I am a music nerd, and Spotify makes me anxious. To start, there’s the guilt inherent in using a service that famously pays artists a pittance for their work. (Buying concert tickets and occasionally downloading an album does help assuage some of those feelings.) I also worry that Spotify's business model is bound to collapse on itself—that offering customers an unlimited, on-demand jukebox, an advent that was once considered the miraculous stuff of science fiction, will turn out to be untenable.
Today, Spotify announced that it had reached 10 million paying subscribers (myself included), up from about 6 million in March of last year. Toss in its free, ad-supported streaming service, and the Sweden-based company now has about 40 million active users worldwide. But, as the Financial Times notes, in spite of its remarkable growth, Spotify is still losing money. That has plenty of people, including Bloomberg Businessweek’s Joshua Brustein, wondering whether it can ever turn a profit.*
The challenge is balancing the high demands of record companies with the high demands of music fans. Under its current contracts with the music labels, Spotify is required to pay 70 percent of its revenue as royalties to copyright holders. It could make $100 million or $100 billion; that 70 percent would stay the same. So in order to make a profit while paying the recording industry its cut, Spotify needs to keep scaling by convincing more and more users to shell out $10 a month for a subscription.
It’s unclear whether it can pull off the feat. The first big question is whether $10 is too high a price. David Pakman, the former CEO of eMusic who is currently a partner at Venrock, has argued that it probably is. He notes that in 1999, when the music industry was at the apex of its money-making powers, the typical music buyer spent only $64 per year. Today, those who still pay for their music spend a bit less. In that light, Spotify’s $120 annual subscription fee seems quite steep. Moreover, Pakman points out, it’s not clear Spotify can lower its price, because the labels require it to charge a certain amount for its services.
There’s also the issue of competition from other on-demand services. According to leaked documents, Beats has a piddly 111,000 paying subscribers right now. But assuming Apple does finally purchase Beats, the company will suddenly have enormous marketing muscle behind it. Beats may or may not grow larger than Spotify, but between it and other streaming services, such as Google’s All Access, it may balkanize the market and prevent any single service from turning a profit.
Even if Spotify does pull off more wild growth, some believe that its model is still doomed. Analysts at Generator Research have argued that so long as streaming services are forced to pay out 60 to 70 percent of their revenue in royalties, they simply can’t be profitable. As Brustein put it today: “The worst-case scenario for Spotify isn’t losing to Apple. It’s discovering that its prize is insolvency.”
If that’s the case, it may mean streaming services like Spotify and Beats are destined to serve, at best, as loss-leaders for larger tech companies like Apple and Google. Is that sustainable long term? One can only speculate. But as a fan, I’d prefer it if the all-you-can eat buffet approach to music could stand on its own.
*Correction, May 21, 2014: This post originally misspelled the last name of Bloomberg Businessweek writer Joshua Brustein.