TikTok: Turning the Table on Record Labels

Written by Lillian Gan and Jessie Hung

IBR Editorial Board
Ivey Business Review

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The Rise of TikTok

TikTok is a social media platform built around short, user-created videos and is available in more than 150 markets and 75 languages. Originally launched domestically in China as Douyin, it became available worldwide after a merger with Musical.ly in August 2018. TikTok has revolutionized the way social media is consumed, with its short 15-second video format gaining significant popularity in an age of shortening attention spans. TikTok’s revenue model is based on advertisements and in-app gift purchases. Brands can pay a fee to reach their desired audience on TikTok which uses its proprietary algorithm to target users based on their past viewing activity and engagement levels. TikTok also generates revenue through its users by levying a fee when users choose to directly give monetary gifts to their favorite creators through the in-app currency, TikTok Coins.

Since its launch, TikTok has experienced explosive growth with annual users growing at a 73 percent compound annual growth rate from 2017 to 2021. For users, the short video format makes the in-app user experience addicting and easily consumable. Its “For You Page” feeds content catered to the individualized interests of each user, based on data from user interaction with previous videos, video information (captions, sounds, and hashtags), and account settings. Each video on TikTok is accompanied by a sound clip, commonly a part of a song. Trending sounds on TikTok are used to create millions of videos that pair the sound with original video content. This has allowed both established and unsigned artists to go viral with over 175 trending TikTok songs appearing on the Billboard Hot 100 in 2021. The success of artists like Olivia Rodrigo, who grew her net worth from $500,000 to $5 million in one year after releasing her debut album, exemplifies TikTok’s potential as a hub for music talent discovery and promotion. Rodrigo’s ‘All I Want’ was picked up by a large TikTok audience in 2020, which enabled her subsequent hit ‘Driver’s License’ to top the Billboard Hot 100 in less than 24 hours after release. For creators, the platform promotes creative freedom, a user-friendly interface to post videos, and exposure to a user base of over 1 billion monthly active users. For brands, the app provides valuable insights into consumer trends and preferences, which can be used to promote their products and services to the expansive user base.

Although TikTok has seen unprecedented growth since its inception, it will need to overcome significant obstacles to maintain its position as a global brand within the social media industry. As an app that capitalizes on network effects to derive revenue from advertisements and in-app purchases, the number of active users and videos created on TikTok dictate its success. Key competitors like Youtube and Instagram have reinforced their network effects by building positive long-term relationships with their creators, who are direct drivers of user engagement, content production, and ultimately, ad revenues. In comparison, TikTok has struggled to retain its creators and prevent them from moving to other social media platforms that offer higher pay and more opportunities to nurture creator growth.

A Broken Record (TikTok Overview)

The music industry is characterized by three key dimensions: music creation, music distribution, and talent management, where the key players are artists, streaming platforms, and record labels. As the rights holders to the recordings produced by their signed artists, record labels earn royalties paid by the streaming platforms, commercial licensors, and digital stores for use of their music.

With revenue split between artists, labels, and a series of middlemen, artist compensation is often a topic of frustration for both mainstream and indie artists. Label resources are often allocated to highly limited top talent which has been proven profitable, known as the “blockbuster strategy”. While profitable in the short-term, this strategy limits the creative expression of artists and has resulted in an increasingly stagnant music market, where the number of new songs entering the Billboard Hot 100 is nearly 50 percent below its peak in 1966.

Today’s music industry is dominated by the “Big Three”: Warner Music Group, Universal Music Group, and Sony BMG. Through aggressive acquisition strategies, the three labels and their numerous subsidiaries control nearly 80 percent of the music market, raising concerns about anti-competitive behavior and the exploitation of talent.

A similar power imbalance exists in the streaming industry. Incumbents Spotify and Apple Music have grown too large to be threatened by formerly relevant competitors such as Pandora, Google Play, Tidal, and Rhapsody. The two streaming giants have repeatedly come under fire for their pro-rata model for royalty distribution. The model aggregates revenues from subscriptions and advertisements and allocates to artists according to the percentage of overall streams their music accounted for. While the model’s proportional distribution seems fair at a surface level, features such as playlisting and algorithmic recommendations favor popular artists and further increase the inequality between mainstream and indie artists.

Projected to reach revenues of $142 billion by the end of the decade, the music industry is a prime target for disruption. The growing importance of social media as a tool for influence, promotion, and discovery has established its long-term relevance in the music industry, opening an opportunity for the two to be bridged.

SoundOn

TikTok has signaled an interest in expanding its presence in the music industry with the release of its ancillary service for artists, SoundOn. The new platform, launched to the public in March 2022, allows artists to upload their music directly to TikTok and ByteDance’s streaming service Resso, as well as third-party streaming platforms. By simplifying the upload process, SoundOn seeks to streamline distribution and commercialization for small artists. The service also offers promotional tools and support through audience insights, advice from the SoundOn marketing team, access to TikTok’s song tab, TikTok verification, and creator marketing assistance. There is no charge to the artist for using this service. TikTok will pay 100% of the royalties to music creators on ByteDance-owned platforms, but for other streaming services, payout will start at 100% in the artist’s first year and drop to 90% beyond that, and the artists will retain all rights to their songs.

TikTok’s expansion into the music industry through SoundOn is a low-risk strategy requiring minimal resources and commitment. While it represents a good start, there are several opportunities for the platform to bolster value capture for both TikTok and its artists. While SoundOn offers artists support in the areas of marketing, distribution and commercial opportunities, the support is neither personalized nor proactive. Additionally, SoundOn does not help with or provide the resources needed for the production of music, live event initiatives, or guidance on artist growth. As the primary source of income for artists, financial and operational support for live performances is particularly important, and a significant reason artists are compelled to sign with traditional record labels despite disadvantageous terms. As a result, high-potential artists may feel the need to “graduate” from SoundOn to a label proper to realize this growth.

Based on its features, SoundOn targets small but established artists who have the means and resources to produce music. SoundOn also does not expand TikTok’s revenue streams other than the 10% in royalties collected from artists after their second year with the service. Despite TikTok acting as the catalyst for these artists to achieve stardom, SoundOn does not acquire ownership of this talent, which opens the opportunity for other record labels to capture value. Now that SoundOn has been launched, TikTok should look to fill the gaps in these services with a more committed investment that creates value for both the artists and TikTok themselves.

Hitting Record

TikTok is uniquely positioned as a growing force in the music industry and should capitalize on the opportunity by establishing a global record label. The platform has already signaled an interest in expanding its presence in the music industry with the release of its ancillary service for artists, SoundOn. SoundOn uses an application process to onboard emerging artists, offering promotional and support tools and compensation through royalties, but does not expand TikTok’s existing revenue streams, nor does it encourage high-achieving artists to stay with the platform.

With the introduction of SoundOn, it is clear that TikTok is interested in expanding its presence in the music industry. As a next step, the brand should further develop its offerings by creating a global record label. Doing so requires significant financial and operational investments, raising the stakes for TikTok, but is necessary to capture artists’ potential for value creation. Targeting artists that are in the early-stages of their careers, the record label will actively seek out artists to sign to their label. It will help with music production and distribution, promotional services beyond TikTok, personalized mentorship, and live event management. This initiative will complement SoundOn, offering an incubator-like program to early-stage artists alongside its existing promotional and distribution service for more established individuals. If TikTok can strategically build long-term relationships with its talent, opportunities beyond music will also be opened.

To address the gaps in the service provided by SoundOn, TikTok should establish a record label to build stronger, personalized relationships with creators and provide additional monetization opportunities. By targeting unsigned and emerging artists, TikTok can sign talent that gained recognition through the app. With limited track records of conventional music success, these individuals do not overlap with other record labels’ key demographic and search for conventional music hits. TikTok’s access to an enormous set of data enables it to apply modern computational techniques to identify high-potential artists at an earlier stage and with higher success rates than traditional labels, giving it an effective first right of refusal with these artists. As such, the proposed record label will not be competing directly with the ‘Big Three’, but rather focus on enhancing TikTok’s relationship with their most valuable content creators.

How it Works and How Artists Can Benefit

Using the TikTok algorithm and internal team, the record label should actively identify and contact emerging artists, negotiate and offer contracts to the best candidates, and provide payment based on a percentage of ad and streaming revenues. TikTok should sign the artist exclusively and retain distribution rights, as well as require artists to produce a negotiated number of songs and albums within the contracted period. However, unlike traditional record labels, artists would be given more creative freedom to write and produce songs and their work would benefit from algorithmic audience-targeting. mThrough this model, TikTok can remove payments to record labels in the music value chain.

With less revenue paid to record labels for their music, creators and artists can also be given a more sizable cut of the revenues earned through use on TikTok and other streaming platforms. Over time, contracts can be renewed upon reassessment, offering higher cuts of revenues if artists continue to produce popular songs. The record label should also offer music distribution and promotional support services. TikTok should upload verified versions of signed artists’ songs for use in video creation and help arrange live music performances. Artists should be advised on algorithm optimization and creator marketing opportunities to further drive popularity for the artist, while bolstering the value proposition of the label itself.

The record label would open up various additional monetization opportunities for TikTok. Currently, TikTok’s commercial music library contains approximately 600,000 royalty-free tracks that businesses can use in their in-app advertisements. Notably, this currently precludes advertisers from using songs whose rights are held by music labels and independent artists. TikTok’s record label would enable advertisers to use songs from popular artists signed by the label — the same songs that are likely to go viral on the platform. With 73 percent of TikTok users saying they “stop and look” at ads on TikTok with audio, it is clear that owning the rights to trendier songs will make advertising on TikTok more appealing.

While the usage and revenue earnings of streaming services such as Apple Music and Spotify have seemingly grown exponentially over the past few years, artists and their teams still cannot depend on streaming revenues as their primary source of income. TikTok’s music label would possess far greater bargaining power than any of its individual artists, and would be able to negotiate more favourable revenue-sharing agreements with streaming platforms for its members. If TikTok is able to successfully bring prominence to their artists, high customer demand for these artists’ music will require large streaming platforms to at least consider offering greater payouts. TikTok has worked with both Apple Music and Spotify in the past to offer free subscriptions, further increasing the likelihood of friendly relationships in the future.

Though it often seems as if the world is becoming increasingly digital, the value of live, in-person music continues to stand the test of time. Live events still represent the most lucrative revenue stream for professional musicians, averaging 27 percent of income, and rising as high as 95 percent for the most popular artists. To not only financially capitalize on these opportunities, but also to ensure the meaningful development of artists’ careers, TikTok should also engage in the functions of a traditional artist manager and booking agent to arrange for live events for their artists. While primarily an outlet for the artists, live events also provide a unique opportunity for TikTok to expand beyond its solely digital presence and engage with their users in a unique way.

Artist revenue breakdown (Future of Music Coalition study)

Changing Tune

TikTok has undoubtedly changed the way music is consumed. With early access to a large pool of talent, an in-house alternative to traditional record labels will ensure TikTok maintains its dominance in the social media industry and level the playing field for artists and creators.

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IBR Editorial Board
Ivey Business Review

IBR provides a forum for tomorrow’s business leaders to develop, voice and discuss their thoughts on today’s business strategies, threats and opportunities.