Is Spotify’s Business Model Sustainable?

Well, it’s finally here. After two years of delay and a fresh $100 million round of funding, European music streaming service Spotify launched in the United States yesterday, much to the delight of music geeks, a handful of celebrities and pretty much everyone on Twitter.

In addition to a whole lot of excitement, Spotify has brought with it a number of questions. What does this mean for the future of music consumption? Will artists make money? Perhaps most importantly, is its business model sustainable?

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The big music labels have long expressed concern over this very issue, with Warner Music CEO Edgar Bronfman Jr. saying last year that free music streaming services were “not net positive for the industry.”

On Business Insider yesterday, Matt Rosoff called Spotify “economically unsustainable,” adding that “the way music licensing has traditionally worked, Spotify would be paying the labels and publishers the same rate for all songs that users stream on the service — whether they’re getting them for free or paying. That’s insane.”

Spotify’s revenue comes from a combination of paid subscriptions, ad revenue (from audio and display ads served to the 90% of users who aren’t paying up) and retail partnerships through which music can be sold directly to users.

According to Rosoff, the rates commanded by the type of ads Spotify is serving to its non-paying users are just too low to allow the company to break even. The service did launch in the U.S. with a major sponsor, but has not made public the advertising rates it commands.

Two years ago, a “source close to Spotify” told the Guardian that the company was “a case of ‘spot the idiot,'” in other words, “find somebody stupid enough to buy it before realizing that it’s too costly to run and that the numbers don’t add up to making a profit.”

Of course, much has changed in two years and if the hype is any indication, Spotify may well end up doing well in the U.S., despite a somewhat crowded marketplace.

To thrive, it will have to set itself apart both from popular Internet radio services like Pandora and Last.fm, as well as other on-demand music services like Rdio, MOG and Grooveshark. At first glance, Spotify does seem well-positioned to do just that, thanks to its 15 million-strong music library (bigger than Pandora, MOG and Rdio), the ability for users to include locally-stored tracks they already own (unlike Rdio and Pandora) and its support for mobile music streaming (a leg up over Grooveshark).

The company, which to date is not profitable, currently boasts over 10 million subscribers, about 10% of which are paying. Not bad for a freemium service. But can they maintain, let alone improve, that percentage as they infiltrate an already-crowded U.S. marketplace?

That remains to be seen, as does whether or not Spotify will come close to achieving their rather ambitious projection of acquiring 50 million users within the first year of being live in the U.S.

What do you think? Can Spotify’s business model succeed or is this another music industry failure waiting to happen? Let us know your thoughts in the comments.

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