As far as "killer" Web applications go, Internet radio has great potential. Imagine listening to any station in the country from the comfort of your own computer. And if none of the brick-and-mortar "broadcast" stations suits your fancy, you could listen to hundreds of virtual stations that operate only on the Internet.

A situation like that might spur a move to broadband by the still-reluctant dialup masses; provide a shot in the arm to the PC sector; help struggling artists; and boost sales across the music industry.

There's one big problem, however: Internet radio is withering away, and it will die on the vine unless a bout of common sense breaks out among the major players.

Nascent Net radio
According to Media.org, the first station on the Web was Internet Talk Radio, which started broadcasting on April Fool's day in 1993. In 1995, KPIG-FM became the first commercial station to simultaneously broadcast over the air and on the Internet. Soon, dozens of stations sprang up across the Web, and devoted listeners could hear virtually any type of music they desired.

As the stations spread like wildfire, artists, composers, and music executives naturally began to wonder about compensation. The lobbyists swung into motion, and the end result was the 1998 Digital Millennium Copyright Act (DMCA). It declared that copyright holders (meaning the record companies) have a right to receive royalties from songs played on the Internet.

It's a rather odd piece of legislation, however, because regular broadcast stations don't have to compensate record companies or the artists. Instead, they pay royalties to the composers of the music they play. "For broadcast radio, Congress has always assumed that the promotional value of the airplay was sufficient compensation to those parties," according to the website SaveInternetRadio.org.

Presumably, Internet radio was treated differently because Congress thought its music could be easily copied and duplicated in digital format, and thus artists and record companies needed a way to make up for potentially lost sales. That notion has been debunked, however, because songs played on the Internet are not of sufficient quality to be copied. Besides, there are dozens of sites where users can download high-quality digital music.

Of course, the different parties couldn't agree on the amount of compensation. The Recording Industry Association of America (RIAA), representing the record companies, wanted 15% of a station's gross revenue. The webcasters were willing to give up 3%. Finally, the U.S Copyright Office settled on a fee of $0.0007 per listener, per song (or $0.07 for every 100 listeners to a given song). What's more, the royalties would be retroactive to October of 1998.

Give 'em a break!
Unfortunately for online radio stations, that was just too much. A Web-only station averaging just 1,000 listeners over the past three years would have to pay over $250,000 in fees. A quarter of a million bucks for an operation that usually consists of just a few people is serious money, and most have already closed up shop.

This is wrong on so many levels that it's hard to know where to start. First of all, the royalties for most of these stations far exceed even the 15% the record industry asked for. When the dust settles, only radio giants that own many stations -- such as Clear Channel Communications(NYSE: CCU), Cox Radio(NYSE: CXR), and Cumulus Media(Nasdaq: CMLS) -- will be able to afford to maintain an Internet presence.

Second, the new compensation structure makes no sense. A regular broadcast station that adds a few thousand listeners via an Internet simulcast pays royalties in an entirely different manner -- and at a much higher rate -- than if it gains the same number of traditional over-the-air listeners. Web listeners should be treated no differently than traditional ones.

Third, why would regulators set a royalty rate that kills off a promising industry before it can get off the ground? Small, independent webcasters are what make Internet radio great, but they're closing down in droves.

Fourth, and most importantly, the RIAA is simply one of the most maddening, nonsensical organizations in the country. It either doesn't care about its constituents or can't see that it's killing the goose that laid the golden egg. The RIAA seems oblivious to the fact that Internet radio listeners are far more likely to buy music than traditional listeners, and seems bent on doing everything in its power to alienate them. Even after being awarded far more than the 15% of revenues it originally asked for, the RIAA is now appealing the decision and asking for even more. The RIAA seems to cares not one iota if Internet radio survives.

There's still hope
It seems radio on the Web is down to one last chance. Three congressmen -- Reps. Rick Boucher (D-Va.), Jay Inslee (D-Wash.), and George Nethercutt (R-Wash.) -- have introduced the Internet Radio Fairness Act (IRFA). It would exempt small webcasters with revenue of less than $6 million from the current fee structure until something more reasonable can be worked out. Should that bill be signed into law, many stations forced to shut down would once again crank up the music, and we'd be assured of a steady stream of new startups.

If you'd like to voice support for the IRFA, just click here, and you'll be able to quickly send a pre-written note to your representatives in Congress, free of charge.

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Rex Moore once spun records for KSIG-AM in Crowley, La. Real, vinyl records. At time of publication, he owned no companies mentioned in this column. The Motley Fool's disclosure policy has gone platinum.