How Spotify And Pandora Could Fail

Spotify founders Daniel Ek & Martin Lorentzon

Photo Credit: Spotify

Boasting more than 2 million users in Britain alone since their launch last October, Spotify, like Pandora, is a force to be reckoned with. They present the new model of music discovery services. However, with reports of a far less than expected number of users choosing the premium services, and advertisers being slow on the uptake, the service’s future is very unclear.

Allow me to also preface this article by clearly stating that, I love both Spotify and Pandora. They are indicative of where music discovery is headed and should be cherished as such. They are far different to anything that has come before. Some people however, as you read on you will no doubt discover have not realised this yet. They both start with the letter L.

A Bleak Outlook

The Guardian is reporting that Spotify is looking to raise more venture capital. The Times estimates Spotify is looking for between £20m and £30m; bringing its valuation up to nearly £200m.

The take up of the premium service in May was reportedly 17,000, less than even 1 percent of the total user base. This worrying figure is bolstered by the fact that it (the premium service) only grew by 2,700 over the previous month, whereas the free user base is supposedly doubling. So far, all the premium service gets you is the removal of advertising, a few “social features, a download service ... and exclusives”. Not the most enticing subscription on the Internet.

Much has been speculated about just how large the shortfall between Spotify’s licensing payments, and the amount recouped from advertising and premium services is. Spotify pays labels a per song royalty, and it supports this with advertising and its premium service. The fact that it is even paying per song is partially worrying, as it's ultimately unsustainable though probably necessary to get the large labels on board.

It’s Not Their Fault

If Spotify, Pandora or any other online music discovery service - be it a website or online radio - were to fail, it would not be their fault. Well, at least not entirely. It can’t be totally their fault. They are all filling a very obvious consumer need. No, it would be the labels and the lawyers who are to blame.

• It would be the labels and lawyers’ fault for extorting these services for more than they can afford. Pandora this week finally settled with SoundExchange on a royalty rate (see below), and has subsequently had to limit its free service to just 40 hours a month. This is stacked on top of the fact that it is already geo-locked to America, due to previous licensing issues.

• It would be the labels and lawyers’ fault for not seeing and understanding how the industry has and is changing. Attention. It’s the new money (see below). Really it is. Obscurity is more of a burden than piracy or low royalty rates. Not being heard is worse than not making money.

• It would be the labels and lawyers’ fault for not changing and adapting their business models to accommodate the economy of abundance, uncontrollable distribution and what “FREE” now means.

A Royal Royalty

Spotify pays labels a per song royalty. Their goal was to have enough people on the premium service, and have enough advertising to support the free portion of the business. Recent news and the analysis of other services would lead us to believe this business model is significantly unsustainable. However, I believe they are completely misguided with their approach, and have misinterpreted users motives for using a music discovery service.

A recent agreement between SoundExchange and Pandora has almost set the precedent for performance royalties for online “webcasters” (streaming services). Pandora will pay “the greater of 25 percent of revenue” or a per song royalty fee every listen, “starting at .08 cent for songs streamed in 2006 and increasing to 0.14 cent in 2015”. Traditional broadcasters only pay a royalty rate of about 3% to 4%, and yet Pandora is being forced to fork out a whopping 25%. As a result they have had to significantly limit their service. In the long term (or is that long tail), this benefits no one.

it would be the labels and the lawyers who are to blame.

Another headache brought about by the apparent need to pay royalties is per country restrictions. Spotify is only available in a few countries, this is mainly due to the difficulty in gaining worldwide licenses. Pandora has been US only for a long time now. Many artists (or should I say their labels?) are struggling to agree on who owns who in which country. Artificial Scarcity is one thing; closing the door on millions of potential fans is another whole ball game.

The Attention Economy

It’s long been said that attention is the new money. That is, whatever is getting the most attention at any given time is the most valuable. More valuable and sustainable than performance royalties. A recent Harvard Working Paper titled “File Sharing and Copyright” drew some interesting conclusions regarding file sharing. Stating that in a study of “2,135 artists” studied over a ten-year period, the demand for “concerts increased due to file sharing.” In short, Complimentary Goods thrive in an attention market (at least in the scope of the music industry).

Also interesting to note is that the same paper drew the conclusions that “unless the industry drums up support for a new release, it is apparently difficult to give it away for free.” This sentiment whole heartedly supports the concept of an attention market, in that the only music that is being shared is music that is garnering attention. If a song or album has no attention, then demand for it is absolutely minimal. So much so that it may never be downloaded, listened to or talked about.

Taking a brief look at other music discovery services you can see these results ring true. Major artists, i.e. artists with a large amount of attention, fare well with large fanbases on the services. The more attention an artist has the more successful they are. Interestingly thesixtyone does not pay a royalty fee to artists, instead opting to have prominent links to allow a listener to purchase the music, or otherwise connect with an artist. Strangely enough, more and more big artists are finding it valuable enough to be on.

What Makes A Good Music Discovery Service?

A good music discovery service should facilitate two things: simple and relevant discovery of new music, and the subsequent discovery of new artists. Both go hand in hand. A good music discovery service, like thesixtyone, Pandora, Last.fm and what Spotify could potentially be, enables you to find new music (and old music you forgot!). Most importantly, it initiates a connection to that artist. The part to monetize therefore should be the connection to fans, not the discovery.

The labels are already benefiting by being given unprecedented access to listeners on Spotify, by apparently being able to market merchandise and other goods to them. This information, properly used, is enough to begin a relationship with a fan, which is arguably all a music discovery service should do; connect artists with fans.

The Hype Machine ranks songs based on activity in the blogosphere, providing an indication of which artists are hot right now. That is, which artist currently has all the attention. It also enables a fan to begin an economic relationship with an artist. As I previously discussed, these few things are now more valuable than money.

Now, this isn’t to say give all your music away for free. There is still a decent amount of revenue to be made in selling music. However, we need make it mutually beneficial for a fan to discover a new artist, their music, and vice versa. We need to remove as many barriers as possible for fans to discover new music and create relationships with artists, economic or otherwise. Anything else is just prolonging the inevitable.

UPDATE: TechDirt has more on this if your interested.

Music Futurist Gerd Leonhard also has a slightly different perspective on the future of our beloved Spotify.

[Sources: HypeBot, Musically, The Guardian]