When regulations attack (internet radio)

Nothing better than starting Sunday morning with some music. The first entry in a google search (here) led me to http://www.pandora.com/.

Pandora is an automated music recommendation and Internet radio service created by the Music Genome Project. Users enter a song or artist that they enjoy, and the service responds by playing selections that are musically similar. Users provide feedback on the individual song choices — approval or disapproval — which Pandora takes into account for future selections.

Here's the latest. Pandora doesn't allow access to listeners outside the United States. This is not the case because of some security threat. Instead Pandora has sited 'licensing constraints' as the reason for disallowing access. And so ... I digged further.

On May 1, 2007, the United States Copyright Royalty Board approved a rate increase in the royalties payable to performers of recorded works broadcast on the internet. The rates include a minimum fee of $500 (U.S.) per year, per channel, with escalating fees for each song played. The decision is retroactive, so for 2006 the applicable fee would be $0.0008 per performance. A performance is defined as streaming one song to one listener, i.e. a webcaster with 10,000 listeners would pay 10,000 times the going rate for every streamed song. The fee increases in increments each year, which amounts to $0.0019 per song by 2010.

The current revenue model of most Internet radio stations is - 1) Advertising (which is often a %age of the number of listeners) and 2) Subscription (which is not very high as there are enough free alternatives for listeners). On the cost side, until now most small webcasters have paid royalties calculated as a percentage of revenue or, pay per song irrespective of the number of listeners. Under this new rule, those outfits will have to pay on a per-song, per-listener basis. Webcasters say, royalties on a per song-per listener basis may exceed the total revenues of the webstation.

On the surface, these amounts of $0.0014 may not sound terribly onerous, but they could add up quickly. For instance, if 10,000 people listened to fifteen songs an hour for 24 hours on an Internet-only station, the fee would be over $5,000 for just one day.

Understanding regulations is crucial before taking an investment decision. Take Reliance Fresh for example. They wouldn't have imagined a strong backlash by vegetable vendors in UP. While the backlash was bearable, the UP government coming to the support of the vendors (with a restrictive clause) was reason enough for Reliance Fresh downing the shutters on 10 stores there. Similar forays intended by the company in the dairy processing segment might also get some restrictive attention. As value investors, we despise these things. Aptly puts : almost all surprises are bad.