable with you (by paying you instead of trading) 

Sue, Sue, Sue...but give on "out": I'm pro-lawsuit in the music industry.  That's big for me too because I'm a big proponent of Tort Reform.  But File Sharing (now that DRM is all but gone) IS stealing and I have no problem with people who steal being sued for it.  But for it to be effective you have to do it right and that means not looking greedy.  Most people like justice and most people believe file sharing is stealing but no one likes revenge and no one likes greed. 

The irony of the RIAA suits is that the record labels come across as greedy when they really never see the money.  The Defendant's don't have that kind of money so they just declare bankruptcy which means the person's life is ruined (to an extent) while the record industry looks greedy for getting no money.  Its stupid. 

So my advice is this: Sue people's pants off.  Dramatically increase the lawsuits both in how many people you sue and in how much you ask for in penalties...and then give the person an out.  Make the law suits massive to send the message that p2p IS WRONG but then let people off by having them do (a lot of) community service.  It still reinforces that p2p is wrong but it also helps the community, allows the traders to go on with their lives and keeps the record labels from looking greedy.  Everyone wins.

Plead Your Case: Most people know that things don't come for free and most people don't have a problem with that.  Further, those who do have a problem with that will never be convinced.  So focus on putting serious effort into explaining the logic behind paying for music to those you can convince.  Maintain a list of artists who have been dropped from their label because they had poor sales and remind people that p2p deprives fans of music when this happens because these artists will probably never release another album.  Map out every conceivable way that p2p hurts the industry and detail it for people. 

If you sell your product for a reasonable price (see above) and you spend some marketing dollars pleading your case most people will side with you in the end.

Support Alternate Uses: Things like remixes SELL the record labels' product and need to be embraced.  There is a problem in that a remix that is too close to the original product is a bad thing but labels still need to empower these people in every way possible.  Perhaps a review process or something like that would do the trick but whatever it takes the labels need to make it so that these people can do their thing. 

Addendum: For the record, when I said "p2p is wrong" above I meant "if the people selling the music don't agree to it".  I don't know of anyone who has tried to make their money off the p2p model (a.k.a. giving away their music for free in order to make it off other revenue like concerts and other items) but if they did I wouldn't have a problem with it.  My issue is with people who use p2p against the wishes of the people who created the content.

There's an article by Simon Napier-Bell over at the Guardian where he essentially says he realized record companies were useless in the 60s and nothing has changed.  I'm not going to quote from it because, to be blunt, its foolish.   The idea that the industry of the 60s is anything like the industry of today is contrary to everything I have ever heard (from people with more to their credit than "I managed Wham! for a few months").  The fact that they look the same from his limited position shows just how little he knows about what is really going on. 

But for the record...Are there fools in every industry?  Yes.  Do record companies take advantage of new acts before those acts gain enough popularity to dictate terms?  Absolutely.  But that's about where his insight ends. 

His article did get me to thinking though...

One regret I have over all the RIAA talk on this blog is that I've never gotten the chance to say what I think the Industry should do to save itself. 

Due to the circles I travel in I've had the opportunity to talk to record execs, starving artists trying to get signed and everyone in between.  So I have a pretty good idea of what is going on and how I think it could be best fixed.  But I've never got a chance to put it into words.    

Which brings us to this.  I had planned on only one post but there's too much to say so today is what I think went wrong and tomorrow will be how I'd fix it.

All that said I think the reality of the situation, from all I've been able to find, is that the Record Labels are in trouble because they have been badly managed in the last decade or two.  Not because of file sharing or p2p as many would have you believe.  The music industry became so big in the 60s and 70s that it essentially become procedural by the 80s.  It has come to the point where there are whole business units for every step of the process.  Which is why the business practically ran itself for the next couple decades and, as successful businesses that need little management tend to do, became even more bloated.

This is something you see in every business or industry where there isn't much innovation.  The tech industry saw it with early IBM when they essentially sat on their laurels and just became bigger and bigger for years.

Anyway, by the late 90s this had caused the management to be poor.  When the business runs itself the people who rise to the top only need to know how to suck up to board members to be successful. 

So you get situations like the ones revealed in the purchase of EMI where spending was so out of control that they were spending hundreds of thousands of dollars on "Fruits and Flowers" (whatever that means).  Or the CEO of Universal saying "he couldn't find a good technology person" (this was at a time when Computer Science was the fastest growing major in existence).  I could go on and on but the bottom line was that the music industries' fall was a result of bad management not technological innovation.  It is hard to keep revenues rising when you are spending like a drunken sailor and doing absolutely nothing to innovate.

But in the same way that bad management got them into this mess I firmly believe that good management could get them out of it.  In fact, I believe the music industry can not only survive but be reinvigorated by digital technology.  But that, is for tomorrow...

Short Addendum: Since this is a technology blog I wanted to address file trading specifically.

I don't believe file trading had that much to do with the industry's downfall.  There's no question that it costs the labels money though and what bothers me is that so much focus is on kids trading songs

Kids have always made copies of music without paying for it and they would have continued to do so in the digital age.  The only thing that changed is the media.  But by not embracing digital distribution early on (another sign of bad management) the labels forced adults to take up file sharing which has led to most of the losses that file sharing has produced. 

Adults were in the habit of paying for music before the labels forced them into the hands of Napster 1.0.   That's now the problem because people will pay for what they have always paid for but will resist paying for what was once free.  Music now fits into the "was once free" category.

That said, I think good management and a little marketing could stop 99% of file trading and I plan to cover that (along with other stuff) tomorrow.

There was one last point that I didn't get to address yesterday and that was this lingering theory on the part of the blogosphere that the Record Labels are close to extinction.  That isn't likely to happen and I'm going to tell you why.

In reading this keep in mind that from High School on I grew up in Southern California and I grew up with a parent who acted in live theatre which eventually got me into the tech part of live theatre.  I grew up doing productions and have more than 75 different musical productions to my credit so I know more than my fair share of actors and musicians.

Also, the characterizations below are generalizations and I know they don't apply to every single person in each category.  That doesn't change the fact that they apply to the great majority of each group and because of that fact they are helpful in addressing the issue at hand. 

All that said, lets start by looking at bloggers.

Bloggers like to think the world is filled with people just like them but the fact is that its not.  In this particular topic that is relevant because bloggers by definition are at least mildly entrepreneurial.  Even if they don't run a company themselves the sheer act of putting  up a web site suggests the presence of the entrepreneurial spirit. 

The polar opposite of bloggers are artists who aren't at all entrepreneurial.  They want to focus on their art and they don't want to worry about marketing their art or packaging their art or any of the trappings of selling their art.  Their ideal world is one where they can spend all their time on the art and just have a pay check show up at the end of the day. 

This is why bloggers don't understand the role of Record Labels.

Record Labels rose up to fill the artist's need by doing all the stuff the artists didn't want to do.  Someone had to step up and get the artist's music into the hands of the consumer and the artists themselves had no interest in being that person.  That is why Record Labels exist and that is why they will continue to exist.

Don't get me wrong, it isn't out of the realm of possibility that the current crop of labels will die.  I doubt it will actually happen but it isn't an impossibility.  But the thing to remember is that the only way they'll die is if someone else shows up to take their place.  Because someone has to continue to fill that void. 

If that new group of business people show up they'll still need to protect the artist's interests so they'll still have to hire lawyers and those lawyers are going to advise them to do the same thing the current labels are doing now.  In fact, the odds are good that a new group would make it worse because they will be up for a fight where as the current crop has, to an extent, been beaten down by public criticism.

But one way or the other Record Labels are still going to have to protect their product from being stolen.  That is an inalienable fact.  There is certainly room for new business models but someone is going to have to make the case for those models to a Record Label.  Whether that's the current crop or a new crop really doesn't matter because each will be facing the same issues and each will be advised by the same lawyers. 

You want to make a difference in the industry my advice would be to build a better mouse trap.  Don't bother hoping for, wishing for or predicting the death of Record Labels because it isn't going to happen.  Instead figure out how the Record Labels can still make their money without having to resort to the RIAA's tactics.  Because answering that question is the only way this situation will ever be resolved.