Streaming Music Has a Problem—It’s a Huge Success Pandora, Spotify and others need revenue—and where they want to get it from is ruffling feathers

By Erin Griffith
January 10 2012

In late September, Spotify CEO Daniel Ek was the first guest Mark Zuckerberg introduced on stage during his keynote speech at the f8 developer conference, which introduced the network’s new media consumption features.

That night, Sean Parker—Napster founder, early Facebook executive and Spotify investor—threw a lavish warehouse party for conference attendees, serving roast pig and lobster during performances by Snoop Dogg, The Killers, Jane’s Addiction and Kaskade. The next-day posts declaring which users were listening to what bands on Spotify trickled into Facebook’s feeds.

The integration helped earn Spotify an additional 4 million U.S.

users over the next six weeks, notable because the Stockholm, Sweden-based company had launched its free music streaming service in the U.S. only a month prior. Until then, it felt as though music fans had largely conceded to paying for music on iTunes. But Spotify’s hotly anticipated—and most importantly, free—arrival electrified the digital music ecosystem.

It was likely no coincidence that the month Spotify landed, digital DJ site launched, also gratis—and with no clear business model—and, soon after, MOG and Rdio, which also participated in the Facebook integration, launched free versions of their subscription-based services. Around that time, Myxer, known for its mobile ringtones, apps and wallpapers, announced Myxer Social Radio, a free music-streaming service. Clear Channel unveiled an amped-up version of iHeartRadio, its previously quiet three-year-old digital service, also free. Even Pandora, the reigning Internet radio champ fresh off its IPO, got into the act, increasing its limit on free streaming from 40 hours per month to 320. It was a free-streaming free-for-all.

But nothing online is ever really free.

The online music industry is in a unique, catch-22 situation: The more successful it is, the more money flies out the door. Digital music companies pay dearly for the rights to stream music. Pandora, for example, turned a profit for the first time this past November—10 years since its launch—thanks to onerous licensing agreements requiring it to pay a fee each time a song is streamed. The firm’s peers, including the smaller players, also pay a hefty rate each time a song is played. The services will never outgrow their costs, an unfortunate arrangement commentators have dubbed a “suicide pact.”

And subscription revenue, a much smaller business, is not enough. The streaming services need advertising dollars, and they have monies previously allotted to broadcast budgets in their crosshairs. It is, in general, a well-trod story: New medium goes after old ad dollars. But in this case, the stakes are unusually high. Online radio’s very survival depends on stealing ad dollars from its traditional counterpart, and it needs to do it fast.

“When [streaming services] look at the pool of radio dollars, which is immense, and ask if there’s a logic to joining that category, it’s impossible not to be seduced by the opportunity,” says Mark Ramsey, president of consultancy Mark Ramsey Media.

EMarketer has estimated online radio would secure $800 million in advertising in the U.S. by the end of 2011, compared with traditional radio’s behemoth $15.7 billion. (The Radio Advertising Bureau’s official 2010 number, which includes off-air ads, is $17.3 billion.) It’s a small but growing sum that increases by 20 percent each year, and eMarketer expects it to hit $1.6 billion by 2015. (All numbers exclude Pandora and Spotify.)

Continue to next page →