FORTUNE — We must presume that the former members of Pink Floyd didn’t actually sit in a room together to compose and sign a letter complaining about Pandora Media’s efforts to cut the royalty rates it pays to stream music to its customers. Those guys really just don’t like each other. Still, it’s a testament to the frustration on the part of a fair number of musicians that the art-rockers were brought together on this issue.
That they are both justified in their frustration and wrong on the facts is a testament to the confusion and misinformation surrounding the issue, as well as to the troubling economics of the music business (where the market value of recorded music is low and falling), especially online (where the market value of advertising is low and falling.)
Music royalties are incredibly confusing, and purposely shrouded in mystery. But the bottom line is that Pandora (P) pays more to stream music to its listeners than do other forms of non-terrestrial radio — cable and satellite. And yet, the royalty payments it shells out don’t add up to much for artists. Another critic of Pandora, David Lowery, founder of the bands Cracker and Camper Van Beethoven, recently complained that after one of his songs was played a million times on Pandora, he got only $16.89. An analysis by blogger Michael Degusta determined that Lowery actually got more than $1,300, a vast difference that nevertheless doesn’t really change Lowery’s point: Pandora doesn’t pay very much to artists.
And it never will. If Pandora paid out what many of these artists believe they should get, the company would go out of business in a week. Consider that satellite radio pays about 7.5% of its revenue in royalties, and cable radio pays about 15%. Meanwhile, more than 60% of Pandora’s revenues go to pay royalties. Terrestrial radio still pays nothing to music publishers.
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Despite the war of words, Pandora is in reportedly in serious negotiations with groups representing artists and music publishers to resolve their differences.
As things stand, Pandora’s costs are expected to keep rising: In 2012, the company paid out just over a tenth of a cent per stream. Next year, that will rise to 0.13 cents, and the year following, to 0.14. In its most recent quarter, Pandora logged sales of $125.5 million, and losses of $28 million.
On the plus side, the company is growing fast. Last week, Pandora announced that its number of listeners in cars had grown past 2.5 million. The service will become available in more than 100 car models this year, the company said, and will be installed in a third of all new vehicles. Half of all Pandora listening takes place in cars. Pandora now has more than 70 million monthly users, representing 7% of all radio listeners. Assuming it can get past its many challenges, Pandora has nowhere to go but up. Investors are optimistic: shares have doubled in value since the start of the year.
But making money from all those listeners is a supreme challenge. Its music-industry opponents say it’s not their fault that Pandora hasn’t been able to collect enough revenue to cover its royalty costs. Advertising rates aren’t enough, so Pandora now caps the amount of free, ad-supported listening, hoping more people will convert to its paid service. But if it can’t get its royalty rates lowered, it seems unlikely that Pandora will manage to break even, much less thrive, any time soon — especially given the burgeoning competition from the likes of Apple (AAPL) and Google (GOOG).
Its chief opponent is the American Society of Composers, Authors and Publishers, which this month accused Pandora of “trying every trick in the book to brazenly and unconscionably underpay” rights holders.
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One of those tricks was Pandora’s decision earlier this month to purchase a terrestrial radio station, KXMZ in Rapid City, S.D. It is in some ways a publicity stunt, but one with a pointed message: radio operator Clear Channel pays lower royalty rates on songs streamed by its Internet service, iHeart Radio, because it is a terrestrial broadcaster. This is an insanely complicated matter of deep dispute between Pandora and ASCAP. Suffice to say that both sides are playing serious hardball.
Meanwhile, Pandora is fending off the charges by Pink Floyd by saying the band, and other musicians, have been misled. Pink Floyd had responded to a letter from Pandora trying to get musicians on board with its mission to get its royalties lowered. The message hit a wall, and Floyd responded that the letter was self-serving, and that Pandora was pretending at being in support of musicians while actually just trying to grow its business “directly at the expense of artists’ paychecks.”
Pandora responded that the band’s assertions were “the result of a well-orchestrated campaign” by the recording industry “to mislead and agitate artists.” Pink Floyd’s assertion that Pandora wants an “85% artist pay cut” is simply not true, the company said. “In fact, Pandora has suggested solutions that would guarantee no reduction in artist payouts while also nurturing the growth of Internet radio.”
Pandora didn’t go into specifics on those “solutions,” but one thing is true: the more Pandora grows, the more money artists will collect.
